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. 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. fcic_final_report_full--463 Figure 1 below, based on the data of Robert J. Shiller, shows the dramatic growth of the 1997-2007 housing bubble in the United States. By mid-2007, home prices in the U.S. had increased substantially for ten years. The growth in real dollar terms had been almost 90 percent, ten times greater than any other housing bubble in modern times. As discussed below, there is good reason to believe that the 1997- 2007 bubble grew larger and extended longer in time than previous bubbles because of the government’s housing policies, which artificially increased the demand for housing by funneling more money into the housing market than would have been available if traditional lending standards had been maintained and the government had not promoted the growth of subprime lending. Figure 1. The Bubble According to Shiller That the 1997-2007 bubble lasted about twice as long as the prior housing bubbles is significant in itself. Mortgage quality declines as a housing bubble grows and originators try to structure mortgages that will allow buyers to meet monthly payments for more expensive homes; the fact that the most recent bubble was so long-lived was an important element in its ultimate destructiveness when it deflated. Why did this bubble last so long? Housing bubbles deflate when delinquencies and defaults begin to appear in unusual numbers. Investors and creditors realize that the risks of a collapse are mounting. One by one, investors cash in and leave. Eventually, the bubble tops out, those who are still in the game run for the doors, and a deflation in prices sets in. Generally, in the past, this process took three or four years. In the case of the most recent bubble, it took ten. The reason for this longevity is that one major participant in the market was not in it for profit and was not worried about the risks to itself or to those it was controlling. It was the U.S. government, pursuing a social policy—increasing homeownership by making mortgage credit available to low and moderate income borrowers—and requiring the agencies and financial institutions it controlled or could influence through regulation to keep pumping money into housing long after the bubble, left to itself, would have deflated. Economists have been vigorously debating whether the Fed’s monetary policy in the early 2000s caused the bubble by keeping interest rates too low for too long. Naturally enough, Ben Bernanke and Alan Greenspan have argued that the Fed was not at fault. On the other hand, John Taylor, author of the Taylor rule, contends that the Fed’s violation of the Taylor rule was the principal cause of the bubble. Raghuram Rajan, a professor at the Chicago Booth School of Business, argues that the Fed’s low interest rates caused the bubble, but that the Fed actually followed this policy in order to combat unemployment rather than deflation. 19 Other theories blame huge inflows of funds from emerging markets or from countries that were recycling the dollars they received from trade surpluses with the U.S. These debates, however, may be missing the point. It doesn’t matter where the funds that built the bubble actually originated; the important question is why they were transformed into the NTMs that were prone to failure as soon as the great bubble deflated. Figure 2 illustrates clearly that the 1997-2007 bubble was built on a foundation of 27 million subprime and Alt-A mortgages and shows the relationship between the cumulative growth in the dollar amount of NTMs and the growth of the bubble over time. It includes both GSE and CRA contributions to the number of outstanding NTMs above the normal baseline of 30 percent, 20 and estimated CRA lending under the merger-related commitments of the four large banks—Bank of America, Wells Fargo, Citibank and JPMorgan Chase—that, with their predecessors, made most of the commitments. As noted above, these commitments were made in connection with applications to federal regulators for approvals of mergers or acquisitions. The dollar amounts involved were taken from a 2007 report by the NCRC, 21 and adjusted for announced loans and likely rates of lending. The cumulative estimated CRA 19 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 fcic_final_report_full--425 House Price Appreciation in Selected Countries, 2002-2008 The United States was one of many countries to experience rapid house price growth 2002 INDEX = 100 United States United Kingdom Spain 200 192 150 158 118 100 ’02 ’04 ’08 ’02 ’04 ’08 ’02 ’04 ’08 200 150 Australia France Ireland 168 152 142 100 ’02 ’04 ’08 ’02 ’04 ’08 ’02 ’04 ’08 SOURCES: Standard and Poors, Nationwide, Banco de España, AusStats, FNAIM, Permanent TSB • The report largely ignores the credit bubble beyond housing. Credit spreads de- clined not just for housing, but also for other asset classes like commercial real estate. This tells us to look to the credit bubble as an essential cause of the U.S. housing bubble. It also tells us that problems with U.S. housing policy or mar- kets do not by themselves explain the U.S. housing bubble. • There were housing bubbles in the United Kingdom, Spain, Australia, France and Ireland, some more pronounced than in the United States. Some nations with housing bubbles relied little on American-style mortgage securitization. A good explanation of the U.S. housing bubble should also take into account its parallels in other nations. This leads us to explanations broader than just U.S. housing policy, regulation, or supervision. It also tells us that while failures in U.S. securitization markets may be an essential cause, we must look for other things that went wrong as well. • Large financial firms failed in Iceland, Spain, Germany, and the United King- dom, among others. Not all of these firms bet solely on U.S. housing assets, and they operated in different regulatory and supervisory regimes than U.S. com- mercial and investment banks. In many cases these European systems have stricter regulation than the United States, and still they faced financial firm fail- ures similar to those in the United States. fcic_final_report_full--452 In this environment, the government’s rescue of Bear Stearns in March of 2008 temporarily calmed investor fears but created a significant moral hazard; investors and other market participants reasonably believed after the rescue of Bear that all large financial institutions would also be rescued if they encountered financial diffi culties. However, when Lehman Brothers—an investment bank even larger than Bear—was allowed to fail, market participants were shocked; suddenly, they were forced to consider the financial health of their counterparties, many of which appeared weakened by losses and the capital writedowns required by mark- to-market accounting. This caused a halt to lending and a hoarding of cash—a virtually unprecedented period of market paralysis and panic that we know as the financial crisis of 2008. Weren’t There Other Causes of the Financial Crisis? Many other causes of the financial crisis have been cited, including some in the report of the Commission’s majority, but for the reasons outlined below none of them alone—or all in combination—provides a plausible explanation of the crisis. Low interest rates and a flow of funds from abroad . Claims that various policies or phenomena—such as low interest rates in the early 2000s or financial flows from abroad—were responsible for the growth of the housing bubble, do not adequately explain either the bubble or the destruction that occurred when the bubble deflated. The U.S. has had housing bubbles in the past—most recently in the late 1970s and late 1980s—but when these bubbles deflated they did not cause a financial crisis. Similarly, other developed countries experienced housing bubbles in the 2000s, some even larger than the U.S. bubble, but when their bubbles deflated the housing losses were small. Only in the U.S. did the deflation of the most recent housing bubble cause a financial meltdown and a serious financial crisis. The reason for this is that only in the U.S. did subprime and other risky loans constitute half of all outstanding mortgages when the bubble deflated. It wasn’t the size of the bubble that was the key; it was its content. The 1997-2007 U.S. housing bubble was in a class by itself. Nevertheless, demand by investors for the high yields offered by subprime loans stimulated the growth of a market for securities backed by these loans. This was an important element in the financial crisis, although the number of mortgages in this market was considerably smaller than the number fostered directly by government policy. Without the huge number of defaults that arose out of U.S. housing policy, defaults among the mortgages in the private market would not have caused a financial crisis. Deregulation or lax regulation . Explanations that rely on lack of regulation or deregulation as a cause of the financial crisis are also deficient. First, no significant deregulation of financial institutions occurred in the last 30 years. The repeal of a portion of the Glass-Steagall Act, frequently cited as an example of deregulation, had no role in the financial crisis. 1 The repeal was accomplished through the Gramm-Leach-Bliley Act of 1999, which allowed banks to affi liate for the first time since the New Deal with firms engaged in underwriting or dealing in securities. There is no evidence, however, that any bank got into trouble because of a securities affi liate. The banks that suffered losses because they held low quality mortgages or MBS were engaged in activities—mortgage lending—always permitted by Glass- Steagall; the investment banks that got into trouble—Bear Stearns, Lehman and Merrill Lynch—were not affi liated with large banks, although they had small bank affi liates that do not appear to have played any role in mortgage lending or securities trading. Moreover, the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) substantially increased the regulation of banks and savings and loan institutions (S&Ls) after the S&L debacle in the late 1980s and early 1990s, and it is noteworthy that FDICIA—the most stringent bank regulation since the adoption of deposit insurance—failed to prevent the financial crisis. CHRG-111shrg50564--72 Mr. Volcker," What about the opposite? The price isn't high enough to stimulate the---- Senator Bennett. That is right. It has gone from $145 a barrel to $35 a barrel and then bounced around. But that is a bubble that burst and a collapse that happened very rapidly and the American motorist is delighted. The housing bubble has burst and we don't know where the bottom is. It is uneven across the country, and that is why I am a little suspect of the Case-Shiller number, because that takes the worst parts. There are some places in the country where housing prices have actually risen, but the mortgage problem remains very much a difficulty because nobody knows what the securities are worth. They don't know how much toxic paper they have, and so on. Let us talk about the credit bubble. It is different from the classic bubbles of the housing bubble and the oil bubble, but we still don't have a firm handle on what is happening with respect to credit. We don't have any kind of normalcy. There was a time when credit was enormously available. Now, it is almost not available at all, except again, like the housing thing, there are some parts of the country where it is available, or there are some markets where it is available and others where it is not. Look into your crystal ball and tell me, or tell us what it is going to take for the credit bubble to resolve itself and how long you think that might be. " fcic_final_report_full--430 China and other Asian economies grew, their savings grew as well. In addition, boosted by high global oil prices, the largest oil-producing nations built up large cap- ital surpluses and looked to invest in the United States and Europe. Massive amounts of inexpensive capital flowed into the United States, making borrowing inexpensive. Americans used the cheap credit to make riskier investments than in the past. The same dynamic was at work in Europe. Germany saved, and its capital flowed to Ire- land, Italy, Spain and Portugal. Fed Chairman Ben Bernanke describes the strong relationship between financial account surplus growth (the mirror of current account deficit growth) and house price appreciation: “Countries in which current accounts worsened and capital in- flows rose . . . had greater house price appreciation [from  to ] . . . The rela- tionship is highly significant, both statistically and economically, and about  percent of the variability in house price appreciation across countries is explained.”  Global imbalances are an essential cause of the crisis and the most important macroeconomic explanation. Steady and large increases in capital inflows into the U.S. and European economies encouraged significant increases in domestic lending, especially in high-risk mortgages. The repricing of risk Low-cost capital can but does not necessarily have to lead to an increase in risky in- vestments. Increased capital flows to the United States and Europe cannot alone ex- plain the credit bubble. We still don’t know whether the credit bubble was the result of rational or irra- tional behavior. Investors may have been rational—their preferences may have changed, making them willing to accept lower returns for high-risk investments. They may have collectively been irrational—they may have adopted a bubble mental- ity and assumed that, while they were paying a higher price for risky assets, they could resell them later for even more. Or they may have mistakenly assumed that the world had gotten safer and that the risk of bad outcomes (especially in U.S. housing markets) had declined. For some combination of these reasons, over a period of many years leading up to the crisis, investors grew willing to pay more for risky assets. When the housing bub- ble burst and the financial shock hit, investors everywhere reassessed what return they would demand for a risky investment, and therefore what price they were willing to pay for a risky asset. Credit spreads for all types of risk around the world increased suddenly and sharply, and the prices of risky assets plummeted. This was most evident in but not limited to the U.S. market for financial assets backed by high-risk, nontradi- tional mortgages. The credit bubble burst and caused tremendous damage. Monetary policy The Federal Reserve significantly affects the availability and price of capital. This leads some to argue that the Fed contributed to the increased demand for risky in- vestments by keeping interest rates too low for too long. Critics of Fed policy argue that, beginning under Chairman Greenspan and continuing under Chairman Bernanke, the Fed kept rates too low for too long and created a bubble in housing. Dr. John B. Taylor is a proponent of this argument. He argues that the Fed set in- terest rates too low in – and that these low rates fueled the housing bubble as measured by housing starts. He suggests that this Fed-created housing bubble was the essential cause of the financial crisis. He further argues that, had federal funds rates instead followed the path recommended by the Taylor Rule (a monetary policy formula for setting the funds rate), the housing boom and subsequent bust would have been much smaller. He also applies this analysis to European economies and concludes that similar forces were at play. CHRG-111hhrg74090--188 Mr. Stinebert," Well, I think when you go back, and there is plenty of history to point fingers at what was the cause of the subprime mortgage crisis and currently economic crisis but I don't think you would get anybody that would predict that whatever is done here today or by Congress that you can control every bubble that is going to occur in the future. Most economists would agree that yes, this bubble is a housing bubble, before it was a tech bubble, before that it was a savings and loan bubble. You cannot have government totally controlling financial markets unless they can totally control potential bubbles, unless you totally stymie innovation and all you have is a plain vanilla standard product out there, and I don't think that is good for the very consumers that we are trying to protect here. " fcic_final_report_full--465 Figure 2. The Effect of Government Policies on the Growth of the Bubble It is not true that every bubble--even a large bubble-- has the potential to cause a financial crisis when it deflates. This is clear in Table 2 below, prepared by Professor Dwight Jaffee of the Haas Business School at U.C. Berkley. The table shows that in other developed countries—many of which also had large bubbles during the 1997-2007 period—the losses associated with mortgage delinquencies and defaults when these bubbles deflated were far lower than the losses suffered in the U.S. when the 1997-2007 deflated. 22 See note 144. CHRG-110shrg50414--7 STATEMENT OF SENATOR ROBERT F. BENNETT Senator Bennett. Thank you, Mr. Chairman. We have had a housing bubble, and the bubble has burst. And every time we have a bubble, whether it is housing or dotcom stocks or anything else, when the bubble bursts there is disaster. And we will have bubbles in the future because the human propensity to believe that the market will always go up is still there. Let us understand that. The economy runs on credit, credit is granted on confidence, and confidence is based on one of two assumptions: the collateral is worth it or the cash-flow will be sufficient. One way or the other, the loan will be repaid. What we are faced with now is finding a way to restore the confidence in the system so that credit can start to flow again. That is what we are here to try to do. Thank you, Mr. Chairman. " fcic_final_report_full--451 What Caused the Financial Crisis? George Santayana is often quoted for the aphorism that “Those who cannot remember the past are condemned to repeat it.” Looking back on the financial crisis, we can see why the study of history is often so contentious and why revisionist histories are so easy to construct. There are always many factors that could have caused an historical event; the diffi cult task is to discern which, among a welter of possible causes, were the significant ones—the ones without which history would have been different. Using this standard, I believe that the sine qua non of the financial crisis was U.S. government housing policy, which led to the creation of 27 million subprime and other risky loans—half of all mortgages in the United States— which were ready to default as soon as the massive 1997-2007 housing bubble began to deflate. If the U.S. government had not chosen this policy path—fostering the growth of a bubble of unprecedented size and an equally unprecedented number of weak and high risk residential mortgages—the great financial crisis of 2008 would never have occurred. Initiated by Congress in 1992 and pressed by HUD in both the Clinton and George W. Bush Administrations, the U.S. government’s housing policy sought to increase home ownership in the United States through an intensive effort to reduce mortgage underwriting standards. In pursuit of this policy, HUD used (i) the affordable housing requirements imposed by Congress in 1992 on the government- sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, (ii) its control over the policies of the Federal Housing Administration (FHA), and (iii) a “Best Practices Initiative” for subprime lenders and mortgage banks, to encourage greater subprime and other high risk lending. HUD’s key role in the growth of subprime and other high risk mortgage lending is covered in detail in Part III. Ultimately, all these entities, as well as insured banks covered by the CRA, were compelled to compete for mortgage borrowers who were at or below the median income in the areas in which they lived. This competition caused underwriting standards to decline, increased the numbers of weak and high risk loans far beyond what the market would produce without government influence, and contributed importantly to the growth of the 1997-2007 housing bubble. When the bubble began to deflate in mid-2007, the low quality and high risk loans engendered by government policies failed in unprecedented numbers. The effect of these defaults was exacerbated by the fact that few if any investors— including housing market analysts—understood at the time that Fannie Mae and Freddie Mac had been acquiring large numbers of subprime and other high risk loans in order to meet HUD’s affordable housing goals. Alarmed by the unexpected delinquencies and defaults that began to appear in mid-2007, investors fled the multi-trillion dollar market for mortgage-backed 445 securities (MBS), dropping MBS values—and especially those MBS backed by subprime and other risky loans—to fractions of their former prices. Mark-to- market accounting then required financial institutions to write down the value of their assets—reducing their capital positions and causing great investor and creditor unease. The mechanism by which the defaults and delinquencies on subprime and other high risk mortgages were transmitted to the financial system as a whole is covered in detail in Part II. CHRG-111hhrg53245--154 Mr. Marchant," Mr. Zandi, would you comment on the fact that this last bubble was created in large part by financial instruments that did not exist maybe 20 years ago, and especially the derivative part of the mortgage part of it, and how it sustained a bubble in the housing market, which really sustained the mortgage market, which continued to sustain the housing market? " FinancialCrisisInquiry--226 ROSEN: I—I think the dot com bubble—the—the main problem there was again, I think related to the underwriting of unprofitable companies. It used to be you had to have, you know, a year of profit under your belt before you could go public. That was the Wall Street standard. They enforced it. Then that all changed. So it’s really the same thing. The lowering of standards, because you could get it done, and there were investors to buy it. This housing problem is much more serious though, because it is such a large sector as Mark said -- $11 trillion. It’s—every financial institution has this. It is larger than the public debt that we have, you know? And that’s why it’s so important, and so why the bubble is so much bigger. I would say the dot com bubble set up this bubble though. Because to clean up the last bubble, the Fed kept at rates too low too long. Their idea of not trying to do something about the bubble is either regulatory or through policy I think is—really is the core of the problem. Monetary policy is poorly—was poorly done under the last chairman. THOMPSON: So you would give monetary policy a shot in the eye for its... ROSEN: Oh I think... THOMPSON: ... role here? ROSEN: ... there’s no question about it that they set this one up, and used the wrong words. Matter of fact in 2007 the chairman who I respect a lot did say that it is demographic demand that was causing the housing market. I wrote a paper that he had read that said it wasn’t true. It was the credit bubble. But based—these demographic demand, all these other things which just the data don’t support it. fcic_final_report_full--467 Association (MBA). 25 This data allows a comparison between the foreclosure starts that have thus far come out of the 1997-2007 bubble and the foreclosure starts in the two most recent housing bubbles (1977-1979 and 1985-1989) shown in Figure 1. After the housing bubble that ended in 1979, when almost all mortgages were prime loans of the traditional type, foreclosure starts in the ensuing downturn reached a high point of only .87 percent in 1983. After the next bubble, which ended in 1989 and in which a high proportion of the loans were the traditional type, foreclosure starts reached a high of 1.32 percent in 1994. However, after the collapse of the 1997-2007 bubble—in which half of all mortgages were NTMs—foreclosure starts reached the unprecedented level (thus far) of 5.3 percent in 2009. And this was true despite numerous government and bank efforts to prevent or delay foreclosures. All the foregoing data is significant for a proper analysis of the role of government policy and NTMs in the financial crisis. What it suggests is that whatever effect low interest rates or money flows from abroad might have had in creating the great U.S. housing bubble, the deflation of that bubble need not have been destructive. It wasn’t just the size of the bubble; it was also the content. The enormous delinquency rates in the U.S. (see Table 3 below) were not replicated elsewhere, primarily because other developed countries did not have the numbers of NTMs that were present in the U.S. financial system when the bubble deflated. As shown in later sections of this dissent, these mortgage defaults were translated into huge housing price declines and from there—through the PMBS they were holding—into actual or apparent financial weakness in the banks and other firms that held these securities. Accordingly, if the 1997-2007 housing bubble had not been seeded with an unprecedented number of NTMs, it is likely that the financial crisis would never have occurred. 3. Delinquency Rates on Nontraditional Mortgages NTMs are non-traditional because, for many years before the government adopted affordable housing policies, mortgages of this kind constituted only a small portion of all housing loans in the United States. 26 The traditional residential mortgage—known as a conventional mortgage—generally had a fixed rate, often for 15 or 30 years, a downpayment of 10 to 20 percent, and was made to a borrower who had a job, a steady income and a good credit record. Before the GSE Act, even subprime loans, although made to borrowers with impaired credit, often involved substantial downpayments or existing equity in homes. 27 Table 3 shows the delinquency rates of the NTMs that were outstanding on June 30, 2008. The grayed area contains virtually all the NTMs. The contrast in quality, based on delinquency rates, between these loans and Fannie and Freddie prime loans in lines 9 and 10 is clear. 25 26 Mortgage Bankers Association National Delinquency Survey. See Pinto, “Government Housing Policies in the Lead-Up to the Financial Crisis: A Forensic Study,” November 4, 2010, p.58, http://www.aei.org/docLib/Government-Housing-Policies-Financial-Crisis- Pinto-102110.pdf. 27 Id., p.42. CHRG-111shrg50564--71 Chairman Dodd," Thank you. Senator Bennett? Senator Bennett. Thank you, Mr. Chairman. Dr. Volcker, welcome. We have had three simultaneous bubbles. They haven't burst simultaneously, but they were going on simultaneously. We have had the housing bubble. We had the oil bubble. And then we had a credit bubble. The oil bubble, everyone who pumps gas is delighted that it has burst. Everyone who produces gas and oil is probably a little sorry that it has burst. But all of the dire consequences that we heard predicted with respect to the oil bubble are now no longer on the front page and we no longer talk about the oil shock and its impact on the economy and the rest of us because the price---- " CHRG-110hhrg46591--269 Mr. Yingling," It was not covered particularly in the Blueprint, but as I testified, I do think there is a real need for a regulator who looks over the economy. Now, that may be different than the regulator who actually regulates day-to-day, but we had not had somebody looking over the economy and identifying these incredible types of growth and these bubbles, such as the mortgage bubble and other bubbles. So we do need a regulator who has the charter to look across the economy and to identify problems before they occur. " fcic_final_report_full--470 First, the gradual increase of the AH goals, the competition between the GSEs and the FHA, the effect of HUD’s Best Practices Initiative, and bank lending under the CRA, assured a continuing flow of funds into weaker and weaker mortgages. This had the effect of extending the life of the housing bubble as well as increasing its size. The growth of the bubble in turn disguised the weakness of the subprime mortgages it contained; as housing prices rose, subprime borrowers who might otherwise have defaulted were able to refinance their mortgages, using the equity that had developed in their homes solely through rising home prices. Without the continuous infusion of government or government-directed funds, delinquencies and defaults would have begun showing up within a year or two, bringing the subprime PMBS market to a halt. Instead, the bubble lasted ten years, permitting that market to grow until it reached almost $2 trillion. Second, as housing prices rose in the bubble, it was necessary for borrowers to seek riskier mortgages so they could afford the monthly payments on more expensive homes. This gave rise to new and riskier forms of mortgage debt, such as option ARMs (resulting in negative amortization) and interest-only mortgages. Mortgages of this kind could be suitable for some borrowers, but not for those who were only eligible for subprime loans. Nevertheless, subprime loans were necessary for PMBS, because they generally bore higher interest rates and thus could support the yields that investors were expecting. As subprime loans were originated, Fannie and Freddie were willing consumers of those that might meet the AH goals; moreover, because of their lower cost of funds, they were able to buy the “best of the worst,” the highest quality among the NTMs on offer. These factors—the need for higher yielding loans and the ability of Fannie and Freddie to pay up for the loans they wanted—drove private sector issuers further out on the risk curve as they sought to meet the demands of investors who were seeking exposure to subprime PMBS. From the investors’ perspective, as long as the bubble kept growing, PMBS were offering the high yields associated with risk but were not showing commensurate numbers of delinquencies and defaults. 5. What was Known About NTMs Prior to the Crisis? Virtually everyone who testified before the Commission agreed that the financial crisis was initiated by the mortgage meltdown that began when the housing bubble began to deflate in 2007. None of these witnesses, however, including the academics consulted by the Commission, the representatives of the rating agencies, the offi cers of financial institutions that were ultimately endangered by the mortgage downdraft, regulators and supervisors of financial institutions and even the renowned investor Warren Buffett, 33 seems to have understood the dimensions 33 See Buffett, testimony before the FCIC, June 2, 2010. 465 of the NTM problem or recognized its significance before the bubble deflated. The Commission majority’s report notes that “there were warning signs.” There always are if one searches for them; they are most visible in hindsight, in which the Commission majority, and many of the opinions it cites for this proposition, happily engaged. However, as Michael Lewis’s acclaimed book, The Big Short , showed so vividly, very few people in the financial world were actually willing to bet money— even at enormously favorable odds—that the bubble would burst with huge losses. Most seem to have assumed that NTMs were present in the financial system, but not in unusually large numbers. fcic_final_report_full--431 Current Fed Chairman Bernanke and former Fed Chairman Greenspan disagree with Taylor’s analysis. Chairman Bernanke argues that the Taylor Rule is a descriptive rule of thumb, but that “simple policy rules” are insufficient for making monetary policy decisions.  He further argues that, depending on the construction of the par- ticular Taylor Rule, the monetary policy stance of the Fed may not have diverged sig- nificantly from its historical path. Former Chairman Greenspan adds that the connection between short-term interest rates and house prices is weak—that even if the Fed’s target for overnight lending between banks was too low, this has little power to explain why rates on thirty-year mortgages were also too low. This debate intertwines several monetary policy questions: • How heavily should the Fed weigh a policy rule in its decisions to set interest rates? Should monetary policy be mostly rule-based or mostly discretionary? • If the Fed thinks an asset bubble is developing, should it use monetary policy to try to pop or prevent it? • Were interest rates too low in –? • Did too-low federal funds rates cause or contribute to the housing bubble? This debate is complex and thus far unresolved. Loose monetary policy does not necessarily lead to smaller credit spreads. There are open questions about the link be- tween short-term interest rates and house price appreciation, whether housing starts are the best measure of the housing bubble, the timing of housing price increases rel- ative to the interest rates in –, the European comparison, and whether the magnitude of the bubble can be explained by the gap between the Taylor Rule pre- scription and historic rates. At the same time, many observers argue that Taylor is right that short-term interest rates were too low during this period, and therefore that his argument is at least plausible if not provable. We conclude that global capital flows and risk repricing caused the credit bubble, and we consider them essential to explaining the crisis. U.S. monetary policy may have been an amplifying factor, but it did not by itself cause the credit bubble, nor was it essential to causing the crisis. The Commission should have focused more time and energy on exploring these questions about global capital flows, risk repricing, and monetary policy. Instead, the CHRG-109hhrg22160--146 Mr. Garrett," That raises the side question then, as you allude to, that, I guess the way I am thinking about it is potentially in the area for the housing market maybe we are--that proverbial bubble that is out there, that they say could someday be down the road that eventually collapses. Could you just touch on that as far as how that would impact on it and where we are going as far as the slight increases that we see in interest rates? Are we getting to that proverbial bubble then, that is potentially out there in the housing market? " FinancialCrisisInquiry--734 ROSEN: I—I think the dot com bubble—the—the main problem there was again, I think related to the underwriting of unprofitable companies. It used to be you had to have, you know, a year of profit under your belt before you could go public. That was the Wall Street standard. They enforced it. Then that all changed. So it’s really the same thing. The lowering of standards, because you could get it done, and there were investors to buy it. This housing problem is much more serious though, because it is such a large sector as Mark said -- $11 trillion. It’s—every financial institution has this. It is larger than the public debt that we have, you know? And that’s why it’s so important, and so why the bubble is so much bigger. I would say the dot com bubble set up this bubble though. Because to clean up the last bubble, the Fed kept at rates too low too long. Their idea of not trying to do something about the bubble is either regulatory or through policy I think is—really is the core of the problem. Monetary policy is poorly—was poorly done under the last chairman. fcic_final_report_full--481 PMBS are Connected to All Other NTMs Through Housing Prices But this does not mean that only the failure of the PMBS was responsible for the financial crisis. In a sense, all mortgages are linked to one another through housing prices, and housing prices in turn are highly sensitive to delinquencies and defaults on mortgages. This is a characteristic of mortgages that is not present in other securitized assets. If a credit card holder defaults on his obligations it has little effect on other credit card holders, but if a homeowner defaults on a mortgage the resulting foreclosure has an effect on the value of all homes in the vicinity and thus on the quality of all mortgages on those homes. Accordingly, the PMBS were intimately connected—through housing prices—to the NTMs securitized by the Agencies. Because there were so many more NTMs held or securitized by the Agencies (see Table 1), their unprecedented numbers—even in cases where they had a lower average rate of delinquency and default than the NTMs that backed the PMBS—was the major source of downward pressure on housing prices throughout the United States. Weakening housing prices, in turn, caused more mortgage defaults, among both NTMs in general and the particular NTMs that were the collateral for PMBS. In other words, the NTMs underlying the PMBS were weakened by the delinquencies and defaults among the much larger number of mortgages held or guaranteed as MBS by the Agencies. In reality, then, the losses on the PMBS were much higher than they would have been if the government’s housing policies had not brought into being 19 million other NTMs that were failing in unprecedented numbers. These failures drove down housing prices by 30 percent--an unprecedented decline—which multiplied the losses on the PMBS. Finally, the funds that the government directed into the housing market in pursuit of its social policies enlarged the housing bubble and extended it in time. The longer housing bubbles grow, the riskier the mortgages they contain; lenders are constantly trying to find ways to keep monthly mortgage payments down while borrowers are buying more expensive houses. While the bubble was growing, the risks that were building within it were obscured. Borrowers who would otherwise have defaulted on their loans, bringing an end to the bubble, were able to use the rising home prices to refinance, sometimes at lower interest rates. With delinquency rates relatively low, investors did not have a reason to exit the mortgage markets, and the continuing flow of funds into mortgages allowed the bubble to extend for an unprecedented 10 years. This in turn enabled the PMBS market to grow to enormous size and thus to have a more calamitous effect when it finally collapsed. If the government policies that provided a continuing source of funding for the bubble had not been pursued, it is doubtful that there would have been a PMBS market remotely as large as the one that developed, or that—when the housing bubble collapsed—the losses to financial institutions would have been as great. PMBS, as Securities, are Vulnerable to Investor Sentiment In addition to their link to the Agencies’ NTMs through housing prices, PMBS were particularly vulnerable to changes in investor sentiment about mortgages. The fact that the mortgages underlying the PMBS were held in securitized form was an important element of the crisis. There are many reasons for the popularity of mortgage securitization. Beginning in 2002, for example, the Basel regulations provided that mortgages held in the form of MBS—presumably because of their superior liquidity compared to whole mortgages—required a bank to hold only 1.6 percent risk-based capital, while whole mortgages required risk-based capital backing of four percent. This made all forms of MBS, including PMBS, much less expensive to hold than whole mortgages. In addition, mortgages in securitized form could be traded more easily, and used more readily as a source of liquidity through repurchase agreements. fcic_final_report_full--428 II. Housing bubble. 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 rapid regional boom-and-bust cycles in California, Nevada, Arizona, and Florida. Many factors contributed to the housing bubble, the bursting of which created enormous losses for home- owners and investors. III. Nontraditional mortgages. Tightening credit spreads, overly optimistic as- sumptions about U.S. housing prices, and flaws in primary and secondary mortgage markets led to poor origination practices and combined to in- crease the flow of credit to U.S. housing finance. Fueled by cheap credit, firms like Countrywide, Washington Mutual, Ameriquest, and HSBC Finance originated vast numbers of high-risk, nontraditional mortgages that were in some cases deceptive, in many cases confusing, and often beyond borrowers’ ability to repay. At the same time, many homebuyers and homeowners did not live up to their responsibilities to understand the terms of their mort- gages and to make prudent financial decisions. These factors further ampli- fied the housing bubble. IV. Credit ratings and securitization. Failures in credit rating and securitization transformed bad mortgages into toxic financial assets. Securitizers lowered the credit quality of the mortgages they securitized. Credit rating agencies er- roneously rated mortgage-backed securities and their derivatives as safe in- vestments. Buyers failed to look behind the credit ratings and do their own due diligence. These factors fueled the creation of more bad mortgages. V. Financial institutions concentrated correlated risk. Managers of many large and midsize financial institutions in the United States amassed enor- mous concentrations of highly correlated housing risk. Some did this know- ingly by betting on rising housing prices, while others paid insufficient attention to the potential risk of carrying large amounts of housing risk on their balance sheets. This enabled large but seemingly manageable mortgage losses to precipitate the collapse of large financial institutions. VI. Leverage and liquidity risk. Managers of these financial firms amplified this concentrated housing risk by holding too little capital relative to the risks they were carrying on their balance sheets. Many placed their firms on a hair trigger by relying heavily on short-term financing in repo and commercial paper markets for their day-to-day liquidity. They placed solvency bets (sometimes unknowingly) that their housing investments were solid, and liq- uidity bets that overnight money would always be available. Both turned out to be bad bets. In several cases, failed solvency bets triggered liquidity crises, causing some of the largest financial firms to fail or nearly fail. Firms were in- sufficiently transparent about their housing risk, creating uncertainty in mar- kets that made it difficult for some to access additional capital and liquidity when needed. CHRG-111hhrg51698--172 Mr. Gooch," I would say in any bubble there is always going to be some level of fraud at the peak of the bubble. I am not blaming the person who tried to buy a home and couldn't afford it. I would blame the unscrupulous mortgage broker who encouraged someone to take a mortgage they couldn't afford, on a house that wasn't worth the mortgage, simply because they were going to get a $3,000 commission. In this circumstance where you have had 7 years of extremely cheap credit and the global, spectacular growth throughout the world's economies, that is what has driven all of these commodity prices up to record levels. I don't know enough about those energy companies. I wouldn't jump to the conclusion that they were involved in insider trading because they imagined the price of oil would go up. I mean, frankly, who knew? Right? Sitting here today we all can see that everybody right up to the highest levels of government isn't able to predict the future that clearly. " CHRG-111hhrg53245--128 Mr. Garrett," Sure. You are where I was going next. Ms. Rivlin. I think there is a difference between the bubble in the 1990's in the stock market and the housing market bubble. I was at the Fed in the 1990's. We did not miss the stock market bubble. We knew it was there. We talked about it. Mr. Greenspan made the speech. We did not do enough about it, in my opinion. We could have raised margin requirements. It would have been largely symbolic, but we should have done it. We did not have the right tool. Raising the short-term interest rate in the middle of the bubble, we also had the Asian financial crisis and a lot of other things going on, so you do not have the right tool if you are relying entirely on the short-term interest rate. " CHRG-111shrg57319--522 Mr. Killinger," Yes. Senator Coburn. Did you see a bubble in housing prices before March 2005? " CHRG-110shrg38109--70 Chairman Bernanke," Senator, as I indicated, I do think that we should be trying to reduce regulatory burden, and in particular ensuring that the costs of the burden are commensurate with the benefits. With respect to Sarbanes-Oxley, my intent was to say that I do believe that there are benefits from that legislation, including improved controls, improved disclosures, improved governance of corporations. So there are certainly some benefits. It is important to decide whether we can reduce the costs and retain the benefits, and in that respect, I think that the proposed change in one audit standard being put forth by the SEC and the PCAOB is a step in the right direction because it attempts to focus on the most materially important issues, and it also makes allowance for the size and complexity of a firm in setting up the audit standard. So to try to summarize, Sarbanes-Oxley accomplishes some important objectives, but I do believe those objectives can be accomplished at lower cost, and I think the new audit standard moves in that direction. And in all other regulatory areas, including those the Federal Reserve is involved, we should continually be looking to find ways to accomplish the social or economic objectives of the regulation at a lower cost. Senator Martinez. Well, I agree that there are many good features to Sarbanes-Oxley. What I was speaking of is some of the excesses, particularly in the auditing arena and some of the areas that have caused such an overburden of costs. So, I appreciate your comment on that. Shifting to the issue of home sales, I used to sit in that very chair when I was Housing Secretary before this Committee, and at times, I would be asked a question about a housing bubble and in the overheated housing market whether, in fact, we were headed for a collapse and a bubble that would burst. In fact, we have seen as significant decrease in housing starts. We have seen the market cool down significantly, but we have not seen a bursting bubble. I always said at the time that the fears of a bubble were misplaced and that the housing market is more regional than it is national, and there were many different features between that and a localized market. But do you feel that the fear of a bubble has receded given the fact that the market cooled off, that it has done so in a fairly modest way without any cataclysmic consequences? " CHRG-111hhrg56766--266 Mr. Foster," Thank you. In this week's Economists magazine, there was an interesting article on Canada and the situation they are in, where they are seeing an incipient housing bubble re-emerge. They have kept interest rates very low for the same reasons we are doing, to try to restart industrial and business spending, and because if this persists for a long time, some of that money is going to leak out and could make a housing bubble. China is also facing similar problems where they have responded, as has Canada, by actually increasing the amount of money you have to put down on a real estate investment, an investment, as opposed to one you live in. I was wondering do you have contingency planning? Are there tools available that you are thinking of in case you keep interest rates low for an extended period of time, and all of a sudden, in regions of the United States, this starts to show up as a local or national real estate bubble? " CHRG-111shrg57322--1096 Mr. Blankfein," There are disclosure materials, yes. Senator Pryor. OK. In the past 25 years, America has seen an increasing number and severity of financial crises. You have the savings and loan crisis, Enron, the dot-com bubble, the housing bubble. What steps will Wall Street take to assure that there is not another financial crisis? " fcic_final_report_full--538 This dissenting statement argues that the U.S. government’s housing policies were the major contributor to the financial crisis of 2008. These policies fostered the development of a massive housing bubble between 1997 and 2007 and the creation of 27 million subprime and Alt-A loans, many of which were ready to default as soon as the housing bubble began to deflate. The losses associated with these weak and high risk loans caused either the real or apparent weakness of the major financial institutions around the world that held these mortgages—or PMBS backed by these mortgages—as investments or as sources of liquidity. Deregulation, lack of regulation, predatory lending or the other factors that were cited in the report of the FCIC’s majority were not determinative factors. The policy implications of this conclusion are significant. If the crisis could have been prevented simply by eliminating or changing the government policies and programs that were primarily responsible for the financial crisis, then there was no need for the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, adopted by Congress in July 2010 and often cited as one of the important achievements of the Obama administration and the 111 th Congress. The stringent regulation that the Dodd-Frank Act imposes on the U.S. economy will almost certainly have a major adverse effect on economic growth and job creation in the United States during the balance of this decade. If this was the price that had to be paid for preventing another financial crisis then perhaps it’s one that will have to be borne. But if it was not necessary to prevent another crisis—and it would not have been necessary if the crisis was caused by actions of the government itself—then the Dodd-Frank Act seriously overreached. Finally, if the principal cause of the financial crisis was ultimately the government’s involvement in the housing finance system, housing finance policy in the future should be adjusted accordingly. 533 -----------------------------------------------------Page 562-----------------------------------------------------  CHRG-111hhrg53244--161 The Chairman," Next--I have to apologize, I forgot that the seniority system here was designed by the choreographer of the Bunny Hop, and it goes this way. And I made a mistake. I told you I was getting old. So I am now at the gentlewoman from Wisconsin. Ms. Moore of Wisconsin. Thank you, Mr. Chairman. And thank you. I was really pleased to see in your testimony, under the regulatory reform section, that you realize that systemic risk is not just too-big-to-fail institutions, but activities and practices that provide systemic risk. Many of us--and, certainly, this article was given to me by Congresswoman Maxine Waters--have been reading the recent Rolling Stone article by Matt Taibbi, ``The Great American Bubble Machine.'' And while it is very critical of a particular firm, I think there are things that we all notice with respect to the housing bubble and the dot-com bubble and the oil bubble that all seem to be activities that seem to be systemic risks. For example, allowing an entity to sort of manipulate the price of an entity, of the housing prices, to ratchet the prices up and then just sort of hedge against their own products. So I guess I would like to ask your opinion about credit default swaps and also the practice of spinning, where executive compensation seems to be a systemic risk factor, as well. So can you tell us what we can do in our regulatory reform to prevent the creation of these bubbles? " CHRG-111hhrg56776--241 Mr. Foster," Thank you. And, let's see, countercyclical mortgage underwriting standards are being implemented at various levels in different countries around the world. And, simply put, what this means, when a housing bubble begins to develop, you turn up the downpayment that's required. And I guess my first question to Chairman Bernanke is that had these type of policies been in place in the previous decade, how effect would they have been at damping down the housing bubble, even in the presence of very loose monetary policy? And more--and secondly, in respect to the subject of this hearing, would countercyclical underwriting requirements be easier to implement in the context of consolidated Fed supervision? " fcic_final_report_full--489 This analysis lays the principal cause of the financial crisis squarely at the feet of the unprecedented number of NTMs that were brought into the U.S. financial markets by government housing policy. These weak and high risk loans helped to build the bubble, and when the bubble deflated they defaulted in unprecedented numbers. This threatened losses in the PMBS that were held by financial institutions in the U.S. and around the world, impairing both their liquidity and their apparent stability. The accumulation of 27 million subprime and Alt-A mortgages was not a random event, or even the result of major forces such as global financial imbalances or excessively low interest rates. Instead, these loans and the bubble to which they contributed were the direct consequence of something far more mundane: U.S. government housing policy, which—led by HUD over two administrations— deliberately reduced mortgage underwriting standards so that more people could buy homes. While this process was going on, everyone was pleased. Homeownership in the U.S. actually grew to the highest level ever recorded. But the result was a financial catastrophe from which the U.S. has still not recovered. -----------------------------------------------------Page 512-----------------------------------------------------  CHRG-111shrg57322--314 Mr. Birnbaum," I want to answer your questions precisely. Senator Tester. I will rephrase it. Why, how, and when did you become convinced that there was a housing bubble that was in decline? " CHRG-111shrg57321--169 Mr. McDaniel," First, Senator, we did not identify a housing bubble in 2003. We certainly---- Senator Kaufman. No. I mean you saw the oncoming. " CHRG-111shrg57319--521 Mr. Killinger," Again, I just do not recall the specifics of this at all. Senator Coburn. OK. Exhibit 78a,\2\ in this email exchange from March 10, 2005, with Jim Vanasek, you wrote, ``I have never seen such a high risk housing market as market after market thinks they are unique and for whatever reason are not likely to experience price decline. This typically signifies a bubble.''--------------------------------------------------------------------------- \2\ See Exhibit 78a, which appears in the Appendix on page 790.--------------------------------------------------------------------------- Is it accurate to say that you saw a bubble in housing prices as early as March 2005? " fcic_final_report_full--257 COMMISSION CONCLUSIONS ON CHAPTER 12 The Commission concludes that entities such as Bear Stearns’s hedge funds and AIG Financial Products that had significant subprime exposure were affected by the collapse of the housing bubble first, creating financial pressures on their par- ent companies. The commercial paper and repo markets—two key components of the shadow banking lending markets—quickly reflected the impact of the housing bubble collapse because of the decline in collateral asset values and con- cern about financial firms’ subprime exposure. fcic_final_report_full--115 COMMISSION CONCLUSIONS ON CHAPTER 6 The Commission concludes that there was untrammeled growth in risky mort- gages. Unsustainable, toxic loans polluted the financial system and fueled the housing bubble. Subprime lending was supported in significant ways by major financial insti- tutions. Some firms, such as Citigroup, Lehman Brothers, and Morgan Stanley, acquired subprime lenders. In addition, major financial institutions facilitated the growth in subprime mortgage–lending companies with lines of credit, securitiza- tion, purchase guarantees and other mechanisms. Regulators failed to rein in risky home mortgage lending. In particular, the Federal Reserve failed to meet its statutory obligation to establish and maintain prudent mortgage lending standards and to protect against predatory lending. FOMC20050630meeting--137 135,MR. MOSKOW.," Thank you, Mr. Chairman. I wanted to make a few comments and then ask a question. First, I’d say that with all of the concerns about froth in housing markets, I found these presentations to be very informative, and I want to congratulate the people who spent a lot of time preparing them. I thought they were all very good presentations. But I also found the information comforting. We’ve all talked about the possibility of local housing bubbles and regional housing bubbles, and clearly there are some in the United States. But we never really looked at it on a national basis before. The net result for me was that I come away from the analysis not feeling any worse than I did before and probably a little better. First, I thought it was very helpful to see quantified—I think this was in Josh’s memo—the size of the potential bubble. He talked about a 20 percent drop in housing prices. But that was equal to only about 30 percent of GDP as compared to the drop in equity prices we had, which was more than twice that. Also, I had the feeling that appropriate monetary policy, as John said, could mitigate much of the distress that might occur. Moreover, the credit risk associated with home mortgages seems to be spread out across many institutions. Governor Bies said that a lot of analysis is being done now, and we’ll want to see the results of the analysis that the Board and the Comptroller are doing. But on the whole, the financial institutions seem to be in pretty good shape. The role of securitizing mortgages is to lay off risks to parties who are willing and able to bear the risks. Capital levels of the financial institutions are relatively high, so it appears that these markets are performing their roles well. And in the event of a sharp drop in housing prices, the odds of a spillover to financial institutions seem limited. And as I mentioned, it was helpful to hear the June 29-30, 2005 48 of 234 housing prices. So I come away somewhat less concerned about the size and consequences of a housing bubble than I was before. The question I had relates to what Governor Yellen was asking about—financial innovation. I was going to make a similar point. The fact is that there has been a great deal of financial innovation in housing markets in the United States. The average person can borrow very easily on his home these days. And I was wondering if there have been—or if it is possible to do—any international comparisons on this. I wondered whether the price-rent ratios in other countries that may not have had the same degree of financial innovation we’ve had differ substantially from ours." CHRG-110shrg50369--23 Chairman Dodd," I do not want to put words in your mouth, obviously, at all here, but I am looking at--obviously the housing burst or bubble, the burst of that bubble is, I think, far more dangerous than a high-tech problem, as you make those comparisons. Inflation and trade deficits are worse. Am I hearing you correctly that we are actually in a worse position today to respond to this than we were 8 years ago? Is that how I hear what you are saying? " CHRG-111shrg57321--170 Mr. McDaniel," Yes, we saw loosening underwriting standards---- Senator Kaufman. Right. Mr. McDaniel [continuing]. And we were certainly aware that home price appreciation was occurring through this period. Senator Kaufman. So, it is hard--Ms. Corbet, I will get back to it and maybe the two of you can work together. There is the chart. Oh, that bubble just came on. Look, I am not saying we are all victims of our own personal experience. In 2005, I sent my children a printout from Merrill Lynch of essentially that chart, and I sent with them what Merrill Lynch said. People say that this is because there are so many more people buying houses, but if that was true, they showed another chart and it showed then rental use would go up, too, and rental use was rock solid. So we have a housing bubble. That is what Merrill Lynch sent out to me as a Merrill Lynch investor and I sent it to my kids. The fact that we were coming onto a bubble, as you say, you didn't say it in 2003, but you are talking about it generally and you are still--do you see my point? These products are still rolling off the assembly lines with AAA on them. " CHRG-110shrg46629--99 STATEMENT OF SENATOR ROBERT F. BENNETT Senator Bennett. Thank you very much, Mr. Chairman. Chairman Bernanke, welcome. I have two issues I want to pursue with you and get your thoughts on, but I want to make just an observation prior. I have been on this Committee now for over a dozen years. And we see the pressure going one way and then the other. First, the requirement on or the desire on the part of Members of this Committee to make capital available to the people that are poor. We have to do everything we can to make capital available to them and push in the direction. No, you are holding capital just for the rich. You have to make it available to the poor. Then when we get into the subprime problem, I understand, at least on the House side, there is legislation to hold the lender responsible for the fact that they pushed money at people who could not afford to pay it. And now that the homes are being foreclosed on it is the lender's fault and we have to punish the lender for making the capital available in the first place. It is an interesting pendulum to watch it swing back and forth in this debate. I hope we do not end up saying to the counselor, the counselor is liable if the counselor said you should make this deal rather than that deal and then the counselor has to pay the damages if, in fact, there is a problem and the people cannot pay their mortgage. The two issues I want to talk to you about are labor and housing. In my home State of Utah, the unemployment rate is two-point-something percent and the something does not really matter. When you get down that low it is a very, very serious problem. We have a labor shortage. Nationwide the unemployment rate is at levels approaching historic lows. I would like your reaction to that problem and what it might do with respect to inflation. Your predecessor, Chairman Greenspan, talked about tight labor markets and the impact of that on inflation. Productivity is going up so we have to have a different historic benchmark on unemployment figures. I was taught in college that 6 percent was full employment, that you got below 6 percent and you were facing serious inflationary pressures. Interestingly enough, at the height of the last recession the unemployment was in the 6 percent range. And now we are at 4 percent or something. So, I would like your comment on that. And then on housing, the housing bubble has the potential, in my view, of triggering an economic downturn just as the dot-com bubble that we were all excited about and thrilled about in the late 1990s triggered the recession that began in 2000 as that bubble started to burst. Everyone was delighted to see his house value go up, particularly if he did not have to buy a new one. And you referred to the number of people who took home equity loans and went out and went on a spending binge. Now the housing prices have flattened, if not fallen, in many areas. There has to be a shakeout just as there was a shakeout from the dot-com bubble there has to be a shakeout from the housing bubble. Look into your crystal ball and see if it is, in fact, going to create an economic downturn? If so, any ideas as to how severe or when? I know you do not make those specific prophecies and I am not asking you to. But just in a general term what you might see as the housing shakeout works its way through the economy. If you could address those two, I would appreciate it. " FinancialCrisisInquiry--717 THOMPSON: Thank you, Mr. Chairman. Many of the questions I had have been addressed, but I do want to ask a few specifics. Ms. Gordon, to what extent, in your opinion, might CRA have been a contributor in any way to the housing bubble? FOMC20050630meeting--382 380,MR. GRAMLICH.," Thank you, Mr. Chairman. I’ll let Tom respond on behalf of the Kansas City Royals. [Laughter] This will be my 62nd and last statement at one of these meetings, and if you’ll bear with me I’d like to give a few parting thoughts before I ride off into the sunset. I believe most of us think about monetary policy in terms of what I will call a modified Taylor rule. We don’t necessarily follow the explicit Taylor rule outcomes of the Bluebook but we look at inflation and unemployment and try to make them hit our target values, at least over some horizon. From time to time, we may shade our judgments based on some other factor that may seem relevant, which is fine. But the basic focus remains on inflation and unemployment. I strongly agree with this basic focus, and I get very irritated when I see columns suggesting that we are trying to inspire or should be trying to prick a housing bubble, for example. There is no way to do that and still maximize the inflation/unemployment outcome. Monetary policy is broad and has broad effects. When we take rates down in a soft economy, we probably will be creating some bubbles, or at least mini bubbles here and there—not because we want to, but because it is inevitable. In the late ’90s, holding out against raising rates and hence letting the economy achieve very low unemployment rates probably did add to the June 29-30, 2005 156 of 234 add to the housing bubble, if, in fact, there is a housing bubble. Given our primary focus on inflation and unemployment, I’m not sure there is anything we could have done about either bubble, and I am sure it would not have been wise to go out of our way to try to prick either bubble. Today’s policy challenge is to reverse the highly accommodative policy we followed a few years ago in response to what I still think was a real threat of deflation. There has been lots of speculation about the so-called neutral level of the federal funds rate, as if once we hit neutrality we can stop raising rates. First off, this speculation is naive in the sense that whatever neutrality is, it is more likely a zone than a precise rate. Moreover, neutrality would only be desirable if the rest of the economy were in balance, which is probably never strictly true, and certainly isn’t true now. For these reasons, I’ve always been disdainful of the search for neutrality. Whatever neutrality is, I think in the current circumstance we ought to take rates somewhere north of it. The reason is simple: lags. We have taken the funds rate very low in response to threats of deflation. That means that at the magic moment when we hit neutrality there will be still some accommodative policy in the pipeline—policy that would have to be offset with at least a slight overshooting on the other side. This is a well-known shower problem that has enlivened countless macro classrooms. One can also see this overshooting in the optimal policy simulations in the Bluebook. One issue that has always been important to me involves national saving. I continue to be a national saving freak. Our rate is too low; no two ways about it. Continued low national saving implies either a drop in investment, which is undesirable, or continued international borrowing, which is unreliable. Like others, I would greatly prefer to correct the problem through fiscal austerity. But despite some welcome bulges in federal revenue, we all know that this is not real June 29-30, 2005 157 of 234 Given that fiscal policy is not measuring up, can we do something about national saving with monetary policy? Unfortunately, I think the answer is no, at least as long as we are operating under a modified Taylor rule. Basically, our approach can determine the level of total output but not its composition between consumption and investment. Regarding this composition, there is an interesting new development resulting from the financial innovation we talked about yesterday. I admit to having always been skeptical of the empirical importance of interest rates on consumption. I would have thought that the form of housing wealth, whether cash or not, should not matter to rational consumers and that these consumers should realize that interest rates have ambiguous effects on their lifetime optimization decision. However, if consumption in fact does depend strongly on interest rates, as our econometricians say, at least some of the crowding-out impact of higher interest rates will be felt by consumption. So I will swallow my empirical misgivings and at least hope that our present easy fiscal and slightly harder monetary regime will be at least slightly less restrictive on investment and slightly more restrictive on consumption. Another issue is, of course, the housing bubble. My own view is that there probably is now a slight macro housing bubble, with the problem obviously being worse in selected real estate markets. As argued above, it would be a great mistake for the Fed to renounce its primary focus on inflation and unemployment and start fighting bubbles. But might it be possible to shape policy in the direction of fighting bubbles? The question sounds very reasonable. The problem comes when one tries to get specific. A few months ago there was a conference at Princeton to address this very question. What should monetary policy do about bubbles? I was enlisted as a speaker in this session, and I then characterized my views in Gilbert & Sullivan terms as, “Well, never. Oh, hardly June 29-30, 2005 158 of 234 There are several arguments why we should hardly ever try to prick bubbles. Asset bubbles may be too small to matter much in macro terms; they may be endogenous—the result of expansionary policy we have consciously followed; and pricking bubbles may run at cross-purposes with the monetary policy properly based on inflation and unemployment. But I think the real problem with pricking bubbles can be seen from yesterday’s discussion. How can we make that type of policy stabilizing? If one reads the press or listens to Europeans—and I did that this weekend at Basel—the high level of house prices should lead us to raise interest rates higher than we otherwise would. If one reads the Greenbook or the staff documents we talked about yesterday, the high level of house prices relative to rents leads to the expectation that house prices are more likely to decline than to rise, so that stabilizing policy would be to keep interest rates lower than we otherwise would. In that sense, the bubble policy conundrum is similar to the bond market conundrum. Great analysis, guys, but do we move rates up or down? In general, I think we aren’t going to know. House prices are high. Do we respond to the expectation by lowering rates to fight the anticipated collapse? To put it mildly, this policy would be very hard to explain and carries the risk that our more accommodative policy would drive house prices even higher. Imagine what Steve Roach and John Makin would say about that! If I can coin a term, this would be viewed as a Greenspan “shotput.” [Laughter] On the other hand, do we do what the press would have us do—raise rates and likely destabilize? This is a tough, perhaps impossible, question. And our best approach is most likely to June 29-30, 2005 159 of 234 Whatever the case, I’m happy to raise the funds rate another notch today and to continue with the “measured pace” rhetoric. For the future, my own five dollars says that you will never figure out what neutrality is, but I am confident that you will be able to tell when to stop raising rates. This leads me to my final point, which is to say how much I’ve enjoyed working with all of you. These meetings have been interesting, challenging, and productive. I can’t say that monetary policy is the hardest thing I’ve ever done in my life, because I did spend three years trying to get diverse people to agree about Social Security, but it was hard. And I think we did well. The staff has been superb. I can’t imagine better preparation for meetings like this than from reading the Greenbook and the Bluebook. All of you have been consistently interesting and sensible. And the Chairman has run great meetings and has admirably melded our diverse views into a coherent and effective monetary policy. I will be eternally grateful for having been a part of it. [Applause] Thank you." CHRG-111shrg57322--270 Mr. Birnbaum," Look, I think that, not working in a lot of areas of Goldman, there are things that may have happened that multiple investment banks and commercial banks may have provided too much credit, and that may have contributed to a bubble. And I would second what Mr. Sparks said. We are all sympathetic to the negative impact of that bubble. There was a lot of human pain and suffering that came from the bursting of the housing bubble. And to the extent that investment banks and commercial banks may have extended too much credit at certain periods of time--and, again, that is just--I do not have any personal witnessing of that--then it is possible. Senator Pryor. I guess what I am hoping to hear from the answers here is that you all take responsibility for your actions, and I have not heard that really so far in the first two, but I would like to ask the third. Mr. Swenson, did--or excuse me---- " FinancialCrisisReport--68 Mr. Vanasek was the senior-most risk officer at WaMu, and had frequent interactions with Mr. Killinger and the Board of Directors. While his concerns may have been heard, they were not heeded. Mr. Vanasek told the Subcommittee that, because of his predictions of a collapse in the housing market, he earned the derisive nickname “Dr. Doom.” 175 But evidence of a housing bubble was overwhelming by 2005. Over the prior ten years, housing prices had skyrocketed in an unprecedented fashion, as the following chart prepared by Paulson & Co. Inc., based on data from the Bureau of Economic Analysis and the Office of Federal Housing Enterprise Oversight, demonstrates. 176 174 9/2/2004 Washington Mutual memorandum from Jim Vanasek, “Perspective,” Hearing Exhibit 4/13-78b. 175 Subcommittee interview of Jim Vanasek (12/18/2009). 176 “Estimation of Housing Bubble,” PSI-Paulson&Co-02-00003, Hearing Exhibit 4/13-1j. fcic_final_report_full--426 These facts tell us that our explanation for the credit bubble should focus on fac- tors common to both the United States and Europe, that the credit bubble is likely an essential cause of the U.S. housing bubble, and that U.S. housing policy is by itself an insufficient explanation of the crisis. Furthermore, any explanation that relies too heavily on a unique element of the U.S. regulatory or supervisory system is likely to be insufficient to explain why the same thing happened in parts of Europe. This moves inadequate international capital and liquidity standards up our list of causes, and it moves the differences between the regulation of U.S. commercial and invest- ment banks down that list. Applying these international comparisons directly to the majority’s conclusions provokes these questions: • If the political influence of the financial sector in Washington was an essential cause of the crisis, how does that explain similar financial institution failures in the United Kingdom, Germany, Iceland, Belgium, the Netherlands, France, Spain, Switzerland, Ireland, and Denmark? • How can the “runaway mortgage securitization train” detailed in the majority’s report explain housing bubbles in Spain, Australia, and the United Kingdom, countries with mortgage finance systems vastly different than that in the United States? • How can the corporate and regulatory structures of investment banks explain the decisions of many U.S. commercial banks, several large American univer- sity endowments, and some state public employee pension funds, not to men- tion a number of large and midsize German banks, to take on too much U.S. housing risk? • How did former Fed Chairman Alan Greenspan’s “deregulatory ideology” also precipitate bank regulatory failures across Europe? Not all of these factors identified by the majority were irrelevant; they were just not essential. The Commission’s statutory mission is “to examine the causes, domestic and global, of the current financial and economic crisis in the United States.” By fo- cusing too narrowly on U.S. regulatory policy and supervision, ignoring interna- tional parallels, emphasizing only arguments for greater regulation, failing to prioritize the causes, and failing to distinguish sufficiently between causes and ef- fects, the majority’s report is unbalanced and leads to incorrect conclusions about what caused the crisis. We begin our explanation by briefly describing the stages of the crisis. FinancialCrisisReport--272 The FBI’s fraud warnings were repeated by industry analysts. The Mortgage Bankers Association’s Mortgage Asset Research Institute (MARI), for example, had been reporting increasing fraud in mortgages for years. In April 2007, MARI reported a 30% increase in 2006 in loans with suspected mortgage fraud. The report also noted that while 55% of overall fraud incidents reported to MARI involved loan application fraud, the percentage of subprime loans with loan application fraud was even higher at 65%. 1053 Press Reports. Warnings in the national press concerning the threat posed by deteriorating mortgages and unsustainable housing prices were also prevalent. A University of Florida website has collected dozens of these articles, many of which were published in 2005. The headlines include: “Fed Debates Pricking the U.S. Housing ‘Bubble’,” New York Times , May 31, 2005; “Yale Professor Predicts Housing ‘Bubble’ Will Burst,” NPR, June 3, 2005; “Cover Story: Bubble Bath of Doom” [warning of overheated real estate market], Washington Post , July 4, 2005; “Housing Affordability Hits 14-Year Low,” The Wall Street Journal, December 22, 2005; “Foreclosure Rates Rise Across the U.S.,” NPR, May 30, 2006; “For Sale Signs Multiply Across U.S.,” The Wall Street Journal , July 20, 2006; and “Housing Gets Ugly,” New York Times , August 25, 2006. 1054 Had Moody’s and S&P heeded their own warnings as well as the warnings in government reports and the national press, they might have issued more conservative, including fewer AAA, ratings for RMBS and CDO securities from 2005 to 2007; required additional credit enhancements earlier; and issued ratings downgrades earlier and with greater frequency, gradually letting the air out of the housing bubble instead of puncturing it with the mass downgrades that began in July 2007. The problem, however, was that neither company had a financial incentive to assign tougher credit ratings to the very securities that for a short while increased their revenues, boosted their stock prices, and expanded their executive compensation. Instead, ongoing conflicts of interest, inaccurate credit rating models, and inadequate rating and surveillance resources made it possible for Moody’s and S&P to ignore their own warnings about the U.S. mortgage market. In the longer run, these decisions cost both companies dearly. Between January 2007 and January 2009, the stock price for both The McGraw-Hill Companies (S&P’s parent company) and Moody’s fell nearly 70%, and neither share price has fully recovered. (2) CRA Conflicts of Interest In transitioning from the fact that the rating agencies issued inaccurate ratings to the question of why they did, one of the primary issues is the conflicts of interest inherent in the “issuer-pays” model. Under this system, the firm interested in profiting from an RMBS or CDO security is required to pay for the credit rating needed to sell the security. Moreover, it requires the credit rating agencies to obtain business from the very companies paying for their rating 1053 4/2007 “Ninth Periodic Mortgage Fraud Case Report to Mortgage Bankers Association,” prepared by the Mortgage Asset Research Institute, LLC, at 10. 1054 “Business Library – The Housing Bubble,” University of Florida George A. Smathers Libraries, http://www.uflib.ufl.edu/cm/business/cases/housing_bubble.htm. judgment. The result is a system that creates strong incentives for the rating agencies to inflate their ratings to attract business, and for the issuers and arrangers of the securities to engage in “ratings shopping” to obtain the highest ratings for their financial products. FinancialCrisisInquiry--185 So this bubble bursting is what’s caused I think the bad loan issues in the financial sector with mortgages being a big part of it. The chart below that though is what was referred to by Mr. Bass earlier—key thing—housing became unaffordable during 2003, 4 and 5. The affordability—that is the income relative to the payments you had to make wasn’t there. And so that is why we had these new mortgage instruments come about. Because people could not afford to buy the house. And so they had to find an instrument that allowed them to make a lower initial payment. This would not have been a bad thing if they had fully verified the person’s income, they’d have laid down 20 percent, did all the things that made sense. Unfortunately we layered these risks, and that did not happen. So it was the affordability problem that really and partly caused the bubble. But because the bubble itself made people go to these instruments that were at least much more risky. From the investment community side, of course as you said earlier, that people wanted to get higher yields. They weren’t getting them cause the interest rates were so low. So they—investor also wanted these instruments. The fall out is figure five, which is unfortunately not over. In a way you’re investigating what caused this, but we’re still in the middle of this crisis from the point of view of the consumer, and—and Main Street. Wall Street feels great, but Main Street does not feel great. And this just shows you that the delinquency and foreclosure the total non-performing loans continue to mount for all of the—both the risky loans, and also for non-risky loans. Remember, there’s $11 trillion of mortgages. There are about $3 trillion of the risky category. There’s $7 trillion of what is called prime mortgages. And those are going bad because house prices have dropped so much, people have lost their jobs, and there’s no end in sight of this. I think 2010 is going to be a bigger year than 2009. CHRG-111hhrg51698--391 Mr. Goodlatte," Thank you, Mr. Chairman. Mr. Masters, just to clarify your testimony, the CFTC, by allowing an excessive speculation bubble, amplified and deepened the housing and banking crisis. Is that your conclusion? " FOMC20050630meeting--79 77,MR. POOLE.," But the point is that there could be a little bubble component or a big bubble component. Obviously, policymakers wouldn’t apply the instrument when prices are regarded as reflecting the fundamentals, but the instrument would be continuously available. The whole point June 29-30, 2005 34 of 234 change the whole nature of asset pricing in a market economy. I think a proper policy analysis really can’t be done on a one-off basis in cases such as the stock market in the ’90s or house prices today." CHRG-111hhrg53245--118 Mr. Garrett," You would put it in the Federal Reserve. The reason why I want to clarify that is if you look at the history of the Federal Reserve on each one of those points, you have to raise the question, why them? On the asset bubbles, someone else raised a question to Ms. Rivlin with regard to the housing bubble that we had, I am going back even further than that with the tech bubble. Alan Greenspan later on said maybe I missed that one and he sort of re-wrote history, some would say, as far as his review, whether he knew about that or not, but if you look at the minutes of the Federal Reserve, not just him but the entire Federal Reserve, they all missed that. There was no discussion whatsoever with regard to an asset bubble during the entire time. They were looking at it purely as an increase in productivity. On the countercylical aspect of it, the Federal Reserve was out front for a long time on Basel II; were they not? Which would go in the wrong direction with regard to that. As far as on the capital requirements, did not the Federal Reserve have the ability with regard to institutions under them, Citi and Bank of America, and did they do anything? The answer is no, regarding raising capital requirements. Here is an entity that you are nodding your head to, with a ``dismal'' track record in each one of those, but you, sir, would suggest they are the ones we are going to give the authority to. " CHRG-111shrg57322--315 Mr. Birnbaum," My sentiment that I expressed in my opening statement was that there was a market in residential mortgage-backed securities in subprime that I thought was overvalued. Senator Tester. OK. So it was based on the housing bubble, and its decline or collapse, however you want to put--however I want to put it. " FinancialCrisisInquiry--184 You can see here that we had—hopefully you have it, but if not I’ll describe the numbers. We were producing in single-family starts about 1.1 million a year on average. That’s roughly the average level of single-family starts. And that’s the demographic demand. During the peak moments here, we produced 1.7 million. So we were producing about -- we produced during this whole bubble about a million more new starts then demographic demand would have you produced. And one of the reasons for that was that these—basically people were able to put down $1,000 or $2,000 or $3,000 to control a $100,000 to $200,000 house. It was a—basically a call option. And homebuilders sold them this house. They took an order, and of course they didn’t have to fulfill that order. If prices went up, they take the order and flip the house. So we built about a million too many. We are now building about 500,000 houses, and as you know in many markets this has led to lots of layoffs. I think roughly 15 percent of the decline in employment is in the construction industry. So this is a—a very big negative. But we’ve begun to come back a little bit, and my guess is we’ll slowly recover. I would agree with Mark. It’s going to take three to four years to get recovery here. Maybe a little bit longer. If we skip to this figure three—there was some reference to this earlier—is the house price bubble, which is on the second page there. And the house price bubble I think is really why we’ve had all this fallout. House prices went up in nominal terms dramatically. And in real terms also very dramatically. We’ve had big house price inflations before. In the late 70s we had that happen. But that was accompanied by overall inflation. This time house prices went up, and we did not have overall inflation. So real house prices went up dramatically. And only one other period of time have we ever seen a—a drop in house prices that was in a big way, and that was in the 1930s. It really didn’t happen in the post-war period. But we’ve seen a cumulative price decline based on realtor data of about 21 percent based on another index Kay short about 30 percent. fcic_final_report_full--429 VII. Risk of contagion. The risk of contagion was an essential cause of the crisis. In some cases, the financial system was vulnerable because policymakers were afraid of a large firm’s sudden and disorderly failure triggering balance- sheet losses in its counterparties. These institutions were deemed too big and interconnected to other firms through counterparty credit risk for policy- makers to be willing to allow them to fail suddenly. VIII. Common shock. In other cases, unrelated financial institutions failed be- cause of a common shock: they made similar failed bets on housing. Uncon- nected financial firms failed for the same reason and at roughly the same time because they had the same problem: large housing losses. This common shock meant that the problem was broader than a single failed bank–key large financial institutions were undercapitalized because of this common shock. IX. Financial shock and panic. In quick succession in September , the fail- ures, near-failures, and restructurings of ten firms triggered a global financial panic. Confidence and trust in the financial system began to evaporate as the health of almost every large and midsize financial institution in the United States and Europe was questioned. X. Financial crisis causes economic crisis. The financial shock and panic caused a severe contraction in the real economy. The shock and panic ended in early . Harm to the real economy continues through today. We now describe these ten essential causes of the crisis in more detail. THE CREDIT BUBBLE: GLOBAL CAPITAL FLOWS, UNDERPRICED RISK, AND FEDERAL RESERVE POLICY The financial and economic crisis began with a credit bubble in the United States and Europe. Credit spreads narrowed significantly, meaning that the cost of borrowing to finance risky investments declined relative to safe assets such as U.S. Treasury securi- ties. The most notable of these risky investments were high-risk mortgages. The U.S. housing bubble was the most visible effect of the credit bubble but not the only one. Commercial real estate, high-yield debt, and leveraged loans were all boosted by the surplus of inexpensive credit. There are three major possible explanations for the credit bubble: global capital flows, the repricing of risk, and monetary policy. Global capital flows Starting in the late s, China, other large developing countries, and the big oil- producing nations consumed and invested domestically less than they earned. As fcic_final_report_full--170 ALL IN CONTENTS The bubble: “A credit-induced boom” ................................................................  Mortgage fraud: “Crime-facilitative environments” ..........................................  Disclosure and due diligence: “A quality control issue in the factory” ................  Regulators: “Markets will always self-correct” ...................................................  Leveraged loans and commercial real estate: “You’ve got to get up and dance” ...................................................................  Lehman: From “moving” to “storage” ................................................................  Fannie Mae and Freddie Mac: “Two stark choices” ...........................................  In , the Bakersfield, California, homebuilder Warren Peterson was paying as lit- tle as , for a ,-square-foot lot, about the size of three tennis courts. The next year the cost more than tripled to ,, as real estate boomed. Over the pre- vious quarter century, Peterson had built between  and  custom and semi-custom homes a year. For a while, he was building as many as . And then came the crash. “I have built exactly one new home since late ,” he told the FCIC five years later.  In , the average price was , for a new house in Bakersfield, at the southern end of California’s agricultural center, the San Joaquin Valley. That jumped to almost , by June .  “By , money seemed to be coming in very fast and from everywhere,” said Lloyd Plank, a Bakersfield real estate broker. “They would purchase a house in Bakersfield, keep it for a short period and resell it. Some- times they would flip the house while it was still in escrow, and would still make  to .”  Nationally, housing prices jumped  between  and their peak in ,  more than in any decade since at least .  It would be catastrophically downhill from there—yet the mortgage machine kept churning well into , apparently in- different to the fact that housing prices were starting to fall and lending standards to deteriorate. Newspaper stories highlighted the weakness in the housing market— even suggesting this was a bubble that could burst anytime. Checks were in place, but  they were failing. Loan purchasers and securitizers ignored their own due diligence on what they were buying. The Federal Reserve and the other regulators increasingly recognized the impending troubles in housing but thought their impact would be contained. Increased securitization, lower underwriting standards, and easier access to credit were common in other markets, too. For example, credit was flowing into commercial real estate and corporate loans. How to react to what increasingly ap- peared to be a credit bubble? Many enterprises, such as Lehman Brothers and Fannie Mae, pushed deeper. FinancialCrisisInquiry--598 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 January 13, 2010 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. And then we had wide-spread speculation. And I submitted an article to you as a commission, which I wrote in 2006 that was published in 2007. Nearly 30 percent of all home sales in the hot markets were just speculators. And this is not a bad thing, but the speculators put down almost no money. They were flipping houses. And our mortgage system was not able to distinguish between a homeowner and a speculator. And I think we really need to do a much better job of that in the future. We already are trying to. We’re— nothing wrong with speculating, but you’ve got to put down hard money -- 30 percent down. Some big number so they’re not destroying the market for the people who want to own and live in houses. There was a regulatory failure, and everybody knew this was happening. Everybody in the country knew this was happening by the middle of 2006 -- late 2006. One of the unregulated institutions—New Century—a mortgage broker—went bankrupt in early 2007. Everybody knew this, but it kept on going on. I tried very hard and others as well to talk to regulators about this—inform them of this—and within institutions—the Fed in particular. There was a big debate going on. Should they do something about it? And it was decided not to. They didn’t think they had the power. They didn’t really believe it was as bad as it was. But there was a big debate with board members about doing something about this. I think really the whole system of a non-recourse loan in both commercial and residential while desirable by the people borrowing has really created this problem. That there is a belief that it’s a—a put option. Things go well, great. If not, I can give it back. And this misalignment of interest at this level—the consumer level, the borrower level—and the misalignment of—of interest throughout the entire system where risk and rewards are disconnected is really how we’re going to fix this. So if I were to summarize I would say too much leverage, poor underwriting and lax regulation. But I want to take you through some of the charts I have. I know I’ve got January 13, 2010 about five more minutes, but tell you where we are today. And I think you have these at the end of the testimony. They’re figures. And let’s take the first one, which is the housing bubble. It says, “Figure One—U.S. Housing, Single Family Starts.” You can see here that we had—hopefully you have it, but if not I’ll describe the numbers. We were producing in single-family starts about 1.1 million a year on average. That’s roughly the average level of single-family starts. And that’s the demographic demand. During the peak moments here, we produced 1.7 million. So we were producing about -- we produced during this whole bubble about a million more new starts then demographic demand would have you produced. And one of the reasons for that was that these—basically people were able to put down $1,000 or $2,000 or $3,000 to control a $100,000 to $200,000 house. It was a—basically a call option. And homebuilders sold them this house. They took an order, and of course they didn’t have to fulfill that order. If prices went up, they take the order and flip the house. So we built about a million too many. We are now building about 500,000 houses, and as you know in many markets this has led to lots of layoffs. I think roughly 15 percent of the decline in employment is in the construction industry. So this is a—a very big negative. But we’ve begun to come back a little bit, and my guess is we’ll slowly recover. I would agree with Mark. It’s going to take three to four years to get recovery here. Maybe a little bit longer. If we skip to this figure three—there was some reference to this earlier—is the house price bubble, which is on the second page there. And the house price bubble I think is really why we’ve had all this fallout. House prices went up in nominal terms dramatically. And in real terms also very dramatically. We’ve had big house price inflations before. In the late 70s we had that happen. But that was accompanied by overall inflation. This time house prices went up, and we did not have overall inflation. So real house prices went up dramatically. And only one other period of time have we ever seen a—a January 13, 2010 drop in house prices that was in a big way, and that was in the 1930s. It really didn’t happen in the post-war period. But we’ve seen a cumulative price decline based on realtor data of about 21 percent based on another index Kay short about 30 percent. So this bubble bursting is what’s caused I think the bad loan issues in the financial sector with mortgages being a big part of it. The chart below that though is what was referred to by Mr. Bass earlier—key thing—housing became unaffordable during 2003, 4 and 5. The affordability—that is the income relative to the payments you had to make wasn’t there. And so that is why we had these new mortgage instruments come about. Because people could not afford to buy the house. And so they had to find an instrument that allowed them to make a lower initial payment. This would not have been a bad thing if they had fully verified the person’s income, they’d have laid down 20 percent, did all the things that made sense. Unfortunately we layered these risks, and that did not happen. So it was the affordability problem that really and partly caused the bubble. But because the bubble itself made people go to these instruments that were at least much more risky. From the investment community side, of course as you said earlier, that people wanted to get higher yields. They weren’t getting them cause the interest rates were so low. So they—investor also wanted these instruments. The fall out is figure five, which is unfortunately not over. In a way you’re investigating what caused this, but we’re still in the middle of this crisis from the point of view of the consumer, and—and Main Street. Wall Street feels great, but Main Street does not feel great. And this just shows you that the delinquency and foreclosure the total non-performing loans continue to mount for all of the—both the risky loans, and also for non-risky loans. Remember, there’s $11 trillion of mortgages. There are about $3 trillion of the risky category. There’s $7 trillion of what is called prime mortgages. And those are going bad January 13, 2010 because house prices have dropped so much, people have lost their jobs, and there’s no end in sight of this. I think 2010 is going to be a bigger year than 2009. And then of course our friends at Fannie Mae and Freddie Mac. Again you can see delinquency rates are rising there dramatically. They are much lower than the—the risky mortgage types even though after some time these numbers are going to continue to rise as far as we can see. The next figure on figure seven shows you the same thing is happening with FHA. Big rises in delinquencies in the FHA mortgage program. So to summarize, we’re not done by any means. The cost to the government so far has been large with the bailouts. But I think that we—we see continual further losses over the next year, year and a half, in the residential mortgage market. So we’re not at all done. I do have some other data which we’ll be able to take in questions. But I— I’m hoping that I will be able to give you some advice in how this happened, and how it—we can make it not happen again. Thank you very much. FOMC20050630meeting--11 9,MR. RUDEBUSCH.," I will review some general issues related to monetary policy and asset prices. Let me start—at the top of page 1—by assuming that an asset price can, in theory at least, be separated into a component determined by underlying economic fundamentals and a non-fundamental or bubble component. An asset price may be in line with its fundamentals, so the bubble component is zero, or bubbles could be positive or negative—perhaps representing irrational euphoria or pessimism. June 29-30, 2005 15 of 234 of monetary policy. For example, a booming stock market is usually followed by higher demand and increased inflationary pressures, so tighter policy would be needed to offset these consequences. Even for the Standard Policy response, it will likely be useful to identify, if possible, the separate components of the asset price. In particular, the bubble component may exhibit more volatile dynamics and be a pernicious source of macroeconomic risk, so optimal policy would likely react more to bubbles than to movements in the fundamental component. The second type of response, the “Bubble Policy,” follows the Standard Policy as a base case, but, in certain circumstances, it also takes steps to contain or reduce the asset price bubble. Proponents of a Bubble Policy argue that movements in the bubble component can have serious adverse consequences for macroeconomic performance that monetary policy cannot readily offset after the fact, so it is preferable to try to eliminate this source of macroeconomic fluctuations directly. Furthermore, because bubbles often seem to display a self-reinforcing behavior, a little preemption and prevention early on can avoid later excesses. A best-case scenario for these two policies is illustrated in the lower half of the first page. Under ideal circumstances, the policymaker knows the fundamental and bubble components, and as history unfolds, the Standard Policy would likely recommend higher interest rates to offset any economic stimulus generated by the bubble before the crash and lower rates afterward. A Bubble Policy would go further and try to mitigate the fluctuations in the bubble and achieve an asset price path like AP′t . This would likely require higher interest rates than the Standard Policy before the crash and lower rates afterward, and it will likely trade off near- term deviations from the central bank’s macroeconomic goals for better overall macroeconomic performance later on. The fundamental difference between the two policies is that the Standard Policy takes the bubble component essentially as given or exogenous, while the Bubble Policy takes into account the endogenous nature of the bubble component—specifically, a linkage between the policy instrument and the bubble. A decision tree for choosing between the Standard and Bubble Policies is shown on page 2. In brief, it asks three questions: (1) Can policymakers identify a bubble? (2) Will fallout from a bubble be significant and hard to rectify ex post? and (3) Is monetary policy the right method to use to deflate the bubble? The answer to the first question—can policymakers identify a bubble?—is “no” if the particular asset price appears aligned with fundamentals. Some have argued that this is nearly always the case because estimates of fundamentals are so imprecise and because asset prices reflect the collective information and wisdom of professional traders in organized markets. If policymakers cannot discern a bubble, then the Standard Policy is the only feasible response. June 29-30, 2005 16 of 234 policy cannot readily offset after the fact. A negative answer to this question is appropriate in two situations. First, if the bubble is in an asset market that is small in domestic economic terms—for example, a localized real estate market—then a central banker should avoid attempts at asset price realignment. Second, even when there are significant macroeconomic consequences from an asset price bubble boom and bust, if they occur with a sufficient lag so the policymaker can adopt a wait-and­ see attitude, then the Standard Policy is again appropriate. This second case seems relevant if fluctuations in the bubble component have only conventional effects on aggregate demand and supply through changes in wealth, the cost of capital, and balance sheets. Then, to a first approximation, the lags involved in these channels are about as long as the lags in the monetary transmission mechanism; therefore, the Standard Policy should suffice. For example, fluctuations in equity prices will affect wealth and consumer demand, but a nimble central banker can essentially offset these consequences by changing interest rates in reaction to—that is, after—the equity price movements. Now to the case where asset price movements have significant macroeconomic consequences and those consequences are hard to clean up after the fact through monetary policy. The most often mentioned possibility is that a bursting asset price bubble will lead to a broad financial crisis and credit crunch. Such financial instability is likely to be transmitted to the economy much more quickly than can be offset by interest rate policy. This may set the stage for invoking a Bubble Policy. Another example is when the asset price misalignment results in significant misallocations of resources, which distort aggregate demand and supply across sectors and over time and impede the achievement of the highest possible long-run economic growth. For example, the dot-com bubble spurred overinvestment in fiber optic cable and decimated the provision of venture capital for new technology startups for years. Of course, after the fact, it is difficult to unwind these problems with the blunt instrument of monetary policy, and, depending on the specifics, it is possible to conceive of a situation in which reducing the bubble in advance is a preferred policy strategy. The final hurdle before invoking a Bubble Policy involves assessing whether monetary policy is the right way to deflate the asset price bubble. Ideally, for the Bubble Policy, a moderate adjustment of interest rates could constrain the bubble and greatly reduce the risk of severe future macroeconomic dislocations. However, bubbles, even if identified, often do not appear influenced by monetary policy actions in a predictable way. Furthermore, even if changing interest rates could alter the bubble path, such a strategy may involve substantial costs, including near-term deviations from the macroeconomic goals of the central bank as well as potential political or moral hazard complications. Finally, even if monetary policy can affect the bubble, alternative strategies to deflate it, such as changes in financial regulations or supervision, may be more targeted and have a lower cost. June 29-30, 2005 17 of 234 questions for two historical episodes. The first episode is the run-up in the stock market during the late 1990s. In 1999 and 2000, one could have made the case that there was an equity price bubble in the high-technology sector and perhaps in the overall market as well. Also, during that time, the possible capital misallocation from the run-up in prices and the possible financial instability that might have followed a bursting of the bubble may have appeared difficult to rectify. However, it was also unlikely that monetary policy could have deflated the equity price bubble without substantial costs to the economy. In the event, of course, a Bubble Policy was not followed, but arguably, the consequences from any bubble boom and bust have been manageable. A different example is provided by the bond market collapse in 1994. One could argue that this “inflation scare,” which pushed up yields on 30-year bonds by over 2 percentage points, resulted in an asset price misalignment that was fairly apparent to the FOMC during the second half of 1994. If this bond bubble had persisted, the widespread propagation of the associated fears of higher inflation could have had severe consequences that would have been costly to unwind with monetary policy later on. Finally, with regard to deflatability, it did appear likely that monetary policy could guide bond prices back to fundamentals. Indeed, one interpretation of the FOMC’s actions in 1994 is that it purposefully and successfully contained a bond market bubble with sizable increases in the funds rate. It is an open question which of these two episodes is the more relevant one today. That concludes my remarks." CHRG-109hhrg28024--179 Mr. Gillmor," Thank you, Mr. Chairman. Let me ask you, in terms of what has been happening in housing, and some people think we have a housing bubble, some don't. I think the Fed position is we don't. One of the things that has been happening is a great proliferation in zero percent down loans, adjustment of rate mortgages, and that was happening in a time of very low short term rates. Now, those are going up. Do you see any dangers to the system and what impact is this going to have on those borrowers? " FinancialCrisisInquiry--738 ROSEN: ... there’s no question about it that they set this one up, and used the wrong words. Matter of fact in 2007 the chairman who I respect a lot did say that it is demographic demand that was causing the housing market. I wrote a January 13, 2010 paper that he had read that said it wasn’t true. It was the credit bubble. But based—these demographic demand, all these other things which just the data don’t support it. CHRG-111hhrg53240--115 Chairman Watt," The gentleman's time has expired. The gentleman from Texas is recognized for 5 minutes. Dr. Paul. I thank you, Mr. Chairman. I have a question for Mr. Carr on how optimistic he might be about what we are trying to do. I tend toward pessimism at times; and I think the problem is almost bigger than what we are dealing with here, and we are just dealing on the edge of the basic problem. So the system that we have had has been around a long time. We have had a system--some people refer to it as capitalism that was unregulated. I happen to think that it doesn't have much to do with capitalism; it has to do with corporatism, where corporations seem to get the benefits of some of the programs that are designed to help the poor. We have multiple programs that have been going on for a long time designed to help the poor, and yet sometimes I think that is so superficial. The poor seem to become more numerous and the poor--especially since the crisis has hit; but it is always on a pretense to help the poor, and yet the corporations stand to make the money. So they make the money and they have the power and they have the insight with some of our financial institutions, including the Federal Reserve; and when the bubble forms, they benefit, and nobody complains too much if it seems to satisfy a lot of people. But when the bust comes, then we have a bailout. Who does the bailout serve? Do we immediately go out and bail out the people that we tried to get houses for? No. We immediately go out and bail out the system. So--the system is so deeply flawed, so they make the money when the bubble is being formed and they get bailed out when the bubble bursts. We come along with a new system that we hope will work. But for housing programs, for instance, you know, we want houses for the poor people, but developers make a lot of money, builders make a lot of money, mortgage companies make a lot of money, the banks make a lot of money. And all of a sudden the system doesn't work very well and the poor get wiped out and they lose their houses. So if we don't address that major problem, the structure of the system, this corporatism which has invaded us, how can this idea that, well, we will regulate a little bit in order to protect the consumer--I guess I am rather cynical, and I want you to tell me whether you share any of that concern, whether my cynicism sometimes is justified or not. " 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-111hhrg53245--130 Mr. Wallison," Yes. I have a comment on the question of bubbles. I think we have to distinguish this bubble from every other bubble. We will always have them. We are human beings. We tend to believe that when things are going in one direction, they will continue to go in one direction. That is both up and down. This bubble was completely different. In this bubble, we had 25 million subprime and non-traditional loans that are failing at rates that we have never seen before. The question we have to answer is, why did that happen? That is one of the major reasons that this particular bubble turned into a worldwide financial crisis. " fcic_final_report_full--475 Indeed, the Commission’s entire investigation seemed to be directed at minimizing the role of NTMs and the role of government housing policy. In this telling, the NTMs were a “trigger” for the financial crisis, but once the collapse of the bubble had occurred the “weaknesses and vulnerabilities” of the financial system— which had been there all along—caused the crisis. These alleged deficiencies included a lack of adequate regulation of the so-called “shadow banking system” and over-the-counter derivatives, the overly generous compensation arrangements on Wall Street, and securitization (characterized as “the originate to distribute model”). Coincidentally, all these purported weaknesses and vulnerabilities then required more government regulation, although their baleful presence hadn’t been noted until the unprecedented number of subprime and Alt-A loans, created largely to comply with government housing policies, defaulted. 6. Conclusion What is surprising about the many views of the causes of the financial crisis that have been published since the Lehman bankruptcy, including the Commission’s own inquiry, is the juxtaposition of two facts: (i) a general agreement that the bubble and the mortgage meltdown that followed its deflation were the precipitating causes—sometimes characterized as the “trigger”—of the financial crisis, and (ii) a seemingly studious effort to avoid examining how it came to be that mortgage underwriting standards declined to the point that the bubble contained so many NTMs that were ready to fail as soon as the bubble began to deflate. Instead of thinking through what would almost certainly happen when these assets virtually disappeared from balance sheets, many observers—including the Commission majority in their report—pivoted immediately to blame the “weaknesses and vulnerabilities” of the free market or the financial or regulatory system, without considering whether any system could have survived such a blow. One of the most striking examples of this approach was presented by Larry Summers, the head of the White House economic council and one of the President’s key advisers. In a private interview with a few of the members of the Commission (I was not informed of the interview), Summers was asked whether the mortgage meltdown was the cause of the financial crisis. His response was that the financial crisis was like a forest fire and the mortgage meltdown like a “cigarette butt” thrown into a very dry forest. Was the cigarette butt, he asked, the cause of the forest fire, or was it the tinder dry condition of the forest? 44 The Commission majority adopted the idea that it was the tinder-dry forest. Their central argument is that the mortgage meltdown as the bubble deflated triggered the financial crisis because of the “vulnerabilities” inherent in the U.S. financial system at the time—the absence 44 FCIC, Summers interview, p.77. of regulation, lax regulation, predatory lending, greed on Wall Street and among participants in the securitization system, ineffective risk management, and excessive leverage, among other factors. One of the majority’s singular notions is that “30 years of deregulation” had “stripped away key safeguards” against a crisis; this ignores completely that in 1991, in the wake of the S&L crisis, Congress adopted the FDIC Improvement Act, which was by far the toughest bank regulatory law since the advent of deposit insurance and was celebrated at the time of its enactment as finally giving the regulators the power to put an end to bank crises. CHRG-111hhrg56776--54 Mr. Watt," I thank the gentleman. The gentleman from Texas, Dr. Paul, the ranking member of the subcommittee. Dr. Paul. Thank you, Mr. Chairman. I have a question for Chairman Bernanke. During the early part of the decade, a lot of the free market economists keet saying, well, interest rates have been too low for too long, and there was a financial bubble and a housing bubble, and there had to be a correction. Of course, we did in 2008. Since 2008, many of the mainstream economists have more or less agreed with that assessment because frequently we will hear them say interest rates were held too low for too long, and I think even Secretary Geithner has made that statement. Where do you come down on that perception? Do you think interest rates were held too low for too long? " CHRG-110shrg50369--140 PREPARED STATEMENT OF SENATOR JIM BUNNING Thank you, Mr. Chairman. The health of our economy and financial markets is a concern to everyone here today. Growth has slowed and we have been through a rough patch in the credit markets. Everyone wants to see stability and growth return. Congress has acted to restore confidence in the economy. The Fed has taken steps to thaw the credit freeze. We hope that these policy actions will head off further damage, but no policy can reverse the busting of the housing bubble and we are not going to regulate away problems in the economy. While I have supported actions taken to respond to our economic problems, I fear they will have unintended consequences. I am most concerned about inflation and the fall of the dollar. We need to think beyond what we have already done and take steps to encourage long term growth. Congress can give taxpayers, businesses, and investors certainty that their taxes are not going to go up. Congress can knock down roadblocks to growth such as artificial limits on our energy supply. Congress can make it more appealing for corporations to stay in the United States by easing regulations and lowering the corporate tax rate. Only with long term permanent policies can we ensure a healthy economy for our grandchildren. I look forward to hearing from the Chairman. ______ 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) CHRG-111shrg57322--1219 Mr. Blankfein," In the context---- Senator Levin. The bubble burst in 2007. We are looking at the causes of that bubble bursting. " CHRG-111hhrg48674--266 Mr. McCotter," Thank you, Mr. Chairman. People in my district woke up one day sometime late last year and found out that the world, as they knew it economically, was going to end because someone had done something wrong to seize up the credit markets. And since that time they have witnessed disorder in the sense of the government's response. They have perceived this to be an unjust appropriation of their money, spent on the very people who caused the problem, and they see a long-term loss of economic freedom due to government intervention. And most importantly, they don't see much benefit to their daily lives from all the things that the government has done. My concern in studying human nature is twofold: one, the concept of ``too big to fail.'' When you tell people they are too big to fail, they will, because they know there is no responsibility to be incurred, no accountability if they do. Where is the stigma for the people who failed and put us in this mess? Where are the measures taken to ensure that they pay a price for their problems that they have put onto us? I don't see any. I don't see any at this point. And the second part of my question is kind of that these people thought they could go on forever doing what they were doing, that it would just keep going, that the dot-com bubble was replaced by a housing bubble, and it would never end. Now we are talking about creating a government bubble to fix the housing bubble, but they never thought they were wrong. I asked you and Mr. Paulson once, ``What happened?'' The answer was, ``Mistakes were made.'' Well, I understand human beings are fallible. But the problem is, if people think they are too big to fail or they are too important, the hubris that enters into the prognostications that they make and the actions that they take leads them to make very, very big mistakes. So my question is this: If these people were wrong and we are suffering the consequences of their bad decisions; if people like Mr. Greenspan, who has admitted he was wrong, have caused us to suffer the consequences of his bad decisions; if--as you have written a book about the Great Depression--the people at the Federal Reserve were wrong and the people at the time had to live with their bad decisions, what in the odd chance happens if you are wrong? What is your worst-case scenario for the decisions and the actions that you have made and taken being incorrect, how will that affect the people who sent me here to work for them? " FOMC20050630meeting--191 189,MR. LACKER.," Yes. I have just a couple of comments and a question. Clearly, there are some perspectives from which housing prices seem to have drifted out of the usual relationship with indicators of fundamentals, and Joshua documented some of them. But it seems to me as if there are a lot of plausible stories one can tell about fundamentals that would explain or rationalize housing prices. Obviously, low interest rates have to top the list. Strong income growth among homeowning populations would be on the list, as would land use restrictions, which were mentioned earlier, and the recent surge in spending on home improvement. I found President Yellen’s suggestions intriguing. I’d like to offer my own, just in the spirit of adding potential explanations here. And it’s really a version of something Governor Kohn observed, which is that housing prices are relative prices. I’ve been struck by the fact that a collection of large metropolitan areas increasingly dominates the national housing figures and that house-price appreciation seems different across various urban regions. It suggests to me that housing values may be affected significantly by—I don’t know exactly how to phrase this—sort of the relative microeconomic value of agglomeration. By that I mean the value of the amenities in a city or the enhanced productivity associated with living in or near where one works. Now, in this age of telecommuting and the Internet, it’s easy to deduce that the value of living in a city has declined. But it seems plausible to me that the value of a thick labor market might be increasingly important for certain skill specialties. And it also seems June 29-30, 2005 63 of 234 urban cores. So I’d be interested if any of our housing data experts have any information relevant to that issue. While I have the floor, I’d like to make just an observation. It seems to me likely that a confluence of several fundamental factors might rationalize the current level of housing prices. So from that point of view, it’s hard for me to see how it would be reasonable to place a great deal of certainty on the notion that housing is significantly overvalued, or that there’s a bubble, or that it’s going to collapse really soon. I think these markets—this is echoing President Poole’s discussion—are too complex. I think our quantitative understanding of them is too limited to warrant second-guessing market forces. And beyond that, the models that we have of bubbles—Glenn wrote it down—are just some statistical noise added to an equation. I don’t think we have any models that give us any reason to hope that we can understand how interest rate changes would affect this little random statistical term added on to these equations. Having said that, housing prices pose a dilemma for us and are going to pose challenges for us soon, I think. Rapid appreciations in asset prices can make monetary policy more difficult. They tend to be associated with tightening labor markets. At the same time, there is a rise in the downside risk. So, even though I’m not very far down Glenn’s decision tree, these are still issues I’m paying attention to. It feels as if it could well occupy our attention here. But I’d be interested in your reaction to this agglomeration story." CHRG-111hhrg48674--99 Mr. Hensarling," Not by way of criticism, but by way of observation, many economists believe that but for the actions of the Federal Reserve earlier in this decade fueling the then existing housing bubble, that we would not have the economic turmoil we have today. Again, nothing is quite as clear to us as 20-20 hindsight. But do you have an opinion on, if we had had explicit inflation targets earlier in the decade, whether or not we might have avoided the present economic turmoil? " CHRG-111shrg57319--92 Mr. Vanasek," Yes, it was. Senator Coburn. How do you account for the fact that somebody has seen a bubble, and by definition, a bubble is going to burst, and then their corporate strategy is to jump into the middle of that bubble? " CHRG-110hhrg46593--379 Mr. Feldstein," Housing prices have to fall further. So I don't think that government should be trying to stabilize house prices at the current level. They overshot on the way up. They have come partly down. They have to come down further. The danger is that they can way overshoot on the way down. And that would be a bad thing. That would destroy financial institutions that are holding mortgage-backed securities. It would destroy household wealth, which, in turn, would make people cut back on their spending. That, in turn, would drag the economy down. So the ideal thing would be to see house prices come down to a sustainable level but not overshoot on the way down. And that is why I talk about this firewall as a way of stopping house prices from falling beyond the amount that is necessary to get back to pre-bubble levels. " fcic_final_report_full--200 Looking back at how the targeted affordable portfolio performed in comparison with overall losses, the  presentation at Freddie Mac took the analysis of the goals’ costs one step further. While the outstanding  billion of these targeted af- fordable loans was only  of the total portfolio, these were relatively high-risk loans and were expected to account for  of total projected losses. In fact, as of late , they had accounted for only  of losses—meaning that they had performed better than expected in relation to the whole portfolio. The company’s major losses came from loans acquired in the normal course of business. The presentation noted that many of these defaulted loans were Alt-A.  COMMISSION CONCLUSIONS ON CHAPTER 9 The Commission concludes that firms securitizing mortgages failed to perform adequate due diligence on the mortgages they purchased and at times knowingly waived compliance with underwriting standards. Potential investors were not fully informed or were misled about the poor quality of the mortgages contained in some mortgage-related securities. These problems appear to have been signifi- cant. The Securities and Exchange Commission failed to adequately enforce its disclosure requirements governing mortgage securities, exempted some sales of such securities from its review, and preempted states from applying state law to them, thereby failing in its core mission to protect investors. The Federal Reserve failed to recognize the cataclysmic danger posed by the housing bubble to the financial system and refused to take timely action to con- strain its growth, believing that it could contain the damage from the bubble’s collapse. Lax mortgage regulation and collapsing mortgage-lending standards and practices created conditions that were ripe for mortgage fraud. CHRG-111hhrg55809--58 Mr. Royce," Let me ask you another question. Some economists are arguing that the Fed not only lost control, but its policy actions have unintentionally become procyclical--encouraging financial excesses instead of countering the extremes. And this gets to the point that has been argued by many economists. In fact, Friedrich Hayek won the Nobel Prize in 1974 for arguing that artificially low interest rates lead to the misallocation of capital and the bubbles which then lead to bursts. Looking back, do you agree that the negative real interest rate set by central banks from 2002 to 2006 had a dramatic impact on the boom and the subsequent bust, especially when you take into consideration what was already an inflating housing bubble with the drastic steps taken by the Federal Government to encourage less creditworthy borrowers to get into loans they could not afford? Do you think those combinations could have had an impact on that boom-bust? " CHRG-111shrg57322--725 Mr. Viniar," Correct. So we would have marked it down, but again, that is just an assessment which sometimes proves to be right and sometimes proves to be wrong, of what the value of holding that security would be---- Senator Kaufman. Right. Mr. Viniar [continuing]. In the future, where we think it was going to go, versus what the price would be of buying an offsetting security. Senator Kaufman. But you can understand why some people would be concerned. At the same time that a number of people in your business, in Goldman Sachs, were saying, this market is going south, which I think was--I happen to be one of those not Monday morning quarterbacking, but just at the time, the way I felt, and I am not--but just looking at where the housing market was in terms of where it had been historically, looking at the rental market and seeing the rental market wasn't growing, classic sign of a bubble, that--so there was incentive, kind of. I know you keep--there is an incentive here to go short. I mean, based on--especially, you get to 2007. Let me put it this way. I personally have a hard time believing that folks as smart as you guys didn't see the housing market was having a bubble and that the idea of going short was a good decision based on prudent managers looking at a market that was clearly falling apart. " fcic_final_report_full--172 The numbers were stark. Nationwide, house prices had never risen so far, so fast. And national indices masked important variations. House prices in the four sand states, especially California, had dramatically larger spikes—and subsequent de- clines—than did the nation. If there was a bubble, perhaps, as Fed Chairman Alan Greenspan said, it was only in certain regions. He told a congressional committee in June  that growth in nonprime mortgages was helping to push home prices in some markets to unsustainable levels, “although a ‘bubble’ in home prices for the na- tion as a whole does not appear likely.”  Globally, prices jumped in many countries around the world during the s. As Christopher Mayer, an economist from Columbia Business School, noted to the Commission, “What really sticks out is how unremarkable the United States house price experience is relative to our European peers.”  From  to , price in- creases in the United Kingdom and Spain were above those in the United States, while price increases in Ireland and France were just below. In an International Mon- etary Fund study from , more than one half of the  developed countries ana- lyzed had greater home price appreciation than the United States from late  through the third quarter of , and yet some of these countries did not suffer sharp price declines.  Notably, Canada had strong home price increases followed by a modest and temporary decline in . Researchers at the Federal Reserve Bank of Cleveland attributed Canada’s experience to tighter lending standards than in the United States as well as regulatory and structural differences in the financial system.  Other countries, such as the United Kingdom, Ireland, and Spain, saw steep house price declines. American economists and policy makers struggled to explain the house price in- creases. The good news was the economy was growing and unemployment was low. But, a Federal Reserve study in May  presented evidence that the cost of owning rather than renting was much higher than had been the case historically: home prices had risen from  times the annual cost of renting to  times.  In some cities, the change was particularly dramatic. From  to , the ratio of house prices to rents rose in Los Angeles, Miami, and New York City by , , and , re- spectively.  In , the National Association of Realtors’ affordability index—which measures whether a typical family could qualify for a mortgage on a typical home— had reached a record low.  But that was based on the cost of a traditional mortgage with a  down payment,  which was no longer required. Perhaps such measures were no longer relevant, when Americans could make lower down payments and ob- tain loans such as payment-option adjustable-rate mortgages and interest-only mort- gages, with reduced initial mortgage payments. Or perhaps buying a home continued to make financial sense, given homeowners’ expectations of further price gains. During a June meeting, the Federal Open Market Committee (FOMC), com- posed of Federal Reserve governors, four regional Federal Reserve Bank presidents, and the Federal Reserve Bank of New York president, heard five presentations on mortgage risks and the housing market. Members and staff had difficulty develop- ing a consensus on whether housing prices were overvalued and “it was hard for many FOMC participants . . . to ascribe substantial conviction to the proposition that overvaluation in the housing market posed the major systemic risks that we now know it did,” according to a letter from Fed Chairman Ben Bernanke to the FCIC. “The national mortgage system might bend but will likely not break,” and “neither borrowers nor lenders appeared particularly shaky,” one presentation ar- gued, according to the letter. In discussions about nontraditional mortgage prod- ucts, the argument was made that “interest-only mortgages are not an especially sinister development,” and their risks “could be cushioned by large down payments.” The presentation also noted that while loan-to-value ratios were rising on a portion of interest-only loans, the ratios for most remained around . Another presenta- tion suggested that housing market activity could be the result of “solid fundamen- tals.” Yet another presentation concluded that the impact of changes in household wealth on spending would be “perhaps only half as large as that of the s stock bubble.” Most FOMC participants agreed “the probability of spillovers to financial institutions seemed moderate.”  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-111hhrg61852--62 Mr. Mishel," I don't fashion myself as a housing expert, but I will offer what I can, which is I think we are still in the aftermath of the bursting of the housing bubble, and the prices haven't yet fully dropped to sort of reach the equilibrium. So there is not a lot of incentive to build more houses. The problem in the housing sector, which is one reason why I don't think monetary policy is what got us the recovery from early 2009 to now, because one of the main reasons you would expect monetary policy to lead to growth would be through restoring durable goods and construction, and that really hasn't happened. Other than that, I don't want to venture any other advice. Mr. Miller of North Carolina. Mr. Koo, we had a raging debate in this country a year and a half ago about whether the biggest banks were solvent and what to do about them if they weren't. From our distance from Japan, one of the explanations given for Japan's lost decade, now apparently going on two lost decades, was that there were zombie corporations and particularly zombie banks that were really insolvent, but no one was quite willing to pull the trigger at taking them into receivership. So they continued not to function normally. They continued to hoard cash so they could remain solvent on paper. And looking at the behavior of America's largest banks in the last year and a half, some of their behavior appears to be consistent with what is attributed to zombie banks. They are not lending normally. They are not making wholesome loans to people who are going to pay them back. They are emphasizing proprietary trading, which can kind of create a quicker profit when a bank is trying to get themselves back in the game. But most of all, their failure to make what appear to be economically sensible modifications of mortgages for people who can pay a mortgage on the house they are in, but not the one they have, for whatever reason. Does it appear to you that American banks are behaving normally, or are they behaving the way the zombie banks in Japan behaved in the 1990's? " fcic_final_report_full--487 In addition, Roubini and Parisi-Capone estimated that U.S. commercial and investment banks suffered a further mark-to-market loss of $225 billion on unsecuritized subprime and Alt-A mortgages. 57 They also estimated that mark-to- market losses for financial institutions outside the U.S. would be about 40 percent of U.S. losses, so there was likely to be a major effect on banks and other financial institutions around the world—depending, of course, on their capital position at the time the PMBS market stopped functioning. I am not aware of any data showing the mark-to-market effect of the collapse of the PMBS market on other U.S. financial institutions, but it can be assumed that they also suffered similar losses in proportion to their holdings of PMBS. Losses of this magnitude would certainly be enough—when combined with other losses on securities and loans not related to mortgages—to call into question the stability of a large number of banks, investment banks and other financial institutions in the U.S. and around the world. However, there was one other factor that exacerbated the adverse effect of the loss of a market for PMBS. Although accounting rules did not require all PMBS to be written down, investors and counterparties did not know which financial institutions were holding the weakest assets and how much of their assets would have to be written down over time. Whatever that amount, it would reduce their capital positions at a time when investors and counterparties were anxious about their stability. This was the balance sheet effect that was the third element of Chairman Bair’s summary. To summarize, then, the following are the steps through which the government’s housing policies transmitted losses—through PMBS—to the largest financial institutions: (i) the 19 million NTMs acquired or guaranteed by the Agencies were major contributors to the growth of the bubble and its extension in time; (ii) the growth of the bubble suppressed the losses that would ordinarily have brought the development of NTM-backed PMBS to a halt; (ii) competition for NTMs drove subprime lenders further out the risk curve to find high-yielding mortgages to securitize, especially when these loans did not appear to be producing losses commensurate with their risk; (iv) when the bubble finally burst, the unprecedented number of delinquencies and defaults among all NTMs—the great majority of which were held or guaranteed by the Agencies—caused investors to 56 Timothy F. Geithner, “Reducing Systemic Risk in a Dynamic Financial System,” Remarks at the Economic Club of New York, June 9, 2008, available at http://www.ny.frb.org/newsevents/speeches/2008/ tfg080609.html. 57 Nouriel Roubini and Elisa Parisi-Carbone, “Total $3.6 Trillion Projected Loan and Securities Losses,” p.7. flee the PMBS market, reducing the liquidity of the financial institutions that held the PMBS; and (v) mark-to-market accounting required these institutions to write down the value of the PMBS they held, as well as their other mortgage-related assets, reducing their capital positions and raising further questions about their stability and solvency. FOMC20050630meeting--356 354,MR. GUYNN.," Thank you, Mr. Chairman. Anecdotal reports from our regional contacts and the most recent data releases suggest that business conditions in the Southeast have remained positive since our last meeting. Florida, as has been the case for some time, has been dominant in terms of both employment growth and the pace of economic activity, given the strength in sectors such as tourism and housing. Coincident indicators, like personal income and state tax revenues, suggest that our District’s growth over the past several months has averaged about 3 percent, with major contributions coming not only from Florida but also from Alabama and, to a lesser extent, Georgia and Mississippi. District employment growth has been averaging roughly 35,000 per month until the disappointing report of only 3,000 new jobs in May. Our regional unemployment rate has been running about 0.2 percentage point below the national average. However, absent Florida, the rest of June 29-30, 2005 116 of 234 The apparent slowing in employment growth was a concern in terms of the regional outlook, although I would say that recent anecdotal reports on hiring are more encouraging than the official data. It seems to me that the key question from a policy perspective is whether there are signs of regional imbalances on either the price or the real side that might shed light on the national picture and on the broader risk to either growth or inflation. With respect to growth, the capital spending survey suggests that planned investment spending in our District remains solid. And the motivations for this are now more rooted in the expectation of increased sales rather than the need to cut costs, improve productivity, or to replace obsolete technology. Having said that, let me note that we received some interesting and sobering anecdotal comments from our directors. One director from the paper pulp and forest industry expressed concerns, perhaps selfish concerns, about the overexpansion for certain manufactured building supplies. He indicated, for example, that production capacity for building products such as gypsum wall board, concrete, and manufactured lumber was on a pace to expand 30 to 35 percent worldwide over the next three years. In the specific case of one product that is dear to his heart, oriented strand board, he said that the increase looks more like 40 percent. He characterized the industry’s very aggressive investment spending plans as preparing to, and I quote, “jump off the cliff yet again.” [Laughter] Our reports indicate that investment spending has also increased in the air cargo freight area, driven by international demand. Our bankers tell us that commercial and industrial lending remains highly competitive, with a resulting narrowing of spreads, although credit quality continues to be good. Our director from the forest product sector noted a continued softening in paper box demand, June 29-30, 2005 117 of 234 Finally, there is the housing situation, which we talked about for a long time yesterday afternoon. As I’ve been reporting for several meetings, some of our markets, especially those in coastal areas of South Florida and the Florida panhandle, are experiencing a level of building activity and price increases that are clearly, in my view, unsustainable. Nearly every major Florida city now has experienced increases in the double-digit range, and some, like Miami, Palm Beach, Sarasota, and West Palm, have been reporting increases in housing prices on a year-over-year basis of between 25 and 30 percent. While our discussion yesterday did not seem to indicate a consensus on a national housing bubble, based on past experience I’m reasonably comfortable characterizing the housing feeding frenzy in some of our markets as being a bubble or a near bubble. For example, the number of major projects planned or under construction in Miami now totals 114, most of which are high-rise developments. That includes 61,000 condo units—eight times the number that were built in the last decade—and a total of 100,000 new parking spaces. I know we don’t have any process for introducing exhibits into the record, but I’d like to pass Dave Stockton this pictorial of the new projects in Miami, so that he can continue to worry a little bit along with me. [Laughter] My supervision and regulation staff thinks this is an accident waiting to happen in our area. And while the local market excesses probably do not represent systemic national risk, the shakeouts could have serious regional consequences. My bank supervision staff points out that housing- related credit risks to our bank lenders are not so much from defaults on permanent mortgage financing that we talked about yesterday, but rather from lending for land acquisition, development, and construction. The ugly picture we have seen before—and that they think we may very likely see again June 29-30, 2005 118 of 234 developers to go ahead and complete the construction of additional units to make them saleable, further depressing the market; and speculators who had hoped to see big capital gains walking away or defaulting on their contracts, giving their properties back to the lender. Perhaps it’s because of where I sit, but I am less comforted than some of my colleagues about the housing situation. As for the national economy, my view is that real GDP growth is most likely to remain on its recent path, averaging around 3½ percent, which we judge to be very close to trend. Consumer spending seems to continue to be roughly in line with GDP growth, confidence has rebounded, investment spending is still supportive, and manufacturing has seemed a bit brighter in recent data reports. I would characterize employment growth as better than the “improving gradually” language would suggest, and I think it should be sufficient to at least keep the unemployment rate around current levels or perhaps nudge it even lower. I am less sure about the prospects for underlying inflation. But given the amount of policy accommodation that remains in place, and that will remain in place even if we raise our target rate another 25 basis points today, I believe the inflation risks are now on the upside. While the most recent monthly inflation numbers dipped a bit, the overall path for the last year has clearly been up. And the Greenbook forecast and other forecasts of inflation have been raised for the remainder of this year and into next year. Until further evidence is available, there is the risk of putting too much weight on the high-frequency numbers, such as the May PPI and CPI releases, and losing sight of the longer-run inflation path. Even more important than this, however, is the presence of the longer-term imbalances that we’ve talked about, which increase the risk to the economy. Most of these are largely beyond our June 29-30, 2005 119 of 234 troubles in our domestic auto industry and, of course, problems in the airline industry. Both of these latter problem areas may have undesirable spillover effects to financial markets. It also looks as if higher energy prices are here for a while, and this is reflected in futures prices. Higher energy costs will clearly squeeze energy-dependent businesses first, but I think we’ll also have uncertain trickle-down effects that can’t be good for other industries. I’ve already expressed my concerns about the unstable path of housing in at least some important local markets. I believe that the least risky policy strategy through these unusual times is to set monetary policy so that it does not contribute to unsustainable activities. Therefore, I believe that continuing on our recent policy path for the next few meetings would be the best course of action. Thank you, Mr. Chairman." FOMC20050630meeting--166 164,MR. KOHN.," Thank you, Mr. Chairman. I have three questions. The first one is on the price-to-rent ratio. We’ve been treating it as if most of the adjustment has come on prices. And I wanted to ask Josh particularly whether, as you’ve been looking at the micro data and thinking about this, the dynamics of some of these innovations that have led to a shift from renting to home ownership might have artificially depressed rents relative to prices. And I wondered, after that shift is over, if rents will start rising faster and close the gap that way—use up some of that 20 percent. My question is what you thought of that. And my observation is that that would present a much more difficult situation for us sitting around this table. It would be kind of like a supply shock because prices would be rising, inflation would be higher—and that homeowners’ equivalent rent June 29-30, 2005 54 of 234 if house prices fall. That’s a pure demand shock. But if rents start rising, that’s another matter. So I wondered if you’d comment on that. And then, while I have the floor, let me ask my questions of Glenn and John. Glenn, on the 1994 bubble analogy, I was surprised to see that classified as a bubble. I think there was some inflation scare then, but there was also a real rate adjustment at the same time. If you looked at any of the surveys, I think you wouldn’t have seen much of an increase in inflation expectations. I agree that we had to raise real rates in order to prevent that from happening. But that seems to me a very different animal than equity price changes or house-price changes because we are responsible for inflation. So if we see inflation moving, we’ve got to do something about that, whereas we’re not responsible for the relative prices of houses or equity and other things. So I wouldn’t have put 1994 on a list of situations we might think about as we’re looking at this issue of house-price gains. It seems to me very different. I’d like to hear your comment on that. And finally, my other question for John has to do with this point about the misallocation of resources. Doesn’t it matter what the state of the business cycle is? If we hadn’t had so many houses built and so much consumption over the last few years, we would have had more unemployment. So it’s not obvious that resources have been misallocated. The resources that went into building houses, furniture, and cars, and so forth might have been unemployed, especially if we had raised rates more in order to lean against the house-price increases. If we had, surely unemployment would be higher. So it seems to me that it’s one thing to talk about misallocating resources between two states of full employment, but it’s another thing to talk about a misallocation of resources where there would otherwise be slack in the economy. And the latter case I don’t think really is a misallocation of resources. There’s no opportunity cost. June 29-30, 2005 55 of 234 I’ve looked at the rent side of the picture. As to this idea that perhaps prices are getting too high relative to rents, I’d argue that they’re going to come back in line. Now, maybe rents are going to be doing some of the correcting, as it were. The work that I’ve done gives just a little hint of evidence that maybe rents do a bit of the correcting. So, what we might see going forward is rent growth slightly higher than it otherwise would have been. But statistically speaking, it’s basically no different from zero. Statistically, it doesn’t look like rents do any of the correcting. What really seems to be happening is that rents go up at some rate determined by economic conditions and then prices move around them." CHRG-111hhrg56847--255 Mr. Bernanke," There was a recession that began before--it came after the drop in the tech bubble, the dot-com bubble. March 2001, the recession began. " fcic_final_report_full--462 By 2008, the result of these government programs was an unprecedented number of subprime and other high risk mortgages in the U.S. financial system. Table 1 shows which agencies or firms were holding the credit risk of these mortgages- -or had distributed it to investors through mortgage-backed securities (MBS)-- immediately before the financial crisis began. As Table 1 makes clear, government agencies, or private institutions acting under government direction, either held or had guaranteed 19.2 million of the NTM loans that were outstanding at this point. By contrast, about 7.8 million NTMs had been distributed to investors through the issuance of private mortgage-backed securities, or PMBS, 16 primarily by private issuers such as Countrywide and other subprime lenders. The fact that the credit risk of two-thirds of all the NTMs in the financial system was held by the government or by entities acting under government control demonstrates the central role of the government’s policies in the development of the 1997-2007 housing bubble, the mortgage meltdown that occurred when the bubble deflated, and the financial crisis and recession that ensued. Similarly, the fact that only 7.8 million NTMs were held by investors and financial institutions in the form of PMBS shows that this group of NTMs were less important as a cause of the financial crisis than the government’s role. The Commission majority’s report focuses almost entirely on the 7.8 million PMBS, and is thus an example of its determination to ignore the government’s role in the financial crisis. Table 1. 17 Entity No. of Subprime Unpaid Principal Amount and Alt-A Loans Fannie Mae and Freddie Mac 12 million $1.8 trillion FHA and other Federal* 5 million $0.6 trillion CRA and HUD Programs 2.2 million $0.3 trillion Total Federal Government 19.2 million $2.7 trillion Other (including subprime and 7.8 million $1.9 trillion Alt-A PMBS issued by Countrywide, Wall Street and others) Total 27 million $4.6 trillion *Includes Veterans Administration, Federal Home Loan Banks and others. To be sure, the government’s efforts to increase home ownership through the AH goals succeeded. Home ownership rates in the U.S. increased from approximately 64 percent in 1994 (where it had been for 30 years) to over 69 percent in 2004. 18 Almost everyone in and out of government was pleased with this—a long term goal 16 In the process known as securitization, securities backed by a pool of mortgages (mortgage- backed securities, or MBS) and issued by private sector firms were known as private label securities (distinguishing them from securities issued by the GSEs or Ginnie Mae) or private MBS (PMBS). 17 See Edward Pinto’s analysis in Exhibit 2 to the Triggers Memo, April 21, 2010, p.4. http://www.aei.org/ docLib/Pinto-Sizing-Total-Federal-Contributions.pdf. 18 Census Bureau data. 457 of U.S. housing policy—until the true costs became clear with the collapse of the housing bubble in 2007. Then an elaborate process of shifting the blame began. 2. The Great Housing Bubble and Its Effects CHRG-111hhrg55809--195 Mr. Bernanke," In principle, it would be great. But there are two practical problems that we have to try to confront. One is actually identifying the bubble. And when the policies in question were taking place in 2003, 2004, there really was substantial disagreement among experts about whether this was a bubble and how big it was. The other problem is that by using monetary policy, which is a very blunt tool, to try to pop bubbles, you may have a side effect of having bad effects on the rest of the economy, because you can't just target one sector. That is why, even though, as I say, I am open-minded about the role of monetary policy in bubbles, in affecting bubbles, I do think that the first line of defense needs to be a stronger regulatory system that would, on the one hand, prevent excessive build-ups of risk in the first place; and if they do pop and if there is a problem like that, would make the system strong enough that it wouldn't create such an enormous crisis as we have seen recently. " CHRG-111hhrg48874--189 Mr. Foster," Yes. But you could actually imagine that someone like you would be in a position where the economy is going and the bubble is going up, and, you know, half of this committee is asking you, why are you squeezing the bubble when it's bubbling up? It seems to me that if you could establish formulas that at least provided a basis level for what the loan to value ought to be, then--and established a very high political threshold for changing that formula, that you'd have a much better defense against political pressure to, you know, not rain on the parade. " fcic_final_report_full--75 This resilience led many executives and regulators to presume the financial sys- tem had achieved unprecedented stability and strong risk management. The Wall Street banks’ pivotal role in the Enron debacle did not seem to trouble senior Fed of- ficials. In a memorandum to the FCIC, Richard Spillenkothen described a presenta- tion to the Board of Governors in which some Fed governors received details of the banks’ complicity “coolly” and were “clearly unimpressed” by analysts’ findings. “The message to some supervisory staff was neither ambiguous nor subtle,” Spillenkothen wrote. Earlier in the decade, he remembered, senior economists at the Fed had called Enron an example of a derivatives market participant successfully regulated by mar- ket discipline without government oversight.  The Fed cut interest rates aggressively in order to contain damage from the dot- com and telecom bust, the terrorist attacks, and the financial market scandals. In Jan- uary , the federal funds rate, the overnight bank-to-bank lending rate, was .. By mid-, the Fed had cut that rate to just , the lowest in half a century, where it stayed for another year. In addition, to offset the market disruptions following the / attacks, the Fed flooded the financial markets with money by purchasing more than  billion in government securities and lending  billion to banks. It also suspended restrictions on bank holding companies so the banks could make large loans to their securities affiliates. With these actions the Fed prevented a protracted liquidity crunch in the financial markets during the fall of , just as it had done during the  stock market crash and the  Russian crisis. Why wouldn’t the markets assume the central bank would act again—and again save the day? Two weeks before the Fed cut short-term rates in January , the Economist anticipated it: “the ‘Greenspan put’ is once again the talk of Wall Street. . . . The idea is that the Federal Reserve can be relied upon in times of crisis to come to the rescue, cutting interest rates and pumping in liquidity, thus providing a floor for equity prices.”  The “Greenspan put” was analysts’ shorthand for investors’ faith that the Fed would keep the capital markets functioning no matter what. The Fed’s policy was clear: to restrain growth of an asset bubble, it would take only small steps, such as warning investors some asset prices might fall; but after a bubble burst, it would use all the tools available to stabilize the markets. Greenspan argued that intentionally bursting a bubble would heavily damage the economy. “Instead of trying to contain a putative bubble by drastic actions with largely unpredictable consequences,” he said in , when housing prices were ballooning, “we chose . . . to focus on policies ‘to mitigate the fallout when it occurs and, hopefully, ease the transition to the next expansion.’”  CHRG-109hhrg28024--108 Chairman Oxley," The gentleman yields back. The gentle lady from California, Ms. Waters. Ms. Waters. Thank you very much, Mr. Chairman. I'm pleased to be here with you, Mr. Bernanke. I welcome you to this committee. We are going to miss Mr. Greenspan. No one talks like him, and we don't want you to. I had a great relationship with him. He's been to my district. I'm going to invite you. I want to continue this discussion this morning about rising inequality in two ways. I'm going to talk about housing a little bit more. It's been alluded to any number of ways this morning. I want to talk about the fact that many Americans are priced out of the market. They are not able to buy homes because of the rising cost. I am going to talk about this in relationship to affordable housing and what the Government can or cannot do. Some of the policies of this Administration are such that we don't have support for low- or moderate-income housing that we thought we had, and the cuts that are being made will eliminate the opportunities for first time home buyers and others to get into the housing market. We are concerned about this iddur. I'm also concerned about the bubble. The fact is that some people are stretched to buy a house. It cost too much. They got the special product loans, interest only loans, et cetera. And what is that going to mean to the economy if in fact this bubble does burst? I'd like you to give us a little discussion about housing and housing affordability in relationship to some of the things to which I've alluded and the rising interest rates. Secondly, I want to talk about investment in poor and minority communities. I used to have this conversation with Mr. Greenspan all the time. When I invited him to my district, it was to engage entrepreneurs and business persons and the financial services community in conversation about investment in poor communities. We know we have things like the new markets initiative that's been very helpful and could be even more helpful if in fact we could do more of that. What do you envision? What advice could you give us about how we could spur investment in these poorer communities, where investment can be the only possibility for growing these communities and expanding opportunities for jobs, et cetera? Do you have any ideas about this issue? What can you advise us? What can you work on that would help to expand the idea of the new market tax credit initiative in order to grow these poor communities? " FinancialCrisisReport--69 Mr. Vanasek shared his concerns with Mr. Killinger. At the Subcommittee’s hearing, Mr. Killinger testified: “Now, beginning in 2005, 2 years before the financial crisis hit, I was publicly and repeatedly warning of the risks of a potential housing downturn.” 177 In March 2005, he engaged in an email exchange with Mr. Vanasek, in which both agreed the United States was in the midst of a housing bubble. On March, 10, 2005, Mr. Vanasek emailed Mr. Killinger about many of the issues facing his risk management team, concluding: “My group is working as hard as I can reasonably ask any group to work and in several cases they are stretched to the absolute limit. Any words of support and appreciation would be very helpful to the morale of the group. These folks have stepped up to fixing any number of issues this year, many not at all of their own making.” 178 Mr. Killinger replied: “Thanks Jim. Overall, it appears we are making some good progress. Hopefully, the Regulators will agree that we are making some progress. I suspect the toughest thing for us will be to navigate through a period of high home prices, increased competitive conditions for reduced underwriting standards, and our need to grow the balance sheet. I 177 April 13, 2010 Subcommittee Hearing at 85. 178 3/2005 WaMu internal email chain, Hearing Exhibit 4/13-78. have never seen such a high risk housing market as market after market thinks they are unique and for whatever reason are not likely to experience price declines. This typically signifies a bubble.” 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-111hhrg53248--19 Mr. Royce," Thank you. I think getting to the bottom of what caused the housing bubble should be our primary objective here. And in point of fact, it was the Fed that came to us, came to this committee, and came to the Senate committee, and said that because of the size of the portfolios of Fannie and Freddie and because of the leverage ratios of 100 to 1, 100 to 1 in leverage, because of the direction for them to have purchased a trillion in subprime mortgages for their political, for their affordable housing goals and so forth, that they had to be regulated for systemic risk. In 2003, I put in a bill to do that working with the Fed. In 2005, we in fact had my amendment on the Floor to try to give the regulators the ability to regulate for systemic risk. Fannie and Freddie opposed it. Franklin Raines opposed it. It was opposed by most of the Members of this House. But in 2006, in the Senate, they actually got it out of committee. But again, the Democratic Members on the Senate side opposed that regulation to give the regulators the ability to handle Fannie and Freddie for systemic risk. That is the history of this. We need to address it. " 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. " CHRG-111hhrg53245--155 Mr. Zandi," Well, I think one of the root causes of the bubble in the housing market was that the process of securitization was fundamentally broken, that no one in the chain of the process had a clear understanding of all the risks in its entirety. The lenders made the loan. They sold it to the investment banks. The investment bank's package got the rating. The rating agencies then put their stamp on it. And then it was sold to Goldman investors. And no one was really looking at the entire system, making sure that the structure was properly working, that the loans that were ultimately being made were good loans. So the process of securitization fell apart. It just was not functioning well because in my view there was not a systemic risk regulator looking at it holistically and saying, does this make sense, and will it work if it is stressed under a bad economy, under a bad housing market? " FinancialCrisisInquiry--481 THOMPSON: So a bubble mentality. fcic_final_report_full--456 The Commission’s authorizing statute required that the Commission report on or before December 15, 2010. The original plan was for us to start seeing drafts of the report in April. We didn’t see any drafts until November. We were then given an opportunity to submit comments in writing, but never had an opportunity to go over the wording as a group or to know whether our comments were accepted. We received a complete copy of the majority’s report, for the first time, on December 15. It was almost 900 double-spaced pages long. The date for approval of the report was eight days later, on December 23. That is not the way to achieve a bipartisan report, or the full agreement of any group that takes the issues seriously. This dissenting statement is organized as follows: Part I summarizes the main points of the dissent. Part II describes how the failure of subprime and other high risk mortgages drove the growth of the bubble and weakened financial institutions around the world when these mortgages began to default. Part III outlines in detail the housing policies of the U.S. government that were primarily responsible for the fact that approximately one half of all U.S. mortgages in 2007 were subprime or otherwise of low quality. Part IV is a brief conclusion. -----------------------------------------------------Page 478-----------------------------------------------------  fcic_final_report_full--423 CAUSES OF THE FINANCIAL AND ECONOMIC CRISIS CONTENTS Introduction ......................................................................................................  How Our Approach Differs from Others’ .........................................................  Stages of the Crisis .............................................................................................  The Ten Essential Causes of the Financial and Economic Crisis .......................  The Credit Bubble: Global Capital Flows, Underpriced Risk, and Federal Reserve Policy ................................................................................  The Housing Bubble .........................................................................................  Turning Bad Mortgages into Toxic Financial Assets .........................................  Big Bank Bets and Why Banks Failed ...............................................................  Two Types of Systemic Failure ...........................................................................  The Shock and the Panic ...................................................................................  The System Freezing .........................................................................................  INTRODUCTION We have identified ten causes that are essential to explaining the crisis. In this dis- senting view: • We explain how our approach differs from others’; • We briefly describe the stages of the crisis; • We list the ten essential causes of the crisis; and • We walk through each cause in a bit more detail. We find areas of agreement with the majority’s conclusions, but unfortunately the areas of disagreement are significant enough that we dissent and present our views in this report. We wish to compliment the Commission staff for their investigative work. In many ways it helped shape our thinking and conclusions. Due to a length limitation recently imposed upon us by six members of the Com- mission,  this report focuses only on the causes essential to explaining the crisis. We regret that the limitation means that several important topics that deserve a much fuller discussion get only a brief mention here.  FinancialCrisisInquiry--221 How do you predict the long-term recovery? And how long do you think that recovery— how much longer will it take in circumstances like that? ZANDI: Well, first, let me say that one of the hallmarks of the Great Recession was how broad- based it was across industries and regions of the country. I mean, in past recessions, you always had a large region or two that avoided the recession, and that was a safety valve. People could move from Michigan and go to Florida or move from California to Nevada, and that wasn’t the case in this downturn. Now, having said that, obviously, there are some areas that are harder hit than others and those that suffer— well, were in the housing boom and bubble and now suffered the housing bust are the most severely hit, and that would include Nevada, Las Vegas, Arizona, California, particularly the Central Valley of California, Florida, Rhode Island, interestingly enough, for various reasons, and, obviously, parts of the industrial Midwest. And it will take much, much longer for an economy like Nevada and Florida to turn because its economic base is much less diversified. Obviously, it’s related to leisure and hospitality, which is a discretionary purchase and will not turn, and migration flows. And as I mentioned earlier, migration is going to be significantly impaired because one-third of homeowners with first mortgages, by my calculation, are underwater and can’t move or won’t move as easily. So Nevada’s problems are very severe and will be very long lasting. VICE CHAIRMAN THOMAS: Isn’t it also home construction? I mean, that was one of the fundamental industries in all those areas. And when that’s the problem and you can’t do it, you implode. ZANDI: Well, I—I would say housing in its totality, so that would include housing transactions, home sales. That’s demand, house prices ... and, obviously, housing construction. 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? " fcic_final_report_full--169 COMMISSION CONCLUSIONS ON CHAPTER 8 The Commission concludes declining demand for riskier portions (or tranches) of mortgage-related securities led to the creation of an enormous volume of col- lateralized debt obligations (CDOs). These CDOs—composed of the riskier tranches—fueled demand for nonprime mortgage securitization and contributed to the housing bubble. Certain products also played an important role in doing so, including CDOs squared, credit default swaps, synthetic CDOs, and asset- backed commercial paper programs that invested in mortgage-backed securities and CDOs. Many of these risky assets ended up on the balance sheets of systemi- cally important institutions and contributed to their failure or near failure in the financial crisis. Credit default swaps, sold to provide protection against default to purchasers of the top-rated tranches of CDOs, facilitated the sale of those tranches by con- vincing investors of their low risk, but greatly increased the exposure of the sellers of the credit default swap protection to the housing bubble’s collapse. Synthetic CDOs, which consisted in whole or in part of credit default swaps, enabled securitization to continue and expand even as the mortgage market dried up and provided speculators with a means of betting on the housing market. By layering on correlated risk, they spread and amplified exposure to losses when the housing market collapsed. The high ratings erroneously given CDOs by credit rating agencies encour- aged investors and financial institutions to purchase them and enabled the con- tinuing securitization of nonprime mortgages. There was a clear failure of corporate governance at Moody’s, which did not ensure the quality of its ratings on tens of thousands of mortgage-backed securities and CDOs. The Securities and Exchange Commission’s poor oversight of the five largest investment banks failed to restrict their risky activities and did not require them to hold adequate capital and liquidity for their activities, contributing to the fail- ure or need for government bailouts of all five of the supervised investment banks during the financial crisis. CHRG-109shrg24852--51 Chairman Greenspan," I do not know that. That is factually capable of being ascertained, and I assume some of my colleagues do know the answer to that question. It is not, in my judgment, at least what I have heard, an issue that is critical or something that requires immediate response. But it is enough of an issue that I think we have to look at it, and that is what we are doing, we are looking very closely. Senator Allard. I appreciate your response on that. Now, on various occasions you have downplayed the idea of a national housing bubble, and have instead pointed to a situation which some regions of the country are exhibiting signs of, I quote, ``froth'' I guess. And I am pleased to hear comments that while housing prices may well decline, such a decline would not necessarily derail the economy. Would you not agree though that while this may be true for the Nation as a whole, a correction could have a significant impact within a specific community or region? Could you please elaborate what the future could hold for such a city or region, and what can or should be done to mitigate the damage such a correction could cause? " fcic_final_report_full--19 BEFORE OUR VERY EYES In examining the worst financial meltdown since the Great Depression, the Financial Crisis Inquiry Commission reviewed millions of pages of documents and questioned hundreds of individuals—financial executives, business leaders, policy makers, regu- lators, community leaders, people from all walks of life—to find out how and why it happened. In public hearings and interviews, many financial industry executives and top public officials testified that they had been blindsided by the crisis, describing it as a dramatic and mystifying turn of events. Even among those who worried that the housing bubble might burst, few—if any—foresaw the magnitude of the crisis that would ensue. Charles Prince, the former chairman and chief executive officer of Citigroup Inc., called the collapse in housing prices “wholly unanticipated.”  Warren Buffett, the chairman and chief executive officer of Berkshire Hathaway Inc., which until  was the largest single shareholder of Moody’s Corporation, told the Commission that “very, very few people could appreciate the bubble,” which he called a “mass delusion” shared by “ million Americans.”  Lloyd Blankfein, the chairman and chief executive officer of Goldman Sachs Group, Inc., likened the financial crisis to a hurricane.  Regulators echoed a similar refrain. Ben Bernanke, the chairman of the Federal Reserve Board since , told the Commission a “perfect storm” had occurred that regulators could not have anticipated; but when asked about whether the Fed’s lack of aggressiveness in regulating the mortgage market during the housing boom was a failure, Bernanke responded, “It was, indeed. I think it was the most severe failure of the Fed in this particular episode.”  Alan Greenspan, the Fed chairman during the two decades leading up to the crash, told the Commission that it was beyond the abil- ity of regulators to ever foresee such a sharp decline. “History tells us [regulators] cannot identify the timing of a crisis, or anticipate exactly where it will be located or how large the losses and spillovers will be.”  In fact, there were warning signs. In the decade preceding the collapse, there were many signs that house prices were inflated, that lending practices had spun out of control, that too many homeowners were taking on mortgages and debt they could ill afford, and that risks to the financial system were growing unchecked. Alarm bells  were clanging inside financial institutions, regulatory offices, consumer service or- ganizations, state law enforcement agencies, and corporations throughout America, as well as in neighborhoods across the country. Many knowledgeable executives saw trouble and managed to avoid the train wreck. While countless Americans joined in the financial euphoria that seized the nation, many others were shouting to govern- ment officials in Washington and within state legislatures, pointing to what would become a human disaster, not just an economic debacle. “Everybody in the whole world knew that the mortgage bubble was there,” said Richard Breeden, the former chairman of the Securities and Exchange Commission appointed by President George H. W. Bush. “I mean, it wasn’t hidden. . . . You cannot look at any of this and say that the regulators did their job. This was not some hidden problem. It wasn’t out on Mars or Pluto or somewhere. It was right here. . . . You can’t make trillions of dollars’ worth of mortgages and not have people notice.”  Paul McCulley, a managing director at PIMCO, one of the nation’s largest money management firms, told the Commission that he and his colleagues began to get wor- ried about “serious signs of bubbles” in ; they therefore sent out credit analysts to  cities to do what he called “old-fashioned shoe-leather research,” talking to real es- tate brokers, mortgage brokers, and local investors about the housing and mortgage markets. They witnessed what he called “the outright degradation of underwriting standards,” McCulley asserted, and they shared what they had learned when they got back home to the company’s Newport Beach, California, headquarters. “And when our group came back, they reported what they saw, and we adjusted our risk accord- ingly,” McCulley told the Commission. The company “severely limited” its participa- tion in risky mortgage securities.  FinancialCrisisInquiry--709 ZANDI: Well, first, let me say that one of the hallmarks of the Great Recession was how broad- based it was across industries and regions of the country. I mean, in past recessions, you always had a large region or two that avoided the recession, and that was a safety valve. People could move from Michigan and go to Florida or move from California to Nevada, and that wasn’t the case in this downturn. Now, having said that, obviously, there are some areas that are harder hit than others and those that suffer— well, were in the housing boom and bubble and now suffered the housing bust are the most severely hit, and that would include Nevada, Las Vegas, Arizona, California, particularly the Central Valley of California, Florida, Rhode Island, interestingly enough, for various reasons, and, obviously, parts of the industrial Midwest. And it will take much, much longer for an economy like Nevada and Florida to turn because its economic base is much less diversified. Obviously, it’s related to leisure and hospitality, which is a discretionary purchase and will not turn, and migration flows. And as I mentioned earlier, migration is going to be significantly impaired because one-third of homeowners with first mortgages, by my calculation, are underwater and can’t move or won’t move as easily. So Nevada’s problems are very severe and will be very long lasting. FinancialCrisisInquiry--482 BASS: Well, do we prick the bubble or not? All right? CHRG-111shrg55739--117 Mr. Coffee," Let me say you are right, Senator. You probably wanted to hear that. You are right. And I have some charts in my statement that show that the percentage of liar loans, no-document and low-document loans, in subprime mortgages went from in the year 2001 about 28 percent to the year 2006 about 51 percent. That is a very sharp jump, and no one noticed because no one really wanted to look. The loan originators had no interest because they got rid of the entire loan. Senator Bunning. But the Federal Reserve was responsible for overseeing the banks that made those loans, and/or the mortgage brokers, we gave that power to the Fed and just because they did not write any regulations, we ran into all this mischief. And so the housing bubble and the bursting of it was caused by some not doing their homework. " CHRG-111hhrg49968--136 Mr. Nunes," There is some concern out there and there are some numbers that float out there that basically the Federal Government, in some form or fashion, is involved in 75 percent of all mortgage-backed securities, of all mortgages out there. And I think there is a concern out there that this could create another bubble, a different type of bubble long term where essentially you have the Federal Government owning everyone's home or their mortgage. Do you see this trend continuing? Do you agree with the 75 percent number? Is it lower than that? " fcic_final_report_full--117 The origination and securitization of these mortgages also relied on short-term fi- nancing from the shadow banking system. Unlike banks and thrifts with access to de- posits, investment banks relied more on money market funds and other investors for cash; commercial paper and repo loans were the main sources. With house prices al- ready up  from  to , this flood of money and the securitization appara- tus helped boost home prices another  from the beginning of  until the peak in April —even as homeownership was falling. The biggest gains over this pe- riod were in the “sand states”: places like the Los Angeles suburbs (), Las Vegas (), and Orlando (). FOREIGN INVESTORS: “AN IRRESISTIBLE PROFIT OPPORTUNITY ” From June  through June , the Federal Reserve kept the federal funds rate low at  to stimulate the economy following the  recession. Over the next two years, as deflation fears waned, the Fed gradually raised rates to . in  quarter- point increases. In the view of some, the Fed simply kept rates too low too long. John Taylor, a Stanford economist and former under secretary of treasury for international affairs, blamed the crisis primarily on this action. If the Fed had followed its usual pattern, he told the FCIC, short-term interest rates would have been much higher, discourag- ing excessive investment in mortgages. “The boom in housing construction starts would have been much more mild, might not even call it a boom, and the bust as well would have been mild,” Taylor said.  Others were more blunt: “Greenspan bailed out the world’s largest equity bubble with the world’s largest real estate bubble,” wrote William A. Fleckenstein, the president of a Seattle-based money management firm.  Ben Bernanke and Alan Greenspan disagree. Both the current and former Fed chairman argue that deciding to purchase a home depends on long-term interest rates on mortgages, not the short-term rates controlled by the Fed, and that short- term and long-term rates had become de-linked. “Between  and , the fed funds rate and the mortgage rate moved in lock-step,” Greenspan said.  When the Fed started to raise rates in , officials expected mortgage rates to rise, too, slow- ing growth. Instead, mortgage rates continued to fall for another year. The construc- tion industry continued to build houses, peaking at an annualized rate of . million starts in January —more than a -year high. As Greenspan told Congress in , this was a “conundrum.”  One theory pointed to foreign money. Developing countries were booming and—vulnerable to financial problems in the past—encouraged strong saving. Investors in these coun- tries placed their savings in apparently safe and high-yield securities in the United States. Fed Chairman Bernanke called it a “global savings glut.”  CHRG-111shrg57923--25 Mr. Liechty," I would be happy to. I will echo what Allan has said, what Dr. Mendelowitz has said, about in the importance in terms of political pressures that the institute is able to act in a way that it feels is in the best interest for the country. I have five reasons for being here: Joseph, Jacob, Sam, Matt, and Tom, my five boys. I want them to have a safe, secure financial system that gives them the same opportunity as I had when they grow up and get into the real world and start providing for a family. I think you need to have somebody who has the ability to speak the truth in the middle of a crisis or in the buildup to a crisis and can have the protection. There are really two roles that you think about in terms of systemic regulation. One is advisory, seeing and understanding the risks, and then speaking about them. The second one is the actual regulatory implementation, the different actions you might take in terms of how capital requirements--or how the institutions themselves are regulated. And I think it is very important to separate those two, and making the National Institute of Finance independent would do that. A second point that you want to consider in terms of why you want to keep the National Institute of Finance independent and why you want to also have somebody of high stature involved who is a Presidential appointee, who is going to be able to serve not at the will of the President but for a fixed term, is that if there is a crisis, again, that does happen and the National Institute of Finance is in place, all eyes will turn to the National Institute of Finance. And it needs to have absolute credibility. It needs in some sense to be like the National Oceanic and Atmospheric Administration. When it speaks, it is not speaking because it has some political agenda or because it has to worry about whether its budget is going to be cut or not cut. It is speaking because it is trying to serve the best interests of the Nation. Senator Reed. I want to invite the other panelists to comment also, but one other factor that I think strikes me is that it goes to your point about surprise, and I thought the analogy with the hurricane of 1938 was--I will borrow it. It seems very compelling. But part of this was this was never seriously discussed at a national level--``this'' meaning the growing housing bubble, the national characteristics of it, the growing derivatives trade from a notional value of X to 200X. And as a result, it sort of got lost in the shuffle, and I think one of the purposes of having an agency like this is to get critical topics on the agenda of Congress and the regulators. Then it is our responsibility. But if you do not have an authoritative institution supported by data doing that, then the problem I think you will have is that the next time it will be something different. It will not be a housing bubble and subprime mortgages. It will be something we are not even thinking about, and it will come up. Regulators will talk about it. I am sure the Fed debated internally about the housing bubble. I am sure that the OCC and everybody did. But it never broke through because there was no one tasked with saying this is a serious systemic risk or should be considered at least at this juncture as such. So that is my two bits on the point. Dr. Engle, please, and then Mr. Horne. " CHRG-111shrg57319--523 Mr. Killinger," I do not recall my exact timing. I do remember making public comments beginning in the middle part of 2005. I remember talking to the board from time to time about that there was growing risk because housing prices are growing faster than the rate of inflation. But also at the same time, I can remember everybody arguing of why that is going to be OK and it is unlikely to be a significant downturn in housing. We were kind of the front edge of trying to assess that there was a concern here. Senator Coburn. Well, that follows into my second question because in January 2005 is when you pushed forward a high-risk lending strategy for board approval. Only 2 months earlier, if you saw that prices would decline in the near future, why would you be pushing through a high-risk strategy on a market that you thought was a bubble? " CHRG-111hhrg53245--122 Mr. Garrett," It is not in their rules that they should be weighing in with regard to asset bubbles? " CHRG-109hhrg22160--148 Mr. Garrett," The bubble is about to burst as soon as I buy my house down here in the Washington, D.C., area. I assume it is going to--that is when the market price will start going down again. But going back to the GSEs. Assuming we take some action with regard to the regulatory nature of them, along the lines that have been suggested, is there some other method that we could also be looking into, a more efficient way to finance mortgages back into the private sector, to open up the private sector to allow them to have a more, if you will, competitive on a same playing field, that they can compete with the GSEs and open up that market so that they--if we are not just purely through the regulatory climate, we are actually allowing them to bring down that effect as well. " CHRG-111hhrg56776--57 Mr. Bernanke," If interest rates are below their normal levels, it is because the economy is operating at a very low level. Currently, we are not in anything an economist would call optimum equilibrium or anything like that. We certainly are in a situation where a lot of people are out of work and consumption is well below its normal levels and low interest rates serve the function of increasing demand and putting people back to work. Dr. Paul. You do not think that if interest rates are 2 and 3 percent instead of 6 percent, without artificially low interest rates, there would not be a temptation for people to build too many houses or people to try to capitalize on the fact they are anticipating price inflation and in the bubble? " FinancialCrisisReport--259 C. Mass Credit Rating Downgrades In the years leading up to the financial crisis, Moody’s and S&P together issued investment grade ratings for tens of thousands of RMBS and CDO securities, earning substantial sums for issuing these ratings. In mid-2007, however, both credit rating agencies suddenly reversed course and began downgrading hundreds, then thousands of RMBS and CDO ratings. These mass downgrades shocked the financial markets, contributed to the collapse of the subprime RMBS and CDO secondary markets, triggered sales of assets that had lost investment grade status, and damaged holdings of financial firms worldwide. Perhaps more than any other single event, the sudden mass downgrades of RMBS and CDO ratings were the immediate trigger for the financial crisis. To understand why the credit rating agencies suddenly reversed course and how their RMBS and CDO ratings downgrades impacted the financial markets, it is useful to review trends in the housing and mortgage backed security markets in the years leading up to the crisis. (1) Increasing High Risk Loans and Unaffordable Housing The years prior to the financial crisis saw increasing numbers of borrowers buying not only more homes than usual, but higher priced homes, requiring larger and more frequent loans that were constantly refinanced. By 2005, about 69% of Americans had purchased homes, the largest percentage in American history. 1005 In the five-year period running up to 2006, the median home price, adjusted for inflation, increased 50 percent. 1006 The pace of home price appreciation was on an unsustainable trajectory, as is illustrated by the chart below. 1007 1003 4/27/2007 email from Yuri Yoshizawa to Noel Kirnon, PSI-MOODYS-RFN-000044 (Attachment, PSI- MOODYS-RFN-000045). 1004 See S&P’s “Global Compensation Guidelines 2007/2008,” S&P-SEC 067708, 067733, 067740, and 067747. 1005 See 3/1/2006 “Housing Vacancies and Homeownership Annual Statistics: 2005,” U.S. Census Bureau. 1006 “Housing Bubble Trouble,” The Weekly Standard (4/10/2006). 1007 1/25/2010, “Estimation of Housing Bubble: Comparison of Recent Appreciation vs. Historical Trends,” chart prepared by Paulson & Co. Inc., Hearing Exhibit 4/23-1j. CHRG-111shrg51290--65 Many of these risky mortgage instruments were made in areas where housing was least affordable, such as California, Florida and Arizona, leading to concentrated areas of unsustainable housing values. (See Figures 3 and 4). This concentration of risky loans put the entire local markets at risk, due to the sudden and extreme withdrawal of credit in the aftermath of a bubble.\10\ \10\ See Susan M. Wachter, Andrey D. Pavlov & Zoltan Pozsar, Subprime Lending and Real Estate Markets, in Mortgage and Real Estate Finance__(Stefania Perrucci, ed., Risk Books 2008).--------------------------------------------------------------------------- Figure 3. Geographic Distribution of Interest-Only Loans, 2006.\11\--------------------------------------------------------------------------- \11\ Anthony Pennington-Cross, Mortgage Product Substitution and State Predatory Lending Laws, Presentation at the 2008 Mid-Year Meeting of the American Real Estate and Urban Economics Association, Washington, D.C., May 27, 2008. Figure 4. Geographic Distribution of Low-Documentation Loans, 2006\12\--------------------------------------------------------------------------- \12\ Id. fcic_final_report_full--403 H o u se h o l d Net W ort h The crisis wiped out much more wealth than other recent events such as the bursting of the dot-com bubble in 2000. IN TRILLIONS OF DOLLARS $ 7 0 60 50 $54.9 4 0 30 20 10 0 1952 1960 19 7 0 1980 1990 2000 2010 NO TE: Net worth i s assets m i nus li ab ili t i es for U . S . househo l ds . SOURC E: F edera l Reserve Fl ow of F unds Report Figure . early in . The homeownership rate declined from its peak of . in  to . as of the fall of . Because so many American households own homes, and because for most homeowners their housing represents their single most important asset, these declines have been especially debilitating. Borrowing via home equity loans or cash-out refinancing has fallen sharply. At an FCIC hearing in Bakersfield, California, Marie Vasile explained how her family had relocated  miles into the mountains to a rental house to help her hus- band’s fragile health.  Their old home was put up for sale and languished on the mar- ket, losing value. Eventually, she and her husband found buyers willing to take their house in a “short sale”—that is, a sale at a price less than the balance of the mortgage. But because the lender was acting slowly to approve that deal, they risked losing the sale and then going into foreclosure. “To top this all off,” Vasile told commissioners, “my husband is in the position of possibly losing his job. . . . So not only do I have a house that I don’t know what’s happening to, I don’t know if he’s going to have a job come December. This is more than I can handle. I’m not eating. I’m not sleeping.” Serious mortgage delinquencies—payments that are late  days or more or homes in the foreclosure process—have spread since the crisis. Among regions, the eastern states in the Midwest (Ohio, Indiana, Illinois, Wisconsin, and Michigan) had the highest delinquency rate, topping  in .  By fall , this rate had risen to .. Other regions also endured high rates—especially the so-called sand states, where the housing crisis was the worst. The third quarter  serious delinquency rate for Florida was .; Nevada, .; Arizona, .; and California, .. The data company CoreLogic identified the  housing markets with the worst records of “distressed” sales, which include short sales and sales of foreclosed proper- ties. Las Vegas led the list in mid-, with distressed sales accounting for more than  of all home sales.  “The state was overbuilt and some , jobs were predicated on a level of growth and consumer spending that seemed to evaporate al- most overnight,” Jeremy Aguero, an economic and marketing analyst who follows the Nevada economy, testified to the Commission.  fcic_final_report_full--448 The inability to find funding, financial firm deleveraging, and macroeconomic weakness translated into tighter credit for consumers and businesses. Securitization markets for other kinds of debt collapsed rapidly in  and still have not recovered fully, cutting off a substantial source of financing for credit cards, car loans, student loans, and small business loans. Decreased credit availability, the collapse of the housing bubble, and additional wealth losses from a declining stock market led to a sharp contraction in consump- tion and output and an increase in unemployment. Real GDP contracted at an annual rate of . percent in the third quarter of , . percent in the fourth quarter, and . percent in the first quarter of . The eco- nomic contraction in the fourth quarter of  was the worst in nearly three decades. Firms and households that had not previously been directly affected by the financial crisis suddenly pulled back–businesses stopped hiring and halted new in- vestments, while families put spending plans on hold. After the panic began, the rate at which the economy shed jobs jumped, going from an average of , jobs lost per month in the first three quarters of , to an average of over , jobs lost per month in the fourth quarter of  and the first quarter of . The economy continued to lose jobs through most of , with the unemployment rate peaking at . percent in October  and remaining above . percent for the rest of  and the first eleven months of . While the shock and panic therefore appear to have ended in early , the harm to the real economy continues through today. Firms and families are still deleverag- ing and are uncertain about both future economic growth and the direction of future policy. The final tragedy of the financial and economic crisis is that the needed recov- ery is slow and looks to be so for a while longer. NOTES 1. A vote of the Commission on December 6, 2010, limited dissenters to nine pages each in the approximately 550-page commercially published book. No limits apply to the official version sub- mitted to the President and the Congress. 2. Ben S. Bernanke, “Monetary Policy and the Housing Bubble,” Speech at the Annual Meeting of the American Economic Association, Atlanta, Georgia, January 3, 2010 (www.federalreserve.gov/ newsevents/speech/bernanke20100103a.htm). 3. Ibid. 4. “Risky borrowers” does not mean poor. While many risky borrowers were low-income, a borrower with unproven income applying for a no-documentation mortgage for a vacation home was also risky. 5. Bernanke, “Monetary Policy and the Housing Bubble.” 6. The Commission vigorously debated the relative importance and the motivations of the dif- ferent types of securitizers in lowering credit quality. We think that both types of securitizers were in part responsible and that these debates are less important than the existence of lower standards and how this problem fits into the broader context. 7. While bad information created by credit rating agencies was an essential cause of the crisis, it is less clear why they did this. Important hypotheses include: (1) bad analytic models that failed to account for correlated housing price declines across wide geographies, (2) an industry model that encouraged the rating agencies to skew their ratings upward to generate business, and (3) a lack of market competition due to their government-induced oligopoly. 8. In most cases during the crisis, the three key policymakers were Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke, and Federal Reserve Bank of New York Presi- dent Timothy Geithner. Other officials were key in particular cases, such as FHFA Director Jim Lockhart’s GSE actions and FDIC Chairman Sheila Bair’s extension of temporary loan guarantees to bank borrowing in the fall of 2008. During the financial recovery and rebuilding stage that be- gan in early 2009, the three key policymakers were Treasury Secretary Timothy Geithner, Fed Chairman Ben Bernanke, and White House National Economic Council Director Larry Summers. 9. Ben S. Bernanke, testimony before the FCIC, Hearing on Too Big to Fail: Expectations and Impact of Extraordinary Government Intervention and the Role of Systemic Risk in the Financial Crisis, session 1: The Federal Reserve, September 2, transcript, p. 78.  FOMC20050630meeting--118 116,VICE CHAIRMAN GEITHNER.," I remember that bubble! [Laughter] I have two questions. My first is for John Williams or perhaps for Dave Stockton. What is the right way to think about dealing with uncertainty in considering the policy question? Put aside Glenn’s question about whether you know anything ever about the relationship between prices and fundamentals at a given point. What if what you don’t know is simply the likely path of home prices going forward? You could take the group here around the table and assume some path, but there would be a fairly fat band of uncertainty around that path. What does your regime imply, John, for policy in that particular circumstance? Do you basically ignore housing prices and look at all the other things we look at?" fcic_final_report_full--226 THE BUST CONTENTS Delinquencies: “The turn of the housing market” .............................................  Rating downgrades: “Never before” ...................................................................  CDOs: “Climbing the wall of subprime worry” .................................................  Legal remedies: “On the basis of the information” .............................................  Losses: “Who owns residential credit risk?” ......................................................  What happens when a bubble bursts? In early , it became obvious that home prices were falling in regions that had once boomed, that mortgage originators were floundering, and that more and more families, especially those with subprime and Alt-A loans, would be unable to make their mortgage payments. What was not immediately clear was how the housing crisis would affect the fi- nancial system that had helped inflate the bubble. Were all those mortgage-backed securities and collateralized debt obligations ticking time bombs on the balance sheets of the world’s largest financial institutions? “The concerns were just that if people . . . couldn’t value the assets, then that created . . . questions about the solvency of the firms,” William C. Dudley, now president of the Federal Reserve Bank of New York, told the FCIC.  In theory, securitization, over-the-counter derivatives and the many byways of the shadow banking system were supposed to distribute risk efficiently among investors. The theory would prove to be wrong. Much of the risk from mortgage-backed securi- ties had actually been taken by a small group of systemically important companies with outsized holdings of, or exposure to, the super-senior and triple-A tranches of CDOs. These companies would ultimately bear great losses, even though those in- vestments were supposed to be super-safe. As  went on, increasing mortgage delinquencies and defaults compelled the ratings agencies to downgrade first mortgage-backed securities, then CDOs. Alarmed investors sent prices plummeting. Hedge funds faced with margin calls from their repo lenders were forced to sell at distressed prices; many would shut down. Banks wrote down the value of their holdings by tens of billions of dollars.  fcic_final_report_full--208 Credit default swaps greased the CDO machine in several ways. First, they al- lowed CDO managers to create synthetic and hybrid CDOs more quickly than they could create cash CDOs. Second, they enabled investors in the CDOs (including the originating banks, such as Citigroup and Merrill) to transfer the risk of default to the issuer of the credit default swap (such as AIG and other insurance companies). Third, they made correlation trading possible. As the FCIC survey revealed, most hedge fund purchases of equity and other junior tranches of mortgage-backed securities and CDOs were done as part of complex trading strategies.  As a result, credit de- fault swaps were critical to facilitate demand from hedge funds for the equity or other junior tranches of mortgage-backed securities and CDOs. Finally, they allowed spec- ulators to make bets for or against the housing market without putting up much cash. On the other hand, it can be argued that credit default swaps helped end the hous- ing and mortgage-backed securities bubble. Because CDO arrangers could more eas- ily buy mortgage exposure for their CDOs through credit default swaps than through actual mortgage-backed securities, demand for credit default swaps may in fact have reduced the need to originate high-yield mortgages. In addition, some market partic- ipants have contended that without the ability to short the housing market via credit default swaps, the bubble would have lasted longer. As we will see, the declines in the ABX index in late  would be one of the first harbingers of market turmoil. “Once [pessimists] can, in effect, sell short via the CDS, prices must reflect their views and not just the views of the leveraged optimists,” John Geanakoplos, a Yale economics professor and a partner in the hedge fund Ellington Capital Management, which both invested in and managed CDOs, told the FCIC.  CITIGROUP: “I DO NOT BELIEVE WE WERE POWERLESS” While the hedge funds were betting against the housing market in  and , Citigroup’s CDO desk was pushing more money to the center of the table. CHRG-111hhrg51591--41 Mr. Harrington," The question about whether the train has left the station, or I guess the horse leaves the barn as well, is a really good one. With AIG and then the life companies asking for TARP money, I have had to ask myself, basically the safety net has now been extended so far and there is really no going back or constraining it. And I don't think so. I think that the AIG situation and the asset bubble, the housing bubble, is unique enough that if we pay close attention to what happened and why and think about patching the places where there was a clear breakdown, whether it is the Office of Thrift Supervision or whatever, that maybe we can then think about the bigger picture, which is if we need to guarantee banks because of the payment system, do we want to have that guarantee spread implicitly or explicitly broadly throughout the financial system? And if we are going to have it spread one way or the other, then we probably should make it formal and regulate accordingly. We will have to have a lot tighter regulation in principle. But I would think as part of that process, maybe we could revisit the whole issue of what activities are fundamentally central to the economy that require a strong guarantee, and maybe revisit whether or not we don't need to wall-off those activities. I was always skeptical with Gramm-Leach-Bliley about how you allegedly can have part of the bank holding company guaranteed, and there is not going to be any spillover on the unguaranteed parts. To me that is fine in theory, but in practice probably doesn't work, so maybe we need to reconsider it. " FinancialCrisisInquiry--731 THOMPSON: So you live in California. And you’ve lived through the hubris of the dot com bubble. CHRG-111hhrg53245--123 Mr. Zandi," No. There is a reluctance to weigh against asset bubbles, yes, at the Federal Reserve. " CHRG-111shrg55278--112 PREPARED STATEMENT OF ALICE M. RIVLIN Senior Fellow, Economic Studies, Brookings Institution July 23, 2009 Mr. Chairman and Members of the Committee, I am happy to be back before this Committee to give my views on reducing systemic risk in financial services. I will focus on changes in our regulatory structure that might prevent another catastrophic financial meltdown and what role the Federal Reserve should play in a new financial regulatory system. It is hard to overstate the importance of the task facing this Committee. Market capitalism is a powerful system for enhancing human economic well-being and allocating savings to their most productive uses. But markets cannot be counted on to police themselves. Irrational herd behavior periodically produces rapid increases in asset values, lax lending and overborrowing, excessive risk taking, and outsized profits followed by crashing asset values, rapid deleveraging, risk aversion, and huge loses. Such a crash can dry up normal credit flows and undermine confidence, triggering deep recession and massive unemployment. When the financial system fails on the scale we have experienced recently the losers are not just the wealthy investors and executives of financial firms who took excessive risks. They are average people here and around the world whose jobs, livelihoods, and life savings are destroyed and whose futures are ruined by the effect of financial collapse on the world economy. We owe it to them to ferret out the flaws in the financial system and the failures of regulatory response that allowed this unnecessary crisis to happen and to mend the system so to reduce the chances that financial meltdowns imperil the world's economic well-being.Approaches To Reducing Systemic Risk The crisis was a financial ``perfect storm'' with multiple causes. Different explanations of why the system failed--each with some validity--point to at least three different approaches to reducing systemic risk in the future.The highly interconnected system failed because no one was in charge of spotting the risks that could bring it down. This explanation suggests creating a Macro System Stabilizer with broad responsibility for the whole financial system charged with spotting perverse incentives, regulatory gaps and market pressures that might destabilize the system and taking steps to fix them. The Obama Administration would create a Financial Services Oversight Council (an interagency group with its own staff) to perform this function. I think this responsibility should be lodged at the Fed and supported by a Council.The system failed because expansive monetary policy and excessive leverage fueled a housing price bubble and an explosion of risky investments in asset backed securities. While low interest rates contributed to the bubble, monetary policy has multiple objectives. It is often impossible to stabilize the economy and fight asset price bubbles with a single instrument. Hence, this explanation suggests stricter regulation of leverage throughout the financial system. Since monetary policy is an ineffective tool for controlling asset price bubbles, it should be supplemented by the power to change leverage ratios when there is evidence of an asset price bubble whose bursting that could destabilize the financial sector. Giving the Fed control of leverage would enhance the effectiveness of monetary policy. The tool should be exercised in consultation with a Financial Services Oversight Council.The system crashed because large interconnected financial firms failed as a result of taking excessive risks, and their failure affected other firms and markets. This explanation might lead to policies to restrain the growth of large interconnected financial firms--or even break them up--and to expedited resolution authority for large financial firms (including nonbanks) to lessen the impact of their failure on the rest of the system. Some have argued for the creation of a single consolidated regulator with responsibility for all systemically important financial institutions. The Obama Administration proposes making the Fed the consolidated regulator of all Tier 1 Financial Institutions. I believe it would be a mistake to identify specific institutions as too-big-to-fail and an even greater mistake to give this responsibility to the Fed. Making the Fed the consolidated prudential regulator of big interconnected institutions would weaken its focus on monetary policy and the overall stability of the financial system and could threaten its independence.The Case for a Macro System Stabilizer One reason that regulators failed to head off the recent crisis is that no one was explicitly charged with spotting the regulatory gaps and perverse incentives that had crept into our rapidly changing financial structure in recent decades. In recent years, antiregulatory ideology kept the United States from modernizing the rules of the capitalist game in a period of intense financial innovation and perverse incentives to creep in. Perverse Incentives. Lax lending standards created the bad mortgages that were securitized into the toxic assets now weighting down the books of financial institutions. Lax lending standards by mortgage originators should have been spotted as a threat to stability by a Macro System Stabilizer--the Fed should have played this role and failed to do so--and corrected by tightening the rules (minimum down payments, documentation, proof that the borrow understands the terms of the loan and other no-brainers). Even more important, a Macro System Stabilizer should have focused on why the lenders had such irresistible incentives to push mortgages on people unlikely to repay. Perverse incentives were inherent in the originate-to-distribute model which left the originator with no incentive to examine the credit worthiness of the borrower. The problem was magnified as mortgage-backed securities were resecuritized into more complex instruments and sold again and again. The Administration proposes fixing that system design flaw by requiring loan originators and securitizers to retain 5 percent of the risk of default. This seems to me too low, especially in a market boom, but it is the right idea. The Macro System Stabilizer should also seek other reasons why securitization of asset-backed loans--long thought to be a benign way to spread the risk of individual loans--became a monster that brought the world financial system to its knees. Was it partly because the immediate fees earned by creating and selling more and more complex collateralized debt instruments were so tempting that this market would have exploded even if the originators retained a significant portion of the risk? If so, we need to change the reward structure for this activity so that fees are paid over a long enough period to reflect actual experience with the securities being created. Other examples, of perverse incentives that contributed to the violence of the recent perfect financial storm include Structured Investment Vehicles (SIV's) that hid risks off balance sheets and had to be either jettisoned or brought back on balance sheet at great cost; incentives of rating agencies to produce excessively high ratings; and compensation structures of corporate executives that incented focus on short-term earnings at the expense the longer run profitability of the company. The case for creating a new role of Macro System Stabilizer is that gaps in regulation and perverse incentives cannot be permanently corrected. Whatever new rules are adopted will become obsolete as financial innovation progresses and market participants find ways around the rules in the pursuit of profit. The Macro System Stabilizer should be constantly searching for gaps, weak links and perverse incentives serious enough to threaten the system. It should make its views public and work with other regulators and Congress to mitigate the problem. The Treasury makes the case for a regulator with a broad mandate to collect information from all financial institutions and ``identify emerging risks.'' It proposes putting that responsibility in a Financial Services Oversight Council, chaired by the Treasury, with its own permanent expert staff. The Council seems to me likely to be cumbersome. Interagency councils are usually rife with turf battles and rarely get much done. I think the Fed should have the clear responsibility for spotting emerging risks and trying to head them off before it has to pump trillions into the system to avert disaster. The Fed should make a periodic report to the Congress on the stability of the financial system and possible threats to it. The Fed should consult regularly with the Treasury and other regulators (perhaps in a Financial Services Oversight Council), but should have the lead responsibility. Spotting emerging risks would fit naturally with the Fed's efforts to monitor the State of the economy and the health of the financial sector in order to set and implement monetary policy. Having explicit responsibility for monitoring systemic risk--and more information on which to base judgments would enhance its effectiveness as a central bank. Controlling Leverage. The biggest challenge to restructuring the incentives is: How to avoid excessive leverage that magnified the upswing and turned the downswing into a rout? The aspect of the recent financial extravaganza that made it truly lethal was the overleveraged superstructure of complex derivatives erected on the shaky foundation of America's housing prices. By itself, the housing boom and bust would have created distress in the residential construction, real estate, and mortgage lending sectors, as well as consumer durables and other housing related markets, but would not have tanked the economy. What did us in was the credit crunch that followed the collapse of the highly leveraged financial superstructure that pumped money into the housing sector and became a bloated monster. One approach to controlling serious asset-price bubbles fueled by leverage would be to give the Fed the responsibility for creating a bubble Threat Warning System that would trigger changes in permissible leverage ratios across financial institutions. The warnings would be public like hurricane or terrorist threat warnings. When the threat was high--as demonstrated by rapid price increases in an important class of assets, such as land, housing, equities, and other securities without an underlying economic justification--the Fed would raise the threat level from, say, Three to Four or Yellow to Orange. Investors and financial institutions would be required to put in more of their own money or sell assets to meet the requirements. As the threat moderated, the Fed would reduce the warning level. The Fed already has the power to set margin requirements--the percentage of his own money that an investor is required to put up to buy a stock if he is borrowing the rest from his broker. Policy makers in the 1930s, seeking to avoid repetition of the stock price bubble that preceded the 1929 crash, perceived that much of the stock market bubble of the late 1920s had been financed with money borrowed on margin from broker dealers and that the Fed needed a tool distinct from monetary policy to control such borrowing in the future. During the stock market bubble of the late 1990s, when I was Vice Chair of the Fed's Board of Governors, we talked briefly about raising the margin requirement, but realized that the whole financial system had changed dramatically since the 1920s. Stock market investors in the 1990s had many sources of funds other than borrowing on margin. While raising the margin requirements would have been primarily symbolic, I believe with hindsight that we should have done it anyway in hopes of showing that we were worried about the bubble. The 1930s legislators were correct: monetary policy is a poor instrument for counteracting asset price bubbles; controlling leverage is likely to be more effective. The Fed has been criticized for not raising interest rates in 1998 and the first half of 1999 to discourage the accelerating tech stock bubble. But it would have had to raise rates dramatically to slow the market's upward momentum--a move that conditions in the general economy did not justify. Productivity growth was increasing, inflation was benign and responding to the Asian financial crisis argued for lowering rates, not raising them. Similarly, the Fed might have raised rates from their extremely low levels in 2003 or raised them earlier and more steeply in 2004-5 to discourage the nascent housing price bubble. But such action would have been regarded as a bizarre attempt to abort the economy's still slow recovery. At the time there was little understanding of the extent to which the highly leveraged financial superstructure was building on the collective delusion that U.S. housing prices could not fall. Even with hindsight, controlling leverage (along with stricter regulation of mortgage lending standards) would have been a more effective response to the housing bubble than raising interest rates. But regulators lacked the tools to control excessive leverage across the financial system. In the wake of the current crisis, financial system reformers have approached the leverage control problem in pieces, which is appropriate since financial institutions play diverse roles. However the Federal Reserve--as Macro System Stabilizer--could be given the power to tie the system together so that various kinds of leverage ratios move in the same direction simultaneously as the threat changes. With respect to large commercial banks and other systemically important financial institutions, for example, there is emerging consensus that higher capital ratios would have helped them weather the recent crisis, that capital requirements should be higher for larger, more interconnected institutions than for smaller, less interconnected ones, and that these requirements should rise as the systemic threat level (often associated with asset price bubbles) goes up. With respect to hedge funds and other private investment funds, there is also emerging consensus that they should be more transparent and that financial derivatives should be traded on regulated exchanges or at least cleared on clearinghouses. But such funds might also be subject to leverage limitations that would move with the perceived threat level and could disappear if the threat were low. One could also tie asset securitization into this system. The percent of risk that the originator or securitizer was required to retain could vary with the perceived threat of an asset price bubble. This percentage could be low most of the time, but rise automatically if Macro System Stabilizer deemed the threat of a major asset price bubble was high. One might even apply the system to rating agencies. In addition to requiring rating agencies to be more transparent about their methods and assumptions, they might be subjected to extra scrutiny or requirements when the bubble threat level was high. Designing and coordinating such a leverage control system would not be an easy thing to do. It would require create thinking and care not to introduce new loopholes and perverse incentives. Nevertheless, it holds hope for avoiding the run away asset price exuberance that leads to financial disaster.Systemically Important Institutions The Obama administration has proposed that there should be a consolidated prudential regulator of large interconnected financial institutions (Tier 1 Financial Holding Companies) and that this responsibility be given to the Federal Reserve. I think this is the wrong way to go. It is certainly important to reduce the risk that large interconnected institutions fail as a result of engaging in highly risky behavior and that the contagion of their failure brings down others. However, there are at least three reasons for questioning the wisdom of identifying a specific list of such institutions and giving them their own consolidated regulator and set of regulations. First, as the current crisis has amply illustrated, it is very difficult to identify in advance institutions that pose systemic risk. The regulatory system that failed us was based on the premise that commercial banks and thrift institutions that take deposits and make loans should be subject to prudential regulation because their deposits are insured by the Federal Government and they can borrow from the Federal Reserve if they get into trouble. But in this crisis, not only did the regulators fail to prevent excessive risk taking by depository institutions, especially thrifts, but systemic threats came from other quarters. Bear Stearns and Lehman Brothers had no insured deposits and no claim on the resources of the Federal Reserve. Yet when they made stupid decisions and were on the edge of failure the authorities realized they were just as much a threat to the system as commercial banks and thrifts. So was the insurance giant, AIG, and, in an earlier decade, the large hedge fund, LTCM. It is hard to identify a systemically important institution until it is on the point of bringing the system down and then it may be too late. Second, if we visibly cordon off the systemically important institutions and set stricter rules for them than for other financial institutions, we will drive risky behavior outside the strictly regulated cordon. The next systemic crisis will then likely come from outside the ring, as it came this time from outside the cordon of commercial banks. Third, identifying systemically important institutions and giving them their own consolidated regulator tends to institutionalize ``too-big-to-fail'' and create a new set of GSE-like institutions. There is a risk that the consolidated regulator will see its job as not allowing any of its charges to go down the tubes and is prepared to put taxpayer money at risk to prevent such failures. Higher capital requirements and stricter regulations for large interconnected institutions make sense, but I would favor a continuum rather than a defined list of institutions with its own special regulator. Since there is no obvious place to put such a responsibility, I think we should seriously consider creating a new financial regulator. This new institution could be similar to the U.K.'s FSA, but structured to be more effective than the FSA proved in the current crisis. In the U.S. one might start by creating a new consolidated regulator of all financial holding companies. It should be an independent agency but might report to a board composed of other regulators, similar to the Treasury proposal for a Council for Financial Oversight. As the system evolves the consolidated regulator might also subsume the functional regulation of nationally chartered banks, the prudential regulation of broker-dealers and nationally chartered insurance companies. I don't pretend to have a definitive answer to how the regulatory boxes should best be arranged, but it seems to me a mistake to give the Federal Reserve responsibility for consolidated prudential regulation of Tier 1 Financial Holding Companies, as proposed by the Obama Administration. I believe the skills needed by an effective central bank are quite different from those needed to be an effective financial institution regulator. Moreover, the regulatory responsibility would likely grow with time, distract the Fed from its central banking functions, and invite political interference that would eventually threaten the independence of monetary policy. Especially in recent decades, the Federal Reserve has been a successful and widely respected central bank. It has been led by a series of strong macroeconomists--Paul Volcker, Alan Greenspan, Ben Bernanke--who have been skillful at reading the ups and downs of the economy and steering a monetary policy course that contained inflation and fostered sustainable economic growth. It has played its role as banker to the banks and lender of last resort--including aggressive action with little used tools in the crisis of 2008-9. It has kept the payments system functioning even in crises such as 9/11, and worked effectively with other central banks to coordinate responses to credit crunches, especially the current one. Populist resentment of the Fed's control of monetary policy has faded as understanding of the importance of having an independent institution to contain inflation has grown--and the Fed has been more transparent about its objectives. Although respect for the Fed's monetary policy has grown in recent years, its regulatory role has diminished. As regulator of Bank Holding Companies, it did not distinguish itself in the run up to the current crisis (nor did other regulators). It missed the threat posed by the deterioration of mortgage lending standards and the growth of complex derivatives. If the Fed were to take on the role of consolidated prudential regulator of Tier 1 Financial Holding Companies, it would need strong, committed leadership with regulatory skills--lawyers, not economists. This is not a job for which you would look to a Volcker, Greenspan, or Bernanke. Moreover, the regulatory responsibility would likely grow as it became clear that the number and type of systemically important institutions was increasing. My fear is that a bifurcated Fed would be less effective and less respected in monetary policy. Moreover, the concentration of that much power in an institution would rightly make the Congress nervous unless it exercised more oversight and accountability. The Congress would understandably seek to appropriate the Fed's budget and require more reporting and accounting. This is not necessarily bad, but it could result in more Congressional interference with monetary policy, which could threaten the Fed's effectiveness and credibility in containing inflation. In summary, Mr. Chairman: I believe that we need an agency with specific responsibility for spotting regulatory gaps, perverse incentives, and building market pressures that could pose serious threats to the stability of the financial system. I would give the Federal Reserve clear responsibility for Macro System Stability, reporting periodically to Congress and coordinating with a Financial System Oversight Council. I would also give the Fed new powers to control leverage across the system--again in coordination with the Council. I would not create a special regulator for Tier 1 Financial Holding Companies, and I would certainly not give that responsibility to the Fed, lest it become a less effective and less independent central bank. Thank you, Mr. Chairman and Members of the Committee. ______ 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. " 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-111hhrg55809--194 Mr. Paulsen," And if I could just switch gears then. Let me ask another question, the Federal Reserve's approach to managing monetary policy in advance of the last two recessions, if you go back in time, seems to be a little bit unstable. In other words, by waiting for an asset bubble to build up and then rescuing the economy after the bubble bursts, you know, it appears that you can create other problems. And just maybe give some comments on, why can't the Federal Reserve show a little bit more restraint in the monetary policy in advance when we are faced with what looks like a risky asset bubble coming down the pike? Would it ultimately be better to protect job loss or inflation down the road if we are able to--it is not often popular, for instance, to do it, but is that going to make more sense than--given the recent experience we have had recently, does that make more sense to look more in advance on that? " CHRG-111hhrg61852--61 Mr. Hinojosa," Madam Chairwoman, I am going to pass. I yield back. Mrs. McCarthy of New York. I recognize the gentleman from North Carolina. Mr. Miller of North Carolina. Thank you, Madam Chairwoman. This morning, Mr. Bernanke said that the housing market remains weak with the overhang of vacant and foreclosed homes weighing on home prices and construction. That seemed to be the kind of understatement that you would have expected from his predecessor. In 2005, housing starts were 2,068,000; last year, there were 554,000. Some have said that 2 million was way too many, that was part of the bubble. But from 1996 through 2002 or so, new housing starts were at 1.5 million to 1.6 million, and the estimate this year is that it is going to come in less than last year. That seems to be an enormous burden on the economy. That is a huge employer. Home building has been 16 percent of our GDP, and if it is a quarter of what it has been, it is hard to imagine how we are going to come out of the recession in a very strong way. And usually it is housing that has led us out of downturns in the past. There is some debate about what the problem is. Some have said we just have too many houses for our population. Others have said that it is really tied to the recession; that demand is down because of recessionary forces, the liquidity trap; that people aren't buying houses because nobody is buying the stuff that their employer is making, so their wages are down, or they are unemployed. And there is also the foreclosure crisis that continues to push down home values, which continues to be a huge disincentive to building new houses. There is a large number of houses that are foreclosed or destined for foreclosure that are either in the inventory or part of the shadow inventory. Mr. Mishel, what is your sense of what the demand is for housing now? If we got the economy functioning halfway normally, how many new housing starts could we expect in a year? And how much of this is because of foreclosure? How much of this is because of recessionary factors? " CHRG-110shrg50418--99 Mr. Morici," Yes. I think it is important to recognize that these three companies in the context of the other major Japanese competitors and Korean competitors, no one of them can decide to sit on the sidelines when there is a credit hysteria and not participate because of the loss of market share, then the consequent impact on their product development budgets and so forth. It isn't like they could get together and say, gee, we are making too much credit. You become part of the economy. It is much like the homebuyer in 2005 saying, gee, there may be a bubble out there. I should sit this out. And they sit it out 2 years and they find out the house costs $100,000 more than before. They have to participate. That said, America is over-car-ed just as it is over-housed. I am a macroeconomist and I know something about this. We can expect to sell fewer cars going forward for a variety of reasons. Credit is going to be more expensive. People are going to be saving more than they have in the past. The cars last longer. They are much more durable. People have been buying cars because they get tired of them, not because they wear out. I drive a Ford truck. " CHRG-110hhrg46591--34 The Chairman," I thank the gentleman. I would just take a second to note that both of them quite correctly pointed out that credit unions bear absolutely no responsibility for the bad lending practices, and I think they are entitled to that recognition. We will now begin with our witnesses. We will begin with Alice Rivlin, who is a senior fellow at the Metropolitan Policy Program, economic studies, and director at the Brookings Institution. Dr. Rivlin. STATEMENT OF THE HONORABLE ALICE M. RIVLIN, SENIOR FELLOW, METROPOLITAN POLICY PROGRAM, ECONOMIC STUDIES, AND DIRECTOR, GREATER WASHINGTON RESEARCH PROJECT, BROOKINGS INSTITUTION Ms. Rivlin. Thank you, Mr. Chairman, and members of the committee. Past weeks have witnessed historic convulsions in financial markets around the world. The freezing of credit markets and the failure of major financial institutions triggered massive interventions by governments and by central banks as they attempted to contain the fallout and to prevent total collapse. We are still in damage control mode. We do not yet know whether these enormous efforts will be successful in averting a meltdown, but this committee is right to begin thinking through how to prevent future financial collapses and how to make markets work more effectively. Now pundits and journalists have been asking apocalyptic questions: Is this the end of market capitalism? Are we headed down the road to socialism? Of course not. Market capitalism is far too powerful a tool for increasing human economic wellbeing to be given away because we used it carelessly. Besides, there is no viable alternative. Hardly anyone thinks we would be permanently better off if the government owned and operated financial institutions and decided how to allocate capital. But market capitalism is a dangerous tool. Like a machine gun or a chain saw or a nuclear reactor, it has to be inspected frequently to see if it is working properly and used with caution according to carefully thought-out rules. The task of this committee is to reexamine the rules. Getting financial market regulation right is a difficult and painstaking job. It is not a job for the lazy, the faint-hearted, or the ideologically rigid. Applicants for this job should check their slogans at the door. Too many attempts to rethink the regulation of financial markets in recent years have been derailed by ideologues shouting that regulation is always bad or, alternatively, that we just need more of it. This less versus more argument is not helpful. We do not need more or less regulation; we need smarter regulation. Moreover, writing the rules for financial markets must be a continuous process of fine-tuning. In recent years, we have failed to modernize the rules as markets globalized, as trading speed accelerated, as volume escalated, and as increasingly complex financial products exploded on the scene. The authors of the financial market rule books have a lot of catching up to do, but they also have to recognize that they will never get it right or will be able to call it quits. Markets evolve rapidly, and smart market participants will always invent new ways to get around the rules. It is tempting in mid-catastrophe to point fingers at a few malefactors or to identify a couple of weak links in a larger system and say those are the culprits and that if we punish them the rest of us will be off the hook, but the breakdown of financial markets had many causes of which malfeasance and even regulatory failure played a relatively small role. Americans have been living beyond their means individually and collectively for a long time. We have been spending too much, have been saving too little, and have been borrowing without concern for the future from whomever would support our overconsumption habit--the mortgage company, the new credit card, the Chinese Government, whatever. We indulged ourselves in the collective delusion that housing prices would continue to rise. The collective delusion affected the judgment of buyers and sellers, of lenders and borrowers and of builders and developers. For a while, the collective delusion was a self-fulfilling prophesy. House prices kept rising, and all of the building and borrowing looked justifiable and profitable. Then, like all bubbles, it collapsed as housing prices leveled off and started down. Now bubbles are an ancient phenomenon and will recur no matter what regulatory rules are put in place. A housing bubble has particularly disastrous consequences because housing is such a fundamental part of our everyday life with more pervasive consequences than a bubble in, say, dot com stocks. More importantly, the explosion of securitization and increasingly complex derivatives had erected a huge new superstructure on top of the values of the underlying housing assets. Interrelations among those products, institutions, and markets were not well-understood even by the participants. But it is too easy to blame complexity, as in risk models failed in the face of new complexity. Actually, people failed to ask commonsense questions: What will happen to the value of these mortgage-backed securities when housing prices stop rising? They did not ask because they were profiting hugely from the collective delusion and did not want to hear the answers. Nevertheless, the bubbles and the crash were exacerbated by clear regulatory lapses. Perverse incentives had crept into the system, and there were instances where regulated entities, even the Federal Reserve, were being asked to pursue conflicting objectives at the same time. These failures present a formidable list of questions that the committee needs to think through before it rewrites the rule book. Here are my offers for that list: We did have regulatory gaps. The most obvious regulatory gap is the easiest to fill. We failed to regulate new types of mortgages--not just subprime but Alt-A and no doc and all the rest of it--and the lax, sometimes predatory lending standards that went with them. Giving people with less than sterling credit access to homeownership at higher interest rates is actually, basically, a good idea, but it got out of control. Most of the excesses were not perpetrated by federally regulated banks, but the Federal authorities should have gotten on the case, as the chairman has pointed out, and should have imposed a set of minimum standards that applied to all mortgage lending. We could argue what those standards should be. They certainly should include minimum downpayments, the proof of ability to pay, and evidence that the borrower understands the terms of the loan. Personally, I would get rid of teaser rates, of penalties for prepayment and interest-only mortgages. We may not need a national mortgage lender regulator, but we need to be sure that all mortgage lenders have the same minimum standards and that these are enforced. Another obvious gap is how to regulate derivatives. We can come back to that. But much of the crisis stemmed from complex derivatives, and we have a choice going forward. Do we regulate the leverage with which those products are traded or the products themselves? " CHRG-111hhrg53244--200 Mr. Foster," And the second point is, do you think that the Fed is necessarily helpless to mitigate future real estate bubbles? For example, in this week's Economist Magazine, they discuss China's response. And of course, as you know, they are pushing very heavily on monetary policy and credit availability and so on, but at the same time, to avoid reinflating a real estate bubble they are turning up the mortgage origination requirements. You now have to put 40 percent down and so on, and so that they are independently operating both of those. Do you think that actually there is a reasonable role for the Fed or some other regulator to try to make this happen? " CHRG-111shrg54533--61 Secretary Geithner," I don't think you need to wait for the Fed on that to proceed with the legislative process on design. There is the specific set of questions around how to deal with some of the concerns Senator Shelby and others raised about the role of the Reserve Bank Boards, the set of firewalls and constraints that prevent involvement of Federal Reserve Bank Boards in supervision, a range of things like that where we think it would be appropriate for the Fed to try to clarify, bring recommendations for how to tighten up those kind of safeguards and constraints, and I think that can happen on that path without getting in the way of your efforts to consider legislation. I know the Chairman is considering coming together, and will be happy, I am sure, to come before the Committee and talk about what role they think the Fed should play in looking at systemic risk and how to respond to the concerns many of you raised that that not distract them from their core responsibilities for monetary policy. Senator Reed. You know, my sense is that with these new responsibilities, there has to come not only new organizational arrangements, which we would like to, I guess, have them suggest what their recommendations are, and then second, I think, is even the issue of culture. That is this issue of is it safety and soundness trumps everything else? I think also, too, in terms of transparency, one of the--my sense from talking in hearings and just generally is that, you know, there were rather vigorous debates in the Fed about is there a housing bubble, is there not a housing bubble, were savings rates too low, et cetera. That never got out. How do we have an agency that is going to be transparent in terms of these issues? Similarly, will there be an independent analytical staff? Will there be someone charged, not just at the Board, but a Deputy for Systemic Regulation that may or may not be subject to the confirmation process? And then this raises the bigger issue which many of my colleagues have talked about is just oversight. Ultimately, they are imposing legislation. I can recall, along with many others, writing several letters, I think, to the Fed about one of these HOEPA regulations coming out. So these are critical issues and I wonder if you could just comment briefly. " CHRG-111hhrg55814--361 Mr. Foster," So you contemplate using it in concert with monetary policy? For example, to cool off a real estate bubble? " FOMC20050503meeting--172 170,MR. STOCKTON.," Just briefly, the special topic at the June meeting will be the question of May 3, 2005 103 of 116 has developed. The lineup is Josh Gallin and Andreas Lehnert here at the Board. They are going to present our views on the probability and potential magnitude of an asset price misalignment in residential real estate markets. And they’re also going to talk about how that might unwind if, in fact, there is some overvaluation. They will address the issues of whose balance sheet the risks reside on and what the consequences might be for household and financial institutions should we get a more serious retrenchment in house prices. Dick Peach from the New York Fed is going to offer a more skeptical assessment of those bubble concerns, and Glenn Rudebusch and John Williams of the San Francisco Fed have agreed to discuss what, if any, consequences there might be from conditions in the housing market for your monetary policy. We’re going to post the presentations at least a week in advance, and we’ll also post any supporting materials as they become available." FOMC20060131meeting--116 114,MR. KOHN.," Thank you, Mr. Chairman. The projections I submitted for this meeting reflected expectations of an economy that probably is operating in level terms somewhere in the neighborhood of its long-run, sustainable potential and will continue to do so over the next two years with growth broadly in line with the growth of potential and inflation basically stable. My forecasts for 2006 are very close to those I submitted last January and June. That’s partly a product of innate stubbornness. [Laughter] But it also reflects the fact that 2005 came in largely as expected—after allowance for hurricanes and an energy shock last year that elevated core inflation and damped growth somewhat compared with our forecasts last January. This is encouraging in that it suggests that we are not looking at major unexplained and unanticipated forces acting on the economy. At this point, our focus appropriately is on keeping inflation contained. I see several reasons for optimism in this regard. One is the performance of core consumer prices and price measures, which continue to suggest that the pass-through of higher energy prices will be limited. Core inflation was roughly stable last year. It picked up a bit in the fourth quarter, but that was from unusually low readings in the third quarter. Declining consumer inflation expectations in the most recent Michigan survey, along with the failure of market-based inflation compensation readings to respond significantly to the substantial run-up in oil prices and higher core readings over the intermeeting period, just reinforce my assessment that any pass-through should be small and limited in duration. As we noted at the last meeting, perhaps the greater threat to sustained good inflation performance comes from possible increases in pressures on resources. The critical question is whether growth in output close to trend is a reasonable expectation with only modest further policy firming, given the low level of long-term rates, reduced drag from energy prices, and a boost from rebuilding. I thought it was a reasonable expectation, for a number of reasons. First, after smoothing through the fluctuations caused by auto incentives and hurricanes, private domestic final demand already showed signs of moderation last year. Growth in private domestic final sales slowed from 4¼ percent in the first half of the year to 3 percent in the second half of the year, with every element—consumption, business fixed investment, residential housing investment— moderating. The staff estimates that about 0.3 of this was due to hurricane effects, but that still leaves underlying private demand slowing to an annual rate of about 3¼ or 3½ percent. This moderation did not reflect the full effects of our policy tightening, especially on the housing market. Even well-anticipated increases in the short-term rates seem to be having a significant effect on housing markets, which have become more dependent on adjustable rate mortgages to maintain affordability. We are just beginning to see the anticipated slowdown in this sector. With growth in consumption and sales constrained by a leveling-out of housing wealth, businesses are unlikely to see the need to step up the pace at which they are adding to their capital stock. As a consequence, investment growth could slow, at least slightly, over the next few years, reflecting reduced impetus from the accelerator. Finally, although foreign economies are strengthening some, foreign investment and consumption remain subdued relative to income. And given our continuing outsized appetite for imports, net exports are unlikely to be putting added impetus to demands on domestic production. I think there are several upside and downside risks around this picture of growth near potential, as a number of you pointed out. I agree that the housing market is the most likely source of a shortfall in demand. I don’t think we can have much confidence about how the dynamics of this market will play out now that it has begun to soften. My suspicion is that, as little bubbles in the froth are popped, the risks are tilted more toward quite a sharp cooling off than toward a very gradual ebbing of price increases and building activity. On the other side, it seems to me global demand would be a major upside risk to growth and to price stability. The extraordinarily rapid rise in commodity prices and upward movement in global equity prices may indicate a very fundamental turnaround in foreign demand and attitudes beyond just a stepwise strengthening of growth. For now, these remain risks that we’ll need to monitor. In making my forecast, I assumed we would tighten at this meeting, and likely at the next as well, to gain greater assurance that inflation will remain contained over time, consistent with my forecast of a 1¾ percent increase in core prices in 2007. However, I do see action in March as dependent on the readings we get in coming months. There is, as usual, considerable uncertainty about the precise nature and magnitude of the risk to the outlook, but we’re dealing with an economic picture that overall is remarkably good and expected to remain that way for the foreseeable future. Reflecting on this situation, among many, many aspects of the past, I end my remarks as I began them: Thank you, Mr. Chairman." CHRG-111hhrg56766--267 Mr. Bernanke," We are monitoring that very carefully. It is obviously very difficult to know if there is a bubble, particularly in the early stages. Our best assessment right now is there is not any obvious level in U.S. economy. If there was a bubble, then the response probably would depend on which asset it was, what part of the economy it was. My view is that in the longer term, when possible, you want to address those kinds of systemic risks through regulation and supervision rather than through monetary policy, but if there were not appropriate tools, and you are right, there are some countries where they can vary the loan to value ratio as a policy tool, which I think-- " CHRG-109hhrg22160--147 Mr. Greenspan," I think we are running into certain problems in certain localized areas. We do have characteristics of bubbles in certain areas but not, as best I can judge, nationwide. And I don't expect that we will run into anything resembling a collapsing bubble. I do believe that it is conceivable that we will get some reduction in overall prices, as we have had in the past, but that is not a particular problem. Remember that there is a very significant buffer in home equity at this stage because with most of mortgages being of conforming type with a 20 percent down payment, and even when it is less, prices since the homes were bought have gone up on average very considerably, so we have a fairly large buffer against price declines and therefore difficulties which would emerge with homeowners. " CHRG-111shrg57319--91 Mr. Cathcart," I would say the Board was responsive. The Board would continually ask management why progress hadn't been made on certain chronic issues which were repeat items from both internal audit, credit review, and from the regulators. But it appeared as if there was little consequence to these problems not being fixed. Senator Coburn. OK. Thank you. Mr. Vanasek, on Exhibit 78a,\1\ there is an email exchange between you and Mr. Killinger where he said, ``I have never seen such a high-risk housing market. . . . This typically signifies a bubble.'' You responded, ``All the classic signs are there.'' Wasn't this email written just months after WaMu made a strategic decision to shift to riskier lending?--------------------------------------------------------------------------- \1\ See Exhibit No. 78a, which appears in the Appendix on page 790.--------------------------------------------------------------------------- " FOMC20050630meeting--193 191,MR. STOCKTON.," That certainly seems possible. When I look at Josh’s exhibit 3 on page 5, I see the Miami price-rent ratio at 64 percent above its trend. Now, it’s possible that everybody just woke up and decided, boy, there are people in Miami who are just really terrific to be around—it’s an exciting city and fascinating people live there. [Laughter] But it’s also possible that that statistic could be an indication that people have unrealistic expectations about the rate of increase in house prices expected in Miami. And there is certainly a lot of anecdotal evidence that in that particular city there is a lot of flipping of properties going on as well as other developments that might not be reflective of a purely equilibrium move in house prices or of agglomeration economies. So I’m still a little nervous about this. There are a lot of good reasons why prices ought to be high relative to rents and relative to incomes. And I think even President Poole’s suggestion that maybe housing is undervalued can’t be ruled out. We’ve done simple dividend discount-type calculations on rents and interest rates. And if you make a certain assumption about the growth rate of real rents going forward and the persistence of low interest rates, you can get figures showing further appreciation of maybe not 40 percent but rates that are pretty high. So we think that’s within June 29-30, 2005 65 of 234 nation as a whole a run-up in prices that certainly looks very unusual by historical standards. It could very well be that this time is different and it’s all being driven by fundamentals. But we don’t think you should rule out the possibility that you could be facing a period in which prices could be declining or just be softer. One point that has been made is that we obviously don’t know how the end will look—if there is an end. The end could come through a long period of just relatively subdued growth in nominal house prices. It wouldn’t have to be associated with a 20 percent decline. As we noted in the Greenbook, that is an extreme drop. In fact, to get to John’s scenario 3, a lot of extreme things have to happen. It takes an unusually large drop in house prices and a lot of spillover effects. As you recall, the first scenario was pretty tame; if you move down 50 basis points on interest rates, it offsets that. But if you layer on top of the decline in house prices a big drop in consumer confidence, a big equity extraction effect, or a much bigger wealth effect from housing—which looks to us to be pretty much on the edge—and throw in some covariance with a bond market event, the situation worsens substantially. But it takes a lot to get to a real disaster type of scenario. So even though we feel that house prices have moved out of alignment with the fundamentals, we don’t necessarily think the implications of that are that you’re going to be confronted immediately with some large problem. In fact, our best guess would be that the misalignment would unwind in ways that would be quite feasible for you to offset and insulate. There are questions on the supervisory side. There I don’t think the historical evidence suggests that supervisory policy has been used effectively to head off asset bubbles or to elegantly deflate them when they occur. What you might hope to do is to have in place policies that will prevent the kind of spillover effects of John’s scenario 2 so that you just have a wealth effect. In June 29-30, 2005 66 of 234 sheets as a reduction in wealth. One might hope that they respond accordingly and that we won’t have the complications with intermediation or other kinds of things that would add to that effect. So our story basically is that we’re worried about valuations in the housing market, but we don’t necessarily see that as having profound consequences for your policy going forward." fcic_final_report_full--427 STAGES OF THE CRISIS As of December , the United States is still in an economic slump caused by a fi- nancial crisis that first manifested itself in August  and ended in early . The primary features of that financial crisis were a financial shock in September  and a concomitant financial panic . The financial shock and panic triggered a severe con- traction in lending and hiring beginning in the fourth quarter of . Some observers describe recent economic history as a recession that began in December  and continued until June , and from which we are only now be- ginning to recover. While this definition of the recession is technically accurate, it ob- scures a more important chronology that connects financial market developments with the broader economy. We describe recent U.S. macroeconomic history in five stages: • A series of foreshocks beginning in August , followed by an economic slowdown and then a mild recession through August , as liquidity prob- lems emerged and three large U.S. financial institutions failed; • A severe financial shock in September , in which ten large financial institu- tions failed, nearly failed, or changed their institutional structure; triggering • A financial panic and the beginning of a large contraction in the real economy in the last few months of ; followed by • The end of the financial shock, panic, and rescue at the beginning of ; followed by • A continued and deepening contraction in the real economy and the beginning of the financial recovery and rebuilding period. As of December , the United States is still in the last stage. The financial sys- tem is still recovering and being restructured, and the U.S. economy struggles to re- turn to sustained strong growth. The remainder of our comments focuses on the financial crisis in the first three stages by examining its ten essential causes. THE TEN ESSENTIAL CAUSES OF THE FINANCIAL AND ECONOMIC CRISIS The following ten causes, global and domestic, are essential to explaining the finan- cial and economic crisis. I. Credit bubble. Starting in the late s, China, other large developing countries, and the big oil-producing nations built up large capital surpluses. They loaned these savings to the United States and Europe, causing interest rates to fall. Credit spreads narrowed, meaning that the cost of borrowing to finance risky investments declined. A credit bubble formed in the United States and Europe, the most notable manifestation of which was increased investment in high-risk mortgages. U.S. monetary policy may have con- tributed to the credit bubble but did not cause it. CHRG-111hhrg53245--114 Mr. Garrett," You need someone to address situations, future asset bubbles, for dealing with being countercyclical as opposed to being procyclical? " fcic_final_report_full--424 HOW OUR APPROACH DIFFERS FROM OTHERS’ During the course of the Commission’s hearings and investigations, we heard fre- quent arguments that there was a single cause of the crisis. For some it was interna- tional capital flows or monetary policy; for others, housing policy; and for still others, it was insufficient regulation of an ambiguously defined shadow banking sec- tor, or unregulated over-the-counter derivatives, or the greed of those in the financial sector and the political influence they had in Washington. In each case, these arguments, when used as single-cause explanations, are too simplistic because they are incomplete. While some of these factors were essential contributors to the crisis, each is insufficient as a standalone explanation. The majority’s approach to explaining the crisis suffers from the opposite prob- lem–it is too broad. Not everything that went wrong during the financial crisis caused the crisis, and while some causes were essential, others had only a minor im- pact. Not every regulatory change related to housing or the financial system prior to the crisis was a cause. The majority’s almost -page report is more an account of bad events than a focused explanation of what happened and why. When everything is important, nothing is. As an example, non-credit derivatives did not in any meaningful way cause or contribute to the financial crisis. Neither the Community Reinvestment Act nor re- moval of the Glass-Steagall firewall was a significant cause. The crisis can be ex- plained without resorting to these factors. We also reject as too simplistic the hypothesis that too little regulation caused the crisis, as well as its opposite, that too much regulation caused the crisis. We question this metric for determining the effectiveness of regulation. The amount of financial regulation should reflect the need to address particular failures in the financial sys- tem. For example, high-risk, nontraditional mortgage lending by nonbank lenders flourished in the s and did tremendous damage in an ineffectively regulated en- vironment, contributing to the financial crisis. Poorly designed government housing policies distorted market outcomes and contributed to the creation of unsound mortgages as well. Countrywide’s irresponsible lending and AIG’s failure were in part attributable to ineffective regulation and supervision, while Fannie Mae and Freddie Mac’s failures were the result of policymakers using the power of government to blend public purpose with private gains and then socializing the losses. Both the “too little government” and “too much government” approaches are too broad-brush to explain the crisis. The majority says the crisis was avoidable if only the United States had adopted across-the-board more restrictive regulations, in conjunction with more aggressive regulators and supervisors. This conclusion by the majority largely ignores the global nature of the crisis. For example: • A credit bubble appeared in both the United States and Europe. This tells us that our primary explanation for the credit bubble should focus on factors common to both regions. FOMC20070321meeting--73 71,MS. YELLEN.," Thank you, Mr. Chairman. Recent data on economic activity have been downbeat in many sectors, and I agree with the general tenor of the Greenbook that the near-term outlook is weaker than before. Indeed, we have cut expected growth this year almost ½ percentage point, to 2¼ percent. This pace of growth is substantially below potential, and we expect the unemployment rate to start to edge up fairly quickly. Even relative to this lower baseline, I think the downside risks to the prospects for output growth have sharpened in the intermeeting period. I’m especially concerned about two risks—broader retrenchment in financial markets along the lines that we’re seeing in the subprime mortgage market and a further hesitation and faltering of capital spending. As we discussed in detail two years ago, an asset price bubble inevitably leads to unsustainable imbalances in the economy and a misallocation of resources. The extraordinary run-up in house prices in recent years led to construction and sales booms that couldn’t last. So far the adjustments to more-sustainable levels of housing starts and sales have been relatively orderly. However, there is still an overhang of precarious financing from the past relaxed mortgage-lending standards that has to be eliminated. For example, in 2005 and 2006 something like 40 percent of first-time homebuyers put no money down with their purchase. The market is beginning to recognize the size of this overhang and, with the recent deterioration in the performance of subprime mortgages, is dramatically reassessing mortgage risk. Going forward, we will have to closely monitor increases in mortgage-risk compensation and tightening of credit standards. Such changes, especially if they go too fast or too far, could amplify the housing- sector decline as has been recognized, pushing housing prices and activity down, and with spillovers to consumer spending, they could prove to be a substantial drag on the overall economy. Despite the recent turmoil in equity and mortgage markets, a reassessment of overall risk has yet to occur. We are still in an environment of low long-term yields, ample liquidity, and what appears to be a generally low level of compensation for risk. For example, I recently talked with the principals of several major private-equity funds, who were not just amazed but also appalled about the amount of money their industry has attracted. [Laughter] One partner said that he would have no difficulty immediately raising $1 billion. Indeed, one of his biggest problems is would-be investors who get angry at him because he is unwilling to take their money. This unwillingness reflects his difficulty in identifying deals that are likely to yield adequate returns even though, for the buyout firms, debt also is available in what they depict as very attractive so-called covenant-lite terms—perhaps too attractive given the vulnerability of some of the highly leveraged yields. My contacts suggest that some private-equity firms with similar assessments of the shortage of profit opportunities are less restrained and do take additional money, partly because of the large upfront fees that are generated by these deals. So just as we have seen in mortgage markets, the bubble in private equity, as my sources characterize it, and the overabundance of liquidity more generally raise the risk of a sharp retrenchment in credit and higher risk spreads with associated risks to economic growth and, conceivably, even financial stability. A second, related risk concerns investment spending. It’s surprising that, despite the ample financing available, firms have still been reluctant to ramp up their capital spending. Certainly, any precipitous tightening of financing could curtail investment. However, as noted in one of the Greenbook alternative simulations, greater business pessimism about future returns to new capital is also a significant risk. The recent pullback in orders and shipments for capital goods has persisted and deepened more than any of us had anticipated. Even for high-tech spending, which continues to expand, my contacts on the manufacturing side are not very optimistic. Sales of PCs and related equipment were mildly disappointing in 2006, and our contacts don’t see the introduction of the Microsoft Vista operating system in January as having generated much enthusiasm among businesses. Turning to inflation, our outlook for core inflation, like that of the Greenbook, has changed little since January. I continue to anticipate gradually moderating inflation with core PCE price inflation edging down from 2¼ percent in 2006 to 2 percent this year. There are certainly clear upside risks to this forecast, especially given the resumption of increases in energy prices. These risks remain despite some weakening in the outlook for real activity. In principle, the anticipated subpar growth should help relieve inflationary pressures. However, we remain very uncertain about what par is. The continued low unemployment rate, coupled with recent sluggish output growth, suggests via Okun’s law that potential output could be growing in the vicinity of 2¼ percent. If, contrary to our assumption, that were the case, any labor market tightness now boosting inflation might not diminish this year. More-favorable news is found in recent survey evidence on inflation expectations. As many of you have commented in past meetings, inflation expectations are perhaps more influential to the inflation outlook than is the unemployment rate. Their relative stability over the past several years has probably been a key factor restraining the rise in inflation over the past two years. However, what has not generally been noted is the importance of near-term inflation expectations, those with a forecast horizon of a year or two. Both economic theory and empirical evidence suggest that these near-term inflation expectations are as important as long-run expectations for determining inflation dynamics. The latest Blue Chip and Professional Forecasters surveys both show expectations of core inflation edging down next year. For example, the SPF shows core PCE inflation dropping to 2 percent next year, exactly in line with our own forecast. I also see the general downward tilt in inflation expectations over the next couple of years as contributing to a favorable inflation prognosis." CHRG-111hhrg61852--90 Mr. Koo," At this juncture, I must say government has to be involved and in a sustainable way with a substantial amount until private sector balance sheets are repaired. I am not always for fiscal stimulus. I started my career at the New York Fed. I believe the monetary policy, all the market stuff. Occasionally, once in every several decades, the private sector does go crazy, and that is called a bubble. And once the bubble bursts, I am afraid there is this long period where they will have to do their balance sheets repair. And when the private sector is in that mode, the public sector must come in. " FOMC20050630meeting--170 168,MR. WILLIAMS.," In fact, the third scenario that I considered involved trying to emphasize that point—namely that, at least by some measures that people have come up with, there is a big difference in where bond rates are relative to standard estimates of fundamentals. It’s actually a much bigger problem for the economy than just the house-price effect directly, at least according to the FRB/US model. More importantly, it could be one of the factors driving a big part of the house- price appreciation. In terms of needing strong house prices to keep the economy moving, the way I view your third question is that if it weren’t for the house-price run-up, monetary policy would need to be easier, given current economic conditions. And I think that’s absolutely right. One way to think about my scenarios is just to reverse the signs, especially in scenarios 1 and 2, and think about it as this as the positive stimulus we’ve gotten from a 20 percent appreciation of housing prices and this is the positive effect we’ve gotten from some other factors. Especially scenario 1, I think you can see that way. The reason I mentioned the misallocation of resources toward housing-related activities in June 29-30, 2005 57 of 234 is that they actually lead to, as Glenn mentioned, a misallocation of resources. Therefore, these gaps between fundamental prices and actual prices should appear in the policymaker’s objective function, in addition to inflation, output and employment. So there is a notion here that that’s just another problem that you would want to balance off if you could. Now, I’d like to emphasize in my closing remarks that the assumption that you could affect the bubble is very problematic. As Josh himself mentioned, these relationships between housing prices and interest rates are just not as strong as one would think and not as strong as economic theory would suggest." CHRG-110shrg50418--88 Mr. Wagoner," Sure. " Chairman Dodd," ----that what you were doing here was actually going to end up in a bubble kind of situation, that could only end up in the situation we are now facing? " CHRG-111shrg57322--312 Mr. Tourre," I would echo some of my colleagues' comments that the compensation structure which is based on the firm's performance, the business' performance, and, the personal performance, at least at Goldman Sachs, I think were aligning incentives correctly. Senator Ensign. OK. Thank you, Mr. Chairman. Senator Levin. Thank you, Senator Ensign. I think as all the questions have gone today, I think that we are seeing some of the problems. Thank you, Senator Ensign. Senator Tester. Senator Tester. Thank you, Mr. Chairman. I appreciate your holding this hearing. It has been a pretty long morning. I do not know if there is going to be anybody coming after me or not, but I want to thank you folks for being here today. I appreciate it very much. I think we will head in a couple different directions here. Mr. Birnbaum, why, how, and when did you become convinced that there was a housing bubble on the verge of collapse? " CHRG-111hhrg53245--78 Mr. Kanjorski," I agree with you, but I wanted to perhaps attack part of your premise there. I recall very clearly in 2005, the Chairman of the Federal Reserve was testifying before this committee. I specifically asked him a question, whether or not there was a real estate bubble in his opinion, and he said he thought there was, and that the price of real estate was ever increasing, but it was perfectly manageable and it did not constitute a risk to the system. If he in fact were the gatherer of that information and the analyzer of that information, we would have missed the opportunity to have found systemic risk. What is your answer to Mr. Greenspan's lack of perceiving that difficulty? Ms. Rivlin. I think he was just wrong. He said that himself. He did not see this one. I think we have learned a lot about bubbles. One thing we have learned is that interest rates is not a perfect tool for controlling them, which is why I would give them more leverage control as well. " 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? " FOMC20060808meeting--58 56,MS. PIANALTO.," Thank you, Mr. Chairman. My outlook hasn’t changed very much since last spring, when I was contemplating the not-so-welcome cycle of slowdown in economic activity and some persistence in both headline and core inflation due to the lingering effects of large energy-price increases. In fact, the Greenbook projections for real GDP now reflect something close to the pessimistic end of where I thought things could be heading. The difference is that I have been thinking more of a cyclical slowdown and not so much of a slowdown in demand and supply, as reflected in the Greenbook baseline. The possibility that slack might not be widening as economic growth moves down puts the recent inflation numbers in a particularly bad light. I have been especially concerned about how broadly based the inflationary pressures appear to be. When you take energy components out of the CPI and you look at the median that Richard was referring to earlier, about 67 percent of the expenditure-weighted items in the CPI increased at an annual rate of 3 percent or more in June, which is about the same share that we have seen since March. As Richard mentioned, the PCE statistics yield basically the same results. In Procter & Gamble’s most recent earnings report, the company attributed its good earnings performance partly to the ability to pass on higher costs through to product prices, and I am hearing similar remarks about pricing power from our directors and District business contacts. Although my business contacts have been reporting some ability to pass on price increases now at the retail level, where in the past they were saying that it was very difficult to go beyond intermediate goods, they’re not so sure that they will get more than one-time catch-up adjustments. Most of my business contacts have not expressed concerns about an elevation in the long-term inflation trend. Nevertheless, I think there are clearly reasons to be worried about the risk of inflationary pressures intensifying over the balance of the projection period. I also think that there is a risk that we’re not going to see as much slack as is embedded in the Greenbook baseline. As in many other parts of the country, activity in the housing sector is slowing in the Midwest, particularly in the Fourth District, and the housing situation in the Fourth District could never be characterized as bubbly or frothy. Some of the veteran Realtors in my District with whom I have been talking are saying that this housing market is the worst that they can recall. Comments like these, although they are selected, do suggest some more uncertain prospects for the housing sector. My directors and business contacts have also been sounding a bit more cautious about the outlook for their sales, but at the same time their capital spending plans appear to be intact. They remain vocal about the ability to get productivity gains, and they remain disciplined about their hiring plans. So as I contemplate the weaker spending track that’s forecast in the Greenbook, I’m inclined to attribute more of it to the demand side of the economy than to the supply side. That is, I am expecting the Greenbook’s call for moderation in economic growth to result in a little more slack than appears in the Greenbook’s baseline. In a qualitative sense, my outlook carries lower inflationary pressure than the Greenbook baseline and thus is similar in spirit to the “lower NAIRU” alternative scenario. Separating the cyclical and structural performance of the economy, of course, is a real challenge, and it is natural, I think, to feel unsure about the real-time estimates and projection of slack. If the slower growth of potential output in the Greenbook baseline is accurate, it raises the possibility that the equilibrium real interest rate may be lower than it was in the last half of the 1990s. In summary, Mr. Chairman, I still think there are risks to both of our objectives. Thank you." fcic_final_report_full--469 One of the many myths about the financial crisis is that Wall Street banks led the way into subprime lending and the GSEs followed. The Commission majority’s report adopts this idea as a way of explaining why Fannie and Freddie acquired so many NTMs. This notion simply does not align with the facts. Not only were Wall Street institutions small factors in the subprime PMBS market, but well before 2002 Fannie and Freddie were much bigger players than the entire PMBS market in the business of acquiring NTM and other subprime loans. Table 7, page 504, shows that Fannie and Freddie had already acquired at least $701 billion in NTMs by 2001. Obviously, the GSEs did not have to follow anyone into NTM or subprime lending; they were already the dominant players in that market before 2002. Table 7 also shows that in 2002, when the entire PMBS market was $134 billion, Fannie and Freddie acquired $206 billion in whole subprime mortgages and $368 billion in other NTMs, demonstrating again that the GSEs were no strangers to risky lending well before the PMBS market began to develop. Further evidence about which firms were first into subprime or NTM lending is provided by Fannie’s 2002 10-K. This disclosure document reports that 14 percent of Fannie’s credit obligations (either in portfolio or guaranteed) had FICO credit scores below 660 as of December 31, 2000, 16 percent at the end of 2001 and 17 percent at the end of 2002. 31 So Fannie and Freddie were active and major buyers of subprime loans in years when the PMBS market had total issuances of only $55 billion (2000) and $94 billion (2001). In other words, it would be more accurate to say that Wall Street followed Fannie and Freddie into subprime lending rather than vice versa. At the same time, the GSEs’ purchases of subprime whole loans throughout the 1990s stimulated the growth of the subprime lending industry, which ultimately became the mainstay of the subprime PMBS market in the 2000s. 2005 was the biggest year for PMBS subprime issuances, and Ameriquest ($54 billion) and Countrywide ($38 billion) were the two largest issuers in the top 25. These numbers were still small in relation to what Fannie and Freddie had been buying since data became available in 1997. The total in Table 7 for Fannie and Freddie between 1997 and 2007 is approximately $1.5 trillion for subprime loans and over $4 trillion for all NTMs as a group. Because subprime PMBS were rich in NTM loans eligible for credit under HUD’s AH goals, Fannie and Freddie were also the largest individual purchasers of subprime PMBS from 2002 to 2006, acquiring 33 percent of the total issuances, or $579 billion. 32 In Table 3 above, which organizes mortgages by delinquency rate, these purchases are included in line 1, which had the highest rate of delinquency. These were self-denominated subprime—designated as subprime by the lender when originated—and thus had low FICO scores and usually a higher interest rate than prime loans; many also had low downpayments and were subject to other deficiencies. Ultimately, HUD’s policies were responsible for both the poor quality of the subprime and Alt-A mortgages that backed the PMBS and for the enormous size to which this market grew. This was true not only because Fannie and Freddie 31 2003 10-K, Table 33, p.84 http://www.sec.gov/Archives/edgar/data/310522/000095013303001151/ w84239e10vk.htm#031. 32 See Table 3 of “High LTV, Subprime and Alt-A Originations Over the Period 1992-2007 and Fannie, Freddie, FHA and VA’s Role” found at http://www.aei.org/docLib/Pinto-High-LTV-Subprime-Alt-A.pdf . stimulated the growth of that market through their purchases of PMBS, but also because the huge inflow of government or government-directed funds into the housing market turned what would have been a normal housing bubble into a bubble of unprecedented size and duration. This encouraged and enabled unprecedented growth in the PMBS market in two ways. FinancialCrisisInquiry--11 Finally, our shareholders will have an advisory vote on the firm’s compensation principles and the compensations of its named executive officers at the firm’s annual meeting of shareholders in 2010. Once again, we appreciate the opportunity to assist the commission in your critical role. And I look forward to your questions. Thank you. CHAIRMAN ANGELIDES: Thank you very much. Thank you so much. Mr. Dimon? DIMON: Chairman Angelides, Vice Chairman Thomas and members of the commission, my name is Jamie Dimon and I am chairman and chief executive officer of JPMorgan Chase and Company. I appreciate the invitation to appear before you today. If we are to learn from this crisis moving forward, we must be brutally honest about the causes and develop a realistic understanding of them that is not overly simplistic. The FCIC’s contribution to this debate is critical, and I hope my participation will further the commission’s goals. I’d like to start by touching on some of the factors I believe led to the financial crisis. Of course, much has been said and much more will be written on the topic, so my comments are summary in nature. As we know all too well, new and poorly underwritten mortgage products helped fuel housing price appreciation, excessive speculation and far higher credit losses. When the housing bubble burst, it exposed serious flaws in mortgage underwriting, and losses flowed from the chain from mortgages to securitizations to derivatives based on these products. CHRG-111hhrg48875--142 Secretary Geithner," More generally, I would say that, again, this country, our Nation, did not have effective means to prevent the buildup of risk that would be threatening to the system nor to protect the economy from the consequences of the unwinding of those big bubbles. " CHRG-111shrg57923--38 Mr. Horne," I have known that there has been a national housing problem since the first time that our partners--we have over 900 data partners that we work with. One of our largest data partners is First American CoreLogic, which is the largest collector of deed, tax, and mortgage roll property information in the country. So when I started analyzing their data and combining it with Dow Jones information about the individual market segments and the tremendous volumes--I mean, we collect terabytes and terabytes of information--and start looking at the various factors that we call trigger events--these are things that occur that show an action taking place that is either positive or potentially adverse actions--we saw this occurring, frankly, before 2007. We actually saw the bubble before the bubble and could tell some of these things were starting to happen. The problem, again, is this is macro data. When they roll it up and look at it, they usually look at it within the housing market, within the specific segment of the database that they have, and we haven't brought it together with our unemployment findings, with our bankruptcy findings, with our commercial real estate information to separate it from the residential real estate information. And this disaggregation of information in these individual silos prevent us from being able to do, except through very extensive manual efforts, the ability to bring this data together in a way so we actually can build real models on the symbiosis, the systemic issues that are occurring between all these different factors in the marketplace. The systemic issues that occur within an institution and institutions, which I think we are talking about here, between the majors, the Citicorps, the JPMorgans, the AIGs, are extensive and we understand that they are very complex and the counterparty risks there are very difficult to track, particularly if you don't have access to all of the other pieces of information. Now, we have large amounts of information regarding derivative data, regarding all sorts of different kinds of financial instruments, but it is only segments of the market. We don't have all of it because not all of it is available, even in public or private data. So part of the issue here is the investment that needs to be done to actually build the database. Senator Reed. Well, I don't--we have taken a great deal of your time and it has been extremely valuable, so thank you. But I don't sense there is a mutually exclusive sort of agenda here. I think we are talking about the same thing, which is building in the short term an information gathering and an analytical capability that will help us, but in the longer term, getting to the point where it is just not prediction, there might be even some treatment involved, which is the point you made. Dr. Mendelowitz, a final point. " FOMC20050630meeting--12 10,MR. WILLIAMS.," I’ll be referring to the exhibits beginning on page 26. In my presentation today, I’ll lay out a few scenarios that illustrate the potential macroeconomic fallout resulting from a significant decline in house prices, and I will examine policy responses that minimize it. I’ll start by describing the possible size of the current problem—assuming there is one. As pointed out in Dick Peach’s presentation, there are serious difficulties in accurately measuring both actual and “fundamental” house prices. But, for the purposes of my presentation, I will take as a working hypothesis that house prices are high relative to fundamentals—or, in terms of the decision tree that Glenn just laid out, I assume that the answer to his question 1 is “Yes, the asset price appears misaligned.” As Josh Gallin indicated, it would take up to a 20 percent decline in house prices to bring the price-to-rent ratio back in line with fundamentals. With housing wealth standing at around $18 trillion today, such a drop in house prices would extinguish $3.6 trillion of household wealth. That’s equal to about 30 percent of GDP. Based on a marginal propensity to consume from housing wealth of 3½ cents on the dollar, this decline in wealth would entail a nearly 1½ percentage point increase in the personal saving rate. And, according to estimates from the FRB/US model, it implies a 40 basis point reduction in the long-run neutral real funds rate. June 29-30, 2005 18 of 234 at that time were arguably some 50 to 70 percent overvalued. Correction of prices to fundamentals at that time would have implied a reduction in household wealth of $6.7 trillion, equal to about 70 percent of contemporaneous GDP. In the event, stock market wealth fell by $4.6 trillion between March 2000 and March 2001, and at its lowest point was down $8.5 trillion. There is considerable uncertainty regarding the magnitude of the effects of changes in stock market and housing wealth on household spending; nonetheless, it seems clear the magnitude of the current potential problem is much smaller than, and perhaps only half as large as, that of the stock market bubble. Of course, if house prices continue to soar—and in the San Francisco Bay Area, at least, they show no signs of slowing—the magnitude of the housing overvaluation problem will rise as well. A cautionary note worth emphasizing is that the monetary policy cushion available today, as measured by the prevailing federal funds rate, is noticeably smaller than it was in early 2000 at the peak of the stock market. The first question that comes to mind is: What should monetary policy do, if anything, about the apparent overvaluation in house prices? The answer to that depends crucially on the answer to Glenn’s second question: “Do bubble fluctuations result in large macroeconomic consequences that monetary policy cannot readily offset?” Therefore, I now explore the effects of a bubble collapse and the ability of policy to respond effectively to them. I consider three scenarios in which a housing bubble deflates relatively quickly. I use the FRB/US model to quantify these effects. Note that for the materials posted last Wednesday, I based my simulations on the April Greenbook projection. I have since updated the simulations, and the ones that I will be showing today are based on the extended June Greenbook projection. In each scenario, I assume that house prices fall by 20 percent relative to the baseline over the next 2½ years. June 29-30, 2005 19 of 234 gap, and with the long-run natural rate of interest that appears in the rule varying in accord with sustained changes in housing wealth and bond premiums. The second page of my exhibit shows the results from model simulations of a 20 percent decline in house prices, where only the standard channels included in the FRB/US model are in play. For comparison, I have also plotted the baseline paths, based on the June extended Greenbook projection but modified under the assumption that monetary policy is set optimally in the way I just described. Because a decline in house prices primarily influences demand, not supply, it does not pose a difficult tradeoff between policy goals. In addition, according to the model, the macroeconomic effects play out gradually and are moderate in magnitude, giving policy time to respond. The optimal policy calls for a path for the funds rate that averages about 3¼ percent during 2007 and 2008—about 40 basis points below the baseline path. Under this policy, the unemployment and inflation rates are nearly the same as in the baseline. The very small rise in inflation reflects the effects of the depreciation of the dollar resulting from the reduction in domestic interest rates. The modified Taylor rule is able to mimic the outcomes under the optimal policy reasonably well, indicating that policy need not fully anticipate future house- price declines to be effective, but can simply respond to events as they unfold. Note that if the house-price decline were larger (or the marginal propensity to consume out of housing wealth bigger), then the policy implication would simply be to cut rates by proportionally more. In summary, assuming that the FRB/US model does a good job of capturing the macroeconomic implications of declining house prices, such an event does not pose a particularly difficult challenge for monetary policy. One lingering concern, however, is that the model may be missing other important avenues by which large movements in house prices affect the economy. I now consider a scenario that entertains that possibility. June 29-30, 2005 20 of 234 The Taylor rule, however, is not as successful. It fails to anticipate the spillover effects and responds too timidly once they occur. Still, it contains the rise in unemployment to only about ½ percentage point above baseline and moves inflation slightly more rapidly toward the assumed inflation objective. I should note that, given the uncertainty regarding the size and timing of such spillovers, the ideal outcome in the optimal policy simulation exaggerates the real-world ability of monetary policy to offset the effects of such shocks. As I noted before, the thought experiment behind these first two sets of simulations is that house prices fall in a kind of vacuum, without any relationship to other events. Some commentators have argued that the current high level of house prices is the outcome of a history of very low interest rates and past house-price appreciation that has given rise to irrationally optimistic expectations of future appreciation. Indeed, a simple estimated equation relating the current price-to-rent ratio to the user cost of housing and past house-price appreciation does a reasonably good job of explaining much of the run-up in house prices over the past several years. If this explanation holds water, a potential risk to housing prices and the outlook in general lies in the path of longer-term interest rates—which have been surprisingly low, given prevailing economic conditions—and the usual behavior of term premiums. Bond yields could return to more normal levels and in so doing contribute to a downward trajectory in house prices. I explore such a possibility in the final scenario, which builds on Scenario 2, and is the subject of the next page of my exhibit. I now add the assumption that the term premiums on long-term bonds rise by 75 basis points, relative to baseline, over the second half of this year and remain at these levels. This aspect of the scenario is similar to an alternative scenario reported in the June Greenbook. This shock to bond premiums by itself reduces the long-term equilibrium real funds rate by about 70 basis points. Optimal policy calls for the funds rate to fall below 1 percent by the middle of next year and for the funds rate to remain below 3 percent through 2008. The optimal policy is just able to contain the rise in unemployment without confronting the zero bound. The Taylor rule, on the other hand, responds too gradually to events, and, as a result, the unemployment rate reaches 6 percent in early 2007. This scenario presents a difficult challenge for monetary policy, especially in light of the looming zero lower bound on interest rates under the optimal policy. More generally, it highlights that the risks posed by a house-price decline are magnified if they occur in tandem with other events that damp economic activity. June 29-30, 2005 21 of 234 other factors, upon which such a policy necessarily would rely, is imperfectly understood and may have changed over time. Moreover, as seen in the earlier presentations, there remains considerable uncertainty over the degree of overvaluation. Thus, the successful use of monetary policy to reduce the magnitude of a misalignment of house prices would be a daunting task, even assuming that such a goal were deemed desirable. This concludes our prepared remarks." fcic_final_report_full--101 U .S. Home P ri c es INDEX VALUE: JANUARY 2000 = 100 300 250 200 150 100 50 0 Sand states U.S. total Non-sand states U. S . A pr il 2006 201 U. S . A ugust 2010 145 1976 1980 1985 1990 1995 2000 2010 NOTE: Sand states are A rizona, California, Florida, and Nevada. SOURCE: CoreLo g ic and U.S. Census B ureau: 2007 A merican Community Survey, FCIC calculations Figure . ings netted these households an estimated  billion; homeowners accessed an- other  billion via home equity loans.  Some were typical second liens; others were a newer invention, the home equity line of credit. These operated much like a credit card, letting the borrower borrow and repay as needed, often with the conven- ience of an actual plastic card. According to the Fed’s  Survey of Consumer Finances, . of homeowners who tapped their equity used that money for expenses such as medical bills, taxes, elec- tronics, and vacations, or to consolidate debt; another . used it for home improve- ments; and the rest purchased more real estate, cars, investments, clothing, or jewelry. A Congressional Budget Office paper from  reported on the recent history: “As housing prices surged in the late s and early s, consumers boosted their spending faster than their income rose. That was reflected in a sharp drop in the per- sonal savings rate.”  Between  and , increased consumer spending ac- counted for between  and  of GDP growth in any year—rising above  in years when spending growth offset declines elsewhere in the economy. Meanwhile, the personal saving rate dropped from . to .. Some components of spending grew remarkably fast: home furnishings and other household durables, recreational goods and vehicles, spending at restaurants, and health care. Overall consumer spending grew faster than the economy, and in some years it grew faster than real disposable income. Nonetheless, the economy looked stable. By , it had weathered the brief re- cession of  and the dot-com bust, which had caused the largest loss of wealth in decades. With new financial products like the home equity line of credit, households could borrow against their homes to compensate for investment losses or unemploy- ment. Deflation, against which the Fed had struck preemptively, did not materialize. At a congressional hearing in November , Greenspan acknowledged—at least implicitly—that after the dot-com bubble burst, the Fed cut interest rates in part to promote housing. Greenspan argued that the Fed’s low-interest-rate policy had stim- ulated the economy by encouraging home sales and housing starts with “mortgage interest rates that are at lows not seen in decades.” As Greenspan explained, “Mort- gage markets have also been a powerful stabilizing force over the past two years of economic distress by facilitating the extraction of some of the equity that home- owners had built up.”  In February , he reiterated his point, referring to “a large extraction of cash from home equity.”  CHRG-111hhrg53245--11 INSTITUTION Ms. Rivlin. Thank you, Mr. Chairman. I am really glad you're holding this hearing to focus on the question of systemic risk and how do we avoid getting into this situation again; and, as you pointed out, I don't think anybody wants more bailouts ever if we can avoid it. I think that requires focusing on prevention. How do we fix the financial system so that we don't have these perfect storms of a huge bubble that makes our system very prone to collapse? And then if this does happen, how do we make it less likely that we would have to resort to bailing out institutions? So I think the task before this committee is first to repair the regulatory gaps and change the perverse incentives and reduce the chances that we will get another pervasive bubble. But, however, hard we try to do this, we have to recognize that there's no permanent fix. And I think one concept of systemic risk, what I call a macro system stabilizer that we need is an institution charged with looking continuously at the regulatory system at the markets and at perverse incentives that have crept into our system. Because whatever rules we adopt will become obsolete as financial innovation progresses, and market participants find around the rules. This macro system stabilizer, I think, should be constantly searching for gaps, weak links, perverse incentives, and so forth and should make views public and work with other regulators and Congress to mitigate the problem. Now, the Obama Administration makes a case for such an institution, for a regulator with a broad mandate to collect information from all financial institutions and identify emerging risk. It proposes putting this responsibility in a financial services oversight counsel, chaired by the Treasury with its own expert staff. That seems to me likely to be a cumbersome mechanism, and I would actually give this kind of responsibility to the Federal Reserve. I think the Fed should have the clear responsibility for spotting emerging risks, and trying to head them off before it has to pump trillions into the system to avert disaster. The Fed should make a periodic report to the Congress on the stability of the financial system and the possible threats to it, similar to the report you heard from Mr. Bernanke this morning about the economy. It should consult regularly with the Treasury and other regulators, but it should have the lead responsibility for monitoring systemic risk. Spotting emerging risk would fit naturally with the Fed's efforts to monitor the state of the economy and the health of the financial sector in order to set and implement monetary policy. Having that explicit responsibility and more information on which to base it would enhance its effectiveness as a central bank. I would also suggest giving the Fed a new tool to control leverage across the financial system. While lower interest rates may have contributed to the bubble, monetary policy has multiple objectives, and the short-term interest rate is a poor tool for controlling bubbles. The Fed needs a stronger tool, a control of leverage more generally. But the second task is one you have emphasized in your title, how to make the system less vulnerable to cascading failures, domino effects, due to the presence of large interconnected financial firms whose failure could bring down other firms and markets. This view of what happened could lead to policies to restrain the growth of large interconnected financial firms or even break them up. " fcic_final_report_full--482 However, some of the benefits of securitized mortgages are also detriments when certain mortgage market conditions prevail. If housing values are declining, losses on whole mortgages are recognized only slowly in bank financial statements and will be recognized even more slowly in the larger market. PMBS, however, are far more vulnerable to swings in sentiment than whole mortgages held on bank balance sheets. First, because they are more easily traded, PMBS values can be more quickly and adversely affected by negative information about the underlying mortgages than whole mortgages in the same principal amount. PMBS markets tend to be thin, because PMBS pools differ from one another. If investors believe that mortgages in general are declining in value, or they learn of a substantial and unexpected number of defaults and delinquencies, they may abandon the market for all PMBS, causing the general PMBS price level to fall precipitously. For example, in his book Slapped by the Invisible Hand , Professor Gary Gorton of Yale notes that the ABX index, initially published in late 2006, for the first time gave investors a picture of how others saw the value of a selected group of PMBS pools. The index showed steeply declining values, which caused many investors to withdraw from the market. Gorton observed: “I view the ABX indices as revealing hitherto unknown information, namely, the aggregated view that subprime was worth significantly less…It is not clear whether the housing bubble was burst by the ability to short the subprime housing market or whether house prices were going down and the implications of this were aggregated and revealed by the ABX indices” 49 Whatever the underlying reason, as shown in Figure 3, this seems to be exactly what happened in the financial crisis. The result was a crash in the MBS market as investors fled what looked like major oncoming losses. 49 Gorton, Slapped by the Invisible Hand , note 41, pp.121-123. FinancialCrisisInquiry--652 GORDON: January 13, 2010 Yes. You know, what we’ve observed over time with traditionally underserved borrowers or people with lower or nontraditional credit histories is that we always had higher delinquency rates than was typical in the prime markets but our actual loss rates always ran under 1 percent. And part of that was because—part of how to run a successful operation, lending to these communities, includes understanding that there can be different kinds of income interruptions and vicissitudes of life and working with borrowers through those periods to keep the loan performing. And so, really, we—you know, now, of course, we’ve been impacted by the larger crisis. But just—then what’s become what we now talk about as subprime lending is loan products that had risky features and, as Professor Rosen’s discussed, lots of layers of risk. And these were not products, for the most part, except in the narrowest, narrowest sense—for the most part, these were never products that provided particular benefits to the consumers. They were products that were push-marketed to, you know, more vulnerable populations and then spread out as the bubble grew and housing became more unaffordable for most families. 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. FOMC20060808meeting--74 72,MS. BIES.," Thank you, Mr. Chairman. I think our decision today is going to be a close call because of the recent information we’ve gotten both on inflation and on the growth of the economy. We know that, as President Poole and others have mentioned, wage and price inflation has been accelerating and is fairly broadly based. The recent NIPA revisions also concern me because of the faster growth in core PCE prices that those data show. The business surveys, in fact, show that companies feel they have more pricing power than they have had in the past. We know that we are going to have some continuing feed-through of the higher prices of oil. After talking to some folks in the oil industry, I am concerned about the recent Alaska situation. It clearly shows that maintenance of equipment and the efficiency of the operations of some of these companies may be under stress with the high volumes of capacity at which they have been running. We pray that it doesn’t extend much further in additional surprises. What also concerns me about the NIPA revisions are the changes in the productivity numbers. The fact that with the NIPA revisions we are seeing lower productivity and faster- rising labor costs has implications for our forward expectations on inflation. We also see that business investment in equipment and software was much lower. That downward revision worries me because it implies that less capital deepening has occurred, and that would have been a strong base to support productivity going forward. Now we apparently cannot rely on it as a base as much as we could before the revisions. In terms of the housing markets, the rapid escalation of home sale cancellations clearly has been very surprising. Again, the gross sales figures don’t show this, but the information we’ve got on the cancellations indicates a much more pronounced slowdown than we might have expected. In looking through other housing cycles and in talking to bankers and lenders, one of the good things I find is that the industry learned in the 1980s. Because those in the industry are more sophisticated in the way they manage their land costs and their inventory, I think the length of the cycle is unlikely to be as long. In the 1980s, bankers made plenty of funds available for companies to continue to develop land and to put in infrastructure. When the housing bubble burst, all of a sudden we had unsold housing units. They had to be sold before builders could start building on the developments that had already been laid out, and it took us several years to work through that. This time we don’t have the unfinished inventory of developments that we had in the ’80s. So I think that the cycle is likely to be much shorter than it was then and that it will put some firmness in that market. At the same time, this is the sector, aside from energy and commodities, that had a very rapid rise in prices, and it’s good that we’re seeing some correction in those prices right now. The other good trend that I take comfort in is the one that Dino mentioned earlier—that we’re seeing central banks around the world raising rates. When we started raising our rates a couple of years ago, there weren’t too many moving at the same time we did. We know that today monetary policy has global effects: Excessive accommodation in some countries clearly can affect investments in other countries. So I think we now have support in what we’re doing to remove accommodation. We’re seeing that support more broadly across the world; and in the aggregate, then, it will help to moderate inflation in the period going forward. Finally, I’m reminded that we do have long lags in monetary policy, and we still have to see the full impact of what we have already put in train. Thank you, Mr. Chairman." FOMC20080121confcall--49 47,MR. HOENIG.," Mr. Chairman, I hear you, and I appreciate your concerns. I do understand that there is a psychology in the market that is having its effect. I think if we make this statement as strong as we can about the need to watch inflation, and if we understand among ourselves that, as we take this action today and the follow-up actions that I am certain we are going to take, we will watch these inflation numbers, including broad asset values--I know we don't prick bubbles and that sort of thing, but watching these broad asset-price movements--that would be very, very important, at least to think about. I do not wish to be dissenting on this, as troubled as I am about it. I do understand the psychology of it. For those reasons, I am willing to go along with this. But I worry about our ability to deal with reversal as this takes place, especially given where our projections for growth are right now and my concern that we already have inflation above 4 percent. So I defer to you at this point. I would vote for it because I think the psychology of the marketplace is, of course, rather fragile, and I will leave it at that. Thank you. " 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 FOMC20080318meeting--196 194,MR. HOENIG.," Vice Chairman, we have a bubble developing in some parts of our area. I think they are aware of that, and so I think we have to be mindful of that in our discussion more broadly. That is why I think there are important differences that we should necessarily be able to--and should in fact--acknowledge publicly. " FinancialCrisisInquiry--222 GEORGIOU: And construction, right. ZANDI: Let me just give you a statistic. Of the 8 million jobs lost after revision, almost 20 percent are in the construction trade. GEORGIOU: No, I think I’m fine. Thank you. I’ll yield the rest of my time. ZANDI: Good luck with that home. CHAIRMAN ANGELIDES: Mr. Thompson? THOMPSON: Thank you, Mr. Chairman. Many of the questions I had have been addressed, but I do want to ask a few specifics. Ms. Gordon, to what extent, in your opinion, might CRA have been a contributor in any way to the housing bubble? GORDON: We don’t see CRA as a contributor to the—the crisis that occurred. CRA had been working for several decades to get some more lending to people who were qualified for the loans that they were getting. CRA was not intended to put unqualified people into home loans. It was intended to get lending to otherwise qualified people who weren’t being serviced by the financial institutions. THOMPSON: And you would agree with that, Dr. Rosen? CHRG-111hhrg53245--121 Mr. Zandi," Exactly; right. I do think there was a general philosophy, maybe even to this day, that the Federal Reserve should not weigh against asset bubbles, that is not in their job description, so to speak. I think that is inappropriate. I think that it should be something they should do and the tool that they need to implement that-- " CHRG-110shrg50409--55 Mr. Bernanke," Well, a part of what has been happening--and this goes back to Senator Menendez's question about the role of the subprime crisis and so on--is that there was, if you will, a credit boom or a credit bubble where there was an overextension of credit in a lot of areas. There has been a big reversal of attitudes. Banks and other financial institutions are scaling back on their credit risk. They are deleveraging. They are raising capital. And that adjustment process is part of what is happening now that is creating the drag on economic growth. So it is harder to get a mortgage, it is harder to get a business loan. And until we come to a more stable situation where banks are comfortable with their credit standards and their balance sheets, the leveraging process is going to continue and is part of what we are seeing here. Senator Tester. And very quickly, because my time is over, do you--I mean, we have heard figures of 150 banks potentially going down because, I assume, of this adjustment that you just talked about. Do you guys have any projections on what kind of impact banking institutions going down, how many there potentially could be in the next year or do you not want to comment on that? " FOMC20070131meeting--156 154,MR. BARRON.," Thank you, Mr. Chairman. I thought I’d focus a little more today in my comments on the State of Florida as it relates to the housing sector. We’ve heard a lot more positive comments in just the past few minutes about housing. So let me offer a contrarian view, if you will. Florida accounts for about 41 percent of our District employment and 6 percent of overall U.S. employment. As for housing, Florida represented 8 percent of U.S. home sales in 2005 and 6 percent in 2006 as sales and construction continued to decline. To put these numbers in perspective, single-family existing home sales in Florida have dropped 40 percent since January 2005 versus an 11 percent decline in the United States as a whole. Anecdotal reports are that builders are continuing to work down existing inventory and are not starting new projects. In most areas of the state, starts have fallen even more than sales, which should lessen the run-up in housing inventory over the immediate future. Permit issuance for single-family homes is down 54 percent in Florida since January 2005 compared with 28 percent in the nation as a whole. There are certain encouraging signs from reports noting, as mentioned earlier, that buyer traffic is better in some areas, and several of the building contacts that we spoke with expect or, perhaps I would note more accurately, are hopeful that new home sales will improve by the second quarter of 2007. Home prices have declined modestly but remain well above the levels implied by the pre- 2003 trends in most areas. This places housing affordability at a relatively low level by historical standards. As I noted at previous meetings, the demand in coastal markets is being constrained by the steep rise in homeownership insurance that has caused monthly housing costs to rise sharply, even as house prices moderate. We’ve heard reports that in markets where prices accelerated the most in recent years, such as south Florida, employers are struggling to recruit staff because of the high housing costs, with some firms electing to leave south Florida and others beginning to convert corporate owned land to corporate housing just so that they can recruit employees. As I reported at our last meeting, the decline in housing activity continues to have a negative effect on housing- related sectors specifically in the South because of our concentration in the carpet and other related industries. Housing-related employment is no longer a net contributor to year-over-year employment growth in the United States, even though overall job growth has remained very firm. District banks reported that credit quality has softened but remains at very strong levels. However, banks are beginning to be a bit more vocal in expressing concern with regard to the possibility that builders will face financial problems in the coming months. In addition, banks express concern about the number of speculative condominium projects in south Florida. District banks have lower earnings targets for 2007, and the expectation is that bank merger and acquisition activity and layoffs will increase in the coming year. Some banks are even putting out the “for sale” sign in the hope of cashing out now, noting that things could get ugly over the next two years in some areas. Outside the housing sector, indicators of economic performance in the District were mixed. Reports on holiday-related sales were on the positive side, whereas tourism remains relatively mixed across the District. Reports from the manufacturing sector were also mixed, with a weakness in the housing-related industries offset to some extent by the expanding activity in industries related to defense and energy. For the U.S. economy as a whole, the drag from housing that we experienced over the second half of 2006 does not appear at this time to pose a serious threat to the overall economy, although some forecasters anticipate below-trend real GDP growth for the end of 2006 and the first quarter of 2007. Most would say that this situation is temporary and would anticipate that real GDP growth will rebound and be close to the trend rate of 3 percent for the rest of 2007. Our staff projections of real GDP growth have had about the same tone as those of the external forecasters. Our staff believes real GDP growth will be sustained in 2007 by job creation that should match the experience that we’ve seen in 2006. Measured core inflation was well in excess of 2 percent at the end of 2006. The staff forecast is that core inflation will continue to hover just above 2 percent for all of 2007. The expectation is that price growth in services will continue to dominate core inflation going forward. In my comments I’ve focused a bit more on housing. I would just close by noting that my continued concern would be the lack of impetus to drive down inflation over the long term. Thank you." CHRG-110shrg50369--32 Mr. Bernanke," Senator, I realize my testimony was not the most cheerful thing you will hear today, and I was thinking very much about the short-term challenges that we face in terms of the financial markets and growth and inflation. But I do very much believe that the U.S. economy will return to a strong growth path with price stability. We have enormous resources, resilience, productivity, and I am quite confident in the American economy and the American people that we will have strong economic growth in the next few years. Senator Shelby. Mr. Chairman, a commonly watched measure of inflation, as you well know, is the core CPI. Housing constitutes, I understand, almost a third of the core CPI. To what extent has the recent decline in housing prices moderated recent increases in the core CPI? As housing prices go down, inflation, you know, should play here in a negative way, should it not? " CHRG-111shrg55278--65 BROOKINGS INSTITUTION Ms. Rivlin. We are on a roll here. Thank you, Mr. Chairman and Members of the Committee. Controlling systemic risk breaks into two questions, I think, how to avoid the excesses of a bubble economy that can burst and cause a catastrophic downward spiral, and second, how to make sure that if a large interconnected institution fails, it doesn't start that downward spiral and take others with it. On the first question, how to prevent the excesses of a bubble, we need to fix regulatory gaps. Ineffective regulation contributed to the excesses and allowed lax lending standards and all of the things that we have worried about. And we need to correct the perverse incentives that crept into the system, as with the originate-to-distribute model. That can be done, correcting the gaps and perverse incentives, but however we do that, the job is not over. Participants in the financial system will try to avoid the rules, whatever they are. The system will need constant monitoring to make sure that new gaps and perverse incentives are not creeping in that lead to new excesses and instability. So I think one job is this monitoring function. The Obama Administration would put this function with a Financial Oversight Council chaired by the Treasury but with its own staff. I think it would make more sense to put this function at the Federal Reserve, perhaps consulting with a council. The Fed has the clear overview of the whole economy. It fits with the job that they already have for monitoring the economy and the health of the banking system. I would also give the Fed another tool, broader control of the amount of leverage in the system. Bubbles get out of hand when demand is fueled by big increases in speculation with other people's money. The short-term interest rate is not a sufficient tool for controlling as that price bubbles. So I would recommend working out a system in which not only capital requirements, but other constraints on leverage across the system could be tightened in the face of a serious bubble threat. Then there is the problem of the large interconnected institution. This can be mitigated by making it more expensive to get big, having capital requirements rise as institutions grow, for instance. We need much more effective prudential regulation of all financial institutions, especially as they get big enough to threaten the system. The Obama Administration proposes designating institutions that pose systemic risk and giving the Fed responsibility for consolidated prudential regulation of what they call Tier 1 Financial Holding Companies. I think both parts of that proposition would be a mistake. We should not designate institutions as too-big-to-fail and give them their own regulator. It is hard to make up that list. But we would also be creating a new set of GSEs. There is a danger that the regulator of too-big-to-fail institutions would see its job as keeping them from failing and the result would eventually be expensive bailouts. Second, I would definitely not put additional regulatory responsibility at the Federal Reserve. The Fed is very good at monetary policy. It should be headed and staffed by strong macroeconomists who are charged with keeping on top of economic developments. These are different skills from regulation and I think putting an additional regulatory responsibility which they have historically not been very good at at the Fed would dilute their monetary policy focus. I also fear that adding a new set of regulatory authorities to the Fed's task would threaten the independence of monetary policy, which is very important to preserve. Congress would justifiably want more control over such a powerful agency, appropriations, accountability for policy, and so forth. It might easily threaten the independence of the Federal Reserve in taking unpopular decisions to rein in the bubble economy. Thank you, Mr. Chairman. Senator Warner. Professor Meltzer.STATEMENT OF ALLAN H. MELTZER, PROFESSOR OF POLITICAL ECONOMY, FOMC20080805meeting--60 58,VICE CHAIRMAN GEITHNER.," I have a question similar to President Plosser's. Both the financial shock--the housing adjustment--and the big relative price shock you could say all in different forms could hurt the rate of growth of the economy's productive potential. You could say that they all might, in some dimension, reduce the near-term expected path of potential growth. I guess my question is that you have this ""costly sectoral reallocation"" alternative scenario--do you attribute any effect on potential growth over the forecast period in your baseline to the combined effect of the housing adjustment and the big relative price shock from energy? " CHRG-111hhrg51698--78 Mr. Buis," In a very losing position, and they are locked into these higher costs, whether it is livestock producers or grain producers. Buy fertilizer based on record inputs, and fertilizer prices followed oil, and we all know that was a false bubble as well. " FinancialCrisisInquiry--183 And then we had wide-spread speculation. And I submitted an article to you as a commission, which I wrote in 2006 that was published in 2007. Nearly 30 percent of all home sales in the hot markets were just speculators. And this is not a bad thing, but the speculators put down almost no money. They were flipping houses. And our mortgage system was not able to distinguish between a homeowner and a speculator. And I think we really need to do a much better job of that in the future. We already are trying to. We’re— nothing wrong with speculating, but you’ve got to put down hard money -- 30 percent down. Some big number so they’re not destroying the market for the people who want to own and live in houses. There was a regulatory failure, and everybody knew this was happening. Everybody in the country knew this was happening by the middle of 2006 -- late 2006. One of the unregulated institutions—New Century—a mortgage broker—went bankrupt in early 2007. Everybody knew this, but it kept on going on. I tried very hard and others as well to talk to regulators about this—inform them of this—and within institutions—the Fed in particular. There was a big debate going on. Should they do something about it? And it was decided not to. They didn’t think they had the power. They didn’t really believe it was as bad as it was. But there was a big debate with board members about doing something about this. I think really the whole system of a non-recourse loan in both commercial and residential while desirable by the people borrowing has really created this problem. That there is a belief that it’s a—a put option. Things go well, great. If not, I can give it back. And this misalignment of interest at this level—the consumer level, the borrower level—and the misalignment of—of interest throughout the entire system where risk and rewards are disconnected is really how we’re going to fix this. So if I were to summarize I would say too much leverage, poor underwriting and lax regulation. But I want to take you through some of the charts I have. I know I’ve got about five more minutes, but tell you where we are today. And I think you have these at the end of the testimony. They’re figures. And let’s take the first one, which is the housing bubble. It says, “Figure One—U.S. Housing, Single Family Starts.” CHRG-111hhrg51698--623 Mr. Boswell," You are very welcome. Anyone else? Mr. Marshall? I think that concludes our panel today. We cannot thank you enough for your time, your presence. I also think it is fair and reasonable to say we are going to need to continue the dialogue. As I think you may have heard earlier today, we have to do this right. We are counting on your input. So, again, thank you very much, and we will call this meeting adjourned. [Whereupon, at 3:18 p.m., the Committee was adjourned.] [Material submitted for inclusion in the record follows:] Submitted Statement of Hon. Bart Chilton, Commissioner, U.S. Commodity Futures Trading Commission I commend Chairman Peterson for his continued leadership and support his efforts to restore the public's confidence in U.S. futures markets by ensuring appropriate oversight. The proposal incorporates needed changes to our current regulatory structure that will greatly improve our ability to protect consumers and businesses alike. In a speech last week, I quoted the American folklorist Zora Neale Hurston, who said; ``There are years that ask questions, and there are years that answer.'' This year must be a year of answers. During my remarks, I went on to lay out what I see as necessary steps to healing our fractures in our regulatory system. I'm pleased that the Chairman's proposal also addresses several of these critical components. (1) Require OTC reporting and record-keeping. This will enable the CFTC to examine trading information, particularly information about sizable, look-alike or price discovery transactions that could impact regulated markets--markets that have a bearing on what consumers pay for products like gasoline or food, or even interest rates on loans. (2) Oversee mandatory clearing of OTC Credit Default Swap (CDS) transactions, and encourage clearing for other OTC products as appropriate. The stability and safety of our financial system is significantly improved by enhancing clearing systems for CDSs--in a manner that does not lead to cross-border arbitrage--as well as for other OTC derivatives. Such clearing would not only provide counterparty risk, but a data audit trail for regulators. (3) Regulate OTC transactions if the Commission determines that certain trades are problematic. The CFTC should be given the authority to determine and set position limits (aggregated with exchange positions, and eliminate bona fide hedge exemptions) to protect consumers. Congress should also extend CFTC anti- fraud, anti-manipulation and emergency authorities as appropriate to OTC transactions to allow greater openness, transparency and oversight of our financial markets. These provisions are included in the Chairman's proposal. I am hopeful that the Committee will also consider two other items, one within its jurisdiction--the other an appropriations matter. (4) Public Directors on Investment Industry Boards. Corporate boards would benefit greatly from the inclusion of public directors who bring a diversity of backgrounds and experiences to the boardroom. Such a provision would allow farmers, consumer representatives or other individuals to serve and provide different, yet important perspectives. All too often, these boards look more like an extension of the companies themselves than a group of individuals that are there to spot problems and deliver constructive criticism. Unfortunately, what we witnessed in the securities world is that this had to be mandated rather than simply encouraged. For that reason, I would urge Congress to consider a requirement that a third of board members be considered public directors. (5) Congress should appropriate immediate full funding ($157 million for Fiscal Year 2009) in additional resources, which would allow the CFTC to hire an additional 150 employees, and fund related technology infrastructure so that the agency can properly effectuate our duties under the Commodity Exchange Act, as amended by the farm bill. Many in Congress have joined together to call for increased resources for the Securities and Exchange Commission (SEC). By comparison, the CFTC oversees exchanges with significantly greater market capitalization than the SEC. For example the CME Group alone has a market capitalization of roughly $11 billion, while NYSE/Euronext (largest U.S. securities exchange regulated by the SEC) has a market capitalization of $5.5 billion. The SEC has 3,450 employees, while the CFTC struggles with roughly 450--fully 3,000 less staff. It is not a popular thing to call for more money for Federal employees, but cops on the beat are needed to detect and deter crimes. The CFTC needs these additional resources and we need them now. There are many other provisions in the Chairman's proposal that I support, such as closing the London Loophole and ensuring exclusive jurisdiction over environmental futures market regulation. Simply put, the success of a cap-and-trade system requires an experienced regulator. The Chairman's proposal, if enacted, will bring much needed transparency and accountability to both over-the-counter and certain overseas markets; provide the CFTC the authorities necessary to prevent market disruptions from excessive speculation; and give regulators a window into currently ``dark markets'' by requiring reporting and record-keeping. ______ Supplemental Material Submitted by Michael W. Masters, Founder and Managing Member/Portfolio Manager, Masters Capital Management, LLC Dear Congressman Marshall: Thank you for your insightful questions and your leadership on the issue of excessive speculation. I wanted to respond promptly to your request for written answers to the two questions you posed during the hearing. Your first question pertained to a scenario wherein the commodities derivatives markets are balanced, with an equal number of speculators seeking trading profits on the one hand, and physical producers and consumers hedging their real business on the other. What happens, then, if a large number of ``invesculators'' enter the markets? What problems would that pose and what solutions would we need? I believe the scenario you describe is precisely what has happened to our commodity markets in the last 5 years, culminating with the extreme price movements of the last 18 months. ``Invesculators,'' as you referred to them, are extremely damaging to the commodities derivatives markets, due to their belief that commodities are an ``asset class.'' Commodities are raw materials that are consumed by individuals and corporations. They are not an ``asset'' (like a stock or a bond) that can be bought and held for the long term. As much as institutional investors want to believe that commodities can be considered assets, they simply cannot. Physical hedgers--those who produce and consume actual commodities--never suffer from ``irrational exuberance.'' When prices rise, producers are motivated to produce more (that's their business), and consumers are motivated to consume less. In contrast, the ``Invesculator'' responds to an increase in price by thinking, ``oh, that would be a good investment,'' and jumps on the bandwagon by submitting their own buy orders. This is the dynamic that causes price bubbles to form. Every capital asset category has had its bubbles through history: the Japan bubble, the emerging markets bubble, the Internet bubble, the housing bubble, the credit bubble, etc. Eventually, wherever investors go, price bubbles appear. When physical hedgers dominate the commodities derivatives markets then traditional speculators, because they are outnumbered, will emulate the behavior of the physical hedgers. But when speculators rule these markets then they can drive prices to irrational heights that have nothing to do with supply and demand. In the scenario that you described, wherein five speculators and five physical hedgers are transacting in the derivatives market, and then 45 ``invesculators'' show up, the result is a bubble, just as if you put your house on the market, had an open house, and 45 people showed up with their checkbooks. You're going to get a much higher price than if no one, or even a couple of people, showed up. While bubbles in asset markets can be intoxicating, bubbles in commodities are devastating. Every human being around the globe suffers when we experience bubbles in food and energy prices. So what can Congress do about it? Fortunately, the solution is simple, and Congress has already done it since 1936: put a limit on the size of positions that speculators can hold in order to prevent them from dominating the market. This worked superbly from 1936 until about 1998. It is simple and proven, and carries no unintended consequences. Unfortunately in 1998 the CFTC began to let speculative position limits slide. For them the term ``excessive speculation'' came to mean basically the same as ``manipulation.'' At which point the CFTC decided position limits were only necessary to prevent manipulation. Then, in 2000 the Commodities Futures Modernization Act (CFMA) allowed the formation of the Intercontinental Exchange (ICE), and exempted over-the-counter (OTC) swaps dealers from all regulation. The result was that there were no longer any real speculative position limits in energy. Also, the OTC markets effectively rendered position limits in agricultural commodities meaningless. What ensued was rampant speculation, which led to the bubble that finally burst in the second half of 2008. It's easy to see why it is not only essential to reinstate a system of speculative position limits on the exchanges, but it is also critical for those limits to apply to ICE and other exchanges, as well as the OTC markets. When there is a clearly defined limit placed on the money flowing into a market, then prices cannot expand fast enough to cause a bubble. Your question seemed to also pose a more nuanced scenario: assuming a market in which the speculative position limit is, for example, 1,000 contracts, and further assuming that 50,000 contracts are held by speculators and 100,000 contracts are held by physical producers and consumers, what if 300 new speculators show up and they all stay below the 1,000 contract limit, they can still buy 300,000 contracts combined, what should be done then? The answer is that speculative position limits need to be adjusted as market conditions dictate. This scenario provides an excellent illustration of why we recommend the formation of a physical hedgers' panel that would serve to adjust speculative position limits every 3-12 months. If the ratio of speculators to physical hedgers becomes too high (like 350,000 : 100,000--which, for reference, was the approximate ratio in 2008), then the panel should lower the speculative position limit from 1,000 contracts down to, say, 500 contracts. Similarly, if the ratio of speculators to physical hedgers is too low and the markets need more liquidity, then the panel would have the ability to raise the limit to allow speculators to take larger positions. Think of speculative position limits like a valve that controls the level of speculative money in the markets, as well as the speed with which money flows into the markets. We believe that the optimal ratio of speculators to physical hedgers is one to two (34% speculative). The commodities futures markets operated efficiently with no liquidity issues for decades while open interest stayed generally in the range of one speculator for every four physical hedgers. So if the physical hedgers' panel would target a ratio of one speculator for every two physical hedgers that would give the commodities derivatives markets abundant liquidity. Your second question pertained to the possible challenges of implementing across-the-board speculative position limits. The simplest and most effective way to implement speculative position limits is to enforce an ``aggregate'' speculative position limit that a speculator will face regardless of the transaction venue (e.g., a CFTC-regulated futures exchange like NYMEX, a non-CFTC-regulated futures exchange like ICE, or in the OTC market). Let's say that the physical hedger panel determines that the speculative limit for oil should be 5 million barrels or 5,000 contracts. Speculators would be told that they can buy up to 5 million barrels anywhere they want as long as they do not exceed this limit. Consider the problems that can arise if a system of speculative position limits is not established on an aggregate basis and instead individual trading venues are assigned their own unique limits. No matter what system is used for assigning those limits it will run into problems. As an example, if the aforementioned 5,000 contract speculative position limit for crude oil is apportioned as follows: NYMEX: 1,000 ICE: 1,000 OTC: 1,000 contract equivalent (1 million barrels) IPE: 1,000 (International Petroleum Exchange) DME: 1,000 (Dubai Mercantile Exchange) Then, under this scenario, speculators will be forced to spread their trading around in order to access their entire 5,000 contract speculative position limit. Since the amount of liquidity varies from one exchange/venue to the next, it would not make sense to encourage an equal amount of trading on each venue. For example, ICE has half the volume of NYMEX, so should they have the same limit as NYMEX or half the limit of NYMEX? Different problems arise however if unequal speculative position limits are imposed. If the limits were set to match current liquidity like this: NYMEX: 1,000 ICE: 500 OTC: 2,500 IPE: 800 DME: 200 Then the growth of ICE and other exchanges would be stunted due to their low relative limits. This system has the further effect of forcing speculators to trade OTC in order to reach their 5,000 contract maximum. This is not something that I believe Congress wants to do. If limits are placed on some venues but not others, then trading will flow to the places that offer unlimited speculation (currently the OTC markets). This would fail to safeguard against future speculative bubbles, which is what the speculative limits are designed to do. The best system for implementing aggregate speculative position limits would entail the following: (1) All OTC commodity derivative transactions must clear through an exchange. (2) Each speculator would have a trader identification number which would be associated with every trade, just like a customer account number. (3) Foreign boards of trade would have to supply information to the CFTC on U.S. traders (looking at the parent entity level). Those who oppose exchange clearing will complain about ``chicken fat'' swaps and the like, but in reality, 99% of all commodity swaps are composed of futures contracts and basis trades, which would all clear. Congress should resist attempts by Wall Street to avoid exchange clearing by claiming that their derivatives are too exotic and that therefore large segments of the market need to be exempted from the clearing requirement. Almost all OTC commodity derivatives should clear. As part of the clearing process OTC derivatives are transformed into futures contract equivalents. Therefore the process of applying speculative position limits to OTC derivatives that have exchange cleared is as simple as applying limits to futures contracts. Under this system of speculative position limits and exchange clearing, the aggregate activity for an individual trader can be calculated simply by tracking the trader identification number and adding up how much each trader has bought through each venue in each commodity. A trader who exceeds their limit could face a stiff financial penalty (100% of which can go to the CFTC to fund their operations) and that trader's positions could be liquidated on a last-in, first-out basis. In order for this regulation to capture transactions on foreign boards of trade, they must be required to submit the necessary information to the CFTC on a real-time basis in exchange for the CFTC allowing them to place direct terminals in the United States. The CFTC has many ``hooks'' that would allow them to ensure that aggregate speculative position limits apply to foreign boards of trade as well. In summary, the idea is to give speculators one limit and let them ``spend'' it wherever they see fit. I hope I have clarified why aggregate speculative position limits and exchange clearing are the surest protection against a future commodity bubble. Please let me know if I can be of any further assistance. Best regards,Michael W. Masters,Portfolio Manager,Masters Capital Management, LLC. ______ fcic_final_report_full--574 Register 60, no. 86 (May 4, 1995): 22155–223. 83. Division of Consumer and Community Affairs, memorandum to Board of Governors, August 10, 1998. 84. Federal Reserve Board press release, “Order Approving the Merger of Bank Holding Companies,” August 17, 1998, pp. 63–64. 85. Lloyd Brown, interview by FCIC, February 5, 2010. 86. Andrew Plepler, interview by FCIC, July 14, 2010. 87. Assuming 75% AAA tranche ($1.20), 10% AA tranche ($0.20), 8% A tranche ($0.30), 5% BBB tranche ($0.40), and 2% equity tranche ($2.00). See Goldman Sachs, “Effective Regulation: Part 1, Avoid- ing Another Meltdown,” March 2009, p. 22. 88. David Jones, interview by FCIC, October 19, 2010. See David Jones, “Emerging Problems with the Basel Capital Accord: Regulatory Capital Arbitrage and Related Issues,” Journal of Banking and Finance 24, nos. 1–2 (January 2000): 35–58. 89. Henry Paulson, testimony before the FCIC, Hearing on the Shadow Banking System, day 2, ses- sion 1: Perspective on the Shadow Banking System, May 6, 2010), transcript, p. 34. 90. Jones, interview. Chapter 7 1. For example, an Alt-A loan may have no or limited documentation of the borrower’s income, may have a high loan-to-value ratio (LTV), or may be for an investor-owned property. 2. Inside Mortgage Finance, The 2009 Mortgage Market Statistical Annual, vol. 2, The Secondary Mar- ket (Bethesda, MD: Inside Mortgage Finance, 2009), p. 9, “Mortgage & Asset Securities Issuance” (show- ing Wall St. securitizing a third more than Fannie and Freddie); p. 13, “Non-Agency MBS Issuance by Type.” FCIC staff calculations from 2004 to 2006 (for growth in private label MBS). 3. Charles O. Prince, interview by FCIC, March 17, 2010. 4. John Taylor, interview by FCIC, September 23, 2010. 5. William A. Fleckenstein and Frederick Sheeham, Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve (New York: McGraw-Hill, 2008), p. 181. 6. Alan Greenspan, “The Fed Didn’t Cause the Housing Bubble,” Wall Street Journal, March 11, 2009. See also Ben Bernanke, “Monetary Policy and the Housing Bubble,” speech at the Annual Meeting of the American Economic Association, Atlanta, Georgia, January 3, 2010. 7. Alan Greenspan, testimony before the Senate Committee on Banking, Housing, and Urban Affairs, 109th Cong., 1st sess., February 16, 2005. 8. Fed Chairman Ben S. Bernanke, “The Global Saving Glut and the U.S. Current Account Deficit,” re- marks at the Sandridge Lecture, Virginia Association of Economics, Richmond, Virginia, March 10, 2005. 9. Frederic Mishkin, interview by FCIC, October 1, 2010. 10. Pierre-Olivier Gourinchas, written testimony for the FCIC, Forum to Explore the Causes of the Financial Crisis, day 1, session 2: Macroeconomic Factors and U.S. Monetary Policy, February 26, 2010, pp. 25–26. . 11. Paul Krugman, interview by FCIC, October 6, 2010. 571 12. Ellen Schloemer, Wei Li, Keith Ernst, and Kathleen Keest, “Losing Ground: Foreclosures in the Subprime Market and Their Cost to Homeowners,” Center for Responsible Lending, December 2006, p. 22. 13. 2009 Mortgage Market Statistical Annual , vol. 1, The Primary Market , p. 4, “Mortgage Originations by Product.” 14. Christopher Mayer, Karen Pence, and Shane M. Sherlund, “The Rise in Mortgage Defaults,” Jour- nal of Economic Perspectives 23, no. 1 (Winter 2009): Table 2, Attributes for Mortgages in Subprime and Alt-A Pools, p. 31. 15. 2009 Mortgage Market Statistical Annual, 2:13, “Non-Agency MBS Issuance by Type.” 16. 2009 Mortgage Market Statistical Annual , 1:6, “Alternative Mortgage Originations”; previous data extrapolated in FCIC estimates from Golden West, Form 10-K for fiscal year 2005, and Federal Reserve, “Residential Mortgage Lenders Peer Group Survey: Analysis and Implications for First Lien Guidance,” November 30, 2005. 17. Inside Mortgage Finance. 18. Countrywide, 2005 Form 10-K, p. 39; 2007 Form 10-K, p. 47 (showing the growth in Country- wide’s originations). 19. Angelo Mozilo, email to Sambol and Kurland re: Sub-prime Seconds. See also Angelo Mozilo, email to Sambol, Bartlett, and Sieracki, re: “Reducing Risk, Reducing Cost,” May 18, 2006; Angelo Mozilo, interview by FCIC. September 24, 2010. 20. David Sambol, interview by FCIC, September 27, 2010. 21. See Countrywide, Investor Conference Call, January 27, 2004, transcript, p. 5. See also Jody Shenn, “Countrywide Adding Staff to Boost Purchase Share,” American Banker, January 28, 2004. 22. Patricia Lindsay, written testimony for the FCIC, hearing on Subprime Lending and Securitization and Government-Sponsored Enterprises (GSEs), day 1, sess. 2: Subprime Origination and Securitization, April 7, 2010, p. 3 23. Andrew Davidson, interview by FCIC, October 29, 2020. 24. Ibid. 25. David Berenbaum, testimony before Senate Committee on Banking, Subcommittee on Housing, CHRG-111hhrg56766--274 Mr. Foster," As you know, I am an enthusiast for actually looking into this as a way of stabilizing our economy against future, especially real estate, bubbles. We had some testimony from our snow-canceled hearing by a gentleman called Richard Koo from Nomura Securities Institute, and he talked about what he called a ``balance sheet recession.'' He said there was a qualitative difference between normal business circumstances where businesses respond to a lower interest rate by actually expanding operations, and a situation where after the bursting of a bubble that was fueled by deficits and so on, that you behave differently. If you are terrified you are insolvent, then a lower interest rate does not interest you, except in helping you pay off your debt faster. I was wondering if you think that is a valid point of view and really if there is an element to that. He made the comparison also of Japan 15 years ago and the United States today. I was wondering if you would comment on that. " FinancialCrisisReport--74 Home Equity originations were projected to grow from $4 billion in 2005 to $30 billion in 2008. On the other hand, WaMu’s low risk originations were expected to be curtailed dramatically. Government backed loan originations, which totaled $8 billion in 2005, were projected to be eliminated by 2008. Fixed rate loan originations were projected to decline from $69 billion in 2005 to $4 billion in 2008. The 2007 “Strategic Direction” memorandum to the Board is dated June 18, 2007, well after U.S. housing prices had begun to decline, as Mr. Killinger acknowledged: “For the past two years, we have been predicting the bursting of the housing bubble and the likelihood of a slowing housing market. This scenario has now turned into a reality. Housing prices are declining in many areas of the country and sales are rapidly slowing. This is leading to an increase in delinquencies and loan losses. The sub-prime market was especially rocked as many sub-prime borrowers bought houses at the peak of the cycle and now find their houses are worth less and they are having difficulties refinancing their initial low-rate loans.” 192 While the memorandum’s section on home loan strategy no longer focused on overall growth, it continued to push the shift to high risk lending, despite problems in the subprime market: “Home Loans is a large and important business, but at this point in the cycle, it is unprofitable. The key strategy for 2008 is to execute on the revised strategy adopted in 2006. … We need to optimize the sub-prime and prime distribution channels with particular emphasis on growing the retail banking, home loan center and consumer direct channels. We also expect to portfolio more of Home Loans’ originations in 2008, including the new Mortgage Plus product. We will continue to emphasize higher-risk adjusted return products such as home equity, sub-prime first mortgages, Alt A mortgages and proprietary products such as Mortgage Plus.” 193 The testimony of other WaMu executives further confirms the bank’s implementation of its High Risk Lending Strategy. Ronald Cathcart, who joined WaMu in 2006, to become the company’s Chief Risk Officer, testified: “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 192 6/18/2007 Washington Mutual memorandum from Kerry Killinger to the Board of Directors, “Strategic Direction,” JPM_WM03227058-67 at 60, Hearing Exhibit 4/13-6a. 193 Id. at 66 [emphasis in original removed]. See also 1/2007 Washington Mutual presentation, “Subprime Mortgage Program,” JPM_WM02551400, Hearing Exhibit 4/13-5 (informing potential investors in its subprime RMBS securities that: “WaMu is focusing on higher margin products”). 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.” 194 fcic_final_report_full--13 While many of these mortgages were kept on banks’ books, the bigger money came from global investors who clamored to put their cash into newly created mortgage-re- lated securities. It appeared to financial institutions, investors, and regulators alike that risk had been conquered: the investors held highly rated securities they thought were sure to perform; the banks thought they had taken the riskiest loans off their books; and regulators saw firms making profits and borrowing costs reduced. But each step in the mortgage securitization pipeline depended on the next step to keep demand go- ing. From the speculators who flipped houses to the mortgage brokers who scouted the loans, to the lenders who issued the mortgages, to the financial firms that created the mortgage-backed securities, collateralized debt obligations (CDOs), CDOs squared, and synthetic CDOs: no one in this pipeline of toxic mortgages had enough skin in the game. They all believed they could off-load their risks on a moment’s no- tice to the next person in line. They were wrong. When borrowers stopped making mortgage payments, the losses—amplified by derivatives—rushed through the pipeline. As it turned out, these losses were concentrated in a set of systemically im- portant financial institutions. In the end, the system that created millions of mortgages so efficiently has proven to be difficult to unwind. Its complexity has erected barriers to modifying mortgages so families can stay in their homes and has created further uncertainty about the health of the housing market and financial institutions. • We conclude over-the-counter derivatives contributed significantly to this crisis. The enactment of legislation in 2000 to ban the regulation by both the federal and state governments of over-the-counter (OTC) derivatives was a key turning point in the march toward the financial crisis. From financial firms to corporations, to farmers, and to investors, derivatives have been used to hedge against, or speculate on, changes in prices, rates, or indices or even on events such as the potential defaults on debts. Yet, without any oversight, OTC derivatives rapidly spiraled out of control and out of sight, growing to  tril- lion in notional amount. This report explains the uncontrolled leverage; lack of transparency, capital, and collateral requirements; speculation; interconnections among firms; and concentrations of risk in this market. OTC derivatives contributed to the crisis in three significant ways. First, one type of derivative—credit default swaps (CDS)—fueled the mortgage securitization pipeline. CDS were sold to investors to protect against the default or decline in value of mortgage-related securities backed by risky loans. Companies sold protection—to the tune of  billion, in AIG’s case—to investors in these newfangled mortgage se- curities, helping to launch and expand the market and, in turn, to further fuel the housing bubble. Second, CDS were essential to the creation of synthetic CDOs. These synthetic CDOs were merely bets on the performance of real mortgage-related securities. They amplified the losses from the collapse of the housing bubble by allowing multiple bets on the same securities and helped spread them throughout the financial system. Goldman Sachs alone packaged and sold  billion in synthetic CDOs from July , , to May , . Synthetic CDOs created by Goldman referenced more than , mortgage securities, and  of them were referenced at least twice. This is apart from how many times these securities may have been referenced in synthetic CDOs created by other firms. FOMC20050630meeting--10 8,MR. PEACH.," Hardly a day goes by without another anecdote-laden article in the press claiming that the U.S. is experiencing a housing bubble that will soon burst, with disastrous consequences for the economy. Indeed, housing market activity has been quite robust for some time now, with starts and sales of single- family homes reaching all time highs in recent months and home prices rising rapidly, particularly along the east and west coasts of the country. But such activity could be the result of solid fundamentals underlying the housing market. After all, both nominal and real long-term interest rates have declined substantially over the last decade. Productivity growth has been surprisingly strong since the mid-1990s, producing rapid real income growth primarily for those in the upper half of the income distribution. And the large baby-boom generation has entered its peak earning years and appears to have strong preferences for large homes loaded with amenities. One of the conditions of an asset bubble is that the price of the asset has risen well above what is consistent with underlying fundamentals. In the current debate, two measures of relative value have been applied to single-family home prices— price relative to income and rent relative to price. In the comments that follow I will concentrate on the price-to-income measure, but my conclusions apply equally to the rent-to-price measure. June 29-30, 2005 12 of 234 average price of homes purchased (or mortgages refinanced) with loans purchased by Fannie Mae and Freddie Mac, or conforming conventional loans. Therefore, it excludes cash sales as well as purchases or refinancings financed with FHA [Federal Housing Administration], VA [Veterans Affairs], and jumbo conventional mortgages. It is called a repeat-sales index because it is derived by observing the sales prices—or appraised values, in the case of refinancings—of properties at specific addresses at two or more points in time. Finally, it is a transactions-based index in that it reflects the prices of homes that are sold (or refinanced) rather than the entire universe of single-family homes. A lesser known home price index is the constant-quality new home price index published by the Bureau of the Census (exhibit 2). This index is based on a sample of new homes sold, regardless of how the sale was financed. Hedonic methods are employed to hold the physical and locational characteristics constant over time. This index is part of the Census Bureau statistical program through which the single- family residential investment deflator of the national income and product accounts is derived. As shown in exhibit 3, the increase in prices indicated by these two indexes is quite different. For example, over the four years from 2000 to 2004, the OFHEO index increased at a compound annual rate of 8.2 percent, while the constant-quality index increased at a 5.4 percent annual rate. As shown in exhibit 4, the current ratio of price over median family income derived from these two indexes is vastly different. If the OFHEO index is giving an accurate picture of what is happening to home prices, I think one could say with some confidence that prices have been bid up to unsustainable levels. However, if the constant-quality index is a better reflection of reality, home prices actually look somewhat low relative to median family income, particularly compared to the late 1970s. I believe the constant- quality index provides a more accurate indication of what is happening to the price of a typical single-family home. In contrast, the OFHEO index is subject to upward biases that accumulate over time and distort ratios such as price-to-income and income-to-rents. To help us understand the biases in the OFHEO index, exhibit 5 presents the distribution by value of all single-family homes in the U.S. in 2003, with the specific values at the 25th, 50th, 75th, and 80th percentiles. 4 The median value in 2003 was $150,000 with the distribution skewed toward the right. The value at the 25th percentile was $90,000 while the value at the 75th percentile was $250,000. We do not know with certainty where the OFHEO index falls on this distribution, as it is an index rather than a series of values. But we can be reasonably certain that it lies somewhere between the average price of all existing single-family homes sold and the average price of homes purchased with conventional loans. That means the OFHEO index is a closer reflection of what is happening at the 75th percentile rather than the 50th percentile. Moreover, it is very likely that over time the point on that distribution represented by the OFHEO index has been drifting to the right. One June 29-30, 2005 13 of 234 cause of this rightward drift is what I call transaction bias. As shown in exhibit 6, the American Housing Survey (AHS) data suggest that both appreciation rates and turnover rates increase as one moves out the home value distribution. For example, from 1997 to 2003 the compound annual rate of appreciation at the 25th percentile was 4.5 percent, increasing to 8.7 percent at the 80th percentile. Corresponding average turnover rates for the period from 1997 to 2003 were 5.9 percent and 7.4 percent. That means, of course, that the average rate of appreciation of the units that turn over is higher than the average rate of appreciation of the entire distribution. While the amount of bias in any one year is likely to be small, it does cumulate over time and becomes quite important when one is comparing levels versus income or rents. Another potential upward bias in the OFHEO index is that while it is a repeat- sales index, there is evidence to suggest that it is not a constant-quality index. In addition to the strong pace of new housing starts, another aspect of the housing boom of the past decade has been a significant increase additions and alterations to the existing housing stock. Exhibit 7 presents in the top panel the ratio of the OFHEO index over the constant-quality index plotted over the period from 1977 to the present. In the lower panel are plotted real improvements per unit of housing stock per year over the same period. Over the past decade real improvements per unit have increased about 25 percent, which appears to be associated with a further increase in the ratio of the OFHEO index over the constant-quality home price index. Research suggests that higher-income households have a higher income elasticity of demand for improvements to their primary residences, suggesting that this source of upward bias is likely to be more pronounced in the right half of the distribution of all single-family homes. 5 Another way of looking at the issue of home prices over income is to go back to the AHS data and see what is happening at various points on the distribution of all single-family homes. This information is presented in exhibit 8. At the 25th percentile the ratio of home price to income has been relatively stable, while it has increased sharply at the 75th and 80th percentiles, reminiscent of the price-to­ income ratio computed with the OFHEO index. Let me pause just a moment and emphasize that I am comparing home prices at a percentile with the incomes of the people who live in those homes at the same percentile. This chart is likely the equivalent of the finding that the increase of home prices has been most pronounced in areas of the country where home prices were already relatively high due in part to relatively inelastic supply. It is likely that in these areas of the country, where land values are high, the inclination to make substantial improvements to existing properties is the greatest. Clearly, not everyone agrees that the constant-quality new home price index provides an accurate indication of what is happening to the price of a typical single- family home. For example, it has been argued that most new construction takes June 29-30, 2005 14 of 234 place at the fringe of metropolitan areas where land prices may not be rising as fast as is intra-marginal land. There are several counter arguments. First, the theory leading to the conclusion that intra-marginal land values increase at a faster rate than land at the fringe is based on a theory of the development of a metropolitan area with fairly restrictive assumptions. Modern metropolitan areas have multiple commercial/employment centers. Many households have preferences for rural or suburban residences over urban residences. Restrictions on development to counter suburban sprawl have reportedly resulted in sharp increases in prices of parcels of land suitable for home building. Finally, I would like to note that the increases in land prices implicit in the constant-quality home price index, shown in exhibit 9, are substantial, particularly in the Northeast and the West. These estimates were derived assuming that land represents 50 percent of the value of the total property and that the prices of the other inputs increase at the same rate in all regions of the country. In closing, I would like to comment on one other aspect of the housing bubble issue that has received substantial attention. Earlier this year a major real estate related trade association released the results of a survey indicating that a significant percentage of single-family home sales were of investment properties and second homes. This was widely interpreted as evidence of speculative buying of rental properties, another feature of a housing bubble. Again, I believe that such reports should be viewed skeptically. According to the AHS, in 2003 single-family investment properties, defined as homes renter-occupied or for rent, represented 14.2 percent of all single-family homes while second homes represented another 4.7 percent. Therefore, we should not be surprised that such properties represent about 20 percent of the sales that take place at any point in time. Moreover, the American Housing Survey data indicate that single-family investment properties have been declining as a share of all single-family homes for some time and declined in absolute numbers from 2001 to 2003. A principal reason the rental vacancy rate for single-family homes has risen in recent years is that the number of renter-occupied single-family homes has declined as people switch from renting to owning. So if a lot of people are buying rental properties, it must also be the case that a lot are selling as well. That concludes my report. Thank you." FOMC20050630meeting--78 76,MR. RUDEBUSCH.," I guess I’d make a distinction there, in that I think the proponents are talking not about setting asset prices in general but about trying perhaps to reduce the bubble component. Clearly, if asset prices are set equal to the fundamentals, that’s going to lead to the proper functioning of—" 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. " CHRG-111hhrg61852--19 Mr. Koo," My idea of the situation is that once the bubble burst, the economy began to weaken because of all these balance sheet problems that I mentioned. But we had one accident in between, which was, in my view, totally unnecessary, and that was the Lehman shock. The fact that Lehman Brothers was allowed to fail when so many other financial institutions had the same problem at the same time, that caused a massive panic, which was, in my view, totally unnecessary. " FOMC20070628meeting--81 79,MS. LIANG.," If we had started this series in the early ’90s, this would be the high. We have the stock market bubble of 2000 in here, and it has come off, but it is 5½. Even at the end of the projection period, it is 5½ times disposable income. That is historically high. Before ’96, it would have been about 3½ or 4." FOMC20070628meeting--117 115,MR. HOENIG.," Thank you. I will spend just a couple of minutes extra on the District this time because, generally speaking, our District economy continues to perform very well despite the weakness in the housing sector. Energy and agriculture remain very strong, and manufacturing remains generally strong although we have seen some leveling-off of that in the past month. The strength in these three sectors has helped spur broad-based job growth throughout the District and a significant tightening of our labor markets and their conditions. Many of our contacts report labor shortages and higher wage pressures. Demand for skilled labor remains very strong, and some firms have limited hiring plans because of the unavailability of qualified workers. To bolster recruiting, a few companies have partnered with vocational schools to offer industry- specific training programs to try to fill the gap. Since our last meeting, hiring announcements, which we try to track, have outpaced layoff announcements by a margin of 6 to 1. One anecdotal piece of information—we have some fairly large engineering firms in Kansas City that build power plants globally, including in China, and also ethanol plants. Last year, one CEO told me that they hired 2,100 engineers and were unable to fill 900 positions on a global basis. So there is a lot of activity going on out there. Construction activity remains mixed, with weakness in residential construction balanced by strength in commercial construction. On the residential side, we have seen some pickup in sales, but high inventories have limited new construction. For us, problems with subprime loans are concentrated in Colorado and in a few other areas. But because of the strength in energy and agriculture, some parts of the region are actually experiencing a housing boom, with strong home-price appreciation. Relative to the total market, that is small, but it is a rather sharp contrast. Conditions in agriculture are the best in recent years. Spring rains have alleviated drought conditions in much of our region. Strong demand and limited supplies continue to boost farm commodity prices and farm incomes. However, we are also beginning to see the effects of higher livestock and crop prices on retail food prices themselves. An additional concern is the sharp rise in land prices throughout much of our District. First-quarter cropland values in the District rose roughly 12 percent above year-ago levels, and ranchland values have strengthened as well, that much or perhaps a little more. Our contacts in the real estate industry indicate that some of the recent surge in land prices is speculative in nature, and some District bankers have expressed concern about the bubble in farmland values driven in part by the ethanol boom that we have heard about. In recent examination reports, our supervision staff have begun to see some increases in nonperforming real estate loans, and that includes some pickup in other real estate owned as well. These developments are very preliminary, but they are reminiscent of an earlier time, and we are trying to pay a little more attention to that. On the national outlook, data released since the last meeting support the view that growth will pick up over the year. I have been encouraged by the recent pickup in retail sales and by positive news on employment and personal income. At the same time, the recent increase in longer-term interest rates, if sustained, is likely to damp growth somewhat in the period ahead. In particular, the rise in the thirty-year fixed mortgage rate may deepen and prolong the ongoing housing slump. The combined effects of weaker growth in the first quarter and the rise of long-term rates have led me to lower my estimate of growth in 2007 to about 2.3 percent. I expect growth of 2.7 in ’08 and 2.8 in ’09. I now think the risks, perhaps, are roughly balanced. While the downside risk from housing remains, the outlook for other sectors, as others have reported, has appeared to improve. Markets seem to have adopted this view as well, as removal of the expected policy easing has contributed to the flattening of the yield curve at this point. In terms of the inflation outlook, recent data have been favorable, with core CPI on a twelve-month basis down to 2¼ percent. I expect continued moderation over the year. In particular, if owners’ equivalent rent continues at the slower pace of the past three months, it will help bring down the twelve-month core inflation number over time. Despite these recent improvements, I continue to believe that upside risks to inflation remain. The possible pass-through of recent energy and food price inflation to core inflation may slow progress toward lower inflation. In addition, pressures from resource utilization and slow productivity growth, if that happens to be the case, could affect that outlook as well. Finally, I am somewhat concerned with the recent uptick in longer-term inflation expectations. We have talked about the TIPS five-year, five-year-ahead breakeven inflation rate; as mentioned in the earlier briefing, it has increased about 20 basis points over the past month. So in light of these factors, I believe it is important that we continue to signal to the markets that current inflation rates are not acceptable over the longer term. Thank you." fcic_final_report_full--20 Veteran bankers, particularly those who remembered the savings and loan crisis, knew that age-old rules of prudent lending had been cast aside. Arnold Cattani, the chairman of Bakersfield, California–based Mission Bank, told the Commission that he grew uncomfortable with the “pure lunacy” he saw in the local home-building market, fueled by “voracious” Wall Street investment banks; he thus opted out of cer- tain kinds of investments by .  William Martin, the vice chairman and chief executive officer of Service st Bank of Nevada, told the FCIC that the desire for a “high and quick return” blinded people to fiscal realities. “You may recall Tommy Lee Jones in Men in Black, where he holds a device in the air, and with a bright flash wipes clean the memories of everyone who has witnessed an alien event,” he said.  Unlike so many other bubbles—tulip bulbs in Holland in the s, South Sea stocks in the s, Internet stocks in the late s—this one involved not just an- other commodity but a building block of community and social life and a corner- stone of the economy: the family home. Homes are the foundation upon which many of our social, personal, governmental, and economic structures rest. Children usually go to schools linked to their home addresses; local governments decide how much money they can spend on roads, firehouses, and public safety based on how much property tax revenue they have; house prices are tied to consumer spending. Down- turns in the housing industry can cause ripple effects almost everywhere. FOMC20060920meeting--75 73,MR. STOCKTON.," I would say you have it just about right—somewhere on the order of 1 percent in the second half and something certainly under 2 percent in 2007. Obviously, in putting our forecast together we were contending both with weaker housing and with some of these offsets that we factored in that have provided some cushion to the downside surprise that we have had in housing through greater labor income, more purchasing power from lower energy prices, and a little higher stock market. In some sense, those effects get us back to just modestly below trend growth rather than significantly below trend growth." CHRG-111hhrg63105--73 Mr. Conaway," Speaking of the crisis, I have a short amount of time. I take that that you are fine with these dates. Mr. Chilton, you mentioned that some time frame in the run-up to the bubble in 2008 that there was $200 billion in new money in the system. How much of that money has fled the system? What are the levels today versus then? " CHRG-111hhrg53245--127 Mr. Zandi," My view is bubbles are created largely by leverage, that if they have a very clear ability to control or manage leverage throughout the entire financial system, which they would have as the systemic risk regulator, then they would have the tool they need to be able to manage that aspect of monetary policy. Ms. Rivlin. May I? " FOMC20060920meeting--74 72,MR. STERN.," Thank you, Mr. Chairman. Dave, I’m trying to understand your forecast and its evolution. As I read the Greenbook, at least on the demand side, it seemed to be largely a housing story as you cut through everything. So my question is, If I put myself back in August before I knew that incomes were going to be as high as they were, that energy prices were going to come down, that equity values were going to go up, and so forth, and I plug the current view of housing into that, what would it give me? I assume it would give me growth for the second half of this year at something close to maybe 1 percent and maybe growth next year of less than 2 percent. I know that there are a lot of moving parts, but anyway, that is the question. If we had known about housing and not plugged in this other stuff, where would we be?" 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." FOMC20050630meeting--368 366,MS. YELLEN.," Thank you, Mr. Chairman. At our last FOMC meeting, I worried about a slowdown in growth and a pickup in inflation. I hypothesized and hoped that both would prove transitory. On the whole, I consider recent data reassuring that the soft patch in the spring was just that—maybe not even that—and not a precursor of a more entrenched slowdown. While the Greenbook subscribes to the view that the slowdown in growth was transitory, the staff has made an upward revision, by a couple of tenths, to its forecast for core PCE inflation for this year and next year, now projecting inflation of about 2 percent in both years. I’m a bit less pessimistic on inflation than the staff. Recent data on core inflation have been pretty good of late. Moreover, I see the fundamentals—namely, the pressures on future inflation—as providing room on balance for some optimism. The most worrisome factor is that oil prices have risen further, although this should tend to boost core inflation more this year than next year. As David noted, the recent jump in compensation per hour should probably be discounted, since it appears to be due to one-time factors. On the encouraging side, I see a noticeable decline— about 17 basis points—in inflation compensation at both the 5- and 10-year horizons, high markups, an appreciation in the dollar, a leveling off of commodity prices, very modest increases in the ECI, June 29-30, 2005 132 of 234 The situation with regard to slack, as David noted and emphasized, is complicated because the unemployment rate is relatively low, near most estimates of NAIRU. But several other measures, as he pointed out and as we also routinely monitor—including the employment-to­ population ratio, capacity utilization, the output gap, and the other indicators that David showed us— do suggest that slack remains. One final point on the inflation outlook is that one of the best forecasters of future inflation is past inflation. And I’m told that this is a point that was emphasized at a special topic session a couple of years ago. On this score, things look fairly good, with core PCE price inflation at 1.7 percent over the past 12 months. While I guess I can and have quibbled a bit about the inflation outlook for the next year, overall I think the Greenbook forecast seems reasonable. Real GDP appears poised to grow just slightly above its potential rate, gradually eliminating remaining slack. And core inflation, while currently near the upper end of my comfort zone, at least to me seems likely to moderate a bit over the next few years. The Greenbook forecast depicts an almost textbook scenario of an economy continuing along the path toward a rather attractive steady state. Going forward, there are obviously some sizable risks, and I count the unwinding of possible house and bond market bubbles as one or two that are high on my list. But I think the most likely outcome is—as in the Greenbook projection— that we will continue to move in a positive direction over the next couple of years. And given what we now know, I think the funds rate path assumed in the Greenbook, which is very close to the market’s current view, is appropriate. That is, we are likely to need to raise rates a couple more times before slowing the pace of tightening rather substantially. And I want to emphasize that, in June 29-30, 2005 133 of 234 economy moving along this textbook path during a period characterized by some quite difficult circumstances. I know that Monday’s pre-FOMC briefing emphasized that economic activity has been burdened by some major drags over the past year or so. These include the oil shock, the deterioration in the trade balance, and the still low level of investment spending relative to GDP. The result is that we’ve had to keep interest rates exceptionally low for a long time, just to get respectable economic growth. In fact, respectable and not stellar growth is all we have gotten, even with exceptionally low long-term yields and unexpectedly rapid gains in house prices. And those are two factors that, on their own, would be working to push up the equilibrium real funds rate. So the merely respectable growth in the economy has really rested on the backs of just a few interest rate-sensitive sectors: business investment, consumer durables, and housing. From that perspective, it’s really not all that surprising that house prices have risen a great deal, and it’s not surprising to hear our directors and other contacts comment that liquidity is abundant and that lending is taking place for deals that one of our directors simply characterized as “stupid.” I think he meant by historical standards. [Laughter] My point is that to offset the drags, we’ve needed to give the economy a strong dose of stimulus, which inevitably boosted the housing sector—and that just to get reasonable economic growth. That is equivalent to saying that the equilibrium real fed funds rate is unusually low—1.4 percent in the Greenbook path. So, for me, the policy imperative that follows is that we need to be careful not to overdo the pace of policy tightening. I noted that in recent months several FOMC members have commented that we usually know we’ve come to the end of the tightening phase when we have tightened one or two times too many. I think we should be especially attentive to this concern this time around, June 29-30, 2005 134 of 234 John Williams’s analysis yesterday highlighted the fact that if house and/or bond prices fall, the zero bound could become an issue we would be discussing again. To conclude, I’m all for raising the funds rate by 25 basis points at this meeting, and I believe the language in the press release should seek to maintain the path for the expected fed funds rate that now exists in the market. My worry is that unless we’re careful in crafting the language as we raise the rate today—and likely again in August—markets will start to build in more increases in subsequent months than they have so far. I think we are nearing the point when we will need to start pausing, and I hope we can maintain that expectation in the market in the period ahead." 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. FOMC20070321meeting--87 85,MS. MINEHAN.," Thank you very much, Mr. Chairman. Perhaps unlike in the rest of the country, most of the recent cyclical data point to some reasons for optimism about near-term growth in New England, with the possible exception of the rate of foreclosure initiations related to subprime mortgages. The annual benchmark revisions by the BLS paint a happier picture of the current state of regional job growth, especially in Massachusetts and Connecticut. The overall message is that the region has been growing at a pace that is about at its long-term trend and has been adding jobs consistently in recent months. This picture is a bit different from the one we’ve been seeing for some time. The region’s unemployment rate remains about at the nation’s, and demand for skilled labor, as measured by both online and newspaper help-wanted ads and by anecdotal reports, is quite strong. Indeed, many continue to note that hiring the skilled workers they need has been difficult. Both temporary-help service firms and software and IT firms report strong demand for labor, particularly to meet finance and technical positions and to meet a growing backlog in activity in high-tech businesses. This aspect of the region’s labor market may be pulling some discouraged workers back into the labor force, as reflected in the perhaps temporary uptick in unemployment. Reflecting this better news on regional job growth, the Philadelphia Fed’s coincident economic indexes point to economic activity in the region’s two largest states that is on a par with national growth. When we surveyed a wide swath of retail contacts, we saw a bit of gloom on the retail side. But the fact that in New England you have an array of very small companies, sometimes in unique circumstances, may have given a little downbeat sense to the retail climate. The reports from larger retailers in the survey—and we have a couple of them— show solid year-over-year growth. Manufacturing employment continued to decline, but manufactured exports last quarter rose at a pace just a bit slower than the nation’s and were buoyed by airline-related products, fabricated metals, and general machinery. As I’ve noted before, downtown vacancy rates in most of the cities in New England are declining, as are suburban office vacancies; rents are rising; and one or two corridors fanning out from Boston are reportedly hot sites for new biotech firm locations. Business confidence, as measured by local surveys, is up, as is consumer confidence. So, overall, things are not too bad. A concern among this mostly brighter news is the rising rate of initiations of real estate foreclosures, especially those related to properties financed with subprime adjustable-rate mortgages. According to data from the Mortgage Bankers Association, whether one looks at the rate of total foreclosures or at the pace of foreclosures among just subprime mortgages, initiations have risen rapidly in New England from a very low base and now outstrip the nation’s. This is not a contest you want to win. Anecdotes abound about individual borrowers lured into what appear to be quite inappropriate mortgages, and the Federal Reserve Bank of Boston has been working with local bankers’ associations and the Massachusetts Banking Department and others on outreach and education. Why New England generally, and Massachusetts specifically, should be outstripping the nation in this area isn’t really clear. The local banking industry does not appear to have played much of a role in subprime lending, nor were we an area of bubble-like real estate growth, though clearly prices rose rapidly in the region over a fairly long time. The detrimental effects to local communities from the rise in foreclosures and the potential for negative political fallout—not unlike what President Lacker mentioned—seem obvious. On the national scene, the incoming data on the real economy, with the possible exception of job growth, have been slower than I expected. Inflation data, if anything, have been higher. The picture is not comforting, and it is complicated by questions related both to the housing market and the surprisingly slow pace of business spending. Many people around the table have mentioned both those things. The degree of national fallout from problems in subprime mortgage lending is a question right now, as it bears both on the pace of recovery in residential real estate investment and on the potential for wider spillovers from housing to consumption. At present, we in Boston, like the Greenbook authors, don’t expect that subprime mortgage problems will by themselves have much of an effect on overall growth. But we do have a concern if these problems lead to tighter lending standards, making mortgages and other borrowing more difficult to obtain and thereby exacerbate housing inventory overhangs, extend the current period of sluggish new home starts, and create further downward pressure on home prices. So far, we don’t see much of that happening. Trends in overall market and banking liquidity, mortgage interest rates, and new mortgage issuance are all positive. We think that those trends, combined with positive consumer home-buying attitudes, paint a reassuring picture that some of the downward trends will not be as severe as they otherwise might be. Indeed, I spoke to members of the advisory board of Harvard’s Joint Center for Housing Studies in late February. The group was composed of about fifty major homebuilders and major suppliers to the building industry. They were in a bit of collective shock regarding the rapid deterioration that they saw in their industry from late last year into the current quarter and seemed to be focused on inventory and cost control rather than on profits this year, which they didn’t expect. However, they saw continuing spending on home improvement, growth from commercial construction, and strength in non-U.S. markets as partial offsets. No one in the group mentioned the subprime issue or potential problems in mortgage financing, but that may have just been the fact of the moment. It was actually the day before the market break in late February, so it’s possible that they are not thinking along the same lines today. We have also been asking ourselves why business fixed investment has been so slow relative to fundamentals. We had been assuming that this inexplicable trend would right itself and that growth of producers’ durable equipment would show greater signs of health, but that hasn’t happened. We, like the Greenbook, have written down expectations regarding PDE. I’d really like to be wrong on the downside regarding this area, as it worries me a bit more than subprime mortgages or any of the recent financial market ups and downs. If businesses lack the confidence to invest in new equipment as much as they might be expected to given the fundamentals, how much longer will they continue to hire staff? If job growth slows, what will happen to consumption? To date, both hiring and consumption remain pretty solid. But while I saw some upside risks here at our last meeting, now I’m a little worried on the downside. In view of the incoming data, we have written down our forecast, much as the Greenbook has, and we have joined the Greenbook in a lower estimate of potential. We see growth a bit above 2 percent this year, rising to the mid 2s in ’08, with slightly rising unemployment and only slightly slowing core PCE inflation. However, as I probably implied before, I think the risks around this forecast on both sides seem to have risen. Will housing trends and the possible effects of diminished business spending affect the resilient consumer more than we now expect? Will the underlying pattern of core inflation continue to surprise on the upside, with the moderation we expect remaining mostly in the forecast? I don’t mean to overreact here. There are positives. External growth is strong. Fiscal spending at both the state and the national levels should be supportive. Financial markets, though certainly a bit more volatile and nervous, remain accommodative. Perhaps the downside risks to growth that I see are simply the ebb and flow of the U.S. economy continuing its transition from an above-trend rate of expansion just a year ago, not unlike the slow patch we saw in the late summer and early fall of last year. All in all, I remain somewhat more concerned about risks on the inflation side than about risks to growth. But it does seem to me as though the balancing act in meeting our two objectives has gotten a bit more difficult." FOMC20070131meeting--99 97,MR. SLIFMAN.," I don’t think so. Personally, I could think of equally plausible reasons that we could get stronger aggregate demand growth or somewhat weaker aggregate demand growth over the next year. We highlighted one possibility in the Greenbook with regard to the weaker investment scenario. Another could be the housing forecast: Housing could turn out to be weaker than we’re forecasting. So, on the aggregate demand side, I’d give them equal weighting. With regard to the aggregate supply side, I suspect there, too, the weighting probably is equal. It’s a little harder for me to judge. I don’t know whether Bill wants to add something." CHRG-110shrg50415--29 Mr. Stein," Good afternoon. Chairman Dodd and Members of the Committee, thank you for the opportunity to testify. In the middle part of this decade, Wall Street demand led to literally trillions of dollars of subprime and Alt-A loans to be originated. What was interesting about it was that Wall Street paid more the more dangerous the loan was. For example, in 2004, Countrywide, if they gave a borrower a fixed-rate conventional mortgage, they received 1 percent. If they put that exact same borrower in a subprime loan, they received 3.5 percent. It is not a surprise that they paid their originators more if they put that borrower in the more expensive loan, the one that statistically has been shown more likely to cause a foreclosure. Wall Street then bundled these mortgages into mortgage-backed securities, and credit rating agencies, paid by the issuers only when they are issued, found many too many of them to be AAA quality. And then they were sold around the world. In 2006, the top five investment banks earned $1.7 billion in revenues structuring and packaging these subprime mortgage-backed securities. These are the loans that helped cause the housing bubble, and what they have in common, the subprime and the Alt-A loans, are that they start at what seems like an affordable level, but built into the structure of the loan is unsustainability. They start cheaper, but then they get more expensive. There is no free lunch in a mortgage. And that is what they have in common, and that helped build the housing bubble because people were put in a larger loan than they could actually afford, and on the flip side, once the bubble burst, it caused the massive foreclosures that we have now because when the housing bubble was going up, that unsustainability was masked. Once people could not afford the mortgage, they could refinance or they could sell. When the bubble comes back down, they no longer have those options, and that is why we have the foreclosure crisis that we have today. This leaves the question: This is what Wall Street was doing. Where were the regulators? I will not repeat what has been said. I will just identify a couple, and my testimony goes into more regulatory failings. The first is the Federal Reserve. Back in 2000, my boss testified, and Chairman Leach, I remember him saying that the Federal Reserve is AWOL because they received the authority to prevent abusive lending in 1994 and had not used it. The second one that I would like to mention is the Office of Thrift Supervision. They allowed Washington Mutual and IndyMac to push abusive mortgages until they failed and did not even put them on the watchlist until right before they failed, so the FDIC could not clean them up sooner. It is clear now that a lack of common-sense rules, like how about only making a loan if the borrower can afford it, actually impeded the flow of credit beyond anybody's wildest dreams. Many of us who were trying to get the regulators to crack down on predatory lending abuses were fighting a defensive action in Congress, saying don't preempt the State laws that are there, since the proposed bills would have made the situation worse. And the regulators would always say, ``We cannot stop the free flow of credit,'' and we can see the results today. Since the problem is rooted in excessive foreclosures, the solutions must start there. I would like to identify five very briefly. The first is that Congress should lift the ban on judicial loan modifications, which would allow hundreds of thousands of families to have their loans restructured and stay in their homes at no cost to taxpayers. We are spending $700 billion when we can do something that is free. In Chapter 13 bankruptcy, the only secure debt that cannot be modified is the home on the principal residence, whereas loans on a yacht or investment property can be modified now. I would like to illustrate that point for a second. If you consider Candace Weaver, who is a school teacher from Wilmington, North Carolina, in 2005 her husband had a heart attack, and she refinanced her mortgage with a lender called BMC. She received what seemed like a reasonable rate, a little bit high, 8.9 percent. Two years later, it turns out--she was not told this--it was an exploding 2-28 subprime mortgage. The rate goes up to 11.9 percent, which she just could not afford. She was diagnosed with kidney cancer and had surgery scheduled. She called the servicer and said, ``I cannot make my July payment. This payment is too high. I can barely make it. But I cannot make the July payment because of surgery.'' The servicer said, ``I am sorry. I cannot even talk to you until you are delinquent.'' She had the surgery, became delinquent because she could not keep it up, called again, and they said, ``We cannot talk to you until you are in foreclosure.'' Then she can't keep up, she actually goes into foreclosure, calls again, and they say, ``OK, we will give you a repayment plan. Make your current payments of 11.9 percent, and on top of that catch up the past payments that you did not make,'' which she could not do. The bankruptcy judge cannot help her even though she could afford a market rate mortgage. Consider, on the other hand, Lehman Brothers. They were among the biggest purchasers and securitizers of subprime loans, earning hundreds of millions of dollars. They were a huge investor in these mortgages at 30:1 leverage, which caused their failure, and hurt everybody. Finally, they owned a mortgage lender named BMC, the exact same lender that is potentially costing Ms. Weaver her home--hopefully not because she has representation now. The Wall Street Journal investigated BMC Mortgage and found widespread falsification of tax forms, cutting and pasting documents, forging signatures, ignoring underwriter warnings. Lehman Brothers last month, as everybody knows, went to bankruptcy court. They can have their debts restructured, but Ms. Weaver cannot. The second thing I would focus on is for Treasury under the TARP program to maximize loan modifications, as some of the Senators have mentioned. Whenever Treasury buys equity in a bank, buys securities from a bank, buys a whole loan or controls a whole loan, they should do the streamlined modification program that Sheila Bair is doing at FDIC. What she does is target an affordable payment, first by reducing the interest rate, then by extending the term, then by reducing principal if you need to. And they should focus on a 34-percent debt-to-income ratio, which is the target in the Attorney General settlement with Bank of America over Countrywide. The other thing that they should do, which I think you had something to do with, Senator Dodd, is to guarantee modified mortgages, which would be cost-effective, but you need to make sure that the mortgage is modified well. But that could be a powerful tool. The third thing I would suggest is go ahead and merge OTS into OCC. They have not proven up to the challenge. Fourth, the Federal Reserve should extend their HOEPA rules to cover yield-spread premiums, broker upselling, and, second, extend the subprime protections to nontraditional mortgages. Those are problematic now, too. And, finally, Congress should pass the Homeownership Preservation and Protection Act--two things to mention there--that Senator Dodd sponsored and many Members of the Committee co-sponsored. This would stop abuses. First, no preemption. If there is preemption, there should not be a bill because the States are doing all they can. And, second, if anything is clear by now, it is that Wall Street will pay best money for mortgages and loans that help their short-term profits and that originators will supply those if they are paid well for it. But that is not necessarily the same thing as a long-term sustainable mortgage for the homebuyer. Purchasers need a continuing financial incentive to ensure good lending through the imposition of strong assignee liability. Thank you very much. " FOMC20050630meeting--80 78,MR. RUDEBUSCH.," I’m sympathetic to that view. It seems as if there might be a threshold. That is, policymakers might be more interested in certain asset markets or might be more interested in prices in asset markets in general at certain times. But I think you’re alluding to the moral hazard or political complications that could arise from this type of intervention or from trying to use this bubble component as a monetary transmission mechanism." CHRG-111shrg50564--69 Mr. Volcker," I believe this is an area that has to be reviewed. We made a few suggestions in the report, including the one that you mentioned. I don't feel that that is the last word, frankly, what we say in this report. The whole compensation structure is important and we allude to it, but we don't say what the answer is. I am not prepared now to say I think I know the answer to that, but it is not an unimportant question, obviously. Senator Reed. Let me ask you a final sort of set of questions. The Chairman raised the issue of 1,800 economists at the Federal Reserve. Did anyone sort of notice the implications of the housing bubble building up and other problems? The Ranking Member has talked about sort of looking into the regulatory practices of the Federal Reserve, particularly regulating these large institutions. My assumption is that on a daily basis, the Federal Reserve would have hundreds, perhaps, of examiners within these institutions. Why wasn't anyone aware of some of these off-balance sheet devices, liquidity puts? Was it an area of concern? Was this an issue they were aware or, or were they completely blindsided? I think it goes to the point of trying to discover who knew what when so we have an idea of how we can restructure the---- " CHRG-110hhrg41184--119 The Chairman," Thank you. The gentleman from Texas, a ranking member of the subcommittee. Dr. Paul. Thank you, Mr. Chairman. Chairman Bernanke, earlier you were asked a question about the value of the dollar, and you sort of deferred and said, ``You know that is the Treasury's responsibility.'' I always find this so fascinating, because it has been going on for years. Your predecessor would always use that as an excuse not to talk about the value of the dollar. But here I find the Chairman of the Federal Reserve, who is in charge of the dollar, in charge of the money, in charge of what the money supply is going to be, but we don't deal with the value of the dollar. You do admit you have a responsibility for prices, but how can you separate the two? Prices are a mere reflection of the value of the dollar. If you want to control prices, then you have to know the value of the dollar. But if you are going to avoid talking about the dollar, then all you can do then is deal with central economic planning. You know, if we stimulate the economy, maybe there will be production and prices will go down, and if prices are going up too fast you have to bring on a recession. You have to try to balance these things, which I think is a totally impossible task and really doesn't make any sense, because in a free market if you had good economic growth you never want to turn it off, because good economic growth brings prices down just like we see the prices of computers and cell phones, those prices come down where there is less government interference. But you know the hard money economists who have been around for awhile, they have always argued that this would be the case. Those who want to continue to inflate will never talk about the money, because it isn't the money supply that is the problem, it is always the prices. And that is why the conventional wisdom is, everybody refers to inflation as rising prices, instead of saying inflation comes from the unwise increase and supply of money and credit. When you look at it, and I mentioned in my opening statement that M3, now measured by private sources, is growing by leaps and bounds. In the last 2 years, it increased by 42 percent. Currently, it is rising at a rate of 16 percent. That is inflation. That will lead to higher prices. So to argue that we can continue to do this, continue to debase the currency, which is really the policy that we are following, is purposely debasing, devaluing a currency, which to me seems so destructive. It destroys the incentives to save. It destroys--and if you don't save, you don't have capital. Then it just puts more pressure on the Federal Reserve to create capital out of thin air in order to stimulate the economy, and usually that just goes in to mal-investment, misdirected investment into the housing bubbles, and the NASDAQ bubble. And then the effort is once the market demands the correction, what tool do you have left? Let's keep pumping--pump, pump, pump. And it just is an endless task, and history is against you. I mean, history is on the side of hard money. If you look at stable prices, you have to look to the only historic, sound money that has lasted more than a few years, fiat money always ends. Gold is the only thing where you can get stable prices. For instance, in the last 3 to 4 years, the price of oil has tripled, a barrel of oil went from $20 to $30 up to $100 a barrel. And yet, if you look at the price of oil in terms of gold it is absolutely flat, it is absolutely stable. So if we want stable prices, we have to have stable money. But I cannot see how we can continue to accept the policy of deliberately destroying the value of money as an economic value. It destroys, it is so immoral in the sense that what about somebody who saved for their retirement and they have CDs. And we are inflating the money at a 10 percent rate, their standard of living is going down and that is what is happening today. The middle class is being wiped out and nobody is understanding that it has to do with the value of money, prices are going up. So how are you able to defend this policy of deliberate depreciation of our money? " CHRG-109hhrg23738--6 The Chairman," The gentlelady's time has expired. The gentlelady from Ohio, Judge Pryce? Ms. Pryce. Thank you, Chairman Oxley. Welcome, Chairman Greenspan. Thank you for taking time to discuss with us your insightful thoughts on monetary policy and the state of our economy. I am pleased to read in your testimony that you believe overall the economy remains steady. Many financial analysts have credited the strong, vibrant housing market as a vital segment of the health of our economy. Recent studies have found that housing accounted for more than one-third of economic growth during the previous 5 years. Many observers, including yourself, have noted that mortgage refinancing provided crucial support to the economy during the past recession, enabled homeowners to reduce their debt burdens and maintain adequate levels of consumer spending by tapping into the equity of their homes. I for one took great advantage of that. Despite these latest gains in home ownership, I am concerned about the recent surge in home prices in many metropolitan areas. In most countries, the recent surge in home prices has gone hand in hand with a much larger jump in household debt than in previous booms. Not only are new buyers taking out bigger mortgages, but existing owners have increased their mortgages to turn capital gains into cash that they can spend. So I hope to hear your views on the current status of this country's housing market and whether a nationwide bubble exists, also what effect a measured rise in inflation will have on the housing market. As we have seen in the Australian economy, they experienced a surge and were able to slowly raise rates and control real estate speculation, keeping that economy healthy after the market peaked. So I look forward to talking more about that with you. Shifting gears, I would also like to know--and I will ask later--whether you feel the recent string of data security breaches has affected consumer confidence in our payment systems. As you know, Mr. Chairman, I, along with many of my colleagues on both sides of the aisle here, are working hard on some legislation that will provide uniform national standards for consumer protection and data breach notification, and we would appreciate any insights you care to share. Data security breaches are something that all of us are concerned with, as we see more and more instances of breaches in the headlines every day. I am pleased to be working with many members, Congressman Castle and LaTourette, Moore, Hooley, even Mr. Frank, on these important issues. And we appreciate the leadership of Chairman Oxley and Chairman Baucus as well. But under Gramm-Leach-Bliley, financial services firms already have an obligation to keep consumer information secure and confidential, and we need to extend those safeguards to information brokers and others. When a breach occurs that could lead to financial fraud or misuse of sensitive financial identity information, customers have the right to be informed about the breach and what steps they should take to protect themselves. I believe there should be one federal standard for data security and for notification. Disparate standards that vary from state to state are an administrative nightmare and make compliance very difficult. Varying standards can cause consumer confusion, and customers should be assured that when their information is breached, they receive the same notification no matter where they live. So, thank you, Mr. Chairman, for your appearance today. I look forward to your testimony. And thank you, Chairman Oxley. I yield back. " fcic_final_report_full--43 This new system threatened the once-dominant traditional commercial banks, and they took their grievances to their regulators and to Congress, which slowly but steadily removed long-standing restrictions and helped banks break out of their tra- ditional mold and join the feverish growth. As a result, two parallel financial sys- tems of enormous scale emerged. This new competition not only benefited Wall Street but also seemed to help all Americans, lowering the  costs  of their mortgages and boosting the returns on their (k)s. Shadow banks and commer- cial banks were codependent competitors. Their new activities were very prof- itable—and, it turned out, very risky. Second, we look at the evolution of financial regulation. To the Federal Reserve and other regulators, the new dual system that granted greater license to market par- ticipants appeared to provide a safer and more dynamic alternative to the era of tradi- tional banking. More and more, regulators looked to financial institutions to police themselves—“deregulation” was the label. Former Fed chairman Alan Greenspan put it this way: “The market-stabilizing private regulatory forces should gradually dis- place many cumbersome, increasingly ineffective government structures.”  In the Fed’s view, if problems emerged in the shadow banking system, the large commercial banks—which were believed to be well-run, well-capitalized, and well-regulated de- spite the loosening of their restraints—could provide vital support. And if problems outstripped the market’s ability to right itself, the Federal Reserve would take on the responsibility to restore financial stability. It did so again and again in the decades leading up to the recent crisis. And, understandably, much of the country came to as- sume that the Fed could always and would always save the day. Third, we follow the profound changes in the mortgage industry, from the sleepy days when local lenders took full responsibility for making and servicing -year loans to a new era in which the idea was to sell the loans off as soon as possible, so that they could be packaged and sold to investors around the world. New mortgage products proliferated, and so did new borrowers. Inevitably, this became a market in which the participants—mortgage brokers, lenders, and Wall Street firms—had a greater stake in the quantity of mortgages signed up and sold than in their quality. We also trace the history of Fannie Mae and Freddie Mac, publicly traded corpora- tions established by Congress that became dominant forces in providing financing to support the mortgage market while also seeking to maximize returns for investors. Fourth, we introduce some of the most arcane subjects in our report: securitiza- tion, structured finance, and derivatives—words that entered the national vocabu- lary as the financial markets unraveled through  and . Put simply and most pertinently, structured finance was the mechanism by which subprime and other mortgages were turned into complex investments often accorded triple-A ratings by credit rating agencies whose own motives were conflicted. This entire market de- pended on finely honed computer models—which turned out to be divorced from reality—and on ever-rising housing prices. When that bubble burst, the complexity bubble also burst: the securities almost no one understood, backed by mortgages no lender would have signed  years earlier, were the first dominoes to fall in the finan- cial sector. CHRG-109hhrg23738--1 Speaker,Speech The Chairman," [Presiding.] The committee will come to order. The chair recognizes himself for an opening statement. Chairman Greenspan, once again, we welcome you back to the Financial Services Committee for now your 35th appearance before this committee and our predecessor, the House Banking Committee, for the Monetary Policy Report. I know I speak for all of our 70 members when I say that your economic analysis and our discussion with you is the highlight of our calendar year here at the Financial Services Committee. Welcome once again, in what will likely be your final appearance here before the Financial Services Committee. To that end, we have enjoyed the opportunity to work with you in a number of capacities over the years, and I know I speak for the entire committee when I say that. We can report to the nation today that our U.S. economic growth is steady and strong. While we face some uncertainty abroad, and we can be assured of the likelihood that there will always be uncertainty abroad, our national economic performance is the envy of the world. More Americans are working than ever before. We recently received the news that 146,000 jobs were created in June, achieving a 5 percent unemployment rate, the lowest since the fateful month of September 2001. Not so long ago, many economists believed that there was a structural unemployment floor of 6 percent or 7 percent. They did not believe that our economy had the ability to reach the goal of 5 percent unemployment, and yet it has done so this month, with a total of 1.1 million jobs created this year alone. An important leading indicator, durable goods, increased 5.5 percent in May, and U.S. manufacturing continues to expand at rates that exceed expectations. Our GDP is growing at a good clip of nearly 4 percent, and the important non-manufacturing sector has been increasing each month now for over 2 years. The markets have risen nicely, recovering from their post-bubble and post-9/11 declines and selloffs, with the Dow now just 500 points shy of its historic high. These positive economic conditions mean that more Americans than ever before have reached the goal of home ownership. With President Bush's housing policies and the American Dream Downpayment Act, home ownership will soon be within reach for even more American families. With 14 consecutive quarters of economic growth, there is further good news for American consumers, and that is, inflation has remained in check. The prices of goods and services did not go up during the month of June. Prices for businesses, the producer price index, actually went down slightly, indicating that businesses have been able to handle recent high energy prices. Americans are well aware of the economy's steady growth, low inflation, and strong housing markets. Consumer confidence numbers are optimistic, and economic predictions show annual growth in the 3 percent to 4 percent range. A thriving economy, growing businesses, and working Americans are the components of a healthy tax base and strong revenues. President Bush's tax cuts have been an important factor in the recent projection that the federal budget deficit will be far lower than previously expected, perhaps up to $100 billion lower, and that will help to keep interest rates as low as possible. Over the long term, the president's programs to make the tax cuts permanent, to restrain government spending, to ensure retirement security, and to expand U.S. exports through free trade will further enhance our economic success. Mr. Chairman, according to the Federal Reserve Web site, its objectives include ``economic growth in line with the economy's potential to expand, a high level of employment, stable prices, and moderate long-term interest rates.'' It is an immense achievement that all of those objectives have been met, and we congratulate you and your colleagues at the Fed. You have the distinction of having served the Council of Economic Advisers under President Ford and serving as the Fed chairman under every president since Reagan. Certainly the confidence of five presidents is also a testament to the nation's faith in your economic leadership. We thank you for your extraordinary service to our country, for the stalwart policies that have guided us to many years of prosperity. This success has advanced American businesses, has increased American influence throughout the world, and has created economic conditions in which American families thrive. I again thank you for your service. I now yield to the gentleman from Massachusetts for an opening statement. " FinancialCrisisInquiry--154 THOMPSON: So a bubble mentality. BASS: Well, do we prick the bubble or not? All right? THOMPSON: Mr. Mayo? MAYO: Yes, three things. Number one, I went back. I did a thousand-page report in 1999, and, right upfront, I talked about what—the real estate situation and how that could fall out and cause a lot of difficulties. So I had to think about why did I put that in there. And I remembered, because every—not every—many management presentations I went to—we as analysts sit in an audience, hear what the company wants to do over the next three, five years. Many management presentations I went to, they said, “We want to expand home equity.” “We want to expand home equity.” “We want to expand home equity.” And so, they all had the same goal. So the goal by itself may have made sense. They just weren’t paying enough attention to what their competition was doing. By the way, the same thing happened with branches. Right? They said, “Oh, I think there’s a good spot for a branch,” they just weren’t anticipating the other two or three banks also opening up a branch on that corner. Right? So that’s what happened in home equity, and that was certainly a tipoff to me. And that is a tipoff that might not have been gotten by the regulators that early, but analysts who were going to all these meetings would get that. The second thing would be deposit insurance. I’ve written about this nonstop since 1994. And in the early part of this decade, I thought it would be increased. It wasn’t. I was wrong. And some of my clients, you know, reminded me of that. CHRG-111hhrg61852--99 Mr. Koo," I think consumers were shell-shocked after the so-called Lehman crisis because the whole economy collapsed and then everybody thought they would be losing jobs left and right. But that was countered very strongly by what the Federal Reserve has done, Treasury, everybody. According to the IMF, the amount of money the governments in the world threw in was something like $8.9 trillion. If you threw in $8.9 trillion to a problem, which is basically due to a policy mistake of allowing Lehman to fail, then people say, oh, we don't have to worry about so much after all. So they are coming back, which is good. That is the V-shaped recovery we saw from March of 2009 to the present period. But whether we can extend this going forward, I am a little more skeptical, because all the balance sheet problems in the private sector, the consumers are still with us. And house prices are not recovering back to the bubble levels. They are still falling. And so these people will still have to worry about their balance sheets. Many of them will continue to deleverage. And if that is the case, just because we recovered to this point doesn't mean we can stay here or that this recovery will continue. I think we have to be very vigilant. " fcic_final_report_full--438 In effect, many of the largest financial institutions in the world, along with hun- dreds of smaller ones, bet the survival of their institutions on housing prices. Some did this knowingly; others not. Many investors made three bad assumptions about U.S. housing prices. They assumed: • A low probability that housing prices would decline significantly; • Prices were largely uncorrelated across different regions, so that a local housing bubble bursting in Nevada would not happen at the same time as one bursting in Florida; and • A relatively low level of strategic defaults , in which an underwater homeowner voluntarily defaults on a non-recourse mortgage. When housing prices declined nationally and quite severely in certain areas, these flawed assumptions, magnified by other problems described in previous steps, cre- ated enormous financial losses for firms exposed to housing investments. An essential cause of the financial and economic crisis was appallingly bad risk management by the leaders of some of the largest financial institutions in the United States and Europe. Each failed firm that the Commission examined failed in part be- cause its leaders poorly managed risk. Based on testimony from the executives of several of the largest failed firms and the Commission staff ’s investigative work, we can group common risk management failures into several classes: • Concentration of highly correlated (housing) risk. Firm managers bet mas- sively on one type of asset, counting on high rates of return while comforting themselves that their competitors were doing the same. • Insufficient capital. Some of the failed institutions were levered : or higher. This meant that every  of assets was financed with  of equity capital and  of debt. This made these firms enormously profitable when things were go- ing well, but incredibly sensitive to even a small loss, as a  percent decline in the market value of these assets would leave them technically insolvent. In some cases, this increased leverage was direct and transparent. In other cases, firms used Structured Investment Vehicles, asset-backed commercial paper conduits, and other off-balance-sheet entities to try to have it both ways: fur- ther increasing their leverage while appearing not to do so. Highly concen- trated, highly correlated risk combined with high leverage makes a fragile financial sector and creates a financial accident waiting to happen. These firms should have had much larger capital cushions and/or mechanisms for contin- gent capital upon which to draw in a crisis. • Overdependence on short-term liquidity from repo and commercial paper markets. Just as each lacked sufficient capital cushions, in each case the failing firm’s liquidity cushion ran out within days. The failed firms appear to have based their liquidity strategies on the flawed assumption that both the firm and these funding markets would always be healthy and functioning smoothly. By failing to provide sufficiently for disruptions in their short-term financing, management put their firm’s survival on a hair trigger. • Poor risk management systems. A number of firms were unable to easily ag- gregate their housing risks across various business lines. Once the market be- gan to decline, those firms that understood their total exposure were able to effectively sell or hedge their risk before the market turned down too far. Those that didn’t were stuck with toxic assets in a disintegrating market. fcic_final_report_full--98 Mortgage credit became more available when subprime lending started to grow again after many of the major subprime lenders failed or were purchased in  and . Afterward, the biggest banks moved in. In , Citigroup, with  billion in assets, paid  billion for Associates First Capital, the second-biggest subprime lender. Still, subprime lending remained only a niche, just . of new mortgages in .  Subprime lending risks and questionable practices remained a concern. Yet the Federal Reserve did not aggressively employ the unique authority granted it by the Home Ownership and Equity Protection Act (HOEPA). Although in  the Fed fined Citigroup  million for lending violations, it only minimally revised the rules for a narrow set of high-cost mortgages.  Following losses by several banks in sub- prime securitization, the Fed and other regulators revised capital standards. HOUSING: “A POWERFUL STABILIZING FORCE ” By the beginning of , the economy was slowing, even though unemployment re- mained at a -year low of . To stimulate borrowing and spending, the Federal Reserve’s Federal Open Market Committee lowered short-term interest rates aggres- sively. On January , , in a rare conference call between scheduled meetings, it cut the benchmark federal funds rate—at which banks lend to each other overnight—by a half percentage point, rather than the more typical quarter point. Later that month, the committee cut the rate another half point, and it continued cut- ting throughout the year— times in all—to ., the lowest in  years. In the end, the recession of  was relatively mild, lasting only eight months, from March to November, and gross domestic product, or GDP—the most common gauge of the economy—dropped by only .. Some policy makers concluded that perhaps, with effective monetary policy, the economy had reached the so-called end of the business cycle, which some economists had been predicting since before the tech crash. “Recessions have become less frequent and less severe,” said Ben Bernanke, then a Fed governor, in a speech early in . “Whether the dominant cause of the Great Moderation is structural change, improved monetary policy, or simply good luck is an important question about which no consensus has yet formed.”  With the recession over and mortgage rates at -year lows, housing kicked into high gear—again. The nation would lose more than , nonfarm jobs in  but make small gains in construction. In states where bubbles soon appeared, con- struction picked up quickly. California ended  with a total of only , more jobs, but with , new construction jobs. In Florida,  of net job growth was in construction. In , builders started more than . million single-family dwellings, a rate unseen since the late s. From  to , residential construction con- tributed three times more to the economy than it had contributed on average since . fcic_final_report_full--477 PRECIPITATED A FINANCIAL CRISIS Although the Commission never defined the financial crisis it was supposed to investigate, it is necessary to do so in order to know where to start and stop. If, for example, the financial crisis is still continuing, then the effect of government policies such as the Troubled Asset Repurchase Program (TARP) should be evaluated. However, it seems clear that Congress wanted the Commission to concentrate on what caused the unprecedented events that occurred largely in the fall of 2008, and for this purpose Ben Bernanke’s definition of the financial crisis seems most appropriate: The credit boom began to unravel in early 2007 when problems surfaced with subprime mortgages—mortgages offered to less-creditworthy borrowers—and house prices in parts of the country began to fall. Mortgage delinquencies and defaults rose, and the downturn in house prices intensified, trends that continue today. Investors, stunned by losses on assets they had believed to be safe, began to pull back from a wide range of credit markets, and financial institutions—reeling from severe losses on mortgages and other loans—cut back their lending. The crisis deepened [in September 2008], when the failure or near-failure of several major financial firms caused many financial and credit markets to freeze up.” 45 In other words, the financial crisis was the result of the losses suffered by financial institutions around the world when U.S. mortgages began to fail in large numbers; the crisis became more severe in September 2008, when the failure of several major financial firms—which held or were thought to hold large amounts of mortgage-related assets—caused many financial markets to freeze up. This summary encapsulates a large number of interconnected events, but it makes clear that the underlying cause of the financial crisis was a rapid decline in the value of one specific and widely held asset: U.S. residential mortgages. The next question is how, exactly, these delinquencies and losses caused the financial crisis. The following discussion will show that it was not all mortgages and mortgage-backed securities that were the source of the crisis, but primarily NTMs— including PMBS backed by NTMs. Traditional mortgages, which were generally prime mortgages, did not suffer substantial losses at the outset of the mortgage meltdown, although as the financial crisis turned into a recession and housing prices continued to fall, losses among prime mortgages began to approach the level of prime mortgage losses that had occurred in past housing crises. However, those levels were far lower than the losses on NTMs, which reached levels of delinquency and default between 15 and 45 percent (depending on the characteristics of the loans in question) because the loans involved were weaker as a class than in any previous housing crisis. The fact that they were also far larger in number than any 45 Speech at Morehouse College, April 14, 2009. 471 previous bubble was what caused the catastrophic housing price declines that fueled the financial crisis. 1. How Failures Among NTMs were Transmitted to the Financial System FOMC20070131meeting--172 170,MR. KOHN.," Thank you, Mr. Chairman. In preparation for submitting my forecast, I looked at my previous forecasts—a humbling but instructive experience usually. [Laughter] Going back a year, I found that, based on the staff’s estimate for 2006, inflation and growth had each turned out within a quarter point of my projections. I’m quite certain that this is not a consequence of any particular expertise on my part. Rather, it is indicative that, in a broad sense, the economy is performing remarkably close to our expectations. President Poole was making this point. Even going back a few years to when we started to remove accommodation, despite large fluctuations in energy prices in recent years, huge geopolitical uncertainties, and a housing boom and bust the dimensions of which we really didn’t anticipate three years ago, the economy is in the neighborhood of full employment, and core inflation is at a fairly low rate by historical standards. Now, the surprises last year were the surge of inflation in the spring and early summer. That has not been entirely reversed. The extent of the slowdown in productivity growth, both in terms of trend and of actual relative to the lower estimated trend, and the related decline in the unemployment rate suggest that we are entering 2007 with a higher risk of inflation than I had anticipated a year ago. Given this risk, it is especially important that economic growth be no greater and perhaps a little less than the growth rate of potential, and that is my forecast—a small uptrend in the unemployment rate. The issue I wrestled with was how fast the economy will be growing when the drag from housing abates. In early December, the debate might have been about whether demand would be sufficient to support growth as high as potential. But given the stabilization of housing demand, the strength of consumption, and ongoing increases in employment, I asked myself whether we might not find the economy growing faster than its potential beginning in the second half of 2007 and in 2008, thereby adding to inflation pressures. A couple of forces, however, gave me a little comfort in supporting my projection of only moderate growth. One is the modest restraint on demand from the recent rise in interest rates, especially the restraint on the housing market, and the dollar exchange rate. Another is the likelihood that consumption will grow more slowly relative to income and will lag the response to housing as housing prices level out and as energy prices begin to edge higher. Consumption late last year was probably still being boosted substantially by the past increases in housing wealth and by the declines in energy prices, which combined with warm weather to give a considerable lift to disposable income. On the housing wealth factor, I think our model suggests that it takes several quarters for a leveling out in housing wealth to build into consumption. In fact, the data through the third quarter suggest that prices were really just about leveling out in the third quarter. So it may be a little early to conclude that, just because we’re not seeing a spillover from the housing market to consumption, there isn’t going to be any. I expect some, though modest, spillover. Moreover, some of the impulse in the fourth quarter was from net exports. These were spurred in part by a temporary decline in petroleum imports and an unexpected strength in exports. Those conditions are unlikely to be sustained. In addition, business investment spending has been weaker than we anticipated. Now, I suspect this is, like the inventory situation, just an aspect of adapting to a slower pace of growth, and investment will strengthen going forward. But it does suggest that businesses are cautious. They are not anticipating ebullient demand and a pressing need to expand facilities to meet increases in sales, and their sense of their market seems worth factoring into our calculations. Finally, the fact that I would have been asking just the opposite question seven weeks ago suggests that we’re also putting a lot of weight on a few observations, [laughter] whether regarding the weakness then or the strength more recently. I do continue to believe that growth close to the growth rate of potential will be consistent with gradually ebbing inflation. For this I would round up the usual suspects, reflecting the ebbing of some temporary factors that increased inflation in 2006. One factor is energy prices. Empirical evidence since the early 1980s to the contrary notwithstanding, the coincidence that President Lacker remarked between the rise and fall in energy prices in 2006 and the rise and fall in core inflation suggests some cause and effect. The increase in energy prices into the summer has probably not yet been completely reversed in twelve-month core inflation rates, so I expect some of that to be dying out as we go into the future. Increases in rents are likely to moderate as units are shifted from ownership to rental markets. The slowdown in growth relative to earlier last year seems to have made businesses more aware of competitive pressures, restraining pricing power. When we met last spring, we had a lot of discussion about businesses feeling that they had pricing power—that they could pass through increases in costs. I haven’t heard any of that discussion around the table today. The recent slowdown in inflation is encouraging but not definitive evidence that the moderation is in train. The slowdown could have been helped by the decline in energy prices, and that decline won’t be repeated. Goods prices might have been held back by efforts to run off inventories, and that phenomenon, too, would be temporary. As I already noted, the initial conditions—the recent behavior of productivity and the relatively low level of the unemployment rate—suggest upward inflation risks relative to this gentle downward tilt. To an extent, the staff has placed a relatively favorable interpretation on these developments. They haven’t revised trend productivity down any further. They expect a pickup in realized productivity growth over this year. They see a portion of the strength in labor markets as simply lagging the slowdown in growth—a little more labor hoarding than usual as the economy cools, along with some statistical anomalies. Thus, in the Greenbook, the unemployment rate rises, and inflation pressures remain contained as activity expands at close to the growth rate of potential. President Yellen at the last meeting and Bill Wascher today pointed out two less benign possibilities. One is that demand really has been stronger, as indicated by the income-side data, and that the labor and product markets really are as tight as the unemployment rate suggests. In this case, the unemployment rate wouldn’t drift higher with moderate growth. Businesses might find themselves facing higher labor costs and being able to pass them on unless we take steps to firm financial conditions. The second possibility is that trend productivity is lower. In this case, actual productivity growth might not recover much this year. Unit labor costs would rise more quickly. Given the apparent momentum in demand, we might be looking at an even further decline in the unemployment rate in the near term. Now, my outlook is predicated on something like the staff interpretation, but I think these other possibilities underline the inflation risks in an economy in which growth has been well maintained. Thank you, Mr. Chairman." FOMC20070628meeting--105 103,MS. YELLEN.," Thank you, Mr. Chairman. Data relating to both economic activity and inflation during the intermeeting period have been encouraging. Economic indicators have strengthened considerably, and recent readings on core inflation have been quite tame. Although a portion of the recent deceleration of core prices likely reflects transitory influences, the underlying trend in core inflation is still quite favorable. I view the conditions for growth going forward as being reasonably solid. The main negative factors are tied to housing. The latest data don’t point to an imminent recovery in this sector, and I fear that the recent run-up in mortgage rates will only make matters worse. In addition, housing prices are unlikely to rise over the next few years and, indeed, may well fall, and the absence of the housing wealth gains realized in the past should damp consumption spending. I agree with the Greenbook that the recent run-up in bond and mortgage rates reflects primarily a shift in market expectations for the path of policy and, therefore, implies only a small subtraction to my forecast for growth in 2008. In my view, the stance of monetary policy over the next few years should be chosen to help move labor and product markets from being somewhat tight today to exhibiting a modest degree of slack in order to help bring about a further gradual reduction in inflation toward a level consistent with price stability. The stance of monetary policy will need to remain modestly restrictive, along the lines assumed in the Greenbook and by markets, in order to achieve that goal. My forecast is for growth to be around 2½ percent in the second half of this year and in 2008, slightly below my estimate of potential growth, and for the unemployment rate to edge up gradually, reaching nearly 5 percent by the end of next year. Under these conditions, core inflation should continue to recede gradually, with the core PCE price index increasing 2 percent this year and 1.9 percent in 2008. This forecast is predicated on continued well-anchored inflation expectations and the eventual appearance of a small amount of labor market slack. In addition, special factors such as rising energy prices and the sustained run-up in owners’ equivalent rent that have boosted inflation should ebb over time, contributing a bit to the expected decline in core inflation. In terms of risks to the outlook for growth, I still feel the presence of a 600-pound gorilla in the room, and that is the housing sector. The risk for further significant deterioration in the housing market, with house prices falling and mortgage delinquencies rising further, causes me appreciable angst. Indeed, the repercussions of falling house prices are already playing out in some areas where past price rises were especially rapid and subprime lending soared. For example, in the Sacramento metropolitan area east of San Francisco, house prices shot up at an annual rate of more than 20 percent from 2002 to 2005. Since then, however, they have been falling at an annual rate of 3½ percent. Delinquencies on subprime mortgages rose sharply last year, putting Sacramento at the top of the list of MSAs in terms of the changes in the rate of subprime delinquencies. Research by my staff examining metropolitan areas across the country indicates that the experience of Sacramento reflects a more general pattern. They found that low rates of house price appreciation, and especially house price decelerations, are associated with increases in delinquency rates even after controlling for local economic conditions such as employment growth and the unemployment rate. One possible explanation for these findings is that subprime borrowers, especially those with very low equity stakes, have less incentive to keep their mortgages current when housing no longer seems an attractive investment, either because prices have decelerated sharply or interest rates have risen. These results highlight the potential risks that rising defaults in subprime could spread to other sectors of the mortgage market and could trigger a vicious cycle in which a further deceleration in house prices increases foreclosures, in turn exacerbating downside price movements. The risks to inflation are also significant. In addition to the upside risks associated with continued tight labor markets, a slowdown in productivity growth could add to cost pressures. Although recent productivity data have been disappointing, I expressed some optimism at the last meeting about productivity growth on the grounds that at least some of the slowdown appeared to reflect labor hoarding and lags in the adjustment of employment to output, especially in the construction industry. Data since that meeting have reinforced my optimism concerning trend productivity growth. In particular, new data in the recently released Business Employment Dynamics report suggest that productivity growth may have been stronger than we have been thinking. This report, which includes data that will be used in the rebenchmarking of the payroll survey in January, shows a much smaller increase in employment in the third quarter of 2006 than is reported in the payroll survey; it, therefore, implies a larger increase in output per worker. A second risk to inflation is slippage in the market’s perceptions of our inflation objective. Although inflation compensation over the next five years is essentially unchanged since our last meeting, long-run breakeven inflation rates implied by the difference between nominal and indexed Treasury securities are up about 20 basis points. However, our analysis suggests that this increase reflects in good part an elevation in risk premiums or the influence of various—let me call them “idiosyncratic”—factors of the type that Bill Dudley mentioned, such as a possible shift in the demand by foreign central banks for Treasuries or special factors affecting the demand for inflation-indexed securities and not an increase in long-run inflation expectations. We base this conclusion on the fact that long-run breakeven inflation rates have also climbed in the United Kingdom—a country where inflation expectations have been remarkably well anchored over the past decade and where inflation has been trending downward. The fact that breakeven inflation rates rose in both countries, despite their different monetary policy regimes, suggests that a common explanation is needed rather than one specific to the United States. I think this conclusion is supported by the Board staff model that attributes about half of the movement in breakeven inflation to risk premiums. That said, our understanding and estimates of risk premiums are imprecise, so we must continue to monitor inflation expectations very carefully—of course, along with everything else. [Laughter]" FOMC20060629meeting--111 109,MS. BIES.," Thank you, Mr. Chairman. I continue in my concern, which I expressed at the last meeting, about the recent pickup in inflation, especially given the news that we’ve had since the last meeting. In the past three months, core CPI prices and core PCE prices have grown, respectively, at 3.8 percent and 3.4 percent, twice their rate of growth in the previous three months. It has been interesting to listen to and read the analyses that many folks are doing, trying to parse the reasons for the jump in the inflation rates, no matter what index people are following. The question, as several of you have mentioned, is really whether the reason is persistent inflation or whether it’s one-off kinds of changes. We’ve already had several thoughts about how to look at the relation of energy-price increases and their persistence to the rate of inflation. I won’t add any more to what has already been said, but I thought Mr. Wilcox had a good discussion of the owners’ equivalent rent problem. What are we really looking at here? Some of the possibilities I found amusing. One of them, for example, pointed out that the index used to look at the cost of bank services was up significantly because the opportunity cost on demand deposits had gone up. If that’s the problem, we can cure it by just stopping the raising of rates. [Laughter] So I do think we need to really focus on where we are. Without being able to really understand the underlying framework here, I am very concerned about the trend. When I looked at the dramatic drop in forecast growth, at first I became very pessimistic about the outlook, as several of you have also commented. But the more I looked at the numbers, the more I came to realize that the reduction is all coming from residential housing construction. Everything else is basically a push from the last forecast for this year and next year. When I look at the forecast with that perspective, I see things differently. I’ve been concerned about the amount of speculation in housing construction throughout the country. To the extent that what’s coming out of the housing sector is this excess speculation, that’s healthy both for the long-run economy and for the stability of the financial system. One of our challenges in looking at some of the recent indicators is to determine whether we will really have a soft transition to more sustainable long-term growth of new housing or whether the transition will be bumpier or perhaps more abrupt. A chart in the Greenbook that got my attention was how rapidly the cancellation of sales orders for new housing had jumped within the past five months, from its long-run trend of 22 percent since ’95 to a high rate of 30 percent. Some of these sales data or permit data that we’re seeing today may mean more additions to excess inventory, and so we may see more of a blip; that’s something I think we need to watch. I think we can’t be complacent that a nice easing into long-term sustainable growth of housing is a sure thing at this point. At the same time, because the drop in the forecast is all housing, the question is how to look at the relative growth of the rest of the economy. Since on net it’s basically moving the way it was, I said to myself that I was comfortable with that. But why am I uncomfortable going forward? I, too, hear anecdotes about companies’ optimism about what they can do in terms of increasing revenues and profits. Regarding the capacity issue, we need to realize that a lot of the resources in housing construction are not necessarily transferable to other sectors, except perhaps to commercial real estate. That sector is forecast to pick up, and so some of the growth could happen there. But the inability to transfer resources still raises issues, in terms of both fixed investments and people, and I don’t believe that the apparent slowdown to below trend, since it is driven by housing construction, is really going to create much excess capacity. So that situation makes me concerned about inflation. Finally, I’d like to talk about how housing affects liquidity and monetary policy and our accommodation. Several of you and the staff said earlier that we have seen a bit of adjustment in debt spreads since the last meeting—and volatility is up—but we all agree that spreads are still very narrow by historical standards. Focusing on the staff’s forecast of the flow of funds for the next two years, I found an interesting thing if you look at what’s happening when housing drops to the level forecasted in the Greenbook. Households, in borrowing for mortgages, basically have been the major user of net borrowing in the past couple of years. The forecast is for households’ need for funds, the net borrowing, to drop one-third between 2005 and 2007. The amount by which net household borrowing drops is more than the borrowing by all other sectors combined last year. So part of the issue is that, because households are such a powerful engine in net borrowing, there will be plenty of funds available. Also, as to the extent that bank borrowing and funds provision are forecast to drop, the bankers I talked with said that they aren’t going to let the amount of loans that they extend drop as much as I think is in that forecast. So I really believe that the drop in housing is actually on net going to make liquidity available for other sectors rather than being a drain going forward and that will also get the growth rate more positive than the current Greenbook forecasts." fcic_final_report_full--42 SHADOW BANKING CONTENTS Commercial paper and repos: “Unfettered markets” ...........................................  The savings and loan crisis: “They put a lot of pressure on their regulators” ...........................................................................  The financial crisis of  and  was not a single event but a series of crises that rippled through the financial system and, ultimately, the economy. Distress in one area of the financial markets led to failures in other areas by way of interconnections and vulnerabilities that bankers, government officials, and others had missed or dis- missed. When subprime and other risky mortgages—issued during a housing bubble that many experts failed to identify, and whose consequences were not understood— began to default at unexpected rates, a once-obscure market for complex investment securities backed by those mortgages abruptly failed. When the contagion spread, in- vestors panicked—and the danger inherent in the whole system became manifest. Fi- nancial markets teetered on the edge, and brand-name financial institutions were left bankrupt or dependent on the taxpayers for survival. Federal Reserve Chairman Ben Bernanke now acknowledges that he missed the systemic risks. “Prospective subprime losses were clearly not large enough on their own to account for the magnitude of the crisis,” Bernanke told the Commission. “Rather, the system’s vulnerabilities, together with gaps in the government’s crisis-re- sponse toolkit, were the principal explanations of why the crisis was so severe and had such devastating effects on the broader economy.”  This part of our report explores the origins of risks as they developed in the finan- cial system over recent decades. It is a fascinating story with profound conse- quences—a complex history that could yield its own report. Instead, we focus on four key developments that helped shape the events that shook our financial markets and economy. Detailed books could be written about each of them; we stick to the essen- tials for understanding our specific concern, which is the recent crisis. First, we describe the phenomenal growth of the shadow banking system—the investment banks, most prominently, but also other financial institutions—that freely operated in capital markets beyond the reach of the regulatory apparatus that had been put in place in the wake of the crash of  and the Great Depression.  fcic_final_report_full--474 Of course, in the early 2000s there was no generally understood definition of the term “subprime,” so Fannie and Freddie could define it as they liked, and the assumption that the GSEs only made prime loans continued to be supported by their public disclosures. So when Fannie and Freddie reported their loan acquisitions to various mortgage information aggregators they did not report those mortgages as subprime or Alt-A, and the aggregators continued to follow industry practice by placing virtually all the GSEs’ loans in the “prime” category. Without understanding Fannie and Freddie’s peculiar and self-serving loan classification methods, the recipients of information about the GSEs’ mortgage positions simply seemed to assume that all these mortgages were prime loans, as they had always been in the past, and added them to the number of prime loans outstanding. Accordingly, by 2008 there were approximately 12 million more NTMs in the financial system—and 12 million fewer prime loans—than most market participants realized. Appendix 1 shows that the levels of delinquency and default would be 86 percent higher than expected if there were 12 million NTMs in the financial system instead of 12 million prime loans. Appendix 2 shows that the levels of delinquency would be 150 percent higher than expected if the feedback effect of mortgage delinquencies—causing lower housing prices, in a downward spiral—were taken into account. These differences in projected losses could have misled the rating agencies into believing that, even if the bubble were to deflate, the losses on mortgage failures would not be so substantial as to have a more than local effect and would not adversely affect the AAA tranches in MBS securitizations. The Commission never looked into this issue, or attempted to determine what market participants believed to be the number of subprime and other NTMs outstanding in the system immediately before the financial crisis. Whenever possible in the Commission’s public hearings, I asked analysts and other market participants how many NTMs they believed were outstanding before the financial crisis occurred. It was clear from the responses that none of the witnesses had ever considered that question, and it appeared that none suspected that the number was large enough to substantially affect losses after the collapse of the bubble. It was only on November 10, 2008, after Fannie had been taken over by the federal government, that the company admitted in its 10-Q report for the third quarter of 2008 that it had classified as subprime or Alt-A loans only those loans that it purchased from self-denominated subprime or Alt-A originators, and not loans that were subprime or Alt-A because of their risk characteristics. Even then Fannie wasn’t fully candid. After describing its classification criteria, Fannie stated, “[H]owever, we have other loans with some features that are similar to Alt-A and subprime loans that we have not classified as Alt-A or subprime because they do not meet our classification criteria.” 43 This hardly described the true nature of Fannie’s obligations. On the issue of the number of NTMs outstanding before the crisis the Commission studiously averted its eyes, and the Commission majority’s report 43 Fannie Mae, 2008 3rd quarter 10-Q. p.115, http://www.fanniemae.com/ir/pdf/earnings/2008/q32008. pdf. 469 never addresses the question. HUD’s role in pressing for a reduction in mortgage underwriting standards escaped the FCIC’s attention entirely, the GSEs’ AH goals are mentioned only in passing, CRA is defended, and neither HUD’s Best Practices Initiative nor FHA’s activities are mentioned at all. No reason is advanced for the accumulation of subprime loans in the bubble other than the idea—implicit in the majority’s report—that it was profitable. In sum, the majority’s report is Hamlet without the prince of Denmark. 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.  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-111hhrg48674--362 Mr. Bernanke," Well, by strengthening supervisory oversight over the risk management, making banks responsible for strengthening those controls. I think the system just got carried away by the credit bubble, and the risk management systems didn't succeed in protecting the system from that. There are also a lot of gaps in the regulatory system, places where there is duplicate oversight, places where there is not enough oversight. So we have a lot of work to do. " FinancialCrisisReport--260 Subprime lending fueled the overall growth in housing demand and housing price increases that began in the late 1990s and ran through mid-2006. 1008 “Between 2000 and 2007, backers of subprime mortgage - backed securities – primarily Wall Street and European investment banks – underwrote $2.1 trillion worth of [subprime mortgage backed securities] business, according to data from trade publication Inside Mortgage Finance .” 1009 By 2006, subprime lending made up 13.5% of mortgage lending in the United States, a fivefold increase from 2001. 1010 The graph below reflects the unprecedented growth in subprime mortgages between 2003 and 2006. 1011 1008 See 3/2009 U.S. Department of Housing and Urban Development Interim Report to Congress, “Root Causes of the Foreclosure Crisis,” at 36. See also “A Brief History of Credit Rating Agencies: How Financial Regulation Entrenched this Industry’s Role in the Subprime Mortgage Debacle of 2007 – 2008,” Mercatus on Policy (10/2009), at 2. 1009 “The Roots of the Financial Crisis: Who is to Blame?” The Center for Public Integrity (5/6/2009), http://www.publicintegrity.org/investigations/economic_meltdown/articles/entry/1286. 1010 3/2009 U.S. Department of Housing and Urban Development Interim Report to Congress, “Root Causes of the Foreclosure Crisis,” at 7. 1011 1/25/2010, “Mortgage Subprime Origination,” chart prepared by Paulson & Co. Inc., PSI-Paulson&Co-02-0001- 21, at 4. fcic_final_report_full--419 On November , , a bankruptcy court ruled that the Bank of New York could not foreclose on a loan it had purchased from Countrywide, because MERS had failed to endorse or deliver the note to the Bank of New York as required by the pooling and servicing agreement. This ruling could have further implications, be- cause it was customary for Countrywide to maintain possession of the note and re- lated loan documents when loans were securitized.  Across the market, some mortgage securities holders have sued the issuers of those securities, demanding that the issuers rescind their purchases.  If the legal challenges succeed, investors that own mortgage-backed securities could force the is- suers to buy them back at the original price—possibly with interest. The issuers would then be the owners of the securities and would bear the risk of loss.  The Congressional Oversight Panel, in a report issued in November , said it is on the lookout for such risks: “If documentation problems prove to be pervasive and, more importantly, throw into doubt the ownership of not only foreclosed prop- erties but also pooled mortgages, the consequences could be severe.”  This sentiment was echoed by University of Iowa law professor Katherine Porter who has studied foreclosures and the law: “It is lack of knowledge of how widespread the problems may be that is turning the allegations into a crisis. Lack of knowledge feeds specula- tion and worst-case scenarios.”  Adam Levitin, a Georgetown University associate professor of law, has estimated that the claims could be in the trillions of dollars, ren- dering major U.S. banks insolvent.  NEIGHBORHOOD EFFECTS: “I ’M NOT LEAVING ” For the millions of Americans who paid their bills, never flipped a house, and had never heard of a CDO, the financial crisis has been long, bewildering, and painful. A crisis that started with a housing boom that became a bubble has come back full cir- cle to forests of “for sale” signs—but this time attracting few buyers. Stores have shut- tered; employers have cut jobs; hopes have fled. Too many Americans today find themselves in suburban ghost towns or urban wastelands, where properties are va- cant and construction cranes do not lift a thing for months. Renters, who never bought into the madness, are also among the victims as lenders seize property after landlords default on loans. Renters can lose the roof over their heads as well as their security deposits. In Minneapolis, as many as  of buildings with foreclosures in  and  were renter-occupied, according to sta- tistics cited in testimony by Deputy Assistant Secretary Erika Poethig from the U.S. Department of Housing and Urban Development to the House of Representatives Subcommittee on Housing and Community Opportunity.  CHRG-111shrg54533--33 Secretary Geithner," Our plan does not address a range of other causes of this crisis, including policies pursued around the world that helped produce a long period of very low interest rates and a very, very substantial boom in asset prices, housing prices, not just in this country but in countries around the world. And I think you are right to underscore the basic fact that a lot of things contributed to this crisis. It was not just failures in supervision and regulation. And as part of what the world does, major countries around the world, in trying to reduce the risk we have a crisis like this in the future, it will require thinking better through how to avoid the risk that monetary macroeconomic policies contribute to future booms and asset prices and credit bubbles of this magnitude. Senator Bunning. Your plan puts a lot of faith in the Federal Reserve's ability to spot risk and exercise its power to prevent the next crisis. However, if the Fed and other regulators have been doing their jobs and paying attention to what the banks and other firms were doing earlier this decade, they almost certainly could have prevented the mess. And the Fed has proven it is unwilling to use its power it has. Let me give you an example. Just look how slow it addressed the credit card abuses, and it took 14 years for the Fed to write one regulation on mortgages after we gave them the power to do that. So giving them the power and making them act are two different things. What makes you think that the Fed will do better this time around? " fcic_final_report_full--413 THE FORECLOSURE CRISIS CONTENTS Foreclosures on the rise: “Hard to talk about any recovery” ..............................  Initiatives to stem foreclosures: “Persistently disregard” .....................................  Flaws in the process: “Speculation and worst-case scenarios” ...........................  Neighborhood effects: “I’m not leaving” .............................................................  FORECLOSURES ON THE RISE: “HARD TO TALK ABOUT ANY RECOVERY ” Since the housing bubble burst, 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. When the economic damage finally abates, foreclosures may total between  million and more than  million, according to various estimates.  The foreclosure epidemic has hurt families and undermined home values in entire zip codes, strained school systems as well as community support services, and depleted state coffers. Even if the economy began suddenly booming the country would need years to recover. Prior to , the foreclosure rate was historically less than . But the trend since the housing market collapsed has been dramatic: In , . of all houses, or  out of , received at least one foreclosure filing.  In the fall of ,  in every  outstanding residential mortgage loans in the United States was at least one payment past due but not yet in foreclosure—an ominous warning that this wave may not have crested.  Distressed sales account for the majority of home sales in cities around the country, including Las Vegas, Phoenix, Sacramento, and Riverside, California.  Returning to the , borrowers whose loans were pooled into CMLTI - NC: by September , many had moved or refinanced their mortgages; by that point, , had entered foreclosure (mostly in Florida and California), and  had started loan modifications. Of the , still active loans then,  were seriously past due in their payments or currently in foreclosure.  The causes of foreclosures have been analyzed by many academics and govern- ment agencies. Two events are typically necessary for a mortgage default. First, monthly payments become unaffordable owing to unemployment or other financial  hardship, or because mortgage payments increase. And second (in the opinion of many, now the more important factor), the home’s value becomes less than the debt owed—in other words, the borrower has negative equity. “The evidence is irrefutable,” Laurie Goodman, a senior managing director with Amherst Securities, told Congress in : “Negative equity is the most important predictor of default. When the borrower has negative equity, unemployment acts as one of many possible catalysts, increasing the probability of default.”  CHRG-111hhrg53244--201 Mr. Bernanke," I think that could be addressed under the systemic risk regulation rubric that we have been discussing with the Council or with the Fed overseeing large financial institutions, that when you have an asset whose prices is rising quickly, you could require greater capital against it, for example, or greater downpayments. So even if you don't know there is a bubble or not, that still might be a prudent thing to do. So I do think that looking at asset price fluctuations in a supervisory context could be very helpful. " FOMC20061212meeting--179 177,MS. MINEHAN.," Let me put in another plug for section 2 of alternative C: “Economic growth has slowed over the course of the year, partly reflecting a substantial cooling of the housing market.” Why do you want to go on and on about it?" FOMC20071031meeting--62 60,MR. LACKER.," Conditioning on the Philadelphia index, we actually have marginal predictive value for the national ISMs. But I continue. A modest housing spillover into business investment plans seems to be unfolding as well. In the recent Board-commissioned survey of capital investment plans, our District was among those in which more businesses plan to trim rather than boost spending in the months ahead. Again, a more detailed look reveals that most firms planning reductions have ties to housing. Reports on retail sales in the District remain soft, with sales of automobiles and building materials notably weak. In addition, an executive from a major transportation firm headquartered in the District told us that freight volumes, both rail and trucking, are now at the lowest level since the 2001 recession. Although in a number of District markets commercial real estate activity remains healthy, we are hearing scattered reports of commercial construction projects being shelved. One director from D.C. said that commercial development there “doesn’t have the pulse it had six weeks ago.” The turmoil in financial markets has not appreciably constrained business lending in our District, however. Contacts generally describe credit as readily available to creditworthy borrowers, but some say spreads have widened a bit. On the price front, our monthly measures suggest some moderation in growth despite ongoing complaints of higher input costs. At our last meeting, I was more optimistic than the Greenbook on the national economy. A significant part of the difference was related to housing, where I saw greater probability of the drag receding sooner. Longer term, I had a somewhat higher estimate of trend productivity growth, which supported a somewhat stronger outlook for household consumption. The main shift in my perspective since the last meeting is that I am now at least as pessimistic as the Greenbook about prospects for housing bottoming out anytime soon. The 10 percent fall in housing starts in September was certainly eye catching, and it indicates that the weak summer housing market tailed off further toward the end. In our District, and this seems to be true elsewhere as well, the housing downturn appears to have spread into many formerly unaffected markets. It is hard for me to believe that any discernible stabilization is likely before the spring, when the seasonal pickup in housing activity typically takes place. Even then a prolonged period of depressed activity seems more likely than any noticeable bounceback. Other recent news suggests a bit more demand-side fallout from the housing market than I had been expecting. Manufacturing production was sluggish in August and September, and durable goods orders have shown only modest growth, especially outside the aircraft industry. I mentioned a minute ago that our survey of the Fifth District manufacturing sector—which, by the way, is larger than the Philadelphia and New York manufacturing sector—[laughter] is showing a significant slowdown for October, particularly in housing-related industries. Consumer spending has been a source of stability during this housing correction, and I expect that to remain true over the forecast period. I think household spending will generally expand in line with disposable income, but even though consumption advanced broadly in the third quarter, it now seems we’re in for a bit of a slowdown this quarter. In that regard, I’m feeling sympathy for what President Yellen said. So I’m less sanguine overall about the near-term outlook for growth at this meeting, although that may just represent catching up on my part to the Greenbook’s past level of gloominess. Having said all that, I do believe that the effects of this summer’s financial market adjustments are likely to be limited; and out beyond the middle of the next year, I’m, again, more optimistic than the Greenbook and for the usual reasons. I think that productivity growth and, thus, real income growth will be somewhat higher than in the Greenbook forecast, and my outlook for the personal saving rate is centered on its current value rather than a steady increase. Inflation appears to have ticked up a bit in September, at least according to the CPI. Still, year-over-year core PCE inflation remained reasonably contained, and I’ve been struck by the extent to which TIPS inflation compensation has held relatively steady in recent months, especially given our easing move last month and the run-up in oil prices. While I would like to see inflation come down further, I’m somewhat more comfortable about inflation than I was at the beginning of the year. Thank you, Mr. Chairman." FinancialCrisisInquiry--401 MAYO: I think about your question a lot. And, you know, accountants try to recreate reality in numbers, and we, January 13, 2010 as financial analysts, take those numbers and try to recreate reality. So if the numbers that accountants give us aren’t good, then the conclusions of the analysts won’t be good either. So, definitely, more disclosure is good and would be helpful. I’d say innovation always outpaces regulation, but in this case, it was just much further ahead. And, you know, you certainly need more capital for newer activities or more risky activities or other activities without a long enough track record. And you saw that. And, as Mr. Solomon said, we’ve had a lot of once-in-a-lifetime events. And you—you know, whether it’s Enron and WorldCom or Russia and Asia and Mexico or, you know, the tech bubble and then the real estate bubble. It seems as though these once-in-a- lifetime events happen every couple of years. So the idea of more capital overall makes a lot of sense for these once-in-a-lifetime events for these new activities. And as far as additional disclosure, no question. It would have been very helpful during the crisis and would still be helpful now especially with regard to problem loans at U.S. banks. I would make one point, though. We can’t be too pro-cyclical. If you try to correct all at once, then you’re going to kill the economy. So you have to do this in a balanced way. 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. FOMC20060131meeting--76 74,MR. SANTOMERO.," I wanted to go to the housing issue. In the projection in the Greenbook, as I understand it, you’ve got housing prices going up at about a 5½ percent rate as compared with last year’s number, which I think is 12 percent. We’ve been looking at the sensitivity of what happens to our GDP growth rate in ’06 and ’07 to the extent that housing prices stay flat. Our numbers suggest that a flat housing price associated with the decline in residential investment would shave about ½ percentage point off GDP in ’06 and about 0.6 or 0.7 if you add the consumption effects. Does that sound like a reasonable sensitivity to you?" FOMC20070628meeting--138 136,MR. MISHKIN.," Thank you. My view of what has been happening in the economy is that we have been basically going through a rebalancing. We had a sector that was clearly bubble-like with excessive spending, and now we are getting the retrenchment, which is taking a bit longer than we expected. But the good news is that we are going through a rebalancing in which we are just moving resources to other sectors and that is actually going much along the lines that we want to see. The problem in a rebalancing episode is that you are always worried about the risk that is possible because these transitions don’t always occur smoothly. I think that we were much more worried about that—at least I was more worried—at the previous meeting. But we have been seeing that the rebalancing is actually going along pretty well. In particular, although the housing market is very weak, very much along the lines of the Greenbook forecast, it hasn’t surprised us this particular period. It’s just that it is pretty bad. But the risks are actually fairly balanced on housing because we do not see it as very strong and that is part of the process of undoing the previous excesses. Another very important thing is that we have not seen any surprising spillovers from the housing market. As time goes on and nothing really bad happens, we become more confident that, in fact, the downside risk isn’t there either. We have also seen that the investment sector has been looking a little stronger. Again, that really did concern me at the last FOMC meeting. Yet we have had some reasonable numbers; they are not spectacular, but I think the downside risks have dissipated. So the bottom line is that I see the economy as rebalancing and doing it in a fairly good way. In fact, from a long-run perspective, this is a good thing and not a bad thing. The downside risk has dissipated, and the risks are now quite balanced. So I am quite comfortable with the Greenbook forecast on this, which is that we have growth somewhat below trend but moving back toward trend, and I see that there has been a shift in a positive direction and the risks are not excessively on the downside but are much more balanced. When I look at the inflation picture, I am in a way pleased with the recent numbers because there is no strong indication that we are far from potential output and, in particular, there is a little indication that the tightness in the economy certainly will be unraveled. According to our forecast, not much is going on in that area, so what’s going on in inflation expectations will be dominant. I mean, given that inflation expectations have been pretty well anchored around 2 percent, although there is some uncertainty, I thought that we would have a return to 2 percent numbers a bit more quickly than the original Greenbook forecast showed. I was really pleased because the Greenbook has basically moved closer to the picture that I had all along; so now I’m very comfortable with the Greenbook forecast. In contrast to some other people, I think the risks are pretty balanced. Now, maybe that is not really different because of the people who have inflation going below 2 percent, and I don’t see that. So I believe it’s going to be 2 now and it’s going to be 2 for a while unless we make a concerted effort to change inflation expectations. Then there is the whole issue of how we might go about doing that. But given the current environment, my view is that risks are fairly balanced. Other people are saying that there is risk on the upside, but I think that’s because they just have slightly lower numbers regarding where they think inflation will be. But probably when we look at it from that perspective, it is about the same. So right now I think the economy is evolving in a pretty reasonable way, and I’m sure we will be surprised in one direction or another in the future. Thank you very much." CHRG-110shrg50409--30 Mr. Bernanke," So the second quarter appears to be actually better than expected, and, therefore, our forecast for the entire year might actually be stronger than it was earlier. But with that strength having been brought forward to some extent into the second quarter, we are looking at the remainder of the year as being probably positive growth, but certainly not robust growth. Senator Bennett. The one thing the markets hate more than anything else is uncertainty, and I have the feeling that that is part of the problem with respect to oil prices and part of the problem with respect to the housing market. Now, you have suggested that the housing market might stabilize over the next 6 to 12 months so that people will begin to say, OK, we have now reached bottom and we are starting to build back up again. Do you feel that the deal that was made over the weekend with Fannie and Freddie can help eliminate some of the uncertainty and cause people to have a greater degree of confidence that the timeframe that we have been talking about will indeed come to pass? " FOMC20061212meeting--118 116,MR. MADIGAN.," I think the basic answer to that is “yes,” but there are perhaps things going on here at a cyclical level and at a more structural level. Chairman Bernanke’s hypothesis was more of a structural or a secular explanation of interest rates. What we’re seeing in the upper panel of chart 5 obviously has important cyclical characteristics with, among other things, investment spending being depressed for quite a while in the aftermath of the bubble that apparently prevailed earlier." FOMC20061025meeting--227 225,MS. BIES.," Thank you, Mr. Chairman. First, I support leaving the fed funds rate unchanged at this meeting. I’ve puzzled over section 2, and I like what Governor Kohn has suggested because one of the challenges I have had in this whole thing is what I heard around the table yesterday, which in general supports the conclusion I’ve been coming to. We really are going from very rapid growth to slowing, but if you parse out the pieces, what’s really changing is housing. The rapid growth from 2003 to 2005 was due to unsustainable housing construction; it’s coming down, and it’s a big chunk of that change. Now, other sectors have noise or are weak. Sectors like autos and exports are jumping around, but it’s housing that has to adjust. I think it’s going to run below trend as the Greenbook says. At the same time, as we all were mentioning yesterday, we have tightness in the labor market, which again signals that in most sectors of the economy it’s hard to find people who are available to work to sustain the economy. It’s almost as though we have a dichotomy right now whereby housing is running below trend but the rest of the economy is running at or above potential. So I think it’s important to leave in the comment about the housing sector—that is what we’re focusing on. To me that is bringing the aggregate number below potential and is moderating the growth rate. But in terms of the way to go on section 2, I can go either way. I do like the change that Governor Kohn suggested in section 3. I think that is a good change. I believe that we should not change section 4, the assessment of risk, at this meeting. It has been only five weeks. We’ve had a discussion about changing more frequently; again, I think we ought to leave that to the communications subcommittee to think about. But I think we ought to leave it as it is because it says what we really mean. The first sentence says that there are inflation risks, and that’s a sense that we need to convey. Too much could be read into a change that may be unintended, and so I’d rather just at this meeting leave it the way it was at the previous meeting. Thank you." FOMC20070628meeting--201 199,CHAIRMAN BERNANKE.," The proposal is, “Economic growth appears to have been moderate,” and then it goes on, as it says here, “during the first half of this year, despite the ongoing adjustment in the housing sector.” I see nodding, so I think that is accepted. I’m sorry. No?" FOMC20070628meeting--120 118,MS. PIANALTO.," Thank you, Mr. Chairman. News from the Fourth District is little changed from my last report. The District economy continues to be weighed down by weakness in the housing market, and there is general consensus among my contacts that the housing sector has not yet seen bottom. To date, adverse spillovers from housing to other sectors of the economy have not been observed, although this remains a significant risk to the outlook. While I have heard some reports from my business contacts that the labor market is strengthening, the official data still do not show net employment growth in the region. My projections for the national economy still call for growth to resume to a more typical expansionary pace as we move beyond 2007. My projection for GDP is slightly stronger than what is seen in the latest Greenbook because of my assumption for slightly stronger growth in potential. Obviously, I don’t make that judgment with great confidence. However, the business leaders I talk with tell me that their plans to expand capital are consistent with a pickup in productivity growth from its recent cyclical low. This includes the Cleveland Cavaliers—[laughter]—a franchise which, as many of you know, experienced a substantial productivity shortfall against the San Antonio Spurs a couple of weeks ago. [Laughter] Here, too, we are projecting a good rebound, so to speak, in 2008. In the meantime, I would like the record to show that I am making good on my wager with President Fisher. I brought with me a selection of Cleveland’s finest, and I will present those to Richard after this meeting with my heartfelt congratulations. I am putting this back, because it feels funny having a beer bottle in my hand. [Laughter]" 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 FOMC20061025meeting--85 83,MR. KOHN.," Thank you, Mr. Chairman. The Committee’s focus has been on encouraging a gradual abatement of core inflation, and I think the limited evidence we’ve gotten since the last meeting is consistent with this outcome. The price data themselves show some signs of deceleration of core inflation on a three-month basis from the very high levels of last spring and summer, though the rates are still elevated. A further decline in energy prices should help to keep inflation expectations down and will take a little pressure off business costs and core inflation even if pass-throughs are fairly small. As expected, the rent-of-shelter component has been increasing less rapidly, supporting the projection that, in a soft housing market with overhangs of unsold housing units, this component will not be boosting measured inflation rates very much. Inflation expectations as derived from financial market quotes remain at the lower levels reached earlier this fall. As the Bluebook notes, the exact level of these expectations is really impossible to tease out of the data; and although they may be a bit higher than we would like, they do look lower than the recent twelve-month inflation rates and, at these levels, should exert some downward gravitational pull on realized inflation. The economy appears to be running modestly below the rate of growth of its potential, and this should relieve pressure on labor and product markets. How far the economy is running below potential in an underlying sense is uncertain. I suspect it is not as weak as the estimated third-quarter GDP number but is somewhat softer than the labor market indicators, which show no slackening in the pace of demand or decline in resource utilization. I base this conclusion in part on the data and projections of final domestic and total demand, which the Greenbook has averaging in the neighborhood of 2 percent in the second half of the year. Industrial production was weak in August and September, pulled down by the ongoing inventory corrections in housing and autos, and this reinforced my sense that, at least for a time, the economy is growing a bit below the rate of growth of its potential. Going forward, I think a projection of economic growth gradually recovering next year as the drag from housing abates is reasonable, with growth supported by favorable financial conditions and lower energy prices. How quickly it returns to potential is an open question. Though other forms of spending have proven resilient to date, I agree with the staff analysis that some spillovers on consumption and investment from the weakness in housing and in housing wealth are likely to restrain growth at least a little next year. I also see that the spending risk is still pointed somewhat to the downside, although less so than at the last meeting. To be sure, the recent signs are somewhat reassuring that the housing market isn’t weakening faster than expected. Still, in the staff forecast the housing market is left with a relatively high level of inventory at the end of 2008, and prices are still elevated relative to rents, suggesting the possibility of greater declines in activity and prices. In addition, equity prices are vulnerable to disappointing earnings as labor costs rise even gradually. The economy is most likely to grow a little below its potential for a while and inflation to trend gradually lower. All in all, this is a pretty good outcome following the earlier oil price shock and rise in core inflation and housing market correction. With demand outside of housing as resilient as it has been and inflation as high as it has persisted, the extent and trajectory of the expected inflation trend is uncertain and should remain our focus. A failure of inflation to reverse the uptick of earlier this year before it becomes embedded in higher inflation expectations continues to be the main risk to good, sustained economic performance over time. Thank you, Mr. Chairman." CHRG-111hhrg54867--161 Mr. Lucas," Because, after all, Secretary, in my region, we went through both an agricultural and energy property boom, bust, and bubble in the 1980's. We were slaughtered economically. We did not receive capital injections. Our industries were not propped up. It took us, 10, 15 years in some segments to recover from it. We do not wish that on anyone else, but by the same token, let us not make the matter worse because the feud back home is, it was the big boys that damn near killed us all, not the little players. " CHRG-110hhrg34673--19 Mr. Bernanke," Congressman, the story was misreported, and you misunderstand my position. I did not address the affordable housing fund, either pro or con. The concern that the Federal Reserve has had for a long time about GSE's is the potential for their portfolios to create systemic risk in our financial system. I should say that we very much support the GSE's housing mission, and we believe, in particular, that the securitization function contributes to liquidity in the mortgage market. Again, our concern is about the portfolios and their enormous size and the complex derivative exercises that are needed to maintain the balance of those portfolios. My comment was one that built on suggestions that Chairman Greenspan had made in previous testimonies, which was that one way to limit the growth of the portfolios, but also to achieve the stated public purpose of the GSE's was, in some way, to anchor the portfolios in the public purpose, which is affordable housing. According to OFHEO, only about 30 percent of the portfolios are related in any way to affordable housing. So I think what I would like to see would be the portfolios to be more directly connected to a public purpose, perhaps holding affordable housing mortgages or another way, more directly promoting affordable housing rather than acquiring all different kinds of assets that are not related to affordable housing. " FOMC20050322meeting--132 130,MR. OLSON.," Thank you, Mr. Chairman. In my comments I want to follow up on President March 22, 2005 70 of 116 increasing anecdotal evidence and concern about this issue, and I think the characterization in yesterday’s Wall Street Journal that day trading is now occurring in residential housing markets is a further indication of the concern. Of course, the extent to which the speculative purchases make a difference is reflected not only in the possibility of its impacting the pace of the growth in housing values but also the pricing of risk, as Jack suggested. But I think the question has been whether or not the size of the market was significant enough to have an impact. Clearly, the trend was eye- catching, but was the market significant enough to make a significant difference? Data collected recently and provided by our economists indicate that non-owner-occupied mortgages constitute 5½ percent of the total outstanding and have fluctuated around 7 percent of new originations. With respect to second homes, the numbers were about 2.8 percent of total mortgage loans and 3 percent of new originations. However, this week, the National Association of Realtors revised significantly their sense of the size of the market, based on surveys they had made and also on information from the 2003 Census Bureau report. They indicated that, in their view, 23 percent of all home purchases in 2004 were for investment and an additional 13 percent were for vacation homes. The difference was that through their surveys they have been able to isolate the investment purchaser of single-family homes as distinct from the purchaser of a second home. The implications of that are significant, and the size of the market is much larger than they had perceived. Also, those numbers would suggest that many of those buyers have made multiple purchases of single-family homes, which brings in another element of risk—the risk associated with the debt service capability they need to maintain those purchases in the event of a downturn. I think it’s appropriate that we are going to be looking at the issue of real estate bubbles and the speculative component of that market at our meeting in June. There are a number of indications March 22, 2005 71 of 116 tightened their loan requirements for interest-only loans and for those with low down payments. And we have seen the criteria for loans being tightened in other places also. With respect to our policy decision today, I think the question is not so much what we should do but how we explain why we are doing it. As Governor Ferguson did, let me take you back 18 months, when we began using the phrase “for a considerable period.” Notwithstanding the impact on implied volatility, also implicit in the statement “for a considerable period” was that there needed to be an exit strategy. And the exit strategy—or transition, if you will—went from “considerable period” to “patient” to “measured pace.” I don’t think today is the time to change “measured pace,” but it’s time to think about an exit strategy from it. Thank you." CHRG-111hhrg48867--11 Mr. Hensarling," Thank you, Mr. Chairman. No doubt we would all love to figure out a way to properly end systemic risk, but it kind of begs the question who, what, how, and at what cost? I have a number of questions. Number one, do we have any other examples where this has been tried before and tried successfully? Has it worked? And if not, why not? Who are the so-called experts on the subject? Second of all, what is our accepted definition of systemic risk? Is it too big to fail, too interconnected to fail? I note that mutual funds have worldwide assets of $26.2 trillion at the end of the last fourth quarter. Are they too big to fail? Are they representative of systemic risk? Next, which of our regulators is to be trusted with this responsibility? Should it be the Federal Reserve that many economists view helped lead us into this housing bubble in the first place? Perhaps it should be the SEC, who apparently knew about the Madoff fraud and did nothing about it. Perhaps OTS, who is responsible for IndyMac, the largest bank failure in American history. If not them, who? The next question is to what extent does this become a self-fulfilling prophecy? Once you designate a firm too big to fail, then is this not Fannie and Freddie revisited with only the taxpayers left to pick up the tab? There are many questions to be asked. I look forward to hearing from our witnesses, and I yield back the balance of my time. " FinancialCrisisReport--67 Mr. Schneider told the Subcommittee that the numbers listed on the chart were not projections, but the numbers generated from actual, historical loan data. 172 As the chart makes clear, the least profitable loans for WaMu were government backed and fixed rate loans. Those loans were typically purchased by the government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac which paid relatively low prices for them. Instead of focusing on those low margin loans, WaMu’s management looked to make profits elsewhere, and elected to focus on the most profitable loans, which were the Option ARM, home equity, and subprime loans. In 2005, subprime loans, with 150 basis points, were eight times more profitable than a fixed rate loan at 19 basis points and more than 10 times as profitable as government backed loans. The gain on sale data WaMu collected drove not only WaMu’s decision to focus on higher risk home loans, but also how the bank priced those loans for borrowers. In determining how much it would charge for a loan, the bank calculated first what price the loan would obtain on Wall Street. As Mr. Beck explained in his testimony before the Subcommittee: “Because WaMu’s capital markets organization was engaged in the secondary mortgage market, it had ready access to information regarding how the market priced loan products. Therefore my team helped determine the initial prices at which WaMu could offer loans by beginning with the applicable market prices for private or agency-backed mortgage securities and adding the various costs WaMu incurred in the origination, sale, and servicing of home loans.” 173 (5) Acknowledging Unsustainable Housing Price Increases In 2004, before WaMu implemented its High Risk Lending Strategy, the Chief Risk Officer Jim Vanasek expressed internally concern about the unsustainable rise in housing prices, loosening lending standards, and the possible consequences. On September 2, 2004, just months before the formal presentation of the High Risk Lending Strategy to the Board of Directors, Mr. Vanasek circulated a prescient memorandum to WaMu’s mortgage underwriting and appraisal staff, warning of a bubble in housing prices and encouraging tighter underwriting. The memorandum also captured a sense of the turmoil and pressure at WaMu. Under the subject heading, “Perspective,” Mr. Vanasek wrote: “I want to share just a few thoughts with all of you as we begin the month of September. Clearly you have gone through a difficult period of time with all of the changes in the mortgage area of the bank. Staff cuts and recent defections have only added to the stress. Mark Hillis [a Senior Risk Officer] and I are painfully aware of the toll that this has taken on some of you and have felt it is important to tell you that we recognize it has been and continues to be difficult. 172 Subcommittee interview of David Schneider (2/16/2010). 173 April 13, 2010 Subcommittee Hearing at 53. “In the midst of all this change and stress, patience is growing thin. We understand that. We also know that loan originators are pushing very hard for deals. But we need to put all of this in perspective. “At this point in the mortgage cycle with prices having increased far beyond the rate of increase in personal incomes, there clearly comes a time when prices must slow down or perhaps even decline. There have been so many warnings of a Housing Bubble that we all tend now to ignore them because thus far it has not happened. I am not in the business of forecasting, but I have a healthy respect for the underlying data which says ultimately this environment is no longer sustainable. Therefore I would conclude that now is not the time to be pushing appraisal values. If anything we should be a bit more conservative across the board. Kerry Killinger and Bill Longbrake [a Vice Chair of WaMu] have both expressed renewed concern over this issue. “This is a point where we should be much more careful about exceptions. It is highly questionable as to how strong this economy may be; there is clearly no consensus on Wall Street. If the economy stalls, the combination of low FICOs, high LTVs and inordinate numbers of exceptions will come back to haunt us.” 174 CHRG-109hhrg28024--106 Mr. Bernanke," Our expectation is that if and when the housing market slows, that savings rates will tend to rise. We have built into the forecast, so to speak, some increase in personal savings. As home values grow more slowly, then consumers can rely less on the increase in equity as a source of wealth building and, therefore, must save more out of their current income. Again, that's to be expected. As I've indicated, our current expectation is that process will be gradual and is consistent with continued strong growth in the economy. However, as I also indicated, the housing market and the consumer response to any changes in the housing market is one of the risks to the forecasts and one we will be monitoring closely as we try to assess the state of the economy in the coming year. " fcic_final_report_full--457 SUMMARY Although there were many contributing factors, the housing bubble of 1997- 2007 would not have reached its dizzying heights or lasted as long, nor would the financial crisis of 2008 have ensued, but for the role played by the housing policies of the United States government over the course of two administrations. As a result of these policies, by the middle of 2007, there were approximately 27 million subprime and Alt-A mortgages in the U.S. financial system—half of all mortgages outstanding—with an aggregate value of over $4.5 trillion. 4 These were unprecedented numbers, far higher than at any time in the past, and the losses associated with the delinquency and default of these mortgages fully account for the weakness and disruption of the financial system that has become known as the financial crisis. Most subprime and Alt-A mortgages are high risk loans. A subprime mortgage is a loan to a borrower who has blemished credit, usually signified by a FICO credit score lower than 660. 5 Typically, a subprime borrower has failed in 4 Unless otherwise indicated, all estimates for the number of subprime and Alt-A mortgages outstanding, as well as the use of specific terms such as loan to value ratios and delinquency rates, come from research done by Edward Pinto, a resident fellow at the American Enterprise Institute. Pinto is also a consultant to the housing finance industry and a former chief credit offi cer of Fannie Mae. Much of this work is posted on both my and Pinto’s scholar pages at AEI as follows: http://www.aei.org/docLib/Pinto-Sizing- Total-Exposure.pdf , which accounts for all 27 million high risk loans; http://www.aei.org/docLib/ Pinto-Sizing-Total-Federal-Contributions.pdf , which covers the portion of these loans that were held or guaranteed by federal agencies and the four large banks that made these loans under CRA; and http:// www.aei.org/docLib/Pinto-High-LTV-Subprime-Alt-A.pdf , which covers the acquisition of these loans by government agencies from the early 1990s. The information in these memoranda is fully cited to original sources. These memoranda were the data exhibits to a Pinto memorandum submitted to the FCIC in January 2010, and revised and updated in March 2010 (collectively, the “Triggers memo”). 5 One of the confusing elements of any study of the mortgage markets is the fact that the key definitions have never been fully agreed upon. For many years, Fannie Mae treated as subprime loans only those that it purchased from subprime originators. Inside Mortgage Finance , a common source of data on the mortgage market, treated and recorded as subprime only those loans reported as subprime by the originators or by Fannie and Freddie. Other loans were recorded as prime, even if they had credit scores that would have classified them as subprime. However, a FICO credit score of less than 660 is generally regarded as a subprime loan, no matter how originated. That is the standard, for example, used by the Offi ce of the Comptroller of the Currency. In this statement and in Pinto’s work on this issue, loans that are classified as subprime by their originators are called “self-denominated” subprime loans, and loans to borrowers with FICO scores of less than 660 are called subprime by characteristic. Fannie and Freddie reported only a very small percentage of their loans as subprime, so in effect the subprime loans acquired by Fannie and Freddie should be added to the self-denominated subprime loans originated by others in order to derive something closer to the number and principal amount of the subprime loans outstanding in the financial system at any given time. One of the important elements of Edward Pinto’s work was to show that Fannie and Freddie, for many years prior to the financial crisis, were buying loans that should have been classified as subprime because of the borrowers’ credit scores and not simply because they were originated by subprime lenders. Fannie and Freddie did not do this until after they were taken over by the federal government. This lack of disclosure on the part of the GSEs appears to have been a factor in the failure of many market observers to foresee the potential severity of the mortgage defaults when the housing bubble deflated in 2007. 451 the past to meet other financial obligations. Before changes in government policy in the early 1990s, most borrowers with FICO scores below 660 did not qualify as prime borrowers and had diffi culty obtaining mortgage credit other than through the Federal Housing Administration (FHA), the government’s original subprime lender, or through a relatively small number of specialized subprime lenders. An Alt-A mortgage is one that is deficient by its terms. It may have an adjustable rate, lack documentation about the borrower, require payment of interest only, or be made to an investor in rental housing, not a prospective homeowner. Another key deficiency in many Alt-A mortgages is a high loan-to-value ratio—that is, a low downpayment. A low downpayment for a home may signify the borrower’s lack of financial resources, and this lack of “skin in the game” often means a reduced borrower commitment to the home. Until they became subject to HUD’s affordable housing requirements, beginning in the early 1990s, Fannie and Freddie seldom acquired loans with these deficiencies. FOMC20050630meeting--125 123,VICE CHAIRMAN GEITHNER.," My second question is about policy, but not monetary policy. Glenn, in your note, you allude to other instruments if monetary policy doesn’t seem to be the appropriate tool to address a concern about lower value prices. What do we know about the history of the use of the supervisory tool in past periods of concern about real estate bubbles or imprudent lending? Do we have a rich history on the use of those instruments that tells us something about the efficacy or about our foresight in deploying them?" FOMC20060808meeting--144 142,MS. MINEHAN.," I think that President Plosser has a good point there and President Poole did as well. Section 2 is aimed at explaining what has happened with growth in the past. Everything moderated. To me, the most surprising thing was how slow business fixed investment was. It was not so surprising that housing was slow because we expected housing to be slow, so I think you could easily take housing out of there. You have the lagged effects of increases in interest rates, which affect housing as well as a whole range of other things. I also think that Charlie has a good point. We don’t want to hang our action on one piece of data versus another piece of data going forward. I’m agnostic about productivity, to tell you the truth. I think the unit labor cost numbers are not good news—we have some problems there—and to hang it out as a saving factor again and again may not be what we want to do." 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. " 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." FinancialCrisisInquiry--478 BASS: When you look back—Mr. Mayo talked about loan growth doubling that of GDP growth. When you look back at the housing market—and you can go back through OFHEO’s raw data, all the way back to about I think it’s 1971, you look, you can go back and plot the housing price appreciation x inflation and chart that against median income. January 13, 2010 It only makes sense that as income moves up, housing prices should be able to move up in a perfectly parallel fashion—you make a little bit more money, you can afford a little bit more house. Those lines were parallel for the good part of 40 years. And what happened in 2001, when Dr. Greenspan traded the dot.com bust for the housing boom, he lowered rates down to 1 percent. He made money free, and encouraged all of the lending possible to try to restart the economy after the dot.com bust. I simply think he did a bad job. Other people think he did a great job. But I think that he enabled this housing market. So when you started seeing rates—rates started—they started raising rates in 2004? When rates started to be—started an increasing path, you saw prime mortgage origination in 2004 drop 50 percent. That just makes sense. Everybody refinanced their homes that could. Everyone got reset and settled, but subprime origination in 2004 doubled. And then it doubled again in ‘05, as prime originations fell off a cliff because rates were moving up. So what happened is Wall Street had these machines built to manufacture mortgages. We wanted affordable housing, so they could lower rates with exotic mortgages. And what you saw from 2001 on is you saw those two parallel lines, home price—median home price and median income—diverge. And not only did they diverge by—for those of you that are statisticians, it was an eight standard deviation divergence. OK? That doesn’t happen very often. I know we talk about once-in-a- lifetime calamities every 10 years, that one just hasn’t happened. FOMC20060328meeting--146 144,MR. KOHN.," Thank you, Mr. Chairman. Since the last meeting, as many of us have remarked, we have seen stronger domestic demand and a little less core inflation than expected. To a degree, this extends a pattern. In looking at the Greenbook chart on the evolution of the staff forecast, I was struck by the steady upward drift since last fall of projected growth in 2006 and 2007, coupled with flat to downward movement in projected inflation for those years. Now, much of the 2006 growth was shifted from 2005, but the unemployment rate at the end of this year and next is lower than it was projected last fall—without any more, and maybe even a little less, price pressure projected. One possibility is that we are seeing a smaller effect from higher energy prices than anticipated, at least on inflation and perhaps on demand as well. Since we expected the effect of energy prices on growth rates of output and core prices to be temporary in any case, this sort of information should not deflect us from our underlying view that growth is in the process of slowing to trend, holding underlying inflation roughly stable. The cooling of the housing market is the main impetus for a slight moderation in growth. In this regard, although the incoming data on housing have been distorted by unusual weather and subject to considerable noise, I judge them on balance to lend added support to the sense that activity and price increases are softening, albeit to an unknown extent. I agree with President Stern that an orderly cooling of these markets with moderate effects on growth is the most likely outcome, but we just do not know yet. Rising inventories, declining new home sales, downward movement in building permits, and a drop in mortgage applications—all point to an appreciable drop-off in the demand for housing. In the staff forecast, residential construction flattens out this year and next, after contributing nearly half a point to GDP growth last year. Logically, softer demand should also be reflected in prices. Unfortunately, data for prices are even harder to read than those for activity, but the recent monthly information on existing and new home prices seems consistent with the March slowdown in the rate of increase of these prices, which should feed through to wealth and consumption. And we probably haven’t seen the full effect of the rise in short-term interest rates on housing demand, particularly for those who are liquidity or income constrained. Mortgage rates have also picked up somewhat this year, and they are at the upper end of the range they have been in for the past several years. So we could see some of the long-term mortgage rate effects as well. It is possible, of course, that the damping influence of the housing market could be offset by greater strength elsewhere, and two logical contenders are exports sparked by stronger growth abroad and business investment. We have seen another in the series of upward revisions to foreign growth in the current Greenbook, but we have also seen greater tightening of monetary policy get built into financial markets, offsetting some of the increase in the strength of demand abroad. Moreover, the dollar has risen on balance, reducing the feed-through of higher demand abroad to purchases from U.S. producers. Business investment looks robust, albeit a little less so after Friday’s data on orders and shipments. If housing takes something out of consumption, however, prospective sales growth will not be quite so strong, and this will constrain the increase in investment demand. So, on balance, I see a moderation of growth to around the rate of increase in potential as a reasonable expectation, given the structure of interest rates built into markets. The key question is whether such a path for output will be consistent with low, stable inflation. I think we can be encouraged by the recent data on prices and compensation. Core consumer and inflation measures have been flat or declining on a twelve-month basis over the last six months or so, despite the uptrend in energy prices. And inflation expectations have remained quite stable on balance. Compensation measures are a bit more mixed. The broadest measures, ECI and total compensation, have not picked up despite the erosion of purchasing power implied by higher energy prices and despite good trend productivity growth. In this regard, Mr. Chairman, we do see an increase in average hourly earnings of nonsupervisory workers. Maybe we are beginning to see some of this feed-through to workers on the lower end of those wages. But, overall, I think compensation growth has been very well behaved. To be sure, we have not yet seen the effects of the recent increases in resource utilization, decline in the unemployment rate, or rise in capacity utilization—and these feed through to inflation pressures with pretty long lives. Given the flatness of the Phillips curve, it could take some time to perceive the inflationary effects if, indeed, the economy is operating beyond its sustainable potential. Moreover, the staff is looking for a notable pickup in compensation. The unit labor costs this year and next are partly absorbed by smaller markups. At this point, however, given the recent data, I would judge these potential developments to weigh on the side of upside risks to inflation rather than tilting the most likely outcome. Both compensation and price increases have fallen short of model projections in recent quarters. While the less-than-expected effects of energy prices could explain this more favorable relationship of output and inflation, we can’t reject the hypothesis that we are seeing something more fundamental developing, especially on the supply side of the economy. Recent data suggest it is not an unexpected increase in productivity. Some combination of the lower NAIRU and the anchored inflation expectations alternative simulations in the Greenbook or other factors could be holding down wages and prices. It is far too soon to say whether anything is going on or to tease out the policy implications, but we would do well to remember just how wide those confidence intervals are, how little we know about price and output determination, and especially how little we know about the level and growth rate of potential GDP. Thank you, Mr. Chairman." FOMC20060920meeting--142 140,MR. KOHN.," Thank you, Mr. Chairman. Whatever you want to call me is fine. [Laughter] I’m just glad to be here. [Laughter] I don’t think I can follow that up. Given the initial conditions—the doubling and more of energy prices over the past two years, the overexuberant housing market coming to grips with a renormalization of interest rates, a very low personal saving rate, and an uncomfortable increase in inflation this spring—a period of modestly below-trend growth and gradually ebbing inflation, as in the Greenbook forecast, is about as good an outcome as we can expect, as Dave Stockton noted. In that regard, several developments over the intermeeting period have made me a bit more comfortable with the plausibility of such an outlook. The weakness in housing has deepened and is more definitively leading to growth of output below potential. In fact, in my view the behavior of the housing market constitutes the main downside risk to sustained moderate economic growth. We’re in the middle of a housing adjustment, which has been hard to forecast, especially because it involves the unwinding of an unknown amount of speculative demand. With inventories rising and reports of price cuts getting greater prominence, the market isn’t yet showing signs of clearing and stabilizing. In the Greenbook forecast, residential investment, though weak, is supported by continued growth of income and relatively low mortgage rates, while house prices basically level out in nominal terms. As the Greenbook notes, however, this forecast leaves some aspects of the existing disequilibrium intact, most notably the high level of prices relative to rents. Also, the cutback in construction doesn’t completely offset the apparent excess building of the boom period. As a consequence, I see the housing forecast in the Greenbook as very far from the worst-case scenario that President Minehan characterized it as. And, we are just beginning to see the effect of the downshift in house-price inflation on consumption starting to play out. Outside of housing, however, recent developments should help to sustain continued economic expansion. Financial conditions remain quite supportive of both business and household spending. Long-term interest rates have fallen appreciably since midyear, and they are low in both real and nominal terms. Risk spreads are narrow, banks have not pulled back on business credit, and equity prices have risen on balance in recent months. Lenders and investors appear to remain confident that the economy will continue to expand at a decent pace. Higher levels of labor income in the first half of the year, along with a favorable effect on disposable income of a decline in energy prices, will help support consumer spending going forward. Economies elsewhere seem to be expanding at a solid clip. Moreover, they are probably less vulnerable to spillovers from a housing-led slowdown of growth in the United States than they were to weakness in 2001. That weakness was centered in a global market for investment goods and was reflected in global declines in equity prices. The less robust economy should present businesses with a more competitive environment in which it will be harder to pass through cost increases. In addition, the decline in energy prices, along with the leveling out of other commodity prices, will reduce cost pressures on businesses and should feed through in some measure to lower core inflation, especially as slower growth damps pricing power. The drop in energy prices has already restrained inflation expectations a bit. For all these reasons, I’m also a little more comfortable with the forecast of gradually ebbing core inflation. Nonetheless, I still see significant upside risk to such a path for inflation. In part, this reflects my uncertainty as to the reasons for the rise in inflation this spring and summer. Feed- through of energy and other commodity prices must have contributed to some extent, and we can see evidence of this in the greater price increases for some of the more energy-intensive sectors, such as for airfares. A portion of the pickup is in the rent-of-shelter category, likely from a shift to rental housing as expectations of house-price appreciation have been scaled back. But price increases have picked up in a number of other categories, and although energy costs probably accounted for some of this acceleration, we can’t dismiss the possibility that other forces were at work—for example, more general pressure of demand on potential output. A reduction of those types of pressures is still only a forecast. On the cost side, as many have commented, the compensation and unit labor cost data, while flawed in many respects, could be pointing to a risk that higher labor costs will persist, putting pressure on prices that might only be partially and reluctantly absorbed by profit margins. In sum, Mr. Chairman, I’m a bit more comfortable with something like the path for the economy and inflation in the Greenbook forecast, but uncertainties are quite high. They might even justify the “higher than usual” description. The downward path for inflation remains at risk, and as others have noted, the costs of exceeding that path could be disproportionate. Thank you." CHRG-110shrg38109--59 Chairman Bernanke," I would say that qualitatively it is fairly similar to the recovery that followed the 1991 recession, with many of the same features. There was weakness for some time after the recession ended, including a period of so-called ``jobless growth.'' Senator Bunning. But we did not have a housing market that---- " FinancialCrisisReport--27 To ensure an ongoing supply of loans for sale, lenders created compensation incentives that encouraged their personnel to quickly produce a high volume of loans. They also encouraged their staffs to issue or purchase higher risk loans, because those loans produced higher sale prices on Wall Street. Loan officers, for example, received more money per loan for originating higher risk loans and for exceeding established loan targets. Loan processing personnel were compensated according to the speed and number of the loans they processed. Loan officers and their sales associates received still more compensation, often called yield spread premiums, if they charged borrowers higher interest rates or points than required in the lender’s rate sheets specifying loan prices, or included prepayment penalties in the loan agreements. The Subcommittee’s investigation found that lenders employed few compensation incentives to encourage loan officers or loan processors to produce high quality, creditworthy loans in line with the lender’s credit requirements. As long as home prices kept rising, the high risk loans fueling the securitization markets produced few problems. Borrowers who could not make their loan payments could refinance their loans or sell their homes and use the sale proceeds to pay off their mortgages. As this chart shows, over the ten years before the crisis hit, housing prices shot up faster than they had in decades, allowing price increases to mask problems with the high risk loans being issued. 36 36 See “Estimation of Housing Bubble: Comparison of Recent Appreciation vs. Historical Trends,” chart prepared by Paulson & Co. Inc., Hearing Exhibit 4/13-1j. CHRG-111hhrg51698--63 Mr. Gooch," They are the members, but, that you definitely require their cooperation. But you also require global cooperation, because these instruments are also traded throughout Europe. So you can't have a clearing mechanism that considers that all of the transactions are only in the U.S. Additionally, of course, there are highly illiquid instruments that just dump themselves for clearing, and that the financial system benefits from the willingness of investors to put capital at risk that provides liquid markets. I am a free marketeer myself, so I believe that it is important to have free liquid markets. If you create price controls, you create shortages. This price control, which is what it would amount to be, would be creating a shortage of credit. You know, blaming the CDS is like shooting the messenger, because the CDS were the instruments that were certainly used in the financial markets, but there was no ultimate failure in the CDS market. The CDS markets performed perfectly. What is failing is the mortgages and the lending that was done to persons that shouldn't have been borrowing. And to that extent we have a sort of global responsibility for having just enjoyed living beyond our means and having a massive global credit bubble, and that credit bubble also drove oil prices to $140. I mean, until it burst, investors overseas that would be concerning themselves with the future needs of the growing economy in countries like China, buying up oil reserves, was what partly was driving the price of oil. So it is not the credit derivatives that are at fault, it is the entire free, cheap credit in the system that was the problem. " CHRG-111shrg56262--36 Mr. Miller," Right. And I am distinguishing here--I am speaking at the security level, so the mortgage---- Senator Bunning. I understand that, but those securitized mortgages were the things that were sold as AAA rated, and that is where we got into all kind of the devil is in the details. And I find that the rating agencies were right in the middle of all that. In other words, they were the ones that were selling those as AAA quality to not only other banks, but the same banks that had sold them the mortgages in the first place, and all around the world. And that is why when the bubble burst, it didn't just burst here in the United States, it burst in Europe and other places. " FOMC20050630meeting--378 376,MS. BIES.," Thank you, Mr. Chairman. I thought I’d focus my remarks today on the topic we discussed yesterday—the housing markets. And then I’d like to talk a little bit about some of the liquidity issues in housing markets and relate that to monetary policy. Let me start by saying that overall I agree that there is not a major risk of significant problems in the housing markets. But there is momentum building in the housing area that is raising some issues about which I am not as sanguine as many of the staff who gave the presentations yesterday. But I want to compliment the staff from both the Board and the Reserve Banks. I thought they did a fantastic job in pulling all of the information together While inflation overall is apparently well contained, I, too, am generally concerned about the continued ratcheting up of our expectations. The one thing that stands out is how much housing prices have jumped relative to overall price levels. We know that the average price for new homes in May was up 8 percent from a year ago. Existing home prices were up 10.2 percent, as was said yesterday. But inventories remain relatively lean, even though the supply has risen by about half a month since the beginning of the year. When I look at the jump in housing prices, I’m trying to see if consumers are saying, “We have good, strong income growth and we’re able to afford more.” Or are they seeing these price increases and trying to jump in while they still can afford a house, before home prices get totally out of their range? Are they viewing real estate as an alternative for investment purposes, after being stung in the stock market drop of a few years ago? Really, all of these factors may be at the heart of the strong demand for housing. But I also think that the financing markets are sending different signals in these areas. I know Mark is going to talk about some of the specifics but I want to discuss some of the macro June 29-30, 2005 149 of 234 customers going to banks to refinance and take advantage of low, long-term fixed interest rates. So most of the mortgage originations in the 2001-2002 period were predominantly fixed-rate loans or they were ARMs that had fairly long fixed-rate periods before becoming adjustable. What is striking is how this has been changing in the last 12 months. ARMs of all types have jumped from about 16 percent of originations in 2001 to about one-fourth in 2002 and 2003, to over half of mortgage originations last year. This is happening in a period when short rates are rising and long rates are flat to down. If bankers are really working to the benefit of their customers, why aren’t they locking in long rates in this environment? It is also the case, when we look at the mix of products, that more of the mortgages are subprime products. Subprime originations have climbed to over 18 percent of total originations. In terms of where these mortgages are being parked—whether they are on the books of banks and other financial institutions or are being securitized—about two-thirds of originations continue to be securitized. So the use of the markets is about the same. But the types of mortgages being securitized are changing. Again, these are predominantly ARMs, and more of them tend to be option ARMs—the higher-risk kinds of structures. As we saw in the information presented about the real estate mortgage pools that are being created, the risk profile in those pools is changing. Interest-only mortgages were basically nonexistent in those pools two years ago; they are now running over 3.6 percent of them. Whereas a lot of these IO mortgages had very conservative loan-to-value ratios—under 80 percent—more and more of them now have loan-to-value ratios in excess of 80 percent. And about 9 percent of the IOs in these pools are going to subprime borrowers—that is, the riskiest customers. Yet those loans require interest-only payments, no amortization. Two weeks ago S&P required additional June 29-30, 2005 150 of 234 HELOCs are being used more for purchase money down payments. People no longer have to save to make a down payment. And when we look at HELOCs in general, for the last three years they’ve grown at a compound rate of over 30 percent a year. As would any supervisor, when I see a product growing 30 percent a year for three years, I tend to get a little nervous about the concentration risk. Where is the liquidity coming from for these? Again, a big chunk of it is going to the securitization markets. I think one of the challenges we have as bank supervisors is that, to the extent the banks are originating these loans with the intent to sell them to the market, they’re looking to the market for the credit definitions. We know from our QIS-4 [Quantitative Impact Study 4] results, looking at the Basel II exercise, that we had a huge disparity in the results on loss expectations on home equity loans and other mortgage products. A lot of these are new types of products. The confidence intervals around the expected defaults, I think, are a lot wider for them than for those that have traditional structures. We also know that there’s a lot of correlation risk that could happen here. If the housing price bubble does break in a market where employment is dropping, people could be leaving an area and we could have more defaults. In addition, we know that the dropping of home prices, in and of itself, tends to create more defaults, especially with negligible equity in these properties. Also, to the extent that people default and the banks have more properties to foreclose, there are neighborhood effects, with losses getting bigger when the defaults do occur. So, what I am concerned about from a liquidity perspective, since these are being securitized and moving into the markets—and there is plenty of appetite in the market to take these products— is the lack of discipline relative to previous periods. In the ancient days, when mortgage loans stayed on the books of financial institutions, liquidity limitations forced them to choose the higher June 29-30, 2005 151 of 234 understands the structure of these loans any better than some of us do in terms of pricing the risk, as evidenced by the S&P move two weeks ago. So, again, I’m not overly concerned. Especially with the record profits and capital in banks, I think there’s a huge cushion. But the implications of this for housing wealth and for investors who take the ultimate risk in these securities could create some problems in terms of the way economic growth proceeds going forward. And it’s something that I think was appropriate to spend the time talking about today." fcic_final_report_full--476 The forest metaphor turns out to be an excellent way to communicate the difference between the Commission’s report and this dissenting statement. What Summers characterized as a “cigarette butt” was 27 million high risk NTMs with a total value over $4.5 trillion. Let’s use a little common sense here: $4.5 trillion in high risk loans was not a “cigarette butt;” they were more like an exploding gasoline truck in that forest. The Commission’s report blames the conditions in the financial system; I blame 27 million subprime and Alt-A mortgages—half of all mortgages outstanding in the U.S. in 2008—and a number that appears to have been unknown to most if not all market participants at the time. No financial system, in my view, could have survived the failure of large numbers of high risk mortgages once the bubble began to deflate, and no market could have avoided a panic when it became clear that the number of defaults and delinquencies among these mortgages far exceeded anything that even the most sophisticated market participants expected. This conclusion has significant policy implications. If in fact the financial crisis was caused by government housing policies, then the Dodd-Frank Act was legislative overreach and unnecessary. The appropriate policy choice was to reduce or eliminate the government’s involvement in the residential mortgage markets, not to impose significant new regulation on the financial system. **** The balance of this statement will outline (i) how the high levels of delinquency and default among the NTMs were transmitted as losses to the financial system, and (ii) how the government policies summarized above caused the accumulation of an unprecedented number of NTMs in the U.S. and around the globe. CHRG-111hhrg54869--173 Mr. Cleaver," Thank you. We are going to have votes in maybe 15 or 20 minutes. I do think we can get all members in if the members will use the Reader's Digest version of your questions and if you will give the Cliff Notes version of the answer, I think we can get through all of these. We will begin with the gentlelady from Illinois, Ms. Bean. Ms. Bean. Thank you, Mr. Chairman, and to the witnesses for sharing your expertise today. Many of us have advocated for countercyclical capital requirements to avoid the kind of depth and width of the downfall that we recently experienced, specifically to discourage the type of leverage that we saw. And as Mr. Zandi said in his own testimony, if I understood it properly, suggesting that when we see a bubble in formation, obviously increasing capital requirements will maybe minimize how big that bubble gets. In a precipitous downfall we would ease up capital requirements as well, which we didn't do, so it doesn't get so wide as institutions divest themselves, even in this case non-subprime related assets. Given that history suggests that regulators, though they have the authority to impose those changes, tend not to want to be the buzzkill when the party is going, will regulators follow guidance from the Feds or does Congress really need to be more proscriptive in that regard and require those type of changes relative to capital requirements? I am asking Mr. Zandi specifically. " CHRG-110hhrg38392--88 Mr. Campbell," Thank you, Mr. Chairman. Oddly enough, Chairman Bernanke, I have a series of economic questions for you. I believe I am correct in characterizing that about 6 months ago, you said that you thought one of the greatest risks to economic growth would be a hard fall in the residential housing market. You have said that today some of our slow-down in growth is largely attributable to that sector. How would you assess the risk of a hard fall in that market at this point? What are the risks to that happening, or what are the opportunities for its not happening? " FOMC20070131meeting--55 53,MR. GAGNON.," Your first international exhibit (exhibit 9) covers recent market developments. As shown by the green line in the top left panel, oil prices dropped further this month, bringing the West Texas intermediate spot price back to pre- Katrina levels. The IMF index of nonfuel commodity prices (the red line) was little changed this month after a year of remarkable increases. Readings from futures markets imply a flattening out of nonfuel commodity prices and only a moderate increase in oil prices going forward. The top right panel shows that our real trade- weighted dollar indexes declined on balance last year. In recent weeks the dollar rebounded modestly against the major industrial-country currencies (the red line), but we estimate that it continued to decline in real terms against the currencies of our other important trading partners (the green line). As usual, our forecast calls for a small downward trend from current levels, reflecting our belief that the risk of significant depreciation is slightly greater than the risk of significant appreciation, owing to the unsustainably large U.S. trade deficit. The bottom panels report equity market indexes, with industrial countries shown on the left. The lines are set to equal 100 in March 2000, the previous peak month for the Wilshire 5000. Equity prices have risen broadly across the industrial countries over the past two years and are now just above their March 2000 levels in the United States, the United Kingdom, and Japan, but not in the euro area (the red line). For major emerging markets, on the right, equity indexes are well above March 2000 levels. In Mexico (the blue line), equity prices have more than tripled over this period. In Thailand (the green line), the government’s recent attempts to slow capital inflows and relieve upward pressure on the currency have taken their toll on equity prices, but contagion to other emerging equity markets has been minimal. Overall, commodity and financial market developments are consistent with expectations of strong global growth. Exhibit 10 focuses on financial flows between emerging markets and industrial countries. As shown in the top left panel, the major developing regions have continued the downward trend in their reliance on external borrowing. Fiscal deficits have declined in most countries, and many governments have turned increasingly to local, rather than external, borrowing. The panel to the right shows that yield spreads on dollar-denominated sovereign debt of emerging market countries have dropped to historically low levels. But emerging markets, in the aggregate, have gone much further than just reducing their borrowing. In recent years, emerging markets have experienced record outflows of official capital (the gold bars in the middle panel). These official outflows are composed of the accumulation of foreign exchange reserves, the servicing and paying down of sovereign debt, and the purchase of foreign assets by government-run investment funds such as the Kuwait Investment Authority. In all the emerging market regions, official capital outflows have recently exceeded current account surpluses (the blue bars), which are themselves at record levels. For example, the IMF estimates that in 2006, governments in emerging Asia invested on balance $270 billion outside their borders, a sum that greatly exceeds their combined current account surplus of $185 billion. Most of these official flows have taken the form of additions to foreign exchange reserves, as governments have built up war chests against future financial crises and sought to counter upward pressures on their currencies. The bottom panel looks at these flows from the point of view of the industrial countries, plotting aggregate emerging market net official flows (the gold bars) relative to industrial-country GDP, with negative values denoting net flows into the industrial countries. The statistical accounts do not report the destinations of all these flows, but the available evidence suggests that the overwhelming majority is destined for the industrial countries. Before 2003, net official inflows or outflows from the emerging markets had never exceeded 1 percent of industrial-country GDP. But since 2003, things have changed. Net official outflows from emerging markets are now estimated to equal 2½ percent of the combined GDP of the industrial countries. As shown in the panel, the timing of this unprecedented increase in net official flows corresponds well with the puzzling decline in real short-term interest rates in the industrial countries (the green line) that persisted long after industrial-country GDP growth (the purple line) rebounded from the slowdown early in this decade. The evidence suggests that aggregate policy-driven capital flows from the emerging markets may be an important factor behind low real interest rates in the industrial countries. Moreover, low real rates are not limited to short-maturity instruments. The top panels of exhibit 11 show that ten-year indexed bond yields are also low and have been for several years in the major industrial countries. These rates have ticked up over the past month or two, but only by a small amount. Long-term inflation compensation (shown in the middle row of panels) remains contained. Indeed, in Japan and Canada (the two panels on the right) inflation compensation has moved down in recent months. In the euro area and the United Kingdom (the two panels on the left), where inflation compensation lingers above policymakers’ targets, we project modest additional policy tightening early this year, shown in the bottom row of panels. Despite recent and expected future inflation rates close to zero, the Bank of Japan seems poised to tighten gradually over the next two years. In Canada, policy is expected to remain on hold. If these projections prove to be the peak policy rates for this cycle, they will be the lowest cyclical peaks for short-term interest rates in these countries for at least forty years. Nevertheless, we judge that these policy stances are likely to be consistent with low and stable inflation this year and next. The large capital inflows and low real interest rates in the industrial countries have contributed to rising housing prices in many of these countries. Higher home prices in turn have stimulated housing construction. The top panel of exhibit 12 shows that the extent and timing of the house-price boom differs markedly across countries. The Netherlands (the blue line) was one of the leaders of the global housing boom, with prices rising continuously since the early 1990s, though at much slower rates in recent years. Japan (the green line), on the other hand, is a notable exception to the trend of rising house prices in recent years, reflecting the lingering effects of the bursting of the 1980s asset bubble and Japan’s extended economic slump. The middle panels focus on two countries that experienced strong house-price increases (the purple lines) early in this decade but where house-price increases subsequently halted, at least temporarily. In both Australia and the United Kingdom, as in the United States, residential investment (the green lines) responded positively to higher house prices. In Australia, on the left, real house prices have been flat for the past three years, and residential investment has declined gradually about 1 percentage point of GDP, though it remains above its historical average. In the United Kingdom, on the right, house prices stabilized in 2005 and picked up again modestly last year. Despite lower house-price inflation, residential investment has continued to rise toward historically high levels. The relevance of these foreign experiences for the United States is difficult to gauge, but they provide some support for Larry’s forecast that the downturn in U.S. housing is nearly over. In light of the signals from financial and commodity markets, as well as other real-side indicators, we project continued solid growth in the foreign economies at rates that are not likely to strain resources or to put upward pressure on inflation. As shown in the bottom panel, total foreign growth (line 1) is estimated to have stepped down last year from 4½ percent in the first half to about 3½ percent in the second half, and it is projected to remain around 3½ percent over the forecast period. This projection is about 1 percentage point stronger than the staff’s projection for U.S. growth, shown at the bottom of the panel. The foreign industrial economies (line 2) overall are projected to grow at about the same rate as the United States, Japan a bit slower (line 4), and Canada a bit faster (line 5). The emerging market economies (line 6) are projected to grow at nearly twice the pace of the industrial economies over the forecast period. We expect that emerging Asia (line 7) will continue to grow very rapidly and that Latin America (line 8) will grow at a solid, though not exceptional, rate. Our forecast assumes that the Chinese government will take additional measures if necessary to reduce the growth rate of investment, and we project that Chinese GDP growth will be slower this year than last. But the risks to our growth forecast for China are probably greater on the upside. Exhibit 13 provides an assessment of what all these foreign influences mean for the U.S. economy. Overall import prices, the black line in the top left panel, fell sharply last quarter and are projected to continue to fall in the current quarter, primarily owing to the drop in the price of imported oil. As oil prices stop falling and begin to move gradually back up, overall import price inflation should turn positive. Prices of imported core goods (the red line), which exclude oil, gas, computers, and semiconductors, rose at a rate of nearly 4 percent in the middle of last year, primarily owing to sharply higher prices of nonfuel commodities. With commodity prices projected to stabilize and with only a small depreciation of the dollar in our forecast, prices of imported core goods should increase at a subdued pace over the next two years. The contributions of exports and imports to U.S. GDP growth are shown in the lower panel. We now estimate that the external sector made a positive arithmetic contribution to growth last year, the first positive annual contribution since 1995. Import growth stepped down from previous years as U.S. GDP grew more slowly. Export growth benefited from robust foreign economic activity, but exports turned out even stronger than our models project. Line 1 in the top right panel shows that, for the first eleven months of last year at an annual rate, exports of goods grew 10½ percent from the previous year in real terms. Lines 2 through 4 show that three categories of capital goods—aircraft, machinery, and semiconductors—contributed nearly half of total export growth. Although it is possible that blistering growth rates in exports of these goods may continue, we base our forecast on a return of export growth to a rate more consistent with historical relationships. With the vast majority of aircraft production being exported in recent months and with aircraft factories running at high utilization rates, further large increases in exports from this sector, at least, do not seem likely. Returning to the bottom panel, we project that the negative arithmetic contribution of imports (the red bars) to GDP growth will outweigh the export contribution (the blue bars) in 2007 and 2008 by about ¼ percentage point (the black line). This projection is driven by the historical tendency of U.S. imports to grow at a much faster rate than U.S. GDP. In addition, the larger value of imports relative to exports means that, even if imports and exports were to grow at the same rate, the negative contribution of imports would be greater than the positive contribution of exports. The projected strong growth rates of foreign GDP, discussed in your previous exhibit, are not large enough to outweigh these factors over the next two years. On balance, relative prices have little effect on net exports over the forecast period, as the real trade-weighted dollar has moved in a relatively narrow range over the past couple years and is not projected to move substantially over the forecast period. And now Larry will complete our presentation." FOMC20050630meeting--85 83,MS. YELLEN.," Thank you, Mr. Chairman. I just wanted to make a couple of comments June 29-30, 2005 35 of 234 seen. It seems to me that there might be a couple of factors that could explain at least some portion of the run-up, though probably not all of it, that weren’t mentioned in the presentations. First, it seems to me that financial innovations affecting housing could have improved the view of households regarding the desirability of housing as an asset to be held in portfolios and thus raised the equilibrium price-to-rent relationship for residential real estate. What I’m thinking of is the idea that equity held in residential real estate is a lot more accessible today than it has been in the past. Home equity credit at commercial banks is up fourfold since 1999, and many households obviously are now keenly aware that refinancing provides a low-cost avenue for tapping into the equity in their homes. So, in a sense, there might be less of a liquidity premium embodied in the return for housing. Also, if people feel that the liquidity constraints in holding housing as an asset are diminishing, that could explain a reduced need for precautionary saving in traditional liquid assets. It could even make people willing to put more of their wealth into down payments on houses and may have raised prices through that mechanism. The other thing that occurred to me is that there might be effects from tax changes. We’ve had changes in the rules for tax exemption and in 1997 on capital gains from the sale of primary residences that would make holding real estate assets more attractive. And the changes in capital gains taxes more generally in 1997 and then again in 2003 would have worked in the same direction. One of the things that we looked at that we thought was interesting was the behavior of price-rent ratios for residential housing and for commercial office space. Commercial office space price-rent ratios are highly cyclical—I guess they always have been—but it appears that the behavior of price-rent ratios in residential housing has closely mirrored what we’ve seen in June 29-30, 2005 36 of 234 1998, though the dynamics are totally different. Commercial office space rents have been falling— it’s not that the prices have been rising—but the price-rent ratios have moved very similarly. A second comment I wanted to make concerns the relationship of creative finance to the housing market. One view that I think is very prevalent is that the use of credit in the form of piggyback loans, interest-only mortgages, option ARMs [adjustable-rate mortgages], and so forth, involves financial innovations that are feeding a kind of unsustainable bubble. But an alternative perspective on that is that high house prices, in fact, are curtailing effective demand for housing at this point and that house appreciation probably is poised to slow. So the increasing use of creative financing could be a sign of the final gasps of house-price appreciation at the pace we’ve seen and an indication that a slowing is at hand. Previously, lenders applied very rigid constraints on loan-to­ value ratios, but essentially those constraints are now being eased at the margin through these creative financing techniques. And that’s providing some elasticity to what was a firm roof. It may slightly diminish the price elasticity of the demand for housing, but the fact that it is blossoming now basically suggests that we really are at the ceiling where it’s binding and will ultimately constrain appreciation. Finally, with those two comments, a question. It concerns the presentation by Andreas and the numbers cited on loan-to-value ratios at origination. One of the things we’re seeing in California and elsewhere in our District—and maybe this is true nationwide—is a growing use of piggyback loans. Loan-to-value ratios of 90 to 95 percent are common in California, and we’ve even seen combination loan-to-value ratios and piggyback loans going up to 125 percent. I guess that means two things, one of which is that the traditional first mortgage looks utterly conventional. Those mortgages have an 80 percent loan-to-value ratio and I suppose they are being sold off to June 29-30, 2005 37 of 234 and Freddie, there’s no need for private mortgage insurance. So Fannie’s and Freddie’s books may look better in some sense—less risky—than they really are because of all of the second mortgages going up to possibly 125 percent." CHRG-110shrg46629--140 PREPARED STATEMENT OF SENATOR JIM BUNNING Chairman Bernanke, I watched your testimony yesterday with interest. Apparently the markets did too, but I am not sure if they did or did not like what they heard. You covered a lot of ground yesterday, but there is some new ground I will cover in the questions and some things that are worth repeating. First, it has been interesting to watch market reactions and expectations to Fed policy statements over the last few months. For a while, the markets did not believe your clear statements that the biggest concern was that inflation would not moderate as expected. Market indicators have moved more in line with your view in the last month or two, and I hope both the markets and you have learned about communication and the way each other think. While this is a monetary policy hearing, I think it is worth repeating that many of us believe the Fed and other regulators share some responsibility for the current state of the housing market. Low interest rates fueled the housing boom, and loose supervision of mortgage writing allowed it to proceed. The market is certainly punishing bad behavior by lenders, but some of the damage could have been prevented by more careful scrutiny of some of the most undisciplined lending. The Fed should have been especially careful because of the credit bubble it created with cheap money. I am glad you and your fellow regulators have taken action, and that you did not overreact and cause further damage. It is important for you to remain vigilant, but not to give in to pressure to over regulate. I would also say to Chairman Dodd that I hope we can quickly confirm the new nominees so that the Fed board will have more industry experience when tackling these issues. I continue to be impressed by the current economy, which seems to have passed through the worst of the slowdown caused largely by Fed tightening. My biggest concerns are rising food and energy prices, and the negative effects on the economy of the massive tax increases the new majority in Congress seems determined to allow. The current economic expansion is driven by the 2001 and 2003 tax cuts, and allowing a tax increase in 2010 will reverse years of gains in the economy and the stock markets. I look forward to hearing your responses. ______ 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]" FOMC20070807meeting--94 92,MR. LACKER.," Thank you, Mr. Chairman. In the Fifth District we continue to see moderate economic growth, though it has been uneven across sectors in recent weeks. Manufacturing activity rebounded somewhat in June and July after several months of weakness, with our indexes showing increases in new orders and shipments. Activity at District services firms advanced at a steady pace, with solid revenue growth and a broader pickup in hiring. The retail sector, however, has lost much of the momentum reported last month, as softness in big-ticket categories continues to constrain revenue growth. On the employment front, District labor markets are increasingly taut, given steady hiring activity and slower labor force growth. In addition, in contrast to the Eighth Federal Reserve District, contacts continue to report rising wage pressures and difficulty finding qualified workers. Housing markets remain weak across much of the District. However, commercial real estate activity remains healthy, with steady demand reported for office and industrial space. Some contacts, however, have expressed concern about slower activity in the retail segment of that market. Turning to prices, our July surveys indicate increased inflation pressures. The average current rate of increase of manufacturers’ prices has moved up for both raw materials and finished goods over the past few months, reversing the decline seen earlier this year. Price pressures on the services side have picked up as well, though expectations for future prices eased somewhat in the July report. At the national level, we continued to receive fairly good news on inflation. After annualized rates of monthly core PCE inflation above 2 percent at the beginning of the year, we’ve now had four months of readings below 2. But there are still abundant reasons for caution, as President Moskow, for example, noted. I’ll mention the Greenbook, which cites transitory factors—apparel and owners’ equivalent rent, for instance—that have contributed to the recent moderation. The passing of these damping forces could well push core inflation back up in the near term. So although I think we have reason to take some comfort from recent inflation numbers, and I do, I want to wait to see more evidence, especially as growth moves back toward trend. I still think the prospects for a return to trend growth are reasonably good, and my assessment of trend is still a bit higher than the Greenbook’s, in part because I’ve not revised my estimate of productivity growth much in response to the GDP revisions. Obviously, there are downside risks to be concerned about, and financial market activity since the last meeting obviously raises some concerns. As far as we can tell at this point, the heightened turbulence of the past month is all pretty closely related to subprime and nontraditional mortgages and the leveraged financing of private equity buyouts in the corporate sector. These two market segments are relatively new, and they represent the latest manifestation of the broad, ongoing wave of financial innovation that we’ve been seeing over the past few decades. Because these two markets are so young, one would expect participants’ risk assessments to be more uncertain and thus be more sensitive to what is learned from market events and incoming news. That said, developments in the past month have certainly been quite dramatic, and it looks less like rapid learning than it does rapid unlearning of what was previously viewed as known—although that, too, is of course a form of learning. The implication of these revised risk assessments for the economic outlook and for policy depend on whether they affect business investment or household spending on consumption or new housing. At this point the answer to that question is not yet clear, but it’s worth noting that, by many measures, corporate credit quality seems to remain pretty good by historical standards, and the buyout movement, as President Poole just noted, seems to have been more about restructuring liabilities and governance arrangements and less about funding capital spending. So it’s not obvious why there should be dramatic effects on business investment. What about consumption? PCE was fairly soft last quarter, and this softness could be a harbinger of more-sustained weakness. The second-quarter softness may well be a one-time phenomenon, however, reflecting both the sharp rise in gasoline prices in the first five months of the year and some payback from the strong spending growth in Q4 and Q1. Moreover, the outlook for household income looks pretty good, with labor market conditions fairly firm and consumption gains showing no sign of slowing down. In addition, household net worth is coming off a relatively high base. Neither of these fundamentals seems likely to be seriously threatened by the repricing that’s in train. Housing, on the other hand, continues to be the predominant area of concern regarding real spending, and financial market developments have only heightened that concern. The Greenbook paints a fairly pessimistic picture. The decline in residential investment accelerates over the remainder of year and continues into next, and the inclusion of three “greater housing correction” alternative scenarios suggests that the staff is especially concerned, justifiably so in my view, with the downside risk to their outlook. But even though the housing market has definitely deteriorated, the outlook for housing is quite uncertain in my mind, and I continue to think that a more moderate decline is also possible and that housing could be somewhat less of a drag on growth than the Greenbook forecasts. At this point, however, the reassessment under way in secondary markets regarding housing-related credits still has a way to go, and until that process plays out, it’s going to be hard to gauge the resulting magnitude of repricing at the retail level. About all I conclude at this point is that the outlook for housing is still awfully uncertain right now. Thank you." CHRG-111hhrg51698--398 Mr. Masters," I think common sense says that is not the case. We have plenty of studies that we can show that say that index funds were in fact an issue, and excessive speculation was a driver in creating the commodity markets bubble. There are studies from MIT, from the World Bank, from the United Nations. I saw one a couple days ago from the Austrian Ministry of Finance. There is one from the Japanese Ministry of Trade. There have been a lot of studies that have come to the opposite conclusion. So I could submit those if you would like to see them. " FOMC20081216meeting--154 152,MR. LACKER.," Yes. So it is sort of a bummer that these go up in the recession if you are trying to measure what is happening to the NAIRU. But I always thought of the phrase ""sectoral reallocation"" as having to do with the theories of the business cycle in which cyclical downturns are caused by an unexpected decline in a given industry that causes resources to shift out of that industry and that it takes time for them to be absorbed into some other industry. From that point of view--if you are trying to measure that component as opposed to policy-induced, widespread declines in activity--I would think you would want not to take out the cyclical part. I am thinking about housing. We devoted a lot of resources to housing in 2005, much less now. Those resources thrown on the market, in fact, are the proximal cause of the initial downturn in employment growth. A lot of ancillary industries are related, so I would think that, if we didn't take out the usual housing cyclical thing, which is really sharp in the early periods, you would see a bigger rise here. " FOMC20061025meeting--12 10,MR. STOCKTON.," Thank you, Mr. Chairman. About a week ago, as we were closing the forecast, I was marveling at how little it had changed over the intermeeting period—both the broad strokes and the details. But the warm glow of accomplishment had barely been kindled when a glance at my desk calendar revealed the source of our success. The last FOMC meeting had been only five weeks ago, so we simply had not had time to accumulate our usual backlog of forecasting errors. [Laughter] I recognize that even this assertion is open to some challenge. Because of the incoming data, we have revised down our estimate of third-quarter growth of real GDP about ¾ percentage point, to an annual pace of just 1 percent. However, we don’t think this downward revision carries with it much, if any, macroeconomic signal about greater weakness going forward. Importantly, consumption, housing, and business fixed investment all came in very close to our September forecast. The downside surprises that we experienced last quarter were concentrated in motor vehicle production, defense spending, and net exports. In each case, we believe some good reasons exist for anticipating that these sources of restraint will abate or reverse in the fourth quarter. With regard to motor vehicles, the production cuts needed to deal with the inventory overhang that developed last spring have been larger and have come more quickly than we had expected. As a consequence, the drop in motor vehicle output took a bigger bite out of growth in the third quarter and is now expected to be a roughly neutral factor for growth in the current quarter, rather than being a small drag on growth in both quarters. Defense spending also fell far short of our expectations last quarter, but we expect these outlays to rebound in the fourth quarter to a level more in line with defense appropriations. Finally, imports are estimated to have surged in the third quarter more than seems warranted by the fundamentals and, as best we can tell, without a full offset in other components of spending. Karen and her team expect some of that import surprise to be unwound in the fourth quarter, providing a small plus to estimated growth. All told, we are projecting the growth of real GDP to rebound to a pace of 2¼ percent in the fourth quarter. For the second half, output is anticipated to grow at an annual rate of 1½ percent, a forecast not much different from the one in September. We also have made only minor adjustments to our longer-term GDP forecast. By our assessment, lower oil prices and a stronger stock market more than offset the effects of a slightly higher dollar and a bit weaker trajectory for house prices. All told, we revised up our forecast for the growth of real GDP 0.1 percent in both 2007 and 2008, to 2.2 and 2.5 percent respectively. Basically, the general contour of the forecast is the same as in September. As before, the very subdued pace of the expansion that is projected for the second half of this year results principally from a sharp contraction in residential investment that directly subtracts more than 1¼ percentage points from the growth of real GDP. Residential investment continues to contract next year, though that contraction gradually diminishes. In addition, the drag on spending and activity from the run-up in energy prices that has occurred, on net, over the past three years is expected to lessen considerably from this year to the next. The attenuation of the drags from housing and energy alone would result in a prompter return of growth to potential. However, we expect the housing slump to restrain the growth of real output this year and next through wealth effects and multiplier-accelerator influences. Most notably, house prices are projected to about flatten out; and as the impetus from past house appreciation wanes, consumption growth should slow, and the saving rate should begin to edge up. With its usual lag, the overall deceleration in output, income, and sales further damps consumption and business investment. As a consequence, growth remains slightly below potential in 2007, and the output gap edges up to roughly ½ percent of GDP by the end of the year. With the bulk of the direct and indirect effects of the housing slump expected to have largely played out by then, real GDP growth is expected to expand in line with its potential in 2008. Meanwhile, core PCE price inflation, which is currently running a bit less than 2½ percent, edges down to about 2 percent in 2008. The opening up of a small output gap helps to head off an intensification of inflation pressures. But by far the most potent influences are the diminishing upward pressures from prices for energy, non-energy imports, and other commodities. Because this basic story is virtually unchanged from the September Greenbook and because we had relatively few surprises to deal with in the forecast, I thought that I would dispense with a further explication of the contours of the forecast. Instead, I=ll offer you a scorecard of sorts to help you audit the plausibility of the forecast story in light of data that we will be receiving in coming months. Let me start with housing, because as I noted a moment ago, the recent and projected contraction in residential investment is the principal source of the below-trend growth that we are projecting over the next year. For that story to be on track, housing starts will need to drop sharply further by the end of the year. Single-family starts averaged about 1.4 million units in the third quarter, and in our forecast, we are anticipating a further 12 percent decline, to a pace of 1¼ million units this quarter. We read the incoming data as being consistent with that outlook. Although starts bounced up in September, permits—a less noisy indicator of housing activity—continued to plunge. Moreover, inventories of unsold homes remain at a very high level, and sales cancellations have continued to increase. But after a long period of what seemed to be unrelentingly bad news, the housing data received over the intermeeting period could be fairly characterized as more mixed. Sales of new and existing homes firmed a bit in late summer, the index of pending home sales moved up in August, and homebuying attitudes as measured in the Michigan survey jumped up in September and October. Although it is far too early to conclude that these indicators are pointing to stabilization in housing markets, they provide at least some encouragement to the view that the bottom may now be closer than the top. We will also be scrutinizing the information on house prices. Another reading on the OFHEO (Office of Federal Housing Enterprise Oversight) price index will become available in early December before the next meeting. Here we will be looking for another noticeable step-down in the rate of house-price appreciation, from the 5 percent pace posted in the second quarter to a projected 1¾ percent pace in the third. That forecast is roughly consistent with our near-term forecasting models that make use of the information in the Case-Shiller price indexes and other high-frequency measures of home prices. As you know, we are not forecasting the national average of house prices to drop, but our very low projected rate of house-price appreciation implies that a substantial fraction of households will be experiencing outright declines. Consumption will be the second major area that should be monitored, in part because we are expecting the slowing in house prices to show through here. In brief, we will be looking for a continuation in coming months of the moderate increases in consumer spending that we have observed since the spring. Over the past half year, consumer spending excluding motor vehicles has been increasing at a pace of roughly 2¾ to 3 percent, and we are expecting more of the same in coming months. That relatively steady expected growth reflects some crosscurrents that seem likely to be at work. Real income gains should be bolstered by the recent fall in energy prices and continuing, albeit modest, gains in employment. But the lagged effects of higher borrowing costs and an ebbing of positive wealth effects from housing are expected to hold spending below the gains in income and result in a slight upward tilt to the saving rate. Obviously, given the importance of consumption in overall aggregate demand, developments here will have a critical bearing on the probability of achieving our projected soft landing. A snap-back in consumer spending in coming months—an outcome that seems to underlie some of the outside forecasts that are stronger than ours—might lead to no landing rather than a soft landing. In contrast, any serious faltering of consumer spending is “buckle the seat belts and assume the crash position.” The third major development that we will be looking for is another sustained step- down in the pace of employment growth. Slower employment growth is a key link in the multiplier mechanism through which the housing-induced slowdown in aggregate output and spending propagates forward into below-trend growth next year. We correctly anticipated the first leg of that slowing earlier this year, when average gains in nonfarm payrolls dropped from the 200,000 per month pace of the preceding several years to the roughly 120,000 per month pace observed since the spring. But our projection anticipates a further slowing in the fourth quarter to an average pace of about 75,000 per month. To be sure, the increase in September was just 51,000, but that came on the heels of a gain in August of 188,000, so we wouldn’t want to lean too heavily on the September observation for support. Moreover, if asked to present just one piece of evidence that casts the greatest doubt on the staff projection at present, I would point to initial claims for unemployment insurance. Claims have basically been moving sideways in recent months and provide no indication that a further softening in labor markets is under way. Given the looseness of the relationship, our forecast of payroll employment is not inconsistent with the current level of initial claims, but right now this important piece of our forecast seems to have more upside risk than downside risk. The fourth element of our forecast that we will be looking for in coming months is some signs of slowing in business fixed investment. Of course, the accelerator consequences for equipment spending of the slowing we now think is under way in aggregate demand is really a story for 2007, and given the volatility in the data, it will take some time to detect that slowing when, or if, it occurs. But more immediately, we are expecting to see some slowing in nonresidential construction from the 20 percent pace that we’ve experienced over the past half year to something closer to a 10 percent pace in coming quarters, thus providing less offset to the weakness in residential construction than has been the case thus far this year. With energy prices leveling out, the upward impetus from drilling and mining activity seems likely to gradually abate. Outside drilling and mining, smaller employment gains, slower growth of manufacturing output, and still-high vacancy rates suggest to us that this sector will cool somewhat going forward. The final item on the scorecard is inflation. We are going to be looking for core PCE prices to continue to increase an average of about 0.2 percent per month for the remainder of the year, with core CPI running between 0.2 and 0.3 percent per month. Those increases would be higher than in most recent years but lower than the pace observed last spring. Moreover, some of the key factors that underlie our projection of a gradual slowing of core inflation over the projection period now seem to be falling into place. After nearly three years of persistent upside surprise, oil and other energy prices have dropped noticeably from the levels of late summer. If these recent developments hold, the cost pressures from rising energy prices should ease over time. Moreover, the sharp increases in residential rent that occurred in the spring appear to have simmered down of late, and we are expecting that pattern to continue in coming months. Meanwhile, most of the major measures of inflation expectations that we monitor have continued to fluctuate in a reasonably narrow range, and we expect that to remain the case going forward. I am tempted to say that, armed with this scorecard, you will arrive at the December meeting with a clear idea of how the staff forecast has stood up to the incoming data. But of course, we all know how the story goes. Much like the cliffhanger serial movies of the 1930s, the promise appears to be that, if you come back next time, all the current problems will be resolved. However, given rational expectations, you know that, to the extent any problems are resolved over the intermeeting period, they will simply be replaced by a new set of puzzles and perils. Karen will continue our presentation." FinancialCrisisInquiry--203 Yes. You know, what we’ve observed over time with traditionally underserved borrowers or people with lower or nontraditional credit histories is that we always had higher delinquency rates than was typical in the prime markets but our actual loss rates always ran under 1 percent. And part of that was because—part of how to run a successful operation, lending to these communities, includes understanding that there can be different kinds of income interruptions and vicissitudes of life and working with borrowers through those periods to keep the loan performing. And so, really, we—you know, now, of course, we’ve been impacted by the larger crisis. But just—then what’s become what we now talk about as subprime lending is loan products that had risky features and, as Professor Rosen’s discussed, lots of layers of risk. And these were not products, for the most part, except in the narrowest, narrowest sense—for the most part, these were never products that provided particular benefits to the consumers. They were products that were push-marketed to, you know, more vulnerable populations and then spread out as the bubble grew and housing became more unaffordable for most families. CHAIRMAN ANGELIDES: All right. Thank you very much. And, last question here, before we move on, which is that—do you have data on—and maybe, again, it’s contained. I’ve read a lot, but at 56, I don’t retain all. And that is, do you have data on the extent to which community banks engaged in subprime origination? CLOUTIER: Yes, we—we—I’m sure we have data on that, but it was very, very little. Let me—can I just add on to both of these comments... CHAIRMAN ANGELIDES: Can you—well, let me just say, can you get us some data on... CLOUTIER: CHRG-110shrg50418--78 Mr. Nardelli," So, Mr. Chairman, let me answer two or three points, please. First of all, having been there a year-and-a-half, let me share with you what we did find and what we did do. We immediately eliminated four vehicle nameplates because what we found is they were designed for Europe and being sold in the U.S. We immediately put in the first ever Chief Customer Officer. We have identified over 400 line items to improve performance, reliability, durability, and finish. So yes, we have made some mistakes in Chrysler and what we are trying to do is move expeditiously to remedy those. Our warranty costs as a result of that in the last 15 months has gone down 29 percent by focusing on customer first and quality, period. Your other point, and having spent a lot of time in the housing industry, I can share with you that there was this unbelievable bubble. As you know, people were extracting a tremendous amount of equity, trillions of dollars, and reinvesting and rolling up. The mistake the Chrysler probably made during that period is that we were responding to the customer who wanted bigger, more expensive, higher horsepower vehicles to go with their second homes, their boats, their trailers, and we chased that consumer demand up. Lesson learned for us, and we are moving as fast as we can to make sure our product portfolio is much more balanced, that we have smaller, more fuel efficient, more efficient cars to blend with those things that we are doing, both like Alan and Rick, in producing hybrids, producing electric vehicles, to make sure that we have the appropriate blend as we go forward. " 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. " FOMC20050630meeting--35 33,CHAIRMAN GREENSPAN.," We do obviously have BEA [Bureau of Economic Analysis] data on transaction costs and, one would presume, profit margins, so that in a way we have at least one element of the markup over cost. The differences that we’re looking at here are so large that it’s not a minor question. Indeed, if you take Dick’s bubble—or lack thereof, I should say—you get the impression that deflation is probably going on. [Laughter] I’d be curious, frankly, to have Andreas, who has looked at this to a great extent, comment on Dick’s paper." CHRG-111shrg57322--1220 Mr. Blankfein," In the context of the chaos in the market, all the size positions, all the market making we were doing in that period of time, with all that was going on, getting within $500 million of flat during that year 2007, I think, reflects a desire and an accomplishment to get closer to home. We bought--OK, and I will just--so anyway, I just wanted to respond to you---- Senator Levin. You may not think a half-a-billion dollars is a lot, but the fact that you were able to get through 2007, when the bubble burst, was because you went with the big short. Those are your own---- " FOMC20070321meeting--120 118,CHAIRMAN BERNANKE.," Thank you. Thank you very much for the comments. I’m going to offer, as I always do, a brief summary and invite any comments and corrections, and then I’d like to add a few comments of my own. Most participants today agree that growth looks as though it’s going to be slower, but there is some diversity of opinion about how persistent the slowdown would be. Many people have marked down growth expectations for the remainder of the year, and there was a general sense that the uncertainty about growth prospects and downside risk have increased. However, some people saw the current slowdown as only a soft patch that would be reversed soon. Housing remains weak, and some participants noted the risk that problems in mortgage and credit markets and increased foreclosure rates might contribute to further weakness. However, others felt that the housing situation has not changed materially since the last meeting. The slowdown in capital investment drew more concern, in part because it has proved difficult to explain. An inventory correction continues, but automobile inventories have been brought into line. Some factors that will support growth include a booming global economy and stronger government spending at both the federal and the state and local levels. The labor market continues to be tight, with some noting increases in wages. Developments in the labor, housing, and credit markets will be important in determining the future course of consumption. Several participants pointed to potential financial risks, including possible knock-on effects of the subprime mortgage problems and the possibility of the drying up of currently abundant liquidity and financial markets. Corporate earnings are also likely to slow. If these risks materialize, they could add to downside pressures on output. However, some thought that financial conditions will remain supportive. Some, but not all, think that inflation will continue to moderate, albeit very slowly. There is general disappointment with recent inflation readings, and some were skeptical that any meaningful progress against inflation is being made. In particular, resource utilization pressures, particularly tight labor markets, pose a longer-term inflation threat. Import prices and slower productivity growth also add to inflation risk. The views of most participants were that upside inflation risks still outweigh downside risks to output, that uncertainty has increased, and that the tails of the distribution have become fatter. Are there comments? If not, let me just add a few thoughts. It’s very difficult to speak last—all the good ideas have already been presented. So I’ll say just a few things. I think the growth outlook is slightly worse. The housing market is, of course, central to near-term developments. The central scenario that housing will stabilize sometime during the middle of the year remains intact, but there have been a few negative innovations. We’ve noted the subprime issues and the possibility of foreclosures, reduced confidence, and tightened credit terms, and I’ve also noted that reports from builders about the spring selling season have not been particularly upbeat, in general. At the same time, we continue to see rough stability in sales, starts, and permits. The effects of the decline in subprime lending may have already been mostly seen, since that has slowed from last fall. Mortgage rates, of course, remain quite low, and the labor market is a key determinant of housing demand and of mortgage delinquencies, particularly cross- sectionally. Across the country, there’s a very close correlation between foreclosure rates and state unemployment rates. So long as the labor market remains strong, I would think that the general health of the housing market would be improving. The housing market, I think, will follow the same scenario, but there are a few negative innovations. There was a lot of discussion about capital investments, and I share the puzzlement about why that’s happening. Like Governor Mishkin, I am concerned that it might signal something about productivity. Another possibility in the current environment goes back to my Ph.D. thesis on the effects of uncertainty on investment, which found that greater uncertainty can make people delay their commitments. In our last meeting, we discussed the possible upside risk to consumption. I think that risk is much diminished now. Our retail sales have been quite flat, and the strong growth of consumption in the first quarter is almost entirely due to the December blip, which will carry through to the quarterly arithmetic. But consumption is very likely to slow. Gas prices are another reason that consumption is likely to slow. The labor market, again, remains strong. I agree with the Greenbook that there is some likelihood of softening going forward. In particular, I think Governor Kohn mentioned that the slowing productivity growth we’re seeing could be consistent with some labor hoarding in this late stage of the cycle. Again, I’ve marked down my growth expectations only a bit, but if we were handicapping recessions, I’m afraid that risk has probably gone up a bit. I would cite at least three reasons. First, there seems to be a pretty good chance that potential output growth is lower than in the past; and almost by definition, if growth is lower, then the chance of negative quarters is greater. Second, the Greenbook has a 60 basis point increase in unemployment occurring stably over the next two years. If that happens, it will be the first time it has ever happened. [Laughter] Generally speaking, increases in unemployment tend either not to occur or to be bigger than 60 basis points. Finally, we’ve discussed the financial market sensitivities, which are having an effect, so that changes in the outlook could have pretty substantial feedback effects onto the economy through the stock market, other financial markets, and credit markets. So I think, as President Fisher does, that the tail in that direction is unfortunately somewhat fatter. Likewise with inflation, the news was disappointing. We knew that there would be—and we have seen—month-to-month volatility. It is difficult, as President Pianalto noted, to make a firm conclusion based on the recent data about whether or not inflation is moderating. I would just note that rents and owners’ equivalent rent are still pretty important here. They have not yet slowed much, which may have to do with the nature of the uncertainties about the housing market. That possibility will be helpful going forward. At an earlier meeting I indicated that medical costs were a risk; and they have, indeed, proved to be a risk. Speaking about inflation makes me reflect on the difficulties of measuring aggregate supply in general. As we think about the economy going forward, we face two countervailing possibilities. One, which I and several others have already mentioned, is that potential output growth may well be lower than many outsiders and maybe even the Greenbook think. Obviously that will make it difficult to get economic slack and will make this situation much more challenging. At the same time, the lack of wage acceleration at least raises the possibility that the NAIRU might be somewhat lower than 5 percent, which would be helpful in the other direction. With respect to inflation, again, as I said, I’m disappointed by the recent numbers. I don’t get a sense from business people or from surveys and so on that the general public’s worry about inflation has increased very much, except insofar as they perceive that inflation is constraining the Fed from acting. So, again, I don’t think we’ve seen an adverse breakout by any means, but obviously we’re going to have to remain very vigilant and make sure that we maintain our credibility on the inflation front. As the last item, I would like Vincent to distribute table 1. We made a couple of changes in the description of the economy. He can make a few comments, and then everyone will have an opportunity to look at it overnight, and we can discuss the communication issues tomorrow." FinancialCrisisInquiry--755 ROSEN: So it’s a much smaller number. We have something called a mend and extend happening now where they are mending and extending loans. But the same bubble that happened in residential happened somewhat in commercial. Big value increase and now a 40 percent value decline. So there’s a—a lingering issue that’s going to be there. I—it - it doesn’t all hit at once. The good news is it’s stretched out over the next five years. So I think we’re OK. It’s not good. It—but I think the residential losses going forward for the next year and a half are going to be bigger still, than the commercial over five years. FOMC20070131meeting--174 172,MS. BIES.," Thank you, Mr. Chairman. Like several of you, I’m going to focus on housing and what we’re seeing in the banking sector and in mortgage performance. Since the last meeting, I am feeling better about the housing market in the aggregate. It looks as though home sales are stabilizing for the fourth quarter. On the whole, home sales actually did go up a bit. The inventory of new homes for sale has now fallen for five months through December, and mortgage applications for home purchases continue to move above the levels of last summer, when they hit bottom. The National Association of Realtors is estimating that existing home sales have already bottomed out, and homebuilder sentiment improved in three of the four past months. But even if sales really have stabilized, the inventory of homes for sale still must be worked down before construction and growth resume in this market. Given that some existing homes have likely been pulled off the market in light of slower sales and moderating housing prices, this inventory correction period will probably continue into 2008. I think this is particularly true in markets such as Florida, as First Vice President Barron mentioned, where a large amount of speculative investment occurred during the boom period—with three to five years of excess construction from the investor side. So those homes still have to be worked through. Asset quality in the consumer sector as a whole is very good. We have come through one of the most benign periods. The exception, as Bill mentioned in his presentation earlier today, is the subprime market. When you dissect it, you see that prime mortgage delinquencies are flat and subprime mortgages at a fixed rate are flat. The whole problem is in subprime ARMs, which are running into difficulties. The four federal regulatory agencies are looking harder at some of these subprime products. We started reviewing 2/28 mortgages, and now we’re looking at and testing some other products. We’re finding that the issues are getting more troublesome the further we dig into these products. To put the situation in perspective, subprime ARMs are a very small part of the whole mortgage market. As Vincent mentioned, subprime is about 13 percent, and the ARM piece of the subprime is about half to two-thirds, so we’re talking perhaps around 8 percent of the aggregate mortgages outstanding. We’re seeing that the borrowers who got into these during the teaser periods now are seeing tremendous payment shocks. For example, 2/28s that are going from the fixed two-year period to the adjustment period basically had their interest rates double, so they’re going from a 5 percent handle to a 10 percent handle, and the borrowers don’t have the discretionary income to absorb that. This type of mortgage was sold to a lot of subprime borrowers on the idea that they are lending vehicles to repair credit scores. You will show that you are going to pay during the early period, and then you can refinance and get a lower long-term rate, so you’ll never pay the jump. But we’re finding that some of these mortgages have significant prepayment penalties, and so to refinance and get the better terms, some borrowers are getting into difficulty. Because of the moderation in housing prices, these borrowers haven’t built up enough equity to absorb the prepayment penalty. So the problem stems from a combination of factors. There are a lot of spins on these products, but we’re trying to take an approach based on principles in looking at what’s really happening. I also want to mention that, although the ownership of the mortgages is very diffuse and so we’re not seeing any real concentrated risk, particularly in banking, we do need to pay more attention to where the mortgage-servicing exposures are. The servicing of these mortgages that are securitized is concentrated in certain institutions. Clearly, when you have such a high level of delinquencies and potential defaults, all profitability in servicing is gone. So there could be some charge-offs in these securitized mortgages. Also, I think all of you have noticed the number of mortgage brokers that have closed up shop in the past six months because they couldn’t get enough liquidity or capital to repurchase the early defaults of these recent pools. That is really shrinking the origination pocket. I should also say that, with the exception of the subprime ARM mortgages, we feel very good about overall credit quality. When I look at the economy as a whole, I also see that except for housing construction and autos, the rest of the economy is sound. The recent growth in employment and the strong wage growth give me comfort that the income growth of consumers is there to mitigate some of the wealth effects that we may have with moderating housing prices. But I also share the concerns that some of you mentioned here, and that President Yellen spoke of in a speech, about the issue regarding productivity trends and wage growth, and determining how fast the economy is growing. Productivity is going to have to grow faster to absorb the higher wage growth, particularly as employment growth continues strong, and I think the slack in the skilled labor force is getting very, very limited. When I think, in aggregate, about the data since our last meeting, I feel a little better about inflation because it appears to be moderating, but I’m not jumping for joy because we need a few more months. However, the growth information has been, instead of mixed as at the last meeting, generally stronger, and that does make me feel better. In net, then, based on the recent information, I’m even a bit further along on the side that the risks have moved higher for inflation than on the side of the risk of a slowdown in the economy. Thank you, Mr. Chairman." FinancialCrisisInquiry--128 I’d say innovation always outpaces regulation, but in this case, it was just much further ahead. And, you know, you certainly need more capital for newer activities or more risky activities or other activities without a long enough track record. And you saw that. And, as Mr. Solomon said, we’ve had a lot of once-in-a-lifetime events. And you—you know, whether it’s Enron and WorldCom or Russia and Asia and Mexico or, you know, the tech bubble and then the real estate bubble. It seems as though these once-in-a- lifetime events happen every couple of years. So the idea of more capital overall makes a lot of sense for these once-in-a-lifetime events for these new activities. And as far as additional disclosure, no question. It would have been very helpful during the crisis and would still be helpful now especially with regard to problem loans at U.S. banks. I would make one point, though. We can’t be too pro-cyclical. If you try to correct all at once, then you’re going to kill the economy. So you have to do this in a balanced way. VICE CHAIRMAN THOMAS: A question to all of you, and it’s just from my previous job on Ways and Means and the tax code. Would it make a big difference, not much difference, if we had in the time of all of these once-in-a-lifetime events, a better understanding between equity and debt and the way in which major American corporations and even international corporations can utilize debt versus equity? And had we recognized it in the tax code, that, to a certain extent, the old cash-on-the-barrel head is, perhaps, a good way to see what’s going on, notwithstanding the complexity of the world today? CHRG-110hhrg44901--67 Mr. Bernanke," Again, I think I would not put much weight on this technical terminology. I mean, I think it is clear that growth has been slow, and that the labor market is weak. And so conditions are tough on families. I have no doubt whether it is technically a recession or not, and I don't see how that makes a great deal of difference. As far as the projection is concerned, we see continued growth, positive growth but weak for the rest of the year. Looking at the housing market, it is beginning to stabilize, at some point around the end of the year, early next year. And with the hope that we can continue to strengthen the financial system, we would hope to see recovery back to more normal levels of growth in 2009. But like all economic forecasting, there are uncertainties in both directions. But with respect to the current situation, again, whether it is a recession or not doesn't really play in our policy decisions. " CHRG-110hhrg45625--119 Mr. Bernanke," Let me say that if the financial situation stays where it is, or doesn't improve, that we are going to see higher unemployment, fewer jobs, slower growth, more foreclosures, fewer people able to buy houses and cars, and a much slower economy. If you look at other countries, Japan had a decade of slow growth. We see other countries with very severe downturns. This is going to have real effects on people at the lunch bucket level because it is going to affect the way the economy and jobs can grow in this country. " fcic_final_report_full--243 COMMISSION CONCLUSIONS ON CHAPTER 11 The Commission concludes that the collapse of the housing bubble began the chain of events that led to the financial crisis. High leverage, inadequate capital, and short-term funding made many finan- cial institutions extraordinarily vulnerable to the downturn in the market in . The investment banks had leverage ratios, by one measure, of up to  to . This means that for every  of assets, they held only  of capital. Fannie Mae and Freddie Mac (the GSEs) had even greater leverage—with a combined  to  ratio. Leverage or capital inadequacy at many institutions was even greater than re- ported when one takes into account “window dressing,” off-balance-sheet expo- sures such as those of Citigroup, and derivatives positions such as those of AIG. The GSEs contributed to, but were not a primary cause of, the financial crisis. Their  trillion mortgage exposure and market position were significant, and they were without question dramatic failures. They participated in the expansion of risky mortgage lending and declining mortgage standards, adding significant demand for less-than-prime loans. However, they followed, rather than led, the Wall Street firms. The delinquency rates on the loans that they purchased or guar- anteed were significantly lower than those purchased and securitized by other fi- nancial institutions. The Community Reinvestment Act (CRA)—which requires regulated banks and thrifts to lend, invest, and provide services consistent with safety and sound- ness to the areas where they take deposits—was not a significant factor in sub- prime lending. However, community lending commitments not required by the CRA were clearly used by lending institutions for public relations purposes. FOMC20070509meeting--61 59,MR. LACKER.," Commercial real estate activity generally remains solid, although some observers expressed concern about the sustainability of the quite strong pace of office construction in Northern Virginia. Our survey measures of manufacturing-price trends seem to have moderated since the beginning of the year, consistent with sluggish demand in that sector. On the services side, price trends seem to have declined somewhat since the first half of last year, although measures of services prices have been choppy and trendless over the past few months as a whole. Turning to the national economy, housing news has been disappointing, but news about business investment and manufacturing has been encouraging. However, the overall outlook hasn’t changed terribly much since our last meeting. Housing begins to stabilize in the second half of this year, business investment in equipment and software picks up, and consumer spending remains relatively healthy. As a result, I expect real growth to return to trend in ’08. Although my outlook broadly agrees with that of the Greenbook, there are some minor differences—but I should emphasize that they are minor. First, I remain a tad more optimistic about trend growth. I’m expecting something closer to 2¾ than to 2½. Second, I still think that residential investment will bottom out in the middle of the year rather than continue to slide into ’08. Of course, it is quite difficult to have a lot of confidence in any one scenario for the housing market, in part because the recent data have been fairly choppy. The figures for homes sales, which late last year suggested that housing demand had stabilized, now suggest that demand may be taking another step downward. If so, this would increase the size of the cumulative reduction in starts relative to new-home sales that will be needed to work off the inventory overhang. It’s very hard to know, however, just how far housing activity needs to fall before it comes back into stable alignment with income and preferences. But my hunch is that the drag on growth will not last quite as long as the Greenbook says, and I still see reasonably good prospects for stability in the housing sector in the second half of this year. I also think that the housing correction will have only limited effects on spending outside residential investment. In particular, I’m a bit more optimistic than the Greenbook about household spending. As for inflation, the Greenbook now has us waiting until the third quarter of ’08 before we see a moderation in core inflation. Even then, we get only 0.1 percent. I would view this outcome as fairly disappointing. But if I had been asked for an unconditional forecast, I probably would have submitted something a lot like that. Instead, we were asked for a projection conditional on what, in our judgment, would be an appropriate monetary policy. So the projection I submitted has core PCE inflation at 1.8 percent next year and 1.6 percent in 2009. Under what, in my judgment, would be an appropriate monetary policy, we use the Chairman’s July testimony to announce that the FOMC’s objective is for PCE inflation to average 1½ percent and that the Committee intends to reduce inflation to that level within two years. While such an announcement would not necessarily shift inflation expectations immediately downward, I project that consistent communications from Committee members accompanied by further rate increases when downside growth risks abate later this year would bring expectations into line with our objective by early next year. Although growth would be weaker this year than in my unconditional forecast, it would ultimately return to trend in 2008, and the properly measured sacrifice ratio would turn out to be significantly smaller than is often assumed or inferred from standard Phillips curve estimates. I mention this scenario simply to reiterate that I believe that there’s a feasible alternative to the hypothesis that inflation will settle in around 2 percent or higher unless we engineer a substantial output gap." fcic_final_report_full--188 As late as July , Citigroup and others were still increasing their leveraged loan business.  Citigroup CEO Charles Prince then said of the business, “When the mu- sic stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” Prince later explained to the FCIC, “At that point in time, because interest rates had been so low for so long, the private equity firms were driving very hard bargains with the banks. And at that point in time the banks individually had no credibility to stop participating in this lending business. It was not credible for one institution to unilaterally back away from this leveraged lending business. It was in that context that I suggested that all of us, we were all regulated entities, that the regulators had an interest in tightening up lending standards in the leveraged lending area.”  The CLO market would seize up in the summer of  during the financial cri- sis, just as the much-larger mortgage-related CDO market seized. At the time this would be roughly  billion in outstanding commitments for new loans; as de- mand in the secondary market dried up, these loans ended up on the banks’ balance sheets.  Commercial real estate—multifamily apartment buildings, office buildings, ho- tels, retail establishments, and industrial properties—went through a bubble similar to that in the housing market. Investment banks created commercial mortgage– backed securities and even CDOs out of commercial real estate loans, just as they did with residential mortgages. And, just as houses appreciated from  on, so too did commercial real estate values. Office prices rose by nearly  between  and  in the central business districts of the  markets for which data are available. The increase was  in Phoenix,  in Tampa,  in Manhattan, and  in Los Angeles.  Issuance of commercial mortgage–backed securities rose from  billion in  to  billion in , reaching  billion in . When securitization markets contracted, issuance fell to  billion in  and  billion in . When about one-fourth of commercial real estate mortgages were securitized in , securitizers issued  billion of commercial mortgage CDOs, a number that again dropped pre- cipitously in .  FOMC20060920meeting--144 142,MS. BIES.," Thank you, Mr. Chairman. I want to start my remarks today by reflecting on some results of the latest Duke University CFO survey. This survey is only about six or seven years old, but the one that was just concluded on September 10 has CFOs’ optimism at the lowest levels in five years, and so it’s continuing to show an erosion of their confidence. I found the CFOs’ number 1 worry—weak consumer demand—interesting because it wasn’t there before, and that uncertainty is part of what the CFOs are worrying about. Their second biggest concern is rising labor costs, which they attribute primarily to the scarcity of labor. They are anticipating that the scarcity is going to continue to drive labor costs higher. In terms of their hiring plans, they are planning now to hire fewer people than they hired last quarter. They are expecting to increase employment over the next twelve months 0.8 percent; last quarter’s survey showed 1.3 percent, so that’s quite a slowdown. However, they’re going to increase outsourced employment 4.3 percent. Thus what is showing up is the uncertainty—wanting to use an adjustable labor force to get the flexibility because of the uncertainty. They are also trimming their capital spending plans over the next twelve months to 5.1 percent, compared with 7.5 percent last quarter. Thus the survey indicates that CFOs have growing concern; they are still optimistic overall, but I think that caution is there. Now, in looking at the numbers myself, I’m perhaps not quite as pessimistic. Again, as several of you have said—and Dave commented in his remarks—except for housing, the economy really does look good. As you know, I’ve been worried about the mortgage market and housing for quite a while. In an endeavor to find something good to say, I have noticed that, in the past couple of months, the Mortgage Bankers Association index of new loan applications for purchase mortgages looks as though it’s starting to level off. Very often that could be a leading indicator, so that could be a positive sign. However, as some of you have remarked, there’s a lot of speculation in the housing markets that has to unwind. All the folks who bought housing for investment have to do something as they see housing prices slowing and the financing costs to carry their investments going up. How that unwinding will occur, given the substantial size of the speculative positions in some markets, is something that will need very close monitoring. I know that our supervisory staff is focusing on that, too. People are focusing on the fact that delinquency rates in mortgages still look good. However, we’ve seen a very rapid increase in debt service ratios since 2004. I’m concerned, again, with the amount of adjustable-rate mortgages out there that will reprice in the months ahead. If, as we think, some of these loans, particularly subprime loans, were made mainly on the collateral value of the house and not on the affordability of the mortgage, we could see more distress in the borrowers’ markets coming forward. If that’s the case, it could have spillover effects on consumer spending more broadly. On the positive side, payroll growth has been good in the past three months—128,000. It has picked up a bit, and it is significantly above the Greenbook forecast, and that gives me some optimism. It’s putting more income in people’s pockets to spend, and the unemployment rate has been stable. Hourly earnings, however, are rising faster. While that acceleration can support consumer spending, it contributes to my concern about where we’re going in the long run on inflation. As I look at the Greenbook forecasts since May, we’ve been continuing to project more and more inflation going forward. The private sector has basically been doing that in their forecasts as well. When I look at those forecasts, I’m concerned that for various reasons we have reduced our estimates of the trend rate of growth. As we bring down the trend rate of growth— and I realize that, as several have said, we’re at the lower end of the private-sector growth forecasts—I worry about the disconnect. Are we seeing a slowdown in potential that others aren’t? Or if we’re right that potential growth is lower and the private forecasters are right that real growth is going to be faster, then we could have more inflation pressures going forward. For the first time, we are also looking at prices in 2008, and they continue to rise at over 2 percent. They’ve been over 2 percent for two years. I worry, from the standpoint of our credibility, about what having such a long period above 2 percent means. So I believe we will see moderation of inflation, but I think it’s important to preserve our flexibility and be able to respond if these worst-case scenarios that I laid out become more troubling to us going forward." FOMC20060328meeting--142 140,MS. BIES.," Thank you, Mr. Chairman. Overall, I agree with many of you around the table and with the Greenbook. I see that you have solid growth going forward. I want first to talk about the corporate sector and then to talk a bit about the household sector. I have talked with several corporate CFOs in the past couple of weeks, and I also just received a copy of the Duke quarterly CFO survey. I found the comments from the CFOs and the survey results to be similar, and so I thought I would just use the Duke survey to make my comments here. The CFOs are expecting to be able to raise prices more over this coming year than they did last year. On average, they are expecting an increase in prices of about 3.3 percent. A year ago at this time, the quarterly survey showed a 2 percent increase. So the increase is slight. And they are also expecting to raise wages and salaries faster, 4.2 percent this coming year. Their biggest concerns continue to be global competition and health care costs—that has not changed at all. What I find really amazing is how much these CFOs continue to be focused on cash levels. Right now, as you know, the liquid assets on the balance sheets of corporations are at the highest level in at least forty-five years. Corporate profit margins relative to GDP are running at 11 percent, and that is again a record level. If you look at the survey results, the CFOs are saying that they plan to increase cash even more in 2006. How are they going to do that? One of the things this group is forecasting this year is for earnings to grow 13.1 percent. Last March the survey said 11.4. So the projection for earnings growth is up about 2 points. They are not expecting top line revenue growth of 13 percent—they are expecting to be able to widen their operating margins. So the trends we have been seeing are what everybody is just building on. This inertia and this new focus on cost management seem to be central to what is going on in corporate America. Partly, too, they are worried about top-line revenue growth, and I am hearing more of them talking about using mergers to widen their operating margins: Grow market share through acquisition, get immediate revenue pops, pull out the extra costs, and get the bottom line growth at 13 percent that way. They also are planning to spend more on capital expenditures this year, up 6.5 percent versus 4.7 percent, and also much more employment growth, 2 percent versus 0.6. So they are optimistic; but again, the focus on widening operating margins from already historically wide levels and on building liquid assets shows that a real focus on the fundamentals in corporate America is continuing. If you look at the survey of small businesses, you can read the same kinds of trends in the responses. The optimism of small business remains at a very high level. So, in summary, I think corporate America is going to continue to push earnings growth and production but is clearly focused on cost containment. And while they may be looking at raising prices a bit, I think overall prices will be contained. Now, a look at the household sector. What I have been noticing in the past few months is that job growth, as many of you have mentioned, has clearly gotten a lot stronger and also that wages are growing much faster—in the last three months, they have gone up at an annual rate of 4.8 percent, which is pretty strong. I think we have to go back about four or five years to get that kind of increase. So the real question, as many of you have said, is what is really happening to productivity. The last time we had this kind of wage growth was in the late ’90s, and we saw the pop in productivity. So unit labor costs were there and helped modify inflation. I heard from the CFOs that this is exactly what they are trying to do—to find ways to improve productivity just so they can handle the higher wage cost because they are finding that skills are short in some areas. But the highly skilled people are probably also more productive, on average, than other folks who may be looking for jobs, and hiring the more-productive workers could also help in that way. I think that the good job growth and the faster wage increases will also help put a floor on housing sales. You know I have been concerned about where we are in terms of the mortgage markets going forward in support of housing. We know that the fixed obligation ratio that our staff constructs has been at record levels; last quarter it showed a tick down in the fourth quarter, but it still is relatively high. Mortgage rates on the long end have not really moved very much in the last couple of years. But to the extent that so many new mortgages were financed with adjustable-rate mortgages in the last year and the ARM rate spread now has really moved up as we have moved short rates up, there is less than a point difference now between one-year ARMs and the term rates. So affordability, I think, is going to continue to come under more pressure going forward. Housing inventories are increasing. Again, I talked to a CFO at a large builder. They clearly are managing inventory much better than they did years ago, but even so, backouts on sales and such things are increasing. The number of housing starts that they have in train and starts going forward are going to be slowing down, and they are giving guidance to the Street that they’re not going to get the sales that they had. But even if it slows down, housing is still going to be very strong in relation to historical standards, but it will be off the peak that we have been seeing. Finally, to follow up on the comments that some of you made, I see that we still have a tremendous amount of liquidity in the financial markets. Again, corporations are sitting on all this liquidity. We do not hear anything from corporations about difficulty in financing big or small business. We know the bankers clearly are looking for loan growth and trying to find it, and the housing market is able to attract all the liquidity it needs. So in terms of how effective our rate increases have been, I see that the lag effect is still there and that plenty of liquidity is still out there, which keeps me focused on where core inflation will be." CHRG-111hhrg51698--116 Mr. Gooch," The entire world was over-leveraged and went through a credit bubble that may have significant causes other than the various instruments that we used to transact the risk. Yes, I completely support the concept of centralized clearing, but I agree with Mr. Duffy, not all products could be put into centralized clearing. Regulation, transparency and limits, limits on positions relative to capital and things like that, those things all make sense. Certainly, AIG should not have been selling credit default swaps and pocketing the premiums and treating it as if it was income. They should have been far more conservative. But there is always, throughout history, the case of either individuals or corporations or governments that overspeculate, and they should be held to some kind of limits. " CHRG-110shrg50415--25 Chairman Dodd," Thank you very, very much, Mayor. And let me just on that point, before turning to Mr. Stein, I am somewhat reluctant to quote the Wall Street Journal on this point, but the Wall Street Journal noted that between 60 and 65 percent of subprime borrowers actually would have qualified for conventional mortgages; 60 to 65 percent of those borrowers would have qualified for less costly mortgages. As you may recall, for those who were here, we had the first hearings and had the representatives from the Brokers Association. We put up the Web page, and the first instruction to brokers from their association was, ``Convince the borrower that you are their financial adviser.'' The most deceptive of practices. They were anything but the financial adviser to the borrower. And as a result, literally thousands and thousands of people ended up with mortgages vastly more expensive than ones they qualified for. That is criminal, in my view. And to make your point, let me just quote on the last point--or the first point you made in your testimony, just to make your point, this is a commentator that wrote an article called ``They Gave Your Mortgage to a Less Qualified Minority.'' And let me quote, if there is any doubt about what you just said. Listen to this quote: ``Instead of looking at outdated criteria, such as the mortgage applicant's credit history and ability to make a downpayment, banks were encouraged to consider non-traditional measures of creditworthiness, such as having a good jump shot or having a missing child named Caylee.'' The article goes on to say that, and I quote, ``Ultimately, the housing bubble burst and, as predicted, food stamp-backed mortgages collapsed.'' The article goes on and refers to this kind of mortgage crisis ``as an affirmative action time bomb that has gone off.'' If there is any doubt about what Mayor Morial just said, that is the kind of articles that are appearing all across the country, and the data is, of course, entirely the opposite. The facts are entirely the opposite. And so I appreciate immensely you testifying this morning about this theory that is being promulgated. I remember Paul Sarbanes, who chaired this Committee--he is a great friend of mine, a great Chairman of this Committee. Chuck Schumer and I--he was a House member in those days, in 1999, we sat up all night on that 1999 law to fight those on this Committee and elsewhere who did everything in their power to get rid of the Community Reinvestment Act, and we prevailed. I think, Bob, you may have been in the House that year, maybe on the Banking Committee. But I will never forget staying up until 5 and 6 o'clock in the morning to fight to keep the CRA. And so I appreciate very much your testimony. " fcic_final_report_full--227 The summer of  also saw a near halt in many securitization markets, includ- ing the market for non-agency mortgage securitizations. For example, a total of  billion in subprime securitizations were issued in the second quarter of  (already down from prior quarters). That figure dropped precipitously to  billion in the third quarter and to only  billion in the fourth quarter of . Alt-A issuance topped  billion in the second quarter, but fell to  billion in the fourth quarter of . Once-booming markets were now gone—only  billion in subprime or Alt- A mortgage-backed securities were issued in the first half of , and almost none after that.  CDOs followed suit. From a high of more than  billion in the first quarter of , worldwide issuance of CDOs with mortgage-backed securities as collateral plummeted to  billion in the third quarter of  and only  billion in the fourth quarter. And as the CDO market ground to a halt, investors no longer trusted other structured products.  Over  billion of collateralized loan obligations (CLOs), or securitized leveraged loans, were issued in ; only  billion were is- sued in . The issuance of commercial real estate mortgage–backed securities plummeted from  billion in  to  billion in .  Those securitization markets that held up during the turmoil in  eventually suffered in  as the crisis deepened. Securitization of auto loans, credit cards, small business loans, and equipment leases all nearly ceased in the third and fourth quarters of . DELINQUENCIES: “THE TURN OF THE HOUSING MARKET ” Home prices rose  nationally in , their third year of double-digit growth. But by the spring of , as the sales pace slowed, the number of months it would take to sell off all the homes on the market rose to its highest level in  years. Nationwide, home prices peaked in April . Members of the Federal Reserve’s Federal Open Market Committee (FOMC) dis- cussed housing prices in the spring of . Chairman Ben Bernanke and other members predicted a decline in home prices but were uncertain whether the decline would be slow or fast. Bernanke believed some correction in the housing market would be healthy and that the goal of the FOMC should be to ensure the correction did not overly affect the growth of the rest of the economy.  In October , with the housing market downturn under way, Moody’s Econ- omy.com, a business unit separate from Moody’s Investors Service, issued a report authored by Chief Economist Mark Zandi titled “Housing at the Tipping Point: The Outlook for the U.S. Residential Real Estate Market.” He came to the following conclusion: Nearly  of the nation’s metro areas will experience a crash in house prices; a double-digit peak-to-trough decline in house prices. . . . These sharp declines in house prices are expected along the Southwest coast of Florida, in the metro areas of Arizona and Nevada, in a number of Cali- fornia areas, throughout the broad Washington, D.C. area, and in and around Detroit. Many more metro areas are expected to experience only house-price corrections in which peak-to-trough price declines remain in the single digits. . . . It is important to note that price declines in vari- ous markets are expected to extend into  and even . CHRG-110hhrg46596--365 Mr. Feeney," I bet it is many multiples of the $20 billion. So, again, this is not GAO's fault. I think Congress and the Administration have led Americans in a direction that may be very difficult long term to recover from. There are things that we can do like managing a monetary supply not to create bubbles. There are things that we simply cannot do. Micromanaging the decisions of 300 million Americans and businesses and institutions is not something that Washington will ever do successfully, in my view. God bless you on your mission. I don't think it will work. I hope it does. It never has in history. With that, I yield back. " CHRG-109hhrg31539--217 Mr. Baca," Okay. Well, the spending of gas prices growing faster than spending for other basic items such as healthcare, housing and college, what impact will this have on long-term economic growth? And do you believe that there should be a greater sense of urgency for Congress and this Administration to do something to stop the rising gas prices? " FOMC20061212meeting--61 59,MS. YELLEN.," Thank you, Mr. Chairman. I have to admit that this time around I found it pretty challenging to read the tea leaves on economic activity. The data are providing distinctly contradictory signals. For example, several key indicators of aggregate spending have come in below expectations, and the Greenbook now sees real GDP growth this quarter and the next averaging a mere 1½ percent. At the same time, the labor market continues to be strong and shows no clear signs of weakening, as evidenced by the November employment report. The latest information on inflation has been fairly favorable; but even with some signs of easing, the underlying trend in core consumer price inflation remains above my comfort zone. The last time we met I described the situation as a bimodal economy with strength in most sectors and weakness limited to just two sectors, housing and domestic auto production. This description by and large remains apt. The correction in the housing sector has continued, even sharpening somewhat compared with our expectations. Still, there are some encouraging signs that the demand for housing may be stabilizing, probably assisted by recent declines in mortgage rates. After a precipitous fall, home sales appear to have leveled off. In addition, equity valuations for homebuilders have continued to rise in the past couple of months, suggesting that the outlook for these businesses may be improving. Finally, the gap between housing prices and fundamentals may not be as large as some calculations suggest because real long-term interest rates have fallen quite a bit recently, raising the fundamental value of housing. That said, the housing sector on balance is a source of downside risk, and the risk could be magnified if mortgage rates were to rise again as foreseen by the Greenbook. Outside residential investment, GDP growth has remained solid. Consumption has continued to be strong; indeed, I think there are upside risks to consumer spending, given the Greenbook’s forecast of a significant rise in the saving rate. But recent indicators of nonresidential investment and activity in the manufacturing sector have come in below expectations. The key question is whether these data hint at a crack in the economy’s armor that could widen. It’s obviously too early to tell, but these weaknesses bear careful monitoring. Overall, the data on spending paint a clear picture of an economy growing well below trend, but it seems as though the BEA hasn’t delivered this message to the BLS. [Laughter] The very latest data show payroll employment growing steadily. The household data are even more alarming. The unemployment rate has declined ½ percentage point over the past year and now stands at 4½ percent, ½ percentage point below our estimate of the NAIRU. My business contacts tell me the same thing. Labor markets are tight, and jobs are hard to fill, especially for skilled positions. But some other indicators suggest that labor markets may have softened a bit. In particular, the Conference Board index of job market perceptions, based on a survey of households, declined in both October and November. This index is historically very highly correlated with the unemployment rate, but now it’s sending a different signal, suggesting that labor markets are roughly in balance. Similarly, in November fewer firms reported openings that are hard to fill. The fall in the unemployment rate this year is hard to square with Okun’s law. Over the past four quarters, GDP growth has averaged 3 percent, just 0.3 above the Board’s estimate of potential GDP growth. A standard Okun’s law calculation suggests that this should have led to a decline in the unemployment rate of only about 0.1 percentage point. In fact, however, it declined 0.5 percentage point. Of course, labor markets do adjust with a lag, so we may just need to be patient and wait for Okun’s law to reassert itself as assumed in the Greenbook forecast. An alternative possibility is that the output gap is more positive than assumed in the Greenbook because of lower growth in potential output or more-rapid growth in actual output. In his presentation, David noted the possibility that the growth rate of potential output may be lower than even the downwardly revised estimate in the Greenbook. It is also possible—and, in fact, there are indications—that actual output growth may have been faster than the pace reflected in measured GDP. Growth in domestic income has outpaced GDP growth by ¾ percentage point over the past year. Now I know that when someone mentions the statistical discrepancy, eyes start to glaze over. But I raise this issue because it could have important implications for the outlook. If the gross domestic income measure ends up being more accurate, then the decline in the unemployment rate this year would not be surprising. Going forward, more-rapid output growth would imply a lower path for unemployment, potentially adding to inflation pressures. Turning to inflation itself, the news has been pretty good on balance since our last meeting. We expect core PCE price inflation to edge down from just under 2½ percent this year to about 2 percent in 2008. We came to this forecast balancing two main pieces of news. On the one hand, recent labor market data point to a lower path for the unemployment rate than before, and all else being equal, this boosts our inflation forecast a bit. Offsetting this effect, on the other hand, is the huge downward revision in compensation per hour. When these data came out, I let out a big sigh of relief. The revised data are more consistent with the indications we were getting from the employment cost index and suggest that wage growth has remained contained. In contrast, my contacts report intensifying wage pressures, resulting in part from more-frequent employee quits and outside offers. Even so, my contacts do not report that these developments are exerting significant pressure on their profit margins or prices, suggesting continued strong productivity growth. But that, in turn, conflicts with the data on productivity growth in the nonfarm business sector, which have been weak, not strong. Output per hour in the nonfarm business sector increased only about 1½ percent over the past year, well below its trend. But there is reason to believe that this decline may overstate the slowing in productivity growth, given continued strong growth in productivity in the nonfinancial corporate sector. At least part of this discrepancy between nonfinancial corporate and nonfarm productivity growth reflects the gap I mentioned before between gross domestic income and gross domestic product. If the GDI numbers are, in fact, more accurate, that alone could add nearly 1 percentage point to nonfarm business productivity growth, perhaps reconciling the reports by my contacts of intensifying wage pressure along with an absence of pressure on prices and margins. In summary, I continue to view a soft landing with moderating inflation as my best-guess forecast, conditional on maintaining the current stance of policy. But there are sizable risks on both sides to the outlook for growth, and the downside risks are now more palpable. There is, likewise, a great deal of uncertainty about inflation going forward; in this case, the risks remain biased to the high side." FOMC20051101meeting--88 86,MR. MOSKOW.," David, I had a question for you about the forecast that activity is going to slow in the second half of ’06 and ’07. You talked about the reasons for the slowdown, which were tighter monetary policy, a slowing in house price appreciation, and diminishing fiscal stimulus. In the Monday morning briefing, you threw in the stock market as well—waning impetus from household wealth in terms of both the stock market and the housing components. I thought the Greenbook had an assumption of 6 percent growth in the stock market per year. I wonder if you could talk about that." FOMC20060328meeting--138 136,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. Like all of you, we think the underlying trajectory of demand and inflation seems quite favorable, perhaps a bit more so than it did in January. We expect real GDP to grow at a rate slightly above the rate of increasing potential in ’06 and to slow to the range of potential in ’07. We expect the core PCE to rise at a rate in the neighborhood of 2 percent over the forecast period. Differences between our forecast and the Greenbook’s are minor. In our forecast, we assume that inflation expectations remain anchored and the term premium remains low and that we are now at a point where little or no resource slack is left in the domestic economy. The monetary policy assumption we adopt is the path currently priced into the futures markets. The major sources of uncertainty in our forecast are the size of the wealth effect we might see accompanying any slowdown of housing, the flexibility of profit margins, and the sustainability of this present configuration of low risk premiums. We view the risk to the growth forecast as roughly balanced, although the usual suspects provide a source of concern. The risk to our inflation forecast, in contrast, still seems slightly tilted to the upside. On the growth front, as I said, we think the underlying pace of demand growth is pretty strong, and we don’t see any signs yet that would point to evidence of a significant slowdown relative to potential in prospect. We think productivity growth is likely to remain quite high, rising perhaps a bit faster this year than in ’05. With the labor market growing on trend and some increase in labor’s share of national income, we expect consumption growth to remain reasonably strong. Stronger income growth offsets the expected deceleration in housing-price appreciation and the effect that might have on consumption. We expect a slight increase in the contribution of business fixed investment to demand growth, due principally to a rise in spending on equipment and software. We expect, of course, the contribution of residential investment to slow with the forecast period. World GDP growth seems stronger and more broadly based. We expect net exports to be a persistent drag, shaving about ½ percentage point off growth for each of the next two years. Despite this forecast of pretty strong spending growth and high levels of resource utilization, we believe core inflation is likely to remain moderate. Under the assumption of a relatively stable dollar and with the energy-price assumption taken from the futures curve, we expect headline inflation to slow to a rate closer to the core over the forecast period. But this forecast rests on three important foundations. The first is that we succeed in keeping inflation expectations reasonably well anchored. The second is that demand growth not only does not accelerate to a rate substantially above trend but also slows to potential over the forecast period. And the third is that the expected rise in compensation and unit labor costs results in a rise in labor share of income—in other words, that compensation growth accelerates but the increase is absorbed by some compression of profit margins and does not lead to a significant acceleration in core inflation. Now, the sources of potential upside risk to the inflation forecast are several. One, of course, comes from the interaction between our views about productivity growth, compensation, and profit margins. If the pace of productivity growth slows significantly relative to our assumption and if, at the same time, conditions in labor markets continue to improve, unit labor costs are then likely to accelerate. A rise in compensation, however, would not by itself portend a troubling increase in core inflation. The extent of this risk, as I said, depends on the degree to which rising unit labor costs are absorbed in shrinking profit margins rather than triggering output price increases as firms attempt to defend existing margins. And because the labor share of income seems somewhat low and, as historical averages suggest, there’s room for unit labor cost growth to be absorbed in profit margins rather than causing price increases, we need to be attentive to the risk that this process may produce a short-term increase in core inflation, perhaps also in inflation expectations. A second potential risk comes from what we think we know about the pace of demand relative to potential supply globally. A continued increase in commodity prices around the globe and, more recently, some modest increase in capital goods prices may suggest that global pressures on resource constraints are pushing up prices. This raises the risk that the recent weakness in core goods prices in the United States may not be sustained. Service price inflation in the United States has shown signs of slowing. Our central forecast, as I said, is conditioned on little movement in the dollar over the forecast period, but any sizable depreciation of the dollar would still carry the risk of some acceleration in core goods prices. For nearly two years, overall inflation, as what is measured by the PCE or the CPI would suggest, has been running substantially above core, and this is true for a range of alternative measures of underlying inflation. If the underlying inflation rate were closer to 1.5 percent than to 2 percent, we might view these potential sources of upward pressure with more equanimity. Although the probability seems low that these forces will act to produce a significant acceleration of core inflation or a significant deterioration in inflation expectations, we need to be careful about those risks. So with underlying inflation at the upper end of the inferred inflation preference of the Committee, we need to be more attentive to these risks. On the growth side, the most obvious sources of downside risk to growth are a substantial rise in energy prices from current levels, a slowdown in productivity growth, a sharp rise in risk premiums, and a more-adverse effect on saving and consumption from the expected adjustment in housing markets and prices. Like the staff forecast, we think it’s reasonable to expect household saving to rise a bit and consumption growth to slow, in part because of changing expectations about the pace of future appreciation in the value of home equity. But we believe that, absent some large, negative shock to perceptions about employment and earned income, the effects of the expected cooling in housing prices are going to be modest. Of course, this view may prove optimistic. We take some reassurance from the fact that the average growth forecast in the private sector probably anticipates a significant cooling in housing and a significant effect of that cooling on saving and consumption. Developments in asset prices and risk premiums over the past several months seem to support this picture of stronger confidence in the growth and inflation outlook because real rates seem to have risen. Equity prices and credit spreads suggest considerable confidence in the prospect for growth. Implied volatilities remain quite low. We don’t know how much of this is fundamental and how much will prove ephemeral. At the moment, though, overall financial conditions seem pretty supportive of the expansion. So with this forecast of growth in the vicinity of potential, core inflation at around 2 percent, and the risk somewhat to the upside for inflation, we think the principal responsibility of monetary policy remains to preserve the sense that we will act to keep long-term inflation expectations contained at levels consistent with price stability." CHRG-111hhrg48867--231 Mr. Silvers," I really appreciate that this is my friend Peter Wallison's religion, but I think that the facts are that when we had well-regulated financial markets they channelled capital to productive activity, they were a reasonable portion of our economy and they were not overleveraged and we did not suffer from financial bubbles. And that describes the period from the New Deal until roughly 1980. And then we started deregulating, and the result was financial markets that grew to unsustainable size, excessive leverage in our economy, an inability to invest capital in long-term productive purposes, an inability to solve fundamental economic problems, and escalating financial bubbles. That is the history of our country. When we had thoughtful, proportionate financial regulation, it was good for our economy. Now we are in a position, pursuant to your question, where we have global financial markets and where a global financial regulatory floor is an absolute necessity if we are going to have a stable global economy. If we choose to be the drag on that process, it is not only going to impair our ability to have a well-functioning global financial system, it will damage the United States's reputation in the world. This question is immediately before us. And I would submit to you that while systemic risk regulation is important here, underneath that are a series of substantive policy choices which will define whether or not we are serious about real reregulation of the shadow markets or not. And if we choose to be once again the defender of unregulated, irresponsible financial practices and institutions, that the world will not look kindly upon us for doing so, as they did not look kindly upon us for essentially bringing these practices to the fore in the first place. " FOMC20070509meeting--49 47,MS. YELLEN.," Thank you, Mr. Chairman. My assessment of the economic outlook and the risks to it is largely unchanged since our last meeting. The data since that meeting have been mixed. On the one hand, the very sluggish real GDP growth in the first quarter gives me pause concerning potential downside risks. Much of the first-quarter weakness, of course, was due to housing, and I really don’t see that sector starting to turn around at this point. My homebuilder and banking contacts report stricter underwriting standards for all mortgages, not just subprime ones, so residential investment could remain a significant drag on the economy over the near term as the Greenbook now envisions. Indeed, whereas the Greenbook assumes that national house prices are flat going forward, I am worried that they may actually fall. On the other hand, the improved picture of auto inventories along with some positive glimmers on manufacturing and business investment suggests that those sectors may prove to be less of a drag on the economy going forward. With respect to inflation, the recent news has also been somewhat mixed with lower-than- expected readings on core consumer prices and labor compensation offset by higher prices for energy, other commodities, and imports. Taking a longer view, I anticipate real GDP growth over the next two and a half years of about 2.6 percent, just a bit below my assessment of potential. My forecasts of both actual and potential growth are a tenth or two stronger than the Greenbook forecasts; but the basic story is very similar, and the underlying assumptions, including the path for the nominal funds rate, are essentially the same. I view the stance of monetary policy as remaining somewhat restrictive throughout the entire forecast period. The key factors shaping the longer-term outlook include continued fallout from the housing sector, with housing wealth projected to be roughly flat through 2008. Given the reduced impetus from housing wealth, household spending should advance at a more moderate pace going forward than over the past few years. This slowdown in consumption is reinforced by more-moderate gains in personal income, as the unemployment rate gradually rises, reaching 5 percent in 2009. Although I anticipate that the labor market will remain fairly tight over the next year, I do not expect faster compensation growth to exert significant upward pressure on prices. I expect it instead to restrain profits, given that labor’s share of income is now at an exceptionally low level. I also anticipate that various temporary factors that have been boosting inflation, such as the run-up in owners’ equivalent rent and the pass-through of energy prices, should dissipate, while inflation expectations remain well anchored. Overall, I’m more optimistic regarding inflation than the Greenbook and anticipate that core PCE price inflation will edge down below 2 percent after next year. One of the more interesting questions about the outlook, as David noted in the questions to him, is how to reconcile the strong labor market performance with the weak growth in output or, equivalently, how much of the recent slowdown in productivity growth is likely to persist. And that is something that we have been thinking about, too. Over the four quarters of 2006, nonfarm business productivity rose 1.6 percent, about half as fast as the average pace set from 2000 through 2005. Whether these recent lower numbers reflect a transitory drop in growth or a downshift in the trend rate is an important issue. A lot of excellent research has been done on this topic by staff at the Board and elsewhere in the System. My reading of the evidence at this point is that the recent decline in productivity growth does largely reflect cyclical factors. I think productivity growth has fallen significantly below trend because of labor hoarding and lags in the adjustment of employment to output. We have also been giving close scrutiny to the behavior of the residential construction sector and productivity in that sector. My staff has done some work on estimating what productivity growth has been over the past year or so in residential investment and in the nonfarm business sector outside residential investment. They estimate that essentially all of last year’s slowdown in labor productivity growth is due to the behavior of productivity in residential construction. We estimate that residential construction productivity dropped 10 to 15 percent in 2006, whereas productivity in the nonfarm business sector outside residential investment was well maintained. Exactly why those lags exist, again, is a mystery to me as well as to David and others. But going forward, it seems to us that, as the adjustment lags work themselves out, residential construction employment will likely post significant declines, and productivity in that sector and the economy as a whole will rebound. That said, the pace of structural productivity growth may also have declined slightly as the Greenbook hypothesizes. Relative to the second half of the 1990s, both the pace of productivity growth in the IT sector and the pace of investment in equipment and software have slowed, and these factors have probably depressed trend productivity growth slightly in recent years and are likely to continue depressing it somewhat going forward. But the hypothesis that the recent decline in productivity growth is mainly structural does not seem to me to square well with the broad range of available evidence. Recall that in the 1990s there was a whole constellation of evidence—including a booming stock market, robust consumption, and rapid business investment—that was consistent with a hypothesis of a lasting increase in the rate of productivity growth. In contrast, over the past year or so, business investment in equipment has been very sluggish and more so than seems warranted by the deceleration in business output. So such weakness could reflect lower assessments by companies of their ability to improve productivity through the installation of new capital, and that is, I think, consistent with the lower trend of productivity growth. But you would think that a marked slowdown in secular productivity growth would also result in downward revisions to the expected paths of future profits and real wages, weakening equity market valuations and crimping consumption growth. I have seen no signs over the past year that household perceptions of their future wealth accumulation have been downgraded. In sum, the data seem consistent with the view that the recent slowdown in nonfarm business productivity represents a temporary cyclical drop that is concentrated in residential construction combined with a modest decline in the trend. So I remain optimistic that the underlying productivity trend is at or only slightly below 2½ percent." FOMC20061025meeting--87 85,MS. BIES.," Thank you, Mr. Chairman. Well, again, as some of you have said, in five weeks we don’t have a whole lot of new information. But I’m coming back and starting with housing again. As you know, that continues to be something I watch. Let me just make a few comments and give you recent feedback from some exams and dialogues with brokers that I’d like to share with you. Looking at both starts and permits, we all know that housing is continuing to soften in terms of construction, and we have also identified the increasing number of contract cancellations for new housing. Someone mentioned earlier the noise that we may be having around housing data, and I get this through some of the anecdotal conversations that I’ve had with folks. One topic was the inventory of existing housing for sale. I’m hearing from a couple of real estate brokers that people who may have wanted to sell their homes or may have put them up for sale are withdrawing them from the market. They don’t need to move, and it isn’t worthwhile for them to move if they don’t get the price they want. I think the supply was possibly bigger than what we’re really measuring, and so we’re seeing some understating of what desired house sales would be in terms of inventory. That’s continuing; it is just beginning at this stage, at least in a couple of regions, according to folks with whom I’ve talked. One of the challenges that we’re faced with here is that—again, I try to look for the good news—in the housing purchase process, people file applications for mortgages very often before they qualify to buy the house. When you look at the Mortgage Bankers Association data on purchase mortgage applications, as I mentioned before, they dropped 20 percent from their peak of last summer, but in the past few months they have been leveling off. So if applications are a leading indicator, we may begin to see some moderation in housing purchases. However, the 20 percent drop in purchase mortgage applications means that mortgage brokers are earning a lot less income. If they don’t close a transaction, most of them get no paycheck because three out of four mortgages are originated not in financial institutions but by independent brokers. We’re beginning to see increasing evidence of this in terms of the quality of mortgages that are out there. We continue to track the mortgages that have vintages—in other words, that were originated—in 2005, and we are continuing to see that, as these mortgages age, the early delinquencies for these are greater than early delinquencies for similar-aged mortgages of earlier vintages, which implies a loosening of underwriting standards and more stress on the borrowers. We are also seeing in a small way increased predatory activity with loans. Certain practices have been described to me lately with new products, such as the 2-28 mortgage, which is fixed for two years and then escalates and becomes an ARM tied to LIBOR in the third year. But don’t worry—you can refinance it with the broker and bring your payment down and do it all over again. We’re seeing those kinds of things—mortgages for which people are being qualified by brokers with no escrow account; all of a sudden taxes are due, and borrowers don’t have the money for them. So predatory lending is rearing its head at the lower end of the scale, and it’s something we have to continue to watch for. However, before I leave housing, let me just say that the bottom line is that overall mortgage credit quality is still very, very strong. We’re seeing predatory lending only in pockets of the market. I continue to believe that the rest of the economy—except for autos, I should add—is still very strong. Consumer spending is good, and business fixed investment is very sound. The moderation in energy prices and the growth in consumer income will continue to add support to the economy going forward. Jobless claims have been low and moving in a very narrow range the past few months. As several of you have mentioned, I’m hearing more concern by corporate executives about the inability to hire the talent they need to meet their business plans, and so I’m seeing more indication of tightness in labor markets. Turning to inflation, as many of you have said, core inflation has moderated from the pace in the third quarter. But going forward in the Greenbook forecast, it is still showing significant persistence even though we think we will be growing, at least for a period, below potential. That concerns me because that level is higher than I’m comfortable with in the long run. We might have had some spillover effects from rising commodity and energy prices earlier on, but I was hoping at this point that, with the reversing, we would see more-positive spillover effects that would mitigate inflation. So I am very worried about inflation. At the same time, I know that negative spillover effects on growth due to the rapid decline in housing construction and the moderating house-price appreciation are risks, which we cannot dismiss, to growth; but on net I am still much more concerned about the persistence of inflation. Thank you, Mr. Chairman." FOMC20061025meeting--81 79,MR. LACKER.," Thank you, Mr. Chairman. The Fifth District survey for October just released today shows manufacturing flattening out after a run-up last month, though expectations remain upbeat. Services firms note solid increases in revenues, and overall District job growth remains strong. Among retailers, big-ticket sales were softer, and housing-related sales slowed further; but with other retailers, the picture brightened, with sales and traffic notably stronger. The housing sector continues to slow, with sales weakening further in the D.C. area and modest price reductions occurring in other large markets. Some cities in the Carolinas, however, continue to report modest increases in home sales prices and even permits, and in many locations, activity varies significantly across different price ranges. District labor markets remain tight, and our surveys indicate that expectations are for some additional wage pressures in the next six months. This commentary includes the now-usual reports of shortages of particular skills. Our price measures moderated some, but they remain elevated. The national outlook has changed only marginally in the past five weeks. At our last few meetings, we have seen the staff mark down their forecast for second-half growth as the pace of the contraction in housing activity has become clear. The information that has come in over the past several weeks does not suggest any steepening in the rate of decline, and if anything, there are scattered signs suggesting that we might be getting close to the bottom. Except for housing, the economy still appears to be in good shape. Consumer spending is holding up well. Employment is tracking labor force growth. Commercial construction is fairly robust, and business investment spending continues to grow. So we’re still not seeing any major spillovers from the housing market to other economic sectors. Housing is certainly going to subtract from headline growth over the next couple of quarters, but I expect GDP growth to return to close to potential at some point next year, and I remain more optimistic than the staff about when that will occur. There is a risk that output growth will come in lower than I anticipate because of a more severe deterioration of the housing markets or more substantial spillover effects on other spending categories. Although it’s certainly too early to rule this out, I think the probability of such an outcome has receded in recent weeks. So my outlook for real growth is about the same as it was in September with, if anything, a tad less downside risk. The inflation outlook has not improved since our last meeting. The September core CPI reading was 2.9 at an annual rate, identical to the August reading, and core PCE inflation for September is estimated at an annual rate of about 2.1 percent, I think. I grant that three-month core PCE inflation has come down off its May peak of close to 3 percent. I do take some comfort in the fact that core inflation did not remain so high, but that measure of inflation has been right about 2¼ percent for three straight months. The Greenbook forecast has it stepping up to 2.4 percent for the next six months and falling below 2.2 percent only in the second quarter of 2008. So three-month core PCE inflation is now as low as it gets for the next year and a half in the Greenbook forecast, and at the end of 2008, core inflation will have been above 2 percent for five straight years. I have my doubts about the prospects for even the modest decline described in the Greenbook. The notion that slowing real growth will bring inflation down much has already been heavily discounted around this table—and rightly so, in my view, given the tenuous status of the relationship between real gaps and inflation. The recent fall in energy prices may help, but relying on tame energy prices is problematic, I think. It would encourage the public to believe that we will allow core inflation to rise whenever energy prices surge. That belief is, for me, the leading hypothesis explaining the run-ups in core inflation that we saw last fall and earlier this year. We are likely to see some significant swings in energy prices in the years ahead. So help from this direction is by no means certain. More broadly, I believe we should be leery of letting a relative price move core inflation around. There was a lot of discussion at our last meeting about the state of inflation expectations, and a number of people pointed to evidence that market participants did not seem to believe we intend to bring inflation down to the center of the 1 to 2 percent range. This is confirmed by the Bluebook, which provides a very useful compilation this time from various sources of market expectations for core PCE inflation, and they are all clustered around 2¼ percent. If the Greenbook forecast is realized and core inflation gradually comes down to 2.1 percent over the next two years, it’s hard to believe these expectations would fall much. So with core inflation running around 2¼ percent and not likely to come down much soon and with expectations apparently settled at about the same rate, I’m deeply concerned about inflation. Thank you." CHRG-110shrg46629--127 Chairman Dodd," Have they done that? That is good to hear. Let me turn to Senator Shelby for one question. I have one additional one after his and then we will complete the hearing. Senator Shelby. Thank you. Chairman Bernanke, GSE reform. We have talked about this before. This Committee has been interested in strengthening the regulatory system for the housing related Government Sponsored Enterprises for a number of years. The House recently, as you are probably aware, considered language giving the new proposed regulator the ability to regulate the size and the growth of the enterprise portfolios and charged the regulator to consider risk of the portfolios. However the language, which was amended on the House floor, I understand, which passed in the House, limited the risk consideration to only risk to the enterprises. Would you view this language, as it was passed by the House as amended on the floor, with what bank regulators have over financial institutions? That is do you consider, as a regulator, only the risk to a particular financial institution? Or do you look at the portfolio? Do you look at other things? The portfolio your predecessor, Chairman Greenspan, says right here in this Committee and I believe you have reiterated that there is risk there in that portfolio, possibly to the taxpayer. Would you comment on this? " FinancialCrisisInquiry--448 BASS: Sure. First of all, I’ll—in the interest of full disclosure, I was a senior managing director at Bear Stearns for five and-a-half years from 1996 to 2001. So a lot of the people at that firm are very good friends of mine. And a lot of the people that ran the firm are very good friends of mine. In—in September of 2006, I went to Bear Stearns to meet with a guy named Bobby Steinberg, who at the time was their chief risk manager at the firm. He congregated a meeting in a conference room at their headquarters for me with the head of mortgage trading, the head of fixed income trading, the head of mortgage risk, fixed income risk and himself. And I went through my entire presentation as to what I saw building in the housing market where I— where I thought mortgage credit was going to go. And—and—and, you know, a couple points that I’ll make. Someone—someone in this morning’s hearing said did you ever contemplate housing prices ever dropping. They didn’t even have to drop for losses to show up. OK? If housing prices just went flat, they would have lost 9 or 10 percent on these securitizations, which would have wiped out everything up to close to the AAs. So to put it into perspective, I—I went through my presentation with their risk committee and said do you realize that if I’m right—and— and by the way, I’m one data point from Dallas, so I realize that they can discount what I had to say. But the presentation’s fairly compelling. If I’m right, do you realize what’s going to happen to this firm, knowing how—the firm’s position? And he said-- he said, Kyle, you worry about your risk management, and we’ll worry about ours. And that was the last time I spoke with them. Again, it’s—it’s one data point. And with regard to the Federal Reserve, I met one of President Bush’s staffers and—and went through it with him. And he suggested I go talk with the Federal Reserve here in D.C. And I met with one of the Federal Reserve board members and went through my— my presentation again, just a data point from Dallas—meeting at the Federal January 13, 2010 Reserve here in D.C. It’s—it’s not a large data point. However, their answer at the time was—and—and this was—this was also the thought that was—that was homogeneous throughout Wall Street’s analysts—was home prices always track income growth and jobs growth. And they showed me income growth on one chart and jobs growth on another, and said, “We don’t see what you’re talking about because incomes are still growing and jobs are still growing.” And I said, well, you obviously don’t realize where the dog is and where the tail is, and what’s moving what. But again, it was my opinion which, you know, they intended—or they—disregarded. CHRG-111hhrg56766--10 The Chairman," I thank the gentleman from North Carolina. The gentleman from North Carolina will have 2 minutes and 10 seconds. The gentleman from Texas is now recognized, the ranking member of the Subcommittee on Domestic and International Monetary Policy, for 3 minutes. Dr. Paul. Thank you, Mr. Chairman. Welcome, Chairman Bernanke. I am interested in the suggestion that Mr. Volcker has made recently about curtailing some of the investment banking risk they are taking. In many ways, I think he brings up a very important subject and touches on it, but I think it is much bigger than what he has addressed. Back when we repealed Glass-Steagall, I voted against this, even though as a free market person, I endorse the concept that banks ought to be allowed to do commercial and investment banking. The real culprit, of course, is the insurance, the guarantee behind this, and the system of money that we have. In a free market, of course, the insurance would not be guaranteed by the taxpayers or by the Federal Reserve creating more money. The FDIC is an encouragement of moral hazard as well. I think the Congress contributes to this by pushing loans on individuals who do not qualify, and I think the Congress has some responsibility there, too. I also think there has been a moral hazard caused by the tradition of a line of credit to Fannie Mae and Freddie Mac and this expectation of artificially low interest rates helped form the housing bubble, but also the concept still persists, even though it has been talked about, that it is too-big-to-fail. It exists and nobody is going to walk away. There is always this guarantee that the government will be there along with the Federal Reserve, the Treasury, and the taxpayers to bail out anybody that looks like it is going to shake it up. It does not matter that the bad debt and the burden is dumped on the American taxpayer and on the value of the dollar, but it is still there. ``Too-big-to-fail'' creates a tremendous moral hazard. Of course, the real moral hazard over the many decades has been the deception put into the markets by the Federal Reserve creating artificially low interest rates, pretending there has been savings, pretending there is actually capital out there, and this is what causes the financial bubbles, and this is the moral hazard because people believe something that is not true, and it leads to the problems we have today because it is unsustainable. It works for a while, but eventually, we have to pay the price. The moral hazard catches up with us and then we see the disintegration of the system that we have artificially created. We are in a situation coming up soon, even though we have been already in a financial crisis, we are going to see this get much worse and we are going to have to address this subject of the monetary system and whether we want to have a system that does not guarantee that we will always bail out all the banks and dump these bad debts on the people, and that it is filled with moral hazard, the whole system is. When that time comes, I hope we come to our senses and decide that the free market works pretty well. It gets rid of these problems much sooner and much smoother than when it becomes politicized that some firms get bailed out and others get punished. It is an endless battle. Hopefully, we will see the light and do a better job in the future. " FOMC20070509meeting--80 78,MR. KOHN.," Thank you, Mr. Chairman. My outlook, like most of the rest of yours, was basically the same as the one in the Greenbook, and it hasn’t changed all that much over the past few weeks. Like the rest of you, I see income growing at less than the growth rate of potential for several quarters, the pace held down by housing and the slower growth of consumption that has become evident in recent data and confirmed by President Poole’s reports. This is offset over time by a strengthening of business spending, the end to the inventory correction that we see in IP and ISM statements, and a pickup in capital expenditures as businesses feel more comfortable that the expansion will continue and that any overbuilding they did when income growth was higher in those three or four years that President Stern was talking about has been absorbed. Like the rest of you, I see a pickup in demand to something like the growth rate of potential some time next year as housing activity adjusts to the lower level of demand and as inventory is worked off. Several favorable factors support this eventual return to potential: supportive financial conditions, especially for businesses; credit availability, which we’ve just been talking about; narrow credit spreads; low long-term rates; and good foreign demand— another upward adjustment in this Greenbook to rest-of-the-world economic growth; and the decline in the dollar—which will support exports. I used the staff structural growth of 2½ percent. It seemed to me that the adjustments the staff made were small, offsetting in participation and productivity, and looked reasonable given the recent data. There is still a tension between the labor data and having potential growth as high as it is, and it leaves the staff in a position in which labor force participation is slightly above the trend, which strikes me as where it ought to be when the unemployment rate is slightly below the NAIRU. Also, productivity is slightly below the trend, so they need faster-than-trend productivity growth just to get back to their now lower trend, which strikes me as where it ought to be after three or four quarters of below-trend growth and presumably some labor hoarding, but not that much below trend. So that looked like a reasonable assumption to me, and that’s what I used in my projection. I differ from the Greenbook in a couple of respects. One is that I had softer equity and house prices than the staff did. On the equity front—I think I said this last time—I expected equity prices to be soft, and they’re up 6 percent. [Laughter] Fortunately, I don’t back my predictions with my personal wealth. But—I’m going to hold to that prediction—[laughter] the market still seems to be building in a more rapid increase in profits than seems consistent with moderate nominal GDP growth and some rebalancing of the labor-capital share, which we may be beginning to see. Certainly, there is practically no growth at all in domestic profits in the Greenbook for ’08. Now, the market may get more from the foreign profits, as people have been saying, but I think there is potential for disappointment there. On house prices, inventories are large, and the price-to-rent ratio is still extremely high. On the demand side, I think demand is being damped by tightening in subprime and alt-A markets. On the supply side, there will be some more foreclosures, particularly as rates adjust up this year. So I presume that prices will need to drop somewhat, rather than just stay level as in the staff forecast, even to get the housing stabilization and eventual slight rebound that the staff and I included in our real GDP forecast. Now, to offset the effects of weakness in wealth from these prices, I had a slight easing of monetary policy this year, next year, and the following year—¼ percentage point each year—to get that same output. This was only a slight easing in real rates given that inflation is edging down and inflation expectations aren’t presumed to change very much. I did this in the context of what I would have as an interim inflation target of 2 percent. I think 2 percent is achievable without significant output loss: It is low by historical standards and broadly consistent with price stability and minimal welfare distortions relative to 1½ percent. I agree that a little lower might be nice eventually, but I would get there opportunistically by leaning against any increases and accepting decreases rather than deliberately going to 1½ percent. I’m skeptical about the expectations effect that might accrue from the announcement of a 1½ percent commitment. A second difference with the Greenbook is that I assumed a slightly lower NAIRU— 4¾ percent. Any point estimate is silly—we really have only the vaguest idea—but it seemed to me that the compensation data, the price data, of the past few years were more consistent with a NAIRU that was a bit below 5—and so I assumed 4¾ percent. As a consequence, I had slightly less inflation than the staff forecast—0.1 in ’07 and in ’08. So I had 2.2 in ’07 and 2.0 in ’08 and had it staying there in ’09. In some sense I thought the more interesting part of the forecast was thinking about the second moments—the skews and the probabilities around the central tendencies. I confess that for ’07 I committed the sin of thinking things were more uncertain than usual, Mr. Chairman. [Laughter] I hate it when I hear people say that." CHRG-111shrg50814--20 Mr. Bernanke," Well, we have seen a very broad-based weakness. Housing is very central. At this point, the housing market has reversed the boom that we saw earlier in the decade. In fact, we are now at levels of construction and price declines that we have not seen for a very long time, if ever, and so I would anticipate some stabilization in the housing market going forward and eventually demographic trends, household formation, economic growth will begin to create recovery in the housing market. Likewise, people are very reluctant right now to make commitments to consumer durables like automobiles. I think the current rates of auto sales are below what we will see once the economy begins to normalize. So I think those sectors will be part of the recovery. But in general, as we see confidence coming back, particularly consumer spending on discretionary items, those areas will begin to strengthen and we will see a broad-based recovery. " 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-110hhrg34673--142 Mr. Bernanke," I would like to see a bill. I think we need to have a strong regulator in this arena, and we need to find some way that we can limit the growth of the portfolios. As a practical matter, I think that restricting portfolios to mortgages related to affordable housing might be an appropriate compromise and an appropriate approach that would provide some limitation, but the Federal Reserve has always been concerned about the size of portfolios. It never has found a substantial benefit to homeowners from large portfolios. " CHRG-111shrg55117--71 Mr. Bernanke," Well, from the Federal Reserve's perspective, we have basically a two-pronged approach. One is to work with banks to work out commercial real estate projects which are no longer performing, in very much the same spirit as we have work-outs for residential mortgages that are not performing. There, as with residential mortgages, there is an incentive to do that if the costs of foreclosure are sufficiently high. I think one slightly positive thing is that I don't think that commercial real estate experienced quite the increase in prices or the bubble component that housing did, but nevertheless it is still under a lot of pressure. The second element of our program is the TALF, which now also will allow borrowing from the Treasury's PPIF program also to come in and buy CMBS through the TALF. Whether Congress wants to take additional steps, you know, you could intervene with guarantees or other kinds of support that would have fiscal implications. It would mean the Government was bearing risk. So I haven't really seen a full-fledged proposal and I would be somewhat reluctant to strongly endorse one. I think really the Congress has to make those tradeoffs between the fiscal cost, the fiscal risk, and what is, I will agree, a very real risk on the side of foreclosures and problems in commercial real estate---- Senator Menendez. As I talk to this industry, Mr. Chairman, they tell me that at least presently, there isn't--they seek the private marketplace. They are not really seeking the Government. But there isn't a private marketplace, certainly not in a sustainable way, for what is coming down the road. And so the question is, do we wait again for the crisis to happen, or do we anticipate where it is headed and seek to stem it because otherwise we have significant risk to our economy. I am just wondering, do you think that what you have today as tools is sufficient to meet that challenge in the days ahead or not? " FinancialCrisisReport--246 CDO securities, delaying thousands of rating downgrades and allowing those securities to carry inflated ratings that could mislead investors. 4. Failure to Factor in Fraud, Laxity, or Housing Bubble. From 2004 to 2007, Moody’s and S&P knew of increased credit risks due to mortgage fraud, lax underwriting standards, and unsustainable housing price appreciation, but failed adequately to incorporate those factors into their credit rating models. 5. Inadequate Resources. Despite record profits from 2004 to 2007, Moody’s and S&P failed to assign sufficient resources to adequately rate new products and test the accuracy of existing ratings. 6. Mass Downgrades Shocked Market. Mass downgrades by Moody’s and S&P, including downgrades of hundreds of subprime RMBS over a few days in July 2007, downgrades by Moody’s of CDOs in October 2007, and actions taken (including downgrading and placing securities on credit watch with negative implications) by S&P on over 6,300 RMBS and 1,900 CDOs on one day in January 2008, shocked the financial markets, helped cause the collapse of the subprime secondary market, triggered sales of assets that had lost investment grade status, and damaged holdings of financial firms worldwide, contributing to the financial crisis. 7. Failed Ratings. Moody’s and S&P each rated more than 10,000 RMBS securities from 2006 to 2007, downgraded a substantial number within a year, and, by 2010, had downgraded many AAA ratings to junk status. 8. Statutory Bar. The SEC is barred by statute from conducting needed oversight into the substance, procedures, and methodologies of the credit rating models. 9. Legal Pressure for AAA Ratings. Legal requirements that some regulated entities, such as banks, broker-dealers, insurance companies, pension funds, and others, hold assets with AAA or investment grade credit ratings, created pressure on credit rating agencies to issue inflated ratings making assets eligible for purchase by those entities. FOMC20051213meeting--38 36,MR. SANTOMERO.," David, could you give us a risk assessment on your consumer spending forecast? In 2006 and 2007, you have consumer spending growth of 3½ percent, while the housing December 13, 2005 18 of 100 with that forecast? You made reference to it in the formal comments, but I wonder if you are quite comfortable with the forecast or a little uncertain about it." CHRG-110shrg50409--97 Mr. Bernanke," There have been similar episodes in the U.K. and Australia, for example. But it is hard to draw strict analogies. One reason is that the financing systems are different in the different countries. Clearly, in this case, the high loan-to-value subprime adjustable rate mortgages, those sorts of instruments were particularly sensitive to the decline in house prices that we saw, and the effects, therefore, on credit quality and on bank balance sheets were stronger. So there are other examples, and we have looked at those. Most of them suggest, which is something which I am sure we are all happy to hear, that eventually the new equilibriums is established, the housing market comes back into balance, and the negative effects of that are ended, and you begin to see more stable growth again. I am sure that will happen here, but there is not an exact analogy. Senator Bayh. Well, along those lines--and I know you are reluctant to offer advice to the legislative branch of Government, but I am sure you have followed the bill that passed out of the Senate last week. Going over to the House, there may be some marginal adjustments, but probably not more than that. Is there anything else we should be looking at doing here in a timely fashion to address the housing challenge that has not been included in this legislation? " FOMC20061212meeting--96 94,MS. BIES.," Thank you, Mr. Chairman. I thought I’d start today talking a bit about housing markets and the condition of banks right now. As many of you have noticed, some of us are optimistic that we may be approaching a bottom in the housing market. I think we’ll see that bottom in housing sales long before we see it on the construction side because there’s a large amount of inventory still to work through. But as we’ve noted, the applications for purchasing mortgages have been level since midyear. The growth in mortgage credit has slowed significantly from where it was in the past two years, dropping to only 10 percent growth this past quarter, a growth rate that is significantly above the growth of personal income and that most of us in the past would have considered to be alarming. Part of what’s amazing in all of this is that in 2004 and 2006, particularly toward the end of that period, purchase money seconds, by which people borrowed the downpayments for homes, were a big part of mortgage financing. Banks are still getting some of this business and putting it on their balance sheets, and it is part of the growth of what you’re seeing the banks funding. But it is at a pace that I think needs to be adjusted. I’m saying that, although the number of applications may have bottomed out, the amount of leverage in each housing deal may still need some correction going forward, and so we may see some slowdown in the volume of dollars that are funded through mortgage lending. Delinquency rates are really, really low by historical standards. The one sector that has had a jump in delinquencies is subprime ARMs, and clearly the jump is related to rates that have already reset. We’ve got more to come. Even though these have jumped, they’re still not at alarming levels. But it’s something that I think the banks are watching very, very carefully. One thing I’m hearing more from some folks who have been investing in mortgage- backed securities and maybe in some CDOs (collateralized debt obligations), where they’ve been tranched into riskier positions through economic leverage, is the realization that a lot of the private mortgages that have been securitized during the past few years really do have much more risk than the investors have been focusing on. I’m hearing this from folks who understand that the quality of what goes into those pools varies tremendously when you don’t have the Fannie Mae and Freddie Mac framework for the underwriting. When a mortgage is originated through a bank, we do a lot through safety and soundness supervision to make sure, if a bank is buying loans from brokers, that the loans are underwritten in a sound manner and are therefore affordable to the borrower when they’re undertaken. We’re seeing that some of the private-label mortgage-backed securities are having very high early default rates or delinquencies in the mortgages, which usually means that the originator has to buy them back out of the pools. There isn’t a whole lot of transparency in the disclosures around some of these bonds, and some of the brokers are underwriting products that have very high early default rates, which is something that investors are starting to focus on. As more products are generated outside the banking sector, they get funneled to pools through broker-dealers as opposed to the banks. I think that we’re missing a level of due diligence regarding brokers, who may not be doing a good job. As you all know, the fraud rate on mortgages has tripled in the past two years. So I think we could see noise in some of the mortgage-backed private deals and some of the riskier CDO economic leverage positions. Bank earnings are really, really strong overall, especially by historical standards. Banks are making a lot of layoffs connected with the mortgage business. They are taking steps to get costs—whether related to originations, post-loan closings, or payoff administration—under control. Net interest margins, however, continue to be under significant pressure. I’m hearing more from banks that, since we’ve stopped raising rates, they’ve lost the nice little lag effect— the ability to wait for us to move before lagging along. In other words, they have lost that lagniappe in their liability cost that has helped them with their margin pressures. So those pressures are going to be more of a challenge for them, especially with a flat or inverted yield curve, depending on where they’re funding and lending. Loan-loss provision continues to be the best in many, many years. No one really expects it to jump, but clearly it can’t get a whole lot better than it is, and so that will also present challenges going forward. As for the economy as a whole, I, too, want to compliment President Yellen because I think she did a fantastic job of helping us think about the different signals we’re getting. When I looked again at the graph that I love in the Greenbook that shows where our forecast has been, I was struck that we’ve seen the forecast of GDP growth continuing to moderate in the past several months but our expectations of inflation are actually flat to up a bit. To me that raises questions about the tradeoff that we really have when we are running below capacity and below potential growth rates. The bit of softness that I’m hearing about from some of my contacts in sectors outside housing and mortgages warns me that we need to be a little more vigilant than I had been expecting about growth maybe softening in a broader sense. But the fact that inflation continues to be above 2 percent in the forecast period is something that does concern me, and I think part of my concern relates to the tremendous amount of liquidity that sits out there in the banking sector, in the U.S. financial markets, and clearly globally. The presence of this liquidity is something that we really need to think about. It’s not back to where it was in my money supply days, when I started my career at the St. Louis Fed; but I do worry that liquidity is, as some of you have said, causing a lot of transactions to occur that economically perhaps wouldn’t otherwise occur. That is also something we need to watch very carefully." CHRG-110shrg50415--64 Mr. Levitt," Sometime over the course of the past 2 years, 3 years. I will get back to you with the specific time of that. But so much of what the SEC does, as I said in my statement, is the sending of signals, the speeches given, not the rules that are passed. And those signals simply have not been sent. Shareholder access to the proxy, a terribly important issue. It has been bubbling around for 10 years now, and the Commission failed to act. A non-binding shareholder vote on executive pay, again, bubbling around for some years. The Commission did not act. Over and over and over again, the message was sent that this Commission is not an investor-friendly Commission. I do not think this is a question of authority except with respect to such issues as derivatives. There clearly we are in an unregulated area, and a lot of us were responsible for not calling attention to this early on. There is more I could have done while I was there, and the condition grew worse and worse and worse. I do not believe this is a question of giving the SEC authority that they lack. I think it is a question of the SEC properly utilizing that authority, reinvigorating their Enforcement Division, which has been demoralized by a variety of factors. Giving them more cops on the beat, allowing them to send a message which only they can send that they truly are the investor's protector. Senator Brown. Thank you, Mr. Levitt. One last question, Mr. Chairman, if I could. The 40,000 angry e-mails and letters and calls I received told me--and they have said it repeatedly--that this is not a natural disaster, this is a man-made one. I would guess, I would say likely, that most of the 40,000 believe that some of this behavior was illegal. There seems to be certainly no self-imposed accountability. Mr. Ludwig, while we do not really know the facts yet, do you think the architects of this disaster might be held accountable by the law? " FOMC20070509meeting--82 80,MR. KOHN.," So here is my reasoning. I thought that the average includes lots of episodes of more or less steady growth in steady state and then other episodes of cyclical adjustments. In my mind, we were in the middle of a kind of mini-cycle, which was an adjustment from greater-than-sustainable growth to growth that we hope is sustainable. We’ve seen that the adjustment had already created some inventory overhangs and some changes in capital spending plans. So I thought that, because we’re not at a steady state, things might be a little more uncertain than usual. But I compensated for that by narrowing my confidence bands in ’08 and ’09 [laughter] when I think we’ll be close to a kind of a steady state. On the skews part, like President Geithner, I had downside skews on output. It wasn’t so much housing because I think that, with the adjustment to demand or activity that’s in the staff forecast and my own adjustment to prices, the risks around that are approximately balanced. Nor was it a spreading of problems in the subprime market to other credit markets; I think we’ve seen enough since the subprime problems started to be pretty sure that the risk is no more than the normal kind. Rather, the risk I saw was from concerns about the financial position and the psychology of the household sector and the interaction of those with housing. So it was a spillover in some sense from housing to consumption. The financial obligations ratio is very high. Households, as President Geithner noted, are highly leveraged. One of the surprises to me in the development of subprime markets was apparently how many borrowers and lenders were counting on the future appreciation in houses just to support the debt service, to say nothing of the consumption that must be going on at the same time. I suspect that this is more widespread than just the subprime market. How many households were expecting price appreciation to continue more as it did before rather than to slow down or even for prices to decline (as I think they will), it’s hard to say. But I suspect there are a lot of these households, and I think we could get some feedback there. The staff has the saving rate actually declining in the second and third quarters, and there might be some technical reasons for that. Even to get modest consumption growth, we see a very gradual uptrend in the saving rate over time. That might be the most likely outcome, but it did suggest to me that there is at least some fatter tail on the possibility that households, seeing what’s happening in the housing market and to their financial obligations, will draw back more quickly from spending. When President Geithner and I were in Basel, the most popular question to us was whether capital spending would really pick up again. A number of central bankers doubted that that could happen as long as consumption wasn’t growing more rapidly. But I’m comfortable with the capital spending pattern so long as the consumption pattern looks something like the pattern in the Greenbook and like the one that I have as my most likely outcome. More generally, as you pointed out at one point last fall, Mr. Chairman, I think we’re in a very unusual situation of below-potential growth for an extended period—a situation that is pretty much unprecedented without breaking out one way or another. Some nonlinearity is going to come up and bite us here, and, as I see it, the nonlinearity is most likely in the household sector. Now, if income proceeds along the expected path, it seems to me that there are upside risks to inflation moving down to 2 percent and staying there in our forecast. I think that overall we’re facing a more difficult inflation environment than we have for the past ten years or so: the high level of resource utilization; rising import prices from the decline in the dollar and the high level of demand relative to potential supply globally, including in the emerging-market economies—one thing we heard in Basel was that increasing numbers of these economies are having trouble sterilizing their reserve accumulation and are running into inflation pressures from that happening—higher prices for energy, food, and other commodities; higher headline inflation; and possibly even slower trend productivity growth. I didn’t see a downside skew to any of these things. But, as I thought about the whole picture with all these things seeming to tilt a bit on one side and their interaction, it seemed to me that there was some upside risk to the possibility that inflation expectations would rise rather than stay where they are as assumed in my most likely outcome. Now, for policy purposes, I would weight the upside risk to inflation more than the downside risk to growth, but we’ll get to that later in the day. Thank you, Mr. Chairman." FOMC20050630meeting--134 132,MS. BIES.," May I say something here? I don’t have any quantitative studies on this, but based on talking to the folks who lived through it, I’d make a couple of observations. If we look at the 1980s—the most recent housing bubble that was nationwide. We saw the bubble bursting nationally as opposed to the pockets we’ve had with the California breakdown or the Boston breakdown, which really related to the local economies and local employment developments. I think the local economic employment situations were the drivers of delinquencies, and the regulators generally missed that because they missed the local economic impact. And I think people focus on the fact that those cycles were driven by local economic conditions. I think the period of the 1980s involved a broader failure on the part of supervisors. If we compare the 1980s experience with what is happening now, in the earlier period a lot of financial institutions were on an exam cycle that went five or six years. So, nobody on the supervisory side was in there looking at what was going on. And that period was before the time when securitization became a prevalent practice, so most of the risk was carried on the books of the banks. Also, many of the banks that were hit very badly were following developers—going out of their footprint and June 29-30, 2005 46 of 234 banks is that while we say they are diversified geographically, many of their loans are to investors or purchasers of second-home resort properties. So, the lenders again are following their customers out of the local area, and in the location of the new property the local lenders aren’t looking at it; the customer’s lender is handling the transaction. So, we still may have that risk embedded within the financial institutions. It’s one of the things we’re focusing on. What is new about it this time, though, is that a lot of these nonconforming products are being securitized by the private sector. So the real question is: Where does the market discipline kick in? And as supervisors, can we fault an institution for responding to a market need when it is offloading the loans and the risk into these types of mortgage structures that Andreas has been describing? We clearly could if the financial institutions were buying the equity or mezzanine risk tranches and the risks were back on the institutions’ books. But in many cases that clearly isn’t what is happening. So, we have some different aspects this time around. Just to let everybody know, the OCC [Office of the Comptroller of the Currency] and the Fed currently are putting together a horizontal review to look at the fringe kind of lending activities where we do need to send some signals. We wrote the HELOC [home equity line of credit] guidance that came out last month. We’re working on this other one and hope to have it out in a couple of months. We don’t want to turn off safe loans or the traditional types of lending activities, but we need to figure out where to go on some of these practices that are on the fringes. But we haven’t done a sterling job. I think that’s why we’re trying to send out some guidance. We sent out the appraisal guidance a year or so ago. But some of the risky practices of the past are starting to be repeated, and it may be that the generation of lenders now didn’t live through the problems before." FOMC20060629meeting--95 93,MS. YELLEN.," Thank you, Mr. Chairman. The staff presentations make abundantly clear that most of the data we have received since we met in May have been disappointing in one way or another. Recent economic activity appears to have been quite a bit weaker than expected, as exemplified by the Greenbook, which shows a significant downward revision to 2 percent growth in the current quarter and a noticeable downward adjustment to 2¾ percent in the second half of this year. However, in view of the possibility that labor and product markets may have moved a bit beyond full utilization, as well as the recent high readings on core inflation, a period of growth a bit below potential could be seen as necessary to prevent a buildup of underlying inflationary pressures. Under the assumption of one more funds rate increase at this meeting, it seems reasonable to me that growth will remain somewhat below its potential rate, that the unemployment rate will gradually trend upward to slightly above the NAIRU by the end of next year, and that core inflation will gradually move down toward my comfort zone. If things work out that way, I suppose the outcome would be nearly optimal, given that we are starting from an undesirably high inflation figure in the second quarter. My concern is that it is very difficult at this stage to rule out a much less desirable scenario in which the lagged effects of our earlier reactions restrain activity more strongly and more persistently than we now expect. We might also see further financial disruptions as a consequence of investors’ increased risk aversion, which is the bearish possibility that Dino described earlier. In other words, the question is whether the large surprise in the second quarter will be followed by a series of similar surprises later this year. I am concerned about downside risks to the real outlook, especially until we can better gauge the magnitude of the repercussions from the weakening in housing markets that now clearly is under way. The data on core inflation in recent months present the opposite concern, having been higher than expected and pushing core inflation slightly above my comfort zone over the past year. This raises the possibility that we are making systematic errors in our understanding of the fundamental forces driving inflation. The key question is whether the necessary decline in inflation requires more action from us or whether inflation is being pushed up by temporary factors that will dissipate on their own. The Greenbook, I think quite reasonably, shows core inflation edging down over the next year and a half as the effects of several temporary factors abate. One possibility in this regard is that there has been a modest pass-through from energy-price increases to core inflation and that these effects will dissipate if energy prices stabilize at today’s elevated levels. Moreover, part of the recent uptick traces to large increases in housing costs that are finally showing up in the CPI just as the housing market is slowing. As David noted in his briefing, the CPI measure of changes in housing prices for owner-occupied housing reflects movements in market rental rates rather than house prices and interest rates. After long being stagnant or even falling, rents are finally moving up. Perhaps with higher mortgage interest rates and lower expectations of house-price appreciation, speculative properties are being dumped into the market, and families in the market for housing are now more inclined to rent rather than buy, driving rents up and housing prices down. It certainly would not be surprising to see a return to a more normal relationship between rents and house prices. Such a phenomenon, if it is now playing out, would most likely be transitory rather than permanent, although it could play out for quite some time. Unfortunately, at this point it is difficult to tell how much of the recent rise in core inflation is temporary and how much is due to underlying inflation pressures like tight labor and product markets, which would suggest a more persistent problem for policy. I would feel more concerned were it not for the largely reassuring data on productivity, labor compensation, and profit margins. That said, the good news is all in the forecast, whereas the bad news is in the data. So I certainly can’t rule out the possibility that the increase in core inflation in the second quarter is the leading edge of a developing trend. In summary, I think the most likely scenario is a relatively benign one. However, we have had some rather large surprises in both output and inflation since we last met. It seems to me that, in the policy round coming up, the more important matters are the risks that growth could slow much more than now seems likely or that inflation could prove to be a more serious problem than I currently expect it to be or, for that matter, that both factors could come into play. It is unlikely that we will be able to sharpen our assessment of these risks very much until more time passes and more data become available." FinancialCrisisReport--197 Resisting FDIC Advice. During the period 2004-2008, internal FDIC evaluations of Washington Mutual were consistently more negative than those of OTS, at times creating friction between the two agencies. OTS also resisted the FDIC’s advice to subject WaMu to stronger enforcement actions, downgrade its CAMELS rating, and solicit buyers for the bank. As early as 2005, the FDIC examination team expressed concerns about WaMu’s high risk lending strategy, even though the bank’s management expressed confidence that the risks were manageable. In an internal memorandum, for example, the FDIC team identified multiple negative impacts on WaMu’s loan portfolio if housing prices were to stop climbing. The memorandum stated in part: “Washington Mutual Bank’s (WMB) single-family residential (SRF) loan portfolio has embedded risk factors that increase exposure to a widespread decline in housing prices. The overall level of risk is moderate, but increasing. … A general decline in housing prices would adversely impact: a) The SRF loan portfolio; b) The home equity loan portfolio; and c) Mortgage banking revenue. … In January 2005, management developed a higher-risk lending (HRL) strategy and defined company-wide higher-risk loans as … sub prime loans … SFR loans with FICO scores below 620, … consumer loans with FICO scores below 660, and … [the] Long Beach … portfolio. Management intends to expand the HRL definition and layer additional risk characteristics in the future. … Management acknowledges the risks posed by current market conditions and recognizes that a potential decline in housing prices is a distinct possibility. Management believes, however that the impact on WMB would be manageable, since the riskiest segments of production are sold to investors, and that these investors will bear the brunt of a bursting housing bubble.” 752 751 See, e.g., April 16, 2010 Subcommittee Hearing at 61 (testimony of OTS Director Reich: “[F]irst of all, the primary regulator is the primary Federal regulator, and when another regulator enters the premises, when the FDIC enters the premises, confusion develops about who is the primary regulator, who really is calling the shots, and who do we report to, which agency.”) 752 Undated draft memorandum from the WaMu examination team at the FDIC to the FDIC Section Chief for Large Banks, FDIC-EM_00251205-10, Hearing Exhibit 4/16-51a (likely mid-2005). In an interview, when shown the draft memorandum, FDIC Assistant Regional Director George Doerr, who was a member of the WaMu examination team, told the Subcommittee that this type of analysis was prepared for a select group of mortgage lenders, including WaMu, to understand where the mortgage market was headed and how it would affect those insured thrifts. He did not have a copy of the final version of the memorandum, but said the FDIC’s analysis was discussed with OTS. Subcommittee interview of George Doerr (3/30/2010). 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." CHRG-111hhrg53240--105 Chairman Watt," Press that button and pull it close to you. Ms. McCoy. Chairman Watt, Ranking Member Paul, and members of the subcommittee, thank you for inviting me here today to discuss restructuring financial regulation. Today I will testify in support of the Consumer Financial Protection Agency Act of 2009. This bill would transfer consumer protection and financial services from Federal banking regulators to one agency dedicated to consumer protection. We need this to fix two problems: first, during the housing bubble, fragmented regulation encouraged lenders to shop for the easiest regulators and laws; and second, banking regulators often dismiss consumer protection in favor of the short-term profitability of banks. Under our fragmented system of credit regulation, lenders could and did shop for the easiest laws and regulators. One set of laws applies to federally chartered banks and thrifts and their operating subsidiaries. Another set of laws applies to independent nonbank lenders and mortgage brokers. Because lenders could threaten to change charters, they were able to play regulators off one another. This put pressure on regulators, both State and Federal, to relax their standards and enforcement. Countrywide, for example, turned in its charters in early 2007 in order to drop the OCC and Federal Reserve regulators and to switch to the OTS. The result was a regulatory race to the bottom that only the Fed had the power to stop. During the housing bubble, three of the four Federal banking regulators--the Federal Reserve, the OCC, and the OTS--succumbed to pressure to loosen loan underwriting standards and safeguards for consumers. Today I will focus on the Fed. Under Chairman Alan Greenspan, the Federal Reserve Board failed to stop the mortgage crisis in thee crucial ways: First, the Federal Reserve was the only agency that could have stopped the race to the bottom. That was because it had the ability to prohibit unfair and deceptive lending for all lenders nationwide under the Home Ownership Equity Protection Act. But Chairman Greenspan refused to exercise that authority. The Fed did not change its mind until last summer when it finally issued such a rule. At that point, the horse was out of the barn. Second, the Fed as a matter of policy did not do regular examinations of the nonbank subprime lenders under its jurisdiction. These included the biggest subprime lender in 2006, HSBC Finance, and Countrywide ranked number three. Finally, the last time the Fed did a major overhaul of its Truth in Lending Act mortgage disclosures was 28 years ago, in 1981. With the rise in subprime loans and nontraditional ARMs, those disclosures became solely obsolete. Nevertheless, the Fed did not even open a full review of its mortgage disclosure rules until 2007, and it still has not completed that review. So why did the Federal Reserve drop the ball? One reason was its overriding belief in deregulation. Another, however, was an attitude that a good way to improve bank safety and soundness was to bolster fee income at banks. We still see that today with respect to rate hikes with credit cards still going on. This focus on short-term profits not only hurt consumers, it undermined our Nation's financial system. The Act would fix these problems in three ways: first, it would stop shopping by providing one set of consumer protection rules for all providers nationwide; second, the Act puts the authority for administering those standards in one Federal agency whose sole mission is consumer protection. We are asking the Fed to do too much when we ask it to excel at four things: monetary policy; systemic risk regulation; bank safety and soundness; and consumer protection. Housing consumer protection in a separate agency in fact will provide a healthy check on the tendency of Federal banking regulators to underestimate risk at the top of the business cycle. Finally, to avoid any risk of future inaction by the new agency, the Act gives backup enforcement authority to the Fed and other Federal banking regulators in the States. My time is up. Thank you and I will welcome any questions. [The prepared statement of Professor McCoy can be found on page 161 of the appendix.] " FOMC20060808meeting--50 48,MS. YELLEN.," Thank you, Mr. Chairman. So far the economy has stuck pretty close to the script of the soft landing sketched out in the June Greenbook. Real GDP growth slowed markedly in the second quarter. Housing construction has declined sharply, and house prices have decelerated; this situation suggests that our policy actions have taken hold in this interest-sensitive sector. The recent sharp rise in oil prices should also put a damper on growth of real income and consumer spending. Most forecasters now expect below-trend growth in the current quarter. Nonfarm payroll employment has shifted down to a more-sustainable pace, and the unemployment rate has risen to 4.8 percent, just a bit below standard estimates of the NAIRU. Core inflation, although uncomfortably high, came in 0.2 percentage point below the June Greenbook’s forecast in the second quarter. In addition, despite further large increases in the price of oil, inflation expectations held firm. In light of these developments, a reasonable forecast is for growth to continue to run slightly below its potential rate, the unemployment rate to edge up, and core inflation to recede gradually. At our last meeting, I laid out some of my concerns about downside risks to the outlook for growth and upside risks to inflation. Quite honestly, I cannot say that the recent data have done much to assuage my angst on either account. The recent falloff in housing activity and the deceleration in house prices have been faster than expected. The current Greenbook has residential investment falling at an annual rate of 14 percent in the second half of this year, nearly twice as fast as projected in June. These surprises intensify the risk of a sharper slowdown as the lagged effects of our past policy actions come fully into effect. For example, the housing slowdown could become an unwelcome housing slump as envisioned in one of the Greenbook alternative scenarios. A large homebuilder in our District summarized the views of many of our contacts when he recently commented that “the housing market has not yet popped, but a hissing sound is now clearly audible.” [Laughter] He pointed to rapidly rising cancellations as a particularly ominous sign. I will be watching the incoming data closely for signs as to whether the housing slowdown remains orderly as hoped or takes a steeper downward slide, posing a greater risk to the economy. My concerns about inflation have also been somewhat heightened by the recent data or, more precisely, revisions to past data. Core measures of inflation continue to be well above my comfort zone. Of course, after the experience of last year, when core inflation was revised up by a considerable amount, I approached this year’s annual NIPA revision with some considerable trepidation. I was relieved to see that the core PCE price inflation data came out of the revision relatively unscathed, revised up just 0.1 percentage point for 2005; but other aspects of the report were somewhat less reassuring for the inflation outlook. First, the rate of labor productivity growth over the past three years has been a bit slower than we thought, primarily because of downward revisions to the rate of capital accumulation, so that the Greenbook now projects structural productivity growth of 2.7 percent, about ¼ percentage point slower than we thought back in June. This revision suggests somewhat less downward pressure on inflation emanating from cost reductions and, therefore, greater upside risks to inflation. But that wasn’t the only surprise tucked away in the annual revision. The upward revision to compensation growth over the past four quarters implies that growth in unit labor costs over the past year has been more rapid than we had believed. I had thought that there was a good chance that compensation per hour and unit labor costs would increase relatively moderately going forward, helping to contain inflationary pressures. The data revision was thus a bit of a wake-up call for me, and I have revised upward my views on the outlook for compensation and unit labor costs. My reading of the report is that the revised data provide a clearer and less sanguine picture of the trend in this measure of compensation. However, the employment cost index was in line with expectations in June and continues to show moderate growth. Moreover, even with revisions to productivity and compensation, the markup in the nonfarm business sector remains very high by historical standards, suggesting that firms do have room to absorb costs. Overall, I view the inflation outlook as highly uncertain, with a pronounced upside risk. As I mentioned at the last meeting, we just don’t have a good handle on why core inflation has risen of late or how persistent this rise will be. While it is comforting to attribute the increase to energy and commodity-price pass-through, empirical evidence suggests that pass-through effects have been quite modest since the mid-1980s. If so, the door is open for other explanations that may have a more lasting influence and require a more aggressive policy response. Something that makes me even more uncertain about the inflation outlook is that standard backward-looking Phillips curve models of inflation appear to be breaking down. It has been widely noted that the estimated effect of resource utilization on inflation in such models has become much smaller over time. But equally striking is the finding that the sum of coefficients on lagged inflation when freely estimated appears to have fallen as well, suggesting that inflation has become far less persistent. In fact, our staff finds that, in looking over the past ten years, it is better to assume that core inflation will return to its sample average over the next four quarters than that it will remain in its recent range or follow a standard Phillips curve model. Interestingly, this decline in the persistence of core inflation has occurred at roughly the same time that long-run inflation expectations, as measured by the Survey of Professional Forecasters, appear to have become well anchored, and this may not be a coincidence. Economic models with forward-looking inflation expectations tell us that, if the central bank has credibility and holds to a fixed long-run inflation target, then inflation will be less persistent than is implied by the standard backward-looking Phillips curve model. Indeed, the puzzle for macroeconomists has been why we see so much inflation persistence. Perhaps we no longer do. If that is true, inflation may decline faster than the Greenbook expects. Admittedly, the past ten years form a relatively small sample from which to draw definitive conclusions. But the inflation process may have changed in a fundamental way, and we should be open to that possibility. I would like to stress that this evidence and the analysis concern the simple correlations of the inflation data that are used for forecasting. The evidence does not relate to structural relationships, and therefore it does not necessarily inform us about how our policy decisions affect the economy or about the best course for policy. In summary, although my modal forecast is relatively benign, I remain very concerned about risks to both growth and inflation." FOMC20080625meeting--82 80,MR. BULLARD.," Thank you, Mr. Chairman. The District economy continues to be sluggish. Severe weather, combined with a very wet spring, is hampering agriculture in some areas. Major flooding has caused significant damage already, and the situation continues to develop. Many business contacts in the District emphasize energy costs along with some other high commodity prices as an overriding concern. Most of the descriptions I have encountered concern businesses and consumers scrambling to adjust to new pricing realities. Many contacts are reporting skittishness over the inflation outlook, fueled by dramatic increases in key commodity prices. Many contacts with deep experience in the commodities markets remain convinced that market manipulation or speculation is behind the run-up in commodity prices across the board over the past several years. This belief is widespread and deeply held. Many predict a crash in market prices of these commodities once the bubble bursts. My assessment is that this very strong belief may, by itself, have important macroeconomic implications. Businesses and households may be reacting very differently to price increases that they see as temporary, as opposed to their reaction if they view price increases as permanent and unlikely to reverse. Reports on the level of economic activity are decidedly mixed. The housing sector remains in a deep slump and subject to a widespread shakeup. Business in the energy sector continues to boom. High energy prices are affecting the logistics business, which has to try to be profitable at higher prices with reduced demand. Still, a very large retailer reports brisk activity, and a large technology firm is essentially unaffected by the macroeconomic slowdown. Recent data on the U.S. economy have been stronger than forecast, keeping economic performance weak but avoiding a particularly sharp contraction. The worst outcomes stemming from financial market turmoil have failed to materialize thus far. There is, to be sure, still some potential for additional upheaval, depending in part on the managerial agility among key financial firms. However, the U.S. economy is now much better positioned to handle financial market turmoil than it was six months ago. This is due to the lending facilities now in place and to the environment of low interest rates that has been created. Renewed financial market turmoil, should it occur during the summer or fall, would not now be as worrisome from a systemic risk perspective. In addition to this lessened risk from financial markets, I see the drag from housing dissipating during the second half of the year. Most likely we will also see a moderation in energy price increases. Output growth is, therefore, likely to be moderately stronger going forward. Policy was very aggressive during January and March of this year. This was, in part, a preemptive action, insurance against a particularly severe downturn brought on by financial contagion. This was a very real possibility, but it did not materialize. This has created a situation with more stimulus in train than would have been intended had we known the outcome in advance. This is putting upward pressure on inflation and inflation expectations in the second half of this year. Policy has to turn now to face this situation. On the long-term projections, I think it is a good idea to put down long-term projections. I am happy with any of the options. I have a slight preference for option 3. I think a trial run would be good. If the objective is to name these numbers, such as an inflation target or the potential growth of the economy, another way to do it would just be to name those numbers and not have it tied to any projection or any particular year. We could just say, ""This is what I think the inflation objectives should be. This is how fast I think the economy could grow in the absence of shocks. And this is what I think the unemployment rate would be if output were growing at potential and inflation were at target."" You could just name those numbers. You wouldn't have to say five years away or ten years away, which kind of brings in new long-run factors that you might not want to get into. Thank you. " CHRG-111hhrg51698--166 Mr. Damgard," The answer to that is certainly yes, to the full extent of the law. And my only point was don't confuse speculation with manipulation. I think speculation doesn't have to be as demonized as it has been. Speculators have been pretty important to the market. I believe the CFTC has done an excellent job in determining when there is manipulation in the market. Frankly, that is why you created the agency; and that is one of its foremost goals. In my judgment, there is no evidence, credible evidence to suggest that any manipulation was taking place. They looked at it long and hard, and they looked at the speculators, and there were more shorts than there were longs in the first half of last year when we saw the bubble. " FOMC20060808meeting--138 136,MR. KROSZNER.," I think it would be odd to take out the reference to housing, given that we have mentioned it a number of times in the past. The rationale clearly says that it’s “partly reflecting” and then gives a number of factors. It is not saying that those factors are the only ones. Also, I don’t interpret this language as being simply about what happened in the past; “has moderated” is also talking about where we are—that growth is not as strong as it was. I see that language as having a forward-looking aspect to it. I think it would be very odd to take housing out, partly because it’s factually accurate, even if you take the historical view, and partly because, given our discussions around the table, we are concerned about “gradual cooling.” It is appropriate to leave the reference in." FOMC20070321meeting--214 212,VICE CHAIRMAN GEITHNER.," It is what we think. The problem with it is that, as Don said, the reference to gains in income itself is empty, and putting so much emphasis on housing as part of our forecast for growth being basically fine going forward is a little awkward. My view is the corner solutions are more attractive than the intermediate, and they are either some modified version of what we have now or a return to minimalism with a stop after “quarters.”" FOMC20060131meeting--118 116,MS. BIES.," Thank you, Mr. Chairman. When I was preparing for this meeting early last week, I was feeling very comfortable with the forecast of good growth in 2006, in the mid-3 percent range near potential, and a modest uptick in core inflation above 2 percent. As many of you have already remarked, the GDP numbers on Friday made me slightly more pessimistic, both on growth and on inflation. The surprise drop in government spending, I have full confidence will turn around. Final sales fell, however, so that all the growth that occurred in the fourth quarter came from inventory growth. Given that inventory–sales ratios continue to run at historically low levels, though, inventories should continue to be a source of growth going forward. As many of you also have noted, other indicators show much stronger performance. Initial unemployment claims, goods orders, capacity utilization, and strong corporate balance sheets—all of them effectively say that we have a strong foundation underneath this growth. The inflation numbers ticking up to 2.2 percent gave me a bit of pause. We came through two good quarters, the second and third quarters, with very low inflation; but again, the uptick shows how much variability we see around the inflation numbers quarter to quarter and warrants attention. The one area—and I want to second Dave Stockton’s remark—of main concern is the housing market. Let me talk about it a little differently from some previous comments today. When we look at the aggregate levels of debt that households have and relative prices, one of the things as an old lender I worry about is the ability to service the debt and the discretionary spending that households have. While 80 percent of mortgages are fixed rate, 20 percent are variable. Starting in 2002, we saw a jump in ARMs, taking advantage of the very steep yield curve at the time. We now are in a period when not only the fancy option ARMs, the exotic products of the past eighteen months, but also the 3/1 ARMs and the five-year ARMS that became very popular in 2002 and 2003 are repricing. If interest rates just hold where they are right now, we estimate that the monthly debt service cost is going to go up by at least 50 percent on that 20 percent of mortgage portfolios. If you look at the Greenbook, you’ll notice that the financial obligation ratio rose quite substantially in the past six months. It is now back to the peaks of 2001 and 2002, and we have a lot of mortgages still to reprice. We also know that some of these exotic mortgages don’t amortize, but they will kick in and start amortization and that will also pull cash out of discretionary spending. In an overall look at consumers, with housing and the cost of heating this winter rising, you’re beginning to see a little caution in the borrowing numbers. The drop in home equity lines of credit that I mentioned a meeting or two ago now has been sustained through the whole quarter. So we have actually seen that home equity lines outstanding that have been drawn on have dropped. Consumer credit as a whole dropped, excluding mortgage credit, and mortgage growth as a whole slowed to just over 10 percent. So households are signaling that they’re pulling back on new borrowing, not just in housing but in general. When you look at the ability of consumers to spend discretionarily out of their monthly take-home pay, these are signals we need to look at. And the rising fixed payments that they have is something, in looking at the tail of the distribution on housing market risk, that I think is important for that segment of the population going forward. The other sad thing is that this is our last meeting with the Chairman, and I just personally also want to echo some of the comments of my colleagues around the table to thank you for your leadership. I’ve been very impressed with the kind of atmosphere that I found when I joined during your tenure as leader of this institution. The integrity with which everything is done, your emphasis on the quality of ideas, and your continuing to search for new ways to look at information—because the economy is dynamic—remind us that we have to watch for new things always evolving. The collegiality with which you have led this organization has made it enjoyable for all of us to be here. And finally, as an old risk manager, I was glad to feel right at home with your approach to monetary policy. [Laughter] So thank you for your leadership. It has been a pleasure to have served with you." CHRG-111shrg57923--30 Mr. Liechty," Well, I think that for the large--when people approach the financial markets, they typically approach from the statistical perspective. Even though it is a whole bunch of individual agents interacting with each other, it is too complicated typically to really model effectively. There are some folks at Los Alamos and there is a really big simulation study over in Tokyo. I know there are IBMs involved with where they are trying to do Asian-based modeling. But typically, you have to sit back and look at aggregate summaries and model it from that perspective. Now, we have a lot of information that is already about the financial markets that is widely disseminated and we would be talking about adding additional information on top of that. I think where you start to begin to have problems or people begin to influence is if you have people all doing the same type of behaviors, so lots of people are making mortgage-backed securities and securitizing them and selling them off to pension fund, and there are lots of similar behaviors happening and then a shock comes through and everybody has to respond in a similar fashion. Then, in some sense, the model collapses down to a much simpler system because everyone is forced into a corner in the way they are going to have to behave. For the most part, I think giving more information and trying to model it is not going to have an impact, because I don't know that anybody is going to really have the ability to nudge the system one way or another. But what you hope you will find is when the system gets to a point where there, in essence, are bubbles that could be collapsing and what might trigger those bubbles, how you respond to that is going to be very carefully thought about, and is going to have to be very carefully thought about by the systemic regulator and the other regulators when they have that information. Do they want to talk to banks quietly? Do they want to make a public announcement? These are things that you are going to have to think very carefully about, and I am not prepared to lay the guidelines out right now. Senator Corker. So you are not really thinking about creating a world full of elevator music or anything. We would still have some degree of chaos in the marketplace. " CHRG-111hhrg53248--200 Mr. Meeks," Thank you, Mr. Chairman. It is good to see all of you again. My first question would be to Chairman Bernanke. It seems that every time you look at reports, we seem to be getting some early signs that if not recovering, at least the recession is bottoming out. But most of the data that we looked at is based on domestic economic trends and housing, employment, etc. But we have also seen that our economy has become increasingly dependent on a broader global economy, and in particular developing countries, which have accounted for some 75 percent of global economic growth this decade and over 60 percent of growth in U.S. exports. So my question is, how do you see trends and risk in the recovery in developing countries impacting our own recovery here at home, going back and forth? " FOMC20060328meeting--107 105,MS. MINEHAN.," Next meeting, okay. [Laughter] We’ve had a wide range of contacts in New England since our last meeting, so what I’m going to do is try to summarize five or six different things that came out as a result of this range of contacts. The first point is basically driven by the data. New England continues to grow more slowly than the nation. Actually, employment growth year over year is about a third of the pace of the nation as a whole—sort of normal, in a way. New England tends to have a slower-growing population and labor force than the rest of the nation. But the recent pace of job growth is decidedly slower than the long-run average. Nonetheless, regional businesses seem to be broadly participating in the growth of the overall economy, and even the pace of losses in manufacturing jobs seems to be slowing. Indeed, merchandise exports for the region were quite strong despite continuing manufacturing job losses, suggesting that regional manufacturers have figured out a way to enjoy some productivity growth and to keep their output relatively high. Almost all contacts have been quite upbeat about sales and revenue expectations for this year. Most state corporate tax collections have been booming, and retail sales and state sales tax revenues are at or above budget almost everywhere except Rhode Island. Rhode Island seems to be going through a kind of flattening of growth. I’m not exactly sure why. At a recent conference of regionwide Realtors, optimism was expressed by heads of state Realtor groups that, so far, home sales and prices, although they are certainly moderating, have held up fairly well. And that’s even considering the fact that in the fourth quarter of last year, sales in the Northeast, unlike for the nation, declined for both new and existing homes. But ’06 was viewed by this group as proceeding fairly well. There is some evidence of tight labor markets for certain skilled jobs. We have in one of our advisory groups a CEO of a software firm that does software and consulting services oriented toward recruitment for Global 2000 customers. She reported that their clients around the world are having difficulty hiring health care, technology, finance, and professional-level sales personnel. So she was seeing some real uptick in labor market tightness at the high end. And I must say that when you look at commercial vacancy rates, which have declined for Class A downtown and suburban space, not just in Boston but elsewhere, you seem to get the impression that maybe businesses haven’t started to hire yet but they do have plans to hire and they do have plans to hire at the high end. Finally, local measures of price growth remain quite contained, though headline CPI data indicate that the region has suffered more than the nation from high energy and utility costs, even with the quite mild winter. In assessing the reaction of contacts about cost increases, we heard a bit less complaining this time around. Maybe people have just given up complaining, or perhaps they have found ways—and I think this is probably more true than not—to offset high commodity and energy costs through rising productivity. The picture for the nation is even better than it is for New England. We, like the Greenbook authors, have been a bit surprised and pleased at the strength of the incoming data after the bump in the fourth quarter. David mentioned all the good reasons to be pleased—strong employment, solid consumer spending, not much evidence yet of a large drag from housing, solid business investment and production, very favorable financing conditions, faster growth than the rest of the world, and through it all, moderating headline and rather flat core inflation, whether you look at the CPI or the PCE, reflecting a leveling-out of energy prices and continued strong productivity growth. True, some luck has been involved, particularly the rather temperate winter weather in the Northeast, with its good news for overall energy and electricity costs. And the drop in new home sales may be a harbinger of worse to come. But the first quarter is over, and it was stronger than we expected, even allowing for a bounceback from Q4. Looking ahead, we agree with the general trajectory of the Greenbook forecast, as we have for some time. However, we have penciled in a somewhat greater effect in ’06 on growth from the expected falloff in housing—that is, an actual small decline in residential investment in every quarter this year and a related effect on consumption from a flattening of the growth in household wealth. So our GDP forecast for ’06 is somewhere between three- and four-tenths lower than the Greenbook’s, though ’07 is just about the same. We also see a smaller uptick in core inflation this year, largely because we see labor markets as having a bit more capacity than does the Greenbook, which we believe accounts for some of the moderation in wage and salary growth, at least by some measures. It may be splitting hairs to mention what in the end are small differences between Boston’s forecast and the Greenbook’s. After all, we don’t have the same number of resources in Boston focusing on making a forecast as you do here for the Greenbook. But I think we are at a point where small differences in outlook really do affect how each of us sees the policy choices. Now, what are the risks around this benign, if not rosy, outlook? Will they continue to revolve around growth that is higher than expected, prompted by a continuation of consumer strength—if, for example, housing takes less of a bite out of growth than we expect—and by financial conditions that could remain more stimulative as well? Indeed, when we look both at where we’ve been off in evaluating the outlook over the past couple of years and at our own Boston forecast, the surprises have mostly been the result of rising household wealth and a related set of very favorable financial market conditions. If these conditions continue, greater inflationary pressure than we expect could well result, given where we are in terms of resource utilization. And of course, new energy shocks are possible, given the possible geopolitical unrest and tight supply conditions. Alternatively, looking at risks on the other side, a greater-than-expected slowdown in housing, with a related larger pickup in saving rates, could put an unexpected damper on growth. Absent new energy shocks, this would act to moderate both growth and inflationary pressures more than expected. So we see housing as integral to both upside risks and downside risks. As I see it right now, the risks to the forecast appear relatively well balanced, maybe a touch to the side of inflation. That’s mostly because we’ve had a lot of recent experiences with surprises on the upside relative to growth, with rising energy and commodity prices, and overall resource capacity is hard to be very precise about. However, I really don’t see large upside inflation risks, mostly because of what we’ve seen in terms of ongoing productivity growth. It remains solid, and it continues to act as a powerful buffer. Indeed, despite the temporary drop-off in Q4, I have not seen or heard anything from my contacts that suggests the underlying business drive to be ever more productive will slow, or slow anytime soon. So although my assessment of risks has a small upside tilt and I am concerned about how expensive being very wrong on the inflation side would be, I don’t see the situation as significantly unbalanced." FOMC20070918meeting--109 107,MR. LACKER.," Thank you, Mr. Chairman. Recent information from the Fifth District, both from contacts and from our survey responses, suggests that growth in economic activity in our District has slowed in recent weeks. The survey indicates that retail sales have weakened, with big-ticket categories such as automobiles and building materials leading the way. Shopper traffic has trailed off somewhat as well. Services firms report slower revenue growth and less optimism about demand going forward. Activity in some District housing markets has slowed markedly in the past two to three weeks, and some formerly healthy markets are now showing signs of weakness. One contact in Charlotte, for example, says that sales agents there are saying the same things they were saying in Atlanta several months ago. Residential foreclosures are more widespread, though they appear to be concentrated or overrepresented among investors rather than owner-occupants. Mortgage activity has fallen off in the past several weeks, according to our contacts. While standards have tightened for marginally qualified applicants, it is reported that mortgages remain readily available for creditworthy borrowers. The CEO of a nationwide title insurance company reports that their open orders have been trending down in recent weeks. He also says that they are seeing an increase in cancellations of title insurance orders because people are applying for more than one mortgage in the current climate. In contrast, commercial real estate conditions appear generally healthy, although recent reports suggest that closer scrutiny is being given to marginal project proposals. Conditions in manufacturing also look positive, shipments and new orders continue to expand, and hiring indicators for this sector have edged higher. District price pressures remain at about the same level they have been in recent months. Let me say that, broadly speaking across our contacts, we have heard in the past week or two more reports mentioning a sense of gloom. This echoes what Presidents Pianalto and Lockhart said. On the other hand, one contact in Charlotte, who has had a lot of successful experience in real estate markets, said that compared with past crises this is a walk in the park. Maybe that is just because he has made his. It may be particular to this situation, so I don’t want to make too much of that. The national economic data that we have received since our last meeting point pretty clearly to a weaker economic outlook for real growth. The employment report is a prominent example. Slower growth in the months ahead would weigh on income growth and consumption, although the Greenbook’s outlook for income remains pretty healthy. Recent reports on housing activity have also been quite disappointing. I think the key question is the effect on the housing market and broader economic activity of the recent financial market turmoil. I won’t survey what has happened; Presidents Yellen and Rosengren and Mr. Dudley did an excellent job on that. I will just comment that it seems, broadly speaking, as if we are on a traverse from a configuration of intermediation that placed a fairly heavy reliance on fairly complicated and structured products and rating agencies’ assessments of those. It is a traverse that is obviously going more rapidly and is fraught with more peril than the path that took us to the configuration we are coming from. So it is hard to know how much of an effect this turmoil will have on housing. I suspect that a lot of the slowdown was already in train before the middle of August. I base that thought on the fact that many mortgage rates rose earlier in the summer than August, though the jumbo market is an obvious exception to that. Beyond housing, any projections of real effects from events in financial markets seem like guesswork at this point. My sense is that, while we may see some marginal slowing in business investment, the effects are likely to be small because I don’t think the marginal cost of funding for most businesses has gone up much and we aren’t hearing reports of wholesale tightening of lending standards in the corporate sector. I haven’t heard that from around the country either. I expect consumer spending to grow more slowly than in recent years, but not too dramatically so. I think that there is a fair amount of uncertainty about the size of the housing wealth effect and that household net worth overall remains fairly high relative to income at this point. As I noted earlier, the Greenbook’s projection for disposable income isn’t too bad, so that would support consumption growth at least at a moderate pace going forward. Overall, then, I come out a touch above the Greenbook, with real growth about 2 percent in the second half and then gradually returning to trend. Of course, I have been expecting less of a slowdown than the Greenbook for about a year now. It turns out that, although we have both been too optimistic, the Greenbook has been closer to reality, so my confidence in my forecasting ability is waning here. The inflation numbers have been encouraging. Core PCE inflation averaged under 1.4 percent for the past five months, and overall PCE inflation was under 2 percent for both June and July. I am particularly pleased that TIPS inflation compensation has not increased even as market participants have marked down their expected funds rate path in the midst of the recent turmoil. That said, it still looks as though market participants expect inflation to settle near 2 percent rather than lower, as I would prefer. That concludes my remarks." CHRG-111shrg57319--113 Mr. Cathcart," It depended very much on the business unit and on the individual who was put in that double situation. I would say that in the case of home loans, it was not satisfactory because the Chief Risk Officer of that business favored the reporting relationship to the business rather than to risk. Senator Coburn. And this is a hard question to answer, but I hope you will make an attempt to do it. Was there a point in time when you recognized the writing on the wall in terms of the fraudulent activity? Mr. Vanasek, you saw a bubble coming, and Mr. Cathcart, I am not sure that we have any comments from you. But was there a point in time when you knew that things were going to come unwound? " CHRG-111hhrg56766--162 Mr. Meeks," Thank you, Mr. Chairman. It is good to see you, Chairman Bernanke, and congratulations on your reappointment, and thank you for your service. My question--and I'm trying to focus more around real estate and the housing industry, I know some of which you deal with and some of which you do not based upon some of the questions, but it is to me--most Americans, it is their largest investment that they will ever make--is in their home. And in listening to some of your testimony earlier, and I know that by, I guess, March 31st, you are scheduled to end the Fed's program to buy more mortgage-backed securities from Fannie Mae and Freddie Mac-backed debt, and I guess there is pressure to tighten up. And the last time the tightening took place, I think it was about 33 months ago, after the recession began and foreclosure rates were 4 times lower than they currently are. And there are signs, from what you are saying now, of growth. But my first question is, is it a little premature to consider tightening today because--will that kill the incipient housing recovery by tightening today and then hurting the housing market? " fcic_final_report_full--171 All along the assembly line, from the origination of the mortgages to the creation and marketing of the mortgage-backed securities and collateralized debt obligations (CDOs), many understood and the regulators at least suspected that every cog was reliant on the mortgages themselves, which would not perform as advertised. THE BUBBLE: “A CREDITINDUCED BOOM ” Irvine, California–based New Century—once the nation’s second-largest subprime lender—ignored early warnings that its own loan quality was deteriorating and stripped power from two risk-control departments that had noted the evidence. In a June  presentation, the Quality Assurance staff reported they had found severe underwriting errors, including evidence of predatory lending, legal and state viola- tions, and credit issues, in  of the loans they audited in November and December . In , Chief Operating Officer and later CEO Brad Morrice recommended these results be removed from the statistical tools used to track loan performance, and in , the department was dissolved and its personnel terminated. The same year, the Internal Audit department identified numerous deficiencies in loan files; out of nine reviews it conducted in , it gave the company’s loan production depart- ment “unsatisfactory” ratings seven times. Patrick Flanagan, president of New Cen- tury’s mortgage-originating subsidiary, cut the department’s budget, saying in a memo that the “group was out of control and tries to dictate business practices in- stead of audit.”  This happened as the company struggled with increasing requests that it buy back soured loans from investors. By December , almost  of its loans were going into default within the first three months after origination. “New Century had a brazen obsession with increasing loan originations, without due regard to the risks associated with that business strategy,” New Century’s bankruptcy examiner reported.  In September —seven months before the housing market peaked—thou- sands of originators, securitizers, and investors met at the ABS East  conference in Boca Raton, Florida, to play golf, do deals, and talk about the market. The asset- backed security business was still good, but even the most optimistic could read the signs. Panelists had three concerns: Were housing prices overheated, or just driven by “fundamentals” such as increased demand? Would rising interest rates halt the market? And was the CDO, because of its ratings-driven investors, distorting the mortgage market?  CHRG-109hhrg31539--205 Mr. Baca," Thank you very much, Mr. Chairman, and Ranking Member Frank, for having this hearing. And thank you, Mr. Bernanke, for being here as well. First, I want to start on the housing crisis. As the housing crisis market slows, areas like California, the Inland Empire where I have quite a few people moving in from L.A., Orange County, into the area, have been heavily dependent on real-estate-related employment will suffer the most. If prices start to drop in San Bernardino County, and homes stay on the market for 5 months instead of the 5 days, it hurts more than just the sellers. It also leads to less work for people, and I state less work for people who build new homes and those who help sell, finance, or insure them. Thousands of people's jobs are at stake, including home construction, real estate agents, mortgage brokers, inspectors, and more. Question number one is what industries of the economy have enough strength to pick up the slack as the housing market continues to cool? And question number two is what will the cooling housing market mean for job growth and unemployment numbers? " FOMC20080625meeting--84 82,MS. PIANALTO.," Thank you, Mr. Chairman. The last two months have brought an interesting shift in my conversations with my business contacts. Their concerns have shifted from problems in financial markets to the rapid increase in input prices. Energy prices are the focus nationwide, but steel prices are also capturing the attention of the business people in my District. Several manufacturers and builders noted that the price they pay for steel has almost doubled since the beginning of this year. Clearly, businesses are worried about signs of growing price pressures, but their reactions to these price shocks tell a more complicated story. Many manufacturers have not been able to pass on price increases, resulting in a clear loss to profit margins. These businesses often report cost-containment or efficiency programs that will affect their hiring and capital decisions for months to come. Interestingly, the consumer price data show a similar dichotomy. My staff noted that our primary measures of core inflation are not providing a consistent story about the path of underlying inflation. In the May CPI report, roughly one-third of the weighted price changes increased at rates above 5 percent, and roughly one-third of prices changed by rates less than 1 percent. For example, while energy costs were up strongly and prices for a number of general service components have been drifting higher, large declines in apparel and vehicle expenses are imparting significant offsets. The 16 percent trimmed mean indicator showed an alarming 4 percent rise in prices, while the median rose just at 2.2 percent. The weight of price changes in the 1 percent to 5 percent range was unusually small, making it difficult to estimate the central tendency of the price change distribution with much confidence. So this makes it difficult to get a good read on where future prices are headed. My District business contacts remain pessimistic about growth prospects. District retail reports focused extensively on the likely effects of gasoline and food prices on the purchasing decisions of consumers. Many manufacturers, builders, and distributors are facing complicated output and investment decisions in the context of input price growth and weaker markets. Overall, most of the business people that I talk with are still quite cautious about their business plans, despite the fact that most of them have found sources of credit and terms that are not too elevated from what they have seen in previous years. In the economic projections that I submitted for this meeting, I raised my near-term forecast for output growth slightly and for headline inflation slightly more. Over the medium term, my outlook continues to be for modest growth because the housing market, in my forecast, recovers slowly, actually more slowly than in the Greenbook. My staff estimated a model for national housing starts that takes into account what has happened in the past in states that have seen major increases in foreclosures. The real estate difficulties that these states faced were much more persistent than anything that we have yet seen in the national data. The bottom line of this analysis is that, if the patterns of past housing cycles from the states that experienced the boom�bust cycles are repeated at the national level, then housing starts should remain relatively weak over the next couple of years. Supporting this analysis, three of the large regional banking organizations in my District are increasing their loan-loss provisions significantly in the second quarter based on the continued deterioration in the housing sector. Based on current projections, these institutions are projecting housing sector credit losses to accelerate in the second half of 2008 and to continue into 2009. Currently, the weak output growth contributes to my forecast of declining inflation rates, especially the core rate, but I also see evidence supporting that view in the ""less worker bargaining power"" scenario that is in the Greenbook. My contacts see very little price pressures coming from labor costs now or in the near future. Finally, implicit in my forecast for output growth and inflation is a fed funds rate path that includes increases later this year and into next year. Although additional risks to growth remain, the primary risk to my forecast concerns input prices and inflation expectations. If commodity prices continue to accelerate, they are going to put upward pressure on both headline and core inflation and downward pressure on output. That environment could lead to a highly undesirable increase in inflation expectations. On the positive side of risk to the outlook, I think that the fed funds rate actions that we have taken, in conjunction with the actions that we took in August to bolster market liquidity, have improved confidence, and I have substantially lowered the odds I had placed on financial market meltdown and on a severe recession. In that sense, since our meeting in April the downside risks to my outlook for economic growth have lessened somewhat, and the risks to my inflation outlook have moved up somewhat. Regarding the issue of providing longer-term forecasts, I have long supported efforts to clarify the underlying objectives of FOMC participants by providing our longer-term economic projections. Of the proposals that were offered by the Subcommittee on Communications, I favor reporting the average values for output growth, unemployment, and total inflation expected over a five-to-ten-year period--option 3. The features of these five-to-ten-year projections that I find attractive are that they indicate where the economy might converge and don't imply too much knowledge of the path to the long run. Thank you, Mr. Chairman. " FOMC20051213meeting--27 25,MR. STOCKTON.," Thank you, Mr. Chairman. In the spirit of the season, I am tempted to report that I bring you great tidings of comfort and joy. However, this is, after all, the Federal Reserve, so it is probably more appropriate to simply note that tidings have improved modestly over the intermeeting period. While not quite in the miracle category, we have raised our projection for the growth of real GDP over the next two years and lowered our projection of price inflation. As you know, we revised up our estimate of the growth in real GDP in the third quarter by more than a percentage point and left fourth-quarter growth unchanged. As a consequence, real output is now projected to expand at an annual rate of nearly 4 percent in the second half of this year—about ½ percentage point faster than we were forecasting in October. The surprising strength in recent months has been widespread. But clearly, one of the standout areas of strength has been consumer spending. To be sure, sales of light motor vehicles were a bit softer than we had expected, but that was more than offset by considerably stronger consumer outlays in other areas. This morning=s retail sales report for November provided further evidence of the underlying strength in consumption. Although spending in the retail control category, which excludes sales at auto dealers and building supply stores, dropped 0.6 percent last month, that decline was more than accounted for by lower gasoline prices. In real terms, we estimate that spending was up more than 1 percent for the month. That figure is somewhat stronger than we had expected and would likely cause us to revise up the growth of consumption nearly ½ percentage point at an annual rate in the fourth quarter. December 13, 2005 10 of 100 In light of the 1 percentage point upward revision that we made to real GDP growth in third quarter, it may appear a bit surprising that we only carried the higher level, and not a higher growth rate, into the fourth quarter. But part of our upward surprise in the third quarter was in non-auto inventory investment. With stocks appearing reasonably well aligned with sales in most sectors, we didn=t see the need to make any further upward adjustment to this aspect of the forecast. Moreover, some of the third-quarter strength in GDP reflected defense spending that seemed likely to have been pulled forward from the fourth quarter. Both of these judgments appear to have been supported, and then some, by incoming data in the past two days. Yesterday=s Monthly Treasury Statement and this morning’s reading on retail inventories suggest that both defense spending and inventory investment are likely to be even weaker in the fourth quarter than we had written down. Balancing these softer readings against the stronger retail sales data would leave our forecast for real GDP growth in the fourth quarter unchanged at about 3½ percent. In contemplating the forecast for 2006 and 2007, we had to make some assessment of the sources of the strength in activity in the second half of this year. As we had anticipated would be the case back in September, we are now in the position of having to interpret whether the errors in our forecast of aggregate activity reflect misestimates on our part of either the hurricane effects or of the underlying behavior of the economy. We do believe that some of the surprising strength of activity is probably attributable to smaller negative effects from hurricanes than we had previously penciled in. To be sure, production in the energy sector is coming back a bit more slowly than we had expected, especially production from the off-shore platforms in the Gulf of Mexico. But outside of energy, production appears to be recovering more quickly. Output of chemicals, paper, rubber and plastics, and some areas of food processing improved noticeably in October and November. And we look to be getting a bigger plus from the production of construction supplies. On the spending side, the hits to consumption of housing services, food, and gasoline—areas that we had thought would be affected by hurricane-related disruptions—appear to have been smaller over the past few months than we had incorporated in our previous couple of forecasts. Of course, most of this remains educated guesswork and needs to be taken with a grain of salt. But all in all, we are inclined to attribute a few tenths of the surprising strength in second-half growth to smaller hurricane effects. December 13, 2005 11 of 100 However, the information that we have received over the past six weeks has not been confined solely to aggregate demand. Developments on the supply-side of the economy also appear to have been more favorable than we had expected. The surge in output growth last quarter was accomplished with almost no increase in hours worked. Consequently, output per hour in the nonfarm business sector rose at a 4½ percent annual rate in the third quarter and is now estimated to have been up more than 3 percent over the past four quarters. As optimistic as we have been, the data have continued to outflank us on the upside in recent quarters. In response to this continued good news, we revised up our estimates of structural labor productivity. In addition to an upward adjustment to the level this year, we boosted the growth of structural labor productivity about ¼ percentage point to a bit above 3 percent in both 2006 and 2007. Capital deepening is making a slightly larger contribution to this estimate, but most of the upward revision has occurred in multifactor productivity. Despite being nearly a decade into this favorable productivity wave, there are few signs that the efforts or abilities of businesses to implement greater technical and organizational efficiencies are flagging. On balance, the revisions that we made to aggregate demand were a touch larger than those we made to aggregate supply, and we estimate the output gap to be slightly narrower, on average, over the next two years than in the previous forecast. In response to these developments, we raised our path for the funds rate another 25 basis points, to 4½ percent by early next year. Despite these modest adjustments, the basic contour of our forecast remains unchanged. After increasing 3¾ percent this year, the rise in real GDP slows to 3½ percent in 2006 and 3 percent in 2007. That pattern reflects several powerful crosscurrents. We expect activity to be boosted early next year by rebuilding efforts in the Gulf Coast region. Moreover, with energy prices projected to level out after increasing sharply over the past two years, the drag on aggregate demand from the earlier run-up in prices should begin to ebb. But these positives are more than offset by fading fiscal stimulus, the lagged effects of tighter monetary policy, and a gradually diminishing impetus to consumer spending from equity and housing wealth. In sorting through the details of our forecast, it should be pretty obvious that a flattening out of activity in the housing sector is one of the principal sources of slower aggregate growth. After contributing about ½ percentage point to growth in real GDP per annum over the past four years, we are projecting residential investment to be a roughly neutral factor over the next two years. But that is still all forecast. To date, the hard data on housing have remained solid. Housing starts have remained at elevated levels, new home sales hit a record high in October, and house prices as measured by the OFHEO purchase index continued to increase at a double-digit pace through the third quarter. December 13, 2005 12 of 100 Board briefing, a variety of indicators of housing activity have turned down in recent months. Household attitudes toward home buying have dropped sharply; builder ratings of new home sales have deteriorated; the index of mortgage applications for home purchase has fallen off; and the inventory of unsold homes has moved up. Taken in isolation, none of these measures has an especially reliable statistical relationship to housing activity. But taken together, they could be indicating that we are at the front edge of some cooling in these markets. I offer one more piece of evidence that I think almost surely suggests that the end is near in this sector. While channel surfing the other night, to the annoyance of my otherwise very patient wife, I came across a new television series on the Discovery Channel entitled “Flip That House.” [Laughter] As far as I could tell, the gist of the show was that with some spackling, a few strategically placed azaleas, and access to a bank, you too could tap into the great real estate wealth machine. It was enough to put even the most ardent believer in market efficiency into existential crisis. [Laughter] Only time will tell if these indicators are giving us a head fake or are the start of our long-awaited slowdown in this sector. For now, we are sticking with our call that housing activity will level off next year. Moreover, we continue to anticipate that a more visible deceleration in house prices will be in evidence by the middle of next year, and the associated slower growth of household net worth contributes to the projected up-tilt in the personal saving rate. In our view, both of these developments are critical for damping growth by enough to prevent the economy from overheating. To date, the news on inflation does not suggest that we have overshot the mark on potential, though our ability to make that assertion with any confidence in real time is admittedly very tenuous. To begin, measures of core consumer prices came in a bit below our expectations. We also had a faster unwinding of the earlier hurricane-related increase in retail energy prices. Survey measures of inflation expectations have retraced virtually all of this autumn=s run-up, and TIPS [Treasury inflation-protected securities] -based measures of inflation compensation have retreated as well. On the cost side, lower hourly compensation and faster growth in structural productivity imply less pressure from labor costs, and the markup of prices over unit labor costs has risen further, pointing to a somewhat larger cushion between costs and prices. December 13, 2005 13 of 100 Obviously, there are some very important risks on both sides of our forecasts for real activity and inflation, and we tried to highlight some of the more prominent ones in the Greenbook. I recognize that our baseline forecast, in which the economy=s growth slows to about trend, output settles out at a level very close to potential, and inflation pressures ease a bit, all with just a little more tightening of policy, seems too good to be true. No doubt, events will conspire to force adjustments, both major and minor, on the staff projection. Perhaps I=ve just written the “flexibility and resilience” speech for the Chairman so often over the past few years that I=m suffering from something akin to the Stockholm syndrome—the tendency of hostages over time to sympathize with the views of their keepers. [Laughter] But as I look back over the past year and observe how well the economy performed in the face of some pretty substantial shocks, I don=t think our optimistic outlook is unwarranted. Karen will continue our presentation." FOMC20061025meeting--76 74,MS. YELLEN.," Thank you, Mr. Chairman. Five weeks have passed since our last FOMC meeting, and not surprisingly the outlook does not appear to have changed in any fundamental way. Recent data bearing on the near-term situation point to noticeably slower growth in the third quarter than we anticipated at our last meeting. However, the Greenbook has revised up its projection for growth during the current and next few quarters so that the overall effect on slack next year is roughly neutral. This forecast strikes me as plausible, but there are few data thus far to bear it out. Meanwhile, measures of consumer price inflation remain uncomfortably high, although the latest readings have been very slightly better. With regard to the pace of economic activity, there’s uncertainty in all directions. In fact, we seem to have a bimodal economy with a couple of weak sectors, and the rest of the economy doing just fine. Those two weak sectors are, of course, housing and domestic auto production. Autos seem likely to have only a short-lived effect. In the case of housing, we agree with the Greenbook assessment of housing activity and find it quite consistent with the reports of our contacts in this sector. Besides the falloff in activity, house-price increases have also slowed markedly. The Case-Shiller house-price index has been flat in recent months, and futures on this index show outright declines next year. However, equity valuations for homebuilders, as Cathy mentioned, have risen moderately in the past couple of months, following large declines over the previous year, and we interpret that as providing some indication that the expected future path of home prices has at least stopped deteriorating. Of course, housing is a relatively small sector of the economy, and its decline should be self-correcting. So the bigger danger is that weakness in house prices could spread to overall consumption through wealth effects. This development would deepen and extend economic weakness, potentially touching off a nonlinear type of downward dynamic that could trigger a recession. But so far at least, there are no signs of such spillovers. Consumption spending seems on track for healthy growth. Nonetheless, the growth estimate for the third quarter begins with a 1 and just barely. Any time a forecast is that low, it’s reasonable to consider the possibility that the economy could enter recession. So for this reason, we, like the Board’s staff, took a careful look at various approaches to assess this issue, including yield-curve-based models, past forecast errors, leading indicator models, and surveys. Our bottom line is that we agree with the basic results reported in Monday’s nonfinancial briefing. The highest probability of recession that we found, around 40 percent, was obtained from a model developed by a Board staff member. The model includes the slope of the yield curve and the level of the funds rate. An issue with this result is that long-term rates may currently be low, hence the yield curve inverted, for unusual and not very well understood reasons having to do with the risk premium. Estimates from the other approaches came in with lower probabilities. Finally, other financial developments that could presage future economic performance, like stock market movements and risk spreads, suggest some optimism on the part of financial market participants. So our sense is that, except for housing and autos, the economy appears to be doing quite well. Indeed, the recent rather sharp drop in energy prices could boost consumption spending even more than assumed in the Greenbook. While this is a possibility, it seems more likely to me that households ran down their savings to fill their gas tanks when gas prices rose and are, therefore, likely to use their recent savings at the pump to bolster their finances, at least partly. Overall, under the assumption of an unchanged funds rate, our forecast shows a beautiful soft landing, with real GDP growing at a moderately below-trend pace for a few more quarters and homing in near trend thereafter. But I must admit that we got this forecast essentially by averaging the strong and weak sides of the economy. I think that way of proceeding is reasonable, and I hope the landing happens that way. But I acknowledge there is plenty of risk. We may end up instead with either the strong or the weak side dominating the outcome. For example, if the housing market decline does not spread significantly to consumption, we could end up with a strong economy in fairly short order. However, if it does spread, the slowdown could last quite a while. Scenarios like this are nicely spelled out in the alternative simulations in the Greenbook. Which way things go is a key issue, given that we’re in the vicinity of full employment. The desired soft landing depends on growth remaining below trend long enough to offset the moderate amount of excess demand that appears to be in the economy so that inflation can trend gradually lower. The slight drop in unemployment, to 4.6 percent, in September did not help in that regard, and I should note that recent comments by our head office directors almost uniformly supported the idea that labor markets, especially for skilled workers, are tight. However, we do expect the unemployment rate to edge higher over the next year in response to sluggish growth. Our forecast for core consumer inflation comes down a bit faster than foreseen by the Greenbook. We have core PCE price inflation edging down from just under 2½ percent this year to just over 2 percent in 2007 and see a good chance that it may fall a bit below 2 percent in the following year. We see the relief on energy prices as helpful, although we keep trying to resist any temptation to overestimate the extent to which past energy price pass-through has been boosting core inflation. Inflation also may benefit from an unwinding of the earlier strong pressures on rents. Finally, as in the discussion we had earlier about the alternative Greenbook scenario, we think inflation may have become less persistent over the past decade, and this is one reason that we’re a bit more optimistic than the Greenbook about the possible degree of disinflation over the next couple of years. But on balance, I have to admit we don’t have a perfect understanding of why inflation has been so high over the past few years, and so I try to remain humble, as always, in my predictions. My bottom line is this. I see a non-negligible chance that the downside risks to the economy, emanating especially from housing, could produce a recession in coming quarters, but there’s a very good chance that the spillovers will be sufficiently modest that the economy will avoid a recession. I also see a significant chance that growth could modestly exceed potential. In that sense, the overall risks to the outlook for real GDP growth could be characterized as balanced. In addition, I see quite a bit of uncertainty about inflation going forward with the risks to my forecast probably being a bit to the high side." FOMC20060328meeting--164 162,CHAIRMAN BERNANKE.," Thank you. I would like now to summarize these views and add a few comments of my own. At that point, if there are additional comments or questions, they will be welcome. We have had, I think, a fairly upbeat group here the last couple of days, which is of course good, both in terms of views of economic activity and in terms of keeping inflation well controlled. The economy appears to be quite strong, but my sense is that most people feel that risks on that score are relatively balanced, which I take to imply that, after being strong in this quarter, growth will slow to something closer to a more-sustainable pace in the remainder of the year. Perhaps the leading source of uncertainty on the output side is the housing market, but I was reassured to hear that most participants think that a decline in housing will be cushioned by strong fundamentals in terms of income, jobs, and continuing low interest rates. The labor market is clearly continuing to strengthen, but I heard not too many concerns about increasing wage pressures. There was some discussion about shortages of more highly skilled workers, which presumably might affect wages at some point but apparently has not so far; and there was additional discussion of productivity gains, which are helping to keep unit labor costs down and to support growth. On the inflation side, I have not been in this conversation for a while, but I was impressed at least relative to a year ago that the angst about inflation seems to have declined. Clearly, inflation expectations are well anchored. Margins are high, and the sense of the group was that pass-through to consumer inflation was likely to be limited. Still, I took from the group some sense of at least a slight upside risk to inflation, reflecting the increasing resource utilization; the fact that inflation is somewhat on the high side of what many people describe as their comfort zone; and the fact that, if inflation does rise, there will be costs to bringing it back down and maintaining our credibility. So that is my overall summary of the Committee discussion. My own views, you will probably not be surprised to hear, are not radically different from what we have heard around the table. I would point out, first, that except for housing, the economy continues to be very strong. One might be tempted to average the expected rate of growth of the first quarter at about 4½ percent with the 1½ percent of the fourth quarter and say we’re at a pace of about 3 percent, but then I would remind you that we had 4.1 percent in the third quarter despite Katrina and about 3.7 percent average growth in the first three quarters of ’05. We have a strengthening world economy. We have consumption that looks likely to be well supported by income and jobs. Several people have talked about the strength of investment in nonresidential construction. Job creation at about 200,000 a month is clearly above the long-run sustainable rate. So except for housing—and that is, of course, a critical sector—it looks as though the economy is, if anything, growing more quickly than potential. Housing is the crucial issue. To get a soft landing, we need some cooling in housing. So far there is a good bit of evidence that there has been a peak, but we do not know a great deal more than that. So obviously we are going to have to watch carefully. The range of possible outcomes is quite wide. I agree with most of the commentary that the strong fundamentals support a relatively soft landing in housing. A pessimist might point out that the expectation of future price increases is itself an important part of the user cost of housing. A sea change in people’s views about what is going to happen to house prices in the future might significantly affect their perceived cost of owning a house and lead to lower prices and to weaker activity. On the other side, residential investment is, of course, only about 6 percent of GDP, and so long as consumption is well maintained by incomes, jobs, and other factors, I think it would take a very strong decline in the housing market to substantially derail the strong momentum for growth that we are currently seeing in the economy. What we might see in the next few quarters is some quarter-to-quarter variation. We may not have the stability of growth that we have had the last couple of years. If that happens, we should be willing to accept it. I might offer a very rough analogy to the way we think about energy prices and core inflation. With core inflation, our goal is to accommodate energy prices but to make sure that they do not get into the underlying rate of inflation. Again, this might be a rough analogy, but if the housing market moves significantly, we should perhaps not try to upset that movement but rather just try to ensure that the resources that are released are deployed in the rest of the economy and that the rest of the economy remains on a stable path. Again, I think we are unlikely to see growth being derailed by the housing market, but I do want us to be prepared for some quarter-to- quarter fluctuations. So, broadly speaking, I agree with the Committee that we should see some cooling for the remainder of the year and that we should approach a more-sustainable pace of growth. But I think there is some upside volatility risk, if you will, because of the fluctuations in residential investment. On inflation, like most of you, I am struck by how well behaved core inflation has been. Indeed, in 2005, core inflation was even slightly lower than it was in 2004, and we have all pointed to a number of explanations, including well-anchored inflation expectations, international competition, productivity growth, and since I wasn’t here, I can say good Fed policy. [Laughter] One area of uncertainty in trying to look forward is unit labor costs. Remarkably, unit labor costs in the nonfarm business sector grew only 1.3 percent in 2005, but as was already mentioned in the staff presentation, I think that understates the trend because it is coming off the surge in the fourth quarter of ’04 in bonuses, stock options, and other types of one-time compensation. If you smooth through that bulge, it looks as though the underlying trend of unit labor costs is more like 1.7 percent, and perhaps that may have some upward bias. There is certainly a lot of uncertainty about that, though. We have seen some indicators, such as average hourly earnings, rising. Other indicators, such as the employment cost index, are slowing. I just point this out as a significant source of uncertainty, given how difficult it is to forecast both compensation and productivity going forward. So, again, the stability of inflation in the last couple of years is very reassuring. I would note, however, that over the past three years, since 2003, we have seen a pickup in inflation. That was, of course, by design, but I think it is important for us to think about why that happened. There’s something of an identification problem here. To the extent that the increase in inflation over the last two to three years reflected the pass-through of energy costs and commodity prices, that is actually good news in a sense because, to the extent that those factors soften and flatten in the coming year, we should see some reduction in inflation in ’06 and ’07. To the extent that inflation increases in the last two and a half years reflected increased resource utilization, the strength in the economy, and the return of pricing power, however, there is a bit of concern that we may see some additional updrift of inflation in the next few quarters. Like most of you, I am not at all alarmist about inflation. I think the worst that is likely to happen would be 20 or 30 basis points over the next year. But even that amount is a little disconcerting for me. I think it is very important for us to maintain our credibility on inflation and it would be somewhat expensive to bring that additional inflation back down. So my bottom line on inflation is that there is a very modest upside risk. Again, I think it’s not a large risk but one that we probably should pay attention to. Are there any comments or questions to close our round on the economic outlook? If not, we can move to the policy round. In a moment I’m going to turn to Vincent to introduce the policy options in the statement. Before I do that, I just want to note that we have left unresolved the discussion about the ownership of the statement—in particular, what we are voting on when we vote at the end of the meeting. Currently we vote on the action, on the directive, and on the risk assessment but not on the rationale. The rationale has, however, been largely a consensus paragraph worked out by the Committee. My sense is that this decision is not entirely separable from a wide range of other issues we may want to talk about over the next few quarters concerning the content of the statement, its structure, whether we use forward-looking language, and whether we consider adopting some kind of numerical guidepost for inflation. And so what I would like to do, if it is okay with the Committee, is to maintain the status quo for today in terms of our voting in this statement. By the next meeting, in May, I will come back to the Committee with a proposal for a process by which we can address this whole range of issues over a period of time, and on the top of the agenda for that process will be the ownership of the statement. Is that acceptable? All right. Seeing assent, we will maintain the status quo on the statement just for today. Vincent, whenever you are ready." 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." fcic_final_report_full--50 Then, beginning in , the Federal Reserve accommodated a series of requests from the banks to undertake activities forbidden under Glass-Steagall and its modifi- cations. The new rules permitted nonbank subsidiaries of bank holding companies to engage in “bank-ineligible” activities, including selling or holding certain kinds of se- curities that were not permissible for national banks to invest in or underwrite. At first, the Fed strictly limited these bank-ineligible securities activities to no more than  of the assets or revenue of any subsidiary. Over time, however, the Fed re- laxed these restrictions. By , bank-ineligible securities could represent up to  of assets or revenues of a securities subsidiary, and the Fed also weakened or elimi- nated other firewalls between traditional banking subsidiaries and the new securities subsidiaries of bank holding companies.  Meanwhile, the OCC, the regulator of banks with national charters, was expand- ing the permissible activities of national banks to include those that were “function- ally equivalent to, or a logical outgrowth of, a recognized bank power.”  Among these new activities were underwriting as well as trading bets and hedges, known as derivatives, on the prices of certain assets. Between  and , the OCC broad- ened the derivatives in which banks might deal to include those related to debt secu- rities (), interest and currency exchange rates (), stock indices (), precious metals such as gold and silver (), and equity stocks (). Fed Chairman Greenspan and many other regulators and legislators supported and encouraged this shift toward deregulated financial markets. They argued that fi- nancial institutions had strong incentives to protect their shareholders and would therefore regulate themselves through improved risk management. Likewise, finan- cial markets would exert strong and effective discipline through analysts, credit rat- ing agencies, and investors. Greenspan argued that the urgent question about government regulation was whether it strengthened or weakened private regulation. Testifying before Congress in , he framed the issue this way: financial “modern- ization” was needed to “remove outdated restrictions that serve no useful purpose, that decrease economic efficiency, and that . . . limit choices and options for the con- sumer of financial services.” Removing the barriers “would permit banking organiza- tions to compete more effectively in their natural markets. The result would be a more efficient financial system providing better services to the public.”  During the s and early s, banks and thrifts expanded into higher-risk loans with higher interest payments. They made loans to oil and gas producers, fi- nanced leveraged buyouts of corporations, and funded developers of residential and commercial real estate. The largest commercial banks advanced money to companies and governments in “emerging markets,” such as countries in Asia and Latin Amer- ica. Those markets offered potentially higher profits, but were much riskier than the banks’ traditional lending. The consequences appeared almost immediately—espe- cially in the real estate markets, with a bubble and massive overbuilding in residential and commercial sectors in certain regions. For example, house prices rose  per year in Texas from  to .  In California, prices rose  annually from  to .  The bubble burst first in Texas in  and , but the trouble rapidly spread across the Southeast to the mid-Atlantic states and New England, then swept back across the country to California and Arizona. Before the crisis ended, house prices had declined nationally by . from July  to February   —the first such fall since the Depression—driven by steep drops in regional markets.  In the s, with the mortgages in their portfolios paying considerably less than current interest rates, spiraling defaults on the thrifts’ residential and commercial real estate loans, and losses on energy-related, leveraged-buyout, and overseas loans, the indus- try was shattered.  FOMC20071211meeting--104 102,MR. HOENIG.," Thank you, Mr. Chairman. I’ll start on the local level. Overall our District economy continues to perform generally well, with ongoing weakness in the housing sector being offset by strength in agriculture, energy, and manufacturing. We have seen some slowing in employment growth over the past few months, but this appears in part to be a supply consideration. Our directors and business contacts continue to report that the labor markets are, in fact, tight across much of the District with shortages of both skilled and unskilled labor and rising wage pressures. There is some reduction in employment, obviously in the housing sector, but that is being offset by these other considerations. I would also note that manufacturing activity remains basically solid, with manufacturers reporting strong export orders. The District’s manufacturing index moved upward in November and still points to moderate growth. In addition, District manufacturers’ capital spending plans actually rose but remained below most of last year’s readings on balance. Turning to spending, general retailers reported a rebound in sales in the latter part of October and early November. Automobile dealers, on the other hand, did report weaker sales and have also become more pessimistic on future sales. Travel and tourism continues to expand in our region, with District airline traffic figures solid, particularly in the Denver area. Likewise, hotel occupancy figures have continued to increase from already strong levels in the region. As has been true for some time, housing activity, as I said, remains soft. For example, the value of residential contracts dropped again in October, and the rate of decline in residential permits steepened again in the past few months in our region. Offsetting this weakness in housing, though, is considerable strength in agriculture and energy. District energy producers continue to expand their capital investments as they are relatively confident that oil and gas prices will remain firm over the longer term. In fact, their capital expenditures have been slowed by a continuing shortage of labor and access to some equipment. Our larger regional banks are still reporting fairly good conditions. The deal flows seem to be coming through, although they are looking at those carefully, just given the environment that they find themselves in on a national level. Finally, price pressures remain mixed. Most businesses report rising input costs, both labor and materials, but differ in their ability to pass those costs on at this point. In transportation, input costs are passed through one for one through customer surcharges. Other businesses continue to find it a little more difficult to pass through the higher costs, but they are beginning to push harder on that as we talk to them. Let me turn to the national outlook. Weakness in incoming data and continuing stress in financial markets obviously are noteworthy, and others have noted that here today. Compared with the Greenbook, however, I see stronger growth in both the short run and the longer run. I expect fourth-quarter growth to be closer to 1 percent, not the zero percent in the Greenbook, and the economy to strengthen slowly through a good part of 2008, starting out slowly obviously and then picking up as we go through the year. Comparing my views with those in Greenbook, the basic difference appears to be largely in some of the judgmental adjustments in the Greenbook concerning spillovers from the housing and financial stress to consumer spending. The current Greenbook forecast, as others have noted, is similar to the Blue Chip Bottom Ten forecast, which suggests to me that it might be better seen as the downside risk outlook not necessarily the most likely outlook at this point. The first half of 2008, as I said, is likely to be somewhat slower than I previously projected because of the high energy prices and continued drag from housing. However, I expect that growth will gradually strengthen as we move toward the end of 2008 and then remain there through the rest of the forecast period. Having said this, I realize that the downside risk to economic activity does remain elevated. The housing slowdown could be deeper and last longer, and continuing financial turmoil could further affect consumer and business spending. However, while financial factors remain a risk to the outlook, in my view the economy, though it will grow below its potential, can weather these forces and is being supported by the policy actions that we have taken in the past two meetings. Against this outlook for economic growth, let me turn now to the inflation outlook. Year- over-year overall and core inflation rates have risen. In addition, Greenbook’s 2008 forecast for overall and core PCE inflation has increased since our last meeting. While below-trend growth in the near term may exert some downward pressure on inflation, the combination of higher prices for oil, commodities, and some services and dollar depreciation should place upward pressure on both overall and core inflation going forward. Over the past several years, the pass-through of dollar depreciation and higher oil prices to inflation has been limited in part because of longer-term inflation expectations remaining, as we said, anchored. My concern is that, if we continue to lower the fed funds rate into a rising inflation environment and the dollar continues to depreciate, these expectations may become unhinged perhaps more quickly than we would like to think. In this environment, I think we should not lose sight of not just the downside risk to the real economy but also some very serious upside risk to inflation. Thank you." FOMC20070321meeting--105 103,MR. LOCKHART.," Thank you, Mr. Chairman. Thank you for the earlier welcome. Over the intermeeting period, aggregate economic activity in the Sixth District showed signs of slowing. Manufacturing activity appeared to soften, with the majority of reports suggesting declining orders. Retail reports pointed to a slowing pace of sales. The BLS employment data revisions for 2006 supported the view that Florida’s economy has decelerated considerably in the wake of the housing downturn. Sales tax data suggest that retail spending in Florida actually declined in late 2006. Recovery on the Gulf Coast of Mississippi and Louisiana continues to proceed more slowly than hoped. The immediate post-hurricane boost to spending has waned, and the problems of housing and insurance availability remain largely unresolved. The biggest concern for the Sixth District continues to be in real estate markets. As stated at the last meeting, it appears to be too early to suggest that the region’s housing situation has stabilized or that the housing sector’s drag on the District has ended. Reports indicate that many areas in Florida are experiencing dramatic declines in sales of single-family homes and condos, even while new product continues to come onto the market. As a result of this oversupply, construction plans have been cut back. In January, permit issuance for single-family homes in Florida was 57 percent lower than a year earlier. For the rest of the United States the decline was 25 percent. Permits for multifamily development declined 40 percent versus a 7 percent decline nationally. This situation is most extreme in Florida. Interestingly, we do hear anecdotal reports of improved potential buyer traffic in Florida, but that improvement is not translating into sales. Buyers appear to be expecting lower prices. In the other states in the District, single-family permits were down 19 percent in January, less than the decline nationally. Regarding the region’s exposure to nonprime and subprime mortgages, the concern is again mostly in Florida. According to the Mortgage Bankers Association, over 9 percent of mortgages serviced in Florida in the fourth quarter of 2006 were subprime ARM loans; this exposure was second only to Nevada, which was at 13 percent, and compares with 6½ percent nationally. In contrast, the exposures of the other states in the District were all at or below the national level. Reports from banking contacts suggest that delinquency rates on nonprime ARM loans in Florida will continue to trend higher this year. Reduced access to credit for nonprime borrowers will slow the absorption of the current oversupply of housing product and will put downward pressure on house prices. Also, the boom in condo conversions and condo construction in 2005 and 2006 drained the supply of apartments in many areas in the District, and landlords have been able to increase rental prices as a result. Turning to our perspective on the country as a whole, much of the slowdown in real activity that occurred in the second half of 2006 reflected weakness in the housing sector. If weakness remains contained within the housing sector, the outlook, although subdued, is acceptable in our view. Much of the recent moderation in real activity is consistent with what we had forecast several months ago. Realization of this moderation does not in itself imply that we should revise our outlook. Some professional forecasters continue to anticipate that real GDP growth will rebound to close to its trend rate of 3 percent for the rest of 2007, in effect discounting any drag from prolonged weakness in residential investment. The Atlanta Fed staff forecasts for real GDP growth are consistent with these optimistic commercial forecasts. The current Greenbook forecast implies a slightly weaker outlook from extended weakness in residential investment and weaker growth of consumer expenditures, perhaps incorporating some signal from the recent financial distress in subprimes. Despite slight differences in these forecasts, the outlooks do not suggest recession at this point. Measured core inflation remains in excess of 2 percent. Our staff consensus forecast sees core inflation continuing in the range of 2 to 2½ percent for all of 2007. This forecast is a bit less favorable than the Greenbook forecast, but we have no sense that the inflation outlook has deteriorated significantly. The implications of the outlook for real output and inflation are that current policy is set about where it should be. The U.S. economy has performed about as expected. Financial market turbulence and subprime mortgage distress raise potential concerns that should be monitored, but for now it seems that the outlook has not substantially changed. Thank you, Mr. Chairman." CHRG-109hhrg28024--90 Chairman Oxley," The gentleman yields back. The gentlelady from Indiana, Ms. Carson. Ms. Carson. Thank you very much, Mr. Chairman, and thank you, Mr. Chairman, for being here today. I have a quick question concerning the housing market. At one point it was just skyrocketing and booming, and now it seems to be on the decline. Could you anticipate what kind of effect, impact that's going to have on the domestic economic growth? " FOMC20060328meeting--115 113,MR. STERN.," Thank you, Mr. Chairman. I see little in the latest information on the District economy or data on the national economy that gives me undue concern about prospects for sustained economic growth. Turning first to the District—as is frequently the case, overall it is performing much like the national economy. The expansion is broadly based, employment is growing, while the usual labor market churning continues. Sectors such as manufacturing, mining, and energy are particularly strong at this point. Some job skills, particularly in health care, accounting and auditing, technology, and the energy sector, are in short supply. Consumer spending overall is well maintained, and nonresidential construction activity appears to be improving. Housing activity is a little more difficult to summarize. Construction remains strong; sales are still relatively substantial, as best I can determine; and inventories of unsold properties are rising as well. Turning to the national economy, I said earlier I wasn’t particularly concerned about the outlook, but I really should put it more positively. It seems to me that the current state of the national economy and its prospects are both quite good at this point, consistent with growth this year of 3½ percent or perhaps even more. I’m impressed by the employment gains that we’ve seen, sustained income gains, and so on, and remind myself and others that, as the 1980s and 1990s demonstrated, the economy is certainly capable of long periods of uninterrupted expansion. I thought I would comment a bit more on two issues in particular—one is housing—where I wonder if the significance of potential developments might not be being exaggerated a bit. I certainly agree that changes in housing prices, up or down, feed into household wealth and through that into consumer spending. I think that’s a perfectly acceptable story. So if housing prices go down or level off, they will have that effect on wealth and potentially on spending. But there seems to be a view that, in some sense, an exogenous pronounced decline in housing prices is possible, maybe even likely, and that this could be more devastating for the economy. It’s not that I would quibble with that story, but I would wonder about its likelihood because it seems to me more likely that housing is the tail rather than the dog in this. That is, as long as employment continues to go up, incomes continue to go up, and mortgage rates remain relatively moderate, then I would expect that we would avoid severe difficulties in housing except for a few markets that are particularly inflated at this point. Putting it the other way around, only if overall economic conditions deteriorate, with employment declining and income growth slowing or declining and so forth, would I expect there to be more broadly based and more-severe problems in housing. The second issue I’d like to spend a little time on is the inflation outlook. The question I asked myself is, How likely is an appreciable acceleration of inflation at this point, particularly in light of the steps we have taken to get the federal funds rate back to a reasonable range? First, I would argue that inflation expectations remain very well anchored at this point. I don’t hear, as I go around and talk to various groups and meet with various business people, any doubt among the participants about the Fed’s ongoing commitment to low inflation. And I think most of the available data support that. One of the things I was looking at was a chart of one-, five-, and ten- year rates of core PCE inflation. And when you look at that, you see that the ten-year rate of inflation has been declining steadily and now is a little below 2 percent. The five-year rate has basically the same pattern. It leveled off in about 2000, but it, too, is a little below 2 percent. And, of course, the one-year rate of inflation, although it bounces around a lot more, ends up at about the same place, also a little below 2 percent. And I just don’t have a sense that there has been any unhinging of inflationary expectations at this point. Another topic that I would comment on only briefly is the issue of lags in policy. That is, presumably the full effects of the actions we’ve already taken have not yet been felt. Finally, we have looked at some forecasting equations that try to incorporate the growth in the money supply in particular and to forecast core PCE inflation. I wouldn’t claim a lot for the quality of these equations. I wish I could, but I can’t. But for the most part, these various equations provide forecasts that are very close to the Greenbook forecast. Inflation might be a little lower this year or might be a little higher this year, but they show very small changes for the most part. My view is that the Greenbook inflation forecast is a pretty good one. Like President Yellen, I originally submitted a number of 1.8 percent for inflation this year, and I don’t see any reason to change it at this point. Thank you." FOMC20070321meeting--59 57,MR. STOCKTON.," That’s possible. We have not taken that view. Overall housing construction had some unexplained strength over the past year, not from a bottom-up demographic addition but just in terms of what we would have expected given the growth in employment, income, and wealth. Admittedly, the evidence is still very tentative, but we think we see some signs of demand stabilizing around current levels so that, in our starts forecast, we’ll be able to drive the months’ supply of homes back down relative to the low level that it had actually been running from the mid-1990s to the middle of the housing boom. So I don’t think we’re seeing an excess supply of homes that people just won’t want at current prices, or roughly current prices, but that is a considerable risk. Adding up household formations and demolitions—there’s a lot of uncertainty about that, and there’s a lot of cyclical sensitivity as well to the overall household formation rates. So whether the housing stock outran the long-run determinants is kind of hard to nail down. We see that as a risk, but it’s not incorporated in this forecast. If that were the case, there could be a bigger drag on housing activity than we’re anticipating." CHRG-111shrg51290--16 Chairman Dodd," Thank you very much, Ms. Seidman. Ms. McCoy?STATEMENT OF PATRICIA A. McCOY, GEORGE J. AND HELEN M. ENGLAND PROFESSOR OF LAW, UNIVERSITY OF CONNECTICUT SCHOOL OF LAW Ms. McCoy. Chairman Dodd and members of the Committee, thank you for inviting me here today to discuss restructuring financial regulation. My name is Patricia McCoy and I am a law professor at the University of Connecticut. I also had the pleasure of living in Alabama where I clerked for Judge Vance some years ago. I applaud the Committee for exploring bold new approaches to this issue. In my remarks today, I propose transferring consumer protection for consumer credit from Federal banking regulators to one agency whose sole mission is consumer protection. We need this to fix three problems. First, during the housing bubble, fragmented regulation drove lenders to shop for the easiest regulators and laws. Second, this put pressure on banking regulators, State and Federal, to relax credit standards. Finally, banking regulators often dismiss consumer protection in favor of the short-term profitability of banks. During the housing bubble, risky subprime mortgages and non-traditional mortgages crowded out safer, fixed-rate loans. Between 2003 and 2005, the market share of non-prime loans tripled, from 11 percent to 33 percent. Over half of them were interest-only loans and option payment ARMs. These loans seemed appealing to many borrowers because their initial monthly payments were often lower than fixed-rate loans, but they had many hidden risks that many borrowers did not suspect. So borrowers flocked to the loans with the lower monthly payments, causing dangerous loans to crowd out the safer loans. Conventional lenders then decided, well, if we can't beat them, let us join them, and they expanded into dangerous loans, as well. Meanwhile, lenders were able to shop for the easiest laws and regulators. There was one set of laws that applied to federally chartered depository institutions and their subsidiaries. There is a wholly different set of laws that applied to independent non-bank lenders and mortgage brokers. At the Federal level, of course, we all know that we have four banking regulators plus the Federal Trade Commission. The States add another 50 jurisdictions on top. Because lenders could threaten to change charters, they were able to play off regulators against one another. This put pressure on regulators to relax their standards in enforcement. For example, in 2007, Countrywide turned in its charters in order to drop the Federal Reserve and the OCC as its regulators and to switch to OTS. The result was a regulatory race to the bottom. We can see evidence of regulatory failure by the Federal Reserve, the OTS, and OCC. As the Committee knows, the Federal Reserve refused to exercise its authority under HOEPA to regulate unfair and deceptive mortgages under Chairman Greenspan. The Fed did not change its mind until last summer under the leadership of Chairman Ben Bernanke. Meanwhile, OTS allowed thrifts to expand aggressively into option payment ARMs and other risky loans. In 2007 and 2008, five of the seven largest depository failures were regulated by OTS, including IndyMac and WaMu. In addition, Wachovia Mortgage FSB and Countrywide Bank FSB were forced into shotgun marriages to avoid receivership. By the way, none of this happened on my colleague Ellen Seidman's watch. She was a leader in fighting mortgage abuses when she was Director of OTS. Finally, how about the OCC? During the housing boom, the OCC allowed all five of the largest banks--Bank of America, JPMorgan Chase, CitiBank, Wachovia, and Wells Fargo--to expand aggressively into low-doc and no-doc loans. The results were predictable. Today, as a result, the country is struggling with how to handle banks that are too big to fail as a result. Bottom line, when you look at all types of depository charters, State banks and thrifts had the best default rates. Federal thrifts had the worst, and national banks had the second worst. Placing consumer protection with bank regulators turned out to be no guarantee of safety and soundness. Having it in a separate agency would counteract the over-optimism of Federal banking regulators at the top of the credit cycle. To fix these problems, we need three reforms. First, Congress should adopt uniform minimum safety standards for all providers of consumer credit, regardless of the type of entity or charter. This should be a floor, not a ceiling. First of all, that is necessary to make sure that the entity, the regulator, does not have too weak of a standard. And second, we have seen that States are closer to people at home and more responsive to their problems. Second, the authority for administering these standards should be housed in one Federal agency whose sole mission is consumer protection. This agency could either be a new agency or the Federal Trade Commission. All responsibility for oversight of consumer credit should be transferred from Federal banking regulators to this agency. And then finally, 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 would be glad to take any questions. Thank you. " FOMC20080430meeting--99 97,MR. BULLARD.," Thank you, Mr. Chairman. The economy of the Eighth District continues to show signs of weakness. The services sector has continued to soften, and sales of both general and big box retailers are down from the same period last year. The residential real estate sector has continued to decline throughout the District. Across major metro areas, sales were about 15 percent below the level from last year, and single-family permits were down about 30 percent. Employment growth has slowed and is estimated to have turned negative in March for many areas. Typically, however, employment growth in the District has been stronger than that for the United States as a whole. Manufacturing has remained roughly flat, despite temporary shutdowns that have affected domestic automobile production. Also, commercial real estate construction remains strong, and vacancy rates are low; however, there are increases in the number of delayed projects. Banks in the District are still in good shape, generally speaking. There have been modest increases in total loans in all categories, including real estate. Contacts in the shipping and trucking industries reported a mixed bag. In some instances, business seems to be holding up, whereas in others it is down substantially. These businesses are being critically affected by increases in energy prices. Similarly, a contact in the fast food industry painted a picture of a business struggling with substantial increases in commodity prices. On the other hand, a contact in a large technology firm indicated that business is holding up quite well, in part because a large fraction of this firm's business is overseas. Contacts in the energy sector reported robust business prospects, as expected. A contact at a large financial firm suggested that the discovery process concerning asset-backed securities, which has been ongoing for many months, has effectively come to a close. The idea that the discovery process--and the considerable macroeconomic uncertainty that attended that process--is over is an important consideration at this juncture. My sense is that expectations of future economic performance are changing rapidly. The probability that the U.S. economy will enter into a debilitating depression-like state has fallen dramatically. In the meantime, other risks have increased markedly--in particular, that the FOMC will lose credibility with respect to its inflation goals. The U.S. economy has certainly encountered a large shock. Monetary policy can mitigate the effects of a large shock but cannot be expected to completely offset exceptional disturbances. Attempts to do too much may create more and moredangerous problems in the future. Best-practice monetary policy would do well, it seems to me, to avoid setting the stage for future problems. The problems with the rate structure, which is too low, are threefold. First, there is the risk of setting up a new bubble. The exceptionally low rates of a few years ago are sometimes cited as providing fuel for today's problems. Some have argued that today's commodity price increases are exactly that new bubble. Second, continued unabated reductions in interest rates will bring the zero bound issue into play with unknown consequences. Third, still lower rates will push the envelope further on inflationary expectations. Those expectations may appear to be reasonably well anchored today, but that is because the private sector expects us to take actions to keep inflation low and stable. Should those expectations become unmoored, it will be too late, and an era of higher and more volatile inflation would be very costly for American households. Much has been done already. A low rate environment has been created and has been in place only for a short time. Marginal moves at this juncture are minor compared with the general thrust of policy over the last nine months. The Committee would do much better at this meeting by taking steps to address eroding credibility. Thank you. " 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-109hhrg31539--2 The Chairman," The committee will come to order. Chairman Bernanke, good morning. In February, this committee was proud to be the venue for your first appearance before Congress on the conduct of monetary policy. Today marks your second appearance, with many more yet to come. In 2001, shortly after I assumed the chairmanship of this committee, the very first hearing I chaired was to receive the testimony of former Chairman Greenspan. We didn't know it at the time, but we had a very rough patch of economic road ahead with the bursting of the tech bubble; and 9/11 and the resulting insurance crisis and the corporate bankruptcies. Back then, we had a weak economy that everyone said was strong. Now we have a strong economy that some are trying to convince us is weak. Some of the credit for the current robust economy goes to the Federal Reserve, of course, where you and Chairman Greenspan have held inflation to lower levels and lower volatility than we have seen in all but 20 years of the life of the Federal Reserve. I would like to enter a chart showing that into the record. The lion's share of the credit goes to President Bush, who had the steadiness to guide us through recession and the courage to do the right thing in seeking tax cuts to spur growth. Now we see that the biggest spurt in tax revenue growth in 40 years has trimmed our expected 2006 deficit by a third in just 6 months, and is on track to drop the deficit as a percentage of GDP to less than half of the similar share in most European economies. Some of the credit goes to Congress, which made the tax cut stick, although we still have some work to do on making tax cuts permanent, and on spending discipline. But the largest credit of all goes to the American people, who with determination, character, and heart, showed what a great country this really is. America suffered a recession, a massive terror attack, scandals of corporate governance, and a destructive hurricane season. Through all of that, we have added 5.4 million jobs in the last 3 years; we have had 34 uninterrupted quarters of growth; we have an unemployed rate lower than that of most of the last 40 years; and we also have growth at or above the average rate for all 6 postwar decades. In June alone, the U.S. economy created 121,000 new jobs, and maintained a low 4.6 unemployment rate. I would be remiss if I did not point out that the unemployment rate is lower than the 6 percent floor that the economists used to call full employment. GDP growth for the first quarter was 5.6 percent, stronger than expected, and the fastest growth in two-and-a-half years. That, Mr. Chairman, is something we can all be proud of. This is a remarkable country and a remarkable economy that constantly renews and reinvents itself--the flexibility that Chairman Greenspan talks so much about. The Federal Reserve has led monetary policy extremely well, and I am certain that will continue to be the case during your tenure. Mr. Chairman, America is doing well, and will continue to do well. Of course, we will continue to have to work and think and innovate, because other countries have smart people and good economies as well. However, since the recession and the terror attacks, this country's economy has grown a great deal. In real terms, U.S. growth alone is half as big as the total economy of China. So with that, Mr. Chairman, I thank you and all of the many people at the Federal Reserve, most of whom we have never met, for their insight and experience and dedication. And we look forward to your testimony, Chairman Bernanke. And with that, I yield back the balance of my time and now recognize the ranking member, the gentleman from Massachusetts. " CHRG-111hhrg53244--102 Mr. Castle," Thank you, Mr. Chairman. Chairman Bernanke, let me just say in praise of you, because my questions may imply some negatives, I think you are doing a good job on monetary policy. And I think that meets one of the goals of the Humphrey-Hawkins Act. Just looking at that Act, it outlines four goals for a strong economy: full employment; growth in production; price stability; and balance of trade and budget, of which I think price stability is the one that sort of stands out now. And I think that has a lot to do with what you do. And maybe this is Government 101, but I am not 100 percent sure what your role is with the Administration. We are watching a circumstance in which we have deficits creating greatly. Debt will go up over $10 trillion, according to the budget, in the next 10 years or so. Appropriations are up dramatically, for this year at least and the ones we have passed in the House so far. The health care legislation that is being considered in the House and the Senate doesn't seem to have any real cost controls in it, some maybe passing wave at that, but that is about the extent of it, and are probably in trouble because of that. My question to you is, does the Executive Branch of government, the White House, consult with you about any of these broader economic issues? I mean, part of your responsibility under Humphrey-Hawkins is to try to make progress towards these goals. And it seems to me just setting monetary policy won't necessarily solve the problems of the full employment, the growth of production, and the balance of trade and budget. And I didn't know if that is just off-bounds for you and for them or if there is any consultation going on. And, obviously, if you have any comments about your point of view on some of these expenditures which are going on, I would be interested in hearing them, as well. " FOMC20060920meeting--59 57,MR. STOCKTON.," Thank you, Mr. Chairman. I cannot recall the precise baseball analogy employed by David Wilcox at the last FOMC meeting, but I have a vague recollection he speculated that I was either due for a forecasting hit or due to be hit by the forecast. [Laughter] In any event, since the Greenbook was completed last Wednesday, we have made several trips to the plate with consequential economic statistics on the mound. And how is the team doing? I guess I=d say, better than the Washington Nationals, not as well as the New York Mets. Last Thursday, we received retail sales figures for August. As you know, we focus on the retail control component of spending, which strips out sales at auto dealers and building material and supply stores. The August increase in this category was 0.2 percent, a bit stronger than we had expected. But both June and July were revised down, and on net these data were a touch weaker than those incorporated in the September Greenbook. Retail inventories for July also were a bit below our expectation. Housing starts for August were released yesterday. In line with our forecast, single-family starts dropped nearly 6 percent, to 1.36 million units, and the permits data point to some further declines in the months ahead. But multifamily starts declined somewhat more that we had expected. If we had to redo the forecast today, we would probably lower the increase in real GDP in the second half of this year to 1½ percent at an annual rate. Last Friday=s report that both headline and core consumer prices increased 0.2 percent in August was right in line with our forecast. The major components of yesterday=s PPI actually came in below our expectations, most especially the core finished goods index, which declined 0.4 percent in August. The only sour note was an increase in the PPI for medical services. The PPI for medical services is used by the BEA in constructing the core PCE price index, and it caused our estimate of core PCE prices for August to revise up from a high 0.2 percent to a low 0.3 percent. All in all, however, the incoming data over the past week left our forecast pretty much unscathed. I am relieved about that, because, if I do say so myself, it=s a beautifully constructed forecast. [Laughter] After all, with no further tightening of monetary policy, the economy eases into an extended period of slightly below-trend growth led by a retrenchment in the housing sector. That slower growth of activity opens a small output gap by the middle of next year but does not trigger a more precipitous cyclical contraction. Then, as the downturn in housing wanes and the associated multiplier and accelerator effects largely play out, the growth of real GDP picks back up toward potential in 2008. Meanwhile, the output gap that develops over the next year or so, in combination with inflation expectations that remain well anchored and a near flattening out of oil and other commodity prices, is projected to impart a mild tilt down in core inflation—to 2¼ percent in 2007 and 2 percent in 2008. So, what should you make of this forecast? Is it a construction as elegant and durable as say the Eiffel Tower in Paris, or is it more like the Eiffel Tower in Las Vegas—it looks pretty good a few blocks away but isn=t that impressive upon closer inspection? [Laughter] In that regard, you could not be faulted for wondering whether this forecast represents our averaging of two possibly more plausible outcomes that we simply didn=t have the courage to choose between. One view could be that this forecast is far too pessimistic. After all, our projection for growth in the second half of this year and in 2007 is now well below the consensus. Most of the available measures of aggregate activity remain solid. Real GDP is estimated to have increased 3½ percent over the year ending in the second quarter, about in line with its pace over the past several years. More recently, despite some notable month-to-month swings, manufacturing industrial production is up at a 5 percent annual rate over the three months ending in August. An even more timely economic indicator, the level of initial claims for unemployment insurance, has moved sideways through the middle of this month and does not yet suggest any inflection point in activity. Moreover, oil prices are down, the stock market is up, and financial conditions in the corporate sector remain favorable. These developments could cast doubt on our projected slowdown in real GDP. The other view might be that our forecast is too optimistic. Cyclical contractions are often precipitated by large imbalances in the economy that cause a great deal of pain and extensive damage when they get rectified. Certainly, housing is looking increasingly like a sector that could play that role. Starts and sales have dropped sharply in recent months, inventories of unsold homes are still soaring despite cutbacks in production, and prices are rapidly decelerating. This jolt is occurring while households are still dealing with the substantial hit to their purchasing power from the higher energy prices that they have encountered over the past several years. Yet all of this results, in our forecast, in only a very modest and gradual rise in the unemployment rate over the forecast period. I must admit that there were times over the past several weeks when I felt as though I=d seen this forecast before—specifically, in the summer of 1990 and in the autumn of 2000. At those times, the staff saw that forces of restraint were in place, and we projected a noticeable shortfall of growth from potential. But we failed to anticipate much in advance the impending cyclical downturn in the economy—and I doubt that we will when such an event occurs again in the future. I can assure you that we spent a great deal of time examining both of these possible critiques of our forecast, but in the end, we still view something like our projection as more likely than either of these two alternatives. So let me lay out the logic of the forecast and along the way address some of these concerns. As I noted earlier, we are now projecting the growth of real output in the second half of the year to be around 1½ percent at an annual rate, about ½ percentage point less than in the August Greenbook. The lower scheduled vehicle assemblies announced by the automakers were part of the downward adjustment. But the major source of the projected weakness in aggregate demand lies in residential construction, which is now expected to lop off nearly 1½ percentage points of growth in real GDP in the second half. If it doesn=t really feel to you like an economy that is growing as slowly as 1½ percent, there may be a good reason. Our assessment is that, except for the housing sector, the economy is growing at a pace of roughly 3 percent. So far the collateral damage from the downturn in housing has been limited, and for the most part, we expect it to remain that way, at least for a time. A pickup in nonresidential construction activity has offset some of the weakness in residential construction. Moreover, the recent declines in energy prices seem likely to cushion some of the near-term effects of the housing contraction by restoring some lost purchasing power to households and by helping to support consumer spending. With overall business sales holding up reasonably well so far, the cost of capital still low by historical standards, and financial conditions solid, outlays for equipment should move forward at a fairly rapid clip for the remainder of the year. But it seems implausible to us that the downturn in housing will not have multiplier-accelerator consequences that hold down growth going forward. Along those lines, we expect employment growth to slow more noticeably by the end of the year. Slower job gains and a further deceleration in housing wealth should damp consumer spending as we move into next year. The result is a steady, though gradual, rise in the personal saving rate over the next two years of about 2 percentage points. With the usual lags, slower growth of sales and output cause a mild deceleration in equipment spending. At the same time, fiscal policy is becoming progressively less stimulative over the forecast period. These forces are attenuated, but not offset, by the boost to spending generated by a higher estimated level of labor income and by a lower trajectory of consumer energy prices in this forecast. All told, we see these influences as likely to hold the growth of real GDP below potential over the next two years. Still, we are not anticipating the weakening in activity to cumulate into outright recession. In our forecast, the fact that the implications of the housing downturn for the broader economy are relatively limited rests importantly on two suppositions, both of which are open to question. The first is that the slump in housing produces a sharp slowdown in house prices but not a large nationwide decline in those prices. In the past, housing prices have been relatively sticky on the downside, with homeowners resisting price cuts and keeping their homes on the market longer. Our forecast envisions something similar occurring in this episode. The second assumption is that housing wealth affects consumer spending like other forms of wealth and that there are no other channels of influence of house prices and housing finance on consumption. For example, we have not incorporated any significant negative effects on consumer sentiment that might accompany a rapid deceleration of house prices. We have also made no special allowance for the decline in mortgage equity withdrawal to restrain consumption because we find the empirical evidence of such a connection to be fragile. Previous Greenbook simulations have demonstrated that turning on any of these channels would amplify the effects of a weak housing market on the aggregate economy. Their absence in our baseline forecast is one of the reasons that the economy bends but doesn=t break in response to our projected housing slump. As you know from reading the Greenbook, not all of the action was on the demand side of our forecast. In fact, we revised down aggregate supply by virtually the same amount that we revised down aggregate demand, leaving the output gap nearly unchanged from the August Greenbook. I would not be surprised if some of you were suffering a little reverse “sticker shock” from the low rates of GDP growth that we are now projecting, much of which can be traced to the downward adjustments that we made to potential output in each of the last two projections. The growth of potential is estimated to be about 2¾ percent this year and next and 2½ percent in 2008. Although we still could be characterized as productivity “optimists” with our projection of gains in structural productivity of 2¾ percent per year—a figure that is above many of the outside forecasts that we monitor—we are increasingly looking like potential output “pessimists” because of our expectation of only meager gains in available labor input. As you know, we are projecting a steepening downtrend in labor force participation and a slowing in the working-age population as the front edge of baby-boom retirements arrives late in the projection period. Our views are significantly below the consensus here. However, as we have noted in the past, if potential GDP ultimately proves stronger than we are forecasting, actual GDP will likely be stronger as well. So to a first approximation, the GDP gap and the assumed accompanying path of the funds rate would be largely unaffected by errors in our forecast of potential labor input. Much like the real side of the projection, our inflation forecast had some large moving pieces that, on net, left us pretty much in the same place as our August projection. On the favorable side of the ledger, oil prices are projected to average around $10 per barrel below our previous forecast. Taken in isolation, this development would have led us to revise down our projection of core PCE prices about 0.1 percentage point next year. But there was news on the unfavorable side of the ledger as well. On the basis of unemployment insurance tax records, the BEA revised up the growth in hourly labor compensation to an annual rate of 13¾ percent in the first quarter of the year. Once again, we are confronted with a huge difference between the signal provided by nonfarm business compensation and the employment cost index (ECI) measure of compensation, which increased at a rate of just 2½ percent in that quarter. Such wild discrepancies have led some inflation forecasters to employ reduced-form price equations that circumvent measures of labor compensation altogether. We are sympathetic to that approach, and those types of models are in our stable of forecasting equations. But we think it unwise to ignore entirely the issue of labor costs, given that they constitute two-thirds of business costs. So what do we make of this first-quarter jump in hourly labor compensation? As you know, one of the principal differences between the two major measures is that stock option exercises are included in the nonfarm business measure of hourly compensation but not in the ECI. Our colleagues at the New York Fed have been monitoring data on option exercises by company insiders, and those data suggest that an outsized jump in exercises in the first quarter probably helps to explain an appreciable fraction of the jump in hourly compensation. But that doesn=t seem to be the full story, as wages and salaries were revised up in categories, such as construction, where options probably do not figure prominently in employee compensation. In our forecast, we have assumed that stock option exercises and other nonrecurring nonwage payments provided a temporary boost to the level of income in the first quarter, about half of which will be reversed by the third quarter. What about the consequences of these higher measured labor costs for prices? Models that take the data simply at face value want to revise up the forecast of core consumer price inflation forecast between ¼ and ½ percentage point in 2007. However, these data should not be taken entirely at face value, at least as a measure of incremental business costs. As we have argued in the past, option exercises are not likely to represent a marginal cost of production and, at the very least, are probably misleading with regard to the timing of any such cost increase. Thus we have discounted the price implications of the first-quarter surge in compensation per hour, adding just a tenth to our inflation forecast for this factor. This exactly offsets the negative effects of the lower energy prices and leaves our projection of core PCE inflation unchanged at 2¼ percent in 2007. After that, a further waning of energy and other commodity cost pressures, the emergence of a small output gap, and the assumption that long-term inflation expectations continue to be reasonably well behaved cause inflation to drop to 2 percent in 2008. In that regard, the better core inflation figures of the past two months, the fall in oil prices, and the drop in various readings on inflation expectations over the intermeeting period provide us with some encouragement that inflation pressures will gradually fade over the projection period. But we would hasten to note that none of these developments cinch the case that we have turned the corner on inflation. Karen will continue our presentation." FOMC20081029meeting--232 230,MR. STERN.," Thank you, Mr. Chairman. I'll start with a few comments about the District economy, which will sound pretty familiar by now. The preponderance of the anecdotes from business contacts that I've talked with since our last meeting have been distinctly negative. It's not just a slowing of activity or some deterioration but a sharp contraction in activity, particularly with regard to discretionary spending or discretionary projects, beginning in the middle of September. The one exception to that is commercial construction, where there are enough things under way that business remains pretty good. But the backlogs are dropping, and so weakness certainly is anticipated next year. I thought another possible exception to the negative tone was the housing market in the Twin Cities--not that the housing market in the Twin Cities is in and of itself so important but that it might be representative of some middle-of-the-road markets across the country. Clearly, it's not indicative of what's going on in Florida, California, or places like those because sales volumes in the Twin Cities had been up distinctly. Some of that is no doubt due to short sales and foreclosures; nevertheless, there were some other signs that were favorable. The affordability index has really improved a lot. It is back to levels of 2002-03, which Realtors call very comfortable. The ratio of housing prices to rent has moved back to the levels of 2002-03, and that's also encouraging. I already mentioned the higher sales volumes. Unfortunately, when you get beyond those statistics and look at other things, it's too early to declare stability in the housing market or anything resembling underlying improvement. Part of the problem is something that we've talked about before. The inventory of unsold, unoccupied properties remains very substantial--by historical experience way above anything resembling normal. Second, even though the price-to-rent ratio has come down, it's still elevated relative to the longer-term historical experience. So it looks to me as though, even in that market, there are some further price declines to come and it's going to take some more time to get through all of this-- probably well into next year. As far as the national economy is concerned, I, too, have marked down my outlook for real growth for the balance of this year, for all of next year, and into early 2010 as well. This reflects to some extent the nature of the incoming data but also the intensification of the financial problems and associated headwinds, the impact of the negative wealth effect, and so on. When I looked at my June forecast, back then the forecast obviously looked better, although there were a number of what I called ""identifiable negatives."" They have proven, for worse rather than for better, to be relevant. I already talked about some of them. In addition, we still have the problem in housing with excess inventories. We have steady declines in employment, which obviously have negative implications for consumer spending, and the credit headwinds as well. So now I have the economy contracting through the middle of next year, modest growth resuming thereafter, and robust growth beginning with the second quarter of 2010--quite some distance off. On the inflation outlook, I have for some time been thinking that inflation would begin to slow this quarter. With the decline in commodity prices, the evolution of the economic outlook, and so forth, my confidence in that forecast has increased, and I do expect inflation to diminish over the forecast period. So I think I'll conclude with that. " CHRG-110hhrg44901--25 Mr. Bernanke," Congressman, I couldn't agree with you more that inflation is a tax and that inflation is currently too high, and it is a top priority of the Federal Reserve to run a policy that is going to bring inflation to an acceptable level consistent with price stability as we go forward. I would make one distinction, which is that what the Federal Reserve can control is the increase in prices on the average, over the overall basket of consumer goods and services. The enormous jumps in oil prices and other commodity prices are to some extent at least due to real factors out of the control of the Federal Reserve. The Federal Reserve cannot create another barrel of oil. It is the global supply and demand conditions which are affecting those particulars things to the most significant extent, but to the extent that the Fed does have influence on the overall inflation rate, you are absolutely right that it is very important to maintain price stability, and I take that very seriously. Dr. Paul. But if the oil prices were going up for another reason other than monetary reasons, other prices would have to come down because there would be a limit in the money supply. I think--and the prices are going up today, like I indicated in my opening statement, not necessarily because of the monetary policy of the last year but maybe for the last 15 or 20 years and the fact that we were able to export, so to speak, our inflation. Now it is coming home. Those people who have been holding these dollars are not wanting to buy them as readily. Fortunately, foreign central banks are still not dumping them but even the other central banks might not be as cooperative. So I still see tremendous pressure. I don't see any signs that you are able to do very much because all we hear about is more inflation. You know, it is not so much that they are too big to fail. It just means that everybody needs to be propped up. Congress participates in it. And all the pressure is put on the dollar. It is a dollar bubble. And I think what we are seeing is the unraveling of a dollar bubble that had been building for more than 35 years. " FOMC20070321meeting--83 81,MR. LACKER.," Thank you, Mr. Chairman. Overall, economic activity in the Fifth District expanded modestly in recent weeks, though performance across sectors remains uneven. Growth is centered in the services sector, where moderately positive readings continue. Real activity has recovered somewhat in recent weeks, and big-ticket sales have posted modest gains after two months of quite weak readings. In manufacturing, our survey respondents continue to report a downward drift in activity. They remain optimistic about their future prospects, however, though many comment on generally weak current demand. Labor markets remain tight in most jurisdictions, with the standard reports of spot shortages of skilled workers, but wage pressures are reported to be moderate. We continue to hear of some reasonably firm housing activity in a number of District localities. Home prices remain generally flat, though builders are offering more incentives to buyers. Inflation pressures appear to have moderated in March according to our latest survey, but manufacturers and service providers expect price pressures to increase modestly over the next six months. On the national level, risks seem to have risen lately, but my sense is that prospects are still reasonably sound. Subprime mortgages, obviously, have dominated the financial news in recent weeks. Concerns about the welfare of families suffering foreclosure are quite natural, and anecdotes about outright fraud suggest some criminality. But my overall sense of what’s going on is that an industry of originators and investors simply misjudged subprime mortgage default frequencies. Realization of that risk seems to be playing out in a fairly orderly way so far. Mortgage-backed securities have lost value as risk spreads have widened, and there have been insolvencies among firms that specialized in this sector. The updating of risk estimates in light of recent experience will lead to higher borrowing costs in the affected market segments, and at the margin this increase could shift some households from homeownership to renting. But in my judgment, that isn’t likely to affect the net demand for housing units. Notably, we have not seen broader risks to credit availability in other markets or to the financial safety net. Perhaps the greatest economic risk posed by recent subprime developments is legislation that impedes the availability of credit or that provides financial support ex-post that was unanticipated ex-ante but affects private decisionmaking henceforth, somewhat like ad hoc disaster relief. Housing construction continues to contract, of course, and inventories remain elevated. The choppy winter data make it hard to gauge the descent, but overall home sales seem to be holding steady, and we haven’t heard anything locally that suggests a renewed contraction in demand. So the housing outlook hasn’t changed much for me. However, the recent weakness in business investment has been disappointing. One would expect soft patches related to housing, autos, and the new truck regulations, but the broader sluggishness is a bit at odds with the generally favorable fundamentals. I still expect this investment to pick up ultimately, although I have to admit that the recent data have left me a bit less certain, especially about when. The outlook for consumer spending remains fairly healthy, though. Real disposable income growth has been powered by continuing gains in employment and firmer wage growth. So all in all, I still think the current episode of below-trend growth is fundamentally a transitory phenomenon that will most likely be behind us by the end of the year, although the recent weakness in business investment suggests more downside risk than before. Core inflation continues to firm, and it now seems clear that the fourth quarter’s energy- induced lull is over. We have yet to see much sign of the long-awaited easing in resource utilization. It’s not obvious that we will be getting any help from labor costs any time soon, and inflation expectations remain centered at or above 2 percent. So to me, the prospects for moderation in inflation remain tenuous. I continue to believe that, by summer, growth concerns are likely to be behind us, and we will want to act to reduce inflation, which we recognize is higher than we want. Thank you." FOMC20080625meeting--30 28,MR. SLIFMAN.," Last week, the Washington Post ran a front page story with the headline, ""Why We're Gloomier than the Economy."" Like the author of the Post article, we too have noticed the difference between what people are saying about the economy in surveys and what they apparently are producing and spending. Starting first with the survey indicators, the top left panel of exhibit 6 plots the plunge in the Michigan index of consumer sentiment, which is far deeper than can be explained by its usual predictors such as labor market conditions, inflation, and the stock market. The panel to the right plots two of the most timely surveys of business attitudes, which continue to suggest that the respondents are pessimistic about overall business conditions. Meanwhile, as shown in the middle left panel, although private payrolls continue to shrink, the declines have been much smaller than we were expecting and, as you can see from the shaded area (if you look very closely), [laughter] much smaller than the ones that occurred during the last recession. In terms of spending data, the most striking piece of news was the upward revision to earlier retail sales figures. At the time of the April Greenbook, real outlays for consumer goods other than motor vehicles appeared to be moving sideways (the red line in the middle right panel). However, the black line shows that according to the latest estimates--which, of course, are still subject to additional revisions--spending rose rapidly in March and April and climbed further in May. With these numbers, we revised up appreciably our near-term estimates of the growth rate of real PCE goods other than motor vehicles (the inset box). On the business side, the bottom left table, shipments of nondefense capital goods, excluding transportation, rose further in April, and new orders jumped. In addition, outlays for construction of nonresidential buildings, the bottom line of the table, continued to climb in April. All told, these indicators suggest stronger business spending than we had anticipated in our April forecast. A potentially important downside development may be emerging in the motor vehicles sector--the bottom right panel--where, according to our industry contacts, sales of light vehicles appear to be plummeting in June. Whether this is just a reaction to the surge in oil prices that will be contained within the auto sector or whether it's a canary in the coal mine pointing to something far more serious for the entire economy remains to be seen. But it certainly has grabbed our attention and highlights a downside risk to our projection. Exhibit 7 focuses on the overall GDP forecast through 2009 and some of the key factors that informed our thinking about the outlook. We had a lot of moving parts to deal with this round, and the upper panel summarizes how we put them together. First, in light of the incoming information, we revised up our forecast for the first two quarters of this year, especially the second quarter. We now think that real GDP growth came in at an annual rate of 1.1 percent in the first quarter and picked up to a 1.7 percent pace in the second quarter. As you know, earlier this year we put in some judgmental adjustments to the forecast, which reflected a combination of the tendency for negative model residuals to be correlated during cyclical downturns as well as the macro effects of financial turmoil and uncertainty that are not well captured by our models. We have interpreted some of the recent spending surprise as suggesting that we went too heavy on such effects in the April Greenbook, and so we have tempered them in this projection. That said, we still anticipate that some of these influences will show through to spending, especially in the household sector, and we expect the economy to be on a very subdued growth path for the next few quarters. As I will discuss shortly, residential investment is still projected to be a drag on economic growth well into next year. Moreover, with house prices expected to fall through the end of next year, the ratio of household net worth to income remains on a downward trajectory, reducing some of the wherewithal for consumer spending. Household purchasing power also is being held down by the surge in oil prices that Nathan discussed (the middle left panel). As shown in the inset box, by our reckoning the increases in the spot and futures prices of WTI since the April Greenbook subtract about � percentage point from real GDP growth in both 2008 and 2009, with much of the effect working through PCE. Despite these negative influences, if the story ended here, the economy still would be operating with a somewhat higher utilization rate--that is, a smaller GDP gap--than in the April Greenbook. In light of this consideration, as well as the less favorable outlook for inflation that Bill will discuss, we have conditioned this forecast on a tighter path for monetary policy than the one in the previous Greenbook. As you can see in the middle right panel, by the end of next year the federal funds rate is 100 basis points higher than in the April Greenbook. I should note here that we also have raised our estimate of the growth rate of potential GDP, which Bill will discuss shortly. Because we view our revised estimate of potential as merely the staff's catching up with what individuals and firms were already expecting, these revisions result in corresponding adjustments to the growth rate of real GDP going forward. All told, as illustrated in the bottom left panel, after increasing substantially faster in the first half of the year, real GDP is now projected to grow at an annual rate of � percent in the second half of 2008, a bit less than in our previous projection. In 2009, real GDP is expected to increase 2.4 percent, about � percentage point less than in the April Greenbook. The bottom line of the forecast is perhaps most easily seen by the path of the GDP gap. As shown in the bottom right panel, the gap starts out the projection period being much narrower than in the April forecast. By the fourth quarter of 2009, however, the gap is essentially the same as in the April Greenbook. After that high-altitude flyover of the projection, the next two exhibits swoop down for a closer look at some of the details. Exhibit 8 focuses on the housing sector. With demand weak, the overhang of unsold new and existing single-family homes-- the vacancy rate--has soared, putting downward pressure on prices. As shown to the right, the OFHEO purchase-only index of house prices fell at an annual of 6.7 percent in the first quarter of 2008, and we expect home prices to continue declining around this pace into next year. Anecdotes and common sense suggest that many prospective homebuyers, leery of purchasing an asset whose value is falling, are waiting for house prices to bottom out before entering the market. This behavior further saps already sagging housing demand. We don't have direct survey evidence for this supposition; however, the middle panels present some suggestive numbers taken from the Michigan survey. First, as shown by the black line in the panel to the left, the share of current homeowners who think the price of their home fell over the past 12 months jumped dramatically through early this year and remains elevated. In addition, the share that thinks the price will fall over the next 12 months also has drifted up. The panel on the right, which is based on work by my colleague Claudia Sahm, looks at the views of renters. Here the blue bars show the percentage of renters in the Michigan survey who say that now is a bad time to buy a house. The red line plots an estimate of house price overvaluation derived from a price�rent model that we follow. As you can see, as houses became increasingly overvalued, more and more renters became pessimistic about homebuying--apparently for affordability reasons. Of course, relative prices are not the only influence on affordability. General macroeconomic and credit market conditions also are important. Thus, even though the extent of overvaluation has diminished so far this year, renters, at least thus far, remain quite pessimistic about homebuying conditions. So what brings us out of this seeming death spiral? If house prices follow the expected trajectory, we estimate that they will move into rough alignment with their long-run relationship with rents early next year and then, as typically happens, overshoot somewhat. As the market returns to something closer to equilibrium, prospective homebuyers who had been waiting out the price bubble in rental quarters should begin to see housing as more affordable and be more willing to buy into owner-occupied housing. As that happens, the rate of decline in house prices should slow, and sales of single-family homes (the bottom left panel) should start to improve. With demand improving and the inventory overhang being worked off, we expect housing starts to level out and then begin to gain altitude slowly in 2009. Exhibit 9 presents the medium-term outlook for consumer spending and business investment. Starting with PCE, real spending is projected to fall, on balance, in the second half of this year. Tax rebates push up the third quarter and create a pothole in the fourth quarter as rebate-related spending drops off. More fundamentally, spending is held back by the effects of higher oil prices on household purchasing power, the ongoing hit to household wealth from falling home prices and earlier declines in equity prices, and the restraining effects of financial turmoil and unusually pessimistic consumer sentiment. In 2009, spending picks up as many of these factors begin to improve; but at 1� percent, the increase is still rather tepid. The middle panels focus on business outlays for equipment and software. Real spending on the high-tech component (the green bars) has slowed sharply this year and is expected to remain relatively soft throughout the projection period. The major U.S. computer manufacturers--such as HP, Dell, and Sun--have expressed caution about the outlook for sales. Meanwhile, capital spending guidance from telecommunications service providers points to a slowing in their outlays for communications equipment. As shown by the blue bars, investment outside the hightech segment has been declining at a modest pace since late last year, and we expect it to contract further over the next year and a half. Spending is held back by normal accelerator effects, tight lending standards, and gloomy business sentiment. For nonresidential structures, the lower panels, the BEA reported that outlays in the drilling and mining component (the green bars) dipped in the first quarter. Anecdotal reports suggest that this may have reflected bottlenecks stemming from shortages of skilled labor and supplies. However, recent data on footage drilled and the number of drilling rigs in operation have picked up, signaling a near-term rise in spending. Looking forward, escalating energy prices are likely to spur continued increases in investment. In contrast, as shown by the blue bars, real construction spending for buildings is projected to be very weak following sizable increases in 2006 and 2007. The evolving supply-and-demand factors for this sector are almost uniformly downbeat: Vacancy rates are moving up; sales and prices of existing properties are sagging; and financing conditions are tight for new projects. Because of these developments, we expect outlays in this category to fall throughout the projection period. Bill will now continue our presentation. " FOMC20080805meeting--130 128,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. Like the Greenbook, our modal forecast shows weaker real activity and slightly higher core inflation over the forecast period. Downside risks to growth remain substantial, in my view, and have probably increased relative to what we thought in June. Risks on the inflation front remain weighted to the upside, perhaps somewhat less than in June, but this is hard to know with confidence. The adverse growth risks are worse for several reasons. The labor market and labor income are weakening more quickly than expected. Although there were some tentative signs of stabilization of housing demand in the spring, demand seems to have fallen further since. Credit conditions are tighter and are expected to be tighter longer, and this seems likely to produce a further deterioration in overall demand--note, of course, the reduction in credit for autos, the rise in mortgage rates, and the more conservative lending standards for consumer and corporate credit. Growth outside the United States seems likely to slow further. Of course, fundamental to this dynamic, as has been true for 12 months, each shift in perceptions that the bottom in overall economic growth is further away produces additional stress for financial institutions and markets, adding to the intensity of prospective financial headwinds and to concerns about downside risks to growth. Now, the adverse tail on the inflation front remains significant. Many measures of underlying inflation suggest a broad-based, if limited to date, acceleration in the rate of underlying inflation. Market- and survey-based measures of long-term expectations are high. Surveys suggest that firms are able to pass on some part of the acceleration in energy and materials costs. On the more positive side, energy, commodity, and materials prices have declined significantly, principally it seems because of expectations of slower growth in global demand. Growth is moderating significantly around the world, and it's going to have to moderate further in the most populous parts of the world as central banks there get monetary policy tighter. The growth of unit labor costs has been and is expected to be very moderate here. Profit margins still show plenty of room to absorb cost increases, and as David reminded us, you can have a relatively benign outlook for the path of core inflation without margins narrowing very dramatically. Inflation expectations have not deteriorated meaningfully here, even with the flatter expected path of monetary policy in the United States. Of course, it's very important that inflation expectations and pricing power moderate from current levels. If some of the downside risks to growth materialize, this will happen, and inflation risks will moderate. If, however, the economy continues to prove to be resilient to these downside risks, then we will face higher inflation. On balance, the rate of growth in underlying inflation suggests that growth in demand in the United States will have to be below potential for a longer period of time if inflation expectations are to come down sufficiently. This means that we will have to tighten monetary policy relatively soon compared with our previous behavior in recoveries--perhaps before we see the actual bottom in house prices and the actual peak in unemployment. However, at this point, the risks to real growth remain critical. In my view, we need to have more confidence that we have substantially reduced the risks of a much sharper, more protracted decline in growth before we begin to tighten. I think it is unlikely that we will be able or will need to move before early next year. Short-term market expectations for monetary policy in the United States seem about right at present. I don't see a strong case for trying to alter those expectations in either direction at this point. To try to pull forward the expected tightening would risk adding to the downside risk to growth and magnifying the risk of a much more severe financial crisis. On the other hand, if we avoid some of these downside risks to growth, then policy will need to tighten more quickly, perhaps, than the expected path now priced in the markets. The evolution of monetary policy expectations and of inflation expectations since May illustrates how uncertain the markets are about what path of policy will be appropriate. But the pattern of changes in both of these measures of expectations suggests that the markets believe we will get this balance right--that we will do enough soon enough to keep underlying inflation expectations from eroding materially. Thank you. " FOMC20050630meeting--372 370,MR. LACKER.," Thank you, Mr. Chairman. Economic activity in the Fifth District advanced moderately in May and June. The survey results we released earlier this week showed that manufacturing shipments edged higher and that revenues of service firms grew somewhat more quickly this month. New orders in manufacturing seemed to slip this month, however. Growth in retail sales moderated in June, as our big ticket sales index contracted slightly after having moved sharply higher in May. District housing markets remained fairly hot—maybe not as hot as Miami, but fairly hot. Home sales continued at high levels. Bids above asking prices were common in popular locations. Markets for beach properties and for condos in downtown areas are especially June 29-30, 2005 136 of 234 growth to pick up over the next six months. Our contacts also expect an upturn in capital spending growth over that period, and price pressures in the District remain contained. Indications are that the national economy continues to perform well, although concerns about the housing market and energy prices are causing jitters in some quarters about the sustainability of the expansion. Average net job growth for the three months ending in May exceeded 150,000 per month—a rate sufficient to keep up the steady improvement in labor markets we’ve seen since last year. And the Greenbook expects real GDP to average above 3½ percent through the end of 2006, slightly faster than potential. To me, the most striking revision in the June Greenbook was the 0.2 increase in the projected path for core PCE inflation through 2006. Expected inflation is now 2.1 percent for ’05 and 1.9 percent for ’06. I found this revision striking, because 2 percent is the upper limit of my own comfort zone for core PCE inflation. Moreover, market participants are aware that the core PCE index is the Fed’s preferred inflation measure. And if we allow it to drift much above 2 percent, we run the risk of unhinging longer-run inflation expectations, especially if energy prices spike up further as well. Having said that, I take heart from the fact that inflation expectations have fallen somewhat in the past couple of months. TIPS inflation compensation, both near-term and longer-run, has continued to decline even in the face of climbing oil prices. Of course, inflation expectations build in beliefs about our future behavior. I read declining inflation compensation, along with the apparent fall in inflation uncertainty for which Vincent’s staff apparently finds evidence, as implying that markets expect us to do whatever is necessary to hold the line on inflation. I see three main risks to the outlook. First, with oil markets as tight as they are, the world June 29-30, 2005 137 of 234 Second, we’ve been anticipating a handoff from housing investment to business investment over the course of this recovery. While business investment has continued to pick up, the demand for new capital appears to be limited now by the rate at which firms expect their output to grow. So the potential problem is that businesses may be reluctant to pick up more slack before they see that housing is headed for a soft landing. Yet that reluctance would interfere with or impede a smooth handoff, making it more difficult to achieve. Third, I find myself worrying about the possibility of an inflation scare in the bond market, despite the recent decline in TIPS spreads. It’s not clear how likely this is, but if it happened, it would be very costly. A spike in long-term yields could be particularly harmful today for elevated housing prices. It would raise long-term mortgage rates directly, obviously. Moreover, it would force us to raise short-term real rates. And in such circumstances I think it would be even harder for us to facilitate this handoff of investment from the housing sector to the business sector without an intervening recession. Thank you." CHRG-110shrg50369--31 Mr. Bernanke," I do not anticipate stagflation. I do not think we are anywhere near the situation that prevailed in the 1970's. I do expect inflation to come down. If it does not, we will have to react to it, but I do expect that inflation will come down and that we will have both return to growth and price stability as we move forward. Senator Shelby. Do you still believe that the fundamentals of our economy is still robust, is strong, other than the housing market and some of the financial challenges that we have coming out of that? " FOMC20061025meeting--49 47,MS. MINEHAN.," Thank you, Mr. Chairman. The New England District economy continues to grow at a moderate pace, pretty much as it was growing the last time we met, with job counts slowly increasing and business and consumer confidence relatively good about both current and future conditions. As I’ve noted before, income growth has been robust in the District, with regional income growing better than 7 percent from second quarter ’05 to second quarter ’06. Indeed, incomes in Massachusetts and Connecticut both rose about 9 percent. Reflecting this rise, the fiscal condition of the states in the region, while varied, remains positive. Regional corporate health is solid, and readings of regional stock indexes follow the positive pace of the nation’s financial markets. Contacts from a wide range of manufacturing industries reported positive trends; fewer cost pressures from commodity, energy, and interest rates; and a continuation of competitive pressures to restrain costs and keep prices stable. We regard this pressure as a return to business as usual. On the negative side, the slowdown in the housing sector becomes more apparent with each passing month. According to the overall OFHEO house-price indexes, year-over-year appreciation in the second quarter of ’06 for New England was about half of that for the nation. The change from the first to the second quarter in ’06 was virtually zero. The region now has the lowest rate of annual housing appreciation of any area of the country except the Midwest. This situation is not entirely unwelcome, as housing price levels in the region remain quite high relative to the nation, and there has been much hand-wringing locally about the effect high housing costs have on attracting skilled labor to the region. Of course, the cyclical effect of a sharp residential investment slowdown is of concern. Existing home sales volumes are down 12 percent from their 2005 peaks. New home construction is weakening significantly, and construction employment has declined in both Connecticut and Massachusetts since year-end 2005. Indeed, negative commentary from area business contacts revolved mostly around markets for products aimed at the residential housing industry. While there may be some light at the end of this tunnel, with recent lower mortgage interest rates and some sense of bottoming out, the usual seasonal slowdown in the real estate industry as winter approaches may make this improvement difficult to appreciate for some time. The effect of slowing residential investment remains one of the key uncertainties on the national scene as well. Combined with the negative effect of trade, housing trends have caused us to mark down our estimate of third-quarter GDP growth to about the level of the Greenbook. However, positive incoming data on employment, consumer spending, and corporate profits, spurred as they have been by favorable trends in energy prices, financial markets, and worldwide growth, support a modest rebound in overall activity in the fourth quarter and a forecast for 2007 and 2008 of just slightly less than potential. Indeed, I was pleased to see the upward revision to the Greenbook forecast for the fourth quarter of this year, as I had worried whether the earlier trajectory had increased the risk of a spiral downward into a recession. I don’t think that’s likely, and I realize that overall the second-half GDP projection remains about the same. But the upward revision to the fourth quarter in the Greenbook, which brings it closer to our Boston forecast, makes me somewhat more comfortable about the underlying trajectory of economic activity. We, like the Greenbook authors, have revised down slightly our estimate of potential, so our sense of any gap in resource usage remains about the same as it was at the last meeting. Thus, unemployment rises very slowly, to just about 5 percent in 2008, and inflation falls slowly as well, along the lines of the forecast at the last meeting. All in all, that is not a lot of change. I must admit, however, to some small amount of hope that we may be seeing the bottoming out of the housing market decline because of the mixture of the data that Dave referred to earlier. Moreover, other aspects of the current situation seem quite positive as well—in particular, the very accommodative nature of financial markets and the continuing profitability of the nation’s corporations. Thus, the risks to what continues to be in many ways a rather benign forecast seem to me to be a bit less on the downside than they seemed at our last meeting. Energy-driven inflation may be lower as well, but I remain concerned about the underlying pressures on resource utilization if the economy does not slow as much as we now expect. Corporate-driven productivity growth, though we haven’t seen it escalate recently, could come to the rescue here, but I think it’s hard to bet on that. Thus, I do see some continuing uncertainty as to whether inflation will be as well behaved as in either the Boston or the Greenbook forecast." FOMC20061212meeting--94 92,MR. KOHN.," Thank you, Mr. Chairman. As many of you have remarked, the incoming data on spending at least have been consistent with our basic outlook for economic activity. Weakness in housing and autos will hold activity to below the growth rate of potential for a few quarters but with limited spillover to other forms of household spending. As inventory overhangs in these two sectors are dealt with, growth will return to something like the growth rate of potential. From some perspectives, the recent data have actually suggested diminished downside risk to the story. Stabilizing house sales, recovering mortgage applications, and improving consumer attitudes toward home purchases may be the signs of a housing market beginning to find a bottom. The expected downward path of prices in the Case-Shiller index futures market has actually been revised higher over the intermeeting period; it is still sloping down but not as much. Auto producers have held production steady in the fourth quarter and announced a small increase in production for the first quarter. Moreover, consumption outside autos has remained on a healthy track. Now, the downside risks in these areas may be smaller, but they certainly haven’t been eliminated. The Greenbook projection has starts stabilizing at the current level, but we have yet to see hard evidence of that stability. The last data point was a substantial decline that was larger than we expected. Inventory overhangs in the housing sector are large and will be worked down fairly slowly in the staff forecast. Heads of households may be just coming to the realization that their kids’ tuition and their retirement will not be taken care of by further outsized increases in the value of their homes. A bit more troubling than the housing and consumption data—and perhaps indicative of other sources of downside risk—have been the rise in inventories and the softness in manufacturing production outside the auto and construction-related sectors. Much of the downward revision to private final demand from the last Greenbook to this one, taking into account both the third and the fourth quarters, was in business fixed investment, and it occurred when profits remained robust and sales—excluding autos and residential housing—strong. Evidence of broader weakness in the manufacturing sector seemed to account for at least a portion of the reaction of the financial markets over the intermeeting period. There are a number of reasons to think that this weakness is limited. The underlying economy remains in good shape. Commodity prices have continued to climb, probably partly reflecting the weaker dollar but also indicative of underlying strength in global demand. Firms are adding to payrolls in a way they wouldn’t if they were sensing the possibility of softness spreading outside manufacturing. Equity prices and risk spreads suggest expectations of continued good growth, even if in the eyes of investors it might take some easing of policy to produce that outcome. As President Stern noted, anecdotes—as reflected in the Beige Book and what we’ve heard from visitors, including the Reserve Bank chairs and vice chairs who were here very recently—suggest that businesses are experiencing and expect continued good business conditions. These anecdotes very markedly contrast to the fall of 2000, when by November the tone of the feedback from businesses had turned decidedly gloomier. The Committee has been focused on housing and consumption, but the recent data and the financial market’s response may suggest the possibility that something else could be going on. Perhaps the removal of policy accommodation has affected other forms of spending more than we had anticipated. I think that the basic story of growth strengthening to potential over the next year remains valid and that it will be strong enough to withstand a rise in longer-term interest rates that would accompany a flat fed funds rate as in the Greenbook. Moreover, the overall downside risks to that forecast probably haven’t increased very much, but they may have changed source or character. We will need to be alert to possible sources of weakness that we hadn’t anticipated. With regard to the inflation outlook, I, like the staff, have characterized the incoming data as leaving expectations for a very gradual decline in inflation intact, if the economy follows something like the Greenbook path. To be sure, core PCE inflation did not ease back, but the CPI did quite a bit. Labor cost pressures appear to be less than we had previously estimated, and various measures of long-term inflation expectations remain within their ranges of the past several years. My presumption, like that of the staff, is that at some point lagging spending growth will be reflected in labor markets and will help to remove inflation pressures. But for now, the risks around the expected downward trend in inflation remain skewed to the upside. Unit labor costs are still accelerating, although not as much as we thought they were, and businesses won’t readily absorb higher costs and reduced profit margins. The unemployment rate remains low. The index of capacity utilization in manufacturing continues to be above its long-term average, suggesting continued pressures in resource markets and, by extension, in markets for goods and services, which will contribute both to higher costs and to the ability of businesses to pass them on. The forecast path to inflation is sufficiently gradual that upward deviations from it could entail outsized costs in terms of embedding another notch up in underlying inflation and inflation expectations. Thank you, Mr. Chairman." FinancialCrisisInquiry--152 And so there should be some separation, and I am shocked and amazed because banks are still allowed to do all the activities they were doing before the crisis. But I’m not sure it has to go that far where you automatically separate everything off. There’s other risk factors to think about, such as management continuity, consistency of strategy, success over the last, you know, decade or two. There’s other factors than just the one factor of what the activity is. GEORGIOU: Thank you. CHAIRMAN ANGELIDES: Thank you very much. Thank you, Mr. Georgiou. Mr. Thompson? THOMPSON: Thank you, Mr. Chairman. Gentlemen, no calamity of this size could ever occur with it emanating signals of its building well ahead of it being visible the public at large. And so, I noticed in your testimony, both Mr. Bass and Mr. Mayo, that you indicated that, gee, I saw this coming. So what I’d like to know is how early did you see it? Not 2006 or 2007, but how much earlier than that? And what signals did you see that others should have seen as well and taken action? Mr. Bass? BASS: When you look back—Mr. Mayo talked about loan growth doubling that of GDP growth. When you look back at the housing market—and you can go back through OFHEO’s raw data, all the way back to about I think it’s 1971, you look, you can go back and plot the housing price appreciation x inflation and chart that against median income. FOMC20070131meeting--126 124,MS. MINEHAN.," Thank you very much, Mr. Chairman. The New England regional economy continues to grow at a moderate pace with relatively slow job growth, low unemployment, and moderating measured price trends. Consumer and business confidence is solid, and while retail contacts reported an uneven holiday season, manufacturers were generally upbeat about business prospects. Skilled labor continues to be in short supply and expensive. In every one of the New England states, there is concern over the long-run prospects for labor force growth, given their mutual low rates of natural increase, out-migration of 25 to 34 year olds, and dependence on immigration for labor force growth. New England is an expensive place in which to live, and concerns abound about how to attract and retain the highly skilled workers that are needed for its high preponderance of high value added industries. Obviously, there’s nothing new or particularly cyclical about the foregoing comments. But I’ve been to quite a few beginning of the year “let’s take stock of things” conferences in all the states recently, so perhaps I’ve become more impressed than usual by the medium-term to long-term challenges facing the region. In the short run, however, the positive overall trend of the regional economy does seem to be a powerful offset to the continuing decline in real estate markets. At our last meeting it seemed as though New England’s real estate problem was more significant than that in the rest of the country. But now it appears that both are similarly affected whether one looks at prices, sale volumes, inventory growth, or declining construction. As with the nation as a whole, there are signs of stabilization; but at least in New England, making any judgment about the imminent revival of real estate markets in midwinter is foolhardy at best. On the national scene, the data have been more upbeat since our last meeting. Apparently the holiday season was a bright one, with consumption likely growing at a pace of more than 4 percent in the last quarter. That’s remarkably strong given the continuing decline in residential real estate and proof—to reiterate what President Stern said—that the U.S. economy continues to be unusually resilient. Supporting consumption are tight labor markets, lower energy prices, tighter though still reasonably accommodative financial conditions, strong corporate profits and some signs of revival in business spending after declines related to housing and motor vehicle expenditures, and continuing strong foreign growth. Even inflation has moderated a bit, with three-month core price increases in both the PCE and the CPI trending down. Our forecast in Boston and that of the Greenbook are virtually indistinguishable. The last quarter of ’06 was stronger than expected. The first quarter of this year will be slightly better as well, but after that, the trajectory remains the same as it has been for the past two or three meetings. An increasing pace of growth in ’07 and ’08 as the housing and motor vehicle situations unwind, a slight rise in unemployment, and a fall in core PCE inflation to nearly 2 percent by the end of the forecast period. In many ways, this is the definition of perfection, a forecast that is seemingly getting better each time we make it, with growth a bit higher, unemployment a bit lower, and inflation ebbing slightly more. The underlying mechanics that produce this outcome are relatively straightforward, but I wonder whether we should have a heightened sense of skepticism about such a halcyon outlook. Let me focus on two reasons for such skepticism. First, all other things being equal, inflation could be less than well behaved. One reason that inflation ebbed in earlier forecasts was that slower growth brought about a small output gap and rising unemployment. Now, the output gap is virtually eliminated, and unemployment remains below 5 percent. Ebbing inflation is solely the product of recent favorable inflation readings, which are assumed to persist: lower energy prices, declining import prices, and falling shelter prices. It’s hard to tell at this point whether the recent readings on core inflation are the result of fundamentally lower inflation pressures or just luck or maybe a combination of the two. I think a similar range of uncertainty applies to oil prices and the strength of the dollar. With virtually no output gap, it seems to me that, while the baseline best guess might be lower inflation, for all of the reasons discussed in the Greenbook one should approach that analysis with some caution. Second, demand could well be stronger. The baseline forecast assumes that consumers somehow get the message some of us have been trying to deliver about the need for an increase in private saving. The saving rate moves from a negative 1 percent to a positive 1 percent, the highest saving rate in several years. As I noted before, I have to ask myself why this is likely to happen over the next coming months when it hasn’t in the wake of the housing situation in 2006. Clearly, the downturn in residential real estate, an important political issue in all our Districts and certainly devastating for subprime borrowers in particular, hasn’t affected consumer spending in general. In fact, household net worth as a share of disposable income remains quite high, buoyed in part by a likely overestimate of real housing values but also by rising equity markets. The timing of the needed increase in the personal saving rate could well be further out in the future, creating some version of the buoyant consumer alternative scenario instead of the baseline. Again, with no output gap, the potential for increased inflationary pressure is obvious. In sum, the Greenbook forecast remains in my view the most likely baseline. There are downside risks, as I mentioned before, for the seven alternative scenarios do anticipate some downside risks; but if the housing situation is beginning to stabilize, I find it hard to believe that broader anxiety about it will affect business spending or the consumer as some of these scenarios contemplate. The bigger risk may well be that business spending picks up in light of consumer strength, unemployment stays low, growth exceeds our current projections, and resource pressures become more intense. I am concerned that risks to inflation have grown somewhat since our last meeting. I think I’m still in a “wait and see” mode, as I do believe there are downside risks to the evolution of housing markets. But if the Greenbook growth forecast is right, the best risk management on our part may have to be to seek tighter policy sooner rather than later." FOMC20051213meeting--84 82,VICE CHAIRMAN GEITHNER.," Our forecast for the national outlook has not changed substantially since the last meeting, and relative to the discussions so far, I guess we’re slightly at the stronger end. The recent data have been encouraging both here and internationally. The underlying pace of demand growth seems pretty good to us—good enough to raise the probability of the expansion continuing at a pace at or slightly above trend. The inflation news has also been reassuring, though December 13, 2005 51 of 100 We believe these conditions justify some further tightening of monetary policy, perhaps another 50 to 75 basis points. We are, therefore, comfortable with the expectations now built into the market. And with that monetary policy assumption, we think the risks to the forecast and to our objectives are roughly balanced. So, relative to September and October, we see somewhat less downside risk to growth, perhaps even some upside risk, and somewhat less upside risk to inflation. As this implies, our view is very close to the Greenbook. Let me mention a few other points. The apparent strength in productivity should make us more comfortable about the sustainability of the expansion and a bit less concerned about the near- term inflation risks because, of course, if the productivity growth stays stronger longer, we can be more confident that consumer spending will stay reasonably strong even if a more substantial slowdown in housing materializes. Scenarios in which more-moderate house price appreciation or some decline in housing prices leads to a sizable increase in the personal saving rate are probably less plausible or less troubling in an environment where consumers are more confident in the outlook for the economy or more confident in their future income growth. The productivity news, combined with continued moderation in the core inflation numbers and the moderation in measures of inflation expectations, make the inflation outlook somewhat more favorable. But against these factors there are others that justify some continued attention. Of course, overall inflation is still high, even though we expect it to moderate. Various measures of underlying inflation are still above what we would be comfortable with over time. There probably is still some energy cost pressure in the pipeline. And the TIPS-derived measures of inflation expectations over the medium term, if you adjust for the carry effect, have not really moved down that much. With compensation growth accelerating, we would expect eventually to see some upward pressure on labor December 13, 2005 52 of 100 surveys and anecdotal reports of pricing behavior, as we read them, suggest that businesses are able to pass on some share of their increased costs. So for these reasons, even with the additional tightening priced into the markets, we probably face some modest upside risk to our inflation forecast and to our objective, and we should continue to lean against this risk in what we do and what we say. We don’t see evidence yet to support a concern that the path of the nominal fed funds rate now priced into the markets risks going too far. Housing may be slowing a bit, but not really much. Other spending indicators look strong—probably stronger than we thought—and the strength is broader than it has been across the components of GDP. Expected real rates don’t suggest a high degree of concern, in our view. It’s just some concern, but not acute concern about the downside risk to future growth. If you try to take out expected inflation from forward rates, it looks as if real rates move up over the 2- to 5-year horizon. Equity prices, credit spreads, and the implied volatility of most asset prices don’t seem to suggest a lot of concern about significant deterioration ahead in the pace of the expansion. Although we don’t think the narrowing of the term spread itself or the low overall level of the yield curve offers clear guidance about monetary policy—clear guidance in terms of arguing for a softer or firmer stance than the other fundamentals might suggest—we’re somewhat more inclined to take the view that this change in the structure of term premia suggests we will have to do more than otherwise would have been the case. So all of this suggests to us that we should continue to tighten further and signal that we think we have still more to do." FOMC20070509meeting--65 63,MR. PLOSSER.," Thank you, Mr. Chairman. The near-term outlook for the Third District is moderate growth going forward. The major source of the strength in the District continues to be employment growth, and nonresidential construction is fairly stable and modestly healthy. However, manufacturing continues to be sluggish and residential construction weak. Job growth has picked up considerably in our District, having grown at 0.9 percent at an annual rate in the past few months. Unemployment rates have fallen in the region, and the labor market in Pennsylvania in particular has been especially strong. To get a better handle on labor market conditions, in our last business outlook survey we asked a panel of firms whether they had experienced problems filling jobs in the past three months because applicants didn’t have sufficient qualifications. Remarkably, more than two-thirds of our firms said that they had trouble with this and that the percentage has been growing since we first started asking the question three years ago. The strength in the regional labor markets is reflected in the rebound in our staff’s indexes of leading indicators of economic activity in the three states in our District, especially in Pennsylvania, where the index is predicting stronger growth over the remaining three quarters of the year. An area of stability in our region’s economy has been the ongoing modest strength in nonresidential construction. The growth in this sector has recently been largely in noncommercial construction—hospitals, education buildings, and so forth. However, general commercial vacancy rates in Philadelphia have been falling steadily, and the absorption rate in Center City is nearly at a record high. With regard to manufacturing, growth is stalled. According to our April manufacturing survey, our general activity index is close to zero, or just mildly positive, as it has been since late last year. Both new orders and shipments are close to zero, as they were. Further, in April the index of future capital expenditures was down somewhat and below the averages that we have been seeing in most expansions. The only bright spot was the significant bump-up in our future activity index, which signaled that more-robust activity is anticipated by our survey participants. It also comes as no surprise that residential construction remains weak in the District, and housing permits have continued to decline as the value of residential construction contracts has as well. Also, there seems to be little or no appreciation in house prices. On the inflation front in the District, prices paid and prices received by manufacturers have moderated a bit. Further, retailers are reporting very little change in prices over the past few months. In summary, the Third District is growing slowly, and our staff projection is for modest growth going forward. Labor market fundamentals appear strong, but we have yet to see any sign of the pickup in manufacturing that some of the national numbers indicate. On the national level, since the last meeting I have actually become a bit more comfortable with the economic situation. While I say that I am more comfortable, that’s a relative not an absolute statement. The most recent month’s readings on core inflation were welcome, but I think that caution and vigilance are still the order of the day. Indeed, the Greenbook authors, as we’ve noted, seem to have been revising their forecast of core inflation upward slightly over the past several months rather than downward, and that to me is a bit disturbing, even if the numbers don’t change a whole lot. News that has made me more comfortable with the projection of a somewhat quicker return to something closer to trend growth in the second half of the year is the recent strength in durable goods orders and the ISM numbers, which are indicating that manufacturing has picked up. Further, recent strength in manufacturing was broadly based, and the output of business equipment was strong. Along this dimension, I am in agreement with the latest forecast of the Board staff. However, these reports represent only one month of data, as people have said, and although they are consistent with a modest bounceback in the second quarter, there is still substantial uncertainty. I hope that, in the coming months, those data will be reinforced as new data come in; but, again, at this point that is only wishful thinking. I would add, though, that my business contacts, particularly in the financial sector, continue to report to me that business loans are strong, C&I loans are strong, demand is strong for loans, and balance sheets and firms still look good. So they see things as looking good from their perspective, but that positive news is not really showing up in some of these other numbers, at least as yet. So I’m a bit puzzled by that. Furthermore, job growth and personal income growth appear to be on solid footing, and I find myself increasingly puzzled by the weakness in the labor market as portrayed by the Greenbook forecast. The strength in personal income, along with a rebound in asset markets, leads me to view consumption as somewhat healthier going forward than the Greenbook sees it. Those circumstances, coupled with the more positive news on investment to which I just alluded, lead me to view closer-to-trend growth as the best forecast and, therefore, to have a little more optimism in my outlook for the second half of the year and into ’08. That is reflected in the forecast that I submitted. That said, I realize there are significant risks to this return to trend growth. The biggest risk remains housing. The extreme fluctuations in weather over the past four to five months have made discerning trends a lot more difficult, and I’m not sure exactly how much seasonal adjustment factors are bouncing the numbers around and making it harder to disentangle effects. Inventories of housing, as we have talked about, remain extremely high, and there is very little signal of a pickup in demand, at least as yet. However, I’m a little skeptical that this sector will continue to subtract a full percentage point of real growth from the forecast, as the Greenbook suggests. I’m a little more optimistic than that. I remain optimistic in part because I think real mortgage rates remain relatively low. I see strong income growth continuing, and I am increasingly less concerned, actually, about the spillover from subprime markets. So I can envision housing demand strengthening a bit more than is implied in the Greenbook, and that leads to less of a subtraction going forward. On the inflation front, I’m a bit less worried than last time but far from sanguine. The last core PCE inflation number was obviously very encouraging at something close to zero, but, again, we have to be very careful in extrapolating out one month’s data. As I said before, the Greenbook authors seem to be inching up their forecast of core inflation or at least pushing the decline out further into the future, and that concerns me a bit. I believe inflation is still too high. Inflation expectations are stable, but they are too high as well, and we need to bring that rate down. Thus, we need to be vigilant here and continue with a somewhat restrictive policy. In regard to my forecast, I’m not going to say much. I just assure you that, without collusion, President Lacker’s view of the forecast and how it evolves is very similar to mine. So rather than repeat what he said, I will just let his comments largely speak for mine. I have a slightly faster return to trend growth, partly because my productivity estimates are somewhat higher. I thought Janet Yellen’s comments about her productivity analysis were quite thoughtful, and I appreciate them. The optimal monetary policy, or at least my preferred path for monetary policy, might include some tightening if trend growth returns more quickly than we had indicated. But, indeed, my forecast for core PCE was actually down to 1.7 percent by 2009. I’ll stop there. Thank you." 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." FOMC20050809meeting--165 163,MS. BIES.," Thank you, Mr. Chairman. I want to focus my comments today on some macroeconomic perspectives and on what we’re learning in the supervisory reviews of mortgage products that we and other regulators are undertaking now. On the positive side, when we look at the large volume of ARMs in existence, most of them are of the traditional form. And currently those ARMs are at a point—whether they’re adjusted annually or they started out as 3-year fixed-rate loans and then move to annual adjustments—where they will be reset. For the ones that started out in 2002 with fixed rates for three years, this is the year when they will go to annual resets. We know all of them, since they’re indexed to short-term rates, are going to have a big increase whenever their anniversary August 9, 2005 70 of 110 To the extent that long mortgage rates or the reindexed rates are very close to those available to most borrowers on refinancings, it looks as if most of these ARMs can be converted into a fixed-rate product without a large amount of payment adjustment. There will be some, but it seems likely to be manageable for many of these borrowers. On the other hand, we’re seeing a lot of subprime ARMs where this may not be true. As you know, those ARM products that have been pushed into the subprime market are much more problematic. So the affordability for that group of customers is questionable. They are going to be hit not only by higher gas prices but higher monthly mortgage payments when their rates are reset. And that is going to be more of an issue as we go forward and as we continue to raise short-term interest rates. Also, I’m a bit more pessimistic about what is happening with regard to some of these option ARMs and the more esoteric ARMs that are being marketed and have been marketed particularly in the last nine months. Bankers as a whole I think clearly are doing a good job at underwriting these. We have some lenders on the edges, though, that we’re working on. But these mortgage market developments have some significant macroeconomic implications. Many of these loans started out with teaser rates that were below current market rates. So first of all, the rates have to catch up to the market level. Then also, the index to which the rate is tied will have moved up by about 250 or more basis points, say, by the end of the year. So if they are interest-only loans, the rate could go from something that maybe started out with a “1” and could get to something with a “4” in front of it. And all of a sudden the monthly payments are going to go up fourfold. Even if defaults don’t increase, it certainly is going to pull August 9, 2005 71 of 110 Another issue is that apparently many of these loans have limits on how much the payment can go up each year in order to try to make the annual adjustment easier. But that puts borrowers in a predicament because it throws them into negative amortization. During the teaser period, they’re in negative amortization; and the cap on the index used to reset the monthly payment could put them further into negative amortization. So if they do want to get out of the ARM and switch to a fixed-rate loan, they have to cover the additional negative amortization. Many of these loans have prepayment penalties, so the lenders recoup that. That may be problematic in moving more people into fixed-rate products as interest rates rise. And to the extent borrowers go to fixed-rate mortgages, they’ll go to fully amortizing loans, which could be a financial burden—even though we are beginning to see mortgages of 40 years and longer. The leverage that we see in households on their borrowing I think is another indication that if they’re stretching to be able to afford these houses, it will be more problematic for them to stay in the houses as their monthly payments go up—perhaps even double or triple. So, when we talk about the wealth effect of housing price bubbles, I’m getting concerned around the edges that we could see a major impact on cash flows of both subprime and prime borrowers because these ARMS are indexed to short rates and those rates are moving up. Since ARMs are a big chunk of the mortgage market today, we have to realize that we can’t just look at long-term mortgage rates and the affordability of housing. We need to look at the short rates, too, because they’re getting to be more and more important. As I look overall at the economy today—and I’m going to echo some of the comments I’ve heard around the table—I’m very comfortable that we have gotten past the soft spot of the spring. I also am a little pessimistic regarding how this recent bounce will be sustained. But I August 9, 2005 72 of 110 And in my view, that is a good pace of growth. I also believe, to echo the comments Governor Kohn just made, that the market has reacted to the understanding that we may have to push rates up even further. There is a tremendous amount of liquidity in the market, and I think that’s what the market is seeing. When we talk about accommodation, the market is looking at the liquidity that can flow into deals for both commercial activity and for consumers. So I think we need to continue to push the funds rate upward. And personally, my number for the upper limit on the funds rate is much higher today than it was three to four months ago." FOMC20070131meeting--124 122,MR. STERN.," Thank you, Mr. Chairman. Trends evident in the District economy for some time fundamentally are continuing. Specifically, employment is increasing moderately and steadily. Most components of aggregate demand are expanding, and I would note, in particular, strength in nonresidential construction. There has been no significant acceleration of inflationary pressures or of wage pressures. The housing sector is subdued, but the District data on sales and starts suggest stabilization, as do the national data. The data on the inventory of unsold homes perhaps are contradictory to that statement because there are still a lot of unsold properties; at least those data suggest that it will be some time before there is any pickup in housing activity. In any event, as Bill Dudley mentioned, mortgage delinquencies and foreclosures are rising, albeit starting from a fairly low level, and though that probably won’t have a significant effect on economic performance, it could be a political issue in Minnesota and elsewhere in the District. As far as the national economy is concerned, it seems to me that the incoming data over the past several months underscore a couple of things. First, the data demonstrate, again, the underlying resilience of the economy. Second, they bolster the case for sustained growth over the next year or more, accompanied by steady to diminishing core inflation. Let me elaborate briefly on those observations. The economy apparently grew better than 3 percent in real terms again last year, despite the significant run-up in energy prices, the appreciable decline in housing activity, and problems in the domestic auto industry. As I think about the prospects for ’07, I see little in the broad scheme of things to suggest that overall real growth over the next year will be much different from that over the past year or, for that matter, much different from that experience from ’03 through ’05. It also seems to me that our earlier concerns about the possibility of a further acceleration of core inflation have diminished, largely on the basis of the incoming information on inflation, thereby through the process of elimination heightening the outlook for steady to declining core inflation. I actually think that case is pretty good, partly because some of the factors that boosted core inflation were transitory and partly because inflation expectations, as best I can judge, have remained well anchored. That’s the message I get, at least from financial markets, from labor markets, and from conversations with our directors, other business people, and so forth. So for me, overall the near-term to medium-term outlook both for real growth and for inflation is constructive. I’ll stop there." FOMC20060920meeting--148 146,MR. KROSZNER.," Thank you very much. Unfortunately, I think we find ourselves in an uncomfortable position like that of six weeks ago, with a continuing mix of inflationary pressures and decelerating economic growth at the same time. I think the fundamentals are in place for a continued moderation of growth but not a contraction, much as the Greenbook describes. Obviously, housing is a risk that everyone has talked about. But the key, as many people have also mentioned, is maintaining contained inflation expectations, and that comes down to thinking about whether some of the factors that we’ve been seeing have been more transitory or more persistent. Let me first talk about growth and go through the C plus I plus G plus net exports. I would agree with the staff’s characterization that world economic growth is not quite as strong as some others have put forward. I don’t think we’re going to be seeing an enormous export boom. Also, as briefly mentioned, I see very little on the government stimulus side. Tax revenues, as Governor Warsh mentioned, were very high. Spending is being kept relatively tight. On investment, we’re seeing some strength in capital spending. My concern is, if consumption goes as low as the Greenbook suggests, what the return on this capital spending will be. Is it going into the right areas? I was a little concerned when President Poole mentioned that the air freight company is expanding rapidly but the on-the-ground delivery company is not expanding at all. So are they going to have to invest in parachutes to get these in? [Laughter] But that is precisely the concern that I have—that capital spending may not conform perfectly to what consumption demand is going to be. We certainly saw this in the late 1990s and early 2000s. I’m just a bit worried about that now, especially given the potential tension between slowing consumption and robust investment growth. Now, regarding consumption—we’ve talked about the potential support from lower energy prices and some positive wealth effect from stronger equity markets, but obviously housing is one key here. It’s a key partially in overall investment but also in the uncertainty that it causes in consumers’ minds. Housing is one of the worst areas for data. It’s very difficult for us to have any concept of what prices are doing because it’s not a market like any other. We do have the Case-Schiller index, and we do have some better indexes that people are now betting on, but they’re still very poor indicators of prices relative to the indicators we have in other markets. We also know that there can be queues and that extras can be thrown in, so there’s a lot of uncertainty with respect to where prices are going. That concerns me quite a bit because I think we just don’t have a good handle on it. Permits and starts have continued to come down from where they were at our last meeting and are now at levels of the beginning of 2003 or even starting to slip into 2002. If they flatten out there, the housing sector is still historically reasonably good. But there’s no indication that we’re necessarily at a turning point and that things are going to flatten out. There is the wealth effect, the direct effect on people’s consumption behavior of lower wealth going forward, and also the confidence effect. We don’t have a perfect analogy with the previous times in which we’ve seen these housing downturns— we have a different context in that the economy is broadly more robust—and so I think it’s less likely that we’re going to see a major housing problem. But I think it is a real risk, and we have to be sensitive to it. On the inflation outlook, we have to come back to transitory versus more-persistent components, as many people have mentioned in the discussion. Obviously, people are heartened that energy prices have come down, but I certainly would not put the same bet on the energy markets that one trader did in a hedge fund that got into a little trouble recently because we know that energy prices can move in ways we don’t expect. So I don’t want to take too much from that. I think it’s appropriate in the Greenbook to use the market’s expectations. What measure do we have other than market expectations? If we did have a better measure, then we’d be running one of those hedge funds. However, there’s a lot of uncertainty around that measure. So I certainly don’t want to bet on better inflation going forward just because we’ve suddenly seen a 15 percent decline in oil prices over the past six weeks. That said, it’s heartening that energy prices are unlikely to lead to greater inflationary pressures going forward than those when we paused six weeks ago. The rise in compensation is obviously troublesome—not if you are an employee receiving the higher compensation, but from our point of view. However, a lot of tension is in those data because we have the compensation numbers versus the ECI. There’s a big statistical discrepancy between gross domestic income and gross domestic product. It’s possible that some of the increase in compensation will be revised away, and we’ll see actually higher productivity growth. We just don’t know, and it may be a while before we see it. Also, as we discussed a lot last time but not this time, the continuing fairly wide margins that businesses are experiencing may come under more pressure and may absorb some of the increases in labor compensation. How much is uncertain, but that may be one potential offset. As many people have said, we can’t become complacent. Inflation expectations have behaved reasonably well since we paused at the last meeting, which is heartening in that the markets believe that inflation is reasonably under control in the near to medium term and even in the longer term. It’s hard to find evidence of increases in inflation expectations, but as many people have said, that does not mean that we don’t have to worry. We have to worry a lot because the key is keeping those expectations well contained. I think we’re in a situation in which we can do that. Slowing growth is not going to give us more of a benefit. The flatness of the Phillips curve, which people have talked about, is what the data have been over the past ten to fifteen years in the United States and most other countries. So even if there is a bit more slowdown, we are not necessarily going to get the potential benefit in significantly lower inflation pressures—maybe a little but not very much. So we still have to worry about the upside on inflation, and that’s why maintaining our credibility is of utmost importance." FOMC20061025meeting--51 49,MR. PLOSSER.," Thank you, Mr. Chairman. Our regional economic story is similar to that of the national economy. Regional activity has slowed in the third quarter, mainly because of the housing sector. In general, our business contacts expect the regional economy to continue to expand, albeit at a modest pace. Price pressures remain elevated in the Third District but have not strengthened over the intermeeting period. Turning to the individual sectors, manufacturing activity in our region has softened over the past two months. The index of general economic activity in our business outlook survey, which turned slightly negative last month, remains slightly negative this month, indicating basically not much change since September. However, there were some positives in the October survey that were not in the September report. In particular, there was a rebound in the indexes of new orders and shipments, suggesting slightly positive growth in our respondents’ firms. Also, manufacturing executives were much more optimistic this month about future activity, with most indicators rebounding from their September low readings. This optimism is consistent with President Moskow’s comment about the optimism of some executives that he has observed. Now, consistent with the slowdown in activity, payroll employment growth in our three states slowed in the third quarter to an annual rate of about 0.7 percent, compared with 1.1 percent in the nation. The unemployment rate, which had been running under the national rate for the past three years, has now moved up to that rate. Still, our business contacts as well as respondents to our manufacturing survey continue to cite difficulty in finding qualified workers as one of their major business concerns. As in the nation, the housing sector in our region continues to decline. We’ve seen some slowing in the value of nonresidential contracts as well over the past three months. But these data are quite noisy, and I think it’s too early to read much of a turning point into the nonresidential construction sector for our region at this point. Office vacancy rates continue to edge down, and the net absorption of office space continues to be positive. Consumer spending continues to hold up well in our region. We saw a pickup in retail sales in September, except for autos. Area retailers told us that their sales had increased in recent weeks, and their back-to-school sales exceeded their expectations. Their view is that continued growth at that pace depended on consumer confidence, which for the mid-Atlantic region increased in September, no doubt because of the decline in oil prices. The Fed’s current economic activity indexes indicate a slowing in activity in our region over the past three months, especially in New Jersey, which has shown the sharpest deceleration. As of August, year-to-date average growth in these indexes (weighted by gross state product) for our three states has been about 1.8 percent, compared with 3 percent for the United States. Over the past three months, regional growth has slowed to about 0.6 percent. The leading indicators for our three states also have moved down this year, suggesting only modest growth over the coming six to nine months. On the inflation front, consumer prices in the Philadelphia region continue to rise at a pace faster than that of the nation. The faster pace is due mainly to the larger increases in shelter prices in the Philadelphia metro area compared with those in the United States. On a more positive note, while area manufacturers continue to report higher production costs, these cost increases have been less widespread in recent surveys than earlier in the year. The index of prices paid in our manufacturing survey has declined for the past three months, and the index of prices received was down significantly in October. So while the levels of these indexes remain high, indicating continued inflationary pressures, some solace may be found in the less elevated levels of these indicators, at least in recent months. For the national economy, my outlook is not much different from what it was at the last meeting. Real GDP growth in the second quarter was revised down to 2.6 percent, as has been noted, and the data received to date suggest that growth in the third quarter was even weaker, perhaps 1 to 1½ percent. I expect some rebound in the fourth quarter and, like President Minehan, was pleased to see the upward revision in the fourth-quarter forecast in the Greenbook. The main source of the slowdown, of course, is the fall in the demand for housing. Manufacturing also softened in the third quarter compared with its robust pace earlier in the year. About half of that slowdown was due to autos, and I expect some rebound there, too, in the fourth quarter. Trade subtracted from growth in the third quarter relative to the second quarter, but again, as has been pointed out, I expect that to be less of a drag in the fourth quarter than it was in the third. So aside from housing, most other sectors of the economy, including consumer spending and business investment, are holding up, even in the Philadelphia region in the Third District. They aren’t growing as rapidly as they were in the first part of this year, but they are growing somewhat below trend, and they continue to expand. If the slowdown in housing continues to be an orderly one, without large spillovers as has been frequently mentioned, I would not characterize that correction as unwelcome. Housing activity has been at an unsustainably high pace in recent years. Of course, at this point we cannot rule out the possibility that the correction in housing from the unsustainably high pace of activity that we’ve seen over the past few years will derail the expansion. But so far, we have not seen spillovers of housing into other sectors. In particular, we have not seen any retrenchment by the consumer for the most part. The moderation we’ve seen in consumer spending after the strong first quarter is largely in line with expectations. Real disposable income growth remains healthy, and we have been lucky with two positives—the decline in gasoline prices and the rise in the stock market. We’ve had some hopeful news on the inflation front over the intermeeting period, but the level of inflation continues to concern me. As we anticipated at the time of our last meeting, the drop in energy prices led to a significant deceleration in headline inflation for September. Although the twelve-month change in core CPI actually edged up to 2.9 percent, a rate that I consider well above price stability, it may be beginning to stabilize. But, frankly, a lot of uncertainty remains, and it is dangerous, to my mind, to rely too heavily on one month’s numbers. Some of the acceleration of core inflation over the past year was likely due to the pass-through from energy prices, as we discussed before. So if oil prices fall or continue to stabilize, then acceleration of core inflation from this source will likely dissipate. However, we’ve seen energy prices retreat only to move back up again, so I don’t think we should become too sanguine. Indeed, the inflation picture remains uncertain. I’ll be more comfortable when we begin to see twelve-month core inflation begin to decelerate. To the extent that some of the acceleration in inflation was fueled by very accommodative monetary policy over the past five years, we still need to consider whether monetary policy has firmed enough to remove the cumulative effects of the past policy accommodation to get inflation back down to a level consistent with price stability in a reasonable time so that our credibility is not at risk. The longer we allow that deviation from price stability to persist, the higher the risk to our credibility and the higher the risk that recent high inflation readings will raise longer-term inflationary expectations. So far, long-run expectations have been stable, and shorter-run expectations have fallen with oil prices. Nevertheless, I think the Fed’s commitment to price stability deserves our protection. One thing to note going forward, though, is that if economic growth remains below trend for a while, then there’s an implicit firming of monetary policy, even without changing the nominal interest rate. Given our economic outlook and the risks to that outlook, at this point that may be actually the most desirable path. Thank you, Mr. Chairman." CHRG-111hhrg54873--19 Mr. Hensarling," Thank you, Mr. Chairman. Clearly, there were a number of causes of our Nation's economic turmoil, and most had their genesis in flawed public policy. Particularly with respect to the affordable housing mission of the government-sponsored enterprises, Fannie Mae and Freddie Mac, a story we know all too well. Now to state the obvious, the three major credit rating agencies badly missed the national housing bubble. That does not necessarily make them duplicitous, and it doesn't necessarily make them incompetent. It just makes them wrong--very, very wrong. It is also a painful and expensive reminder that there is no substitute for some modicum of investor due diligence and personal responsibility. Now there is a sincere bipartisan desire for credit rating agency reform in this committee. Unfortunately, I believe the draft that is before us now falls short. There are a number of good provisions in the draft, in Chairman Kanjorski's draft, including essentially removing the NRSRO designation from current statute in regulation. Unfortunately, the bill also includes provisions that will allow new liability exposure, including joint liability for the rating agencies. I feel that these sections will actually increase barriers to entry into the rating market and make it more difficult to have competition. An increase in lawsuits will become, I believe, an insurmountable barrier to competition. The joint liability provision especially troubles me. To make every rating agency potentially liable for the ratings of other agencies, I don't see the parallel anywhere else in our body of law. I heard someone say that is a little like making Ford liable for a defective car manufactured by GM and then not giving Ford a chance to defend themselves. No nation can sue its way into economic recovery and financial stability. Increasing the agencies' liability does not get at the root of the problem, which is the de facto government stamp of approval behind the rating agency's work product. That is indeed where we need to go. People assume wrongly that the government stamp of approval meant accurate ratings. Congress took a good step with the Credit Rating Agency Reform Act, but it was too little too late. Again, there is a vitally important lesson we have all learned about implied government backing. And so I want to compliment the chairman and the ranking member for having a bill before us that would essentially terminate the NRSRO designation. But unless we eliminate all barriers to entry, I am fearful that it is all for naught. And with that, Mr. Chairman, I yield back the balance of my time. " FOMC20060808meeting--72 70,MR. KOHN.," Thank you, Mr. Chairman. As many of you have remarked, the inflation news over the intermeeting period was not favorable. Core consumer prices continued to run at an elevated level, and the CPI actually came in on the high side of expectations. The shortfall in the PCE that President Yellen referenced was, I think, more of those mysterious nonmarket components. Petroleum prices rose further, implying additional feed-through going forward. Prices of other commodities, as Karen remarked, were on average unchanged to somewhat higher, suggesting not only continuing cost pressures on producers but sustained strength in global demand. Early estimates of unit labor costs for the second half of last year and the first half of this year show a faster increase than had been estimated and anticipated. The compensation data for the early part of this year, in particular, are subject to very large revisions. Even the now-faster growth doesn’t necessarily indicate that the economy has been operating beyond its sustainable potential, given the likelihood of some catch-up with past productivity gains, the still quite elevated profit margins, and the moderate increase in the ECI. But at the very least, the unit labor cost story doesn’t provide as much comfort about future inflation as it did previously. Largely as a consequence, the staff revised up its inflation forecast for 2006 and 2007, and that response seems reasonable to me. At the same time, some developments over the intermeeting period help me feel a touch more comfortable, or perhaps a touch less uncomfortable, with the downward trajectory for inflation after the bulge. One of them that a number of you have mentioned from surveys is that the long-term inflation expectations in the market remained stable or even edged down a little despite higher energy prices and, importantly, despite downward revisions to the expected path of monetary policy. If I were forecasting today, I would forecast a slightly higher inflation rate, but I would also forecast a slightly higher unemployment rate than I did before. To be sure, output gaps, as you’ve mentioned, don’t play a large role in determining inflation, but certainly the growth of demand relative to potential has some effect on the competitive conditions that businesses are facing and on their ability to pass through costs. From the information that we received over the intermeeting period, growth slightly below the growth rate of the economy’s potential seems more likely than it seemed a month or so ago, and this would inhibit the pass-through of higher energy and labor costs. Weakness in the housing sector has deepened, and we have not yet seen the full implications of the rise in long-term and short-term interest rates over the first half of the year. This weakness seems to be having an effect on housing prices as well as on activity. The effects of a lower expected trajectory for housing wealth and the increase in interest rates this year haven’t begun to show through to consumption, judging from the minus 1½ percent saving rate. The energy-price increases of recent weeks will take something more out of consumption. Recent data are consistent with a below-trend track for the growth of economic activity: Private domestic final purchases increased at a rate of only 2 percent in the second quarter. The consumption and investment data for late months in the quarter don’t suggest an acceleration going into the third quarter. The growth of employment has been running slightly below what would be a steady-state pace if participation were to remain stable, and participation has edged higher. The greater increase than had been anticipated in inventories in the second quarter suggests little impetus or even a small drag from inventory accumulation in the third and fourth quarters. The growth of federal government spending seems to be dropping back a bit as Katrina-related expenditures top out. Moreover, the recent higher rates of core inflation, though they are puzzling to a considerable extent, must reflect some influences that are unlikely to be repeated indefinitely into the future. One of those is the rise in oil and energy prices. The recent rise clearly has been associated with escalating tension in the Mideast and other producing areas, as well as the recent cutback in supply from Alaska. At some point, the risks of supply disruptions, while remaining very high, should level out. As a consequence, so, too, should energy prices, which will reduce core inflation as the feed-through fades. Another factor boosting inflation in recent months was related to rising rents and, in particular, to an even greater increase in owners’ equivalent rent. The staff has assumed that owners’ equivalent rent will rise in line with other rents and that both will continue to increase fairly rapidly but less rapidly than they did. That seems reasonable to me, given the increased availability of houses and apartments on the market that would, at some point, seem to limit the rise in rents as well as house prices. So my conclusion is that the staff forecast of a gradual moderation of core inflation after the second quarter is a reasonable expectation, although I am very worried about upside risks to inflation. The inflation rate looks as though it will end up a tad higher than either the staff or I thought likely at the time of our June meeting. Thank you, Mr. Chairman." CHRG-111hhrg52406--8 The Chairman," Next, the prime sponsor of the bill here on the committee, the gentleman from North Carolina, Mr. Miller, for 2 minutes. Mr. Miller of North Carolina. Thank you, Mr. Chairman. One of the issues arising from the financial crisis that this committee must address is how compensation in the financial industry created incentives for taking immediate profits while ignoring only slightly less immediate risk. We will consider how to adjust compensation to ally the long-term interests of companies with the interest of those who work for them. The issue before us today is more difficult and more important, how to ally the interests of the financial industry with those of society. The financial industry has defended every consumer credit practice, regardless of how predatory the practice appeared to those unsophisticated in finance, like me, as an innovation that made it possible to extend needed credit to those who were excluded from traditional lending. And the industry's innovations resulted in inflating the housing bubble, evading existing consumer protections, trapping the middle class in unsustainable debt, and creating risk for financial companies that were dimly understood by regulators, by investors, and even by the investors and CEOs of the companies that created them. And it plunged the country and the world into the worst recession since the Great Depression. The regulatory system we are considering is less restrictive than the regulation of many industries that have done much less damage. At bottom, the question is this: Are consumer lending practices that the industry celebrates as innovation actually useful to society, or are they just a way to make more and more money by betraying the trust of the American people? Other regulators don't just take the regulated industry's word for it that their products are beneficial, and neither should the regulation of the financial industry. I yield back my time. " FOMC20080109confcall--13 11,MR. STOCKTON.," 2 Thank you, Mr. Chairman. Earlier today along with Bill Dudley's materials we circulated a note describing some of the revisions that we have made in our projection since the December forecast. I should caution the Committee 2 The materials used by Mr. Stockton are appended to this transcript (appendix 2). that this projection has not been the result of running the complete machinery that sits behind the staff's forecast. Rather, we've done our usual, I hope, careful job of doing the near-term adding up, and then we've used the model simulations and rules of thumb to adjust our medium-term outlook to reflect changes in the data and changes in the conditioning assumptions that we've taken on board here. That said, I do feel reasonably comfortable that what we're showing you here puts us in the right ballpark in terms of how the data and how changes in some of the major conditioning assumptions are likely to affect the forecast that we will be showing you in a few weeks. Several key features of note in this revised forecast: Growth in real GDP in the fourth quarter of last year has been revised up by a noticeable amount. However, we will revise down growth in real GDP in both 2008 and 2009 also by a noticeable amount. Unemployment runs higher throughout the projection period. Despite that higher level of the unemployment rate, total and core inflation are higher in 2008 than in our December forecast because of sharply higher oil prices incorporated in this forecast. Inflation is roughly unchanged in our 2009 projection. So let me touch briefly on each of these elements. As you can see in the table, we've revised up our estimate of GDP growth in the fourth quarter from a forecast that was basically flat at the time of the December meeting to an increase of about 1� percent at an annual rate. Much of that revision reflects the stronger retail sales data that we received shortly after the last FOMC meeting as well as the stronger consumption of services that we received in the personal income release late last month. In addition, the incoming data on construction put in place for November were much stronger than we anticipated for nonresidential structures and for state and local construction. Not all the data that we've received, however, have been on the positive side. Housing continues to outflank us on the low side. Both starts and permits for November came in well below our forecast, and sales of new homes were much weaker than we'd expected. We now think the trough in housing starts, which we still see as likely to occur in the first half of this year, will be deeper than our previous forecast and by a considerable amount--nearly 10 percent deeper is what we've built into this revised provisional forecast. The other major negative surprise was the employment report for December. Private payrolls contracted by 13,000 last month. We'd been expecting an increase of about 50,000. Moreover, the unemployment rate jumped 0.3 percentage point in December. That increase was certainly eye-catching from our perspective. As we noted in the handout, higher average hourly earnings offset the weaker employment so that the labor income actually is not too much different than we had expected at the time of the December forecast. Still the labor market appears to us to have softened noticeably last month, and we've taken signal from that and revised down expected employment growth going forward. Our forecast for economic growth in the first quarter is unrevised at an annual rate of � percentage point. We do carry a little more momentum in consumer spending and a little more momentum in nonresidential structures into the first quarter, but that is offset by the substantial downward revision that we're making to the housing forecast. Beyond the near term, we've had a lot of negative influences to contend with. I've already noted that we've taken down our housing forecast. That revision alone was sufficient to knock another tenth off GDP growth in 2008, bringing the total subtraction of housing from GDP growth in this projection in 2008 to � percentage point. Oil prices are about $6 per barrel higher on average than was incorporated in our December forecast. The impact of those higher oil prices on purchasing power and consumption are large enough to reduce projected GDP growth in both 2008 and 2009 by a tenth each year. I should note that households are on the verge of experiencing another stiff increase in gasoline prices over the next couple of months, and households are probably not yet aware that that's on the way, except for those that actually follow oil futures markets--I assume that's a relatively small group. We've lowered the path for equity prices by 7 percent in this forecast. About half of that revision reflects the change that occurred since we put the December Greenbook to bed. The forecast that I circulated today doesn't include yesterday's decline or today's increase. We basically used Monday's close. The other half of the decline in equity prices that we've built into this baseline forecast currently reflects the fact that, for purposes of this provisional forecast, we made no change in our assumption about the path of the federal funds rate from our December Greenbook. Obviously, the December path assumed no change in the funds rate at the January meeting. That would come as a significant disappointment to the markets, and by our normal calibration, we estimate it would take about 3� percent off the level of equity prices going forward. So that gets us to the 7 percent. House prices have come in a touch lower than we had forecast. We have also lowered our projection on the level of house prices about 1 percentage point in this forecast. Taken together, those lower equity prices and the lower house prices take 0.1 off growth in 2008 and 0.2 off GDP growth in 2009. Turning to the labor market, the jump in the unemployment rate in December in combination with our weaker outlook for growth in real GDP going forward has led us to raise our projected level of the unemployment rate to 5.2 percent at the end of 2008 and 5.3 percent at the end of 2009. As for prices, the recent news on inflation has been disappointing. Total and core PCE prices came in above our expectations in November. As can be seen in our table, we've raised our estimate of total PCE price inflation in the fourth quarter to 4 percent, and we've increased our estimate of core PCE price inflation to 2.7 percent. Both those figures are � percentage point above our estimates in December. Some of the upward revision in the core price measure is due to higher figures for nonmarket prices, but market-based prices were higher than we had expected as well. Going forward, the higher oil prices that I referenced earlier also leave a clear imprint on projected inflation. We've raised our headline price inflation to 2.4 percent in 2008, up 0.4 percentage point from our previous projection. With energy prices expected to edge off in 2009, total PCE inflation recedes to 1.7 percent. For core inflation, we've added 0.1 percentage point to our projection this year, reflecting the indirect effects of higher energy prices. Our forecast for core inflation in 2009 is unchanged. Some lingering indirect effects from higher energy costs are offset in this forecast by a wider margin of slack in resource utilization. Let me just say a few words about how the risks to the forecast have changed. I believe that the adjustments that we have made to this provisional forecast actually are quite reasonable in light of the developments and the data that we have been contending with, but I'd have to admit that the downside risks to our projection have become more palpable to me. Despite a year of nearly continual downward revision, we just can't seem to get in front of the contraction in housing. The steep descent in sales and construction of new homes has not let up, and there seems to me to be more downside risk than upside risk to our house-price projection. Another area of concern would be the recent readings on the labor market, which have been very soft. Although quite volatile on a week-to-week basis, initial claims for unemployment insurance and insured unemployment have been trending up. Moreover, both the payroll survey and the household survey deteriorated noticeably in December. As I noted earlier, private payrolls contracted last month, and a jump of 0.3 percentage point in the unemployment rate in a single month is rare, though not unprecedented, outside of recessions. The steep decline in the manufacturing ISM in December was both unexpected and of a magnitude well outside the normal volatility in the data. The drop in consumer confidence has pretty much matched our expectations, and it didn't continue to worsen in December; but the total drop that we have seen in recent months is similar to drops seen before previous recessions. Any one of these indicators taken by itself would not be especially troubling; but taken together, they certainly deserve attention. We are not ready to make a recession call yet. The spending data still have exceeded our expectations by a noticeable margin, especially consumer spending. Motor vehicle sales at a 16.2 million unit rate in December certainly don't look like a recessionary development, and business spending has slowed but certainly not slumped thus far. Furthermore, the anecdotes--at least my read of the anecdotes--still seem more consistent with the weak economic growth that we are projecting rather than outright contraction. But at this point we do feel as though we are on very high alert. I'd be happy to take any questions from members of the Committee. " CHRG-111hhrg53240--2 Chairman Watt," This hearing of the Subcommittee on Domestic Monetary Policy and Technology will come to order. We will proceed with opening statements up to 10 minutes per side, and I will recognize myself for a brief opening statement. This hearing is entitled, ``Regulatory Restructuring: Safeguarding Consumer Protection and the Role of the Federal Reserve.'' This is the second in a series of hearings about financial regulatory reform and the role of the Federal Reserve, the second in this subcommittee, that is. The first hearing, held on July 9th, examined how to balance the Federal Reserve's existing role as the independent authority on monetary policy with its proposed role as systemic risk regulator under the Administration's financial regulatory reform proposal. Today's hearing examines a different aspect of the Administration's regulatory reform proposal, the proposed Consumer Financial Protection Agency (CFPA). While the full Financial Services Committee has held a hearing--or a series of hearings, for that matter--on the CFPA, this hearing will drill down further and examine some of the public policy and operational considerations related to the proposed CFPA, including whether the Federal Reserve should maintain a role in consumer protection, given its current responsibilities for writing rules, supervising institutions, and enforcing the Nation's consumer protection laws, and if so, what that role should be and how it might be coordinated with, supportive of, or at least not in conflict with the new CFPA. Although no witnesses from other Federal banking agencies are testifying today, this hearing may also touch upon how the same set of questions should be answered with respect to their consumer protection roles and their interactions with the CFPA. Today there is no single agency focused solely on protecting consumers from products and services that could be detrimental to their financial health. Since the idea of having a single Consumer Financial Protection Agency was advanced by Harvard Law School Professor Elizabeth Warren, other academics, commentators, Members of Congress, and regular citizens have embraced the idea. They have witnessed the way that our fragmented regulatory system produced serious gaps in regulation and oversight and failed to have anyone whose highest priority was protecting consumers, that is, someone who goes to work every day with that as their single most important objective. Others, of course, criticize the idea of a single consumer protection agency as adding another layer of regulation. There can be no doubt that regulatory gaps helped create an environment for toxic financial products such as predatory mortgages and other abuses that helped cause the current financial crisis. To remedy this, the Administration has proposed placing focused authority in the proposed CFPA to administer the Nation's consumer protection laws. As Congress and President Obama work to enact financial regulatory reform, it is critical for us to examine the public policy rationale for vesting virtually all authority for consumer protection of financial products in a single agency. Also, as a matter of public policy, we will examine whether and how the Federal Reserve can effectively balance its responsibilities to execute monetary policy, take on a new role in systemic regulation, and if it continued to have this role, protect consumers effectively. For far too long, consumer protection has been an afterthought. I hope that the record developed at today's hearing will offer further support for the elevation of consumer protection to be on equal footing with prudential and safety and soundness regulation. We also hope that today's hearing testimony will begin to address some of the questions surrounding the operational details of the proposed consumer protection agency, including coordination between and among Federal regulators and State regulators so that there is effective and efficient regulation of the Nation's consumer protection laws in the financial services area, as many believe we have in the food and product safety area. With that, I will recognize the gentleman from Texas, the ranking member of the subcommittee, Mr. Ron Paul, for, I guess, up to 10 minutes or as much time as--I guess, 6 minutes; 6 minutes is what I have been told. Dr. Paul. Thank you, Mr. Chairman. I want to thank you for holding these hearings because I think they are very important. The subject of consumer protection and the role of the Federal Reserve is, to me, a very important issue. I look at this somewhat differently than others because they talk about consumer protection, and they are thinking about financial products and services, credit cards and gift cards and that if there is any harm done to the consumer, that just additional regulation will handle this. But I think there is a much bigger issue related to the consumer and the Federal Reserve, something I think is neglected in a serious manner. For instance, the Federal Reserve has something to do with the value of our money, and the Federal Reserve has been around since 1913 and now we are working on a 4-cent dollar. So the systematic destruction of the value of our money has not helped our consumers; our consumers are destroyed by the loss of their purchasing power. The fact that the Federal Reserve regulates interest rates and gets them down to 1 or 2 percent, so if you happen to be a saver and you are in retirement and you put money away, you get punished. Maybe the market would say that the interest rates ought to be 5 percent or 6 percent or 7 percent, if you are a saver. But we punish them, and this has to do with the regulations and manipulations going on with the Federal Reserve. So the Federal Reserve is hardly a protector of the consumer when it distorts the interest rate that is paid to the savers, and they are the consumers. Think about how the consumer was protected with the collapse of the financial bubble. The financial bubble--it is well-known the financial bubbles come from inflating the money supply, lower interest rates, malinvestment, too much debt. The source of all this mischief comes from the Federal Reserve, and who suffers? The consumer. Who benefits? The people who had been making bundles on Wall Street and the bankers, for years when the bubble is being built, and then all of the sudden the bubble bursts, and who gets punished? The little guy gets punished. He loses trillions and trillions of dollars in value. Who gets bailed out? Goldman Sachs. And we pretend that the Federal Reserve is going to protect the consumer when the consumer is being destroyed under these conditions. Think about the consequence of the collapse of the bubble that has been artificially created. Who suffers? It is the consumer, the people who lose their jobs, the poor people, the middle class. This type of system that we have today, historically it is well-known if we pursue it, and we are pursuing it, because the middle class gets wiped out. Look at all of the inflations throughout history, all of the paper moneys of history. The middle class eventually gets wiped out because the value goes down. And the people who suffer the most aren't the people on Wall Street; the people who suffer the most are the middle class. They lose their jobs. They lose their houses. And I just think that as well intended as this is, to have more regulations to protect the consumer with their financial products and their other services--maybe it will help a little, but if you don't address the subject of how the consumer is destroyed, it won't help. Mexico has gone through this quite a few times with the destruction of currency. Who gets wiped out? The middle class. They are all holding pesos. The peso goes to the dogs. The middle class gets wiped out. Now, and I have had correspondence and meetings with members of congress from Mexico, and now they have a savings account in Mexico where if you are frightened about the destruction of currency, you can actually go in and have a savings account in silver. That is--they are trying to help protect the consumer. But here in this country, if you happen to want to use silver and gold as legal tender, you go to jail, even though the Constitution tells us exactly what to say. So, ultimately, these--this process will work its way through the progress and there will be another consumer protection agency, but it is not going to do a whole lot until we address the subject of how do you protect the little guy, the middle class, by having honest money and not allowing the monetary system to inflate at will behind closed doors and to benefit special interests. This is what has been happening for a long time. Some day, we are going to have a revelation and find out that when we open up the books and find out every agreement that was ever made between the Federal Reserve and Goldman Sachs and have it on the record, maybe then we will find out how we can protect the consumer and not have a system that protects all the wealthy on Wall Street as well as those individuals who happen to work for Goldman Sachs. I yield back the balance of my time. " FOMC20080318meeting--40 38,MR. FISHER.," If I put the two comments together, one of the messages I receive is that we are less confident in the linkage between U.S. slowing growth and rest-of-world slowing growth than we or conventional wisdom was before. You mentioned, in the discussion of the international side, the downside and upside on growth. There is also a downside and an upside on inflation. I just want to ask about our thoughts on this from a staff standpoint. Clearly, the downside price pressures come from our housing crisis and all of the other related issues and, I presume, from the building of slack and rising unemployment and, therefore, restrained wage demands. That is the domestic side. At the same time, I think I hear you saying that on the global side it is not happening in that fashion elsewhere. The emerging countries, particularly China, are still growing at a rapid pace. However, it may become somewhat slower. My question is, Do we feel that there is as much an offset to our domestic disinflationary/ deflationary forces as we thought before? Are these global demand-pull inflationary forces basically mitigating our expectations of the contractionary domestic forces? How has your opinion--the two of you--changed in the intermeeting period? I hope that is a clear question, but I think you get the point that I am making. " FOMC20071031meeting--175 173,MR. ROSENGREN.," Thank you, Mr. Chairman. I, too, find myself torn between alternative A and alternative B and have been anguishing over them much of the last week figuring out where I come out. The economic outcome detailed in both Boston’s and the Board’s forecasts with no change in interest rates seems reasonable. The evidence since the last meeting indicates that there may have been more strength in the real economy than we expected in the third quarter; and financial markets have been recovering, but they are certainly not back to normal. The risks are clearly on the downside, and our forecast expects a weak fourth quarter. So certainly an argument for alternative B is to cut when it is clearer that the fourth quarter will be weak or we have data of more-significant collateral damage from the housing sector. The argument for alternative A would seem to be that we should take out more insurance against the downside risks. The costs for such action are not great; and given the downside risk, some additional insurance is not unreasonable. However, we have discussed the modal forecast at some length, but our rigor around the tail is quite limited, making it difficult to determine how often and how much insurance should be taken out against downside risk. Thus, I prefer to wait until there are more data that the economy is weakening, which I think is likely to happen. Just to comment on the assessment of risks—when I look at the uncertainty in terms of GDP growth, I think of the histograms. That’s quite stark. If the major concern we have is downside pressure on prices of housing, which is my concern—that housing prices continue to decline and housing gets much worse—I think 25 basis points is probably a small premium to pay. But I doubt that I would change where I would put the weighting even with a 25 basis point cut. I think the housing scenario that is detailed in the Greenbook will still be there whether or not we cut the 25 basis points, and my guess is that between now and December we’ll have more confirmation that it is a concern. Whatever we do in terms of the language, we need it to be consistent and accurate, and I am a little worried about the language in alternative A being consistent and accurate with what we are going to portray in our uncertainty of risks if we show those histograms. So if we’re showing the histograms, regardless of whether or not we have a 25 basis point cut, I think the alternative B language is more consistent with at least what we put down. Unless people think that, with the 25 basis point cut, there is a big shift in the uncertainty and the risks to GDP growth, I do worry about how that will play out in the market and what kind of a tension there will be." fcic_final_report_full--156 CDOs in .  The company wouldn’t make the decision to stop writing these con- tracts until .  GOLDMAN SACHS: “MULTIPLIED THE EFFECTS OF THE COLLAPSE IN SUBPRIME ” Henry Paulson, the CEO of Goldman Sachs from  until he became secretary of the Treasury in , testified to the FCIC that by the time he became secretary many bad loans already had been issued—“most of the toothpaste was out of the tube”— and that “there really wasn’t the proper regulatory apparatus to deal with it.”  Paul- son provided examples: “Subprime mortgages went from accounting for  percent of total mortgages in  to  percent by . . . . Securitization separated origina- tors from the risk of the products they originated.” The result, Paulson observed, “was a housing bubble that eventually burst in far more spectacular fashion than most previous bubbles.”  Under Paulson’s leadership, Goldman Sachs had played a central role in the cre- ation and sale of mortgage securities. From  through , the company pro- vided billions of dollars in loans to mortgage lenders; most went to the subprime lenders Ameriquest, Long Beach, Fremont, New Century, and Countrywide through warehouse lines of credit, often in the form of repos.  During the same period, Gold- man acquired  billion of loans from these and other subprime loan originators, which it securitized and sold to investors.  From  to , Goldman issued  mortgage securitizations totaling  billion (about a quarter were subprime), and  CDOs totaling  billion; Goldman also issued  synthetic or hybrid CDOs with a face value of  billion between  and June .  Synthetic CDOs were complex paper transactions involving credit default swaps. Unlike the traditional cash CDO, synthetic CDOs contained no actual tranches of mortgage-backed securities, or even tranches of other CDOs. Instead, they simply referenced these mortgage securities and thus were bets on whether borrowers would pay their mortgages. In the place of real mortgage assets, these CDOs contained credit default swaps and did not finance a single home purchase. Investors in these CDOs included “funded” long investors, who paid cash to purchase actual securities issued by the CDO; “unfunded” long investors, who entered into swaps with the CDO, making money if the reference securities performed; and “short” investors, who bought credit default swaps on the reference securities, making money if the se- curities failed. While funded investors received interest if the reference securities per- formed, they could lose all of their investment if the reference securities defaulted. Unfunded investors, which were highest in the payment waterfall, received pre- mium-like payments from the CDO as long as the reference securities performed but would have to pay if the reference securities deteriorated beyond a certain point and if the CDO did not have sufficient funds to pay the short investors. Short investors, often hedge funds, bought the credit default swaps from the CDOs and paid those premiums. Hybrid CDOs were a combination of traditional and synthetic CDOs. Firms like Goldman found synthetic CDOs cheaper and easier to create than tra- ditional CDOs at the same time as the supply of mortgages was beginning to dry up. Because there were no mortgage assets to collect and finance, creating synthetic CDOs took a fraction of the time. They also were easier to customize, because CDO managers and underwriters could reference any mortgage-backed security—they were not limited to the universe of securities available for them to buy. Figure . provides an example of how such a deal worked. FOMC20070628meeting--139 137,CHAIRMAN BERNANKE.," Thank you, and thanks to everyone. Let me try to give a quick summary, and if I misrepresent you, please let me know. Participants’ expectations for growth were varied, but most people expect to see strengthening over the remainder of this year and into 2008 and 2009. The principal source of downside risk is housing, which remains weak, perhaps in part because of problems in mortgage markets. However, significant spillovers have yet to emerge from the housing situation, and other components of demand appear to be strengthening and thereby offsetting the drag from residential construction. A number of participants referred to the strength of the global economy, which is stimulating U.S. exports but also leading to increases in costs of energy and metals. Investment has picked up from a bit of a pothole and is growing now at a moderate pace with particular strength on the commercial real estate side. Inventories are mostly aligned with sales and manufacturing seems to be strengthening overall. Consumption seems likely to grow at a steady but not exuberant level, with factors such as gasoline prices and slower house appreciation creating some drag but strong employment and incomes acting as supports. Indeed, the labor market continues to be strong, although there are some measurement issues that were noted, with unfilled demands for highly skilled workers and with some signs of wage pressures. Overall, the risks to output seem roughly balanced around the path of a gradual increase in growth. Participants did note the increase in long-term interest rates, which tended to align market policy expectations with those of the Committee. Higher long-term interest rates and some other changes in financial markets may be slightly restrictive but probably not substantially so. Some also noted risks in financial markets, including the aforementioned risks associated with the subprime sector, but also more-general concerns about structured credit products and the possible effects of a decline in liquidity. However, I would note also, as some others did, that a bit of cooling in the financial markets might not be an entirely bad thing. Recent core inflation numbers have been favorable, and most of you see continued moderation in inflation resulting from mildly restrictive policy, the ending of some temporary influences, and slower increases in shelter costs. However, a few of you have suggested that some of the recent improvement in core inflation is transitory, and they noted upside risks, including resource utilization, possible pass-through from energy and commodity costs, slower productivity growth, and the possible effect of high headline inflation on inflation expectations. High capacity utilization—and “globally,” President Fisher—is also a source of possible inflation pressure." FOMC20060328meeting--163 161,MR. KROSZNER.," Obviously, from the remarks that we heard earlier today and yesterday, there is an enormous amount of strength and resiliency in the economy. Clearly, the economy has rebounded from a temporary slowdown in the fourth quarter. The specifics that I have heard from each of the Districts confirm the broad Greenbook view that this is going to be a pretty strong quarter. I particularly like the quotation from President Fisher that it will be “blowing and going” during this quarter. A forecast of 3¾ percent real GDP growth for 2006 with perhaps a bit of slowing in 2007 seems quite reasonable given the data that we have in hand. Consumption remains solid, and despite some less-sanguine reports at the end of last week about some orders, business investment still appears to be reasonably strong. Since there seems to be much agreement with the central tendency of the forecast, rather than review my reasons for supporting it—and I support most of the reasons that people put forward—what I want to do is focus on a few potential risk factors going forward. Not that I necessarily think that these things are likely to happen, but as Dave Stockton mentioned yesterday, there are a number of uncertainties in the forecast, which we need to focus on: First, with respect to housing; second, with respect to energy and commodity prices; and, third, with respect to expectations in the yield curve and the term premium issues that the Chairman asked us about yesterday. We have been receiving some mixed signals with respect to the housing market, although the components that tend to have the most information for assessing the future direction of the market, permits and sales of new single-family homes, suggest some considerable cooling from the very hot period in 2005. The evidence that I have from talking to property developers in the Chicago area and a bit in D.C. seems to be consistent with this evaluation, particularly in things like the condo market. We see a lot of slowing there, particularly in the Chicago area—at least from what I have heard anecdotally. Not only are we faced with the forecaster’s typical dilemma of trying to predict a trend break or a turning point, but we also have relatively few experiences in the United States over the last few decades of a downturn in the housing market. So the key concern is going to be the effect on wealth and on consumption and obviously also on the construction market. In the Greenbook, I believe the direct contribution of wealth to real PCE growth was approximately 1 percent in 2005, and the forecast is about ¾ percent in 2006, with at least half of each of these increments due to housing wealth. So, obviously, we have to be very sensitive to the concerns there. In some countries, such as the United Kingdom and Australia, even some relatively moderate downturns or slowdowns in the housing market seem to have been associated with some fairly important GDP effects. President Stern yesterday made an important point of what’s driving what. Many of the discussions about the housing market suggest that there will be some sort of exogenous shock that somehow may send the housing market down, as opposed to the housing market’s being part of the broader economy in which there are consumption demands for investment and in which houses are an asset as part of a portfolio. It is important to put housing in that context. In the other countries where we have seen downturns and GDP effects, it is hard to pull out what part was due to housing’s lead as opposed to housing’s just being one of the factors affected by a general economic downturn. So with those caveats in mind, and obviously we have to be careful about extrapolating from other countries’ experiences, I do think we should be mindful of the potential risks that are there. Second, energy and commodity prices: So far we have been very fortunate in seeing little, if any, of the run-up in energy and commodity prices feeding through to core measures of inflation, and from what I can tell in the discussions relating to the Greenbook, this has been a bit of a surprise to the staff and a bit of a surprise to the Committee. Now, this may well be due to a confluence of very fortunate factors that perhaps could be reversed in the near term, or it may be due to some longer-run changes, which President Fisher discussed. We had some discussion of this yesterday. So, as you know, productivity growth and international competition could be important factors, but at this point I do not feel that I understand enough whether this situation is just temporary and we are lucky or whether it is part of an ongoing process. And so I think we just have to be mindful of the potential risk there. And obviously with the uptick in forecasts for growth outside the United States, which could be associated with an increase in demand for energy and raw materials, further upward pressure could be put on those prices. Finally, inflation expectations in the yield curve and term premiums: Fortunately, generally the market-based and survey-based measures of inflation seem to be fairly steady, reasonably well contained. I share Kevin’s concern that some of these expectations being above 2, 2½, even in some cases closer to 3 may be a bit of a challenge, but broadly the numbers that we have been seeing around 2 seem to suggest that inflation expectations are well anchored. And it seems that one of the great achievements of this body that I have now been very fortunate and very honored to become part of is the reduction of inflation uncertainty and the reduction of inflation expectations. And these reductions, I think, help us at least in part to understand the very low term premiums that we have been seeing in the United States. But we must also recognize that we have been seeing lower real and nominal rates and generally lower term premiums around the world. In talking to market participants, I hear much less of a fear of an inflation spike in many countries around the world—not that there was a fear of an inflation spike in the United States—but I think a greater certainty about the direction and focus of the FOMC and a greater trust is extremely important. This gets back to a point that President Lacker made yesterday about the incredibly important role of expectations. What we do has to be seen not just in terms of the traditional backward-looking role of thinking about how the higher cost of capital could affect choices that people make, but also about our credibility in going forward. Choices that we make may have opposite effects on interest rates than what we have seen in the past. Raising interest rates in the short-term may have a damping effect rather than an increasing effect on longer rates. If you look to forecasts of economists outside this room and the System, you also see a fair amount of optimism, suggesting growth in the future. So the lower real and nominal rates in the longer-term markets do not seem to be due to concerns about significant slowing of the economy but to differences in views about inflation uncertainty and the level of inflation going forward. So, particularly since some of our measures—of core PCE, core CPI—are at or toward the upper end of the range of where I would feel comfortable (and, I believe, from what I have heard, a number of others around the table would feel comfortable), we have to be vigilant about that. Maintaining our credibility and the good work that this Committee has done is something that I want not to become dreaming the impossible dream but something that is the reality and that we can continue. Thank you, Mr. Chairman." CHRG-110shrg38109--34 Chairman Bernanke," Thank you. Chairman Dodd, Senator Shelby, and other Members of the Committee, I am pleased to present the Federal Reserve's Monetary Policy Report to the Congress. Real activity in the United States expanded at a solid pace in 2006, although the pattern of growth was uneven. After a first-quarter rebound from weakness associated with the effects of the hurricanes that ravaged the Gulf Coast the previous summer, output growth moderated somewhat on average over the remainder of 2006. Real gross domestic product is currently estimated to have increased at an annual rate of about 2.75 percent in the second half of the year. As we anticipated in our July report, the U.S. economy appears to be making a transition from the rapid rate of expansion experienced over the preceding several years to a more sustainable average pace of growth. The principal source of the ongoing moderation has been a substantial cooling of the housing market, which has led to a marked slowdown in the pace of residential construction. However, the weakness in housing market activity and the slower appreciation of house prices do not seem to have spilled over to any significant extent to other sectors of the economy. Consumer spending has continued to expand at a solid rate, and the demand for labor has remained strong. On average, about 165,000 jobs per month have been added to nonfarm payrolls over the past 6 months, and the unemployment rate, at 4.6 percent in January, remains low. Inflation pressures appear to have abated somewhat following a run-up during the first half of 2006. Overall inflation has fallen in large part as a result of declines in the price of crude oil. Readings on core inflation--that is, inflation excluding the prices of food and energy--have improved modestly in recent months. Nevertheless, the core inflation rate remains somewhat elevated. In the five policy meetings since the July report, the Federal Open Market Committee, or FOMC, has maintained the Federal funds rate at 5.25 percent. So far the incoming data have supported the view that the current stance of policy is likely to foster sustainable economic growth and the gradual ebbing of core inflation. However, in the statement accompanying last month's policy decision, the FOMC again indicated that its predominant policy concern is the risk that inflation will fail to ease as expected and that it is prepared to take action to address inflation risks if developments warrant. Let me now discuss the economic outlook in a little more detail, beginning with developments in the real economy and then turning to inflation. I will conclude with some brief comments on monetary policy. Consumer spending continues to be the mainstay of the current economic expansion. Personal consumption expenditures, which account of more than two-thirds of aggregate demand, increased at an annual rate of about 3.5 percent in real terms during the second half of last year, broadly matching the brisk pace of the previous 3 years. Consumer outlays were supported by strong gains in personal income, reflecting both the ongoing increases in payrolled employment and a pick-up in the growth of real wages. Real hourly compensation, as measured by compensation per hour in the nonfarm business sector deflated by the personal consumption expenditures price index, rose at an annual rate of around 3 percent in the latter half of 2006. The resilience of consumer spending is all the more striking given the backdrop of the substantial correction in the housing market that became increasingly evident during the spring and summer of last year. By the middle of 2006, monthly sales of new and existing homes were about 15 percent lower than a year earlier, and the previously rapid rate of house price appreciation had slowed markedly. The fall in housing demand in turn prompted a sharp slowing in the pace of construction of new homes. Even so, the backlog of unsold homes rose from about 4\1/2\ months' supply in 2005 to nearly 7 months' supply by the third quarter of last year. Single-family housing starts have dropped more than 30 percent since the beginning of last year, and employment growth in the construction sector has slowed substantially. Some tentative signs of stabilization have recently appeared in the housing market. New and existing home sales have flattened out in recent months. Mortgage applications have picked up, and some surveys find that homebuyers' sentiment has improved. However, even if housing demand falls no further, weakness in residential investment is likely to continue to weigh on economic growth over the next few quarters as homebuilders seek to reduce their inventories of unsold homes to more comfortable levels. Despite the ongoing adjustments in the housing sector, overall economic prospects for households remain good. Household finances appear generally solid, and delinquency rates on most types of consumer loans and residential mortgages remain low. The exception is subprime mortgages with variable interest rates, for which delinquency rates have increased appreciably. The labor market is expected to stay healthy, and real incomes should continue to rise, although the pace of employment gains may be slower than that to which we have become accustomed in recent years. In part, slower average job growth may simply reflect the moderation of economic activity. Also, the impending retirement of the leading edge of the baby-boom generation and an apparent leveling out from women's participation in the workforce, which had risen for several decades, will likely restrain the growth of the labor force in coming years. With fewer job seekers entering the labor force, the rate of job creation associated with the maintenance of stable conditions in the labor market will decline. All told, consumer expenditures appear likely to expand solidly in coming quarters, albeit a little less rapidly than the growth in personal incomes, if, as we expect, households respond to the slow pace of home equity appreciation by saving more out of current income. The business sector remains in excellent financial condition with strong growth and profits, liquid balance sheets, and corporate leverage near historical lows. Last year, those factors helped to support continued advances in business capital expenditures. Notably, investment in high-tech equipment rose 9 percent in 2006, and spending on nonresidential structures, such as office buildings, factories, and retail space, increased rapidly through much of the year, after several years of weakness. Growth in business spending slowed toward the end of last year, reflecting mainly a deceleration of spending on business structures, a drop in outlays in the transportation sector where spending is notably volatile, and some weakness in purchases of equipment related to construction and motor vehicle manufacturing. Over the coming year, capital spending is poised to expand at a moderate pace, supported by steady gains in business output and favorable financial conditions. Inventory levels in some sectors, most notably at motor vehicle dealers and in some construction-related manufacturing industries, rose over the course of last year, leaving some firms to cut production to better align inventories with sales. Remaining imbalances may continue to impose modest restraint on industrial production during the early part of this year. Outside the United States, economic activity in our major trading partners has continued to grow briskly. The strength of demand abroad helped stir a robust expansion in U.S. real exports, which grew about 9 percent last year. The pattern of real U.S. imports was somewhat uneven, partly because of fluctuations in oil imports over the course of the year. On balance, import growth slowed in 2006 to 3 percent. Economic growth abroad should further support steady growth in U.S. exports this year. Despite the improvements in trade performance, the U.S. current account deficit remains large, averaging about 6.5 percent of nominal GDP during the first three quarters of 2006. Overall, the U.S. economy seems likely to expand at a moderate pace this year and next, with growth strengthening somewhat as the drag from housing diminishes. Such an outlook is reflected in the projections that the members of the Board of Governors and presidents of the Federal Reserve Banks made around the time of the FOMC meeting late last month. The central tendency of those forecasts, which are based on the information available at that time and on the assumption of appropriate monetary policy, is for real GDP to increase about 2.5 to 3 percent in 2007 and about 2.75 to 3 percent in 2008. The projection for GDP growth in 2007 is slightly lower than our projection last July. The difference partly reflects an expectation of somewhat greater weakness in residential construction during the first part of this year than we anticipated last summer. The civilian unemployment rate is expected to finish both 2007 and 2008 around 4.5 to 4.75 percent. The risks to this outlook are significant. To the downside, the ultimate extent of the housing market correction is difficult to forecast and may prove greater than we anticipate. Similarly, spillover effects from developments in the housing market onto consumer spending and employment in housing-related industries may be more pronounced than expected. To the upside, output may expand more quickly than expected if consumer spending continues to increase at the brisk pace seen in the second half of 2006. I turn now to the inflation situation. As I noted earlier, there are some indications that inflation pressures are beginning to diminish. The monthly data are noisy, however, and it will consequently be some time before we can be confident that underlying inflation is moderating as anticipated. Recent declines in overall inflation have primarily reflected lower prices for crude oil, which have fed through to the prices of gasoline, heating oil, and other energy products used by consumers. After moving higher in the first half of 2006, core consumer price inflation has also edged lower recently, reflecting a relatively broad-based deceleration in the prices of core goods. That deceleration is probably also due to some extent to lower energy prices, which have reduced costs of production and thereby lessened one source of pressure on the prices of final goods and services. The ebbing of core inflation has likely been promoted as well by the stability of inflation expectations. A waning of the temporary factors that boosted inflation in recent years will probably help to foster a continued edging down of core inflation. In particular, futures quotes imply that oil prices are expected to remain well below last year's peak. If actual prices follow the path currently indicated by futures prices, inflation pressures would be reduced further as the benefits of the decline in oil prices from last year's high levels are passed through to a broader range of core goods and services. Non-fuel import prices may also put less pressure on core inflation, particularly if price increases for some other commodities, such as metals, slow from last year's rapid rates. But as we have been reminded only too well in recent years, the prices of oil and other commodities are notoriously difficult to predict, and they remain a key source of uncertainty to the inflation outlook. The contribution from rents and shelter costs should also fall back following a step-up last year. The faster pace of rent increases last year may have been attributable in part to reduced affordability of owner-occupied housing, which led to a greater demand for rental housing. Rents should rise somewhat less quickly this year and next, reflecting recovering demand for owner-occupied housing as well as increases in the supply of rental units, but the extent and pace of that adjustment are not yet clear. Upward pressure on inflation could materialize if final demand were to exceed the underlying productive capacity of the economy for a sustained period. The rate of resource utilization is high, as can be seen in rates of capacity utilization above their long-term average, and most evidently in the tightness of the labor market. Indeed, anecdotal reports suggest that businesses are having difficulty recruiting well-qualified workers in certain occupations. Measures of labor compensation, though still growing at a moderate pace, have shown some signs of acceleration over the past year, likely in part the result of tight labor market conditions. The implications for inflation of faster growth in nominal labor compensation depend on several factors. Increases in compensation might be offset by higher labor productivity or absorbed by a narrowing of firms' profit margins rather than passed on to consumers in the form of higher prices. In these circumstances, gains in nominal compensation would translate into gains in real compensation as well. Underlying productivity trends appear favorable, and the mark-up of prices over unit labor cost is high by historical standards, so such an outcome is certainly possible. Moreover, as activity expands over the next year or so at the moderate pace anticipated by the FOMC, pressures in both labor and product markets should ease modestly. That said, the possibility remains that tightness in product markets could allow firms to pass higher labor costs through their prices, adding to inflation and effectively nullifying the purchasing power of at least some portion of the increase in labor compensation. Thus, the high level of resource utilization remains an important upside risk to continued progress on inflation. Another significant factor influencing medium-term trends in inflation is the public's expectations of inflation. These expectations have an important bearing on whether transitory influences on prices, such as those created by changes in energy costs, become embedded in wage and price decisions and so leave a lasting imprint on the rate of inflation. It is encouraging that inflation expectations appear to have remain contained. The projections of the members of the Board of Governors and the presidents of the Federal Reserve Banks are for inflation to continue to ebb over this year and next. In particular, the central tendency of those forecasts is for core inflation, as measured by the price index for personal consumption expenditures, excluding food and energy, to be 2 to 2.25 percent this year and to edge lower to 1.75 to 2 percent next year. But as I noted earlier, the FOMC has continued to view the risk that inflation will not moderate as expected as the predominant policy concern. Monetary policy affects spending and inflation with long and variable lags. Consequently, policy decisions must be based on an assessment of medium-term economic prospects. At the same time, because economic forecasting is an uncertain enterprise, policymakers must be prepared to respond flexibly to developments in the economy when those developments lead to a reassessment of the outlook. The dependence of monetary policy actions on a broad range of incoming information complicates the public's attempts to understand and anticipate policy decisions. Clear communication by the central bank about the economic outlook, the risks to that outlook, and its monetary policy strategy can help the public to understand the rationale that is behind policy decisions and to anticipate better the central bank's reaction to new information. This understanding should in turn enhance the effectiveness of policy and lead to improved economic outcomes. By reducing uncertainty, central bank transparency may also help anchor the public's longer-term expectations of inflation. Much experience has shown that while anchored inflation expectations tend to help stabilize inflation and promote maximum sustainable economic growth, good communication by the central bank is also vital for ensuring appropriate accountability for its policy actions, the full effects of which can be observed only after a lengthy period. A transparent policy process improves accountability by clarifying how a central bank expects to attain its policy objectives and by ensuring that policy is conducted in a manner that can be seen to be consistent with achieving those objectives. Over the past decade or so, the Federal Reserve has significantly improved its methods of communication, but further progress is possible. As you know, the FOMC last year, established a subcommittee to help the full committee evaluate the next steps in this continuing process. Our discussions are directed at examining all aspects of our communications and have been deliberate and thorough. These discussions are continuing, and no decisions have been reached. My colleagues and I remain firmly committed to an open and transparent monetary policy process that enhances our ability to achieve our dual objectives of stable prices and maximum sustainable employment. I will keep Committee Members apprised of the developments as our deliberations move forward. I look forward to continuing to work closely with the Members of the Committee and your colleagues in the Senate and the House on the important issues pertaining to monetary policy and the other responsibilities with which the Congress has charged the Federal Reserve. Thank you. I would be happy to take questions. " fcic_final_report_full--159 Through May , Goldman received  million from IKB, Wachovia, and TCW as a result of the credit default swaps against the A tranche. As was common, some of the tranches of Abacus - found their way into other funds and CDOs; for example, TCW put tranches of Abacus - into three of its own CDOs. In total, between July , , and May , , Goldman packaged and sold  synthetic CDOs, with an aggregate face value of  billion.  Its underwriting fee was . to . of the deal totals, Dan Sparks, the former head of Goldman’s mortgage desk, told the FCIC.  Goldman would earn profits from shorting many of these deals; on others, it would profit by facilitating the transaction between the buyer and the seller of credit default swap protection. As we will see, these new instruments would yield substantial profits for investors that held a short position in the synthetic CDOs—that is, investors betting that the housing boom was a bubble about to burst. They also would multiply losses when housing prices collapsed. When borrowers defaulted on their mortgages, the in- vestors expecting cash from the mortgage payments lost. And investors betting on these mortgage-backed securities via synthetic CDOs also lost (while those betting against the mortgages would gain).  As a result, the losses from the housing collapse were multiplied exponentially. To see this play out, we can return to our illustrative Citigroup mortgage-backed securities deal, CMLTI -NC. Credit default swaps made it possible for new market participants to bet for or against the performance of these securities. Syn- thetic CDOs significantly increased the demand for such bets. For example, there were about  million worth of bonds in the M (BBB-rated) tranche—one of the mezzanine tranches of the security. Synthetic CDOs such as Auriga, Volans, and Neptune CDO IV all contained credit default swaps in which the M tranche was ref- erenced. As long as the M bonds performed, investors betting that the tranche would fail (short investors) would make regular payments into the CDO, which would be paid out to other investors banking on it to succeed (long investors). If the M bonds defaulted, then the long investors would make large payments to the short investors. That is the bet—and there were more than  million in such bets in early  on the M tranche of this deal. Thus, on the basis of the performance of  million in bonds, more than  million could potentially change hands. Goldman’s Sparks put it succinctly to the FCIC: if there’s a problem with a product, synthetics increase the impact.  The amplification of the M tranche was not unique. A  million tranche of the Glacier Funding CDO -A, rated A, was referenced in  million worth of syn- thetic CDOs. A  million tranche of the Soundview Home Equity Loan Trust -EQ, also rated A, was referenced in  million worth of synthetic CDOs. A  million tranche of the Soundview Home Equity Loan Trust -EQ, rated BBB, was referenced in  million worth of synthetic CDOs.  In total, synthetic CDOs created by Goldman referenced , mortgage securities, some of them multiple times. For example,  securities were referenced twice. In- deed, one single mortgage-backed security was referenced in nine different synthetic fcic_final_report_full--10 As our report shows, key policy makers—the Treasury Department, the Federal Reserve Board, and the Federal Reserve Bank of New York—who were best posi- tioned to watch over our markets were ill prepared for the events of  and . Other agencies were also behind the curve. They were hampered because they did not have a clear grasp of the financial system they were charged with overseeing, par- ticularly as it had evolved in the years leading up to the crisis. This was in no small measure due to the lack of transparency in key markets. They thought risk had been diversified when, in fact, it had been concentrated. Time and again, from the spring of  on, policy makers and regulators were caught off guard as the contagion spread, responding on an ad hoc basis with specific programs to put fingers in the dike. There was no comprehensive and strategic plan for containment, because they lacked a full understanding of the risks and interconnections in the financial mar- kets. Some regulators have conceded this error. We had allowed the system to race ahead of our ability to protect it. While there was some awareness of, or at least a debate about, the housing bubble, the record reflects that senior public officials did not recognize that a bursting of the bubble could threaten the entire financial system. Throughout the summer of , both Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paul- son offered public assurances that the turmoil in the subprime mortgage markets would be contained. When Bear Stearns’s hedge funds, which were heavily invested in mortgage-related securities, imploded in June , the Federal Reserve discussed the implications of the collapse. Despite the fact that so many other funds were ex- posed to the same risks as those hedge funds, the Bear Stearns funds were thought to be “relatively unique.” Days before the collapse of Bear Stearns in March , SEC Chairman Christopher Cox expressed “comfort about the capital cushions” at the big investment banks. It was not until August , just weeks before the government takeover of Fannie Mae and Freddie Mac, that the Treasury Department understood the full measure of the dire financial conditions of those two institutions. And just a month before Lehman’s collapse, the Federal Reserve Bank of New York was still seeking information on the exposures created by Lehman’s more than , deriv- atives contracts. In addition, the government’s inconsistent handling of major financial institutions during the crisis—the decision to rescue Bear Stearns and then to place Fannie Mae and Freddie Mac into conservatorship, followed by its decision not to save Lehman Brothers and then to save AIG—increased uncertainty and panic in the market. In making these observations, we deeply respect and appreciate the efforts made by Secretary Paulson, Chairman Bernanke, and Timothy Geithner, formerly presi- dent of the Federal Reserve Bank of New York and now treasury secretary, and so many others who labored to stabilize our financial system and our economy in the most chaotic and challenging of circumstances. • We conclude there was a systemic breakdown in accountability and ethics. The integrity of our financial markets and the public’s trust in those markets are essential to the economic well-being of our nation. The soundness and the sustained prosper- ity of the financial system and our economy rely on the notions of fair dealing, re- sponsibility, and transparency. In our economy, we expect businesses and individuals to pursue profits, at the same time that they produce products and services of quality and conduct themselves well. CHRG-110hhrg34673--10 Mr. Bernanke," Chairman Frank, Representative Bachus, and other members of the committee, I am pleased to present the Federal Reserve Monetary Policy Report to the Congress. Real activity in the United States expanded at a solid pace in 2006, although the pattern of growth was uneven. After a first quarter rebound from weakness associated with the effects of the hurricanes that ravaged the Gulf Coast in the previous summer, output growth moderated somewhat on average over the remainder of 2006. Real Gross Domestic Product is currently estimated to have increased at an annual rate of about 2\3/4\ percent in the second half of the year. As we anticipated in our July report, the U.S. economy appears to be making a transition from the rapid rate of expansion experienced over the preceding several years to a more sustainable average pace of growth. The principal source of the ongoing moderation has been a substantial cooling in the housing market which has led to a marked slowdown in the pace of residential construction. However, the weakness in housing market activity and the slower appreciation of house prices do not seem to have spilled over to any significant extent to other sectors of the economy. Consumer spending has continued to expand at a solid rate, and the demand for labor remains strong. On average, about 165,000 jobs per month have been added to nonfarm payrolls over the past 6 months. And the unemployment rate, at 4.6 percent in January, remains low. Inflation pressures appear to have abated somewhat following a run-up during the first half of 2006. Overall, inflation has fallen in large part as a result of declines in the price of crude oil. Readings on core inflation--that is inflation excluding the prices of food and energy--have improved modestly in recent months. Nevertheless, the core inflation rate remains somewhat elevated. In the five policy meetings since the July report, the Federal open market committee, or FOMC, has maintained the Federal funds rate at 5\1/4\ percent. So far, the incoming data have supported the view that the current stance of policy is likely to foster sustainable economic growth and a gradual ebbing of core inflation. However, in the statement accompanying last month's policy decision, the FMOC again indicated that its predominant policy concern is the risk that inflation will fail to ease as expected, and that it is prepared to take action to address inflation risks, if developments warrant. Let me now discuss the economic outlook in a little more detail beginning with developments in the real economy and then turning to inflation. I will conclude with some brief comments on monetary policy. Consumer spending continues to be the mainstay of the current economic expansion. Personal consumption expenditures, which account for more than two-thirds of aggregate demand, increased at an annual rate of around 3\1/2\ percent in real terms during the second half of last year, broadly matching the brisk pace of the previous 3 years. Consumer outlays were supported by strong gains in personal income reflecting both the ongoing increases in payroll employment and a pickup in the growth of real wages. Real hourly compensation, as measured by compensation per hour in the nonfarm business sector deflated by the personal consumption expenditures price index, rose at an annual rate of about 3 percent in the latter half of 2006. The resilience of consumer spending is all the more striking, given the backdrop of the substantial correction in the housing market that became increasingly evident during the spring and summer of last year. By the middle of 2006, monthly sales of new and existing homes were about 15 percent lower than a year earlier, when the previously rapid rate of house price appreciation had slowed markedly. The fall in housing demand in turn prompted a sharp slowing in the pace of construction of new homes. Even so, the backlog of unsold homes rose from about 4\1/2\ months' supply in 2005 to nearly 7 months' supply by the third quarter of last year. Single family housing starts have dropped more than 30 percent since the beginning of last year. And employment growth in the construction sector has slowed substantially. Some tentative signs of stabilization have recently appeared in the housing market. New and existing home sales have flattened out in recent months. Mortgage applications have picked up. And some surveys find that homebuyers' sentiment has improved. However even if housing demand falls no further, weakness in residential investment is likely to continue to weigh on economic growth over the next few quarters as homebuilders seek to reduce their inventory of unsold homes to more comfortable levels. Despite the ongoing adjustments in the housing sector, overall economic prospects for households remain good. Household finances appear generally solid. And delinquency rates on most types of consumer loans and residential mortgages remain low. The exception is subprime mortgages with variable interest rates for which delinquency rates have increased appreciably. The labor market is expected to stay healthy. And real incomes should continue to rise, although the pace of employment gains may be slower than those to which we have become accustomed in recent years. In part, slower average job growth may simply reflect a moderation in economic activity. Also, the impending retirement of the leading edge of the baby boom generation, and an apparent leveling out of women's participation in the workforce, which had risen for several decades, will likely restrain the growth of the labor force in coming years. With fewer job seekers entering the labor force, the rate of job creation associated with the maintenance of stable conditions in the labor market will decline. All told, consumer expenditures appear likely to expand solidly in coming quarters, albeit a little less rapidly than the growth in personal incomes if, as we expect, households respond to the slow pace of home equity appreciation by saving more out of current income. The business sector remains in excellent financial condition with strong growth in profits, liquid balance sheets, and corporate leverage near historical lows. Last year, those factors helped support continued advances in business capital expenditures. Notably, investment in high tech equipment rose 9 percent in 2006. And spending on nonresidential structures such as office buildings, factories, and retail space increased rapidly through much of the year after several years of weakness. Growth in business spending slowed toward the end of last year, reflecting mainly a deceleration of spending on business structures, a drop in outlays in the transportation sector where spending is notably volatile, and some weakness in purchases of equipment related to construction and motor vehicle manufacturing. Over the coming year, capital spending is poised to expand at a moderate pace, supported by steady gains in business output and favorable financial conditions. Inventory levels in some sectors, most notably in motor vehicle dealers and in some construction-related manufacturing industries, rose over the course of last year leading some firms to cut production to better align inventories with sales. Remaining imbalances may continue to impose modest restraints on industrial production during the early part of this year. Outside the United States, economic activity in our major trading partners has continued to grow briskly. The strength of demand abroad helped spur a robust expansion in U.S. real exports, which grew about 9 percent last year. The pattern of real U.S. imports was somewhat uneven partly because of fluctuations in oil imports over the course of the year. On balance, import growth slowed in 2006 to 3 percent. Economic growth abroad should further support steady growth in U.S. exports this year. Despite the improvements in trade performance, the U.S. current account deficit remains large, averaging about 6\1/2\ percent of nominal GDP during the first three quarters of 2006. Overall, the U.S. economy seems likely to expand at a moderate pace this year and next with growth strengthening somewhat as the drag from housing diminishes. Such an outlook is reflected in the projections that the members of the Board of Governors and presidents of the Reserve Banks made around the time of the FOMC meeting late last month. The central tendency of those forecasts--which are based on information available at that time and on the assumption of appropriate monetary policy--is for real GDP to increase about 2\1/2\ to 3 percent in 2007, and about two- or three-quarters to 3 percent in 2008. The projection for GDP growth in 2007 is slightly lower than our projection last July. This difference partly reflects an expectation of somewhat greater weakness in residential construction during the first part of this year than we anticipated last summer. The civilian unemployment rate is expected to finish both 2007 and 2008 around 4\1/2\ to 4\3/4\ percent. The risks to this outlook are significant. To the downside, the ultimate extent of the housing market correction is difficult to forecast and may prove greater than we anticipate. Similarly, spillover effects from the developments in the housing market onto consumer spending and employment and housing related industries may be more pronounced than expected. To the upside, output may expand more quickly than expected if consumer spending continues to increase at the brisk pace seen in the second half of 2006. I turn now to the inflation situation. As I noted earlier, there are some indications that inflation pressures are beginning to diminish. The monthly data are noisy, however, and it will consequently be some time before we can be confident that underlying inflation is moderating as anticipated. Recent declines in overall inflation have primarily reflected lower prices for crude oil, which have fed through to the prices of gasoline, heating oil and other energy products used by consumers. After moving higher in the first half of 2006, core consumer price inflation has also edged lower recently reflecting a relatively broad-based deceleration in the prices of core goods. That deceleration is probably also due, to some extent, to lower energy prices, which have reduced costs of production, and thereby lessened one source of pressure on the prices of final goods and services. The ebbing of core inflation has likely been promoted as well by the stability of inflation expectations. A waning of the temporary factors that boosted inflation in recent years will probably help foster a continued edging down of core inflation. In particular, futures quotes imply that oil prices are expected to remain well below last year's peak. If actual prices follow the path currently indicated by futures prices, inflation pressures would be reduced further as the benefits of the decline in oil prices from last year's high levels are passed through to a broader range of core goods and services. Nonfuel import prices may also put less pressure on core inflation particularly if price increases for some other commodities, such as metals, slow from last year's rapid rates. But as we have been reminded only too well in recent years, the prices of oil and other commodities are notoriously difficult to predict. And they remain a key source of uncertainty in the inflation outlook. The contribution from rents and shelter costs should also fall back following a step up last year. The faster pace of rent increases last year may have been attributable in part to the reduced affordability of owner-occupied housing which led to a greater demand for rental housing. Rents should rise somewhat less quickly this year and next reflecting recovering demand for owner-occupied housing as well as increases in the supply rental units. But the extent and pace that of that adjustment is not yet clear. Upward pressure on inflation could materialize if final demand were to exceed the underlying productive capacity of the economy for a sustained period. The rate of resource utilization is high, as can be seen in rates of capacity utilization above their long term average, and most evidently, in the tightness of the labor market. Indeed anecdotal reports suggest that businesses are having difficulty recruiting well-qualified workers in certain occupations. Measures of labor compensation--though still growing at a moderate pace--have shown some signs of acceleration over the last year, likely, in part, as the result of tight labor market conditions. The implications for inflation of faster growth in nominal labor compensation depend on several factors. Increases in compensation might be offset by higher labor productivity or absorbed by a narrowing of firm's profit margins rather than passed on to consumers in the form of higher prices. In these circumstances, gains in nominal compensation would translate into gains in real compensation as well. Underlying productivity trends appear favorable. And the markup of prices over unit labor costs is high by historical standards, so such an outcome is certainly possible. Moreover, if activity expands over the next year or so at the moderate pace anticipated by the FOMC, pressures in both labor and product markets should ease modestly. That said, the possibility remains that tightness in product markets could allow firms to pass higher labor costs through to prices, adding to inflation and effectively nullifying the purchasing power of at least some portion of the increase in labor compensation. Thus, the high level of resource utilization remains an important upside risk to continued progress on inflation. Another significant factor influencing medium term trends in inflation is the public's expectations of inflation. These expectations have an important bearing on whether transitory influences on prices, such as those created by changes in energy costs, become embedded in wage and price decisions, and so leave a lasting imprint on the rate of inflation. It is encouraging that inflation expectations appear to have remained contained. The projections of the members of the Board of Governors and the presidents of the Federal Reserve Banks are for inflation to continue to ebb over this year and next. In particular, the central tendency of those forecasts is for core inflation--as measured by the price index for personal consumption expenditures excluding food and energy--to be 2 to 2\1/4\ percent this year and to edge lower to 1\3/4\ to 2 percent next year. But as I noted earlier, the FMOC has continued to view the risk that inflation will not moderate as expected as the predominant policy concern. Monetary policy affects spending and inflation with long and variable lags. Consequently, policy decisions must be based on an assessment of medium term economic prospects. At the same time, because economic forecasting is an uncertain enterprise, policy makers must be prepared to respond flexibly to developments in the economy when those developments lead to a reassessment of the outlook. The dependence of monetary policy actions on a broad range of incoming information complicates the public's attempts to understand and anticipate policy decisions. Clear communication by the central bank about the economic outlook, the risk to that outlook, and its monetary policy strategy, can help the public to understand the rationale behind policy decisions and to anticipate better the central bank's reaction to new information. This understanding should, in turn, enhance the effectiveness of policy and lead to improved economic outcomes. By reducing uncertainty, central bank transparency may also help anchor the public's longer term expectations of inflation. Much experience has shown that well-anchored inflation expectations help to stabilize inflation and promote maximum sustainable economic growth. Good communication by the central bank is also vital for ensuring appropriate accountability for its policy actions, the full effects of which can be observed only after a lengthy period. A transparent policy process improves accountability by clarifying how a central bank expects to attain its policy objectives and by ensuring that policies are conducted in a manner that can seen to be consistent with achieving those objectives. Over the past decade or so, the Federal Reserve has significantly improved its methods of communication, but further progress is possible. As you know, the FOMC last year established a subcommittee to help the full committee evaluate the next steps in this continuing process. Our discussions are directed at examining all aspects of our communications and have been deliberate and thorough. These discussions are continuing and no decisions have been reached. My colleagues and I remain firmly committed to an open and transparent monetary policy process that enhances our ability to achieve our dual objectives of stable prices and maximum sustainable employment. I will keep members of this committee apprised of developments as our deliberations move forward. I look forward to continuing to work closely with the members of this committee and your colleagues in the Senate and the House on the important issues pertaining to monetary policy and the other responsibilities with which the Congress has charged the Federal Reserve. Thank you. I would be happy to take questions. [The prepared statement of Chairman Bernanke can be found on page 71 of the appendix.] " FOMC20061212meeting--69 67,MS. MINEHAN.," It’s not fair. [Laughter] Well, to the extent that this sounds like North Dakota, let me just proceed. Despite data from the housing markets that suggest that New England is suffering the real estate slowdown perhaps more than the rest of the nation—at least in terms of falling house prices—the overall regional economy appears to be doing fairly well. This is the bimodal model that a couple of people have talked about. Moderate employment growth continues. Layoffs are down, and electronic job postings, as opposed to newspaper want ads, are rising. Retailers are cautious about the fallout from the housing market, but except for those in the hardware or furniture businesses, sales were reportedly buoyed by the drop in gasoline prices. Indeed, October saw the first year-over-year decline in gas prices in the Boston area in four years. Manufacturing overall has been running ahead of last year, with aircraft, energy, and scientific equipment particularly robust. Growth in high-tech and biotech service companies remains strong; and while wage growth overall is slightly below national levels, salaries for higher-skilled staff with professional degrees are being bid up, reflecting strong demand. Consumer confidence is solid, especially regarding future conditions, and I’ve seen the same thing that President Moskow commented on—the optimism of business contacts. Business confidence as measured by local organizations has been on a steady upward trend since June, with employers significantly more positive about national economic conditions, the rising stock market, falling energy prices, and favorable interest rates. The mild fall weather, although a major problem for the early ski season, boosted tourism, which is reportedly going gangbusters—that’s a technical term—in Boston and other areas. Convention sites are booked ahead, and hotel rates are rising. The regional housing market continues on the downside. Sales of existing homes declined 20 percent from their year-earlier peaks, and inventories and time on the market continue to rise. Prices of existing homes were down in New England overall for the first six months of the year and down again from Q2 to Q3 for three of the six states, according to the OFHEO index. Moreover, new housing permits were down 13 percent, and the dollar value of construction contracts was off sharply. However, New England’s market for new construction is small, and as near as we can see, not much speculative building occurred during the boom. Thus, homebuilder finances remain in relatively reasonable shape. There will likely be write-offs for suppliers this winter and perhaps some consolidation in the local industry, but we don’t see many major local economic effects from this. On the positive side, price-level declines have the welcome effect of making regional housing stock, particularly housing in the Boston area, more affordable. Suppliers and bankers noted that they saw signs of a modest pickup in sales in September and October, and they look forward to a brighter spring season if mortgage rates stay at their current lows. Commercial real estate remains a very different world, however. In fact, comments regarding commercial real estate investment in a number of cities around New England have served to highlight the liquidity that continues to characterize debt and asset markets, driving the yields lower, keeping spreads tight, and moving prices of even unlikely assets higher. In the notes from our Beige Book contacts was a very interesting conversation with a commercial real estate firm in Hartford, Connecticut, which has long been a depressed area. The contact reported that Hartford was attracting institutional investment interest for the first time since the 1980s and that commercial real estate deals were being done with cap rates of 7 to 8 percent. Providence reported similar commercial real estate strength; and in Boston, cap rates were said to be a bit below 6 percent. Pricing action in Boston remained above replacement cost with inflows of funds for deals reportedly from Middle Eastern and Irish sources. Vacancy rates in Boston are down. Rental rates are up, and pressure to serve the growth of new biotech firms is reportedly creating hot commercial real estate markets in Cambridge and in suburban areas just west of the city. While hot commercial real estate markets in eastern Massachusetts and even Providence are not particularly new news, such interest in Hartford really is. On the one hand, investor interest in places like Hartford may be a sign of real overheating. On the other hand, if the lid stays on, areas like Hartford stand to benefit from a rise in investment and, one hopes, related job growth. Turning to the nation, the recent tone of the incoming data, especially on the manufacturing side, has been subdued, as declines in the housing market and in motor vehicle spending and production have taken their toll. But I think this tone may well result from the ebb and flow of high-frequency observations. At the time of our last meeting, incoming data seemed more positive overall, and many of the factors present then—including solid employment growth, low unemployment, healthy debt and equity markets, solid corporate profits, good foreign growth, and a less negative or even a neutral-to-positive effect of net exports—remain. Fourth-quarter GDP data may well be disappointing to the markets, but given both what the staff believes is a calculation error on the part of the BEA and the fact that so many supportive factors remain, I am hopeful about prospects for ’07 and ’08. Our forecast in Boston retains the same trajectory as the Greenbook’s—a slow fourth quarter and a growing rebound over the next couple of years as residential investment recovers combined with a gradual small uptick in unemployment and an ebb in core inflation to the low 2s. Thus, despite the sense in markets that momentum has shifted downward, I don’t think that the baseline outlook has changed much since our last meeting, and the Greenbook forecast reflects that pretty well. Similarly, although risks exist both that growth will be slower and that inflation will be faster, I believe those risks to be fairly balanced at this point, though they are certainly not minor. Of concern, however, is the cost of being wrong on the inflation side. This is certainly not the time to let down our guard on this front with labor markets fairly tight, the unemployment rate at 4½ percent, and most of the downward effect of declining energy prices behind us. We could see inflation move sideways rather than down, and that could well be an issue. Markets see us beginning to ease as soon as the late first quarter, early second. Perhaps they’re right, but I remain to be convinced by the incoming data. Thank you." CHRG-110shrg38109--170 PREPARED STATEMENT OF BEN S. BERNANKE Chairman, Board of Governors of the Federal Reserve System February 14, 2007 Chairman Dodd, Senator Shelby, and other Members of the Committee, I am pleased to present the Federal Reserve's Monetary Policy Report to the Congress. Real activity in the United States expanded at a solid pace in 2006, although the pattern of growth was uneven. After a first-quarter rebound from weakness associated with the effects of the hurricanes that ravaged the Gulf Coast the previous summer, output growth moderated somewhat on average over the remainder of 2006. Real gross domestic product (GDP) is currently estimated to have increased at an annual rate of about 2\3/4\ percent in the second half of the year. As we anticipated in our July report, the U.S. economy appears to be making a transition from the rapid rate of expansion experienced over the preceding several years to a more sustainable average pace of growth. The principal source of the ongoing moderation has been a substantial cooling in the housing market, which has led to a marked slowdown in the pace of residential construction. However, the weakness in housing market activity and the slower appreciation of house prices do not seem to have spilled over to any significant extent to other sectors of the economy. Consumer spending has continued to expand at a solid rate, and the demand for labor has remained strong. On average, about 165,000 jobs per month have been added to nonfarm payrolls over the past 6 months, and the unemployment rate, at 4.6 percent in January, remains low. Inflation pressures appear to have abated somewhat following a run-up during the first half of 2006. Overall inflation has fallen, in large part as a result of declines in the price of crude oil. Readings on core inflation--that is, inflation excluding the prices of food and energy--have improved modestly in recent months. Nevertheless, the core inflation rate remains somewhat elevated. In the five policy meetings since the July report, the Federal Open Market Committee (FOMC) has maintained the Federal funds rate at 5\1/4\ percent. So far, the incoming data have supported the view that the current stance of policy is likely to foster sustainable economic growth and a gradual ebbing of core inflation. However, in the statement accompanying last month's policy decision, the FOMC again indicated that its predominant policy concern is the risk that inflation will fail to ease as expected and that it is prepared to take action to address inflation risks if developments warrant. Let me now discuss the economic outlook in a little more detail, beginning with developments in the real economy and then turning to inflation. I will conclude with some brief comments on monetary policy. Consumer spending continues to be the mainstay of the current economic expansion. Personal consumption expenditures, which account for more than two-thirds of aggregate demand, increased at an annual rate of around 3\1/2\ percent in real terms during the second half of last year, broadly matching the brisk pace of the previous 3 years. Consumer outlays were supported by strong gains in personal income, reflecting both the ongoing increases in payroll employment and a pickup in the growth of real wages. Real hourly compensation--as measured by compensation per hour in the nonfarm business sector deflated by the personal consumption expenditures price index--rose at an annual rate of around 3 percent in the latter half of 2006. The resilience of consumer spending is all the more striking given the backdrop of the substantial correction in the housing market that became increasingly evident during the spring and summer of last year. By the middle of 2006, monthly sales of new and existing homes were about 15 percent lower than a year earlier, and the previously rapid rate of house-price appreciation had slowed markedly. The fall in housing demand in turn prompted a sharp slowing in the pace of construction of new homes. Even so, the backlog of unsold homes rose from about 4\1/2\ months' supply in 2005 to nearly 7 months' supply by the third quarter of last year. Single-family housing starts have dropped more than 30 percent since the beginning of last year, and employment growth in the construction sector has slowed substantially. Some tentative signs of stabilization have recently appeared in the housing market: New and existing home sales have flattened out in recent months, mortgage applications have picked up, and some surveys find that homebuyers' sentiment has improved. However, even if housing demand falls no further, weakness in residential investment is likely to continue to weigh on economic growth over the next few quarters as homebuilders seek to reduce their inventories of unsold homes to morecomfortable levels. Despite the ongoing adjustments in the housing sector, overall economic prospects for households remain good. Household finances appear generally solid, and delinquency rates on most types of consumer loans and residential mortgages remain low. The exception is subprime mortgages with variable interest rates, for which delinquency rates have increased appreciably. The labor market is expected to stay healthy, and real incomes should continue to rise, although the pace of employment gains may be slower than that to which we have become accustomed in recent years. In part, slower average job growth may simply reflect the moderation of economic activity. Also, the impending retirement of the leading edge of the baby-boom generation, and an apparent leveling out of women's participation rate in the workforce, which had risen for several decades, will likely restrain the growth of the labor force in coming years. With fewer jobseekers entering the labor force, the rate of job creation associated with the maintenance of stable conditions in the labor market will decline. All told, consumer expenditures appear likely to expand solidly in coming quarters, albeit a little less rapidly than the growth in personal incomes if, as we expect, households respond to the slow pace of home-equity appreciation by saving more out of current income. The business sector remains in excellent financial condition, with strong growth in profits, liquid balance sheets, and corporate leverage near historical lows. Last year, those factors helped to support continued advances in business capital expenditures. Notably, investment in high-tech equipment rose 9 percent in 2006, and spending on nonresidential structures (such as office buildings, factories, and retail space) increased rapidly through much of the year after several years of weakness. Growth in business spending slowed toward the end of last year, reflecting mainly a deceleration of spending on business structures; a drop in outlays in the transportation sector, where spending is notably volatile; and some weakness in purchases of equipment related to construction and motor vehicle manufacturing. Over the coming year, capital spending is poised to expand at a moderate pace, supported by steady gains in business output and favorable financial conditions. Inventory levels in some sectors--most notably at motor vehicle dealers and in some construction-related manufacturing industries--rose over the course of last year, leading some firms to cut production to better align inventories with sales. Remaining imbalances may continue to impose modest restraint on industrial production during the early part of this year. Outside the United States, economic activity in our major trading partners has continued to grow briskly. The strength of demand abroad helped spur a robust expansion in U.S. real exports, which grew about 9 percent last year. The pattern of real U.S imports was somewhat uneven, partly because of fluctuations in oil imports over the course of the year. On balance, import growth slowed in 2006, to 3 percent. Economic growth abroad should support further steady growth in U.S. exports this year. Despite the improvements in trade performance, the U.S. current account deficit remains large, averaging about 6\1/2\ percent of nominal GDP during the first three quarters of 2006 (the latest available data). Overall, the U.S. economy seems likely to expand at a moderate pace this year and next, with growth strengthening somewhat as the drag from housing diminishes. Such an outlook is reflected in the projections that the Members of the Board of Governors and Presidents of the Federal Reserve Banks made around the time of the FOMC meeting late last month. The central tendency of those forecasts--which are based on the information available at that time and on the assumption of appropriate monetary policy--is for real GDP to increase about 2\1/2\ to 3 percent in 2007 and about 2\3/4\ to 3 percent in 2008. The projection for GDP growth in 2007 is slightly lower than our projection last July. This difference partly reflects an expectation of somewhat greater weakness in residential construction during the first part of this year than we anticipated last summer. The civilian unemployment rate is expected to finish both 2007 and 2008 around 4\1/2\ to 4\3/4\ percent. The risks to this outlook are significant. To the downside, the ultimate extent of the housing market correction is difficult to forecast and may prove greater than we anticipate. Similarly, spillover effects from developments in the housing market onto consumer spending and employment in housing-related industries may be more pronounced than expected. To the upside, output may expand more quickly than expected if consumer spending continues to increase at the brisk pace seen in the second half of 2006. I turn now to the inflation situation. As I noted earlier, there are some indications that inflation pressures are beginning to diminish. The monthly data are noisy, however, and it will consequently be some time before we can be confident that underlying inflation is moderating as anticipated. Recent declines in overall inflation have primarily reflected lower prices for crude oil, which have fed through to the prices of gasoline, heating oil, and other energy products used by consumers. After moving higher in the first half of 2006, core consumer price inflation has also edged lower recently, reflecting a relatively broad-based deceleration in the prices of core goods. That deceleration is probably also due to some extent to lower energy prices, which have reduced costs of production and thereby lessened one source of pressure on the prices of final goods and services. The ebbing of core inflation has likely been promoted as well by the stability of inflation expectations. A waning of the temporary factors that boosted inflation in recent years will probably help foster a continued edging down of core inflation. In particular, futures quotes imply that oil prices are expected to remain well below last year's peak. If actual prices follow the path currently indicated by futures prices, inflation pressures would be reduced further as the benefits of the decline in oil prices from last year's high levels are passed through to a broader range of core goods and services. Nonfuel import prices may also put less pressure on core inflation, particularly if price increases for some other commodities, such as metals, slow from last year's rapid rates. But as we have been reminded only too well in recent years, the prices of oil and other commodities are notoriously difficult to predict, and they remain a key source of uncertainty to the inflation outlook. The contribution from rents and shelter costs should also fall back, following a step-up last year. The faster pace of rent increases last year may have been attributable in part to the reduced affordability of owner-occupied housing, which led to a greater demand for rental housing. Rents should rise somewhat less quickly this year and next, reflecting recovering demand for owner-occupied housing as well as increases in the supply of rental units, but the extent and pace of that adjustment is not yet clear. Upward pressure on inflation could materialize if final demand were to exceed the underlying productive capacity of the economy for a sustained period. The rate of resource utilization is high, as can be seen in rates of capacity utilization above their long-term average and, most evidently, in the tightness of the labor market. Indeed, anecdotal reports suggest that businesses are having difficulty recruiting well-qualified workers in certain occupations. Measures of labor compensation, though still growing at a moderate pace, have shown some signs of acceleration over the past year, likely in part the result of tight labor market conditions. The implications for inflation of faster growth in nominal labor compensation depend on several factors. Increases in compensation might be offset by higher labor productivity or absorbed by a narrowing of firms' profit margins rather than passed on to consumers in the form of higher prices; in these circumstances, gains in nominal compensation would translate into gains in real compensation as well. Underlying productivity trends appear favorable, and the markup of prices over unit labor costs is high by historical standards, so such an outcome is certainly possible. Moreover, if activity expands over the next year or so at the moderate pace anticipated by the FOMC, pressures in both labor and product markets should ease modestly. That said, the possibility remains that tightness in product markets could allow firms to pass higher labor costs through to prices, adding to inflation and effectively nullifying the purchasing power of at least some portion of the increase in labor compensation. Thus, the high level of resource utilization remains an important upside risk to continued progress on inflation. Another significant factor influencing medium-term trends in inflation is the public's expectations of inflation. These expectations have an important bearing on whether transitory influences on prices, such as those created by changes in energy costs, become embedded in wage and price decisions and so leave a lasting imprint on the rate of inflation. It is encouraging that inflation expectations appear to have remained contained. The projections of the Members of the Board of Governors and the Presidents of the Federal Reserve Banks are for inflation to continue to ebb over this year and next. In particular, the central tendency of those forecasts is for core inflation--as measured by the price index for personal consumption expenditures excluding food and energy--to be 2 to 2\1/4\ percent this year and to edge lower, to 1\3/4\ to 2 percent, next year. But as I noted earlier, the FOMC has continued to view the risk that inflation will not moderate as expected as the predominant policy concern. Monetary policy affects spending and inflation with long and variable lags. Consequently, policy decisions must be based on an assessment of medium-term economic prospects. At the same time, because economic forecasting is an uncertain enterprise, policymakers must be prepared to respond flexibly to developments in the economy when those developments lead to a reassessment of the outlook. The dependence of monetary policy actions on a broad range of incoming information complicates the public's attempts to understand and anticipate policy decisions. Clear communication by the central bank about the economic outlook, the risks to that outlook, and its monetary policy strategy can help the public to understand the rationale behind policy decisions and to anticipate better the central bank's reaction to new information. This understanding should, in turn, enhance the effectiveness of policy and lead to improved economic outcomes. By reducing uncertainty, central bank transparency may also help anchor the public's longer-term expectations of inflation. Much experience has shown that well-anchored inflation expectations tend to help stabilize inflation and promote maximum sustainable economic growth. Good communication by the central bank is also vital for ensuring appropriate accountability for its policy actions, the full effects of which can be observed only after a lengthy period. A transparent policy process improves accountability by clarifying how a central bank expects to attain its policy objectives and by ensuring that policy is conducted in a manner that can be seen to be consistent with achieving those objectives. Over the past decade or so, the Federal Reserve has significantly improved its methods of communication, but further progress is possible. As you know, the FOMC last year established a subcommittee to help the full Committee evaluate the next steps in this continuing process. Our discussions are directed at examining all aspects of our communications and have been deliberate and thorough. These discussions are continuing, and no decisions have been reached. My colleagues and I remain firmly committed to an open and transparent monetary policy process that enhances our ability to achieve our dual objectives of stable prices and maximum sustainable employment. I will keep Members of this Committee apprised of developments as our deliberations move forward. I look forward to continuing to work closely with the Members of this Committee and your colleagues in the Senate and House on the important issues pertaining to monetary policy and the other responsibilities with which the Congress has charged the Federal Reserve. Thank you. I would be happy to take questions. CHRG-110hhrg46591--74 Mr. Stiglitz," Well, I think that it is imperative to continue with mark to market. When there is no market, as is the case in some assets, obviously you can't mark to market, you have to use some other principle. The issue is what you do with mark to market. I had a very brief reference to countercyclical provisioning which takes into account what happens in these kinds of situations to market values. What I find very interesting is that those who have criticized mark to market didn't criticize it when they overestimated the prices in the bubble and haven't offered to give back the bonuses that were based on those over excessive prices when the market was excessively exuberant. They want an asymmetry where when it is too low, they will get the market up, when it is too high, they will leave it up to high. I think we have to stay with a transparent system but think very carefully about how we use that information in regulatory processes. " CHRG-111shrg55117--119 Mr. Bernanke," I do agree. Senator Kohl. Thank you. While consumer spending has remained flat through 2009, the personal savings rate, as you know, has finally started to rise, and quite substantially. The weak economy has made consumers more skeptical of borrowing and increasingly aware of their spending habits, as I am sure you know. As we here consider reforms to the banking system to help financial institutions prepare for possible future economic downturns, we need also to help prepare the American families across the country for their next economic crisis. Do you have any policy recommendations that would help continue the upward trend of the personal savings rate and avoid another bubble based on consumer activity? " FOMC20061025meeting--98 96,CHAIRMAN BERNANKE.," Thank you. Let me summarize what I heard, and then I would like to make a few comments of my own. There were several themes around the table. Many people noted the bimodal economy. Housing is still quite weak, although a number of people noted that they thought the lower tail had been trimmed somewhat. Autos are undergoing inventory adjustment, and some people noted slowing in a few other sectors. However, the general view was that spillovers from housing to the rest of the economy had not yet occurred. Most people noted that the labor market is quite healthy, with widespread shortages of labor, particularly of skilled workers. It was further noted that consumption spending would be supported by the job market, by income growth, and by the fall in energy prices. Overall, the assessments of growth, as I heard them, were that it would be moderate going forward, either around potential or perhaps slightly below potential, and some saw a bit of upside risk to that projection. With respect to inflation, costs of raw materials and energy are rising more slowly or are declining, and headline inflation has fallen with energy costs. Some felt that core inflation would moderate gradually, but others were less confident about that. The behavior of rents and the behavior of productivity are two important unknowns going forward, and wage growth probably presents the biggest upside risk to inflation. Most members expressed concerns that the high level of inflation could raise inflation expectations and undermine Fed credibility. So the general view, which I think essentially everyone shares, was that the upside risks to inflation exceed the downside risks to growth at this juncture. I hope that summary was okay; let me just make a few comments of my own. As a number of people noted, the intermeeting data were actually fairly limited. The employment report did indicate a fairly strong labor market. There is still, to my mind, some disconnect between the anecdotes and the data; in particular, the wage data do not yet reflect what I’m hearing around the table about wage premiums. For example, average hourly earnings actually grew more slowly in the third quarter than in the second quarter. I think the ECI next week will be a very important check for our anecdotes. On the positive side, as Kevin and others noted, the tone was generally stronger in financial markets. The stock market is up. I note the ten-year real rate was up about 15 basis points since the last meeting, which I take to be a positive indication of growth. Oil prices continue to decline, which obviously is good for both growth and inflation. I thought you might be interested in thinking about the quantity effects of the decline in oil prices. We’ve had a decline in oil prices of about $15, which back-of-the-envelope calculations or FRB/US analysis can tell us should add about 0.45 percent to the level of real consumption or about 0.35 percent to the level of real GDP. Dave Reifschneider was very helpful in finding those numbers. That’s a change to the level, so the oil price declines could add 0.3 to 0.4 percentage point to growth, say, over the next six quarters. Another way to look at that is to think about the relationship between oil prices and house prices. A rule of thumb that might be useful is that a $3 decline in oil prices offsets approximately a 1 percentage point decline in house prices in terms of overall consumption effects. So oil price declines are essentially the negative equivalent of a 5 percent decline in house prices. An interesting question that we may have to address at some point is, what is the policy implication of oil price declines? I think it’s clear that oil price declines will lower both total and core inflation, but will also increase growth. Therefore, our policy response to the lower oil prices could depend on our preferences about growth versus inflation and also our assessments of the risks to both of those variables. On the housing correction, I agree that there is perhaps some reduction in the lower tail. But it’s important to point out that, even if we see some stabilization in starts and permits, a lot of inventory is still out there, and there’s going to be an inventory correction process that could be quite significant. The current months’ supply of homes for sale is greater than 6 now, excluding cancellations; the number over the past eight years has been very stable around 4, although before 1997 it was higher and more variable, which is a source of uncertainty. To get a sense of the magnitudes of the potential housing correction, I asked Josh Gallin to do the following simple simulation. Single-family housing sales were about 1.0 million at an annual rate in July, about 1.05 million in August. So I asked Josh to consider a case in which sales flatten out at the level of 1.1 million and continue at that level indefinitely; in addition, homebuilders respond to three-fourths of the increase in sales by extra building and allow the other fourth to go into reducing inventory. When you do that calculation, you find that you actually work off the inventory. By the end of 2008, the months’ supply is down to 4.1. Part of that decrease occurs because the sales level is higher, and so the denominator is bigger as well. Thus that particular scenario is a sensible one in terms of getting the inventories down. However, the effects on GDP, because the correction is still significant, are not trivial, but they are also not that large. The effect of this scenario on GDP growth from the fourth quarter of this year to the second quarter of next year is about 0.2 on growth and about 0.1 in the third and fourth quarters. So a very substantial part of the housing correction is still in place because of the need to work off inventories over the next few quarters. Those are a few comments on the real side. I think that some of the tail risk has been reduced. I agree with the Greenbook that growth should be slow, at least through the first quarter of next year, because of housing corrections, but consumption will probably pick up and lead to a stronger growth path after that. Let me say a few words about inflation. I think I need to push back a little on the view that there has been no improvement in core inflation or total inflation. In fact, inflation is very slow to respond to its determinants, and the fact that we actually have seen some improvement in some sense is a positive surprise, not a negative surprise. The attention that’s paid to the twelve-month lagging inflation measure is a problem in this context, because we had four months of 0.3 percent readings from March to June, and they’re going to stay in that twelve- month lagging measure until next March. I can predict with great confidence that next March through next June the twelve-month lagging inflation measure will decline. So I think it’s more useful, President Lacker, to look, a bit at least, at the higher-frequency measures to see what the trend of movement is. Although, like President Lacker and others, I’m not happy with the level, I think the direction is actually very good. For example, the core CPI three-month went from 3.79 in May to 2.75 in September, so it’s a decline of 104 basis points. The core PCE three- month inflation measure went from 2.95 in May to 2.20 in September, using the staff estimate for the core PCE deflator for September. So it’s certainly moving in the right direction. The other comment I would make about this subject is that we must keep in mind how much is tied to the owners’ equivalent rent component. I would say, in fact, that once you exclude that, if you do, just for comparison, that 2006 is roughly equivalent to 2005 in terms of core PCE inflation. To look at the high frequency numbers, excluding OER, which I’m doing now for illustrative purposes, core CPI fell from 3.01 in May to 2.23 in September, and core PCE inflation fell from 2.52 in May to 1.93 in September at an annual rate. This is saying that a significant part of the speedup and now the decline in the rate is related to this owners’ equivalent rent phenomenon—not all of it, but a significant part. It’s important to know that because, as we’ve discussed around the table, the OER may have its own dynamic. It may respond in different ways to monetary policy than some other components do. It is an imputed price, which people do not actually observe, and so it may have a different effect on expectations than, say, gasoline prices or other easily observed prices. The other important aspect of the OER is that, to the extent that it is a major source of the inflation problem, it makes clear that inflation probably has not been a wage-push problem so far because owners’ equivalent rent is obviously the cost of buildings, not the cost of labor. So if you look at inflation over the past few months, there has been slow improvement, and so far I don’t think that we have seen a great deal of feedthrough of wage pressures into inflation. I’ve looked through all the various categories of goods and services whose prices have increased, and I can find no particular relationship to labor market factors. Another comment along this line: It’s also true that inflation of even 2.20 percent, which was the core PCE three-month inflation rate in September, is too high in the long run. I agree it should be lower than that. We do have to ask ourselves, given that inflation has been high and that, as people pointed out, it has been high for a number of years now, how quickly we should bring it down. Most optimal monetary policy models will suggest that a slow reduction is what you would try to achieve if you start off far away from the target and if the real economy is relatively weak. Now, the question arises whether we are going in the right direction. I think so far we are, but I would certainly agree that we have to ensure that we continue to go in the right direction. The Greenbook forecast is predicated on a constant federal funds rate from the current level; actually the rate declines in 2008. But what it leaves out is the notion that we are gathering information and trying to resolve uncertainty, depending on how things develop. Obviously, policy can respond in one direction or another and could, if inflation does not continue to decline, be more aggressive to achieve that. I felt I needed to talk a bit about the fact that we do have some improvement in inflation, and so the situation cannot really be said to be deteriorating. Having said all of that, now let me come back and agree with what I’ve heard, which is that, although we have not yet seen much wage-push inflation, clearly the risk is there. Anecdotally, and to some extent statistically, we have very tight labor markets. It is surprising how little wage push there has been so far, and if labor markets continue to stay at this level of tightness, then one would expect that you would get an inflation effect that would be uncomfortably persistent. That is a real concern, which I share with everyone around the table. If the Phillips curve language doesn’t appeal to you, another way of thinking about it is that, if the labor market stays this tight, which means that growth is at potential or better, then the real interest rate that is consistent with that growth rate needs to be higher than it is now. I agree with that point as well. So my bottom line is that I do agree that inflation is the greater risk, certainly. I think that the downside risk from output has been slightly reduced. I also think the upside risk to inflation has been slightly reduced. Thus we’re not in all that different a position than we were at our last meeting. We can discuss the implications of that tomorrow. I think I’ll stop there. Yes, President Poole." 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. FOMC20080109confcall--24 22,MR. ROSENGREN.," Thank you, Mr. Chairman. My views are actually very consistent with your own. I would support lowering the fed funds rate 50 basis points, and, if it were up to me, I would support doing it right now. The employment report last Friday was weaker than I expected. In conjunction with the likelihood of several quarters of economic growth below potential, the risk that the economy is in, or could be going into, a recession is too high. Continued declines in housing prices and stock prices raise my concern that deteriorating household wealth will constrain consumption more than we anticipate. I am also worried that weaker labor markets are likely to exacerbate problems in the housing market. Should housing prices fall further and foreclosures rise more rapidly as a result of weak labor markets, financial markets may experience even more turmoil than we have experienced to date. Commodity and oil prices have risen, but I expect that the weakening in labor markets will be sufficient to restrain inflation. The downside risks to the economy are significant, and I think we should take aggressive action to mitigate that risk. Thank you. " CHRG-111hhrg55814--359 Mr. Foster," Thank you. My questions are in regard to subtitle (f) on risk retention during the asset-backed security process. And it is my reading of it that you have very wide authority to set it not just at 10 percent, but to eliminate it entirely or make it significantly higher. My concerns are with the macroeconomic effects and possible politicization of this. It is obvious this could exert a very powerful, and possibly beneficial, damping influence on, for example, real estate price bubbles. If someone had said several years ago that, look, you are securitizing out of Las Vegas, you don't have to put 10 percent down but 25 percent down, it could have had a very beneficial macroeconomic effect. And so my question is, how do you anticipate this will actually be exercised? Do you anticipate varying the risk retention by asset class? By industry sector? By geographical region, in the case of mortgage securitization? Governor Tarullo? " FOMC20070807meeting--107 105,CHAIRMAN BERNANKE.," Thank you for the useful discussion. As usual, I am going to very briefly summarize what I heard. I will be happy to take any comments on that. Then I just want to make a few short points. Again, most of the key points have been made. Most participants expect growth to remain moderate over the forecast period. Despite lower household wealth resulting from weaker house and stock prices, consumption is likely to continue to grow as labor markets remain strong, real incomes increase, and gasoline prices moderate. Business investment should also grow moderately, although lower productivity and higher volatility could be drags on investment. Commercial real estate, in particular, may be slackening, but it retains good fundamentals. The global economy is strong. Industrial production is expanding at a reasonable pace. However, downside risks to growth were noted and perhaps received somewhat greater emphasis than at past meetings. Most notably, housing appears to have weakened further, with sales of new and existing homes declining and inventories of unsold homes remaining high. Homebuilders are experiencing financial strains, and there is downward pressure on home prices. Spillover on consumption spending is not yet evident but is a possible risk. In this regard, developments in credit markets received considerable attention. On the positive side, the repricing of risk and the reevaluation of underwriting standards seem appropriate. Liquidity still exists, credit is still being extended, and markets may work out their problems on their own. A lower dollar and lower long-term Treasury rates also tend to offset financial tightening. However, higher risk premiums, tougher underwriting, and greater uncertainty may constrain housing and investment spending, leading to broader macroeconomic effects. In more-pessimistic scenarios, dislocations in credit markets may last awhile and have a more substantial effect on credit availability and costs for businesses as well as for homebuyers. The possibility of contagion or severe financial instability also exists. Many participants took note of the NIPA revisions and their implications for productivity growth, consumer saving, and unit labor costs. Meeting participants tend to put potential growth at higher rates than the Greenbook. Views on inflation are similar to those in previous meetings. Recent readings are viewed as reasonably favorable. However, risks to inflation remain, including the possible reversal of transitory factors, tight labor markets, the high price of commodities, and higher unit labor costs resulting from lower productivity growth. In all, the risks to inflation remain to the upside. That is my summary of what I heard. I’m sure a lot more could be said. Any comments? If not, let me just make a few additional comments. There have been two very important developments since the last meeting. The first was the downward revision to the NIPA growth numbers. It’s not obvious yet, of course, how much of that reflects a permanent decline in productivity and how much is transitory. But certainly the best guess is that some of it is more long term in nature. I think the main point I’d like to make is that the implications of this downward revision for inflation and monetary policy, except perhaps in the very short run, are not obvious. The question is, What is the effect of the lower productivity growth on aggregate demand? We have examples of both types of phenomena. In the late ’90s, the pickup in productivity growth stimulated a very strong boom working through the stock market, consumption, and investment, so it led to an overheating economy, whereas in the earlier part of this decade, productivity growth picked up again but with weak aggregate demand. We had a jobless recovery associated with that. So it remains to be seen exactly how aggregate demand will respond to these developments. I do think that perhaps that in the very short run, given wage behavior and unit labor costs, if I had to choose, I would say that there is a slight bias toward higher inflation and tighter money. In the longer run, you would expect to see lower long-term rates because of slower growth. The second issue that has been widely discussed around the table is the financial market. It is an interesting question why what looks like $100 billion or so of credit losses in the subprime market has been reflected in multiple trillions of dollars of losses in paper wealth. So it’s an interesting question about what is going on there. I think there are three reasons that the financial markets have moved in the direction they have. First, there has been a widespread repricing of risk. That is, obviously, a healthy development, particularly if there is no overshoot, which is a possibility. But all else being equal, it is restrictive in terms of aggregate demand, and it makes our policy tighter than it otherwise would be. The second reason for the changes in markets is that there has been a loss of confidence in the ability of investors to evaluate credit quality, particularly in structured products. There is an information fog, as I have heard it described. This is very much associated with the loss of confidence in the credit-rating agencies. I think one of the implications of this is that some of the innovations we have seen in financial markets are going to get rolled back. We are going to see more lending taken out of originate-to- distribute vehicles and put back onto portfolio balance sheets. So the question is how much effect this adjustment process will have on the availability of credit. The third reason that I think the markets have reacted as much as they have is concern about the macroeconomic implications of what is happening. In particular, there is a fear that subprime losses, repricing, and the tightening of underwriting standards will have adverse effects on the housing market and will feed through to consumption, and we will get into a vicious cycle. That certainly is reflected in the expectations of policy. I am not going to go through all the things that are going on now in the markets. You have had very good reviews of that. Obviously, the markets right now are not functioning normally. Some conduits of credit are simply closed or frozen. A number of companies are having difficulties with short-term finance, and so, per President Fisher’s comment, we are watching those things very carefully. We are prepared to use the tools that we have to address a short-term financial crisis, should one occur. In the longer term, of course, our policy should be directed not toward protecting financial investors but, rather, toward our macroeconomic objectives. That is very important. Then the question is what the long-run implications of the financial market adjustment will be for the economy. I think the odds are that the market will stabilize. Most credits are pretty strong except for parts of the mortgage market. But even so there will be notably tighter credit, tighter standards, probably some loss of confidence in markets, and higher risk premiums that will on net be restrictive. This restrictive effect could come in various magnitudes. It could be moderate, or it could be more severe, and we are just going to have to monitor how it adjusts over time. Again, there is a bit of a risk—and tail risk has been mentioned not only in a financial sense but also in the macro sense—that, if credit is severely restricted so that we get feedback from lower house prices, for example, into the financial markets, that situation would be difficult to deal with. Those are the two major issues that people have talked about. Just very briefly on the overall assessment—on the output side, economic growth looks a little softer to me, mostly because of housing. There are also some slightly worrying developments in terms of automobile demand, which suggest some weakening in consumer spending. But there are some strong elements as well. Also the labor market has marginally softened. The unemployment rate is about 25 basis points above its recent low; so there has been some movement, and I still expect to see some reduction in construction employment. So I think there is a bit more softness and there are a few more downside risks to output than at our last meeting. Like others, I think the recent inflation data are moderately encouraging. I continue to see risks. If you’re not satiated with risks, I’ll add one more, which is that if the housing market really weakens and people go back to renting, we could get the same phenomenon that we saw last year, by which rents are driven up and we get an effect working through shelter costs. So I agree with those who still view the risk to inflation as being tilted to the upside. If there are no comments or questions, let me turn now to Brian to discuss the policy action." FOMC20050809meeting--163 161,MR. KOHN.," Thank you, Mr. Chairman. As many of you have remarked, underlying demand has shown a surprising degree of vigor over the intermeeting period. Strength in final demand should show through to output as the mini-inventory cycle works itself out. This strength, together with revisions to estimates of the level and rate of growth of potential GDP as a consequence of the NIPA revisions, suggests that the economy is probably a little closer to its long-run sustainable production than we had thought. A smaller output gap, in combination with further increases in oil prices—some portion of which is likely to show through to core prices for a time—in turn suggests that inflation risks are a little higher and raises questions about our policy strategy. In my view, although the risks have shifted a little, they have not shifted enough to throw us off our presumed policy path of measured increases in interest rates, and I would continue to indicate that in our statement. I agree with the staff forecast that the increase in final demand is likely to slow going forward, as we continue to raise rates. The surprise was not in investment, which continues to be August 9, 2005 67 of 110 strong. In part, the unexpected strength reflected auto incentives and is borrowed from spending in the future. The increase in consumption required a further decline in the saving rate from an already low level, a pattern not likely to be sustained absent continued very sharp increases in housing prices. In that regard, at some point rising short-term rates—and recently long-term rates —should take their toll on housing price appreciation. To be sure, to date the indications of cooling housing markets are anecdotal, such as those we heard from President Guynn; they’re not yet data-based. But if, as many assert, the demand for houses is being supported to a considerable extent by ARMs and exotic mortgages tied to short-term rates, the effect of monetary policy tightening should, if anything, be greater than in the past, with the housing wealth channel bearing more of the adjustment. In addition, the further rise in energy prices is likely to shave something off spending, or at least postpone the time when energy prices are no longer holding back growth. And the positive contribution to final sales from net exports in the second quarter appears to be a short- term quirk in either data or behavior. Moderate growth abroad, together with our outsized demand for imports, should once again begin to damp demand on our own productive resources. Moreover, incoming data on prices and compensation continue to indicate, to my mind, that there is some slack remaining, which is working to contain price pressures. Although core PCE data for 2004 and before were revised higher, incoming information about the most recent several months has suggested an appreciable short-term deceleration. The recent price data were, in fact, lower than anticipated. In effect, the data tended to confirm that the higher rates of inflation earlier this year were temporary, probably reflecting the increases in price levels of oil and other imports, and that inflation is not on an upward track. These data have been consistent August 9, 2005 68 of 110 have been contradictory and confounding, but it seems hard to believe that the surprisingly soft numbers for the ECI in Q2 and Q1 were drawn from a labor market under pressure, perhaps giving some more weight to President Poole’s comments on the anecdotal information there. Even the productivity numbers are somewhat ambiguous in their implications for cost and price pressures. Although past productivity growth appears to have been lower, and the staff marked down its estimate of structural productivity growth for 2005 and beyond, actual productivity data for 2005 are running at a higher rate than had previously been anticipated. The estimate for the first half of the year was revised up to 2½ percent, and the current quarter is projected to be substantially higher than that. Market participants seem to think the measured pace of policy tightening will be adequate. They have added to the extent of the tightening but not the pace. And inflation compensation, as President Lacker noted, while edging a little higher over the intermeeting period, remains much lower than it was just a few months ago, despite the further increase in energy prices. Finally, I think the strategy we have followed of tightening at a measured pace and being transparent about our intentions has a number of advantages. In particular, following this strategy—especially compared to one of larger increases or those that weren’t well predicted by the market—reduces the odds of significant overshooting. Gradual changes enable us to get a better handle on their effects on the markets and the economy as they are happening. Their predictability means that they are incorporated into financial conditions more readily and accurately, bringing forward their effects on financial conditions and making observations about August 9, 2005 69 of 110 And I wonder whether this strategy isn’t going to be especially useful given the uncertainty about how our actions could affect housing prices, construction, and consumption. Increasing rates will affect housing markets. Indeed, that’s a necessary condition for constraining inflation pressures. But increased uncertainty about the strength of this channel, given the changing nature of mortgage markets, reinforces the arguments for a gradual approach to policy, if possible. I agree that the incoming data should reinforce and strengthen our intention not to allow inflation and inflation expectations to rise from here. I’m encouraged by the reaction of markets to the news over the intermeeting period in adding 50 basis points to the string of expected gradual increases in the funds rate. This shows that they are not constrained by our language from marking up long-term interest rates, and it strikes me as the right response, at least for now. Thank you, Mr. Chairman." FOMC20070131meeting--170 168,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. Just a few quick points. We feel somewhat better about the outlook for growth and inflation, but we haven’t really changed our forecasts for ’07 and ’08. So just as we expected over the past few cycles, we currently expect GDP to grow roughly at the rate of potential over the forecast period, which we believe is still around 3 percent, and we expect the rate of increase in the core PCE to moderate a bit more to just below 2 percent over the forecast period. We see somewhat less downside risk to growth and somewhat less upside risk to inflation than we did, but the overall balance of risks in our view is still weighted toward inflation—the risk that it fails to moderate enough or soon enough. The basic nature of the risks to both those elements of our forecast hasn’t really changed. As this implies, our forecast still has somewhat stronger growth and somewhat less inflation than the Greenbook does. The differences, however, are smaller than they have been. We see the same basic story that the Greenbook does in support of continuing expansion going forward. We have similar assumptions for the appropriate path of monetary policy—at least two, perhaps several, quarters of a nominal fed funds rate at current levels. The main differences between our view about the economy and the Greenbook’s relate first, as they have for some time, to the likely growth in hours; we’re still not inclined to build in a substantial reduction in trend labor force growth. Second, our view is that inflation has less inertia, less persistence, than it has exhibited over the past half-century. Third, we tend to think that changes in wealth have less effect on consumer behavior than does the staff. We have seen a general convergence in views in the market, as we just discussed, toward a forecast close to this view, close to the center of gravity in this room, and a very significant change in policy expectations as well. We can take some comfort from this, but I don’t think we should take too much. Markets still seem to display less uncertainty about monetary policy and asset prices and quite low probabilities to even modest increases in risk premiums than I think is probably justified. Let me just go through the principal questions briefly. Is the worst behind us in both housing and autos? Probably, but we can’t be sure yet. If we get some negative shock to income—to demand growth—we’re still vulnerable to a more adverse adjustment in housing prices with potentially substantially negative effects on growth, in part because of the greater leverage now on household balance sheets. How strong does the economy look outside autos and housing? Pretty strong, it seems. We see no troubling signs of weakness, despite the disappointment on some aspects of investment spending. What does the labor market strength tell us about the risk to the forecast? It seems obvious that on balance it justifies some caution about upside risk to growth and more than the usual humility about what we know about slack and trend labor force growth. But I don’t think it fundamentally offers a compelling case on its own for a substantial change to the inflation forecast or the risks to that forecast. Is there any new information on structural productivity growth? Not in our view. We’re still fairly comfortable with the staff view of around 2 percent or 2½ percent for the nonfarm business sector. I’m not a great fan of the anecdote, but I’ll cite just one. If you ask people who make stuff for a living on a substantial scale, it’s hard to find any concern that they are seeing diminished capacity to extract greater productivity growth in their core businesses. That’s not a general observation, just a small one. Have the inflation risks changed meaningfully in either direction? I think the recent behavior of the core numbers and of expectations is reassuring. The market doesn’t seem particularly concerned about inflation, and the market is therefore vulnerable to a negative surprise, to a series of higher numbers. Can we be confident we’ll get enough moderation with the current level of long-term expectations prevailing in markets, with the expected path of slack in the economy, and with the range of potential forces that might operate on relative prices— energy, import, and other prices? Again, I think this forecast still seems reasonable, but we can’t be that confident, and we need to be concerned still about the range of sources of vulnerability of that forecast. Another way to frame this question is, Is the inflation forecast consistent with the current expectations for the path of monetary policy acceptable to the Committee? We haven’t fully confronted that issue because we don’t get much moderation with a monetary policy assumption that’s close to what’s in the markets. But I don’t think there’s a compelling case to act at this stage in a way that forces convergence on that. In other words, how tight is monetary policy, and how tight are overall financial conditions today? I don’t think there’s a very strong case for us to induce more tightness or more accommodation than now prevails. There’s a good case for patience and for giving ourselves a fair amount of flexibility going forward, within the context of an asymmetric signal about the balance of risks and a basic judgment that we view the costs of a more adverse inflation outcome as the predominant concern of the Committee." 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. " fcic_final_report_full--118 As the United States ran a large current account deficit, flows into the country were unprecedented. Over six years from  to , U.S. Treasury debt held by foreign official public entities rose from . trillion to . trillion; as a percentage of U.S. debt held by the public, these holdings increased from . to .. For- eigners also bought securities backed by Fannie and Freddie, which, with their im- plicit government guarantee, seemed nearly as safe as Treasuries. As the Asian financial crisis ended in , foreign holdings of GSE securities held steady at the level of almost  years earlier, about  billion. By —just two years later— foreigners owned  billion in GSE securities; by ,  billion. “You had a huge inflow of liquidity. A very unique kind of situation where poor countries like China were shipping money to advanced countries because their financial systems were so weak that they [were] better off shipping [money] to countries like the United States rather than keeping it in their own countries,” former Fed governor Frederic Mishkin told the FCIC. “The system was awash with liquidity, which helped lower long-term interest rates.”  Foreign investors sought other high-grade debt almost as safe as Treasuries and GSE securities but with a slightly higher return. They found the triple-A assets pour- ing from the Wall Street mortgage securitization machine. As overseas demand drove up prices for securitized debt, it “created an irresistible profit opportunity for the U.S. financial system: to engineer ‘quasi’ safe debt instruments by bundling riskier assets and selling the senior tranches,” Pierre-Olivier Gourinchas, an economist at the Uni- versity of California, Berkeley, told the FCIC.  Paul Krugman, an economist at Princeton University, told the FCIC, “It’s hard to envisage us having had this crisis without considering international monetary capital movements. The U.S. housing bubble was financed by large capital inflows. So were Spanish and Irish and Baltic bubbles. It’s a combination of, in the narrow sense, of a less regulated financial system and a world that was increasingly wide open for big international capital movements.”  It was an ocean of money. MORTGAGES: “A GOOD LOAN ” The refinancing boom was over, but originators still needed mortgages to sell to the Street. They needed new products that, as prices kept rising, could make expensive homes more affordable to still-eager borrowers. The solution was riskier, more ag- gressive, mortgage products that brought higher yields for investors but correspond- ingly greater risks for borrowers. “Holding a subprime loan has become something of a high-stakes wager,” the Center for Responsible Lending warned in .  Subprime mortgages rose from  of mortgage originations in  to  in .  About  of subprime borrowers used hybrid adjustable-rate mortgages (ARMs) such as /s and /s—mortgages whose low “teaser” rate lasts for the first two or three years, and then adjusts periodically thereafter.  Prime borrowers also used more alternative mortgages. The dollar volume of Alt-A securitization rose almost  from  to .  In general, these loans made borrowers’ monthly mortgage payments on ever more expensive homes affordable—at least initially. Pop- ular Alt-A products included interest-only mortgages and payment-option ARMs. Option ARMs let borrowers pick their payment each month, including payments that actually increased the principal—any shortfall on the interest payment was added to the principal, something called negative amortization. If the balance got large enough, the loan would convert to a fixed-rate mortgage, increasing the monthly payment—perhaps dramatically. Option ARMs rose from  of mortgages in  to  in .  CHRG-111hhrg56766--183 Mr. Bernanke," I think one thing that would help would be just the general improvement in the economy, and that is one reason why the Federal Reserve has been using accommodative policies. And some of the ideas you have just raised about reducing uncertainty and trying to stimulate growth, those are the kinds of things that would lead back to having people go to the mall or having people be employed and housed in an office building. So that is one, obviously, direct way. I don't have another good suggestion for you, but I would be happy to talk to you about it. Mr. Moore of Kansas. Thank you so much, Mr. Chairman. I yield back my time. " FOMC20070131meeting--281 279,MS. BIES.," Thank you, Mr. Chairman. I favor keeping rates unchanged today, and I favor the language in alternative B in all the sections. Trying to be cautious, looking at the numbers that just came out, and reflecting back to yesterday’s discussion about the NAIRU, last night I looked some more at the exhibit 5 that the staff presented yesterday. I looked at the bottom right panel, which shows the labor force participation rate of those over 62. There are a lot of us baby boomers, and we’re generally healthy folks, and it really is unclear what we’re going to do. The baby boomers have changed participation in the labor force throughout our generation. We were the generation that brought women into the labor force. We now are going to live twenty years after age 65, and we’re not going to sit idle because we’re going to be healthier and we have a lot of skills. The additional skill set that we have could actually mitigate the shortage of some skilled workers. Folks probably want more flexibility. They don’t want to be on a payroll, but they may want to take a job now and then or work on a contract. Whatever historical NAIRU patterns we have, they are going to be tested by the changing labor force participation due to the baby boomers. That’s a big unknown, but it clearly affects potential growth, the output gap, and inflation pressures. So I really don’t want to signal anything. This will play out over a long period, but it is the reason, when I look at the “Lower NAIRU” alternative scenario in the Greenbook, that I read it as “higher participation rate,” and I want to be cautious. That’s why I can’t go to alternative C. I don’t want to signal as much worry about inflation. I also want to be careful that we don’t go as strong as calling something “rebounding” because I don’t want people to think we’re going to go back to mid-3 percent growth rates with housing still as soft as it is on a sustained basis. We do still need to watch housing. The strong job market will put legs under the growth side of this, and I like the changes that were made in section 2. I think firmer growth is exactly what we want to talk about, so I like the tone that we’ve set in the changes in B." FOMC20080805meeting--82 80,VICE CHAIRMAN GEITHNER.," I was just going to say this. I think that you can do crude estimates of likely total losses across the U.S. economy and credit markets in a scenario like the baseline scenario in the Greenbook, and if you use Nellie Liang's study or the stuff done in New York, there's a huge amount ahead still. Even though financial market prices now reflect an expectation for house-price declines that are not significantly more optimistic than David's baseline scenario, I don't think you can say with confidence now that financial institutions have already provisioned for or written down losses to accommodate that. Because the trajectory of house prices will depend in part on financial behavior--the availability of credit--as financial institutions catch up and adjust to that and adjust capital and asset growth, et cetera, there is some risk that you'll push that expected path of house prices down further from where it is. So if institutions have to prepare for the possibility that you're going to have a much weaker economic outcome because there's some probability around that, then there's a risk that they will produce that outcome through the combined effects of their behavior, which is why we're living with such a delicate balance. " CHRG-111shrg56262--40 Mr. Miller," That is certainly part of it. Senator Bunning. Are all of you familiar with the 1994 law that the Congress passed giving the Federal Reserve the jurisdiction over all banks making mortgages and also the mortgage brokers that were making mortgages? They were empowered with oversight--the Federal Reserve was--to see that they were doing their job. In other words, they were watching the store. And it was exactly 14 years from the day that we passed that bill that the first regulation was written, and that was 2 years into Chairman Bernanke's oversight, the first regulations were promulgated on mortgages. So we went 14 years without a regulation. Would someone like to comment on that? Ms. McCoy. Senator, I am very familiar with that history. Senator Bunning. OK. Ms. McCoy. I am actually writing a book on it. [Laughter.] Senator Bunning. I have spoken enough to write a book on it, so---- [Laughter.] Ms. McCoy. I was on the Consumer Advisory Council for the Federal Reserve from 2002 to 2004. We begged the Federal Reserve to exercise that power. We were aware of the burgeoning problems with the subprime market at that time, and I was privately told by Governor Gramlich that he very much supported that rule, but it would never fly with the Board. Senator Bunning. Oh, really? Ms. McCoy. Yes. Senator Bunning. Well, it is funny, but the Congress of the United States gave that power to the Federal Reserve and expected them to completely fulfill their obligation in oversight of the mortgage market, whether it be the bank or whether it be the mortgage broker. Ms. McCoy. When we would talk to Federal Reserve staff during that time period, we were told that we only had anecdotes to offer, that we could not produce proof of a deleterious effect on the macroeconomy, and that, therefore, the Board would not take action. Senator Bunning. Well, I can tell you when Chairman Greenspan and Chairman Bernanke came before this Banking Committee as a whole, they were all warned about it, especially early in the early 2000s, that we were getting ourselves into a potential bubble situation like we did in the dot-com bubble, and we couldn't get action out of the Federal Reserve. I am just wondering if anybody here was aware of that. No one here was aware that the Fed had that power except the person who was in direct contact with the Federal Reserve? Ms. McCoy. Yes. Senator Bunning. OK. Thank you very much. " CHRG-111shrg57321--171 Mr. McDaniel," That is exactly why we were raising the credit protection levels associated with the highly-rated securities. I acknowledge they proved to be insufficient upward adjustments in credit protection. Those adjustments were overwhelmed by the actual performance of the mortgages that were created in the 2006-2007 period. Senator Kaufman. Ms. Corbet, does that agree with some of your position? Ms. Corbet. Yes. In fact, Standard and Poor's was reporting on what they saw was the increasing risks of the housing bubble, and throughout the course of 2004, 2005, through 2007, those analyses and research vis-a-vis publications and teleconferences were provided to the market, as well as what the expected impact might be on subprime mortgages. Senator Kaufman. But you must admit, and I understand and I have understood for a long time that what most people think is AAA and most people think is what you do is not what you do, but it is fair to say that if you are sending out all kinds of advisories and putting all kinds of prints, but the AAAs are still rolling off the assembly line, that is really what affects investors, right? I mean, we have a problem here, but by the way, I am just going to send another group of AAAs down the old pike. And the argument is kind of like, well, historically, we really did well. This never happened before. But you had to have some kind of seeing that there is a dark cloud on the horizon, and you didn't see those in the corporation. You get up every day kind of thinking about it. How am I going to make this work? How am I going to protect my brand? How am I going to make money? How am I going to make all this work? And, Ms. Corbet, I know you don't take any part in doing the ratings, but was there any--I mean, did either of you feel a little bit uncomfortable? Did you get up in the morning and say, we are still rating these things AAA and it doesn't look good, Mr. McDaniel? Let me put it this way, when did it hit you that maybe we ought to really take a hard look at what we are rating AAA, not what we are sending out, not that we are setting up credit backup, but what we are actually--RMBSes that we are rating AAA? About when did you start feeling, there is a problem here and I am the CEO. I am going to have to address that. " CHRG-111shrg54533--9 Chairman Dodd," Well, I appreciate the answer to that. Let me go to the issue--and, again, I want to state--I think all of us have had a chance to talk about this, and obviously the debate about, one, whether or not you want a systemic risk regulator, which I certainly do, and then the question who does it and what authorities do you give them. From my standpoint, I am open on the issue. I have not made up my own mind what is the best alternative. Obviously, you have submitted a plan that gives that authority to the Fed. But let me raise some questions that have been raised by others about the wisdom of that move to the Fed and not looking at the more collegial approach or some other alternative. A fellow by the name of Mark Williams, a professor of finance and economics at Boston University and a former Fed examiner, said the following: ``Giving the Fed more responsibility at this point''--and he had a rather amusing analogy--``is like a parent giving his son a bigger, faster car right after he crashed the family station wagon.'' SEC former Chairman Richard Breeden testified before this Committee, and he said the following: ``The Fed has always worried about systemic risk. I remember in 1982 and 1985 the Fed talking about that it worried about systemic risk. They have been doing that, and still we had a global banking crisis. The problems like the housing bubble, the massive leverage in the banks, the shaky lending practices, and subprime mortgages, those things were not hidden. They were in plain sight.'' And perhaps most significantly, Chairman Volcker in response to a question by Richard Shelby back in February in a hearing we had in this Committee testified that he had concerns about giving the Fed too many responsibilities that would undermine their ability to conduct monetary policy. So the question that many are asking, not just myself but others on this Committee and elsewhere, is: Given the concerns that have been expressed by the former Chairman of the Federal Reserve, the former Chairman of the SEC, and others about the Fed's track record as well as the multiple responsibilities that the Fed already has, why is it your judgment that the Fed should be given this additional extraordinary authority and power? And does it not conflict in many ways or could it not conflict with their fundamental responsibility of conducting monetary policy? " FinancialCrisisInquiry--188 The only reason for these products to have been mass marketed to consumers was for Wall Street, lenders, and brokers to make a huge profit by selling, flipping, and securitizing large numbers of unsustainable mortgages. And the bank regulators who, as many have talked about today, had ample warning about the dangers posed by these loans, either were asleep at the switch or actively encouraging this high-profit, high-risk lending. The impact of foreclosures has been particularly hard on African American and Latino communities. This crisis has widened the already sizable wealth gap between whites and minorities in this country and has wiped out the asset base of entire neighborhoods. The foreclosure crisis was not caused by greedy or risky borrowers. The average subprime loan amount nationally was just over $200,000 and is much lower if you exclude the highest priced markets such as California. A majority of subprime borrowers had credit scores that would qualify them for prime loans with much better terms, and researchers have found that abusive loan terms such as exploding rates and prepayment penalties created an elevated risk of foreclosure even after controlling for differences in borrowers’ credit scores. It’s also not the case that widespread unemployment is in and of itself the reason for the spread of this crisis to the prime market. For the past 30 years, foreclosure rates remained essentially flat during periods of high unemployment because people who lost their jobs could sell their homes or tap into home equity to tide them over. Unemployment is now triggering an unprecedented number of home losses because loan flipping and the housing bubble have left so many families underwater. Most important, it’s crucial to put to rest any idea that the crisis was caused by efforts to extend home ownership opportunities to traditionally underserved communities. Many financial institutions, our own included, have long lent safely and successfully to these communities without experiencing outsize losses. Legal requirements such as those embodied in the CRA had been in effect for more than two decades with no ill effect before the increase in risky subprime loans, and fully 94 percent of all subprime loans were not covered by the CRA. FOMC20070321meeting--81 79,MR. FISHER.," Mr. Chairman, I was reminded the other day that the original story of Goldilocks was not quite as we later came to learn it. The first version that was drafted was actually called Silver Hair. When the three bears came back to the house, the elderly lady, not the little girl, jumped out the window. That was the beginning of the Goldilocks story, which was later adapted to a more palatable commercial story. [Laughter] I’m not ready to jump out the window yet, but I do have some concerns, and I’d like to talk about three areas—the international side, where the porridge seems to be hot; the domestic economy, where it seems to be cooling; and in my District, where it seems to be just about right. So, first, on the international side, just to complement some of Karen’s points, our research and anecdotal findings show that global capacity utilization has moved to the higher end of its range. World unemployment rates have been falling. Capacity expansion seems to be underpaced, even though there is some structural change in utilization, and it seems insufficient to meet demand or quell inflation. Prices for imported U.S. goods have clearly moved away from deflationary trends to neutral or slightly inflationary, as I reported before—and, by the way, across nearly all product categories. The growing tightness in the market for skilled foreign labor may be the contributing factor. A very large foreign retailer operating in China reports that they are seeing wage price inflation for the first time in the stores that they are opening and operating. As one of the high-tech CEOs mentioned to me earlier, even the Indians that they now import, not by bringing them physically across but by fiber optic cable, are being priced much more expensively. If you add turnover, these workers have become increasingly expensive. We see pressure from the shippers, noting that there are continued upward pressures on fleet utilization, spot prices, and port congestion. Airlines are reporting stronger international loads and price traction than in the United States. Express shippers and logistic companies are reporting double-digit growth in the year to date in Europe and still higher rates of growth in Asia. So, on balance, our view from the Dallas Fed from the international perspective is that international data and anecdotal evidence point to some excess demand outside the United States with concomitant increases in price pressures. Turning to the domestic scene, we appear to be sailing between the Charybdis of a slowdown in the economy and the Scylla of higher inflation. I want to talk about both. We’re both measuring and hearing of greater fragility in the domestic economy relating to economic growth and the kind of excess that is leading to the financial turbulence that Janet spoke about. I’ll turn to that in a second. Also, we’re not encouraged, despite our wishful thinking, on the inflationary front. Let me just give you some points other than those that have already been mentioned, particularly other than capital spending, which we see slowing across the nation. Express shippers, logistic companies, report 0.2 percent growth year over year for domestic ground operations and weaker-than-expected overall growth, between 0 and 0.5 percent on balance in the year to date—substantially less than they expected. Rail car loadings are flat to down, reflecting the decline in demand for materials for housing and a decline in durable goods orders. Truck tonnage is off, and orders for replacement of fleets seem to be reflecting more than the effect of these new engine regulations that are going into place. I’ll give you one data point mentioned: Peterbilt’s order book is one-third of what it was last year. Airlines report weaker domestic booking and slackening demand relative to last year. With regard to the retailers, I have been urged to be cautious in analyzing the data, first because last year was in essence a fifty-three-week year because of the late holiday or a thirteen-month year due to gift cards. Our contacts report continued strength for high-end retailers, 3 to 6 percent unit growth in the first quarter for middle retailers like Kohl’s and JCPenney, and significantly lower growth rates with companies like Wal-Mart praying that the advancement of daylight savings time will lift them from flat growth to 1 to 2 percent comps. Finally, restaurants report continued movement down the food chain—no pun intended—[laughter] from the middle-income eateries to the McDonald’s of the world. If you notice McDonald’s reports, they are quite stout, whereas the middle-income eateries are suffering. In short, we expect slower top-line growth across the board. I want to talk for a minute about housing. One of my contacts at Wal-Mart mentioned that, when they recently surveyed their customers, concerns about housing did not even rank in the top ten of consumers’ concerns. Despite that, a large housebuilder, whom I mentioned in previous conversations around this table, says that they have gone from monsoons to scattered thunderstorms, and another reports a decline in the need to grant concessions. Yet both are concerned about subprime and alt-A “infection,” as one called it. Going back to our previous conversation, one of the builders, whose average home price exceeds $300,000, has through thorough analysis just discovered that 40 percent of last year’s builds were financed by alt-A mortgages. If you look at the security analysis for that particular company, the best guesstimate is 20 percent. So, being from the Clinton Administration, I’m a bit worried; I’m getting to the point where “don’t ask, don’t tell” may be the best approach to interviewing some of these homebuilders. Clearly, they are concerned. They have an overstock of inventory, and they’re beginning to cut back significantly on activity. If you remember, David, originally I did talk about a 25 percent peak-to-trough correction when you were not quite at that number. Now I’ve caught up with you. I’m at 40 percent at a minimum and quite concerned about it. I’m also concerned about what President Yellen referred to as a possibility for a retrenchment in the credit markets. I point, as others have done, to the significant oversupply of private-equity capital. To give you a specific example, in the case of Texas Utilities, between a Friday and a Wednesday, the two principal investors lined up $2.5 billion apiece, another billion from five other equity investors, and in the end over $50 billion of committed capital from the banks in a two-day lineup period, only half of which was used. So, Mr. Chairman, in short, in the domestic economy, I’m concerned that the tail in terms of a recession has not become slimmer as I mentioned last time. I would redact those words. I believe it has become fatter, and I believe that financial market turbulence has a potential to become greater. As to the Scylla of inflation, I keep telling myself, David, that with the passage of time we’ll see improvement, that one month’s set of numbers such as we had in December does not a trend make. I tell myself that two months’ numbers, like those we saw in December and January, do not a trend make. But the numbers are less than comforting. On a six-month basis through January, both our trimmed mean at the Dallas Federal Reserve Bank and your PCE excluding food and energy are stuck at 2.1 percent. On a twelve-month basis, the trimmed mean was stuck at 2.5 percent, and your PCE excluding food and energy was 2.3 percent. The recent CPI report was hardly encouraging. Sixty-eight percent of the components rose 3 percent or more. To be sure, there are tamer OER readings, but they’re being offset by a pickup in core goods inflation. I continue to worry about the political effect of this kind of inflationary run. I note yesterday’s headline in the Christian Science Monitor stating that “inflation is eating up U.S. wage gains.” On the regional side, what I’ve reported above is reflected to some extent in the Eleventh District. Growth has slowed, but housing prices are stable, and housing inventories are thus far healthy. Yet we continue to experience significant wage price pressures. Our dynamics are much stronger than those of the rest of the nation. One of the credit card companies reports that sales using their cards in our region were up 10.5 percent year over year through February, versus 1 to 4 percent on the eastern and western seaboards. In short, Mr. Chairman, I see geographic dispersion in the growth patterns—strong growth overseas, relatively strong growth in our District, and a developing worrisome growth scenario for the rest of the United States. We see less abatement of inflation than we had hoped for. With regard to preparing for tomorrow’s discussion about what to do about it, I find myself on the horns of a dilemma. I would say that the risks are more evenly balanced, and yet the tail of less growth and the risk of recession and the other tail of awfully stubborn inflation have fattened and not trimmed. Thank you." FOMC20061212meeting--92 90,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. Our forecast hasn’t changed much since the last meeting. We still expect growth to move back to potential in the first half of next year and to stay in the vicinity of potential, which we think is around 3 percent, over the forecast period. We expect inflation, as measured by the core PCE index, to fall to just under 2 percent by the end of ’08. Our view of the outlook differs from the Greenbook in two respects, as it has over the past few cycles. We have a higher estimate of potential growth, with the difference due to higher estimates of labor force growth, and we expect more moderation in inflation than the Greenbook does, principally because we believe there is less inertia, less persistence in inflation in the United States than does the staff. Both these issues, of course, deserve continued analysis and attention by the Committee. These differences in our forecast relative to the Greenbook don’t extend to the policy assumption. Both outlooks are predicated on a likely path of the fed funds rate that’s nearly flat over the next several quarters. This path, of course, is above the one currently reflected in financial markets. Of course, although some disagreement between our view and the market’s view is not unusual, the size of this gap is significant enough to warrant some attention. It’s hard to know, however, what the source of the difference is and, therefore, what the implications are for what we do in terms of policy. The risks to the forecast may have shifted somewhat in the direction of less upside risk to inflation and more downside risk to growth. But to us, the current weakness in the economy still seems principally to stem from the direct effects of the slowdown in housing on construction activity and related parts of the manufacturing sector as well as from the reduction in automobile and auto-related production. As things now stand, the softer-than-expected recent numbers don’t argue, in our view, for a substantial reassessment of the risks in the outlook. Surveys of business sentiment outside the manufacturing sector still seem consistent with reasonable growth going forward. A slowdown of investment in equipment and software doesn’t seem to be particularly troubling to us at this point. Consumer spending seems to be growing at a fairly good pace. Employment growth, of course, is still quite solid, and growth outside the United States still looks pretty good. We think the fundamentals of the expansion going forward still look good, with strong household income growth even after the lagged effects of the recent downward revisions, productivity growth in the range of 2½ percent for the nonfinancial corporate sector, and strong corporate balance sheets in the United States, and prospects for continued expansion outside the United States. Our recent financial market data don’t, in my view, provide a convincing case for a substantial increase in the probability of a much weaker path for growth going forward. Although the yield curve is inverted and long rates continue to drift down, staff research and other indicators suggest that part of that is due to a decline in term premiums, and forward rates seem to be coming down around the world still. This gradual reduction in term premiums and forward real rates globally suggests that what we’re seeing in the long-term interest rates in the United States may not be principally a sign that confidence in the U.S. growth outlook has deteriorated. It’s not clear even 18 months after the conundrum first emerged whether equilibrium rates globally have really moved substantially lower. The Bluebook estimate suggests we’re still within most estimates of equilibrium real rates in the United States. Equity prices and credit spreads are consistent with the view of sustained expansion going forward. All this seems to reinforce the case for the judgment that we have not yet induced overly restrictive financial conditions. We still face considerable uncertainty about the outlook for growth and the familiar sources of downside risk, but to us these still seem to rest mainly with the possibility that a more-acute and protracted fall in housing activity and prices will cause a significant deceleration in housing and household spending and ultimately business spending. The nature of these risks, however, hasn’t changed in our view, and the probability that the risks will materialize may have risen a bit but not much. On balance, this situation should reduce the probability that we’ll have to tighten further, but it doesn’t seem to suggest that today we need to induce a further easing in overall financial conditions. On the inflation front, we confront the familiar mix of underlying inflation still at uncomfortably high levels and considerable uncertainty about whether we’ll see enough moderation soon enough to keep expectations stable at reasonable levels. The remaining inflation risks, in other words, are about whether we get enough moderation. In the absence of a dramatically different outcome for the dollar and energy prices than what’s in the forecast, we don’t see much risk of inflation accelerating from current levels or remaining stuck at current levels. We haven’t had much evidence to justify a significant change in the expected path of inflation or in the risks of that forecast. The news on unit labor costs may be a bit reassuring. Surveys seem to suggest some evidence of diminishing pricing power, which might imply that margins will adjust downward to absorb future rises in labor compensation. The odds of an early return to above-trend growth seem to have receded a bit. Most of the alternative measures of underlying inflation that many of us look at seem to have moderated a bit after the sustained earlier period of acceleration. Inflation expectations derived from TIPS have eased a bit. These pieces of information are somewhat comforting, but they don’t change the fact that our expectation that we’ll achieve the desired moderation in inflation without further tightening of monetary policy remains just that. It is an expectation or a hope; it is not yet reality. Thank you." FOMC20050630meeting--361 359,MS. MINEHAN.," Thank you, Mr. Chairman. New England continues to expand but probably more slowly than the nation. At our last meeting, I spoke of a couple of bumps along the road to a stronger regional economy. Those bumps remain—in particular, rising concerns about slow job growth, rapidly growing input costs, the strength of demand, and the availability of skilled June 29-30, 2005 121 of 234 Moreover, with the base realignment and closure (BRAC) proposals by the Pentagon now public, there are clear challenges to be faced in both Connecticut and Maine, which together bear about half of the related job losses for the whole nation. While there will be extensive efforts in Washington by New England legislators to modify the BRAC results through the work of the BRAC Commission, judging by the outcome of the last four rounds of base closures, little will change. This will be particularly difficult for Maine, with its smaller and less differentiated economy. And I expect the news of the MBNA/Bank of America merger won’t go over well in Maine either. So it’s not hard to see why the general tone in New England seems a bit on the soft side. Employment in our District is growing but at a slower pace in May than in the three previous months. Unemployment has edged up, and most other indicators of economic health show only modest growth. Indeed, business confidence has trended down sharply, and commercial real estate markets remain sluggish across the region. Regional manufacturers—those contacted for the Beige Book, those who sit on our New England Advisory Council, or those who participate in our economic forums—are for the most part experiencing rising demand and volume growth. But they view increases in costs as a particular impediment. They see the costs of raw materials of all sorts, including energy and transport, as problems. And they believe passing on such costs is difficult, except when they have unique or technologically advanced products. Many talked about margin pressures and, as compared to the last several meetings, fewer talked about pricing power. Perhaps this is because energy surcharges already have been implemented and accepted but other pricing changes are proving more difficult. Health care costs are a concern as well. And the rising costs—or unavailability of—necessary June 29-30, 2005 122 of 234 To end the regional discussion on a little more positive note, there are industries that are clearly doing well. As a generic category, the leisure and hospitality industry is growing. Tourism is solid and hotel margins are good. Retailers are more optimistic as well, though the wet weather in May dampened sales [laughter] and caused inventory levels to rise. Many software companies are facing good demand for their products, and business service firms say that job markets are tightening, especially for technology workers. And I’d have to say that in my 11 years of reading the notes on Beige Book discussions, I’ve never seen a description of the business outlook quite like the one I read in our recent notes, which was, I quote, “Crazy, busting at the seams.” That was the case for one very large regional producer of aircraft integrated systems. For this company, demand from the airlines for retrofits and for fuel management and diagnostic systems has taken off, literally. [Laughter] So, not everything is growing slowly in New England. Turning to the national scene, there is clear evidence that the economic softening we noted at the last meeting has reversed course, at least partially. The so-called soft patch in the first quarter is in the process of being revised away with the changes to net exports and inventory levels. And while the second quarter will suffer some from the unwinding of auto inventories, there does seem to be a solid pattern of underlying growth. Looking further ahead, there is very little difference between our forecast in Boston and that in the Greenbook. Through late ’05 and into ’06, we continue to see an evolving handoff from policy-stimulated, consumer-led growth to a solid pace of underlying demand led by increased business spending that is being driven by relatively sound fundamentals. Incoming data, while June 29-30, 2005 123 of 234 We, like the Greenbook, see four-quarter growth rates in both 2005 and 2006 in the mid- threes, unemployment close to the staff’s estimate of full employment, and both core CPI and core PCE edging downward. This isn’t terribly different from our outlook at the previous meeting. But while some aspects of the earlier soft patch have gone away, new or perhaps more sharply drawn risks have emerged. In particular, oil prices continue to surprise on the upside. This could both dampen growth and contribute more to inflation than we currently expect. The baseline forecast sees inflation moderating over the next year and a half, but that assumes that oil prices flatten and don’t continue their upward climb. By the end of the forecast period, some slack remains, but there are risks on the upside that resource pressures could occur sooner. Indeed, some compensation measures may be hinting at this, and slowing productivity could also contribute. Risks exist on the downside as well, in particular that the drag of higher energy prices will slow worldwide growth even further, working to create greater slack here in the United States. The other major area of risk, as I see it, involves a wide array of asset and financial variables. We’ve discussed whether there is a housing bubble or just symptoms of froth in some markets. While much of the rise in house prices can be explained by rising incomes and demographics, low interest rates clearly have been a contributing factor. They have also contributed to what most market practitioners view as a sense of reaching for risk in markets and to relatively narrow credit spreads. The complications of some of the newer, more intricate, and untested credit default instruments caused a bit of market turmoil recently. This was far from a systemic event, but it does I think illustrate the fact that nasty surprises can occur when markets overdo. I found the papers prepared by Vincent and his colleagues on the conundrum of low 10-year June 29-30, 2005 124 of 234 more credence in the low 10-year yield as a signal of increased financial ease rather than potential economic weakness. But the case for both interpretations I thought was well made. For both these major risks—rising oil prices and excesses in asset and financial markets— there are possible downside effects on growth and upside effects on inflation and market volatility. So how should policy react? Or, more pointedly, when should we pause from our “measured pace” to assess where things are? Given the Greenbook forecast and reasonable assumptions about remaining slack, one could look at the downside risks and say that a pause should occur sooner rather than later. But one could also look at the upside risks and decide a pause should come at a later point. Frankly, I think the latter course is less costly. That is, if we err on the side of tighter policy, easing can be done quickly if it’s necessary—and at little relative cost. Higher rates, if approached sensibly and cautiously, will help to wring out of the system some excesses and protect against unexpected surges in inflation. If we stay too accommodative for too long, then the price of correction in terms of economic growth may well be higher. But, really, pausing is not the question for today. I think our best course of action should be to repeat what we’ve done over the last several meetings and move the funds rate up. I know we’ll have more to say later about the language in the statement, but for now let me emphasize once again that I think saying what we did and why we did it should be enough. I know there will be no desire to change the statement in any fundamental way until we take a pause or decide to move faster. That may be wise, and it has worked pretty well so far. But I continue to believe that there is a risk in continuing to imply that we know more than we do about what the future course of policy will need to be. June 29-30, 2005 125 of 234" FOMC20060328meeting--37 35,MR. STOCKTON.," Thank you, Mr. Chairman. I thought that I would address three related questions in my remarks this afternoon. First, how much momentum is there in current economic activity? Second, how close is the Committee to having put in place sufficient restraint to prevent output from overshooting its potential, with attendant consequences for inflation? And finally, how do we view the current state of resource utilization, and what are the implications of that assessment for the inflation outlook? Let me turn first to the question of momentum. At the last FOMC meeting, I indicated that the staff was in a state of denial concerning the meager 1 percent rate of increase in real GDP that the BEA had just published as their advance estimate for the fourth quarter of last year. We were skeptical that the growth of output had actually been that weak, and we thought that growth, to the extent it had been soft, would bounce back sharply in the current quarter. I am relieved to report that subsequent developments appear to have supported that interpretation. We now estimate that growth of real GDP was about 1¾ percent at an annual rate in the fourth quarter— noticeably above the advance reading and about halfway back to our January Greenbook projection. Moreover, activity appears to be snapping back in the current quarter. We estimate that real output is growing at a pace of more than 4½ percent this quarter. Although, in broad strokes, those developments paint a picture close to that which we envisioned in January, we have had our share of surprises to contend with. Most notably, consumer spending and business spending have been considerably stronger than we had projected. Real PCE is projected to have advanced at an annual rate of 5¼ percent this quarter. Some of that strength reflects a bounceback in motor vehicle purchases. But even setting that aside, real PCE appears on track for a 4¼ percent increase in the current quarter, nearly a percentage point faster than we had projected in the January Greenbook. In the business sector, we are projecting an increase in real outlays for equipment and software of nearly 15 percent at an annual rate in the first quarter. Like consumer outlays, real spending for E&S has been boosted by motor vehicle sales this quarter, and it has received a further bump-up from a recovery in aircraft deliveries. But even abstracting from the jump in spending on transportation equipment, real E&S is expected to increase at a 10 percent annual rate in the current quarter, nearly 3 percentage points faster than we had previously projected. Our surprises have also extended beyond the spending data. Gains in private payroll employment were revised up in the fourth quarter and averaged about 200,000 per month in January and February—a bit above our expectation. Those job gains, coupled with a higher-than-expected workweek, raised the growth in hours worked in the current quarter to more than 3 percent at an annual rate, nearly 2 percentage points faster than we had anticipated in January. The readings on manufacturing industrial production have also exceeded our expectations. Factory output is now estimated to have increased at a 9 percent annual rate in the fourth quarter and is projected to increase at a 6 percent rate in the current quarter; those increases are, respectively, 1 percentage point and ½ percentage point greater than we had written down in January. This rather lengthy litany might suggest that the answer to the first question that I posed should be that there is a great deal more momentum to activity than we had earlier expected. But, in fact, for two reasons, I’d characterize the situation as one in which we perceive just a little more momentum. First, we have had some downside surprises as well upside ones. For example, construction activity in the business sector and by state and local governments has fallen short of our expectations. The biggest downside surprise, however, has come from the external sector, where a surge in imports in the first quarter suggests that some of the additional strength in domestic spending was met by foreign rather than domestic producers. A second reason for not interpreting all the recent strength as added momentum is that we can already see evidence, admittedly tentative, that some of the strength in the first quarter will be transitory. For one, the jump in federal spending in the first quarter mostly reflects a rebound from a low level of outlays in the fourth quarter, and given this year’s federal budget, real purchases should only edge up over the remainder of the year. In addition, some of the strength in the current quarter reflects the effects of favorable weather in January and February on housing construction. And, finally, the data on retail sales, shipments of capital goods, and industrial production suggest that most of the impetus to rapid first-quarter growth in these areas occurred early in the quarter; recent readings have been more subdued. A bit more momentum in private domestic demands, coupled with higher prices for equities and houses and lower prices for imported crude oil, led us to revise up the growth of real GDP by a tenth both this year and next. But these are really just minor tweaks to an outlook that is much the same as it was seven weeks ago. If our forecast for the current quarter is close to the mark, the growth of real GDP over the past four quarters will have been 3½ percent—about the same pace that we have averaged over the past two years. To me, that seems like a very reasonable estimate of the current underlying pace of the expansion. The gradual decline in the unemployment rate and the rise in capacity utilization over the past year suggest that this pace has been above the sustainable trend rate of growth, but just by a little. That assessment helps to explain our answer to the question of how much more restraint will be necessary to head off the inflation pressures that could follow from a serious overshooting by output of its potential. Our answer is not much more restraint—in part because we don=t think that the pace of activity will, in fact, need to slow much. We are assuming that the funds rate is raised to 5 percent by May and then is held at that level through the middle of next year. In our view, that will be sufficient to slow the growth of real GDP from its current pace of 3½ percent to a 3 percent rate next year and to tip inflation down. As growth slows slightly below potential and core inflation edges down, the federal funds rate is assumed to be lowered a bit in the middle of next year. As has been the case for some time, housing is central to our forecast of some modest deceleration of activity. Residential investment has been contributing about ½ percentage point to the growth of real GDP over the past few years. So a flattening out of activity in this sector would, by itself, be sufficient to bring about the necessary slowing in aggregate production. And, roughly speaking, that is what we are forecasting. A few months ago, the deceleration in housing activity that we were projecting was not yet evident in the data. But since then, the data have been providing increasing support for our view that housing is in the process of softening. On net, both new and existing home sales have retreated from last summer’s peaks, household sentiment toward homebuying has turned down, and builder attitudes have deteriorated. Even house-price appreciation appears to have slowed in recent quarters—to be sure, not quite as much as we thought it would, but at least it now seems to be moving in the anticipated direction. About the only housing indicator not signaling some softening is the starts figures themselves. However, as I noted earlier, we think that starts were boosted considerably by favorable weather in January and February, and building permits, which are less affected by weather, are pointing to some fallback in starts in the months ahead. I’m tempted to chalk this situation up as a victory for the staff projection, where victory is defined as any aspect of our forecast not immediately contradicted by the data. But I’m afraid that there is still plenty of scope for surprise in the housing sector. Last week=s reports for February showing an increase in existing home sales and a decline in new home sales certainly highlight contrasting risks. And although we have been encouraged by the recent slowing in home prices, those data hardly confirm that a deceleration in house prices is under way. Nor, for that matter, do they rule out that we are at the front edge of a more abrupt collapse in prices. Right now, it feels a bit like riding a roller coaster with one’s eyes shut. We sense that we=re going over the top, but we just don’t know what lies below. It is, of course, an oversimplification to suggest that housing is the only risk to achieving our forecast of a slowdown with only a minimal amount of additional tightening. But housing is prominent because we are forecasting it to break from its steady uptrend of the past few years. In contrast, the growth of consumption and the growth of business fixed investment are projected to slow only a bit between 2006 and 2007 and to remain on solid upward trajectories. Growth in real PCE is projected to average about 3½ percent over the forecast period. Higher interest rates and waning wealth effects from earlier increases in equity and house prices should act to damp the growth in consumer spending. But a pickup in the growth of labor income and a diminishing drag from higher energy prices on the growth of purchasing power nearly offset those influences. In the business sector, the growth of fixed investment is projected to average about 6½ percent over the forecast period. It slows a bit in response to the deceleration of output and final sales. But a low cost of capital and healthy balance sheets should provide support to equipment spending; declining vacancy rates and ongoing gains in employment are expected to lift office construction; and high energy prices should provide some continuing stimulus to drilling activity. So housing takes center stage in our projected slowing in aggregate activity, and consumption and investment play small supporting roles. We expect the growth of real GDP by early next year to run about 3 percent, a bit less than our estimate of the growth of potential output. Consequently, by the end of the forecast period, the unemployment rate edges back up toward 5 percent, our estimate of the NAIRU. This brings me to the third question: How do we assess the current state of resource utilization? In setting our forecast, we are required to take a stand on a point estimate for the NAIRU and potential output. But we recognize, as I’m sure you do, that we are being forced to split hairs here. In reality, the confidence interval around our estimate of the NAIRU is very wide. A 70 percent confidence interval is roughly plus or minus ¾ percentage point, and a 90 percent confidence interval is about plus or minus 1 percentage point. Moreover, Board staff members have done considerable research that highlights just how tentative real-time estimates of the NAIRU and potential output can be. At this point, all we can say is that you are well within a wide zone of uncertainty as to whether the economy is approaching, has reached, or has already overshot the NAIRU. Some recent developments could be read as pointing to greater slack than we are currently estimating. The relatively small gains in the employment cost index (ECI) over the past couple of years have been well below that expected by our models, offering the strongest evidence in favor of a lower NAIRU. Other wage and price measures, however, offer a more mixed assessment. Hourly labor compensation, as measured in the national accounts, also decelerated last year to a modest pace of 3¾ percent, slower than the rate predicted by our models. But that came on the heels of a 6 percent increase in 2004 that was above the models, with the pattern between the years likely affected by some large swings in stock option exercises. On average over the two years, this measure of hourly compensation has run a bit above model predictions. As for price developments, our core PCE equations employing a 5 percent NAIRU were on track until recently. But in the last few quarters, core PCE price inflation has come in a bit below those equations. Thus far, these residuals are small. Moreover, interpreting the reasons for the recent misses is not straightforward. The misses may reflect a lower level of the NAIRU, but they could also be signaling a smaller pass-through of higher prices for energy, imports, and other commodities. And, of course, they could simply be noise. In the end, we thought that we had not accumulated enough evidence against our 5 percent NAIRU to make a change at this point, but we will certainly be monitoring this aspect of our forecast closely in the months ahead. To be sure, an overshoot of the NAIRU of modest dimensions, even if sustained over a couple of years, would likely result in only a small and gradual updrift in the underlying rate of inflation, given how flat the aggregate supply curve appears to be. Of course, the flip side to a shallow aggregate supply curve is that it would also be more costly to reverse whatever inflation might build up over that period. All told, we made only minor adjustments to our inflation forecast in this Greenbook, as neither the price data nor the major determinants of price inflation presented major surprises. On net, core PCE appears to be coming in close to our earlier expectations. However, that reflected some small offsetting errors. The nonmarket component of core PCE was higher than we had expected, whereas the market-based component was lower. Because we give a bit more weight to the high- frequency movements in the market-based measure, we are inclined to interpret recent consumer price developments as being a touch more favorable than we had expected. Projected oil prices also have been marked down, especially in the near term, reducing some pressure on business costs. Working in the other direction has been the reacceleration in the prices of materials and imported goods since last autumn, a further rise in capacity utilization, and a lower unemployment rate. Taken together, these developments caused us to trim a tenth from this year’s core PCE inflation and to add a tenth to next year’s rate, putting our projection at 2 percent this year and 1.9 percent next year. In sum, our outlook is for pretty stable inflation. I’ll conclude my remarks this afternoon by pointing out some changes that we made in the Greenbook this round, starting with our presentation of the financial assumptions. It has now been seventeen years since the fall of the Berlin Wall and fifteen years since the end of the old Soviet regime, so it didn’t seem like rushing things for the staff to engage in little glasnost ourselves. Therefore we have now laid out the details of our financial assumptions in the Greenbook. As you know, we had already been moving in that direction, and doing so seemed like a logical and useful step toward greater transparency on our part. We have also made some important changes in our construction of the alternative simulations and confidence intervals. We are now reporting only the versions of the simulations that employ the Taylor rule. This has the virtues of reducing the number of permutations that we present and of focusing on the ones that seem most relevant—that is, on the simulations in which policy begins to react to the shocks within the simulation period. To further facilitate their interpretation, we have added a chart that presents the baseline path for the funds rate, an accompanying confidence interval, and the policy paths that are generated by the Taylor rule for each of the alternative scenarios. Finally, we shortened the sample period over which we generate confidence intervals for the Greenbook forecast and those that are generated by stochastic simulations of the model. We now start those calculations in 1986, rather than in 1978. When we first started reporting these confidence intervals four years ago, we choose the longer sample on the concern that we couldn’t rule out shocks like those experienced in the 1970s. Subsequently, we have had shocks similar to those in that period, and the Great Moderation still appears to be holding. So we think a stronger argument can now be made for using the more recent period. All in all, we hope these changes make the document a little clearer and a little more useful. Karen will continue our presentation." FOMC20070321meeting--159 157,MR. MOSKOW.," Thank you, Mr. Chairman. As I mentioned yesterday, my overall assessment of the economy calls for growth to average somewhat below potential in ’07 and to improve in ’08, and I expect labor markets will remain tight with the unemployment rate staying below 5 percent. Core inflation is higher than I like. I see some forces that will help moderate inflation toward 2 percent, but I’m concerned that these will not be strong enough to push inflation below 2 percent within a reasonable time frame. So while I recognize the downside risk to growth, I still think the inflation situation poses the greater risk; and at this point, the costs of a policy mistake on inflation are greater than those of a mistake on growth. The weak growth environment does suggest that the short-term equilibrium real interest rate may be lower now; if so, then maintaining the fed funds rate at 5¼ percent may provide a bit more policy restraint and with it somewhat more impetus for reducing inflation. However, the analysis in the Bluebook suggests that this effect will be minor beyond the near term. So with the increased uncertainty over the growth outlook since our last meeting, it seems reasonable to continue to hold policy steady while we gather more information. So I do favor alternative B. Let me make some comments on the language. I agree with Cathy Minehan’s comment on section 2—of stopping the statement after the phrase “moderate pace over coming quarters.” Just put a period there. I agree with everything she said as reasons for taking out the additional language, and I would just add that, as now written, it mentions housing again. So housing is mentioned twice in that section, and I think it’s unnecessary to add those additional phrases at the end. The statement comes out much more succinct and focused if we stop it after the phrase “coming quarters.” On the question about “predominant” versus “principal,” I prefer sticking with “predominant” since it was used before in your testimony. It would be my guess that the definition is probably the same. I don’t think that’s what should determine the use. I just think it’s better if we’re consistent here, so I would have a preference for using the same language that was used in the testimony. On the “additional firming” question that Tom Hoenig raised, I have some sympathy with him on this. As the Bluebook said, it’s difficult to know how the markets will react to this change. It’s always tentative how the markets are going to react, but the Bluebook said that now the judgment is more tentative than usual as to how they’ll react to this change in the statement. I think it will reinforce the market’s anticipation of future policy ease and probably increase expectations of ease. But having said that, I think the new version does more accurately reflect our views and the views around this table. So it’s a close call, but on balance I think we ought to make the change, and I would support the language in section 4 as written." CHRG-111hhrg48875--159 The Chairman," The gentlewoman from Ohio. Ms. Kilroy. Thank you, Mr. Chairman, and thank you, Mr. Secretary, for returning here. You know, certainly we have talked a little bit about what happened last fall and whether or not things could have--what you're proposing now could have prevented what happened then. And certainly at that time, you know, I was not here. Along with other citizens, we sort of watched and listened to the issues with Lehman, the failure with Lehman, Bear Stearns, and AIG, and we saw government officials scrambling to try to prevent collapse. So, you know, what seemed to me is that Treasury at that time had no Plan B, had no preparation for what to do in that sense, and were winging it, were scrambling. So I appreciate the fact that you are engaging in this kind of process, taking a bigger picture look at it about what we need to do so that we don't get into a situation of housing bubbles and egregious credit default swaps and overleveraged institutions, and even fraud on a dramatic scale, as you said in your earlier remarks. And I certainly look forward to working with you on these issues of systemic risk and capital requirements and over-the-counter oversight, and like some of my colleagues here, take a stronger view on credit default swaps. And I also appreciate the public-private partnership that you announced with addressing the issue of toxic assets and cleaning up that mess. But I think as we heard from Mr. Klein, you know, the AIG bonus uproar did offend a sense of justice that's ingrained in the American people, that those who broke their own company, broke the system and caused such anguish and real hurt out there on Main Street, are also continuing to benefit from that. And what I think we need to hear a lot more is how this will help the taxpayer, how this will help Main Street; the car dealer, the restaurant owner, the dry cleaners, and the hardworking people here who are planning to retire and seeing their 401(k)s that they had hoped to use in a couple of years disappear. So what would you say to them, that this is going to benefit them? " Secretary Geithner," ``This'' being the program of reforms we're announcing today? Ms. Kilroy. Right. " 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." FOMC20051213meeting--88 86,MR. FERGUSON.," Thank you, Mr. Chairman. The concept of the known unknown came to the national consciousness about a year or two ago, and I sense that it’s very much in this room today. The baseline forecast calls for a very nice, soft landing to potential growth with contained inflation if we just tighten our policy one or two more turns. I’m certainly prepared to accept that forecast for the purpose of today’s meeting, but the uncertainties or the known-unknown factors around it are to me quite obvious. To me the risks are clearly to the upside with respect to growth, but surprisingly may be more balanced with respect to inflation. It is easier to see an upside growth risk than a downside one, in large part because the incoming data have been surprisingly robust, making a slowing just a quarter or two away seem a little bit of a stretch. Much of the waning wealth effect on which the baseline is built is due to a slowing in the housing market. It is true that some of the indicators suggest some moderation there, December 13, 2005 56 of 100 when lined up against the actual strength shown in home sales themselves, both existing and new— and also prices, which have continued to appreciate at a double-digit pace through the third quarter— it is hard to say that the housing market is anything but robust. A second element of the wealth effect that the Greenbook assumes is that the equity price appreciation will be no more than needed to keep the current level of the equity risk premium about stable. But again, it is easy to see some upside potential here. The equity risk premium is now above average. The recent run-up in equity prices, coupled with sustained high levels of productivity growth, an attractive profits outlook, and healthy corporate balance sheets all make it perhaps a little more likely that equity prices will rise rather than fall, and indeed, rise more than expected. If this were to occur, the earnings-price ratio would decline and the equity risk premium would return to the normal range, and in doing so would provide more equity wealth impetus to the economy than perhaps the baseline assumes. Finally, global growth is a surprise to the upside. As Dino indicated, equity prices have shown remarkable strength globally. Monetary policy itself has in many cases been somewhat stimulative and generally financial conditions have been supportive of growth. All of this suggests a bias toward faster global growth due to accommodative financial markets broadly. On inflation, I judge that the risks to the baseline forecast are perhaps a little better balanced. While the upside growth risk would certainly pressure resources with inflationary consequences, that is not the entire story. For one thing, inflation has come in a little softer recently than we had expected. Secondly, energy prices seem to have flattened, and market participants expect them to moderate even further, providing a rapid diminution of the upward momentum to headline inflation. December 13, 2005 57 of 100 pass-through has been relatively low. Finally and importantly, longer-term inflation expectations are moderate. I would also add in this regard something that has not been much discussed here: Labor compensation itself has been on the weaker side, even as resource utilization has tightened. And finally, the productivity growth story, I think, has shown continued robustness. In this regard I’d point out that we talk a great deal about the upward adjustment to the structural productivity growth in the staff forecast, but all they’ve really done is just to maintain what has happened from 2001 to 2004. So maybe we’ve put too much weight on the temporary downward movement as opposed to just recognizing that things haven’t changed very much. So given this view of the risks around the forecast, why do I propose that we accept the baseline for purposes of today’s decision and communication? First, I am mindful that policy works with long and variable lags. While the risks for us are not totally balanced, the greater weight of the evidence, I think, is still for a good outcome, given that we have moved rates up quite considerably. And with inflation expectations still well contained, I think there’s no reason to adjust market perceptions of what we’re likely to do going forward. If those two facts did not adhere, my judgment might be different. Secondly, one would have to say that while the housing sector story is yet to come, there are, as we’ve heard around this table, a large number of anecdotes all pushing primarily in the same direction—supporting, I would think, the baseline. Third, I take some comfort in the fact that the baseline forecast is shared roughly by most outside forecasters. The Greenbook does not seem to be out of the trend. The Blue Chip consensus is that after more than two years of above-trend growth, activity in 2006 is likely to moderate to its trend December 13, 2005 58 of 100 underlie the Blue Chip are not distinguishable dramatically from the Greenbook forecast. President Moskow has already talked about what happened in Chicago at their outlook symposium. Again, the consensus seems quite consistent with our forecast from the staff. And the NABE members we met with in this room not too long ago also expect growth to be in the range of 3.25 to 3.5 in 2006. Finally, I am willing to take the baseline as the basis for policy today because I recognize that our language will convey the proper sense of caution to reflect the risks and leave us with the flexibility to respond to other changes. I will delay any further comment on that, as you have suggested, until the second part of our discussion." FOMC20060920meeting--140 138,VICE CHAIRMAN GEITHNER.," Thank you. Let me just start with the broad contours of our outlook. Growth has obviously slowed. The second half is likely to be relatively weak, but the only place we see pronounced weakness is in housing, and we expect a return to moderate growth going forward. Core inflation seems to be easing a bit, and it may have peaked in the second quarter, if you look just at the three-month annualized numbers. But inflation remains uncomfortably high, and our forecast assumes only a very gradual moderation over the next two years. In terms of numbers, we expect the real economy to grow at around its 3 percent potential rate in ’07 and ’08. We expect core PCE inflation on a Q4/Q4 basis to come in just below 2½ percent in ’06 and to moderate to about 2 percent in ’07 and 1.8 percent in ’08. Our outlook is largely unchanged from August. It’s conditioned on a path for policy that is flat at current levels for two to three quarters. This puts us slightly above the level that is currently priced into the risk-adjusted Eurodollar futures curve. In terms of uncertainty and risk, we see somewhat greater downside risks to demand growth than we saw in August, but the inflation risks still seem likely to be to the upside. Weighing the balance among these competing risks, we believe, as we did in August, that inflation risks should remain the predominant concern of the Committee, not so much, to borrow the Chairman’s formulation, because the probability of a higher inflation outcome is substantially greater than that of a much weaker growth outcome but because the costs of an erosion in inflation performance would be more damaging. On the growth outlook, we’re seeing a somewhat greater adjustment in residential investment than we anticipated, but this has not yet induced or been accompanied by a significant weakness outside housing. Of course, the outlook for the economy as a whole should not be particularly sensitive to plausible estimates of the direct effects of the remaining adjustment, whatever it is, left in residential investment. What seems more important, of course, is the potential effect of what’s happening in housing on consumer and business spending. We just don’t see troubling signs yet of collateral damage, and we are not expecting much. The fundamentals supporting relatively strong productivity growth seem to be intact. The acceleration of the nominal compensation growth that appears to be under way, combined with the moderation of headline inflation that we expect as energy prices moderate, should produce fairly strong growth of household income, even with the moderation in employment growth to trend. Corporate balance sheet profitability remains strong. Domestic demand growth outside the United States is expected to remain quite robust even though there has been some moderation in current measures of activity in some markets. Of course, the level of interest rates is not particularly high in nominal or real terms. Equity prices and credit spreads suggest a reasonable degree of confidence in the prospects for future expansion. Financial market participants report very strong continued demand for credit and for risk generally and very ample liquidity. This strength may reflect other factors that are operating on demand for financial assets, but still survey-based measures of confidence have not deteriorated dramatically. This, of course, may prove too optimistic on the growth outlook, and the risks seem weighted to the downside. On the inflation front, recent data have not altered our forecast or, really, our assessment of the risks to that forecast. Although there are signs of moderation in underlying inflation, the core PCE and a range of alternative measures continue to grow at levels that are uncomfortably high. We expect further moderation to occur only gradually over the forecast period. The latest data have been somewhat reassuring, and inflation expectations at various horizons have behaved relatively well since our last meeting. The acceleration in compensation growth and unit labor costs does not justify a higher inflation forecast in our view, provided that expectations remain well anchored, business markups fall, the ongoing moderation in growth reduces pressure on resource utilization, the futures curve proves a reasonably accurate prediction for the path of energy prices, the dollar declines only modestly, and so forth. These are reasonably good arguments, but we still think the risks are to the upside. Over the past two years, we have consistently revised up our forecasts for inflation. I’m not sure we really yet understand the forces behind the unanticipated acceleration in underlying inflation. Medium-term inflation expectations, while not rising at stated levels, may be higher than is consistent with an inflation objective in the range the Committee has talked about in the past. Containing these upside risks should be the dominant focus of policy until we see a more-pronounced moderation in current and expected underlying inflation. As my comments imply, we don’t have a lot of differences with the Greenbook on the contours of the outlook. The Greenbook shows slower growth relative to lower potential but also more inflation than we do. It also shows more slack with more inflation and a little less confidence in the strength of demand growth than we do for the reasons I hope I explained. I see certain questions as key. On the growth front the question is, Will weakness cumulate? If we see a more-pronounced actual decline in housing prices, will that have greater damage on confidence and spending? But the more interesting questions are really on the inflation forecast, and let me just talk very briefly about two. First, does the Greenbook forecast produce enough moderation in inflation soon enough to keep inflation expectations anchored? The baseline forecast has inflation falling to 1.5 percent, at least based on the last time we saw a long-term forecast, only over a very protracted period—a period that is significantly longer than the one many central bankers would consider an acceptable deviation from an inflation target. We have already seen a bit of troubling speculation from people who write about us. This Committee may have more inflation tolerance or a higher implicit target than its predecessor. Should we try to achieve a more rapid moderation of inflation? How should we evaluate the costs and benefits of trying to achieve a quicker and more substantial moderation of inflation, particularly given the tenuous state of the evidence on inertia and persistence? Is this gentle and gradual expected moderation in inflation optimal, given the softness of the outlook for demand? These are questions that are worthy of a more explicit discussion by the Committee, particularly if we’re going to talk about moving toward a quantitative definition of price stability with more disclosure around the forecast. The second and related question is about inflation in our forecast: With the stance of monetary policy that is now priced into the markets—this is a softer path than the one in August—how confident can we be that we are likely to achieve the forecast of sustained growth and gradually moderating core inflation? I think we can be less confident than the confidence you might read into current market expectations and the uncertainty that surrounds them. Of course, the behavior of long-term inflation expectations in financial markets suggests that this risk is not particularly high at present and that we can take some more time to get a better handle on the evolution of the economy before deciding what is next in terms of monetary policy actions. But I think that we may have more to do, and we should try to avoid fostering too much confidence in the markets that we’re done. We need to preserve the flexibility to do more if that proves necessary to keep inflation expectations anchored. Thank you." CHRG-110hhrg34673--3 Mr. Bachus," Thank you, Mr. Chairman, and I appreciate you holding this hearing. And Chairman Bernanke, thank you for your report. As you can see, on this committee, we share the same concerns, but we have different views on how to address those concerns and different philosophies. And as you come before us today, we are interested in your insights regarding not only monetary policy but also the state of the economy, and as the chairman specifically mentioned, global competitiveness and trade and issues of that nature. Of course, when we talk about differences of philosophy--as the chairman and I have--on how to approach these issues, how one perceives the state of the economy greatly depends on one's point of view. From my perspective, the economy appears strong and vibrant, and absent some unforeseen shock, likely to remain so. When I look at your report and the supporting economic data, I see vigorous 3.4 percent growth. I see low unemployment of 4.6 percent and inflation of 2.5 percent. And in a society where opportunity awaits anyone who uses their talents and efforts to improve the standard of living for their family--opportunities are there, educational opportunities, and work opportunities, that is what I see from your report. I see 7\1/2\ million new jobs created since 2003. I see a structurally sound economy performing as well as it did in the 1990's in what we now know is an artificial economic bubble. Currently, I see strong 2.2 productivity increases and record stock market levels not fueled by unrealistic dot.com speculation, but by globally competitive businesses. I also see most Americans benefiting from the stock market growth through individual stock ownership and retirement funds. In this environment, claiming that record corporate profits do not benefit most Americans--as some on this committee do--is not a valid argument. Others have a different perspective. You have heard the chairman's perspective. And they see another reality. Some on this committee believe that the best way to create jobs and promote economic growth is through aggressive trade restrictions and barriers. While I recognize the need to help those economically displaced or as the chairman says, hurt, by global forces beyond their control, economic experience does not lead me to the conclusion that protectionism or isolationism is an appropriate response. Some think we need to somehow mandate the elimination of income disparities. While I share the exasperation of the chairman over some of the outrageous CEO compensation recently reported, I believe our corporate governance system works and that shareholders will correct these abuses without Government interference. I believe education, not government attempts to redistribute income, is the proven route to improve wages for all workers. Chairman Bernanke, the members of this committee, Republicans and Democrats alike, respect your experience, your judgment and your obvious commitment to keeping America's economy strong and competitive. We all share a goal of doing that and doing what is best for American workers. We appreciate you being here and look forward to hearing your comments. " fcic_final_report_full--134 At one meeting, when things started getting difficult, maybe in , I asked the CFO what the mechanical steps were in . . . mortgage-backed securities, if a borrower in Des Moines, Iowa, defaulted. I know what it is if a borrower in Bakersfield defaults, and somebody has that mort- gage. But as a package security, what happens? And he couldn’t answer the question. And I told him to sell them, sell all of them, then, because we didn’t understand it, and I don’t know that we had the capability to understand the financial complexities; didn’t want any part of it.  Notably, rating agencies were not liable for misstatements in securities registra- tions because courts ruled that their ratings were opinions, protected by the First Amendment. Moody’s standard disclaimer reads “The ratings . . . are, and must be construed solely as, statements of opinion and not statements of fact or recommen- dations to purchase, sell, or hold any securities.” Gary Witt, a former team managing director at Moody’s, told the FCIC, “People expect too much from ratings . . . invest- ment decisions should always be based on much more than just a rating.”  “Everything but the elephant sitting on the table” The ratings were intended to provide a means of comparing risks across asset classes and time. In other words, the risk of a triple-A rated mortgage security was supposed to be similar to the risk of a triple-A rated corporate bond. Since the mid-s, Moody’s has rated tranches of mortgage-backed securities using three models. The first, developed in , rated residential mortgage–backed securities. In , Moody’s created a new model, M Prime, to rate prime, jumbo, and Alt-A deals. Only in the fall of , when the housing market had already peaked, did it develop its model for rating subprime deals, called M Subprime.  The models incorporated firm- and security-specific factors, market factors, regu- latory and legal factors, and macroeconomic trends. The M Prime model let Moody’s automate more of the process. Although Moody’s did not sample or review individual loans, the company used loan-level information from the issuer. Relying on loan-to-value ratios, borrower credit scores, originator quality, and loan terms and other information, the model simulated the performance of each loan in , scenarios, including variations in interest rates and state-level unemployment as well as home price changes. On average, across the scenarios, home prices trended up- ward at approximately  per year.  The model put little weight on the possibility prices would fall sharply nationwide. Jay Siegel, a former Moody’s team managing di- rector involved in developing the model, told the FCIC, “There may have been [state- level] components of this real estate drop that the statistics would have covered, but the  national drop, staying down over this short but multiple-year period, is more stressful than the statistics call for.” Even as housing prices rose to unprecedented lev- els, Moody’s never adjusted the scenarios to put greater weight on the possibility of a decline. According to Siegel, in , “Moody’s position was that there was not a . . . national housing bubble.”  CHRG-111hhrg48674--264 Mr. Bernanke," I was just going to make the comment that some economists have suggested transaction fees as a way of reducing liquidity and speculation in stock markets. I would have to say at the moment that liquidity is very short and that we are not seeing much of a speculative bubble in shares. I understand--I understand your general sentiment that trying to find ways to finance some of this cost in the longer term from the financial industry, for example, is worth looking at. But I don't think that is--that wouldn't be my first choice, and I am afraid in the very short run that it doesn't make much sense to put in capital and then take it right back out for financing. But certainly as we go forward, as I said to a number of people, it is going to be very important to try to get back to fiscal sensibility and fiscal stability; and there are lots of ways to get there, and Congress should look at a broad range of options. " FOMC20070807meeting--69 67,MR. PLOSSER.," Thank you, Mr. Chairman. Since our last meeting, the news in the Third District has been generally positive. Economic activity continues to expand in the tri-state area but at a less rapid pace than at our previous meeting. Our Business Outlook Survey indicates that the District’s manufacturing output continued to expand in July, although at a somewhat slower pace than in June. The June measure, you may recall, was more than 18 in our Business Outlook Survey, the highest level that it had been since April 2005. In July the index dropped to a little over 9, although it was still significantly positive. Shipments of new orders increased in July, and the outlook for manufacturers’ own capital spending plans remains positive and is at a level typical of an expansion. Firms in our survey generally see improvements in their businesses coming in the second half of the year. Residential construction, however, continues to be very weak in the region, but we have not seen, at least according to OFHEO indexes, any absolute price declines in our area. This is confirmed by our business contacts, who report that they have not seen steep or broad-based declines in house prices, except for properties along the Jersey shore, where the boom was most prevalent. At our last meeting I characterized the nonresidential investment market as firm, and that characterization continues today. Office vacancy rates in the Philadelphia region remain very low and declining, and rents in office and warehouse spaces remain at a record high. Although reports on retail sales in our region have been mixed, sales appear to have improved somewhat in late June and early July, especially at higher-end retail establishments. Bank lending has continued to advance but at a more moderate pace than at the time of our last meeting. Our banking and other business contacts indicate that banks have money to lend to customers with good credit ratings, and so I don’t get the sense that area businesses are facing a credit crunch of the normal type. Banks are comfortable with their lending standards and do not expect to make any big changes along this dimension in the foreseeable future. For the most part our banks were not in the subprime business and obviously don’t intend to start now, [laughter] and thus they have not seen an appreciable deterioration in their balance sheets or in those of the businesses to which they lend—their customers. Clearly, there is nervousness, but as yet there seem to be few consequences for the real economy. June employment growth in the region was below trend, but the region’s unemployment rate remains relatively low. Our staff expects employment to continue to grow at a moderate pace going forward and expects the region’s unemployment rate perhaps to rise modestly by the second quarter of next year. Yet businesses continue to report tight labor markets. One very large builder, who is headquartered in our area and who builds mostly high-end homes, has actually reported that he cannot finish a number of homes that he has under contract and that buyers are waiting to move into. He cannot find labor. Because of the crackdown on illegal immigrants, who do a lot of the landscaping, a lot of roofing work, and all the labor that goes into finishing these homes, he cannot hire these workers, and so he actually has to put off closing deals because he cannot find workers to complete the homes. On the inflation front in the District, employment costs in the Northeast are increasing at about the same pace as in the nation. Area manufacturers continue to report higher production costs, but there is relatively little evidence of pass-through of those higher costs to customers as they see it. Consumer prices are growing more slowly in the region than in the nation. So in summary, the Third District economy continues to expand at a moderate pace. While there is nervousness caused by the recent volatility in the financial markets, businesses do not yet see that affecting their current growth or prospects for future growth. Business contacts as well as the Philadelphia staff expect this moderate pace of expansion to be continued in the coming months. At the national level, the news has been mixed. On the positive side, employment and income growth remain solid. Manufacturing output continues to improve, and core inflation and inflation expectations remain contained, although both remain higher than I would like to see in the long run. On the negative side, news on business fixed investment and housing has been disappointing. After encouraging signs of stabilization early in the year, the sales of both new and existing homes have continued to decline. Sales of homes declined 6.6 percent in June and almost 8 percent in the second quarter. At the time of our last meeting, I expressed the view that I was getting hopeful that economy was on track to return to near-trend growth later this year. Setting aside the issue that our perception of long-term trend growth in real GDP may need reassessment in light of the benchmark revisions, as we’ve been discussing—and I’ll return to this point in a moment—the recent data on housing are suggestive of a weaker third quarter and perhaps fourth quarter as well. Though I think the underlying steady-state demand for housing is lower than the pace of housing demand before we saw the downturn begin, which implies that much of the adjustment in housing supply is part of a healthy adjustment to a new equilibrium, the stock of unsold homes continues to cause a drag on residential investment. I also think that there is some risk of temporary weakness in business fixed investment going forward simply because of increased uncertainty. So the return to trend growth, which I think will happen within the forecast period, may be delayed by a few quarters and may not get under way solidly until late in the first half of next year. You know the old saying: “If you can’t forecast well, forecast often.” [Laughter] The biggest economic news headlines since our last meeting have focused on the volatility of the financial markets and the repricing of risk. I am inclined to put minimal weight on the current financial conditions for a slowdown in the pace of economic activity going forward. Although risk spreads have widened in the past three weeks or so, the cost of capital for high quality borrowers has hardly changed and remains relatively low by historical standards. This suggests to me that what we are seeing in the marketplace—at least right now but which could change, as we’ve all noted—is a change in the relative price of various measures of types of risk. The cost of capital for some borrowers is increased, but demand for business investments that originate from large corporations with good credit ratings has not changed and is not likely to be adversely affected very much in the repricing of risk, if that’s what this represents. This news was reinforced to me by my conversations with area bankers, as I mentioned earlier, who say that they have plenty of money to lend to good credit risks. There is no evidence of a general credit crunch from their point of view. My general view regarding the limited nature of the credit repricing is reinforced by the fact that default rates on auto loans, credit cards, and other types of consumer debt instruments have not changed much, suggesting that the spillover effects, at least to date, have not been very measurable. Thus, I think that the decline in the subprime market is primarily a result of lax underwriting. Those lenders are now paying the price, but we must be very careful not to act or appear to act in a way that supports bad bets or lax underwriting standards without more widespread evidence of systemic problems affecting the real economy. Let me now turn to what I think is a more fundamental factor for gauging the strength of the economy going forward and, therefore, the appropriate stance for monetary policy. In the most recent Greenbook, the Board staff revised down the rate of growth of structural productivity more or less in line with the reduction in real GDP growth, as we have been discussing. It is certainly reasonable to think that this new information about the pace of real GDP growth during the past three years contains information about the rate of growth of structural productivity going forward. But that is not an infallible signal. In my thinking about how monetary policy needs to be set, distinguishing temporary decreases in the rate of growth of productivity from permanent decreases is a critical piece of the puzzle. A transitory decrease would not affect the steady-state equilibrium real rate to my mind. But a permanent decrease would imply a lower steady-state equilibrium real rate and, thus, a lower natural rate for the federal funds rate. If the equilibrium real rate is lower, holding the fed funds rate constant, of course, would imply an implicit tightening of monetary policy. I am still grappling with the implications of these benchmark revisions for future productivity growth. At this point in my forecast, I’m assuming that the revisions imply a rebenchmarking of the growth rate of structural productivity, but that rebenchmarking or that lowering of the trend rate of growth of real GDP is not enough so that core inflation can decelerate toward price stability in the next two or three years or so under a constant fed funds rate. But the reduction in the growth rate of structural productivity does feed through to a somewhat looser required path of the fed funds rate through 2008 to 2009. In my forecast, appropriate policy has the fed funds rate rising to 5½ percent in the first quarter of ’08, holding steady there for two or three quarters, and then gradually drifting down toward a more neutral rate consistent with lower inflation expectations and lower trend output growth. With this path of the fed funds rate, I expect the economy to return to near potential real GDP growth in the first or the second quarter of 2008. I expect the housing correction to continue through the first half of 2008, but the drag lessens over the year. I expect the core inflation rate to be somewhat higher in the second half of the year than in the first half, but I expect the economy by 2009 to grow near its potential growth rate, which I now assume to be 2.8 percent, about 0.2 percent lower than I had last time, with the unemployment rate close to its natural rate of 5 percent and core inflation at about 1.5 percent. I have two other brief comments I’d like to make about our forecasting exercise and some information I think is relevant. We continue to focus on the PCE price index, and I have some objections to that. I continue to believe that the CPI is a better measure, if for no other reasons than that it is more familiar to the public and that it is not revised. We were lucky this time in the GDP revisions that the PCE price index was not revised very much, and I think we run the risk that focusing too heavily on a measure that does get revised can cause us some difficulty. I also have some concern about the empirical ability of core PCE to actually be a very good predictor of headline PCE inflation at the end of the day. So I am still struggling with our choice of the index there. The other item that I would like to emphasize—and it was driven home to me in a meeting with some reporters in the not-too-distant past—is that I do believe that moving toward measures of uncertainty that include some fan charts would be useful. I was hesitant at first about that in part because getting appropriate measures of uncertainty that are internally consistent across all our forecasts and all our models would be very difficult. Yet some, what I would view as very sophisticated, journalists continue to confuse the issue of the range of our forecasts and our central tendencies with the issue of uncertainty or certainty. They do not understand that our central tendency is an agreement about what our point forecast is but that it may reveal very little or nothing about the degree of uncertainty in our forecasts. So I think it is very important that we quantify that in some way to be clearer and to eliminate some of that confusion. I’ll stop there. Thank you, Mr. Chairman." CHRG-110shrg50369--52 Mr. Bernanke," Well, Mr. Meltzer, who is an excellent economist and indeed who is a historian of the Federal Reserve, is concerned that the current situation will begin to look like the 1970s, with very high inflation and high unemployment. I would dispute his analysis on the grounds that I do believe that monetary policy has to be forward looking, has to be based on where we think the economy and the inflation rate are heading. And as I said, the current inflation is due primarily to commodity prices--oil and energy and other prices--that are being set in global markets. I believe that those prices are likely to stabilize, or at least not to continue to rise at the pace that we have seen recently. If that is the case, then inflation should come down, and we should have, therefore, the ability to respond to what is both a slowdown in growth and a significant problem in the financial markets. He is correct, however, that there is some risk, and if the inflation expectations look to be coming unmoored, or if the prices of energy and commodities begin to feed into other costs of goods and services, we would have to take that very seriously. I mentioned that core inflation last year was 2.1 percent, so it is food prices and energy prices, which are internationally traded commodities, which are the bulk of the inflation problem. Again, we do have to watch it very carefully, but I do not think we are anywhere near the 1970s type situation. Senator Bennett. Thank you. I wanted to get that on the record. As I look at the housing market and talk to some of my friends who are in the housing market, they tell me that the inventory is not monolithic, the inventory overhang--that is that the bulk of the overhang is in the higher-priced homes, because home builders wanted to build places where they would get the highest margin return, and if they built houses in the moderate housing area or affordable housing, their margins were not nearly as great and there were plenty of speculators willing to buy the bigger homes. And, indeed, they tell me that for affordable housing, there is, frankly, not a sufficient supply right now. They are urging me to do something on fiscal policy to stimulate people to build cheaper houses, that the housing construction would begin to catch up--not catch up. Construction levels would begin to pick up, whereas now they are dormant, waiting for the overhang to be worked off. Do you have any data that supports that anecdotal report? " FOMC20070509meeting--89 87,CHAIRMAN BERNANKE.," Thank you. Let me try to summarize the discussion around the table and take any comments on the summary, and then I would like to add just a few thoughts. Broadly speaking, the outlook of most participants has not substantially changed since March. Housing remains weak, and it is the greatest source of downside risk. Whether the demand for housing has stabilized remains difficult to judge, in part because of subprime issues. It is also unclear whether builders will seek to return inventories to historical levels, and if so, at what rate. There is yet no indication of significant spillover from housing to other sectors, although that remains a risk. The downside risks to investment have moderated since the last meeting, although investment seems unlikely to be a strong driver of growth. The inventory cycle is now well advanced, and production is strengthening. Consumption growth seems likely to moderate, reflecting factors such as weakness in house prices and high energy prices. However, the labor market remains strong, particularly in the market for highly skilled workers. Incomes generated by the labor market, together with gains in the stock market and generally accommodative financial conditions, should provide some support for consumption going forward. Financial markets are priced for perfection, which implies some risks on that score. Foreign economies remain strong and should be a source of support, although some are undertaking monetary tightening. Overall, the economy is in a soft patch and will likely grow below trend for a while. Growth should return to potential later this year or in 2008, depending on the evolution of the housing market. The rate of potential growth remains hard to pin down. Several participants seem a bit more optimistic than the Greenbook on potential growth and the NAIRU, although there are risks. Inflation has improved a bit, and most see continued but very slow moderation. However, there are upside risks to inflation, including compensation, the dollar, energy prices, and a slowing in productivity. Moreover, a rise in inflation from current levels would be costly, particularly if it involved unhinging inflation expectations. Vigilance on inflation must, therefore, be maintained. Overall the risks and uncertainties seem a bit less pronounced than at the last meeting, and participants seemed relatively comfortable with the outlook. Although there are some potentially significant downside risks to output, arising particularly from the housing sector and the possible spillover to consumption, the group still appears to view a failure of inflation to moderate as expected to be the predominant risk to longer-term stability. Are there any comments or questions? Hearing none, I will just add a few points. First, following President Yellen, I think that the tension between slow growth and a strong labor market remains central to understanding what’s going on. Okun’s law is supposed to work better than this. [Laughter] I looked at recent history. Over the past twenty years or so, there has been no exact parallel to what we are seeing now. There was a jobless recovery in ’91-’93 in which unemployment remained high even though growth was picking up, and we had a midcycle slowdown in ’95 and ’96, which was relatively short and not very severe, in which the unemployment rate got temporarily ahead of growth. So there have been some deviations. Interestingly, after the 2001 recession, despite lots of talk about jobless recoveries, Okun’s law worked pretty well. So we are in an unusual situation—instead of a jobless recovery, we have growthless job growth. [Laughter] Interpreting this correctly is very important. The staff forecast essentially assumes that Okun’s law will revert to historical tendency. I think that assumption is reasonable, particularly since the staff is not exceptionally optimistic about potential growth and, therefore, that particular source of error is moderated. That would suggest that labor hoarding is probably a good part of what is happening here. If there is one area in which labor hoarding appears to be significant, it would be construction, as President Yellen mentioned. I asked the staff to do a simple study of this relationship, to which Dave Stockton referred. Andrew Figura and Adam Looney of the Board’s staff performed a regression analysis in which they regressed all construction employment against all investment in structures quarterly with lags going back to 1985. The reason to look at all construction in terms of both employment and production is that there is a lot of substitutability between those two categories. That regression approach should also account for unmeasured labor, including undocumented workers and the like. In this analysis they found that employment is roughly proportional to construction activity, but with substantial lags, which again is somewhat surprising. Indeed, the model fits well through the fourth quarter of ’06 but then begins to underpredict significantly in the first quarter of ’07. If this model is correct, then given what is already in the pipeline in terms of reduced construction activity and then going on with the forecast in the Greenbook, we should begin to see fairly significant declines in construction employment on the order of 30,000 per month over the next year, which would be sufficient in itself, with all else being equal, to add 0.2 to 0.3 to the unemployment rate. So if labor hoarding explains the failure of Okun’s law, then we may soon see some gradual rise in the unemployment rate, which would also be consistent with the view that the staff has taken that a good bit of the slowdown in productivity is cyclical. It is actually fairly difficult to calculate the contribution of the construction sector to productivity because it involves not just construction workers but also upstream production of various kinds. But one estimate, which comes from discussions with the Council of Economic Advisers, had the implication of employment hoarding in construction being about ½ percentage point on productivity growth. We will see how that develops. Even though I believe, as does the staff, that we will see some softening in the labor market, I should say that the evidence is still quite tentative. We saw a bit of weakness in the last labor report, but unemployment insurance claims remain low, and we do not really see a significant indication. The other major issue is the housing market. Again, as a number of people pointed out, this is an inventory-cycle problem. The two main determinants of an inventory cycle are (1) what the level of final demand is and (2) how quickly you move to bring inventories back to normal. There does seem to have been some step-down in final demand over the past few months. Assuming that homebuilders would like to get not all the way to but significantly toward their last ten years’ inventories by the end of 2008 implies fairly weak construction, not only in the second quarter but going into the third quarter as well. Only in the fourth quarter will we see a relatively minor subtraction from GDP. That’s also relatively speculative, but residential construction does seem fairly likely to me to be more of a drag than we previously thought and to continue to be a problem into the third quarter. There will also be a slowdown in consumption. We have been having rates near 4 percent, which is certainly not sustainable. We already see indications that consumption may be closer to 2 percent in the second quarter. I think the house-price effects are going to show up. Gasoline prices will have an effect. The labor market is strong, but it is going to slow a bit. So it looks to me as though underlying growth is roughly 2 percent and will be so for a couple of quarters to come. Notice in the thinking about the underlying case that there has been quite an asynchronicity between private domestic final demand and production lately. For example, for the second quarter we expect to see weaker private domestic final demand but probably a stronger GDP number because of rebounds in net exports and the like. But we should look past that—those are just quarter-to-quarter variations—and observe that growth is moderate, an observation that is supported by the sense that industrial production and manufacturing seem to be picking up. To summarize, I think that the notion of moderate growth with some uncertainty and with return toward potential later in the year or early next year is still probably about the right forecast. On inflation, there’s the famous stock market prediction that prices will fluctuate. That seems to be true also for inflation. I mentioned at the last meeting that the monthly standard deviation in inflation numbers is about 0.08, and so between 0.1 and 0.3 there is not necessarily a whole lot of information. We have a few pieces of good news. I think vacancy rates are rising for both apartments and single-family homes. At some point we will begin to see better progress on owners’ equivalent rent and shelter costs. Also, the quarterly average of medical cost increases was much more moderate than in the first two months, which suggests that maybe this risk is not as serious as it may have looked. However, as many people pointed out, there are a number of negatives, including the dollar, energy, food prices, commodity prices, and most importantly, the labor market. The compensation data remain quite mixed—in particular, the ECI, which was a very soft headline number. The 1.1 percent quarterly wage and salary number, or 3.6 percent for twelve months, is now more or less consistent with what we’re seeing in average hourly earnings. If productivity falls below 2 percent, then we are beginning to get to a range in which unit labor costs will be putting pressure on inflation. So I am quite comfortable with the view expressed around the table that, although inflation looks to be stabilizing and perhaps falling slowly, there are significant risks to inflation and we should take those very seriously. Very much a side point—I did have some interesting discussions with the staff about the role of the stock market in the forecast. This is not the staff’s fault, but there is a sort of tension in how the stock market is treated. On the one hand, the stock market is assumed to grow at 6½ percent from the current level. On the other hand, the forecast has profit growth going essentially to zero by the third quarter but interest rates coming up. Those two things are a little hard to reconcile. The difficult problem is which way you should go to reconcile it. On the one hand, it could be that the forecast is right, and therefore the stock market will in fact be weaker; that will have implications for stability, for consumption, and so on. On the other hand, perhaps we should be taking information from the stock market in making our forecast. So it is a very difficult problem, and I just wanted to point out the tension that we will have to see resolved over the next few quarters. One partial resolution is that, as has been noted, the stock market and the economy as a whole can be decoupled to some extent because of overseas profits. This is an interesting example of how financial globalization is creating stability for domestic consumption—you know, decoupling domestic consumption from domestic production. Again, we had a very good discussion with the staff about this issue, and I think it is just something we will need to think about going forward. In summary, in the last meeting we felt that uncertainty had risen. There has been perhaps a slight moderation of those concerns at this point—a little less inflation risk, a little less growth risk. Nevertheless, the balance of risks with inflation being the greater still seems to me to be a reasonable approach. Let me now turn to Vincent to begin the policy go-round." FOMC20061025meeting--40 38,MR. MOSKOW.," Thank you, Mr. Chairman. Conditions in the Seventh District appear to be quite similar to what I reported last time. Except for housing and autos, activity remains on a solid footing, and most of our contacts are relatively optimistic about the outlook. For instance, the two large temp firms we talk to regularly both reported that, although billable hours were roughly flat, their clients were upbeat about the outlook. Furthermore, demand for workers in light industry—the segment most closely tied to the national business cycle—continued to grow. In terms of wages, both temp firms noted that compensation increases have been running much higher than last year at this time. The difficulties of the Big Three automakers continue to be a problem for our region and are showing through in the national numbers for the third quarter. These difficulties don’t stem from an overall lack of demand. Light vehicle sales continue to run at a pretty healthy pace, as the Greenbook notes. To some extent, the Big Three’s difficulties are a consequence of the energy price shock. Demand has shifted away from pickups and big SUVs, which have been their bread and butter. Despite the recent gas price declines, Ford and GM told us that they do not expect a reversal of this shift anytime soon. Otherwise, the District is doing reasonably well. I heard a lot of optimism. Indeed, a few contacts explicitly described the current slowdown as similar to the brief pause in the mid-1990s, which was followed by sustained expansion. Turning to the national outlook, clearly economic activity was soft during the third quarter, but the fairly solid growth in consumption and business fixed investment indicates that at least to date we have not seen a spillover of the weakness in housing to other sectors of the economy. This is consistent with the anecdotes that I’m hearing. Looking ahead, we expect several quarters of weak residential investment, but activity in other sectors should increase roughly in line with longer-run sustainable rates. Assuming market expectations for interest rates, we see GDP growth averaging modestly below potential over the next year and a half. We think growth will be a bit above potential in ’08. In our view, the underlying fundamentals— wealth, income, interest rates, and the current level of liquidity in the economy—should support a higher level of spending than what’s in the Greenbook baseline. Of course, a major risk for our outlook is that there could be more-substantial spillovers from the housing sector. As has been noted around this table, it could take some time for the weakness in housing demand to show through to house prices. I was hoping we could get more information, but it sounds as though the research isn’t there yet. If prices do fall substantially, a reduction in wealth could have serious ramifications for consumption and spending overall. It’s hard to say when we’ll have a clearer picture as to how events are unfolding. At some point, probably before the decline in the broad measures of housing prices, we’ll likely see early evidence in either anecdotes or risk spreads. Or if the risk is overstated, we may hear of improvements from our contacts. Turning to inflation, the projections from our models have not changed much with the incoming data. They still show core PCE inflation in ’08 coming in between 2.3 and 2.6 percent, depending on the period used to estimate the models. So I continue to have the same questions I had last time regarding the interplay between such inflation rates, inflation expectations, and Fed credibility: Will continued high levels of core inflation eventually make the public doubt our resolve to maintain low and stable inflation? Even if inflation is less persistent, as some have suggested, will it settle out at rates like those in the past few years—namely, 2 percent—rather than the 1.6 percent in the Greenbook’s less-persistent inflation scenario? Are the current long-run core PCE inflation expectations, which are likely above 2 percent, just simply too high? I’m quite concerned that the answers to these questions might be “yes.” If so, and the housing spillover risks fade, then we may have to act more forcefully than the Greenbook baseline policy assumption in order to ensure that inflation is more clearly headed into the range consistent with price stability." FOMC20060131meeting--89 87,MS. MINEHAN.," Thank you, Mr. Chairman. There’s not a lot new in New England. So I thought I’d just skip over my usual probably more-lengthy-than-necessary comments on the region. Let me just mention a couple of things, though. Employment growth is still slower, and income growth is still slower than that of the nation. Our regional unemployment rate went up rather than down over the past year, and we have seen some slowing in residential real estate markets. However, surprisingly enough, there seems to be a good deal of optimism in discussions we have had with people about business spending and about commercial real estate markets. So, for the first time in five or six years, we’ve actually had net absorption of space, both downtown and in the suburbs. That situation is making a big difference in the smiles on people’s faces around town. I hope it means that New England is getting back and moving along the same trajectory as the nation. Turning to the nation, we, like most observers, were surprised at the modest growth rate of the economy in the fourth quarter. But we, like almost everybody else, believe that the reduced pace of government spending and smaller-than-expected inventory investment that affected the fourth quarter are likely to be temporary and reflect issues of timing rather than overall economic strength. Thus, we, too, anticipate a slightly stronger first quarter this year than we had before. But our forecast takes the same basic trajectory over the balance of ’06 and ’07—that is, strength in the first half of ’06 and then moderation as the effect of tighter monetary policy, cooling housing markets, and less fiscal stimulus takes hold. This is the same trajectory as that in the Greenbook. However, as we look at GDP, our forecast for ’07 is slower—½ percent or a little bit less— than the forecast for ’06, reflecting an expected outright decline in housing investment. We also see inflation trending off both this year and next, with core PCE inflation never above 2 percent over the two-year period. I mean, not “never,” which is a strong word, but at the points we’re mapping. Some of this difference in price pressures is accounted for by a sense of a somewhat greater supply of labor resources, as reflected in a slightly lower NAIRU and a higher labor force participation rate. Looking at these forecasts and assessing all the data and anecdotal inputs I have received since the last meeting, I am struck by a couple of things. First, these forecasts, and the vast majority of those available from other sources, describe an almost ideal outcome. U.S. demand is strong but slowing, as consumers save more and borrow less. Fiscal stimulus diminishes, business spending remains solid, employment grows, inflation edges off, and foreign growth is spurred by domestic demand at last and acts to create some export growth, though we continue to have a widening current account deficit. If these forecasts were to be realized, it would truly be just about the best of outcomes, and I would agree with President Yellen—a major sweet spot as the Chairman hands over the reins. But that scenario sort of begs the question of risks, both large and small, and how they are balanced. We could certainly be surprised by new energy shocks or geopolitical events of such magnitude to cause financial turmoil and consumer and business retrenchment. We could also witness the turbulence that could accompany a sharp unwinding of the nation’s ever-growing external deficit. But you don’t have to focus on major upsets. Risks of a lesser proportion loom as well. We could very well be wrong about the remaining capacity in labor markets, and the resulting upward pressure on wages and salaries could create a more rapid pace of inflation, particularly given the solid pace of external growth and pressures on a range of commodity prices. To date, however, the growth of wages and salaries has been on the slow side, particularly relative to productivity, and there is little evidence that firms believe they have the pricing power to pass on much more than energy surcharges. Indeed, their profit margins suggest that they have a cushion against increases in input costs. Alternatively, the impact of a cooling housing market could take a larger bite out of consumption than we now expect and cause a greater-than-projected, though welcome, increase in personal saving. This would, of course, slow the economy from baseline and damp price pressures. We haven’t seen this yet either, but it could be just as likely as missing on the inflation side. Thus, as I look at both the upside and downside risks, they seem to me to be more balanced than they have been. As some evidence of this, both the Greenbook and the fed funds futures markets anticipate that policy is near a tipping point—move a bit more now and then retrench in late ’06 or early ’07. I also find myself beginning to wonder about the cost of being wrong. When policy was arguably much more accommodative, it seemed to me that letting inflation get out of hand might be harder to deal with and ultimately more damaging to the economy than if growth slipped a bit. That may still be true. But just as our credibility regarding price stability is important in setting market expectations so, too, is some sense that policy will be supportive of growth when the threat of rising inflation is less imminent. In short, we need to be credible about achieving both our goals. At this point, another nudge toward a policy rate that neither stimulates nor restrains the economy seems appropriate. But the need for further moves seems to me to be increasingly driven by the incoming data." 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-109hhrg23738--157 Mr. Hensarling," In an attempt to deal with at least one facet of our long-term structural deficit, a number of members of Congress, including myself, have introduced budget process reform legislation. Many in this body hold PAYGO to be a panacea in that quest to deal with our long-term fiscal challenges, but as of today I believe that mandatory spending and interest accounts for 61 percent of the federal budget. According to the House Budget Committee, within a decade we will go from 61 percent of the budget to mandatory and interest, to 71 percent. I have personally introduced legislation that would include a ceiling on the growth of the federal budget. If spending is a significant part of the challenge, inasmuch as every PAYGO proposal I have seen does not deal with mandatory spending, does not deal with the automatic inflation included in baseline budgeting, and if our quest is to control spending, is not a ceiling on the growth of government a superior alternative to traditional PAYGO? " CHRG-111shrg61651--14 Mr. Johnson," Thank you, Senator. I strongly support the Volcker Rules, as everybody is starting to call them, in terms of the principles they put forward. I think there are two main principles. The first is that we should redesign the size cap that does already exist for U.S. banks, the size cap from the 1994 Riegle-Neal Act. We should redesign it to reflect current realities. And second, we should address the issue that has arisen, in particular over the past few years, of U.S. Government backing for very large financial enterprises that have basically an unlimited ability to take risk around the world. I do not, however, think that the exact formulation of the Volcker Rules as put forward is the right way to go. I think, actually, you should consider tightening the restrictions on the largest banks and reducing the size cap, and I would emphasize that our banks are now already much larger as a percent of the--our largest banks as a percent of the economy, a percent of total financial assets, than we have ever seen before in the United States. Our largest six banks have assets worth over 60 percent of GDP. This reflects, in addition to what has happened in the financial crisis and the bailout and the rescue, it reflects the underlying concentration of these financial markets. So the big four banks now have more than half of the mortgage market in this country and two-thirds of the market for credit cards. This is unfair competition. Because these banks are too big to fail, they have lower funding costs, they are able to attract more capital, they make more money over the cycle, and they continue to get larger. And I do not think that we have seen the end of this. If you look at the European situation today, for example, it is much worse than what we have in this country with regard to the size of the largest banks. Just as one example, the Royal Bank of Scotland peaked with total assets at 125 percent of U.K. GDP. That is a seriously troubled bank that is now the responsibility of the U.K. taxpayer. If we allow our biggest banks to continue to build on these unfair market advantages and the lower funding costs, we will head in the same direction. I think I would suggest to you that you consider imposing a size cap on banks relative not to total normal assets or liabilities, which is the Volcker proposal, because that is not bubble-proof. If you have a massive increase in house prices, real estate prices, such as happened in Japan in the 1980s, you will have a big increase in the normal size of bank balance sheets. And when the bubble bursts, you are going to have a big problem. I think the size cap should be redefined as a percent of GDP. And I think that while the science on bank size is, to be sure, incomplete and inexact, there is no evidence that I can find of any kind, and I have spent a lot of time talking to technical people from they financial sector and people at central banks, people in the banking system themselves have impressed various points on me. I cannot find anything--I put this in the written testimony--that supports the idea that societies such as ours should have banks with total assets larger than around $100 billion in today's money. Now, if you were to impose a size cap of, say, 3 or 5 percent of GDP, no bank can be larger than that size, that would return our biggest banks roughly to the position that they had in the early 1990s. Now, our financial system worked very well in the early 1990s. Goldman Sachs, as one example, was one of the world's top investment banks. I don't think anyone questioned the competitive sector. But since the early 1990s, we have developed a lot more system risk focused on the existence of these very big banks. So, as Mr. Corrigan said, the essence of this crisis was lending, but it was lending that at the heart of it was based on the idea you could make nonrecourse loans to people who can walk away from their homes when the house value falls, leaving the bank with huge losses. How do people think this was a good idea? Why did they think that this would survive as a business model? Well, I think it was very much about the size of these banks and very much about the support they expected to receive when they are under duress. So in conclusion, I think the Volcker principles are exactly right. I think they are long overdue. I think you should--I hope that you will take them up and develop them further. I think the degree of unfair market competition, the degree to which the community banks are disadvantaged by the current situation, because they have to pay a lot more money--they pay higher interest for funds, their cost of capital is higher--this is unfair. This dynamic will continue unless you put an effective cap on it. The biggest banks will become even larger and even more dangerous. Thank you very much. " FOMC20061212meeting--88 86,MR. BARRON.," Thank you, Mr. Chairman. Over the intermeeting period, the Sixth District’s economic activity largely reflected the trends in the nation as a whole. But the magnitude has been amplified by the region’s relatively large exposure to housing-related activities. Specifically, while Florida continues to bear the brunt of the housing correction, we have increasingly heard reports of sales declines in other areas, too. For instance, an announcement at a recent conference of Atlanta homebuilders was that “Atlanta’s ability to outrun the downturn has run out.” The recent survey of the Beige Book would confirm this, in that contacts indicated that 67 percent of the District builders consider their inventory of unsold new homes to be either high or extremely high. The decline in housing market activity is affecting housing-related sectors such as construction, real estate services, wood products and manufacturing, and carpet production, to which our District is more exposed than are other parts of the country. For instance, Florida has a concentration of residential construction that is about 50 percent greater than that of the United States as a whole, and Florida’s construction employment has been declining at an annualized pace of 10 percent each month since May. Georgia is home to the largest concentration of carpet production in the United States, and these firms have reported that they are scaling back production as well as employment. We expect the negative effect on construction-related sectors to intensify over the next few months as builders complete current projects and significantly curtail future projects. Lending related to real estate has been a significant source of revenue and growth for District banks in recent years. Our banking contacts report that the pipeline of real estate lending has all but dried up. Some also noted concern about the prospective financial strength of smaller builders, although most expect the larger builders to be able to weather the downturn. On the consumer side, asset quality remained good, but some banks noted concern about the potential negative effects from adjustable rate mortgage resets that will occur in 2007. The good news for the housing outlook is that the continued decline in starts and the leveling-off of sales may have arrested the run-up in the inventories of unsold new housing. It’s hard to tell if we’re getting close to the bottom of the housing slump. Several of our builder contacts in Florida say that they expect sales to improve in the second quarter of 2007. Also, most contacts expect a pickup in the multifamily rental market in 2007. Outside the housing sector, indicators of economic performance in the District were mixed. Nonresidential construction remains at modest levels, with the pace for October and November being about what it was in 2005. Builders expect that the overall pace for 2007 will match that of 2006, and signs are that the demand for office and industrial space is picking up, with lower vacancies and rents beginning to firm. Early reports on holiday retail sales were on the positive side. However, tourism performance in Florida has disappointed in recent months. Visitors to all areas of Florida are down so far in 2006, which could give the state the first year- over-year drop since the September 11 terrorist attacks. The shuttering of the Ford auto assembly plant in Atlanta and the weak performance by GM, Saturn, and Nissan have led us to cut District auto production. However, on net, the strong performance by Mercedes, Honda, and Hyundai has been more than enough to keep overall auto production in the District moving along at a relatively solid clip. Along the Gulf Coast, much uncertainty remains about the long-term economic recovery of New Orleans. One hope for a signal of recovery was the restarting of the Crescent City’s tourism and convention business. Unfortunately, indicators such as airport traffic and convention bookings have not strengthened over the year and remain well below pre-storm levels. In contrast, a key Mississippi Coast economic engine is up and running—the casinos. [Laughter] All the casinos damaged or destroyed by Katrina have reopened, and gaming revenues have returned to pre-storm levels, in some cases even above those levels. This signal has generated optimism about the eventual recovery of the Mississippi Coast. Putting aside the problems of accurately calibrating growth in real GDP for the national economy that were discussed in the Greenbook, it seems clear that the slowing of the economy that many of us noted last meeting continues. At the same time, some of the pressures on the inflation side may be abating as well. Housing and its potential spillover effects to other segments of the economy remain a question mark, as does the slowing in manufacturing that now appears to be in progress. However, several factors suggest that the slowdown is transitory and that the risk is relatively small that it will turn into a full-fledged recession. For example, corporate profits remain healthy. Business investment has continued to expand, although a bit more slowly. The most recent labor report is quite positive, with job growth now averaging about 138,000 over the past three months. Going forward, the decline of the dollar suggests that net exports will be less of a drag on our output. This conclusion about the likely path of the economy is also consistent with our own District model forecasts that have changed only slightly from October. They have shifted in almost the same way that the Greenbook forecast has, and the differences are relatively small when all things are considered. Let me stop and save my other comments for the policy go-round." FOMC20061025meeting--72 70,MR. STERN.," Thank you, Mr. Chairman. We had a meeting at the Bank last week with representatives from the housing industry in the Twin Cities, including builders, brokers, and lenders, and most of these participants operate nationally. In fact, one of the first you mentioned, Richard, was there. Some of these firms are in nonresidential development and construction as well. The bottom line of the meeting, I would say, was that the comments overall track pretty well with the Greenbook forecast of housing activity—that is, both a further and a prolonged slump in housing. Let me just give you a few of the specifics. They reported, as we know, that sales of new homes have declined dramatically and prices of new homes are going down with sales, also dramatically. Retail brokerages are starting to contract in terms of both number of offices and number of brokers. It was reported that so-called investors have disappeared entirely from many markets and that inventories of unsold homes are rising and the extent of the increase may be understated by the published data. There was little expectation among this group of improvement in housing in the next several months at least, and I would say not a whole heck of a lot of confidence that there was improvement in store even out beyond that, maybe as you get later into ’07. In contrast, and on a somewhat more positive note, the people who are also in nonresidential construction—in particular, office and retail development—thought that the outlook was promising, indeed positive, and are seeing a lot of activity in that business. The housing situation notwithstanding, I remain somewhat more optimistic about our prospects for real growth both in ’07 and in ’08 than the Greenbook. Apparently my assessment of the implications of the sustained increase in income, of the run-up in equity values, and of the decline in energy prices is just more positive than the Greenbook’s, and that’s how I arrive at a somewhat more optimistic assessment. I continue to think that core inflation will diminish modestly over this period. So my overall view of the outlook really has changed very little since the last meeting." fcic_final_report_full--33 Indeed, Greenspan would not be the only one confident that a housing downturn would leave the broader financial system largely unscathed. As late as March , after housing prices had been declining for a year, Bernanke testified to Congress that “the problems in the subprime market were likely to be contained”—that is, he ex- pected little spillover to the broader economy.  Some were less sanguine. For example, the consumer lawyer Sheila Canavan, of Moab, Utah, informed the Fed’s Consumer Advisory Council in October  that  of recently originated loans in California were interest-only, a proportion that was more than twice the national average. “That’s insanity,” she told the Fed gover- nors. “That means we’re facing something down the road that we haven’t faced before and we are going to be looking at a safety and soundness crisis.”  On another front, some academics offered pointed analyses as they raised alarms. For example, in August , the Yale professor Robert Shiller, who along with Karl Case developed the Case-Shiller Index, charted home prices to illustrate how precip- itously they had climbed and how distorted the market appeared in historical terms. Shiller warned that the housing bubble would likely burst.  In that same month, a conclave of economists gathered at Jackson Lake Lodge in Wyoming, in a conference center nestled in Grand Teton National Park. It was a “who’s who of central bankers,” recalled Raghuram Rajan, who was then on leave from the University of Chicago’s business school while serving as the chief economist of the International Monetary Fund. Greenspan was there, and so was Bernanke. Jean-Claude Trichet, the president of the European Central Bank, and Mervyn King, the governor of the Bank of England, were among the other dignitaries.  Rajan presented a paper with a provocative title: “Has Financial Development Made the World Riskier?” He posited that executives were being overcompensated for short-term gains but let off the hook for any eventual losses—the IBGYBG syn- drome. Rajan added that investment strategies such as credit default swaps could have disastrous consequences if the system became unstable, and that regulatory in- stitutions might be unable to deal with the fallout.  He recalled to the FCIC that he was treated with scorn. Lawrence Summers, a for- mer U.S. treasury secretary who was then president of Harvard University, called Ra- jan a “Luddite,” implying that he was simply opposed to technological change.  “I felt like an early Christian who had wandered into a convention of half-starved lions,” Rajan wrote later.  Susan M. Wachter, a professor of real estate and finance at the University of Penn- sylvania’s Wharton School, prepared a research paper in  suggesting that the United States could have a real estate crisis similar to that suffered in Asia in the s. When she discussed her work at another Jackson Hole gathering two years later, it received a chilly reception, she told the Commission. “It was universally panned,” she said, and an economist from the Mortgage Bankers Association called it “absurd.”  FOMC20060920meeting--121 119,MS. YELLEN.," Thank you, Mr. Chairman. Since our last meeting, the data bearing on the near-term economic outlook suggest both slower economic growth and a bit less core price inflation going forward. In terms of economic activity, the recent news has been uniformly negative, resulting in a significant downward revision to growth in the Greenbook. Indeed, compared with the outlook of other forecasters, the Greenbook’s projection of real GDP growth for the second half of this year is quite pessimistic; it would now rank in the lower 5 percent tail of the distribution of individual Blue Chip forecasters. I think this pessimism is not completely unfounded, however, largely because of my worries about the housing sector. The speed of the falloff in housing activity and the deceleration in house prices continue to surprise us. In the view of our contacts, the data lag reality, and it seems a good bet that things will get worse before they get better. A major homebuilder who is on one of our boards tells us that home inventory has gone through the roof, so to speak. [Laughter] He literally said that. With the share of unsold homes topping 80 percent in some of the new subdivisions around Phoenix and Las Vegas, he has labeled these the new ghost towns of the West. In fact, he described the situation at a recent board meeting in Boise. He had toured some new subdivisions on the outskirts of Boise and discovered that the houses, most of which are unoccupied, are now being dressed up to look occupied—with curtains, things in the driveway, and so forth—so as not to discourage potential buyers. The general assessment is that this overhang of speculative inventory implies that permits and starts will continue to fall. Inventory ratios will rise, and the market probably will not recover until 2008. So far, builders remain hesitant to cut prices, fearing that doing so will cause a surge in cancellation rates on sold but unfinished homes. However, builders now routinely offer huge incentives, and price cuts appear inevitable. We have been following the Case Schiller house-price index, which is based on house-price data in ten large urban markets, three of which are in California. Beginning in May of this year, futures contracts on this price index also began trading; they suggest that house prices will be falling at an annual rate of about 6 percent by the end of this year. Of course, trading in this new futures market is still somewhat thin, but it is a signal that we need to keep a very close eye on the incoming data and watch whether the housing slowdown is turning into a slump. Turning to inflation, core measures of consumer price inflation remain well above my comfort zone, but the latest readings on consumer prices have been modestly better. Unlike the Greenbook, I think the outlook for inflation has actually improved a bit since our last meeting largely because of the recent drop in commodity and crude oil prices. The relief on energy prices is, of course, very welcome, but we do have to be careful not to overestimate the extent to which past energy price pass-through has been boosting core inflation. For example, airfares might seem like an obvious case in which outsized consumer price increases reflect energy price pass-through. However, our staff recently calculated the share of jet fuel costs to total airline operating expenses and estimated that the jump in those costs likely accounted for less than half the rise in airfares this year. Instead, airfares may reflect strong demand and constrained capacity as indicated by very high airline passenger load factors. Still it seems likely that energy pass-through has played at least some role in the run-up of core inflation this year, so any energy price pressure on core inflation is likely to dissipate over time. Now, as David noted, the Greenbook has completely offset the favorable effects on core inflation from lower energy prices by boosting the growth rate of labor costs. In contrast, I attach a little less weight to the recent data on compensation per hour. My guess is that most of the difference between hourly compensation and the ECI does relate to profit-linked items like bonuses and stock options, and that suggests to me that marginal costs of production are not rising significantly faster. Even if they are, it remains true that markups are high. So with sufficient competitive pressures, firms have room to absorb cost increases without fully passing them into prices. Finally, I want to add my compliments to those of others to the Board’s staff for a very interesting analysis of inflation dynamics and monetary policy. As I mentioned at our last meeting, it may be unduly pessimistic to assume that the recent rise in inflation will be highly persistent. Over the past ten years, estimated reduced-form models suggest that core inflation generally returns to its sample average after several quarters. Recently our staff examined persistence at a more disaggregated level and found that the same general pattern also holds for each of the major components of the core PCE price index, with price inflation for durables only slightly more persistent than price inflation for nondurables and services. In the current situation, this suite of regressive models indicates that core PCE inflation should fall to just below 2 percent by the middle of next year. I am not quite as optimistic as these simple models, but on balance my concerns about the inflation outlook have been slightly alleviated by recent developments." CHRG-111shrg57320--303 Mr. Doerr," Chairman Levin, I will be even more brief. I appreciate the opportunity to testify on my role with the FDIC in the supervision of Washington Mutual Bank (WaMu).--------------------------------------------------------------------------- \1\ The prepared statement of Mr. Doerr appears in the Appendix on page 155.--------------------------------------------------------------------------- I am George Doerr, Deputy Regional Director for the FDIC in the San Francisco Regional Office, a position which I have held since June 2007. I have been with the FDIC almost 40 years. From September 2002 until June 2007, I was Assistant Regional Director for the FDIC San Francisco Regional Office. The San Francisco Region covers 11 States--Washington, Oregon, California, Arizona, Nevada, Utah, Idaho, Wyoming, Montana, Alaska, and Hawaii, in addition to the Territories of Guam and American Samoa and also Micronesia. As Assistant Regional Director in those years, among my responsibilities was our Regional Large Bank Program, which included WaMu. The three matters the Subcommittee asked me to be prepared to address with respect to WaMu are, one, Non-Traditional Mortgage Guidance; two, WaMu's condition as assessed through the CAMELS ratings; and three, FDIC's Large Insured Depository Institutions Program and ratings, also referred to as the LIDI program. On behalf of the Corporation, we have provided discussion of these three matters in the written statement submitted to the Subcommittee. Thank you again for the opportunity to testify, and I am pleased to respond to any of your questions. Senator Levin. Thank you both. Mr. Doerr, first, take a look at Exhibit 51a, if you would.\1\--------------------------------------------------------------------------- \1\ See Exhibit No. 51a, which appears in the Appendix on page 392.--------------------------------------------------------------------------- " Mr. Doerr," OK. Senator Levin. It is a memo entitled, ``Potential Impact of Possible Housing Bubble on Washington Mutual.'' In this memo, the FDIC wrote an analysis of WaMu's single-family residential loan portfolio, focusing on Option ARMs, hybrid loans, low documentation loans, which means low number of document loans, payment shock, and geographic concentrations. Now, if single-family residential lending was traditionally safe, what were the risks that FDIC saw with these aspects of WaMu's lending that made it less safe than historical times? " CHRG-110hhrg38392--77 Mr. Bernanke," Well, the Federal Reserve has multiple roles, and the primary purpose of this hearing is to talk about monetary policy in the economy, and that is normally the only topic I would cover. In this case, though, the Federal Reserve also has some regulatory roles in reference to subprime mortgage markets in particular, and I thought this would be a useful opportunity to update this committee on some of the actions we are taking specifically in this particular market. The concerns are in terms of what the effects of tightened lending standards might be on the housing demand, for example, which is one of the factors affecting the growth of the overall economy. But the main concerns I was addressing in the latter part of my testimony were really the maintenance of legitimate subprime lending and the protection of consumers from abusive practices. " CHRG-111shrg56376--96 Chairman Dodd," I thank you very much, Senator Merkley. We will leave the record open for further questions, by the way, for all of you. Senator Bennett. Senator Bennett. Thank you very much. Probably, given the time, this will be more of a statement that you can ponder than questions that I want answers to, but I would like to get some answers later on. It will come as no surprise that I want to talk about ILCs, and no one has discussed the ILC charter in their written testimony. Let us point out that the growth of ILCs over the last 20 years has been one of the great successes in the financial services markets. They are the best capitalized and safest banks in the country. They were in no part a contributor to the financial crisis. They provide credit in places that it has not been available before, niche markets, a diverse set of products, and the Administration's proposal says, let us eliminate them. Now, I find that incredible, that something--we talk about Conseco, Lehman Brothers, CIT. All had ILCs, and as they were wound down, the ILCs were the assets that were the crown jewels. The ILCs were the assets that had the most value. And yet the proposal is, let us eliminate them. Let us eliminate the charter. Now, Mr. Tarullo, you made a comment that the center of this crisis is too big to fail and much of this discussion has been in that area of ``too big to fail.'' May I respectfully suggest that the center of the crisis is not ``too big to fail.'' ``Too big to fail'' is a manifestation that came out of the center of the crisis, and to put it in my very much layman's terms, the crisis was caused because of this game of musical chairs with respect to risk. And we built more and more risk into the system because while the music was playing, more and more institutions passed the risk on to somebody else thinking, to use the phrase that Sheila used, I have no skin in this game anymore, this game being this particular instrument. And you go with the change. It starts with the borrower. He has no risk whatsoever because there is no equity in the house. He is getting a 100 percent loan. Sometimes it is a liar loan. The broker who arranges the loan has no risk in the game because he passes it on to the lender. The lender has no risk in the game because he passes it on to the GSE. The GSE has no risk because with the rating agency that has no risk has rated it, and he can pass it on, securitize it, to somebody else. And at every step in the way, in the path, somebody makes money, on a fee, on a commission, whatever it might be. And when the music stops, it turns out that everybody had risk in the game because the whole thing collapses. And I would like to know a regulator who can focus on that question, not how big you are, but where are you in this chain of musical passing on of risk, musical chairs, if you will, that says somebody can say, no more loans in the beginning. No more liar loans. To brokers, no, you can't pass this on. You have to have some kind of a risk if you get involved in brokering this loan so you will then by market pressure do your job better to see to it that you don't pass it on. To the lender, you maintain some kind of risk as the chain goes forward. The GSE, you maintain some kind of risk. The rating agencies, you will get a risk. But no one had any risk and the bubble, therefore, grew and grew and grew because everybody was making money with no exposure. And that is the problem that I want to solve with this restructuring rather than working around some of the turf battles that we have talked about. Now I will go save the republic and you can respond to Chairman Warner. [Laughter.] Senator Warner [presiding]. Does anybody want to respond? " FOMC20061212meeting--71 69,MR. LACKER.," Thank you, Mr. Chairman. Economic activity continued to expand moderately in our District in November. Manufacturing shipments and new orders bucked the national trend and rebounded last month following an October dip. Revenues and hiring slowed a bit in the service sector but continued to expand moderately. Retail was a bright spot: Stores reported an uptick in sales and customer traffic for November, including the Thanksgiving weekend. Our store contacts were generally optimistic about sales prospects for the coming holiday season. Fifth District housing activity continues to soften on the whole, although there are areas that have seen much less, if any, of a slowdown. We’re not hearing any reports of cutbacks in capital expenditures, and commercial real estate markets appear to remain fairly strong in our District. Reports on price pressures were mixed in November but remained at elevated levels. At the national level, an essential question seems to be how long the current weakness will persist. To a large extent this question centers on the housing market, and it’s still hard to pin down the outlook with much certainty. The special survey on homebuilders paints a picture that varies widely across the country. Construction activity is falling at a rapid clip in many regions, but many housing markets are still fairly stable. Nationally, there are some indicators suggesting that housing demand has stabilized at a low level. Sales of new homes have been fluctuating around an annual rate of 1 million since July, and purchase mortgage applications have been fairly flat since then as well. But the national data also show a sizable overhang of housing inventory that will continue to depress new building activity going forward. If—and, like David, I recognize this is a big “if”—the demand for housing holds up at current levels—and favorable fundamentals such as moderate mortgage rates and continued real income gains should help—then the adjustment process is simply a matter of working inventories down. This is consistent with the Greenbook’s estimate that residential investment will no longer subtract from real GDP growth after the first half of next year. The strength in nonresidential construction has until recently offset the decline in residential. Most recent reports show nonresidential construction spending and employment falling in recent months, although I’m struck by the fact that there are hardly any references in the Beige Book to deterioration in commercial construction and we aren’t hearing such reports from our contacts either. So I’m not sure how much to mark down the nonresidential outlook just now. As David said, consumer spending keeps chugging along at about 3 percent despite weakening auto sales. This is notable because one way the housing downturn could spread to the remainder of the economy is through a wealth effect. So far I’m not persuaded by this gloomy view, and I think there are good reasons to doubt it. Household net worth looks pretty strong, and equities continue to advance. The other leading candidate for a spillover channel is the labor market, but so far the weakness in construction and real-estate-related employment has not been large enough to offset the broader strength in employment. I remain skeptical of a housing-induced step-down in consumption growth. Business investment continues to be a source of strength. The Greenbook notes the possibility of negative accelerator effects, but the other fundamentals still look good. Profitability is high, and cost of capital is low. Moreover, financial markets are not showing signs of impending business weakness or investment slowdown. In sum, it looks as though the current weakness is likely to be relatively transitory, and after the housing market correction plays out, we should return to near-trend growth. There are risks to this outlook, to be sure, but this is what looks most likely to me right now. The recent news on inflation has been disappointing yet again. It is now quite difficult to discern any moderating trend in core PCE inflation over the past several months. You have to be really careful in selecting how many periods you average over, and I have serious doubts about the forces that are described as slowing inflation over the forecast period. First, the recent fall in energy prices is now behind us by a couple of months, and prices are beginning to rise again. If the Greenbook forecast is correct and in 2007 crude oil prices rise somewhat above their current level of $62 per barrel, then we have seen all we are going to see of the abatement of the effects of higher energy prices on core inflation, speaking to President Plosser’s point. Second, since the odds seem to favor a further depreciation of the dollar, I think import prices are unlikely to help ease inflation much. Third, as we’ve discussed at previous meetings, the projected increase in unemployment is not likely to have much of an effect on inflation, over the forecast period at least. On top of all this, inflation expectations appear to be anchored between 2 and 2¼ percent right now, and they’re likely to exert a gravitational pull counteracting any moderation of inflation. Thank you." FOMC20061212meeting--106 104,CHAIRMAN BERNANKE.," Thank you. Let me just summarize and add a few comments. As Governor Kroszner mentioned, we had an avalanche of data, and the snowman is still standing in the same place as before. [Laughter] Most people still see a two-track or bimodal economy. In the first part of the economy— the goods economy, housing and manufacturing—there seems to be some softening since the last meeting but not a large change. Housing remains the center of the weakness. There are some indications that demand for housing may be stabilizing, but a few people noted that there are probably still some downside risks in that sector. Manufacturing is also becoming a bit softer, partly but not entirely linked to housing. Automobiles, too, have softened, and a few other areas as well, as I’ll discuss later. One interesting point was that, where the aggregate data show some decline in growth in commercial real estate and the Greenbook seconds that conclusion, the anecdotes do not seem all that consistent with it. The second part of the economy, which is focused primarily on services, remains quite strong, particularly in sustaining a robust labor market with good income growth. Together with lower energy prices, those factors are leading to well-sustained consumption, which is continuing to drive the economy forward. A few people mentioned balance sheet issues for the consumer, but the references to balance sheets were both negative and positive. Looking forward, again to compliment the staff, I think most people around the table accepted the general contour of the Greenbook forecast—that is, moderate growth perhaps below potential for the next few quarters but returning to potential growth later next year, with risks to the upside as well as to the downside. So far there is little evidence of spillover into consumption in particular, although obviously we have to keep an eye on that. There are a number of strong underlying conditions, including supportive financial conditions, strong profits, and a strong international economy, which are providing a cushion to the economy. On inflation, I have to say there wasn’t much change in view. Most of you still expect a gradual decline in inflation. Others are concerned that we might get stuck at current levels. Even those who expect a gradual decline remain somewhat concerned about the pace of the decline. Some of the factors that may return inflation to lower levels are a slowing economy, well-contained inflation expectations, and the downward revisions to the wage data. Those who are more concerned about inflation cited the weakening dollar, accommodative financial conditions, and the expectation that growth will not be below potential for very long. So I think that some of these concerns and risk assessments do not seem markedly different from those at our last meeting. Let me add just a few comments. These are all marginal because I think the broad outlines of the story and the risks are quite reasonable. First, I think I took a bit more weakness from the data in the first part of the economy than some people around the table. The Greenbook has single-family housing starts leveling out at current levels. They did fall 16 percent in October. We’re not entirely sure that they will, in fact, stabilize. Multifamily construction permits have been dropping: They’re off about 30 percent since the first quarter. That had been a source of stability so far this year. There might be a bit less strength there. Then, nonresidential construction is an issue. The data, in terms of employment and construction put in place, suggest some slowing, and I do think that some slowing from the very strong pace of earlier this year is pretty much inevitable. But the sense of the Committee must be that we will have to wait a bit longer to judge how much that is going to slow. In manufacturing, obviously the strongest slowdowns are related to autos and housing. But if you look at employment and the ISM data, for example, you also see weakness in areas like machinery and electrical machinery, which suggests some possible weakness in equipment and software spending going forward. This remark does not represent a major difference with the Committee; I just saw a bit more weakness in the first area than some did. At the same time, like many members of the Committee, I see a very strong labor market and a very strong services sector plus a very strong nonmanufacturing ISM, which, though it includes construction, was nevertheless still very strong. One begins to wonder a bit about the measurement of the services sector—whether or not we are understating growth and productivity in that sector. That’s a question we’ll need to continue to consider. So like most people around the table, I think that a soft landing with growth a bit below potential in the short run looks like the most likely scenario. I expect the unemployment rate to increase gradually but income growth and other factors to be sufficient to keep consumption above 2 percent, which is essentially what we need to keep the economy growing. Again, I see the risks going in both directions. Let me add a couple of extra comments about risks in the housing market. I talked last time about the dynamics of starts. Even if final demand stabilizes, starts may take a time to fully work out the inventories. A couple of other factors are like that, which I just would like to bring to your attention. One has to do with the very strong presumption we seem to have now that demand for housing has stabilized. That may be the case, but I would point out that we have seen a very sharp decline in mortgage rates. People may have a sort of mean-reverting model of mortgage rates in their minds. It could be they are looking at this as an opportunity to jump in and buy while the financial conditions are favorable. So even if rates stay low, we face some risk of a decline in demand. The counter argument to that, which I should bring up, is that if people thought that prices were going to fall much more, then they would be very reluctant to buy. That’s evidence for stabilization of demand. Another point to make about housing is that, even when starts stabilize, there are going to be ongoing effects on GDP and employment. On the GDP side, it takes about six months on average to complete residential structures. Therefore, even when starts stabilize, we’re going to continue to see declines in the contribution of residential construction to GDP. On the employment side, I asked Bruce Fallick of the staff to run a regression of residential construction employment on residential single-family starts and to project forward what the employment results are going to be. According to this regression, if starts stabilize at the October level, as projected by the Greenbook, the job losses in that sector will actually continue to rise for the next two or three months and return to the November level of about 15,000 per month only by the middle of next year. There will be lagged employment effects from the housing sector and presumably from the associated manufacturing sectors, like appliances and furniture, which also tend to lag. So there will be some employment drag coming forward, and I think it’s reasonable to think that unemployment rates will start to rise. But, again, this is about 15 percent of the economy as compared with 85 percent of the economy. On inflation, I agree that the latest core PCE number was disappointing. I think perhaps it overstates the trend a bit, just as the core CPI number understates the trend a bit. I think there are still indications of a mild deceleration in prices, and most of the factors supporting that are coming into place, including the slowing of rents, the improved energy situation, some increase in slack, and expectations, which include a five-by-five-year expectation which has come down about 20 basis points since we stopped raising rates in August. So I think there are some bases to expect a gradual decline in inflation. I would note also that outside forecasters are a bit more optimistic about this than the Greenbook is. For example, the Blue Chip median forecast of core PCE inflation for next year is 0.2 percentage point lower than the Greenbook on a comparable basis. I’ve talked before about owners’ equivalent rent, which is a somewhat special category, and I’ve indicated that I think its slowing will contribute to slower inflation. In the interest of being even-handed, let me talk about a category that might go in the other direction, which is medical costs. Medical costs in the short run depend a great deal on government policy, Medicare reimbursement decisions, and the like. Therefore, only in the medium term will they respond to monetary policy. I think that’s a source of risk. The twelve-month change in medical costs has been declining: It was 4.3 percent in 2003, 3.5 percent in 2004, 3.3 percent in 2005, and 2.9 percent so far this year. So that gradual decline in medical costs has been a positive in terms of inflation. But in the latest month, the number was 0.6 percent on a one-month basis, or more than 7 percent on an annualized basis. To the extent that we see some bounceback of medical costs, that’s going to be another factor of concern in terms of inflation going forward. Again, however, I think that we have some reason to think that inflation will slow, but I don’t disagree with the very wide sentiment I hear around the table that the slowing is far from certain and that the risks are still to the upside on inflation. Are there any comments on or questions about my summary? If not, let’s go to Brian, who will introduce the policy discussion." 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. " FOMC20061212meeting--186 184,MR. KROSZNER.," Given that the avalanche hasn’t really moved our assessment very much, I certainly don’t see any reason to move interest rates now. I think it is important to acknowledge in section 2 some of the slowing that we’ve seen. As we have discussed, there are two ways to do that. One is to include the substantial cooling of housing. I think there’s consensus for that—I haven’t heard anything said to the contrary—and I think it’s important that we do have that. Then the question is whether we want to go further and whether we can do that clearly, rather than cause confusion. Obviously, the simple option is just to cut it all out—take the Minehan approach and say “substantial” is sufficient. As Governor Warsh mentioned, we’ve been thinking about a simplified version of alternative B that mentions just some “recent indicators.” Then we can get out of the discussion of production, spending, and the specifics. But I do think that’s better than saying “growth.” It’s also better to talk about some of the indicators rather than just the overall growth number, which was in exhibit 4. So I think exhibit 5 is better that way. Then it’s a nuance whether we want to include “somewhat subdued,” “slightly weaker,” or “mixed,” and whether we use “were,” “have been,” or “are.” I’m not quite sure exactly where I stand on all of those, but I do think that simplifying the language to some degree and just saying something about indicators would be the way to go." CHRG-111hhrg61852--63 Mr. Koo," After the bursting of a major nationwide asset price bubble, banks are hit very badly as well, and that is what happened in Japan. That is what is happening in this country as well. Commercial real estate prices in Japan fell 87 percent from the peak. And just imagine Washington, D.C., down 87 percent. What kind of banking system do you think you would have left? That is the challenge we faced in Japan. And when all the banks have the same problem at the same time, we have to go slowly. There is no way we can go quickly, because if they tried to sell the nonperforming loans, there won't be any buyers. Asset prices would collapse even further, and that makes the situation far worse. Mrs. McCarthy of New York. The gentleman's time has expired. I remind the members that if you keep your questions shorter, you can actually get some answers. Mr. Scott from Georgia. " FOMC20061025meeting--83 81,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. Our view of the national outlook hasn’t changed much since September. If monetary policy follows the path that’s laid out in the Greenbook, and it’s flat for the next few quarters, then we expect growth to return to a level close to 3 percent in ’07 and for inflation to moderate gradually from current levels. However, we still face the basic tension in the forecast—the combination of relatively high core inflation today and an economy that has slowed significantly below trend—and we still face the same basic questions: Will inflation moderate enough and soon enough to keep inflation expectations reasonably stable at reasonably low levels? Will weakness spread beyond housing and cumulate? Relative to September, we see somewhat less downside risk to growth and somewhat less upside risk to inflation, but as in September, I think inflation risks should remain our predominant concern. Relative to the Greenbook, we expect somewhat faster growth in ’07, but we have a higher estimate of potential. The difference is really mostly about hours and trend labor force growth. We expect more moderation in core PCE and expect it to fall just below 2 percent in ’07, but this difference is mostly the result of different assumptions about persistence. With these exceptions, our basic story about the contour of the expansion is fairly close to the Greenbook, and the implications for monetary policy are similar. The markets do seem relatively positive, a little more optimistic about the near-term outlook. Equity prices, credit spreads, and market interest rates all reflect somewhat less concern about both recession and inflation risks. Some of this, however, is probably the result of the exceptional factors supporting what the markets call liquidity. What is liquidity, and what’s behind it? I don’t know that we have a good answer to that. Most people would cite a combination of the facts that real interest rates are fairly low in much of the world still, that reserve accumulation by the countries that shadow the dollar is still quite large, that a big energy-price windfall is producing demand for financial assets, particularly in dollars, and that there is confidence in the willingness and ability of the central bank, particularly this central bank, to save the world from any significant risk of a recession. I don’t think all of this, therefore, is the result simply of confidence about fundamentals, so we shouldn’t take too much reassurance. But it still is a somewhat more positive constellation of asset prices, of market views about the outlook. Someone wrote this week that the fog over the outlook has lifted. I don’t think that’s quite right. It’s true that the economy still looks pretty good except for housing, and I do think it’s fair to say that core inflation is moderating and that expectations are behaving in ways that should be pretty reassuring to us. But it is too soon to be confident that inflation is going to moderate sufficiently soon enough with the path of monetary policy priced into markets today, and it is too soon to be confident also that the weakness we see in housing, in particular, won’t spread and won’t cumulate. So I think that overall the balance of risks hasn’t changed dramatically, and as in September, I still view the inflation risk as the predominant concern of the Committee." 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. " FinancialCrisisReport--43 A third problem, exclusive to state regulators, was a 2005 regulation issued by the OCC to prohibit states from enforcing state consumer protection laws against national banks. 91 After the New York State Attorney General issued subpoenas to several national banks to enforce New York’s fair lending laws, a legal battle ensued. In 2009, the Supreme Court invalidated the OCC regulation, and held that states were allowed to enforce state consumer protection laws against national banks. 92 During the intervening four years, however, state regulators had been effectively unable to enforce state laws prohibiting abusive mortgage practices against federally- chartered banks and thrifts. Systemic Risk. While bank and securities regulators focused on the safety and soundness of individual financial institutions, no regulator was charged with identifying, preventing, or managing risks that threatened the safety and soundness of the overall U.S. financial system. In the area of high risk mortgage lending, for example, bank regulators allowed banks to issue high risk mortgages as long as it was profitable and the banks quickly sold the high risk loans to get them off their books. Securities regulators allowed investment banks to underwrite, buy, and sell mortgage backed securities relying on high risk mortgages, as long as the securities received high ratings from the credit rating agencies and so were deemed “safe” investments. No regulatory agency focused on what would happen when poor quality mortgages were allowed to saturate U.S. financial markets and contaminate RMBS and CDO securities with high risk loans. In addition, none of the regulators focused on the impact derivatives like credit default swaps might have in exacerbating risk exposures, since they were barred by federal law from regulating or even gathering data about these financial instruments. F. Government Sponsored Enterprises Between 1990 and 2004, homeownership rates in the United States increased rapidly from 64% to 69%, the highest level in 50 years. 93 While many highly regarded economists and officials argued at the time that this housing boom was the result of healthy economic activity, in retrospect, some federal housing policies encouraged people to purchase homes they were ultimately unable to afford, which helped to inflate the housing bubble. Fannie Mae and Freddie Mac. Two government sponsored entities (GSE), the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), were chartered by Congress to encourage homeownership primarily by providing a secondary market for home mortgages. They created that secondary market by purchasing loans from lenders, securitizing them, providing a guarantee that they would make up the cost of other requirements, the rules prohibited lenders “from making loans based on collateral without regard to [the borrower’s] repayment ability,” required lenders to “verify income and obligations,” and imposed “more stringent restrictions on prepayment penalties.” The rules also required lenders to “establish escrow accounts for taxes and mortgage related insurance for first-lien loans.” In addition, the rules “prohibit[ed] coercion of appraisers, define[d] inappropriate practices for loan servicers, and require[d] early truth in lending disclosures for most mortgages.”). 91 12 CFR § 7.4000. 92 Cuomo v. Clearing House Association , Case No. 08-453, 129 S.Ct. 2710 (2009). 93 U.S. Census Bureau, “Table 14. Homeownership Rates by Area: 1960 to 2009,” http://www.census.gov/hhes/www/housing/hvs/annual09/ann09t14.xls. any securitized mortgage that defaulted, and selling the resulting mortgage backed securities to investors. Many believed that the securities had the implicit backing of the federal government and viewed them as very safe investments, leading investors around the world to purchase them. The existence of this secondary market encouraged lenders to originate more loans, since they could easily sell them to the GSEs and use the profits to increase their lending. FOMC20060510meeting--110 108,MR. HOENIG.," Thank you, Mr. Chairman. Let me start with our District. Evidence from the District continues to show strong growth. While consumer spending has shown some modest slowing, retailers remain very optimistic in our surveys about future sales, and this despite some of the recent increases in energy prices. Manufacturing activity continues to grow solidly, and energy activity remains, of course, very strong in our area, with continued reports of shortages of both labor and equipment. Housing markets in the District are cooling, as you’ve heard described elsewhere, and illustrate I think a potential downside risk overall. Though it’s still high by historical standards, residential construction continues to edge downward. Home sales were still growing modestly in most areas but not fast enough to absorb the supply of homes being brought on the market. As a result, first-quarter inventories in the largest District markets have grown markedly relative to a year ago. In addition, foreclosures also point to some weakening in the housing market. I guess the most notable is a 31 percent increase in March over the previous month that pushed Colorado to the highest foreclosure rate in the nation—as reported anyway. One factor behind the increase is the unusually widespread use of interest-only mortgages in that state. However, nonresidential construction in Colorado and elsewhere in the District appears to be taking up some of the slack from the housing side. Let me turn to the nation and try to be brief. The contours of the outlook that we have are similar to what I reported at our last meeting and not unlike that from the Greenbook. Several factors suggest that the economy will slow over the forecast period. First, as I’ve suggested before, the removal of policy accommodation continues to have its effect. Second, long-term interest rates have, as others reported, risen noticeably. Third, energy prices continue to increase, reducing consumer purchasing power. Finally, we’ve been forecasting a slowdown in housing, but there is a risk that the slowdown could be actually larger than expected. Of course, there are counterbalancing factors that would show continued growth. Those have been outlined by others, but certainly the past stimulus in the amount of liquidity in the market has its effects. In addition, we are seeing improvements in employment and in income, which should help keep the economy moving forward. On the inflation outlook, as others have noted, the recent increase in inflation is a concern to me, but it is not a surprise. We have been expecting last year’s increase in energy prices to feed into a temporary rise in core inflation. We’ve seen that. More recent increases in energy are going to complicate that situation. So in the end, as we prepare for the next portion of this discussion this morning, I would agree with all my colleagues on one thing—monetary policy is going to be much more difficult in the next few months. [Laughter]" CHRG-109hhrg31539--4 The Chairman," The gentleman's time has expired. The Chair now recognizes the gentlelady from Ohio, the subcommittee chairwoman. Ms. Pryce. Thank you, Mr. Chairman. And thank you, Chairman Bernanke, for being with us here today. I was pleased to read in your testimony that you believe that even though the economy is currently in a transition period, that it will continue to expand even under the pressure of increased oil prices, consumer spending, and a slowing housing market. I would like to talk about that just briefly. Studies have shown that housing accounted for more than one-third of economic growth during the previous 5 years. The robust housing market had enabled homeowners to reduce their debt burdens and maintain adequate levels of consumer spending by tapping into the equity of their homes. Unfortunately in research done by the National Association of Home Builders, they show a serious downtrend in housing demand that many believe correlates with the rise in interest rates by the Federal Reserve. As I have said in the past, I am concerned that this house price boom has been driven far more by investors than ever before, and could lead to a series of mortgage failures, and as the Federal Reserve tries to balance rising rates with fluctuations in the markets, I don't need to remind you that your actions have a trickle-down effect to local communities, and losses on housing investments are just one example. A study by the Mortgage Bankers Association puts my own State of Ohio at the very top of the list of foreclosures, and so we are very concerned in the Midwest. Although we would sometimes like to think of our economy as one that stands apart from the rest of the world's sociopolitical issues, the effect of volatility overseas is reaching into our economy more than we might realize. Just yesterday I held a hearing in my subcommittee on currency issues. We had representatives there from the Federal Reserve and the Mint discussing with us the rising cost of the commodities and materials that make up our coins. We heard these commodities are affected by the volatility in the world or through rising demand in other markets, and are also themselves affecting our inflation here in the United States. The more they cost, the more they drive up the cost to make our currency, and the more it drives up costs overall. In your remarks at the Senate yesterday, you touched upon a number of issues concerning citizens, such as rising rates, gas prices, and wage earnings. One of the issues that has been important to me, and a number of other members on this committee, is the ratio of consumer debt to consumer savings in America, and the effects that a slowing economy could have on a more local level. I agree with your statement yesterday that we must be forward-looking in our policy actions, and I would appreciate hearing your thoughts on what Congress can do about low savings rates, especially coupled with rising consumer costs. Some of us, Mrs. Kelly, Mrs. Biggert, Mrs. Maloney, and myself, have worked to bring this issue to a national focus for a number of years, and we mentioned it repeatedly, working with the Administration to highlight increasing financial education in the United States, but much more needs to be done. You also talked about an international savings glut that I believe we have here in America, a credit glut. I believe we can say it is almost a national epidemic. Consumer spending is key to our continued growth, but I believe we also need to send a message that consumer savings is just as important, and I appreciate hearing from you what the Federal Reserve and the rest of us can do to help consumer savings become a priority in this Nation. And I want to thank you once again, Mr. Chairman, for your appearance. I look forward to your testimony, and I yield back. Thank you. " 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? " FOMC20060920meeting--123 121,MS. MINEHAN.," Thank you very much, Mr. Chairman. New England continues to grow modestly, though recent data suggest that some caution is warranted. District employment growth remains slower than that of the nation. Most states in the region are back to their January ’01 levels of employment; but the largest states, Massachusetts and Connecticut, are not. The Philadelphia Fed indexes of overall state activity, which are based largely on employment- and wage-related data, suggest sluggish growth as well, with Maine and Massachusetts at or near the bottom of the index for the country as a whole. Even with slow labor growth, certain categories of positions are very hard to fill—in particular, finance, accounting, certain IT specialties, engineers, biotech, and skilled labor for manufacturing. In fact, one large aircraft manufacturer was quoted as saying that the labor situation as far as he was concerned was insane. Costs for acquiring certain kinds of labor are rising, but in general, we are not seeing increases across the board in overall expected labor costs. But given the kinds of labor that are very much an important part of the businesses in the First District, such increases may not be far off. Housing markets are clearly contracting. We are part of the coastal situation. Through the second quarter, New England house prices escalated at only half the pace of the United States as a whole, and home foreclosures, while still fairly low, ticked up more significantly in the region than elsewhere. Permits have fallen sharply, down 25 percent from last year and 22 percent from the year before, though yesterday’s starts data were a bit better for the Northeast than elsewhere. Slower building is leading suppliers of housing products to project declining business later this year as their sales tend to lag a decline in residential real estate markets. Consumer confidence for the region as a whole dropped off at a faster pace than elsewhere in the nation in August compared with the year before. So there are all those reasons for caution about the growth rate of the New England economy, but not all the data are bad. Consumer prices, in general, are escalating more slowly, even though energy costs are higher. Downtown and suburban office vacancy rates are down, and rents are rising. Hardware and software businesses that were contacted or that are represented on our small-business advisory group report fairly strong revenues and definite concerns about costs. Business confidence measures and surveys were positive both for Massachusetts and Connecticut, reflecting profitable trends and stronger sales and even some strength in manufacturing. As I mentioned at our last meeting, the growth in personal income in the region, despite slow job growth, is on a par with that of the nation. Reflecting this and strong corporate profits, state income, sales, and corporate tax revenues are up, in some cases by relatively large percentages. So even though we have some reasons to be concerned about New England, not everything is negative—though that is sort of hard to find in the local media and you certainly will not hear the politicians talking about it either. Turning to the nation, I would agree that most incoming data since our last meeting have been on the subdued side. Auto sales, trade data, and certainly anything to do with residential real estate markets have been more subdued than was expected. Of course, price measures have been subdued as well, at both the headline and the core levels. But like New England, not everything is slow. I would look at employment growth as fairly solid, even though it has slowed from the beginning of the year. The surprise in wage and salary income may reflect largely the exercise of stock options, but it could also reflect some pressure on overall wage costs because hiring certain kinds of workers is getting difficult. Oil prices are down, and gasoline price declines act as a kind of bonus to the consumer. Consumer spending isn’t too bad. The latest retail sales data aren’t bad at all; and although confidence bounces around a bit, it seems to have recovered—at least as much as gasoline prices have recovered. Industrial production seems pretty good, with strong growth in some equipment categories. Business profits are good. Orders and shipment data suggest that business spending is solid. I am sort of repeating everything you said, David, and I probably should not do that. But I seem to be at the same point as people you mentioned in your presentation might be—a little shocked by the slowness of expected GDP over the next couple of quarters. In fact, when we in Boston look at our baseline forecast, it is a good deal more optimistic largely because we are not seeing as much of a decline in residential investment. I found the briefing yesterday to the Board interesting, when you tracked your own forecast of residential investment. At one time we were lower than you were, but you far surpassed us. In fact, with your decline 50 percent greater than ours in ’06 and quite a bit larger again in ’07, we get a GDP that is 0.3 percentage point higher in ’06 and almost 1 percentage point higher in ’07. We also see a lower NAIRU, and we have a bit higher estimate of potential—so it does not affect the gap as much, but it does affect the headline number of GDP. I understand all the mechanics, but the staff forecast is lower than most private forecasts. I wonder, if growth is that low for that long, whether it might set off a chain reaction of actually higher saving rates than you project and lower confidence that could feed back more strongly than you have anticipated. In that regard, I found the recent estimates of a rising probability of recession interesting. I do not think we’re going to have a recession, but I do wonder about it if, in fact, we do realize the slow growth of the Greenbook forecast. However, how much do we really know about how long residential investment will stay negative without a recession? Mortgage rates are not up that much—only 50 basis points or so from the beginning of the year. Incomes are rising, and nonhousing wealth is rising. At some point, buyers should recognize that housing has gotten more affordable and resume desired purchases, perhaps without further major price declines. Certainly speculative building is off, and investors have backed out of contracts, but how much more of that really will occur? The Greenbook would suggest another year and a half, but shouldn’t builders be acting quickly now to reduce the amount of overbuilding and to preserve price levels? Underlying demographics and other fundamentals have not changed either. So it is hard actually for me to see that residential investment will be that hard hit that long. I take Janet’s comments about the builders in her District. I imagine that, if I had talked directly to builders in the First District, they might have been pretty gloomy, too—again, given some reflection of the coastal situation. I did talk to Nick Retsinas at the Joint Center for Housing Studies, which Harvard runs, and he was not particularly negative. He felt that a correction is occurring but thought that it would be short-lived. Now, he did say that they were going to come out with some revisions and that he was still working on them, so his outlook may get more negative. But I am going to try to keep tabs on where they see things because they do stay in touch with all the large builders across the country. Again, the knock-on effects of lower residential construction may not be all that great. You mentioned that nonresidential construction is up, but the Greenbook says that it will slow soon. A good deal of that is oil related; and as long as people are working, incomes are solid, and financial conditions remain pretty accommodative, consumption ought to remain solid. So I wonder whether the Greenbook baseline is really more of a worst-case scenario for residential construction and GDP, though I realize regional effects of the housing slowdown on employment and spending could be considerable. If growth is faster and if your estimates of the NAIRU and the participation rate are more or less on target, I also wonder about the risks of higher inflation over the forecast period than is the case in the baseline as resource pressures grow. Moderating energy costs are helping here, but they have been volatile in both directions, and I at least would like to see a somewhat longer period below recent highs before declaring victory. In sum, the rather benign baseline forecast may be the best; but as you noted, there are great ranges of uncertainty. There are downside risks to be sure, and it is impossible to rule out a recession given the slow growth forecast of the Greenbook. But I really think the risks to be concerned about lie in the area of stronger growth, more pressure on resources, and higher and more persistent inflation. As many other people have commented, I, too, found the material on inflation persistence of some interest and very well done, though I take the point that it is hard to be confident either about the definition of persistence or about whether it is, in fact, lower or higher. I would argue here that it might be better to assume, as we consider the stance of policy, more rather than less persistence, in part because we are uncertain and in part because the costs of being wrong are somewhat asymmetric. If inflation is less persistent and we assume it is not and take a conservative policy stance, inflation should retreat quickly and help shore up our credibility. Choosing a weaker stance and being wrong about it could be quite costly. Given the uncertainties facing us, the nature of the incoming data, and the fact that we have already paused, it might not be time right now to take out more inflation insurance, but I certainly think it is time to be very vigilant. Thank you." 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.] " FOMC20060328meeting--132 130,MR. STONE.," Thank you, Mr. Chairman, and welcome back. And welcome to the new Governors. First, I’d like to make a couple of comments on the region before I talk about the national economy. The Third District didn’t see a fourth quarter as weak as the national economy, nor is our first quarter as strong. But we’re seeing solid growth, which our indicators tell us will continue at current rates for the foreseeable future. Payroll employment is a particular issue in our District. With the benchmark revisions that were made, our employment growth has been stronger than we originally estimated. Our three-state unemployment rate fell to 4.4 percent in January, and businesses report an increasingly difficult time finding qualified workers. Indeed, more than half the respondents to a special question on our manufacturing survey said that they were having trouble filling openings because of the lack of qualified applicants. That’s an increase from 40 percent when we asked that question two years ago. Firms report the greatest difficulty in finding production workers and computer-savvy employees, but I would go on to point out that one of our directors, who heads a temporary employment agency, has been reporting for the past two years a continuing difficulty in finding workers with even limited skills to deploy. Manufacturing in our area continues to expand at a moderate pace. After a temporary dip in January, the index in our survey has rebounded to the level consistent with last summer, and that level is consistent with moderate expansion in activity. Retail sales in our District are rising only modestly, but retailers tell us that weaknesses in February were weather-related and that they expect a pickup in April. Demand for nonresidential office space in the District is growing, and that’s unusual for our market. The office market absorption rate is rising in the Philadelphia metropolitan area, and the office vacancy rate is declining in both the city and the suburbs. We had some office building in the last couple of years, which is the first office building we’ve had in downtown Philadelphia in a decade. We are seeing a few signs of modest slowdown in housing markets, with permits, home sales, and mortgage lending softening in recent months. Finally, we have received some further welcome news of moderation in price pressures in the District. Our manufacturers’ survey measures of prices received and prices paid have fallen sharply over the past two months. Expectations of future price increases remain subdued, and several respondents told us that, in their view, input price pressures have settled down and that their inflation concerns have subsided. Turning to the national economy, our economic outlook is broadly consistent with the Greenbook baseline. All signs point to a strong rebound of growth this quarter, after the temporary weakness in the fourth quarter. Employment, business spending, and manufacturing remain strong, and consumer spending continues to increase at a solid pace. There are emerging signs that the housing market is beginning to cool off, but no signs of a sharp retrenchment at this point. The economic fundamentals remain solid, and after the rebound this quarter, we expect growth to settle down to a range of 3 percent to 3½ percent, near potential growth. The economy is expected to remain near full employment, with labor markets tight. We expect hourly compensation growth to accelerate somewhat over the forecast period, but not dramatically. Now, in my view, the risks to growth are roughly balanced. A sharper decline in the housing market than that built into our forecast poses some downside risk, but it’s also possible that housing will not turn down as much as or as soon as forecasted. The extent to which we see an improvement or further deterioration in exports is another risk that could go either way. In fact, there appears to be a considerable divergence of views on the path of net exports among private- sector forecasters. In my view, the inflation risks are tilted somewhat to the upside. It’s true that the data on core inflation and inflation expectations and our own recent decline in survey measures of prices paid and received are encouraging. The acceleration of core inflation at the end of 2005 has been reversed in the first months of 2006. So far, firms have had a remarkable ability to absorb cost shocks via new-found productivity gains, and increased global competition has limited their pricing power. Both have helped keep inflation in check. On the other hand, oil prices remain at high levels and continue to be volatile. The ability of firms to maintain low pass-through in the presence of continued higher costs is a question. With inflation running near the top of the range that I consider consistent with price stability and with the economy operating at high levels of resource utilization, there is a risk that strong inflation pressures could emerge. Several times in the past we have seen core inflation quickly rise by a sizable amount when the economy was operating at high levels of resource utilization following periods of accommodative monetary policy, even when oil prices did not rise sharply. So in my view, the inflation risks remain at least moderately on the upside, even though the recent data have been benign. That said, on the whole I think the economy and the economic outlook are very positive. Thank you." FOMC20060808meeting--70 68,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. Growth has moderated, but the economy still seems, to us at least, likely to grow at a reasonably good pace over the forecast period, somewhere in the vicinity of 3 percent. We expect core inflation to moderate gradually from current levels, declining to around 2 percent in ’07. This forecast assumes that monetary policy follows a path fairly close to what’s in the market and in the Greenbook. The key difference between our view of the outlook and that of the Greenbook forecast is in the strength of demand growth relative to potential next year. We have reduced a bit our estimate of potential and also of actual growth, but we still expect the economy to expand at a rate close to potential. This is a very favorable forecast, and we have to recognize, of course, that the economy is going through a set of extremely complicated transitions, including a large, adverse, sustained relative price shock of uncertain duration and a substantial adjustment in asset prices that is now concentrated in housing. Our capacity to anticipate the evolution of these forces and to assess their effect on growth and inflation is, of course, very limited. The forces that now appear to be working on the economy still present the unpleasant combination of upside risk to inflation and downside risk to growth; but for the moment we believe that the former, the possibility that our forecast is too optimistic on inflation, remains the predominant risk. I have a few points on the growth outlook. The economy has clearly slowed, and the composition of growth within the United States and here relative to the rest of the world has changed. These changes were inevitable, and if they continue to occur smoothly, they seem desirable and necessary. As a share of aggregate demand within the United States, residential investment had to contract and consumption had to slow. And U.S. domestic demand had to slow relative to domestic demand growth in the rest of the world. The key issue we face is judging whether we have significantly more weakness ahead of us than we are now expecting. In our view, most signs at present point to fundamentally healthy economic conditions. The survey-based measures of confidence are holding up okay. Real household income growth seems likely to be good going forward. Businesses have the resources and the motivation to sustain fairly strong rates of investment growth. Structural productivity growth, even post- revision, still seems strong. Inventory levels remain relatively thin, and the tentativeness that characterized much of the expansion in terms of investment and hiring should be a source of some comfort. Global demand is still quite strong, of course, and together these forces will offset part, but not all, of the weakness coming from the adjustment in housing and consumption growth. The principal risk to this outlook for growth lies in the possibility that households will slow consumption more sharply because of rising energy costs, higher interest rates, greater pessimism about future income gains, or the effect of the housing adjustment on perceived wealth. Financial markets are showing a little more concern about future growth, but not a lot. This concern is most evident in the greater inversion in the yield curve that has emerged at the one-year to two-year horizon. I think you can see in the market some moderation of exuberance in credit markets, but just a little. Overall, the markets seem to reflect a reasonably favorable view of future growth prospects. On the inflation side, as I said, we expect core inflation to moderate, not quickly and not dramatically but by enough and soon enough to bring core PCE inflation down to just below 2 percent over the next 18 months. The issue we face is not so much about the acceleration in core inflation that occurred in late 2003 and 2004. After that acceleration, core inflation was sort of trendless, in the vicinity of 2 percent for much of the two-year period, until the past six months, when we saw this uptick. The real problem we face is assessing the extent to which the very recent acceleration in core inflation reflects transitory factors, such as the indirect effects of energy prices, and the extent to which it may reflect pressures from higher resource utilization and other things less benign and less transitory. Energy pass-through, of course, seems part of it, but probably not all of it. Shelter doesn’t account for all of it either. This judgment is critical for us, and we need to be careful that we’re not assuming away the more uncomfortable explanation, such as a broader inflationary impulse or a rise in pricing power that could reflect increasing acceptance of higher inflation. How confident can we be that the pressures that have induced this rise in core inflation will moderate sufficiently to bring down the rate of increase in core PCE prices to the vicinity of 2 percent or below? Reasonably confident, I think. With the economy growing at or slightly below trend, with growth of unit labor costs peaking and decelerating a bit as the Greenbook forecast anticipates, with inflation expectations moderating at short horizons and pretty stable at longer-run horizons, with energy prices flattening out, and with the dollar falling only a little, this forecast seems reasonable. But note the number of assumptions and conditions this forecast depends on. Also, the expected path for inflation implies only a very gradual moderation and a period of sustained inflation above what is presumed to be consistent with this central bank’s long-term preferences. The risks of this forecast, as I said, still seem to lie on the upside. It may be some time before we can be confident that the forces are in place to produce the necessary moderation. More generally, however, we face the very difficult consequential challenge of trying to figure out the longer-term consequences of having been in an exceptionally long period of exceptionally low real interest rates—both real short rates and forward rates—that were induced by monetary authorities here and around the world. Real short rates now look as though they were perhaps lower relative to the estimates of equilibrium even than we thought. Perhaps more remarkable was the low level of forward real rates during much of our tightening phase. These financial conditions may have produced more inflation momentum than we thought, and this may be the case even though there is some reassurance in the stability of long-term expectations. Those expectations are substantially below the peak in ’04 at the long horizon. However, the rise in asset prices and residential investment and the leverage caused by this long period of very expansionary monetary policy may lead to a process of adjustment in asset prices that could be more sustained and more damaging in terms of confidence and of demand than we expect. This risk is greater if we end up allowing more inflation than our forecast anticipates, for the required monetary policy response could induce an even sharper adjustment in risk premiums and asset prices. This possibility argues for a lot of humility in judging the appropriateness of the present stance of monetary policy and what will be appropriate over time, and it argues mostly for having as much flexibility as we can going forward, emphasizing that the inflation risks remain the predominant concern of the Committee. Thank you." CHRG-111hhrg61852--101 Mr. Meltzer," Consumers are uncertain about what the future outlook for jobs is going to be. So as long as they are uncertain about the future outlook for jobs, they are not going to spend for durables, for houses, in the rates at which we have become accustomed. Now, as a country, we have a major problem, many problems, but one is that we owe the foreigners--the Japanese and the Chinese--billions and trillions of dollars' worth of debt. To service that debt, we have to export. That is the only way we are going to be able to service that debt. So we have to become a big exporter. And that means we have to invest more. So I believe that what we are seeing is a gradual transition in that direction toward more investment, and less growth and consumption. That is going to be a hard adjustment for Americans who have gotten used to very rapid growth of consumption, and it is going to be hard as the devil on the rest of the world, which has gotten used to the idea they can make their economies grow by selling consumer goods to us. But that is an adjustment that has to be made. So I would like to see much more emphasis on getting investment up, because that is where our future has to be. Mrs. McCarthy of New York. The gentleman's time has expired. Mr. Green from Texas. " CHRG-110shrg38109--71 Chairman Bernanke," Senator, as I indicated in my opening testimony, we think we see some tentative signs of stabilization in demand in the housing market, that nevertheless takes some time yet to work its way out because of the inventories of unsold homes that still exist on the market. I would emphasize that the signs of stabilization are tentative, and we do not want to jump to conclusions. It will be helpful to see what happens when the spring selling season begins and strong demand is at that time. But it is interesting that so far the economy has done a good job of withstanding the slowdown in construction, which, although substantial relative to the last couple of years, is still similar to the late 1990's, for example. It is not that we have had a complete collapse in construction by any means. So the decline in construction, while it has slowed the economy, has obviously not thrown us into a much slower growth situation. And we have not seen substantial spillovers from the housing slowdown to consumer spending or to other parts of the economy. So it is early to say that this problem is over. I think we are going to have to continue to watch it very carefully, and as I indicated, I think it is a downside risk to the economy going forward. But so far, the economy has reasonably adapted to this adjustment in the housing market. Senator Martinez. You mentioned in your remarks also that household finance appears solid and that delinquency rates on most consumer loans, including residential mortgages, were low, but you did note the subprime mortgages with variable interest rates where delinquency rates have increases appreciably. And it is an issue that is of great concern to several of us on this Committee, the issue of predatory lending, the abuse of some of our most vulnerable consumers. Any comments on that or any issues that you see there which could impact the overall economy? " FOMC20051213meeting--86 84,MR. KOHN.," Thank you, Mr. Chairman. The news over the intermeeting period has suggested some shift in the nature of the inflation risks faced by the economy. Low and stable core December 13, 2005 53 of 100 of inflation expectations seem to imply a reduced threat from near-term feed-through of energy prices to expectations or to core inflation. At the same time, however, information on output and demand indicate that the economy remains on a growth track which is expanding a little more quickly than potential supply. And this is a trajectory that would increase pressure on resources at a time when those resources are already being fairly well employed. The reasons for the greater-than-expected momentum in output are unclear. Some of the strength may represent a more muted response to hurricane disruptions or energy prices than anticipated, but much would seem to be related to underlying strength in aggregate demand. The upward surprises in demand in the third quarter were global, not just in the United States. Increases in industrial commodity prices and sizable gains in equity prices around the world evidence widespread economic strength and expectations that it will persist. Added demand and rising equity prices have provoked little, if any, offsetting tightening in financial conditions in credit markets. Long-term interest rates globally were little changed on balance over the intermeeting period, and risk spreads out the yield curve and across risk categories continue to be low, reflecting the basically optimistic outlook of investors. Perhaps the resilience of the global economy to oil price increases and persistent expansion in global GDP, including in such laggards as Japan, are slowly increasing the confidence of non- financial businesses as well. In the United States, the growth of business investment has come into line with past relationships with the cost of capital and changes in output, though the level of investment still remains a bit lower than might be expected. As a consequence of this strength, one question is whether the current constellation of interest rates and asset prices, including expectations of the funds rate topping out in the 4½ to 4¾ percent December 13, 2005 54 of 100 neighborhood of its potential and to keep inflation stable. In the staff forecast and in the markets, such a rise in the funds rate is seen as sufficient to contain inflation, and that strikes me as a reasonable estimate, pending further information. Although long-term rates haven’t changed much for several quarters, short- and intermediate- term rates have increased quite a lot and will continue to move higher as we firm policy. These higher rates should exert increasing restraint on spending, especially for households that have been relying on borrowing at low short-term rates to short-circuit liquidity and income constraints when buying durables or houses. The slowing in consumer credit growth and mortgage loan applications in recent months may, indeed, indicate that higher short- and intermediate-term rates are beginning to bite. Moreover, perhaps as a consequence of the rise in borrowing costs, we do see some signs of a cooling in housing markets, as many of you remarked. Certainly the perceptions about housing markets of both builders and buyers have deteriorated noticeably in recent months, and the shift in attitudes may be particularly important when a significant portion of the activity in this market has been linked to investment demand. Based on these indicators and others, a slowing of house price appreciation and a moderation in construction activity next year seem to be a reasonable expectation. Such a slowing is a critical element behind the moderation in growth next year in the staff forecast, and I suspect in the market’s assessment as well. Still, we need to see more concrete evidence that this channel is working as anticipated, both in prices and in activity, before we can be confident that demand is likely to moderate. Nonetheless, the incoming information also reinforces the notion that we can afford to retain the gradual path of policy tightening as we look for signs that moderation is coming. With the upward revision to December 13, 2005 55 of 100 growth of potential. In addition, the better productivity and the downward revision to compensation data show the increase in business costs being held in check better than had been evident. And the higher rate of growth of structural productivity should help to hold down that increase in costs going forward. Moreover, the markups of price over unit labor costs have risen appreciably in the last two quarters for both nonfarm business as a whole and, within that category, for nonfinancial corporations. And those markups are close to the record highs of the mid-1990s, suggesting that businesses have some room and incentive to absorb some of the increases in labor costs that might be coming. As a consequence of these developments, I think we can be a little less concerned about the immediate threat of higher inflation, though we still need to focus on forestalling the potential for supply-demand imbalances to develop over the medium run. Thank you, Mr. Chairman." CHRG-111hhrg53241--39 The Chairman," Our final witness is Nancy Zirkin, on behalf of the Leadership Conference on Civil Rights.STATEMENT OF NANCY ZIRKIN, EXECUTIVE VICE PRESIDENT, LEADERSHIP CONFERENCE ON CIVIL RIGHTS (LCCR) Ms. Zirkin. Thank you, Mr. Chairman, and members of the committee. I am Nancy Zirkin, executive vice president of the Leadership Conference on Civil Rights (LCCR), the oldest and largest human and civil rights organization in this country comprised of 200 national organizations. We are also a part of the Americans for Financial Reform. LCCR supports a Consumer Financial Protection Agency because it is the key to protecting the civil rights of the communities that LCCR represents. Our interest ties into what has always been one of the key goals of the civil rights movement, homeownership, which is how most people build wealth and improve communities. LCCR and our member organizations have always worked to expand fair housing and also the credit that most people need to buy housing. Despite the progress since the Fair Housing Act, predatory lending has been the latest obstacle standing in the way, and, of course, it is very much the root of the crisis that we find ourselves in today. For years, LCCR and our allies argued that the modern lending system was working against us. Just to be clear, responsible subprime lending is a good thing. The problem is that the industry basically threw the responsible out of the window by giving countless numbers of people loans that weren't realistic or responsible. Even worse, many lenders were steering racial and ethnic minorities into these loans, even when they could have qualified for conventional loans. So, for years, civil rights and consumer advocates have tried to get help from Federal banking regulators, but they ignored us and maintained the status quo. Seemingly, they were more persuaded by the industry's platitudes about access to credit than the growing evidence of what the credit was actually doing. Since 1994, for example, the Fed has been able to ban predatory loans but waited until a year ago to actually start doing so, after most predatory lenders had already skipped down and left taxpayers holding the bag. The OTS and OCC were no better, even when it came to enforcing civil rights laws like the Equal Credit Opportunity Act. During the housing bubble years, neither regulator referred cases to the Department of Justice. In one instance, DOJ had to go after an OTS thrift on its own, Mid-America Bank. I have attached a new brief by the Center for Responsible Lending to my written statement which will be added to the record. The brief contains a lot of compelling horror stories about the lack of financial enforcement. And we all know about the Treasury Inspector General's report on IndyMac, which certainly shows what OTS did--or didn't do, I should say. The problem with relying on Federal bank regulators to protect our communities is simple. Its structure is inherently designed to fail consumers. When regulators are financially dependent on the institutions that they police, consumer interest will always be squeezed out. CFPA will break this pattern. In the same way that our Founders realized that sometimes you have to deliberately pick interests against each other in order to create a stable government, the interest of consumers and civil rights on the one hand and bank profitability on the other need to be pitted against each other. It is obvious that the current system didn't serve either interest. That is why LCCR thinks your legislation, Mr. Chairman, is so important. Speaking of details, my written testimony includes recommendations to the bill that we think are essential, and also LCCR's Fair Housing Task Force has a series of recommendations that we will be sharing. Again, thank you for inviting LCCR here today; and I will be happy to answer any questions you might have. Thank you. [The prepared statement of Ms. Zirkin can be found on page 170 of the appendix.] " FOMC20050920meeting--106 104,MS. BIES.," Thank you, Mr. Chairman. As many of you have already remarked, preparing for this meeting was a lot more challenging than preparing for other recent meetings. The economy was poised for strong growth in the third and fourth quarters before Hurricane Katrina. And the forecast that the staff has developed in the Greenbook I think is reasonable, given what we know at this time. That forecast suggests that while we may see some short-run softness, with growth below the rate we had anticipated, the rebuilding efforts clearly will add stimulus over the next year. I am also comforted that the underlying economy was strong. So while we are going to see a slight downtick due to the impact of the hurricane, the Greenbook forecast of real GDP growth in the mid-3 percent range over the next year indicates that we have sound economic expansion ahead. So while uncertainty about economic growth has increased, I still believe there are much more serious clouds on the inflation horizon. The rapid rise in energy prices in the last couple of months has pushed the level of prices high enough that more firms are likely to find that they cannot absorb the increased costs and must raise prices to protect their profit margins. This will become more so the longer that energy prices remain high. I am still hearing mixed expectations about the availability of natural gas this winter. While the impact of Katrina may not be as severe as first feared, the limited ability to expand natural gas supply, as we saw in the last two years, on top of slower fill due to hurricane damage, September 20, 2005 84 of 117 As the Greenbook notes, business spending on equipment and software has only modest forward momentum. This is despite solid economic growth, healthy profits, and favorable financial conditions. So why is business investment so limited? I’m going to answer this by referring to the most recent quarterly survey of CFOs conducted by Duke University with CFO Magazine. And I would note that this survey was concluded on August 28, the day before Katrina hit. I want to read to you the lead on their press release for this survey. It says: “Corporate Optimism Plummets in Response to Housing and Fuel Concerns.” For the first time in the four- year history of this survey, more CFOs are pessimistic than optimistic about the U.S. economy. Their number one concern is high fuel costs, ranking above health care costs for the first time. Interestingly, the survey also noted a jump in what they call their terrorism index, with one-third of the firms responding that costs to improve security and business recovery response has negatively impacted their bottom line. I think after Katrina there will be more firms looking at their business recovery plans. As some executives have told me, with the rising costs of benefits, energy, and financing, they are closely managing discretionary items, including capital spending. Over the next 12 months, the CFOs who participated in the survey are planning slower growth of investment; they now expect to increase capital spending by only 4.7 percent. The survey indicates that CFOs are also worried about the housing market. They believe the market is overheated and that a necessary and expected decline in housing prices will negatively affect their firms. This echoes comments I’ve heard from others that a reversal in the housing market might have negative September 20, 2005 85 of 117 find the survey results consistent with other comments I’ve been hearing that the business pessimism we’re seeing is due in large part to growing concerns about rising prices on several fronts. While recent inflation numbers are very well behaved, the Greenbook does reflect a rise in the core inflation forecast over the next year. The volatility we saw yesterday in the energy futures market, clearly due to Rita and other concerns, indicates how much the market is focusing on the unknown path for inflation that companies are facing. While the impact on inflation may be unclear—and we know the damage to platforms out in the Gulf and the effects on refinery capacity are still being assessed—the nervousness about costs is a factor that is affecting business behavior, and it is something that we can’t ignore. The fiscal stimulus of Katrina and the rebuilding that will result is only going to add to inflation—and that’s on top of a transportation bill that has a lot of spending on infrastructure that some of us think should have less priority than rebuilding around the Gulf Coast. The chart on page 21—and I also love these new charts—helps us keep things in perspective, in terms of the historical trends in inflation as we’ve been tightening up from meeting to meeting. And we have to keep that in mind as we look to the future. We know that there is still ample liquidity in financial markets, so the risks of higher inflation to me right now are much greater than the risks to economic growth. I think it’s important that at today’s meeting we give the market assurance that we will continue to focus on and be diligent in dealing with inflation, because rising costs appear to be at the heart of companies’ concerns. To me that’s very important, and I want to support an increase September 20, 2005 86 of 117" FOMC20070509meeting--86 84,MR. KROSZNER.," Thank you very much. The last time we met, one theme was the greater uncertainty, and Governor Kohn mentioned that he is feeling greater uncertainty now than he ever had. I am not sure that greater uncertainty has been the tenor of the comments here today, but I think it has been greater uncertainty with downside risk. So the key issue from last time that I think is still with us is that we certainly saw evidence of the slowdown and, as President Stern mentioned, that sometimes we have to acknowledge reality, and we did have much slower growth than many people had been expecting in the two previous meetings. The Greenbook suggests that the slowdown is unlikely to persist—and I broadly agree with that view, as do many people around the table—but I want to review five key uncertainties that we talked about last time and to discuss how they developed and where they are likely to go. The first uncertainty is investment, and of course, a lot of us have spoken about that. I would rate the level of uncertainty as still elevated there. I am not going to use color coding to rate that uncertainty, but I would say it is still elevated. We have recently gotten some more-solid numbers, but those are just recent; and I think it is still more a glimmer of hope than something we can bank on that we are going to get a turnaround in investment. That we have seen some better numbers in ISM, durable goods, and so forth says that the direction is perhaps a little more positive than we were thinking six weeks ago. But there is still a reasonable amount of uncertainty about whether the pickup in business investment will help offset any slowdown in consumption to make sure that we continue to grow in the 2 percent range going forward. The second uncertainty is productivity and potential output. Obviously that is still at an elevated level. As far as I am concerned, it is one of the biggest challenges for us to think about in the intermediate run. In particular, a downside scenario that concerns me is that, if we do not have a pickup in investment, we are unlikely to see a sustained rise in productivity growth. If perhaps one reason for the lower investment is that there are concerns about productivity growth or returns from that investment, we could have a fairly negative scenario in which we get much lower potential output. Offsetting that concern is that we are seeing some glimmers of hope on investment. With respect to potential, I think it is appropriate that the Greenbook has raised participation rates a bit, given that older people seem to be healthier than previous cohorts were and seem to be more willing to work. However, I think the big question mark is, exactly as David said, that not until August will we get a better feel for which way the data revision will go because the difference between the two sides of the balance sheet is fairly big. Broadly, I share Gary Stern’s optimism that it is not a good bet to bet against the U.S. economy and against ultimately good productivity growth. But I have the concern that I do not fully understand the slowness of the investment recovery and some of the productivity slowdown. There is potentially a worrying downside scenario there. Third is the uncertainty about the housing market and subprime. Well, obviously, uncertainty on subprime was highly elevated then, and it has come down quite a bit. We have seen some tightening of lending standards, particularly at the lower end. The survey of senior loan officers asked for a differentiation between subprime and prime lending standards. It showed a very dramatic increase in subprime standards, which is exactly what we would expect in this kind of market, certainly potentially reducing demand at least in the lower end of the housing market. About the housing market in and of itself, the uncertainty is still there. We still have a lot of uncertainty about whether the numbers are telling us about weather or about the actual strength of the market. As I think I have mentioned to a number of you before, we need to have, besides Dave, a meteorologist on the staff to forecast the weather because every number we hear on the housing market is not a number in which we can put any stock; it all has to do with heat or cold or rain or snow or whatever other thing that Mother Nature may throw at us. So I still think there is a pretty mixed picture there. As I said, we have seen very little evidence of spillovers from the subprime market. The main concern, and this is a variation of what Governor Warsh said, is that something we or the Congress might do might cut off this market. We have to be mindful of any actions that we may be taking with respect to guidance, as well as of any actions that the Congress may be taking, that could reduce this market more than otherwise. The yield curve is favorable for a lot of the variable-rate subprime borrowers to move into fixed-rate products, with payment shock of perhaps no more than 50 basis points. The delinquencies we have been seeing have not been due to resets or to payment shock. They have been due primarily to the so-called juvenile delinquents—the early defaulters going bad. That means that we do not know what is coming down the line because we have not really seen the experience of the resets. Now, with the recently benign yield curve, that situation could reasonably be worked out. The key is whether any equity is left. If no equity is left and the resets come, these guys are likely to walk. If they have been doing risk layering—putting really no money down—and the prices go down, that will be a problem. So I think that may be a bit of a slow burn. Coupled with the broader misalignment that we are seeing now of a little increase in housing starts, which in some ways we would see as a positive, is a sort of negative given that housing sales seem to be declining so much. Thus there seems to be a disconnect between supply and demand, and I think the Greenbook is now quite wisely saying that we will likely have a longer transition in the housing market. A fourth area of uncertainty that we talked about last time was the financial markets—the dramatic spike up in volatility. That volatility spike has come down, but we, being good economists, can never be satisfied with either high volatility or low volatility. Low volatility is of concern to us, and I very much share the concerns that Tim, Cathy, Kevin, and others have mentioned. Not only in the United States, but also in the rest of the world, are some of those spreads a bit narrower than they otherwise would be. In particular, there are concerns about banks chasing private equity deals going covenant-free. In many of my discussions with private equity folks, instead of saying, well, bring us on more capital, those contacts are the ones saying that the banks are pushing them to take greater leverage than they otherwise would want. Now, if that isn’t the fox guarding the henhouse, I do not know what is. You want the banks to be the disciplinary force, and that they would potentially be taking on very large risks is a real concern. The fifth area of uncertainty was consumption. We have seen a bit of a step-down in consumption growth, but there is still a lot of uncertainty, and I share the exact concerns that Governor Kohn articulated; given that there are likely to be some wealth effects, even though we have some offsetting effects in the stock market, I do not want to bet on those offsetting effects in the stock market being there for the next three quarters. Housing wealth seems to be flattening, if not coming down, with the Case-Shiller index on average for those ten markets down 3 to 5 percent. If people’s thinking about their consumption pattern is based on some increase in housing wealth, the saving rate should at least gradually increase. At some point, that reality may be biting and leading to some concern. On the inflation front, once again, we will have continuing uncertainty about what drives short-term to intermediate-term inflation. As I mentioned last time, we get very, very mild effects from the traditional things that we think that make a difference. Oil, energy, commodity prices, and resource utilization don’t seem to have that much force, but in both the short and intermediate terms I think they are leaning on the positive side rather than on the negative side. We still have the owners’ equivalent rent issue that is coming in with the transition in the housing market and is still to some extent temporarily pushing up our measured inflation rates. Inflation expectations continue to seem to be quite well contained, and that, I think, is key because, given that these other forces do not seem to be important in the short to intermediate run, inflation expectations are very important. So my bottom line is that, although I see some downside risks on growth, I think the Greenbook scenario is a reasonable central tendency one, and I see some important upside risks on inflation." CHRG-111hhrg54873--9 Mr. Castle," Thank you, Mr. Chairman. Credit rating agencies are meant to provide a valued service to investors by giving them an informed judgment on the risk of certain bonds. As we know, subprime and other mortgages were fragmented into pieces and bundled into mortgage-backed securities and then rated. Investors relied heavily on the rating agency models to assess the risk of these investments before making a purchase decision. Yet when AAA mortgage-backed securities began to fail, it became evident there was a problem with the system. As the housing bubble burst, I grew increasingly concerned with this issue, as did my colleague, Mr. Ackerman from New York. In July 2008, again, this Congress in the form of H.R. 1181, introduced legislation that directs the SEC to establish a process by which asset-backed instruments can be deemed eligible for nationally recognized statistical rating organizations, NRSRO ratings. Under this bill, eligible investments must consist of securities whose future performances can be recently predicted, such as those with established track records or homogenous structures. The SEC would have the authority to strip nationally recognized statistical rating organizations of their NRSRO designation if the rating agency fails to comply with provisions set forth in the legislation. I am pleased that we are continuing debate on credit rating agency reform. Although I believe it is clear that action must be taken, I believe we must do more to set guidance on the eligibility for investment for NRSRO designation to avoid falling into the same problems we currently face. I look forward to working with my colleagues to ensure adequate reform moving forward. Just one further comment beyond my talking points here, and that is the question I will have of the methodology of paying for your services. That was raised a little bit by Mr. Sherman, I think. And I think it is a matter of legitimate concern, that if the entities are asking you to rate a product or paying you, does that influence all the way this comes out or not and are investors shortchanged for some reason or another? I don't have a solution to that. I am just interested in your comments on that as we go forward. I yield back the balance of my time. " FinancialCrisisInquiry--229 ROSEN: The good news is it’s a smaller dollar amount. But it’s a big dollar amount. GEORGIOU: It’s—less than—it’s about $1 trillion isn’t... ROSEN: The loss number is going to be somewhere between $500 and $700 billion out of $3.5 trillion debt component. GEORGIOU: Right. ROSEN: So it’s a much smaller number. We have something called a mend and extend happening now where they are mending and extending loans. But the same bubble that happened in residential happened somewhat in commercial. Big value increase and now a 40 percent value decline. So there’s a—a lingering issue that’s going to be there. I—it - it doesn’t all hit at once. The good news is it’s stretched out over the next five years. So I think we’re OK. It’s not good. It—but I think the residential losses going forward for the next year and a half are going to be bigger still, than the commercial over five years. GEORGIOU: Except that the commercial loans are bigger—each one is bigger. And so they—they— some of them pose a bigger risk to—to... ROSEN: Some institutions. 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. 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. " FOMC20070509meeting--75 73,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. Our outlook has changed very little. As in March, we see the expansion continuing, with growth moving back up to potential—we see potential around 3 percent—later this year. This view rests on the familiar expectations: Housing stabilizes relatively soon without a major drop in prices; investment spending strengthens somewhat as the temporary factors holding it down recede and positive fundamentals reassert themselves; consumption moderates a bit but continues to be supported by strong income growth; the saving rate moves up but only modestly and slowly; and external demand remains strong. We still expect inflation to moderate gradually to a rate just below 2 percent for the core PCE by the end of ’08. We view the recent numbers as somewhat reassuring. Recent data in general have provided a bit more comfort for this scenario. On balance, the downside risks to growth have diminished a bit. The risk that inflation will fail to moderate sufficiently, however, remains significant and material. But in general, the overall outlook, in our view, hasn’t changed that much. Now, our forecast assumes that we hold the fed funds rate where it is for a while. Our expected path is above the market’s but below the Greenbook’s. We’re below the Greenbook because, although our expected forecast is really similar, we attach somewhat greater weight to alternative scenarios that suggest slower growth. The recent growth numbers have been, on balance, encouraging, and the markets are a bit more confident about the outlook than they were. But I still think the downside risks to growth are significant. Housing could still surprise on the downside, and we could see a deeper, more protracted contraction in activity and, of course, broadly based more-substantial declines in prices. Consumption could be weaker for this reason or because the saving rate rises for other reasons, such as pessimism about long-run income growth. The household sector is substantially more leveraged than it was, and it has less of a cushion to absorb shocks and, therefore, presents some risk of amplifying rather than mitigating broader weakness in the economy. Although a bit better than it was in March, the investment outlook is still a bit tenuous, and it seems unlikely to be a substantial source of strength if broader weakness in demand in the rest of the economy materializes. The most rapidly growing parts of the world are growing well above potential and face rising inflation and substantial asset-price inflation, and I think the authorities there are generally starting tentatively to tighten policy more significantly. On the inflation front, we still face substantial uncertainty about what is happening to underlying trends and how they will evolve. The broader inflation environment is, if anything, less benign than it has been over the past three quarters, with inflation accelerating a little outside the United States, energy and commodity prices continuing to show signs of rapid demand growth, the dollar potentially weakening further, compensation here firming a bit, and productivity growth probably staying a bit below what we thought was trend. In this context, with inflation still running about 2 percent, inflation expectations could drift up. Continuing on the risks for a bit, I still think we live with a significant risk of a sharp deterioration in financial markets. Credit spreads, other risk premiums, low levels of implied volatility, and the strength of asset prices in many parts of the world—all imply a level of confidence in ongoing, stable growth and low inflation that seems a bit implausible. In addition, the low level of long forward rates seems hard to reconcile with the strength of demand growth outside the United States, suggesting that much of the world is likely to need to move further toward tighter monetary policy. As financial conditions exert more restraint on demand growth globally, we could see a rapid unwinding of this long period of very benign assessment of fundamental risks. We, of course, face some risk of policy actions here in the form of trade or investment protection. This risk, against the backdrop of some uncertainty about the strength of productivity growth going forward, might make the rest of the world less comfortable financing our still-large external balance on the favorable terms that have prevailed thus far. On the longer-term outlook for potential in the United States, we are sticking with our forecast of 3 percent, but we have altered the mix a bit, just as the Greenbook has in some sense; however, we feel a little less comfortable with our basic view about potential. We lowered our productivity growth assumption a bit, to 2.25 for the nonfarm business sector, and raised our estimate of trend hours a bit. If potential is lower than we’re assuming, then we are less likely to see the moderation of inflation that we currently expect, but we would expect a lower path for output growth as well. At this stage, however, in view of the strength in income growth that we’ve seen, earning expectations, and other measures, we’re reluctant to embrace a more negative view about growth in potential. On balance, in view of these risks, I favor staying where we are for a while. I don’t think there is a very strong case for tightening policy or for inducing a significant rise in market expectations about the path of the fed funds rate going forward, nor do I think now that we’re at risk of being too tight. So, in general, I think the best choice for us is to continue to lean against the expectation that we will move to reduce rates soon. Thank you." FOMC20070131meeting--140 138,MS. PIANALTO.," Thank you, Mr. Chairman. I have the sense that since our last meeting we’ve received a wealth of data but not necessarily a wealth of information. Between the data that have come in and the conversations that I’ve had with my District contacts in the past six weeks, I’m a little more confident about the outlook for real growth, and I view the inflation outlook as unchanged. Housing is an example of having more data, but not necessarily more information. Though some aspects of the residential housing data have been encouraging, neither futures on housing prices nor reports that I have received from people in the business suggest that the slowdown in that sector will end any time soon. Despite that, it still looks as though the spillovers to consumer spending and financial markets have been limited. At our last meeting, there was also some uncertainty regarding the health of the manufacturing sector. For the most part, the intermeeting data have been favorable for the manufacturing sector. The industrial production numbers, for example, have been strong, but manufacturing employment remains flat. The usual story that makes sense of these disparate trends is the continuing strength in manufacturing productivity. But I’d like to mention another element in the picture—others have mentioned it this morning—and that’s the skills mismatches. My directors and business contacts in the manufacturing sector tell me that they have jobs available but that they face great difficulty in filling those jobs because they can’t find people with the right skills. Interestingly, as was mentioned in the staff presentation earlier, the JOLTS data show openings as rising, and that’s also true in the manufacturing sector. Openings have been rising over the past two years. This news really isn’t so good per se, but it does suggest that at least some of the sluggishness in manufacturing job growth is coming out of the structural elements in the labor markets and is not purely a cyclical decline in aggregate demand. In a somewhat related vein, according to the National Association of Colleges and Employers, college placements are up 17 percent this year, the strongest showing since 2001. The story is that relatively high profits and good business prospects are driving up demand. We also understand from the Ohio governor’s office that last year, although sales tax receipts were lower, income tax receipts were stronger than expected. These bits and pieces combined with some of the positive news in the aggregate data reports in the past couple of months make me somewhat less worried about the downside risks to economic growth than I was at the last meeting. I don’t want to go overboard on this. I had that feeling several times last year only to be subsequently moved in the other direction. It is hard to tell whether some of this good news has been related to weather—that is, some spring activity might have shifted into the fourth quarter. On the inflation front, both the official data and the anecdotal stories from my contacts continue to provide some encouragement that core inflation will moderate over the next year, but the data are not yet entirely convincing. My staff has noted that for most of 2006, especially in the later half of the year, the growth rates of individual CPI components exhibited a bimodal distribution. On an expenditure-weighted basis, most components were either falling in price or rising at a troubling rate. Very few CPI components were rising at a pace that the CPI tells us is about average. This pattern is highly unusual, and I don’t know what to make of it, except to say that it does make it more difficult to tell which way the inflation trend is leaning. My only material difference of opinion with the staff baseline projection concerns the assumption about labor supply. Economywide, there is some reason to think that aggregate labor supply is more abundant than the Greenbook baseline contemplates. Labor force participation rates for most demographic groups have been running stronger than the staff has been expecting, indicating that the growth of potential output could lie somewhat above the Greenbook estimate. That’s what I am assuming, and therefore I get a slightly better combination of output and inflation . In the end, my outlook for the economy hasn’t changed. The general contours of the forecast for a modest slowdown in growth coupled with a very gradual decline in core inflation make sense to me. However, I have lowered just slightly my assessment of the risk that real growth will fall short of my projection, and I have not changed my risk assessment of inflation. There’s still a notable risk that year-over-year changes in inflation might remain stuck where they are today as opposed to drifting down half a point or so over time as I would prefer. Thank you, Mr. Chairman." FOMC20060808meeting--82 80,CHAIRMAN BERNANKE.," Thank you. Let me briefly summarize what I’ve heard and add a few comments. I think one thing we can conclude is that this is not getting any easier. [Laughter] Starting with the data, which are not cooperating, the NIPA revisions show that potential growth may be less than we thought and, therefore, we may have to have more of a slowdown, if we believe in the Phillips curve, to begin to contain inflation. The small bit of comfort I take is that the slowdown in potential and productivity appears to be coming from capital rather than from multifactor productivity; so at least that technological component still seems to be with us. The question is whether we are, in fact, slowing to potential or to slightly below potential. I agree with most of what I heard around the table, which is that there is evidence of slowing but, except for the residential construction sector, it is not yet at all definitive that we are falling below potential growth rates. For example, the staff estimated that GDP growth in the second quarter was 3 percent. The staff also estimated that the slower rate of job creation we saw in the second quarter is still fairly close to what is needed to keep the unemployment rate constant. We are certainly seeing areas of strength in the economy, as a number of people noted. That includes the industrial sector—which will grow 0.7 or 0.8 percent, something like that, overall in July—and nonresidential construction, which has been strong enough that so far there has not been a net decline in construction jobs in the United States. So there certainly are some strong elements of the economy. I’d like to talk about the very important housing sector, in terms not of the expected level but of the variance of our forecast, which I think we must think about given our risk-management approach. At least three dimensions of the housing sector provide significant uncertainty as we look forward. The first is the extent to which sales, starts, and permits will decline. The correction in the housing market so far appears to be fairly substantial. In 2005, we had 1.72 million starts. For June, the number of adjusted permits was 1.45 million. We already have a 15 percent decline in the level of construction. As Governor Kroszner pointed out, the curve doesn’t look as though it’s flattening out; it looks as though it’s heading directly south. We have heard anecdotally that cancellations are up very sharply. Inventories are rising significantly, and I note that, just since the last meeting, the GDP contribution estimated by the staff for housing construction went from minus 0.3 percent to minus 0.6 percent. So there is, I think, a lot of uncertainty about where that sector is going to level out. Second, associated with that consideration is a lot of uncertainty about housing prices. Again, as Governor Kroszner noted, we don’t really have much information on what the “true price” of housing is at this point because of the way this market works: People leave things on the market for a long time; they take them off the market; they provide incentives; and so on. So we don’t really see the transaction prices in any kind of quality-adjusted or reliable way for some time after the decline begins. The prices are significant, of course, both because they affect the profitability of future construction and because they are, at this point, an important component of household wealth; we know that these factors are likely to affect spending. Finally, a third element of uncertainty as we look into the forecast is what I would call parameter risk, which is that the staff assumes that the effect of housing wealth on consumption spending is, through the standard wealth effect, about four cents on the dollar. I happen to think that is a good estimate. I think the econometric calculations are persuasive. Nevertheless, there is the possibility that the effect is somewhat greater, perhaps operating through liquidity effects. There may be buffer stock effects. If people see their equity falling, they may become more cautious about spending in order to avoid eliminating their buffer of reserves. Thus there is the possibility that housing will have a stronger effect on consumption than we now expect. I don’t know what the expected growth rate is. If I had to take a guess, I would say that we’re going to be close to or slightly below potential going forward, but I simply want to point out that our forecast may have a higher variance now than it does under normal circumstances. Let me say just a few words about inflation. I heard a lot of concern about inflation around the table. I certainly share that concern, and I don’t expect any near-term improvement, if for no other reason than that these things tend to be highly inertial. I also agree with the general observation that the pickup is fairly broad based, as I discussed in the meeting last time. One indicator of that is the share of goods that have price increases or price increases above a certain level. I tried a somewhat different exercise, and I didn’t do it in any way as an apologist for inflation—I want to be very clear. But I think it’s useful to look at inflation from a different approach, which is to ask what share of the inflation acceleration is attributable to different components. So I asked for a look at the past three months versus the past twelve months to examine the acceleration between those two periods. In a sort of growth-accounting exercise, how can we distribute that acceleration among different components? I have just a few observations from that exercise. First, the shelter component really does play a big role. For example, in this particular calculation, which is somewhat sensitive to sample period, of the 71 basis point increase in the core CPI between twelve months and three months, 48 basis points were associated with the shelter increase. So that component is significant, and our views on where it will go and how that relates to the developments in the housing market need to be thought about. A second observation is that we are seeing energy pass-through, a good example being air fares, which have jumped significantly and which by themselves contribute 19 basis points to the acceleration. So energy pass-through is real. A somewhat more subtle point, which was made in the Greenbook and which I think is interesting, is that there’s a little different behavior between inflation in goods and inflation in non-energy, nonshelter services. Inflation in services has been generally flat. In goods, however, we have seen a bit of acceleration, from a negative number in ’05 to a slightly positive number in ’06. Examples would be the rise in prices in apparel and, more recently, in used cars. In just examining clues, I think that acceleration might say something about international competition, the effects of the declining dollar, and the possibility that import competition has weakened to some extent and is allowing prices of tradable goods to rise a bit more quickly. One theme that is consistent regarding the energy pass-through and the perhaps slightly greater inflation in tradable goods is that an important component of the inflation is product market tightness as opposed to labor market tightness. That suggests that, as we go forward, we should pay a lot of attention to final demand and consumption and see how they are affecting the product markets. My own guess is that unit labor costs and wages will be somewhat lagging; and I think that, if the product markets slow and the slowing reduces pricing power, as we call it, those effects will ultimately have effects on the markup that will offset some of the wage effects. So those are just a few observations about the economy. To summarize, I agree with the sentiment around the table that there is a lot of uncertainty going forward, particularly in the housing sector, but that the inflation risks at this point are still dominant and that our policy action and statement should reflect the greater concern with inflation. On the subject of policy, let me now turn to Brian, who will present the policy options." fcic_final_report_full--479 The best summary of how the deflation of the housing bubble led to the financial crisis was contained in the prepared testimony that FDIC chair Sheila Bair delivered to the FCIC in a September 2 hearing: Starting in mid 2007, global financial markets began to experience serious liquidity challenges related mainly to rising concerns about U.S. mortgage credit quality. As home prices fell , recently originated subprime and non-traditional mortgage loans began to default at record rates . These developments led to growing concerns about the value of financial positions in mortgage-backed securities and related derivative instruments held by major financial institutions in the U.S. and around the world. The diffi culty in determining the value of mortgage-related assets and, therefore, the balance-sheet strength of large banks and non-bank financial institutions ultimately led these institutions to become wary of lending to one another, even on a short-term basis. 47 [emphasis supplied] All the important elements of what happened are in Chairman Bair’s succinct statement: (i) in mid 2007, the markets began to experience liquidity challenges because of concerns about the credit quality of NTMs; (ii) housing prices fell; NTMs began to default at record rates; (iii) it was diffi cult to determine the value of MBS, and thus the financial condition of the institutions that held them; and, (iv) finally, as a consequence of this uncertainty—especially after the failure of Lehman—financial institutions would not lend to one another. That phenomenon was the financial crisis. The following discussion will show how each of these steps operated to bring down the financial system. Markets Began to Experience Liquidity Challenges To understand the transmission mechanism, it is necessary to distinguish between PMBS, on the one hand, and the MBS that were distributed by government agencies such as FHA/Ginnie Mae and the GSEs (referred to jointly as “Agencies” in this section). As shown in Table 1, by 2008, the 27 million NTMs in the U.S. financial system were held as (i) whole mortgages, (ii) MBS guaranteed by the GSEs, or insured or held by a government agency or a bank under the CRA, or (iii) as PMBS securitized by private firms such as Countrywide. The 27 million NTMs had an aggregate unpaid principal balance of more than $4.5 trillion, and the portion represented by PMBS consisted of 7.8 million mortgages with an aggregate unpaid principal balance of approximately $1.9 trillion. As mortgage delinquencies and defaults multiplied in the U.S. financial system, the losses were transmitted to financial institutions through their holdings of PMBS. How did this happen, and what role was played by government housing policy? Both Agency MBS and PMBS pass through to investors the principal and interest received on the mortgages in a pool that backs an issue of securities; the difference between them is the way they protect investors against credit risk—i.e., the possibility of losses in the event that the mortgages in the pool begin to default. The Agencies insure or place a guarantee on all the securities issued by a pool they or some other entity creates. Because of the Agencies’ real or perceived government 47 Sheila C. Bair, “Systemically Important Institutions and the Issue of ‘Too-Big-to-Fail,’” Testimony to the FCIC, September 2, 2010, p.3. backing, all these securities are rated or considered to be AAA. fcic_final_report_full--245 EARLY 2007: SPREADING SUBPRIME WORRIES CONTENTS Goldman: “Let’s be aggressive distributing things” .............................................  Bear Stearns’s hedge funds: “Looks pretty damn ugly” .......................................  Rating agencies: “It can’t be . . . all of a sudden” .................................................  AIG: “Well bigger than we ever planned for” ....................................................  Over the course of , the collapse of the housing bubble and the abrupt shutdown of subprime lending led to losses for many financial institutions, runs on money mar- ket funds, tighter credit, and higher interest rates. Unemployment remained rela- tively steady, hovering just below . until the end of the year, and oil prices rose dramatically. By the middle of , home prices had declined almost  from their peak in . Early evidence of the coming storm was the . drop in November  of the ABX Index—a Dow Jones–like index for credit default swaps on BBB- tranches of mortgage-backed securities issued in the first half of .  That drop came after Moody’s and S&P put on negative watch selected tranches in one deal backed by mortgages from one originator: Fremont Investment & Loan.  In December, the same index fell another  after the mortgage companies Ownit Mortgage Solutions and Sebring Capital ceased operations. Senior risk officers of the five largest investment banks told the Securities and Exchange Commission that they expected to see further subprime lender failures in . “There is a broad recogni- tion that, with the refinancing and real estate booms over, the business model of many of the smaller subprime originators is no longer viable,” SEC analysts told Di- rector Erik Sirri in a January , , memorandum.  That became more and more evident. In January, Mortgage Lenders Network an- nounced it had stopped funding mortgages and accepting applications. In February, New Century reported bigger-than-expected mortgage credit losses and HSBC, the largest subprime lender in the United States, announced a . billion increase in its quarterly provision for losses. In March, Fremont stopped originating subprime loans after receiving a cease and desist order from the Federal Deposit Insurance Corporation. In April, New Century filed for bankruptcy.  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." 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." FOMC20070628meeting--215 213,CHAIRMAN BERNANKE.," The entire statement: “The Federal Open Market Committee decided today to keep its target for the federal funds rate at 5¼ percent. Economic growth appears to have been moderate during the first half of this year, despite the ongoing adjustment in the housing sector. The economy seems likely to continue to expand at a moderate pace over coming quarters. Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.” The last section is the same." 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. " 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. " FOMC20070131meeting--134 132,MR. FISHER.," Well, Mr. Chairman, first on our cheaper, more affordable, and perhaps luckier Eleventh District economy, we estimate that employment growth ran at a rate slightly greater than 3.2 percent last year and our output growth exceeded 4 percent. We do see some possible slowing, but there is still very strong momentum in the Texas economy and to an extent in the New Mexican economy, despite a lower rig count. What I’m about to talk about is not based on the buoyancy of the Eleventh District economy but on my talking with CEOs as well as the economic projections of our own staff. I’ve talked with twenty-five CEOs for today’s discussion. I’ve added two, and just for the record they are the CEO of Disney and the CEO of MasterCard. First, my retail contacts, with one exception, report a pickup in dollar volume and foot traffic that began with the second half of December and has continued. As a result, the Wal-Mart CEO for the United States is much more optimistic and is now forecasting volume expansion of about 2 to 3 percent. My contact from JCPenney, which is in an income range that is double that of Wal-Mart, reports a similar pattern of behavior that started the Friday before Christmas and has carried forward and says that the consumers “feel good about the economy.” The one exception, incidentally, is 7-Eleven, and I would be upset, too. Tobacco constitutes 30 percent of their sales, and Texas just levied a $10 tax on a $30 carton of cigarettes. Otherwise, the retailers seem to be much more optimistic than they were when I last reported. A not unimportant factor in this report has to do with the phenomenon of gift cards. In the public release of Safeway is an interesting piece of data: Their gift card business, which is called Blackhawk, grew 100 percent last year and dropped $100 million to the pretax bottom line. Wal-Mart reports—and this is not yet public information—a peak gift-card balance for this season of $1.2 billion. Now, mind you, 70 percent of the card use occurs before February 1. So this business has extended the retail season, and it may well have affected the buoyancy that I’m hearing from retailers in terms of their current activity. MasterCard confirms the pickup in consumer activity, particularly that it began late in the Christmas season, and its CEO reports from his contacts certainly much less “noise” about a possible recession and sees that risk abating. Just to jump forward, we forecast, based on economic research, economic growth in our District of 2.7 percent for 2007, which is what MasterCard happens to be projecting—so I found that CEO to be instantly credible. Disney reports extremely strong advertising growth. They expect the year-over-year growth to be 20 percent in terms of their first- quarter network advertising, with strength in every sector except for autos, according to the CEO. They also report record foot traffic at their parks over the holidays. In contrast, UPS reports a weak start to December but a strong finish in the last seven days of the year, with year-over-year numbers for January not as robust as expected—running around 1 percent. The rails also report a bit slower volume, as the CEO of one of the large rail companies said. There are clearly shifts taking place. For example, lumber shipments of Union Pacific and Burlington Northern are down 25 percent year over year, reflecting the falloff in the construction of homes. Both CEOs caution that company year-over-year numbers are like comparing apples and oranges, given the robust growth in the first quarter of 2006. I did talk to two of the top five housing CEOs and a third one, a smaller company. They seem to confirm the sense of the staff in that they feel that the housing situation is bottoming out, but they continue to caution that any reading of the housing industry between Thanksgiving and the Super Bowl is of questionable value." FOMC20080130meeting--75 73,MR. SHEETS.," Your first international exhibits focus on the recent strength of the U.S. external sector. As shown in the top panel of exhibit 11, U.S. exports are now seen to have expanded at a moderate 4� percent pace in the fourth quarter, following the 19 percent surge in the third quarter. With import growth in the fourth quarter stepping down to 2 percent, net exports are estimated--as shown on line 3-- to have made a positive arithmetic contribution to real GDP growth of 0.2 percentage point. Going forward, we see the external sector contributing 0.5 percentage point to GDP growth in 2008 and 0.3 percentage point in 2009. Exports are expected to expand at a crisp 7� percent pace in both years, supported by stimulus from the weaker dollar. The pace of import growth, after stepping down on average in the first half of this year, should pick up some through the forecast period, broadly mirroring the contour of U.S. growth. As shown in the bottom left panel, some additional impetus to import growth should come from a projected decline in core import price inflation, due to moderation in both exchange-rate-adjusted foreign prices (the red bars) and commodity price increases (the blue bars). Returning to line 4 of the upper panel, we estimate that the current account deficit increased to 5� percent of GDP during the fourth quarter, driven up by a surge in the oil import bill. We see the deficit declining to 4� percent of GDP in 2009, as the non-oil trade deficit narrows to just 1� percent of GDP. As shown on the bottom right, the oil import bill--which has increased from around 1 percent of GDP early this decade to about 3 percent of GDP at present--looms as an increasingly important factor influencing the evolution of the current account balance. Your next exhibit examines U.S. external performance from a longer-term perspective. As shown in the top panel, the arithmetic contribution from net exports was persistently negative from 1997 to 2005, subtracting � percentage point on average from the growth of U.S. real GDP. The contribution from net exports, however, has swung into positive territory over the past two years, adding about � percentage point to growth, and we expect net exports to continue to make a positive contribution over the next two years. As shown in the middle left panel, this upswing in the net export contribution has reflected--in roughly equal measure--an acceleration in exports and a slowing of import growth. Over the past two years, export growth has stepped up to 8� percent, more than twice its average 1997-2005 pace, and it is projected to moderate only slightly in 2008 and 2009. In contrast, import growth over the past couple of years has fallen off to less than half its 19972005 average and is expected to remain soft through the forecast period. The individual contributions of exports and imports to U.S. GDP growth have both risen about � percentage point in recent years. This swing in U.S. external performance has been driven in large measure by the cumulative effects of the decline in the dollar (shown on the middle right). Since its peak in early 2002, the dollar is down more than 20 percent in broad real terms, including a 30 percent fall against the major currencies. We project that going forward the broad real dollar will depreciate at a pace of a little less than 3 percent a year, with this decline coming disproportionately against many of the emerging market currencies (including the Chinese renminbi), which have moved less since the dollar's peak in early 2002. The bottom panel highlights another factor that has supported the shift in U.S. external performance. From 1997 to 2005, U.S. growth was on average just � percentage point below that of our trading partners. In recent years, U.S. growth has slowed relative to foreign growth, and this gap has widened substantially, reaching 1� percentage points on average in 2006 and 2007. This has, consequently, restrained imports relative to exports. Our forecast calls for this gap to narrow only slightly through the forecast period. But this projection depends crucially on the resilience of growth abroad--an issue that is examined in your next exhibit. Recent data have confirmed our expectation that foreign activity slowed markedly in the fourth quarter. As shown in the top left panel of exhibit 13, economic sentiment in the euro area fell in December for the seventh consecutive month, and the ECB's survey of bank lending pointed to further tightening of credit standards for both households and firms. In addition, euro-area retail sales volumes and industrial production (not shown) have moved down in recent months. In the United Kingdom, the preliminary reading on fourth-quarter GDP growth was surprisingly strong, but other indicators seem to point to some softness going forward. As shown on the right, the Bank of England's new survey of credit conditions indicates a further decline in the availability of credit to corporations during the fourth quarter, and the level of new mortgage lending has plunged. Other indicators, including consumer confidence, have also slid of late. The Japanese economy may be weakening as well. As shown in the middle left panel, the December Tankan survey showed a further retreat in business confidence, including a softening of sentiment among both large manufacturers and large nonmanufacturers. Housing starts have declined dramatically lately, as the construction sector adjusts to new, tighter building standards. We also see signs that labor market conditions may be weakening. As shown in the bottom panel, our assessment is that total foreign GDP growth slowed to about 2� percent during the fourth quarter, distinctly down from the 4 to 4� percent pace recorded through 2006 and the first three quarters of 2007. Notably, the fourthquarter slowdown was broadly based. We estimate that growth in Mexico (line 8) declined sharply, in line with a contraction in U.S. manufacturing output. Chinese GDP data, which were reported after the Greenbook went to press, indicate that growth in the fourth quarter remained below its double-digit pace in the first half of the year, with exports posting a contraction. The middle right panel summarizes what we see as the key sources of this nearterm slowing. First, a number of countries have experienced headwinds from the ongoing financial turmoil; this is particularly the case for the euro area, the United Kingdom, and Canada. In addition, sharp recent declines in equity markets have occurred in a much broader set of countries. The softening of U.S. growth is a second factor weighing on activity abroad, especially for countries like Canada and Mexico and many in emerging Asia that have sizable trade linkages with the United States. Third, through 2006 and 2007, many of the foreign economies enjoyed exceptionally rapid cyclical expansions, so some eventual moderation in the pace of growth seemed inevitable, and we have been projecting a deceleration for some time. Returning to the bottom panel, we see these factors as continuing to weigh on foreign activity through the first half of the year. Thereafter, growth should gradually strengthen, to 3 percent in the second half and to 3.4 percent in 2009, as financial turmoil subsides and as the U.S. economy rebounds. Nevertheless, we expect that growth will remain well below the heady pace recorded over the past two years. As shown in the top left panel of exhibit 14, our foreign outlook is also supported by projected easing of monetary policy abroad. Given mounting evidence of economic weakness and continued financial stress, we see the ECB and the Bank of Canada cutting policy rates 50 basis points by the middle of the year, and the Bank of England easing 75 basis points. Given the persisting inflation risks, this is admittedly an aggressive call. But we see the case for monetary action as compelling and believe that these central banks will be persuaded, notwithstanding their recent hawkish rhetoric. The futures markets also appear to be pricing in some easing, albeit at a more gradual pace than we envision. Finally, we now expect the BoJ to remain on hold until the end of 2009. To be sure, there are a number of risks surrounding our forecast, most of which are on the downside. First, the prevailing financial headwinds or the slowing of U.S. growth may be larger or more protracted than we currently project. Second, we do not yet have a good sense of the extent to which many foreign financial institutions have been affected by the recent turmoil, and the release of year-end financial statements over the next six weeks or so could bring some bad news. A third risk is that overly optimistic expectations of decoupling may lead to policy mistakes. Specifically, to the extent that foreign authorities are convinced that they have decoupled from the United States--or that they are immune from spillovers due to the financial turmoil--they may be too slow to ease policy to address weakening demand. Policy abroad may also be restrained by too narrow a focus on the recent rise in inflation, a topic to which I will return momentarily. Finally, housing markets in some countries may be vulnerable. As shown in the bottom left panel, many countries have experienced run-ups in house prices in recent years that are similar to or even exceed those recorded in the United States, and house prices are now decelerating sharply in a number of these countries. Further weakening of house prices poses the risk of adverse wealth effects. Notably, of the major economies shown in the right panel, only the United States has yet seen a marked downward swing in the contributions from residential investment to GDP growth. Your final international exhibit discusses our projections for foreign inflation. As shown in the top panel of exhibit 15, average foreign inflation jumped up to an annual rate of 4� percent in the fourth quarter, with marked increases in both the advanced foreign economies (line 2) and the emerging markets (line 7). The sources of this rise in inflation--including rapid increases in the prices of food and oil--have been well documented. Going forward, we see average foreign inflation moving back down to an annual rate of 2� percent in the second half of this year and continuing at that pace in 2009. Despite the run-up in realized inflation rates, readings on long-term inflation expectations have remained well anchored. As shown in the middle left panel, breakeven inflation rates for the advanced foreign economies have continued to hover around 2.3 percent on average, and long-term inflation forecasts have stayed near 2 percent. For the emerging markets, average long-term inflation forecasts (shown on the middle right) have remained between 3 and 3� percent in recent years. The bottom panels show four-quarter percent changes for the prices of oil, food, and metals. Given the marked slowing of global activity, the stage seems set for some deceleration in commodity prices; indeed, metals prices are already on a downward trajectory. Thus, in line with quotes from futures markets, we see the pace of increases in oil prices and food prices as declining significantly over the next few quarters. Nevertheless, we have been wrong on this score before and freely acknowledge that there are upside risks to this projection. Brian Madigan will now continue our presentation. " FOMC20061212meeting--86 84,MR. HOENIG.," Thank you, Mr. Chairman. Overall, the Tenth District economy continues to expand at a moderate pace. Activity has slowed somewhat, but our region is still probably doing a little better than the nation as a whole. One area in which we may be doing a bit better is housing, even though we have slowed just as everyone else has. Our surveys show that the inventories of unsold homes, although elevated, are less than they are in other regions of the country and that they have not accelerated much since last summer. Our real estate contacts have indicated to us that they think inventories will be coming down over the next few months because the slowing in construction is bringing them back into line. It will take some time, however. On the manufacturing side also, we have a bit more positive information in the region than perhaps nationwide. While we have had a slowdown in areas related to housing and autos, the areas related to oil and gas, railroads, commercial offices, and high-tech equipment in the District are generally noting strong and even increasing demand, and we’re expecting those businesses to expand their operations accordingly. Some of our machinists and machine manufacturing organizations have actually seen some fairly strong growth, and their six-month outlook is also strong, especially in the export sector. Energy activity has remained strong in the District, despite some declines in our mountain region, where costs of drilling are higher, and that has caused some reduction in rig count. Other areas in the Oklahoma panhandle and so forth are really going quite strong. Consumer spending remains solid, and early holiday returns have generally been quite positive. Mall managers in the District’s cities reported solid traffic after Thanksgiving, and we’re off to a very good start for the December holidays. Labor markets also remain fairly good in the region, and as others have reported, our demand for skilled labor is really quite good, and finding individuals to fill positions is difficult right now. However, a couple of pieces of anecdotal information offset that a bit. In the past couple of months, the temporary hiring area has had a slowdown in their sales growth, which surprised the chairman of our board of directors to some degree—I don’t know whether he mentioned this last week when he was here. Also, a couple of major trucking firms, while not saying that business is bad or anything like that, are saying that business is noticeably slower than it has been in other such holiday periods. Whether or not it’s packaging they’re not willing to say, but they are saying that it sure is slower. On the national outlook, I don’t have any real disagreements with the Greenbook in that we see growth to be below potential. What potential is may be a question. However, we do see growth below potential but returning gradually over 2007 into 2008. Obvious risks to that forecast are, on the downside, housing and, on the upside, perhaps some strength in foreign demand. We have seen the latter, as I mentioned, in our manufacturing sector, and I think it may bring some strength to the economy as we look ahead. On the inflation front, our outlook is for inflation to come down gradually—we continue to think that monetary policy is slightly restrictive—and, with that, inflation numbers. For example, core CPI inflation would come down from 2.8 percent to 2.5 percent in ’07 and perhaps to 2.3 percent in ’08; the core PCE would average around 2 percent over 2007 and 2008, falling from 2.1 to 1.9. Those are obviously rough estimates, but they are showing the trend. The risks, of course, are in what happens to energy. On the other side, frankly, is what happens to the dollar because, if that continues to go down, it would create some upside inflationary pressures that we’d have to think about and deal with as we go forward. So with that, I will stop and wait for the policy discussion for the rest of my comments. Thank you." FinancialCrisisInquiry--225 So beyond Wells Fargo, are there others that you would say… CHAIRMAN ANGELIDES: I’m—I’m going to cede a couple of more minutes. Take... THOMPSON: Are there others that you would say manage this process? ROSEN: Oh, I think you can look at who’s got the—the best delinquency, and default data. I—I don’t want to give individual names. I just know at Wells Fargo they actually—there is an actual person talked to me about it. Said, “We’re blaming you on why we’re not making these loans. It’s your fault. We’re telling our guys we’re not going to do these things, because...” I’ve known it for many years, and they use that as a way to shield—cause they get a lot of pressure from the sales people to compete. I think that’s the nature of the marketplace. And it doesn’t mean they didn’t do some things they regret also—they did. But I think that it’s a competitive market. And it all goes to the lowest common denominator it seems in the mortgage area. And if there’s securitization involved, there’s no consequence it feels like to people. Holding your own portfolio as community banks do, you make a bad loan; you’re going to see it. THOMPSON: So you live in California. And you’ve lived through the hubris of the dot com bubble. ROSEN: Right. THOMPSON: Can you make a comparison for us between the experiences beyond the significantly expanded impact that this one has had on the local.... FOMC20061025meeting--148 146,MR. FISHER.," He’s increasingly addled, but his words do carry weight. In his recent client letter, he says, “Inflation is leveling off at admittedly unacceptable levels.” Hence my careful reference to the word “comportment.” I think first about the immediate statement, and I want to come to that. I also think, by the way, of one thing we’ll get to this afternoon, which is the centennial. The transcripts of these meetings will be released as we approach the centennial, and I think we have to make very clear that this FOMC, like previous ones, is extremely vigilant with regard to the greatest threat to our society, which is inflation—at least to our economic society. We need to issue a statement that makes it clear that we’re mindful of and remain vigilant about inflationary risk. In Vince’s table, something between B and B+, as you laid it out yesterday afternoon, would do the trick. By the way, I would tack on “to the upside” at the end of the first sentence in that right-hand column B—it’s sort of a mix between B and B+—because we do view inflationary risk as being to the upside. That’s an asymmetry. I want to make one other comment. Governor Warsh gave a very impressive briefing yesterday on the financial market’s perspective, and we’ve heard from others that the equity market’s robustness has given us something of a cushion with regard to the weakness in housing. Although many at the table do not seem to share the staff’s estimation of third-quarter growth— we’ll find out on Friday—and to my mind, HSBC is the only securities house I’ve found that has an analysis similar to yours, we have to be very careful in stating our views on growth. And this comes around to Bill’s statement, I think, on the first rationale box of alternative B, because we say that economic growth appears to have slowed further in Q3. I can accept that. But then we say “going forward”—implying going forward from Q3—the economy seems likely to expand at a moderate pace. So are we saying “moderate” from a very slow third quarter? That’s not even what the staff seems to be saying. That phraseology might spook the equity markets, which are being driven, by the way, as I think any analyst would find out, not by top-line growth but by earnings, by continued efficiencies in the cost of goods sold, and the management of cost of goods sold and inventories. Again, we take comfort from the fact that we have a strong equities market. So I’d like to suggest replacing the word “moderate” in section 2 of alternative B with “improved.” I think it’s a small word change. “Going forward”—that’s going forward from the third quarter—“the economy seems likely to expand at an improved pace.” That’s what we’re saying, that’s what the staff is saying, that’s what we’re hearing around the table, and I think we should say so. Thank you, Mr. Chairman." fcic_final_report_full--454 Securitization and structured products . Securitization—often pejoratively described as the “originate to distribute process”—has also been blamed for the financial crisis. But securitization is only a means of financing. If securitization was a cause of the financial crisis, so was lending. Are we then to condemn lending? For decades, without serious incident, securitization has been used to finance car loans, credit card loans and jumbo mortgages that were not eligible for acquisition by Fannie Mae and Freddie Mac. The problem was not securitization itself, it was the weak and high risk loans that securitization financed. Under the category of securitization, it is necessary to mention the role of collateralized debt obligations, known as CDOs. These instruments were “toxic assets” because they were ultimately backed by the subprime mortgages that began to default in huge numbers when the bubble deflated, and it was diffi cult to determine where those losses would ultimately settle. CDOs, accordingly, for all their dramatic content, were just another example of the way in which subprime and other high risk loans were distributed throughout the world’s financial system. The question still remains why so many weak loans were created, not why a system that securitized good assets could also securitize bad ones. Credit default swaps and other derivatives . Despite a diligent search, the FCIC never uncovered evidence that unregulated derivatives, and particularly credit default swaps (CDS), was a significant contributor to the financial crisis through “interconnections”. The only company known to have failed because of its CDS obligations was AIG, and that firm appears to have been an outlier. Blaming CDS for the financial crisis because one company did not manage its risks properly is like blaming lending generally when a bank fails. Like everything else, derivatives can be misused, but there is no evidence that the “interconnections” among financial institutions alleged to have caused the crisis were significantly enhanced by CDS or derivatives generally. For example, Lehman Brothers was a major player in the derivatives market, but the Commission found no indication that Lehman’s failure to meet its CDS and other derivatives obligations caused significant losses to any other firm, including those that had written CDS on Lehman itself. Predatory lending . The Commission’s report also blames predatory lending for the large build-up of subprime and other high risk mortgages in the financial system. This might be a plausible explanation if there were evidence that predatory lending was so widespread as to have produced the volume of high risk loans that were actually originated. In predatory lending, unscrupulous lenders take advantage of unwitting borrowers. This undoubtedly occurred, but it also appears that many people who received high risk loans were predatory borrowers, or engaged in mortgage fraud, because they took advantage of low mortgage underwriting standards to benefit from mortgages they knew they could not pay unless rising housing prices enabled them to sell or refinance. The Commission was never able to shed any light on the extent to which predatory lending occurred. Substantial portions of the Commission majority’s report describe abusive activities by some lenders and mortgage brokers, but without giving any indication of how many such loans were originated. Further, the majority’s report fails to acknowledge that most of the buyers for subprime loans were government agencies or private companies complying with government affordable housing requirements. FOMC20070807meeting--130 128,MR. ROSENGREN.," I support leaving the target for the fed funds rate at 5¼ percent. However, the news since the last meeting would seem to be more elevated downside risk to economic growth. This elevated risk reflects the baseline growth for real GDP as 2 percent (a considerable reduction from the previous Greenbook), greater uncertainty about the evolution of the housing market, and concern about the fallout from financial market disruptions. Given the greater downside risk, I would prefer language in the assessment of risk paragraph from alternative A, though I do like the modification to alternative B that was made, and I am worried about an interpretation of a Fed put for financial markets. So although I’d prefer the risk assessment in alternative A, which more accurately reflects my assessment of risks, I could certainly accept removing the word “predominant.” That would be my second choice. My third choice would be to bow to those who have a better understanding of nuanced language, since that is certainly not my expertise, though I hope I will develop it over the years, and I could live with the alternative B language as my third choice." CHRG-111shrg52619--90 Mr. Polakoff," I will be as short as possible, Senator. Thank you. We are not in the current situation we are in today because of actions over the last six to 12 months by the regulators, or in a lot of cases the bankers. It is from 3, 4, 5 years ago. I think the notion of counter-cyclical regulation needs to be discussed at some point. When the economy is strong is when we should be our strongest in being aggressive, and when the economy is struggling, I think is when we need to be sure that we are not being too strong. Any of us at this table can prevent a bank from failing. We can prevent banks from failing. But what will happen is people who deserve credit will not get credit because they will be on the bubble. The thing I love about bank supervision is it is part art and it is part science, and I think what we are doing today is going to address the situation today. We have got to be careful we are doing the right thing for tomorrow and next year, as well. Senator Reed. Mr. Smith, and then Mr. Reynolds. " FOMC20080130meeting--196 194,MR. KOHN.," Thank you. Thank you, Vice Chairman Geithner, for a little less gloom here. I didn't expect the bright side from that source. [Laughter] Like everyone else around the table, I have revised down my forecast, which looks very much like the Greenbook: a couple of quarters of very slow growth before a pickup in the second half of the year spurred by monetary and fiscal stimulus. The collapse of the housing market has been at the center of the slowdown, and most recent information was weaker than expected. There is no sign in the data anyhow that a bottoming out is in sight. Sales of new homes have dropped substantially, and that must reflect reduced availability of credit, especially for nonprime and prime nonconforming loans, and perhaps buyers' expectations of further price declines. As a consequence, a steep drop in housing construction has made only a small dent in inventories, and those will continue to weigh on activity and prices. Indeed, house-price declines in the Case-Shiller index picked up late last year. I think we just got November. It looks increasingly as though other sectors are being affected as well, slowing from the earlier pace of expansion and slowing a little more than expected. You can see this in broad measures of activity, as President Stern pointed out: industrial production, purchasing manager surveys, and the employment report. I think it is also evident in some measures of demand. Retail sales data suggest a deceleration in consumer spending late in the fourth quarter. Orders and shipments for capital equipment excluding aircraft picked up in December, but that followed a couple of months of flat or declining data. A slowdown in consumption and nonhousing investment probably reflects multiplier-accelerator effects of the drop in housing, a decline in housing wealth, and additional caution by both businesses and households given the highly uncertain and possibly weakening economic outlook. Certainly the anecdotes we've heard around the table reinforce the sense of business caution. But like other people, I see the softening outlook and the spread beyond the housing sector as importantly a function of what's going on in the financial sector and of the potential interaction of that over time with spending. We have seen improvements in short-term funding markets, in spreads, and in the leveling out of the ABCP (asset-backed commercial paper) outstandings, but investors and lenders seem increasingly concerned about the broader economic weakness and spreading repayment problems, and they are demanding much greater compensation for taking risk in nearly every sector. To me one of the defining characteristics of the period since, say, midNovember is the spreading out from the housing sector of lending caution to other sectors in the economy. Nonfinancial corporations have experienced declines in equity prices. Credit spreads on both investment-grade and junk bonds have increased. A substantial portion of banks reported tightening terms and standards for C&I loans. Commercial real estate sector lenders are very concerned about credit. Spreads on CMBS have risen substantially, and most banks--like 80 percent--tightened up on commercial real estate credit, and that has to affect spending in that sector over time. Banks tell us that they are being more cautious about extending consumer credit, as President Yellen noted. A number of large banks noted a pullback in this area and deterioration in actual and expected loan performance when they announced their earnings over the past few weeks. There have also been increasing doubts about how robust foreign economies will remain, and this was evident in equity markets around the globe and in rising risk spreads on emergingmarket debt. The staff has marked down its forecast of foreign GDP growth again this round. The total decrease in projected foreign growth in 2008 since last August has been around � percentage point, and this is at a time when we are counting on exports to support economic activity. The extraordinary volatility in markets is, I think, indicative of underlying uncertainty, and that underlying uncertainty itself will discourage risk-taking. The uncertainty and the caution are partly feeding off the continued decline in housing, the still-unknown extent of the losses that will need to be absorbed, and the extent to which those losses are eroding the capital of key institutions like the monolines. The monoline issue raises questions about who will bear the losses and provides another channel for problems spreading through the credit markets, through losses being felt or credit being taken back on bank balance sheets, making them more cautious, and even more directly, into the muni market through the monolines. Despite these developments, my forecast for 2008 was revised down only a few tenths from October. But that is because of the considerable easing of monetary policy undertaken and assumed in my forecast. I assumed 50 at this meeting, and unlike that piker, President Yellen, I assumed another 50 over the second quarter. " FOMC20061025meeting--23 21,MR. STOCKTON.," A little work has been done in this area, but it’s a bit like modeling the stock market. You wouldn’t take it very seriously in the sense that these are asset markets and they’re sometimes moving in ways that are very difficult to model on the basis of, for example, fundamentals—especially in a period when, by our assessment, prices have moved up significantly above what we think can be justified in terms of interest rates and rents. So now we have a situation in which that asset price misalignment is projected in our forecast to just barely begin to unwind but we’re really uncertain about what the timing of that process is going to be. One of the reasons we wanted to show the alternative simulation is that we’ve taken a fairly conservative approach here. Our slowdown in the growth rate of house prices, to roughly 1½ to 1¾ percentage points over the next two years, doesn’t make a big dent—if you remember from the briefing that we did one and a half years ago—in the price-to-rent ratio, which we plotted there and showed that that had increased very significantly. So our best guess is that, as in the past, those nominal prices will flatten out rather than actually decline. But the run-up was so large that we couldn’t rule out this time around that the adjustment of house prices could be more significant and more rapid than in the past. But I don’t know of any reliable empirical model or evidence. We’ve certainly done our share of work in modeling those house prices, and I know our colleagues at the New York Fed have as well. There’s a lot of controversy about whether there even is an asset price misalignment, much less, if there is, how it will unwind. So I don’t have a lot to offer you there, except that we’re going to try to present you with the range of possible outcomes in the sensitivity of our forecast to the baseline assumption that we’ve made. In that regard, I still see more downside risk there than upside risk to our house-price forecast." FOMC20060808meeting--54 52,MS. MINEHAN.," Thank you very much, Mr. Chairman. Incoming data on the national economy have been slightly lower on the growth side and slightly higher on the side of continuing price escalation than at least we expected, and we have seen reflections of both these trends in the New England economy. Overall, however, my sense is that growth for the region and the nation remains relatively solid but that price pressures are a concern. The region’s economy appears to continue to grow at a pace that will be sufficient to keep local unemployment levels in the fours. The region has a slower pace of job growth than the nation, but total personal income is growing at about the same pace. This suggests that per capita income growth is relatively solid, which is reflected in rising retail sales and state income tax collection. Indeed, local businesses continually comment on their inability to find skilled labor so that at least some of the region’s slow job growth may be attributable to supply rather than demand conditions. New England’s residential housing correction is becoming more evident and, by some measures, may be more significant than that for the nation as a whole. Home sales were 4 percent to 5 percent off their 2005 highs in the first quarter. That is similar to the nation, but the Case-Shiller-Weiss repeat-sales index sees, at least for Q1, the nation’s home-price escalation at about 10 percent year over year but Boston area prices up much less than that. More-recent data from other surveys suggest that regional prices may be falling. Inventories of homes for sale continue to grow, and the value of regional residential construction contracts fell more than 20 percent, compared with about 4½ percent for the nation. This number likely reflects the relatively small amount of residential construction in the region, but the downturn is eye-catching anyway. Despite this, consumer confidence rebounded a bit from earlier this summer, and business contacts report relatively good performance. Now, one thread in my recent conversations with businesses is not dissimilar to what President Fisher just talked about. I found it a bit troubling that manufacturing and related business services appear to believe that they have greater pricing power than before. They are talking less about increasing competition and less about efforts to increase productivity. They seem to be less worried about margin squeezes and more confident that rising input costs, particularly those related to energy, can be passed on. Some even report that strong demand has enabled them to raise prices or to avoid discounting even without major new input cost pressures. In general, there was a disquieting tone of greater tolerance for inflation. On the national scene, recent data on second-quarter growth, employment, and housing market trends seem to indicate a general softening of the economy. This is not unexpected. All of us have been forecasting a gradual slowdown to potential or slightly below over ’06 and ’07 as the economy makes a transition from consumer-led to business-led growth and the saving rate climbs to a positive number. But has the evolving slowdown turned out to be a bigger soft patch than expected, or are we simply suffering through the ups and downs of the transition process? I am not sure of the answer to that question. I found the relatively low GDP and consumption figures for late ’06 and ’07 in the Greenbook forecast a bit disquieting, even after recognizing the effect of the benchmark revisions on potential GDP. Our forecast in Boston had been in sync with the Greenbook’s and on the low side of the range of forecasts around this table, but now we see growth of 0.6 to 0.7 percentage point above the Greenbook in ’07. We’re not projecting as large a hit to residential investment over the period, and we see solid disposable income offsetting high energy costs and lower housing wealth to a greater degree than does the Greenbook. Moreover, although slow job growth is a concern, at full employment or beyond how much of this is a supply rather than a demand phenomenon, particularly when you take into account lower labor force participation? Are firms hesitant to hire because they are fearful of the future or because they can’t find the skills they need? They certainly are not constrained by a lack of resources. Thus, I am inclined to the view that, although things seem slower than we expected and the Greenbook forecast seems softer, not much has really changed since our last meeting. Consumer spending has been relatively well maintained despite a weakness in Q2. Spending for equipment and software appears to be in good shape. And net exports, given growth abroad, will be positive at least for a time. Residential investment is waning, but how fast is hard to say, and there well could be an offset to that from nonresidential investment. Financial markets remain accommodative, and given the rise in inflation, real rates are down. What is a bit different is the fact that inflation is growing at a faster pace in the short run and is growing across most aspects of the core measure. Certainly it is faster and broader based than I would like, and we continue to see leveling-off or falling price numbers only in the forecast. I recognize that will continue to be the case for some time even in the best of circumstances, but I am concerned that we may not face the best of circumstances. Geopolitical events of all sorts and global demand continue to put pressure on input prices. Productivity growth is likely slower, and economic activity may not wane enough to reduce resource pressures. As time goes by and outsized inflation growth continues, one can imagine a sense of inflation complacency growing. In that regard, as I noted earlier, I found the regional anecdotes about making price increases stick of some concern. I should note here that my own board of directors in a telephone meeting just yesterday indicated concern about the ongoing strength of the economy and voted to maintain the current primary credit rate. I myself worry about overdoing the tightening process, but as I told them, I don’t think we’re at risk of that at present. Given the pace of inflation and given financial market activity, real rates have, in fact, gone down not up, leaving policy and overall financial conditions more accommodative than before our last increase. In sum, I continue to be a bit less worried about variations in the cycle and more worried about the medium-term prospects for inflation." FOMC20060629meeting--49 47,MR. SLIFMAN.," Let me start, and then Dave may want to add a few comments as well. Clearly, we did revise down the forecast. The downward revision was based in part, as I said in my briefing, not only on the incoming data but also on some of the other factors that I highlighted in exhibit 2. But I also want to emphasize that the news wasn’t uniformly bad as it came in. Some good news came in as well, which I tried to point out. What we have done is to take down the rate of growth roughly ½ percentage point beginning in the third quarter and moving to the end of the projection period, in large part, I’d say, because of the disappointing developments in the housing sector but because of other things, such as weaker consumption news, as well. I would also say that we don’t see this cumulating. We’ve weakened the forecast, but we don’t see the economy falling apart. We continue to see an economy that, as I said, was in a transition to a rate of growth that will be below potential. We just marked it down further below potential than we had in the last Greenbook. But I don’t think that there’s a disconnect between what we’ve done and the news that we have received. I do not know, Dave, if you have additional comments." FOMC20071031meeting--10 8,MR. STOCKTON.," Thank you, Mr. Chairman. From a forecast perspective, it’s been a pretty wild ride over the intermeeting period, with our outlook for activity shifting sharply at various points in the process in response to large swings in the stock market, the exchange value of the dollar, and the price of crude oil. A couple of weeks ago, with the incoming data stronger, the stock market up substantially, and the dollar down noticeably, we were looking at a forecast that had economic growth moving materially above potential later in the projection period. It appeared that, after taking you for a tour of the sausage factory in my September briefing, I would need to issue a recall of that last batch of sausages even before the arrival of their typically short expiration date. In the event, the stock market retraced most of its earlier increase, and some of the improvement in financial conditions that had occurred immediately following the September meeting was subsequently reversed. As a consequence, our forecast changed relatively little, on net, over the past six weeks. The growth of real activity is higher in the near term, but in 2008 and 2009, the stimulative effects on GDP growth of the lower dollar are offset by the restraint on incomes and spending imposed by the higher path for oil prices. We expect the growth of real GDP to slow from a 2¼ percent pace this year to a 1¾ percent pace in 2008 before edging back up to a 2¼ percent rate in 2009. The period of below-trend growth late this year and next year results in some easing of pressures on resource utilization, and core inflation moves roughly sideways at just under 2 percent over the forecast period. To my mind, recent developments raise three big questions about our forecast. First, does the broad-based strength that we have seen in the data on spending and activity over the intermeeting period suggest that we have overestimated the restraining effects on aggregate demand emanating from the recent financial turbulence? Second, is the staff missing signs of greater restraint on aggregate demand that will weigh more heavily on activity in the period ahead? Finally, with oil prices up sharply, the dollar having depreciated, and resource utilization a touch tighter, why is our forecast for core inflation about unchanged? Let me start with the question about whether the strength in the incoming data casts doubt on our estimates of the restraining effects of financial turbulence. There can be little denying that, almost across the board, the readings on economic activity have been stronger than our expectations in September. In terms of domestic spending, the largest upside surprises have been in consumer spending, and much of the upward revision reflects data on activity after the financial turbulence had already begun. Overall consumer spending was stronger than we had expected in August, and the available information on retail sales and on sales of motor vehicles suggests that real PCE exceeded our expectations for September as well. At this point, we know very little about October. Chain store sales have softened somewhat but only by enough to make us comfortable with the meager monthly gains in spending that we are projecting for the fourth quarter. Our discussions with the automakers suggest that sales this month have remained reasonably steady. All told, third-quarter growth in consumption looks stronger than we had expected, and spending appears to be headed into the fourth quarter with a bit more momentum. In the business sector, stronger purchases of motor vehicles led us to raise our forecast of equipment spending in the third quarter. The other components of E&S came in close to our expectations, though last week’s data on orders and shipments of capital goods, which we received after the Greenbook was completed, were also a bit stronger than we had anticipated. The incoming data on construction put in place are consistent with our projected sharp slowdown in the growth of nonresidential structures after a surge in the second quarter. But even here, the data have outflanked us to the upside, with surprising strength in commercial construction, factory buildings, and telecommunications structures. Taken together, stronger consumption and investment account for only about half of the upward revision that we made to real GDP growth in the third and fourth quarters. The external sector accounts for the other half. In particular, continuing a pattern we have seen during much of this year, the growth of exports once again exceeded our expectations. We estimate that real exports increased at an annual rate of nearly 17 percent in the third quarter, about 3½ percentage points above our September forecast, and we have marked up export growth in the current quarter as well. The greater strength in both foreign and domestic demand led us to revise up the growth of real GDP in the second half of this year about ½ percentage point, with annualized growth rates of 3¼ percent and 1½ percent in the third and fourth quarters, respectively. So, do these fairly broad-based upward surprises in spending and activity suggest that we overreacted in the extent to which we marked down our projection in response to the recent difficulties in financial markets? It certainly seems a legitimate possibility. However, we think it would be premature to make that call. As Bill noted, financial market conditions have improved somewhat over the intermeeting period but remain far from normal. In terms of credit provision, the Senior Loan Officer Opinion Survey revealed a sharp jump in the fraction of banks reporting tighter terms and standards on loans to businesses and households, a development consistent with the restraint on spending that we have built into our forecast. Consumer sentiment remains depressed relative to overall economic conditions, perhaps because of worries about financial developments. For now, although we have slightly trimmed the magnitude of the turmoil effects on aggregate demand, the more important adjustment in this forecast has been to push more of the restraint into next year. At the other end of the spectrum of worry is the second question that I posed earlier: Have we missed some significant signs of potential economic weakness in the developments of the intermeeting period? Financial market participants seem to have reacted to the news of the past six weeks by marking down the expected path for the fed funds rate, whereas our forecast and policy assumptions are nearly unchanged. Is it possible that we are missing signs of an impending downturn in aggregate activity? Of course, the prudent and accurate answer to that question is always “yes.” But if that turns out to be the case, it won’t be for lack of attention. At present, it is difficult to find evidence in high-frequency indicators that the economy is in the process of turning down. Initial claims for unemployment insurance have remained relatively low, motor vehicle sales are reported to have been well maintained at least through mid-October, commodity prices are firm, reports from purchasing managers continue to suggest modest expansion, and few anecdotes outside the housing sector sound as though we’ve moved past a tipping point. If we are missing something important, it seems more likely to me that we could be facing a more-grinding period of subpar economic performance associated with a deeper and more-protracted adjustment in the housing sector. It might seem a bit surprising to point to housing as a major downside risk when this has been one aspect of our forecast that was right on the mark over the intermeeting period; we had expected steep declines in sales and starts, and that is what we got. But I would counsel you not to take too much comfort from that observation. In our forecast, we expect sales and starts of new single- family homes to decline another 8 percent before bottoming out around the turn of the year. The projected configuration of starts and sales is consistent with a dropback in the months’ supply of unsold new homes from an estimated peak of 8½ months early next year to 4½ months by the end of 2009. Residential investment continues to fall through the middle of next year and only edges up thereafter. But it is not difficult to envision a more painful period of adjustment. We know a huge inventory imbalance still exists in the housing sector. If, in response to that imbalance, house prices register steeper declines than the ones we are forecasting, prospective purchasers could experience an even greater fear of buying into a declining market, reinforcing the housing sector’s drag on aggregate activity. Moreover, sharply lower prices could have more-serious implications for the ability of households to refinance existing mortgages and could impair the performance of mortgage markets more broadly. Those strains, as they have in recent months, could spill over into other areas of the financial markets. As we showed in a couple of alternative simulations in the Greenbook, a steeper decline in house prices and construction activity could result in a path for the fed funds rate that does not differ materially from the one that appears to be currently built into market expectations. We remain comfortable with our baseline projection for housing, but it is still easier to see sizable downside risks than sizable upside risks to this aspect of our forecast, and that suggests to me that our modal forecast of GDP still has more weight to the downside than the upside. That said, given the strength over the intermeeting period of the incoming data outside housing, that downward skew is probably less pronounced in this forecast than in the one we presented in September. Turning to the price projection, the question I posed at the outset was why our forecast of core price inflation is largely unchanged given higher oil prices, a lower dollar and tighter resource utilization. With respect to resource utilization, both the GDP gap and the unemployment rate suggest only slightly tighter product and labor markets than in our previous forecast, and given the flatness of our aggregate supply curve, the effect on prices over this period is negligible. As for the lower dollar, we see higher import price inflation in the near term in line with the recent depreciation, but these effects quickly play through. More broadly, the available evidence continues to suggest that exchange rate pass-through to import prices is quite low, which in turn mutes the effects on broader prices. The indirect consequences of higher oil prices are a bit more consequential, and all else being equal, would have added about a tenth to our core price projection in 2008. But not all else was equal. The incoming data on core PCE prices were again slightly more favorable than we had expected. The surprise in this intermeeting period was largely in nonmarket prices. More broadly, the deceleration that we have observed in core PCE prices over the past year has been greater than can be explained by our models, and we have carried a bit larger negative residual forward in this forecast. As a consequence, we expect core PCE price inflation to move sideways at a 1.9 percent pace in 2008 and 2009, unchanged from our previous forecast. Overall price inflation is projected to move down from 3 percent this year to 1.8 percent in 2008 and 1.7 percent in 2009. The deceleration in overall prices reflects some decline, on net, in energy prices over the next two years and a dropback in food price inflation to a rate closer to that of core consumer prices. On the whole, I’d characterize the risks around our inflation forecast as roughly balanced. Nathan will continue our presentation." FOMC20060510meeting--108 106,MR. STONE.," Thank you, Mr. Chairman. Economic activity in the Third District continues to advance at a solid pace. Growth in our region has been steadier than in the nation over the past two quarters. Payroll employment grew in each of the three states through March, and the three-state unemployment rate is now 4½ percent. Our business contacts in the region report increased difficulty in filling open positions. In addition, our employment diffusion index in the business outlook survey rose sharply in April. Regional manufacturing activity continues to expand at a moderate pace. In response to a special survey question in April, the majority of participants said that underlying demand for their products was increasing. On the retail side, performance looks solid. Some of that is seasonal. On the auto side, sales have picked up slightly, but we see some small dealerships actually going out of business. Our retailers have expressed less concern than I’ve heard around the table about the impact of gasoline prices on their sales going forward. While initial reports of nonresidential construction contracts in our region have declined in recent months, demand for office and industrial space in the District continues to strengthen. The office market absorption rate is rising in the Philadelphia metropolitan area, and vacancy rates are declining in both the city and the suburbs. Results of the special survey conducted by the Reserve Bank suggest that commercial construction activity is somewhat softer in our District than in the nation as a whole. Nonetheless, our contacts do see a stronger picture this year than they did last year. In the residential sector, home sales have slowed since the winter. Inventories and time on the market have increased. Demand has fallen particularly for higher-priced homes, more so than for lower-priced homes, and house-price appreciation is slowing in our region. Prices for industrial goods are rising, and construction firms are reporting some shortages of structural materials. Some area builders are starting to stockpile copper, aluminum, and steel for upcoming projects. Employers in a number of industries in our region report that they have paid higher salaries for workers this year compared with hires in similar positions last year. At this time of the year, we usually are traveling around the District and conferring with bankers and other businesses as we’re doing our annual field meetings. Over the past week, we were in the typically most depressed areas of our District—the far western part of our District—and for the first time in many years I was hearing optimism about the future and reports of an actual substantial decline in the unemployment rates in those areas. Turning to the national conditions, our economic outlook is broadly consistent with the Greenbook baseline. However, we see somewhat more economic strength and somewhat higher inflation going forward. We also note that many forecasters have also revised up their forecasts of the second quarter based on the strength of incoming data. Business spending and manufacturing continue to show strength. Notwithstanding the April unemployment report, which came in lower than expected, employment remains strong. Monthly gains have accelerated to an average of 173,000 jobs this year, compared with 165,000 last year. Employment growth will support consumer spending even as house- price appreciation slows. The rising gasoline prices will have a damping effect but probably not a dramatic one. There are no signs of a sharp retrenchment in housing. So far, the slowing has been orderly. With the economy expected to remain at full employment and with labor markets tight, we expect hourly compensation growth to accelerate over the forecast period, but not dramatically so. I recognize that higher oil prices and higher long-term interest rates pose a downside risk to growth and that the downturn in housing and the monetary policy tightening already in the pipeline could prove to be a bigger drag than anticipated. But in my view, given the underlying strength of the economy, the risks to growth are roughly balanced or perhaps even tilted modestly to the upside. I have somewhat more concern about inflation over the intermeeting period. It’s true that we haven’t seen an acceleration in core inflation measured year over year. But at shorter horizons, as has been previously mentioned, we’ve seen a marked uptick in core inflation. In addition, inflation forecasts have been revised up, reflecting the recent higher-than-expected inflation data and the view that higher oil prices might add to inflationary pressures. Longer-run inflation expectations, as measured by the TIPS and the Michigan survey, as reported earlier, are apparently up somewhat, which is troubling to me. Higher productivity growth will help to keep inflation in check. With inflation running at the top of the range that I consider consistent with price stability and with the economy operating at high levels of resource utilization, there’s a risk that stronger inflation pressures could emerge. Thank you, Mr. Chairman." FOMC20070131meeting--101 99,MR. STOCKTON.," At the time of the last FOMC meeting, we were feeling as though the incoming spending data were coming in pretty darn close to our expectations and were pretty consistent with our story about entering a period of below-trend growth. As we noted, and President Moskow quizzed us about, the big fly in the ointment with respect to our story was the labor market and its ongoing strength. Since then, as Larry noted, the spending data have moved toward the labor market data rather than the labor market data moving toward the spending data. The developments have certainly brought into sharper focus the upside risk associated with buoyant consumer spending. If we made an important policy-magnitude type error, it might be that the third quarter was just a period of low measured GDP growth but basically we haven’t moved much below trend. I think that you would need to take that risk very seriously as you thought about the current setting of policy. There are some critical reasons for remaining patient about whether, in fact, we have or have not moved below trend. I think that we still haven’t seen the full effects of the housing shock that we had in the second half of 2006. I suspect that we are going to see more of the employment effects associated with that going forward. I don’t think that we’ve seen the full multiplier accelerator effects of that, and we certainly haven’t seen, if our estimated econometric models are anywhere close to right, the lagged effects of the slowing house prices and consumer wealth that we think will be part of the reason for motivating a higher saving rate. So we’ve raised the forecast, and we’ve raised it significantly, but I don’t think we’re yet surrendering the notion that this current setting of policy can produce a period of modestly below trend growth. Now, I think that the upside risk continues to be the labor market strength. As Larry said, even given the overall dimensions of the housing shock, we’ve been encouraged about our story of stabilization. But I remember that, as we went into the investment shock earlier in this decade, we just didn’t have enough imagination about how bad things could get, and we kept thinking that we were seeing signs of slowing or stabilization, that the new technology was still great, and that there should be reasons or underlying motivation for investment. Perhaps what we’ve seen recently as stabilization are the beneficial effects of the drop in long-term interest rates that occurred from last summer into the fall and pulled some people forward, but really we may not have fully made the adjustment yet. The overhang of unsold homes out there is very large, and we could be underestimating the size and duration of that. So even given the recent stronger data on spending, I still don’t see all the risks on that side of things. I still think there are some significant downside risks that you ought to be at least concerned about." 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." CHRG-111hhrg51592--16 Mr. Hensarling," Thank you, Mr. Chairman. We know there are a number of causes of our Nation's economic turmoil. Most have their genesis in flawed public policy. To state the obvious, the three major credit rating agencies missed the national housing bubble. This doesn't necessarily make them duplicitous, doesn't necessarily make them incompetent, but it does make them wrong--very, very wrong. Unfortunately, many investors, due to legal imperatives or practical necessity, relied exclusively on ratings from the three largest CRAs, without performing their own conservative due diligence. We now know that the NRSRO term has been embedded in our law, approximately 10 Federal statues, approximately 100 Federal regulations, roughly 200 State laws, and around 50 State rules. I believe the failure of the credit rating agencies would not have generated the disastrous consequences that it did had the failure not been compounded by further misguided government policies which effectively allowed the credit rating agencies to operate as a cartel. By adopting the NRSRO system, the SEC has established an insurmountable barrier to entry into the rating business, eliminating market competition among the rating agencies. People assumed, wrongly, that the government stamp of approval meant accurate ratings. Now, we took a step in the right direction with the Credit Rating Agency Reform Act of 2006, but it was too little, too late. There's a vitally important lesson we must all learn regarding implied government backing. We have seen the results from the government stamp of approval on Fannie Mae and Freddie Mac. We now see the results, the impact of denying a competitive market for credit rating agencies. We must certainly consider this in a development of a potential systemic risk regulator designating specific institutions as too-big-to-fail, creating a self-fulfilling prophecy. Outcomes in the market cannot and should not be guaranteed by the government. It causes people to become reliant, dependent, and engage in riskier behavior than they otherwise would. When people believe that the government will perform their due diligence for them on the front end, or will bail them out on the tail end, this is very dangerous for the investor, and disastrous for the Nation. I yield back the balance of my time. " 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." 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." FOMC20070131meeting--53 51,MR. SLIFMAN.,"2 Thank you, Mr. Chairman. I’ll wait for my colleagues to come to the table. We’ll be using the chart package that you all should have on the economic outlook. Separating the signal from the noise in the recent economic data has not been easy—what with the motor vehicle anomaly, the defense spending pull- forward, and the transitory swings in oil imports. We tried to cut through the clutter by highlighting in the Greenbook real private domestic final purchases, or PDFP— that is, the sum of consumption, residential investment, and business fixed 2 Material used by Mr. Slifman, Mr. Wascher, and Mr. Gagnon is appended to this transcript (appendix 2). investment. We think this aggregation, which is shown on line 3 of the table in exhibit 1, currently is giving a fair representation of the thrust of aggregate demand. The data that we have received since the December meeting have been stronger than expected. As a result, we have revised up our estimates of the growth of PDFP in both the fourth and the first quarters to annual rates of about 2 percent—roughly the same rates as those in the middle two quarters of 2006. The remaining panels of exhibit 1 highlight some of the indicators that have informed our judgment about the current pace of activity. Starting with the labor market, the middle left panel, increases in private payroll employment averaged 119,000 in the fourth quarter, close to the average pace in the preceding two quarters. As you may remember, at the last FOMC meeting we commented on the stronger signal for activity coming from the labor market compared with the spending data. That tension seems to have been largely resolved, not because of weaker employment but because of stronger spending—especially consumption. Retail sales increased briskly in November and December; accordingly, in this Greenbook, we boosted our estimate of fourth-quarter real PCE growth, the middle right panel, to an annual rate of about 4½ percent. The fundamentals for consumption remain quite solid: steady employment gains, recent declines in energy prices that have raised real income, well- maintained consumer sentiment, and further increases in stock market wealth. That said, at least according to some of our models, the fourth-quarter pace of consumer spending was stronger than would have been consistent with those fundamentals. Our forecast for the growth of real PCE in the first quarter, at 3.6 percent, reflects a bet that some of the surprising fourth-quarter strength will carry forward for a while. Turning to housing, sales of new and existing homes—which are not shown in the exhibit—appear to have stabilized in recent months, and the ratio of new home inventories to sales has moved down a bit. As shown in the bottom left panel, the apparent stabilization of housing demand may now be starting to show through to permits and starts for single-family homes. Of course, the unusually warm weather in December makes a definitive assessment at this time particularly difficult. In the business sector, investment spending slowed appreciably in the fourth quarter. In particular, shipments of nondefense capital goods, the red line in the panel to the right, have been unexpectedly soft recently, including the December figure that we received after publishing the Greenbook. Part of the recent weakness in this category appears to be for purchases of equipment related to construction and motor vehicle manufacturing. With orders remaining above shipments, we expect real equipment spending to rise modestly in the first quarter. Exhibit 2 takes a closer look at some recent developments, starting with an examination of the effects on the industrial sector coming from the recent sharp declines in the production of light motor vehicles and residential investment. By our reckoning, production of light motor vehicles, the top left panel, tumbled nearly 20 percent at an annual rate in the third quarter of 2006 and dropped further in the fourth quarter. Meanwhile, we estimate that residential investment, shown to the right, plunged at an annual rate of about 20 percent in both the third and the fourth quarters. In thinking about the effects of these developments on industrial production, we need to keep in mind the upstream effects. As noted in the bulleted items in the middle left panel, the drop in production of light motor vehicles affects IP not only through its direct effect on light motor vehicle manufacturing but also indirectly through its influence on production in upstream industries such as primary metals, tires, and, nowadays, semiconductors. In the case of construction, of course, all the IP effect comes through the influence on upstream industries—lumber, concrete, plumbing fixtures, and so forth. The table to the right shows the estimated effects on IP growth, including upstream effects, associated with the declines in the production of light motor vehicles and residential construction illustrated in the top panels. We have used input-output relationships to estimate the direct and upstream effects and then translated these effects into their IP contributions. Lines 2 and 3 show that, after we account for upstream influences, motor vehicles and residential construction were sizable drags on IP in the third and fourth quarters. Yet, as shown in line 4, the drag from those two sectors was not the whole story. Even so, we think the more likely track from here forward involves modest growth rather than a cumulative weakening of industrial activity, in part because we think that most producers have been moving reasonably promptly to address any emerging inventory problems. The bottom panels widen the scope from the industrial sector to the economy as a whole and address the question of whether developments in less-cyclical industries have been helping support economic activity. My colleague Stephanie Aaronson divided the establishment survey employment data into three categories—highly cyclical industries, moderately cyclical industries, and acyclical industries—based on the correlation of individual industry employment changes with the GDP gap. The bottom left panel presents some history, with the highly cyclical grouping plotted by the black line and the moderately cyclical plotted in red. To keep the chart easier to read, the acyclical group is not plotted. The chart shows what you might have expected ex ante: Fluctuations in both series are highly correlated, but the amplitude of swings in the moderately cyclical is more damped. The panel to the right puts a microscope on the past few years—note the change in scale. As you can see, despite the step-down of employment gains in the highly cyclical industries, employment in the moderately cyclical industries has continued to grow apace. This suggests that the softness we’ve seen lately in residential construction and some parts of manufacturing has not spilled over to other parts of the economy. That conclusion is an important factor that has shaped our view about the longer- run outlook for the economy—the subject of exhibit 3. As shown in line 1 of the table in the top panel, later this year the growth rate of real GDP is expected to move back up toward our estimate of the growth rate of potential, and it stays there in 2008. This basic pattern is unchanged from the last Greenbook. The bullets in the middle panel highlight some of the major forces shaping this projection. The most important is our forecast that the restraint from housing will diminish this year and that its contribution to GDP growth will turn slightly positive next year. Second, the recent declines in oil prices, plotted in the bottom left panel, have raised real income; we believe that the drag from the earlier increases in oil prices should dissipate in the near term, and over time the stimulus from the recent price declines should begin to predominate. Third, federal fiscal policy, the bottom right panel, also is a bit stimulative, although the impetus is projected to ebb over the next two years. Finally, given our conditioning factors, the assumed path of the nominal federal funds rate is consistent with a real funds rate that closes the output gap over time. Exhibit 4 focuses on the components of PDFP. As I noted earlier, the leveling-off of home sales, the uptrend in mortgage applications, and the improvement in homebuying attitudes suggest that housing demand may be leveling off. The top panel shows the historical relationship between housing demand, as measured here by sales of new homes (the red line), and housing construction, shown here by single- family housing starts (the black line). The shaded areas highlight previous housing downturns as well as the current situation. As you can see, cyclical recoveries in sales and starts have generally been fairly coincident historically. You’ll have to take my word for it, but this has been the case even when the inventory of unsold homes has been high. Accordingly, we think that the recent stabilization of sales should be accompanied soon by a stabilization of starts. Then, as sales move up, so should starts. The middle panels focus on the consumption forecast. We expect real PCE, the red bars in the left panel, to increase 2¾ percent this year and next. The forecast reflects two main crosscurrents. On the one hand, real income growth, the blue bars, is projected to be robust, reflecting, in part, continued increases in real wages as well as further employment gains. On the other hand, the wealth-income ratio, plotted by the black line in the panel to the right, falls in our forecast as house prices appreciate only about 1 percent per year. With slower gains in wealth, and spending gradually coming back into line with fundamentals after the current period of unexplained strength, the saving rate should rise. The bottom panels present some details on the outlook for business fixed investment. As illustrated in the bottom left panel, total real outlays for equipment and software, excluding the volatile transportation equipment component, are projected to increase about 6 percent both this year and next. You can see from the red portion of the bars that the bulk of the support comes from spending for high-tech equipment as telecommunications service providers further expand their fiber optic networks and as businesses continue to invest in information technology equipment and software. We expect the contribution from the other equipment category (the blue portion) to narrow this year and then to edge up in 2008, largely reflecting the pattern of changes in the growth of business output. The bottom right panel shows our forecast for nonresidential structures excluding drilling and mining. The incoming information on construction outlays for nonresidential buildings and the forward-looking indicators that we monitor suggest that spending growth has downshifted. Accordingly, after rising 12¾ percent in 2006, real outlays for this component of nonresidential structures are expected to decelerate to a pace of 5½ percent this year. Our projection for 2008 brings growth in this component of nonresidential structures down to its long-run average. Bill will now continue our presentation." fcic_final_report_full--187 The OTS approved Countrywide’s application for a thrift charter on March , . LEVERAGED LOANS AND COMMERCIAL REAL ESTATE: “YOU ’VE GOT TO GET UP AND DANCE ” The credit bubble was not confined to the residential mortgage market. The markets for commercial real estate and leveraged loans (typically loans to below-investment- grade companies to aid their business or to finance buyouts) also experienced similar bubble-and-bust dynamics, although the effects were not as large and damaging as in residential real estate. From  to , these other two markets grew tremen- dously, spurred by structured finance products—commercial mortgage–backed se- curities and collateralized loan obligations (CLOs), respectively—which were in many ways similar to residential mortgage-backed securities and CDOs. And just as in the residential mortgage market, underwriting standards loosened, even as the cost of borrowing decreased,  and trading in these securities was bolstered by the development of new credit derivatives products.  Historically, leveraged loans had been made by commercial banks; but a market for institutional investors developed and grew in the mid- to late s.  An “agent” bank would originate a package of loans to only one company and then sell or syndi- cate the loans in the package to other banks and large nonbank investors. The pack- age generally included loans with different maturities. Some were short-term lines of credit, which would be syndicated to banks; the rest were longer-term loans syndi- cated to nonbank, institutional investors. Leveraged loan issuance more than dou- bled from  to , but the rapid growth was in the longer-term institutional loans rather than in short-term lending. By , the longer-term leveraged loans rose to  billion, up from  billion in .  Starting in , the longer-term leveraged loans were packaged in CLOs, which were rated according to methodologies similar to those the rating agencies used for CDOs. Like CDOs, CLOs had tranches, underwriters, and collateral managers. The market was less than  billion annually from  to , but then it started grow- ing dramatically. Annual issuance exceeded  billion in  and peaked above  billion in . From  through the third quarter of , more than  of leveraged loans were packaged into CLOs.  As the market for leveraged loans grew, credit became looser and leverage in- creased as well. The deals became larger and costs of borrowing declined. Loans that in  had paid interest of  percentage points over an interbank lending rate were refinanced in early  into loans paying just  percentage points over that same rate. During the peak of the recent leveraged buyout boom, leveraged loans were fre- quently issued with interest-only, “payment-in-kind,” and “covenant-lite” terms.  Payment-in-kind loans allowed borrowers to defer paying interest by issuing new debt to cover accrued interest. Covenant-lite loans exempted borrowers from stan- dard loan covenants that usually require corporate firms to limit their other debts and to maintain minimum levels of cash. Private equity firms, those that specialized in investing directly in companies, found it easier and cheaper to finance their lever- aged buyouts. Just as home prices rose, so too did the prices of the target companies. One of the largest deals ever made involving leveraged loans was announced on April , , by KKR, a private equity firm. KKR said it intended to purchase First Data Corporation, a processor of electronic data including credit and debit card pay- ments, for about  billion. As part of this transaction, KKR would issue  billion in junk bonds and take out another  billion in leveraged loans from a consortium of banks including Citigroup, Deutsche Bank, Goldman Sachs, HSBC Securities, Lehman Brothers, and Merrill Lynch.  FOMC20070509meeting--57 55,MS. MINEHAN.," Thank you, Mr. Chairman. Conditions in New England seem broadly supportive of the continued expansion of the region at about the pace of the nation as a whole, perhaps because the pace of national activity has slowed somewhat and so the region seems to be lagging less, though I do think there is a bit of a brighter tone to economic activity. I certainly do not want to overemphasize that, however, as concerns do linger about the strength of job growth and the housing market, among other things. Two matters came up in our rounds of gathering data and anecdotes around the region. First, although growth in overall labor costs in the region is moderate relative to that of the nation, concerns continue about the cost and availability of skilled labor. Respondents are also increasingly concerned about other input costs—oil, copper, zinc, other metals, and chemicals—and report that they are attempting to pass on higher costs within the supply chain or directly to consumers and are succeeding in many cases. We have not heard much locally yet about the effect of three dollars a gallon for gasoline, and I am hoping the refinery outages that apparently caused this uptick prove temporary enough not to dent regional demand or to increase price pressures. However, the general rise in primary energy costs is not particularly reassuring. Second, while the residential real estate data for the region continue to be downbeat in terms of permits, starts, year-over-year sales, and price trends, anecdotes—particularly as they regard high-end markets, as I noted before—offer some hope that the spring picture for sales of existing homes will be brighter when all the data are in. I had a comment in here about spring weather; but that turned yesterday, so I won’t make that comment. [Laughter] The incoming data since the last Committee meeting contained some pluses and minuses that, by and large, offset one another. Thus our forecast in Boston, which is quite close to the Greenbook and similar to other forecasts around the table, has not changed an awful lot. In short, the economy appears to have made what one hopes is the final step-down in overall growth from its unsustainable momentum of only a year or so ago and is in the process of settling in at a pace that will gradually accelerate over this year to slightly below potential in ’08 and ’09. This forecast assumes that the effect of the housing bust begins to subside by midyear and that business and consumer confidence remains strong enough to support continued hiring, consumption, and business investment. It also assumes that strength in the rest of the world buoys corporate profits and foreign consumption of our exports and, combined with a slowly declining dollar, adds at least marginally to U.S. growth. All of this occurs with a continuation of very accommodative financial markets that both sustain household wealth and ease borrowing costs and provide a haven for foreign investment flows. Finally, the current boost in energy costs proves temporary, and inflation subsides gradually as unemployment moves up slightly, reflecting the output gap created by a year or more of slightly sub-potential performance. Looking at the data we received on other projections through ’09, our forecast fell within the central tendency in all the areas, but I think that we see inflation as somewhat more persistent than others do—along the lines of the Greenbook. In fact, this forecast sounds pretty good to me as an outcome if it works out this way, and I have even begun to think, versus where I was at the last meeting, that the risks around both sides of this forecast may be a little smaller. On the growth side, the big question involves spillovers from the housing bust and possibly the problems with subprime adjustable-rate mortgages, but we have been expecting to see spillovers for some time, and they are yet to emerge in any real way. They still might, and we, like the Greenbook authors, have marked down our forecast for residential investment in ’07 based on incoming data. But I am inclined to think that broader market and economic spillovers get less likely over time. In fact, as I noted before, maybe there is some leveling-off in sales of existing homes if we smooth through the month-to-month variation in the data. Credit restraints could well damp the participation of subprime borrowers in home purchases, but low mortgage rates ought to support prime borrowers, and we see evidence for this in discussions with local banks and certainly all the advertisements in newspapers and on television that are focusing on the theme that now is the time to borrow because mortgage rates are low and maybe they will not stay that way for long. So we think—I think anyway—that we have some reason to believe that, through this year, home buying may help keep home prices and equity positive or perhaps neutral contributors to household wealth. Indeed, assuming that gasoline prices edge off their current high levels and that equity markets continue on an upward pace, there is at least some possibility on the upside for consumer spending. Another aspect to the growth forecast that concerned me at our last meeting was the unusually slow pace of business investment in equipment and software. Given the underlying fundamentals of robust corporate profits, cash reserves, and a declining user cost, especially for high-tech goods, we would have expected faster growth. I am still concerned here, especially as such spending patterns could augur poorly for continued hiring, but I find the most-recent data on orders and shipments and the ISM survey encouraging, although as President Moskow mentioned, one should not take a lot of confidence from a single month’s data. So all in all, it seems, to me anyway, that the downside risks around growth in our forecast are a bit less. On the inflation front, I remain concerned that the forecast is just a bit too perfect. Without too extended a growth slump, unemployment rises slightly, and inflation falls slowly. We have not done the work that San Francisco has on slicing and dicing productivity, and I found Janet’s comments very interesting. I also am very much in agreement with her and others’ perspective that the level of underlying structural productivity growth may not be declining to the degree that the Greenbook authors seem to think it might. However, if what seems to be a cyclical low continues, unemployment could well be sticky. Both the recent increase in energy and raw material costs and the burgeoning growth in the rest of the world could increase resource pressures at the same time that the dollar continues its slow decline. All of this taken together could be a recipe for accelerating rather than decelerating inflation. As I’ve noted before, I really have no problem with stable inflation around its current low level. What does concern me, however, is the potential for acceleration. In that regard, the recent small moderation in core data was welcome, though certainly not sufficient to ease this concern entirely. In sum, I remain ready to bet on the baseline forecast. I think it is about as good as we can hope for. There continue to be risks on both sides, but at this point I would not weigh them equally. Being wrong on the inflation side could be a more difficult place to be. That is, if growth falters, it is clear what to do; but if inflation should accelerate, it might take a while and be quite costly to remedy. Thus, I would continue to favor policy that incorporates a bit of insurance. But we will get to that later. Thank you." fcic_final_report_full--483 Figure 3. The MBS market reacts to the bubble’s deflation 477 Source: Thompson Reuters Debt Capital Markets Review, Fourth Quarter 2008, available at http:// thomsonreuters.com/products_services/financial/league_tables/debt_equity/ (accessed July 30, 2009). The decline in housing values had a profound adverse effect on the liquidity of all financial institutions that were exposed to PMBS. As noted above, one of the benefits of holding PMBS, especially those with AAA ratings, was that they were readily marketable. As such, they were considered sound and secure investments, carried on balance sheets at par and suitable to serve as collateral for short term financing through repurchase agreements, or “repos.” In a repo transaction, a borrower sells a security to a lender with an option to repurchase it at a price that provides the lender with a return appropriate for a secured loan. The lender assumes that if its counterparty defaults the collateral can be sold. Accordingly, if the collateral asset loses its reputation for high quality and liquidity, it loses much of its value for both capital and liquidity purposes, even if the collateral itself has not actually suffered losses. This is what happened to AAA-rated PMBS as housing prices first leveled off and then began to fall in 2007, and as mortgage delinquencies rolled in at rates no one had expected. As discussed more fully below, when AAA- rated PMBS became unmarketable they lost their value for liquidity purposes, making it diffi cult or impossible for many financial institutions to fund themselves using these assets as collateral for repos. This was the liquidity challenge to which Chairman Bair referred in her testimony. The near-failure of Bear Stearns in March 2008 was an excellent example of how the unexpected collapse of the PMBS market could cause a substantial loss of liquidity by a financial institution, and ultimately its inability to survive the resulting loss in market confidence. The FCIC staff ’s review of the liquidity problems of Bear Stearns showed that the loss of the PMBS market was the single event that was crippling for Bear, because it eliminated a major portion of the firm’s liquidity pool—AAA-rated PMBS—as a useful source of repo financing. According to the Commission staff ’s Preliminary Investigative Report on Bear, prepared for hearings on May 5 and 6, 2010, 97.4 percent of Bear’s short term funding was secured and only 2.6 percent unsecured. “As of January 11, 2008,” the FCIC staff reported, “$45.9 billion of Bear Stearns’ repo collateral was composed of agency (Fannie and Freddie) mortgage-related securities, $23.7 billion was in non-agency securitized asset backed securities [i.e., PMBS], and $19 billion was in whole loans.” 50 The Agency MBS was unaffected by the collapse of the PMBS market, and could still be used for funding. FOMC20070807meeting--102 100,MR. KROSZNER.," Thank you very much. I was looking back at my notes of the past few meetings and noted that the position we are in is a bit like that in the May meeting, at least the way in which people are characterizing things—that economic fundamentals still suggest moderate growth for the intermediate term but that uncertainty has gone up dramatically. Then, in the June meeting, we said that uncertainty went down, and now we’re saying that uncertainty has gone up again. So we seem to have a little volatility just like the markets do, but obviously, we are responding to what the markets are doing. Clearly, there are key downside risks. The risk that I’ve mentioned many times before that concerns me and that we now have more data on is productivity and potential growth. With the revisions since ’03, the compounded growth rate of productivity is down to 1.4 percent from 1.8 percent. The revision is fairly significant over this period. I am not ready to go quite as far as the Greenbook has gone in marking down potential, but I do think that it is a real possibility, and it is very closely linked to my concerns about investment, which obviously the financial market volatility has affected. Orders and shipments of durable goods have been a bit choppy, and we haven’t seen the kind of rise that we would expect, given the balance sheets and given all the other sorts of strength that we would otherwise see in the economy. Nonresidential investment has been strong, and there is still some strength in mining and drilling, but I have a lot of concerns outside that area. As a number of people have mentioned, there is little change in the actual cost of capital, even though spreads have risen, because the Treasuries have gone down. But with more uncertainty and more volatility, as Governor Warsh and others have mentioned, undoubtedly that is going to weigh heavily in the board room. It is going to weigh heavily on capital expenditure plans. So all other things being equal, businesses are likely to be a bit more cautious going forward. But that caution with respect to investment and the slowing of the investment recovery make it harder to be optimistic about a rebound in productivity growth. So that’s something that I watch very closely because I think it is a very, very important effect. On the consumption-saving balance, certainly we still have very robust labor markets— average growth of 120,000 private-sector jobs per month this year, which is a step down from last year but still a robust level. We have a transition from a sort of cushion of the strong equity market offsetting the negative wealth effect in the housing market. Now, if they become more correlated—and, in particular, more correlated and both go down—that obviously would raise some concerns about slowing consumption growth and increasing saving. So I think that is something to be very mindful of. With respect to housing and financial markets, in the senior loan officer survey with respect to mortgages, when you drill down into it, both in April and in July more than 50 percent of the senior loan officers reported that they are tightening credit standards for subprime, and about 15 percent are for prime. That is fairly significant. The depository institutions are pulling back, and we have certainly heard reports that some of the large institutions are no longer offering 2/28s or 3/27s. There has also been a tightening outside the depository institutions. The reason for part of the tightening is that some of the mortgage providers are simply no longer there. We have had dozens of smaller providers of credit go out of business, and the ones that are still there are obviously changing their underwriting standards. As President Rosengren mentioned, we are seeing some questions about the originate-to-distribute model. We are also seeing volatility on the financial market side. But part of that volatility, as a number of people have expressed, is about concerns about what is going into those securities in the originate-to- distribute model. That may raise some questions in the long run about how much we’re going to see this market come back. I share Governor Warsh’s concerns, not only from the point of view of the financial markets but also regarding the structure of mortgage markets—that we may be seeing a little less of that kind of structure than we have seen in the past. So that, combined with the tightening of standards more broadly, may make financing more difficult to get. This, of course, is occurring in many parts of the country—not all parts but many parts—where housing inventories are very high and in some cases are still rising. Obviously, that puts a lot more pressure on the housing market, and I think the drag from the housing market, as many of you said, is likely to continue. Fortunately, the financial market volatility is coming at a time of relative strength in corporate balance sheets. Debt-to-asset ratios have been declining, and liquid assets as a percentage of total assets have been high. That provides much more of a cushion, much more insurance. As President Poole mentioned, the banking system is in a dramatically different state from when we had challenges before in the housing market or major challenges in financial markets. The major banks have very high, relative to historical trends, capital-to-asset ratios in excess of the required minimums. They have been very, very profitable. If you look at the largest banks—and I was just looking at some that were most involved in the leveraged-loan market—they each have tier 1 capital on the order of $80 billion to $90 billion. The earnings for each over the last year are $25 billion to $35 billion. There is also a lot of discussion of the amount of highly leveraged loans in the pipeline—on the order of $300 billion. But unless they have to take losses on that $300 billion, which is not going to happen, they have very thick capital cushions and very high earnings. So at least for the foreseeable future, this will just be more a challenge to their earnings than a challenge to capital. That is extremely important because the banking system can provide a critical automatic stabilizing mechanism, as it did in 1998, when there are liquidity challenges. In 1998 we had the Asian crisis that spread to Latin America, then the Russian crisis, and LTCM. There were some parallels to what we are seeing now: Risk spreads were rising very dramatically after a period of near-record low levels, and we saw the yields on Treasuries go down quite a bit because that’s where people were going. But what was happening in the system was that people were pulling money out of various funds and instruments and putting it into the banking system. So the banks do act as liquidity providers and liquidity insurers, and I think we’re starting to see a bit of that now with people pulling out of some of these instruments and so more is flowing into the banks. It’s a little early to tell. We haven’t gotten enough data on that. But anecdotal reports are consistent with exactly what happened in 1998. As people need an alternative to commercial paper or other short-term sources of credit, it can be very helpful that the banking system will have more liquid resources to do that, and obviously it’s a strong capital environment. Also, as Governor Warsh mentioned, there are more large private pools of capital to step in to bid for the LTCMs, if such things happen. When we look back to LTCM, only one offer was on the table— from Warren Buffett—and there were a lot of questions about how serious that offer would be. Now a number of players have the wherewithal to be the equivalent of that in this market, which has the potential to be quite helpful. There are obviously more potential downside risks, but a lot of stability exists in the banking system to deal with some of these risks and, given the strength of the balance sheets, should be helpful in the short or the intermediate run. With respect to inflation, as many people have mentioned, a number of risks are still skewed to the upside, with robust global growth, potential pass-through, some previous high energy prices, and a lower dollar. So I still think that there is much more of a potential upside skew to inflation than a downside skew. Basically, I would start taking my first steps, but just very first steps, a little more toward a balance of risk because of the greater downside to growth. Although there are still upside risks to inflation, as Vice Chairman Geithner mentioned, overall we might want to think of moving a little more toward a greater balance of risk but still with a predominant concern for inflation." CHRG-111shrg51290--25 Chairman Dodd," Certainly. Ms. Seidman. I think that calling for counter cyclical capital regulations now turns into a conversation about fair value accounting. But 6 or 8 years ago--8 years ago, the question being asked was about loan loss reserves. In Spain, where their banking system has gone through a bubble and not been in as much trouble as ours, the loan loss reserves are required without particular reference to historical conditions. The banking regulators worked really hard to try to get the SEC to understand that bankers make more loans in good times and then those loans go bad in bad times and that we really need to have far greater loan loss reserves than historic experience, particularly with untested products, which is what the subprime mortgages were. Senator Shelby. By loan loss reserves, you talking about capital, aren't you? Ms. Seidman. Well, you know, loan loss reserves are the first line of defense and capital is the second, and frankly, if we can increase the loan loss reserves to the point where the combination is counter cyclical, that will do. " CHRG-111shrg57319--535 Mr. Rotella," Senator, as I said in my opening statement, shortly after arriving at Washington Mutual and having been an observer from JP Morgan Chase, I was aware of the fact that the company had an extreme concentration in real estate loans as a thrift. It had a concentration in Florida and in California, 60 percent of its mortgage assets. As I said earlier, it was going through explosive growth, particularly in higher-risk lending, and the operating infrastructure was quite weak. That combined with the view that the housing market was softening led a group of us to begin a process of diversifying the company and de-emphasizing the mortgage business, which over time we hoped would lead us to a company that was concentrated less in real estate and had other asset classes. Senator Coburn. So in your testimony, on the one hand you say that you were simply carrying out the chairman and CEO's strategies as far as the high-risk category; but on the other hand, you are saying it was your decision to decrease the high-risk lending. Which is it? " FOMC20051101meeting--121 119,MS. MINEHAN.," Thank you, Mr. Chairman. Economic conditions in New England have bounced around a little bit over the last year or so. Right now they show a few signs of flattening out. Surveys of both consumer and business confidence show some current strength, but opinions about activity six months from now either remain at a low level in the case of consumers or, for businesses, turned negative for the first time in the last five years. Worries about fuel and benefits costs, interest rate increases, and the war in Iraq are most often mentioned by contacts as shaping a less-than-rosy outlook. And when you talk to them about big profit margins, they look at you with a puzzled expression, wondering what business you are talking about because that’s certainly not the case for their business. I think there’s some difference of opinion when looking at your own numbers versus the numbers in the aggregate. Anyway, for the present, most firms do report profits, with those serving the defense industry making notable headway. Consumers are spending, if not on cars then on housing, though at least according to one survey they perceive rising pressures on their personal finances. And core inflation in the Boston area is surprisingly low relative to the nation. It’s usually higher. Thus, there’s a sense in which the region may be experiencing a period of calm before a possible storm of negative trends. Employment in the region dropped in September, and the unemployment rate rose. The employment decline was widespread by state and involved, in part, the usual suspects of trade and manufacturing, but about half reflected government workers in Maine. September government employment can move around a lot, depending on the hiring of teachers for kindergarten through November 1, 2005 42 of 114 report that skilled labor is hard to find and expensive. There are continuing references to caution in hiring and a desire not to add a single new employee until it’s necessary to do so. Both businesses and consumers are concerned about the impact of high heating oil, natural gas, and gasoline prices. Local heating oil companies that have provided lock-in rates for the winter in the past will not do so now, likely feeding into concerns. Despite many fervent prayers for the opposite, the winter is expected to be a bad one. And that forecast was underlined by the early snowfalls in northern New England a couple weeks ago and by the flurries in Massachusetts over the weekend. Certainly this is good in terms of prospects for skiing revenues, but not so good for general optimism, given concerns about energy. Finally, let me say a word about residential real estate markets. The Boston area is often mentioned as having bubble-like characteristics. This is an obvious concern, given the problems the region experienced with falling prices and related banking failures in the early ’90s. However, there’s good reason to assume that recent rising prices in New England reflect a lack of supply and an older, wealthier population capable of supporting both a primary and a secondary residence, rather than a fundamentally unstable situation. And some of the froth is fading. Home prices continue to escalate but are currently increasing at about the same pace as in the nation as a whole rather than leading it. Four out of the eight other regions of the country are now experiencing more rapid escalation. Contacts in the real estate industry report two trends. First, there was a rather abrupt softening in the high-end suburban markets this summer, with escalating supply and the advent of a buyer’s market—something not seen in several years. The other trend is an increase in the supply of multifamily units, particularly condominiums, and a marked upturn in condo inventory. Thus, most November 1, 2005 43 of 114 much of the change at the high end. This could feed into some concerns about spending in the future and could certainly make people feel less wealthy. But given where it seems to be centered, it doesn’t appear likely to do a lot of near-term damage. Turning to the national scene, incoming data appear to confirm the underlying strength of the U.S. economy. Separating out the impact of several hurricanes is not easy. Readings on unemployment and business spending net of hurricane effects seem consistent with the continuation of solid growth through the remainder of 2005. The strength of consumer outlays remains a question, given the now 2-month downturn in confidence and the fact that the outsized motor vehicle purchases that had supported such outlays in the third quarter are falling off their highs. However, labor market data seem consistent with continued strength in hiring. One would suppose that, at least in the near term, working consumers will be spending consumers, especially if confidence improves in the face of waning energy prices—or at least prices for gasoline. Finally, I take the continued strength in housing as a sign that, under it all, consumers still have the confidence to make rather long-term investments. Our forecast in Boston for the next year and into ’07 differs little from the Greenbook’s. Assuming energy prices subside, or at a minimum that we don’t have any new shocks, growth should pick up in the spring, as the impact of the energy tax on consumers eases and as rebuilding in hurricane-ravaged areas accelerates. Over the same 6-month or so period through the winter into spring, low inventory levels are likely to be replenished, feeding factory activity. Growth outside the United States is, on balance, expected to be positive as well. Employment growth should return to its pre-Katrina monthly pace, and the remaining slack in the U.S. economy should wane. The post-Katrina “throw money at it” attitude in Washington seems to have moderated, but a fiscal November 1, 2005 44 of 114 The worrisome headline numbers on both the CPI and the PCE moderate; the feed-through to core inflation ticks up but then moderates through the year; and this process pulls in on the upward trajectory of near-term inflation expectations. There are obvious risks here. Energy-based headline inflation could feed more strongly into the core, and inflation expectations could remain elevated. We could see the moderate trends in wage and salary growth, as measured by the ECI, begin to take off. However, I’m hopeful, along the same lines that President Yellen is, that inflation expectations will moderate, as gasoline prices have, and that we won’t see even as big a feed-through to the ECI data as the Greenbook projects. However, if a big rise in wages were to occur, it would set red lights flashing on everybody’s economic dashboard. If we are lucky, our rather benign forecast for the next year will work out. If we’re not, we could be looking at both rising inflation and falling growth, as one of the alternative scenarios highlights. In that regard, we need to pay careful attention to incoming data on expectations, compensation, and core inflation. If they’re blinking yellow or green, we may be on track. If red predominates, the risks have clearly escalated. It certainly seems clear that managing such risks in the near term involves placing a premium on remaining credible regarding inflation. Doing so should moderate price growth by tightening financial conditions and should result in better pricing of risk. It should also convince consumers that inflation will not continue to exacerbate the growing strain on their pocketbooks. It should moderate inflation expectations and limit the feed-through into wage and salary growth. But we also need to take care not to overdo. There are downside risks. With a small amount of additional tightening in the mix, the Greenbook sees growth at below potential in late ’06, a November 1, 2005 45 of 114 slowing in real estate markets and a decline in relative household wealth. The related expected rise in personal saving may be just what the doctor ordered to start the process of reining in the excesses in the U.S. economy, but I think we do need to take care about dispensing excessive amounts of inflation medicine. In my view, we’re not at a tipping point as yet. Our process of measured steps toward removing the remaining accommodation should continue for a time, taking us closer to the middle of the range of equilibrium rates. But we should also begin to consider when we might have moved enough and how we might prepare markets for that. In that regard, I was interested in the proposal that President Yellen had for an evolution in our statement. I think it’s going to take some time to absorb what she has recommended. Maybe this meeting is not the meeting to make a change. I’m probably comfortable with alternative B. A couple of meetings ago, the Chairman suggested that I take on the task—because I was opening my mouth at the time—of putting some proposals on the table, and I’ve been dragging my heels. I’m more than happy to work with President Yellen on the direction she’s trying to take the statement. Thank you." CHRG-110shrg46629--13 STATEMENT OF SENATOR CHARLES E. SCHUMER Senator Schumer. Thank you, Mr. Chairman. I want to thank you for holding this hearing and I want to thank Chairman Bernanke. As Chairman of the Joint Economic Committee, I am always interested in hearing your thoughts on the current state of economy and appreciate your availability on so many issues when we reach out to you. As I have said in the past, we live in interesting economic times. And you face a number of important challenges in setting a course for monetary policy that will achieve the multiple goals of high employment, balanced economic growth, and low inflation. Right now, there are certain reasons to be concerned about where we find ourselves. In the short-term, even with the likely improvements in the second quarter, overall economic growth in the first half of the year has been disappointing to say the least. Most forecasters have revised downward their expectations for economic growth through the rest of the year. The Administration continues to run high budget deficit that threaten our future stability to compete with the rest of the world. And our trade gap, particularly with China, remains immense and growing at a rapid rate. Energy prices are hovering at record highs, feeding our trade gap and fueling anxiety among middle-class families. The collapse of parts of the housing market which you call a correction has become a serious drag on our economic growth and a threat to economic security of too many American families. And while I welcome the Fed's new pilot program to monitor independent subprime brokers, I do not think consumers will truly be safe from irresponsible and deceptive lending practices until we enact tougher Federal laws to protect the subprime mess from happening again. As indication of the weakness in the housing market continue to mount, there is an urgent need for better protections for existing and aspiring homeowners, although I do want to thank--the Appropriations Committee did a $100 million in for the workouts. So nonprofits can do workouts that Senators Casey, Brown, and I had asked them to do. Most importantly, a view is recognized. We have an economy whose rewards seems to be more and more going to fewer and fewer privileged Americans. We are facing the greatest concentration of income since 1928 right before the crash and the beginning of the Depression when 24 percent of all income went to the richest 1 percent. It is now close to 22 percent and will pass the 24 percent, if present trends continue, all too soon. At a time when the wealthiest in this country have been doing extremely well, the American middle class, the engine of our economy, has not been as fortunate. Most Americans have not seen the benefits of working harder in their paychecks. Between 2000 and 2006 the typical worker's earnings grew less than 1 percent after accounting for inflation while productivity increased a whopping 18 percent. And now that economic growth seems to be slowing, its fair to ask whether most middle-class Americans will slip even further behind. The dramatic increase in productivity and its failure to raise wage rates is a great conundrum for our economy that needs all of our attention. I do not pretend that there are easy solutions to the troubling challenges facing our economy but we need to remember that our collective focus must be on achieving strong sustainable long-term economic growth that can be shared by all families in this country, not just those in the top 1 or 5 percent. Unless economic fortunes in this country grew together rather than apart, we cannot be confident about our children's economic futures. I look forward to your testimony, and thank you, Mr. Chairman, for the time. " FOMC20071031meeting--12 10,MR. MADIGAN.,"2 I will be referring to the package labeled “Material for FOMC Briefing on October Projections.” The table shows the central tendencies and ranges of your current forecasts for 2007 and the next three years. Where available, the central tendencies and ranges of the projections last published by the Committee―those submitted for inclusion in the July Monetary Policy Report―are shown in italics. 2 Materials used by Mr. Madigan are appended to this transcript (appendix 2). Notably, a majority of you conditioned your current projections on an easing of monetary policy, with most of that majority apparently seeing lower rates as appropriate either imminently or within the next six months or so. Even with that assumed easing, your GDP growth forecasts for 2007 have been marked down slightly since last June, and your outlook for next year has been revised down more substantially. Many of you noted that last summer’s NIPA revisions led you to lower your estimate of potential GDP growth. Most of you cited the intensification of the downturn in housing markets, the turmoil in financial markets, and higher oil prices as factors leading you to scale back your expectations for actual growth in 2007 and 2008, though some participants commented that rising net exports could provide support to aggregate demand. The central tendency of the economic growth forecasts for 2008 is now 1.8 percent to 2.5 percent, below the central tendency of 2½ percent to 2¾ percent in June. Perhaps partly because you expect easing whereas the staff assumed an unchanged stance of policy, the central tendency of your economic growth projections is above the Greenbook forecast of 1.7 percent for real economic growth in 2008. That difference may also reflect your somewhat more optimistic view of potential growth. It is worth noting that the divergence among your views concerning the outlook for next year has widened substantially: The width of the central tendency, for example, at nearly ¾ percentage point, is about three times that in the June projections. The downward revision to the outlook for GDP growth was mirrored in a small upward revision to the unemployment rate: The central tendency of the projections for unemployment at the end of this year is around 4¾ percent, and it centers on a rate just under 5 percent at the end of next year. Based on the comments that some of you have made about sustainable rates of unemployment and on your longer-run unemployment projections, many of you apparently predict the emergence of a small amount of slack by the end of next year. With incoming data on core inflation a bit better than you had expected and with some slack likely next year, the central tendency of your projections for core PCE inflation is down noticeably for 2007 and is a shade lower for 2008; most of you now see core inflation below 2 percent in both years. Your near-term forecasts for total PCE inflation are higher than those for core inflation, reflecting surging energy prices and, in some cases, an expectation of continued brisk increases in food prices. With regard to the uncertainties in the outlook, most of you see the risks to growth as tilted to the downside—even with an assumed easing of policy—and judge that the degree of uncertainty regarding prospects for economic activity is unusually high relative to average levels over the past twenty years. Your commentaries highlighted downside risks arising from the possibility that financial market turmoil and tighter credit conditions could exert unexpectedly large restraint on household and business spending and that the downturn in housing could prove even steeper than currently anticipated. A slight majority perceived the risks to total inflation as broadly balanced, and a more sizable majority judged that the risks to core inflation are in balance; in both cases, those in the minority saw the risk to inflation as tilted to the upside. As the experience in the September trial run highlighted, the Committee’s policy statement will need to be reviewed carefully for potential inconsistencies with the risk assessments submitted with the projections. I will return to that issue tomorrow. Turning to the longer-horizon forecasts, you expect real GDP growth of around 2½ percent and unemployment slightly above 4¾ percent in both 2009 and 2010. Judging from your forecast narratives, these projections are close to your estimates of the economy’s potential growth rate and the level of the NAIRU. The former is a bit higher than the staff estimate of about 2.1 percent potential growth, and the latter is close to the staff estimate. For 2009 and 2010, all of your core inflation forecasts are in a range of 1½ to 2 percent. A couple of you expect rising prices of food and energy to keep total inflation above 2 percent in 2009, but all of your forecasts for total inflation are within a range of 1½ to 2 percent in 2010. Many of you state that you view your projections for inflation in 2010 as consistent with price stability." FOMC20070918meeting--53 51,MS. JOHNSON.," In the International Division, we, too, were challenged to assess the avalanche of events and information that arrived during the intermeeting period and to make our best judgment as to how these developments would affect the rest of the global economy and the U.S. external sector. One striking feature of the baseline forecast that resulted is the difference between prospects for the industrial countries and those for the emerging-market economies. For the industrial countries, the surprises in the latest data were generally negative, and considerable financial turmoil has been evident in the markets in the euro area, the United Kingdom, and Canada. In contrast, the most recent surprises in economic data for the emerging-market economies have generally been positive, and so far there has been little evidence of financial disruption in those countries. We have revised down total foreign growth a bit less than ½ percentage point for the second half of this year and ¼ percentage point for next year. This downward revision is due entirely to revisions to projected average growth in the industrial countries. The foreign industrial countries are largely being spared the direct effects of contraction in the residential construction sector so far. But they are vulnerable to negative effects on the pace of overall economic activity from increased volatility and impaired functionality in financial markets. As market participants have demanded higher returns for risky assets and have withdrawn from some exposures, many asset prices in Europe and Canada have fallen sharply. As in the United States, these developments have had implications for bank balance sheets and earnings, as banks have experienced calls on lines of credit or have taken other steps in response to funding difficulties of conduits and other entities sponsored by them. Some markets have experienced severe disruption, particularly European ABCP and a portion of the Canadian ABCP market. Although it is too soon for us to have actual data on the consequences of stresses being put on bank balance sheets, we think it is likely that some constraint on credit extension will result. In addition, business and consumer confidence could well be impaired by the general awareness of heightened risk and uncertainty as strains persist in financial markets. We have very little historical experience on which to base a projection of the magnitude of these effects. Our downward revision of the forecast for real GDP growth in the industrial countries in response to recent financial market events has been small, but we acknowledge that recent financial events have been severe and have lasted long enough that they likely will have some effect on domestic demand in the affected countries. Other channels of transmission from developments over the intermeeting period are more straightforward. The downward revision to U.S. real output growth causes us to lessen projected export demand growth in our trading partners; for Canada, this channel could be particularly strong. In exchange markets, the intermeeting period has seen upward pressure emerge on the euro, with the dollar-euro rate reaching new highs. This euro appreciation should weaken demand by other countries for exports from the euro area. The downward revision of real growth in the United States and in other industrial countries should, in turn, reduce demand for exports from emerging- market economies. Economic indicators of activity from months before August have also led us to revise down projected growth in the major foreign industrial countries. In Canada, both retail sales and real manufacturing shipments fell in June. In Japan, second- quarter real GDP growth has been revised to show a decline of more than 1 percent at an annual rate, and industrial production and real household expenditures fell in July. In the euro area, some moderation in expansion is implied by recent data: Real GDP decelerated in the second quarter, and a number of measures of business sentiment, some of which contain responses after August 9, have moved lower. Taking all this together, we revised down our outlook for real GDP growth in the foreign industrial countries, with the change for the second half negative ½ percentage point at an annual rate. Accordingly, we now expect that monetary tightening measures in those countries this year and next, which we and the markets had been projecting in August, will not occur except in Japan. The upward revision of our figure for average second-quarter real GDP growth in the emerging-market economies from 6 percent at an annual rate to about 7½ percent is indicative of the magnitude of positive surprises we received about activity in these regions. The news was broadly based across Asia, Latin America, and other areas. Importantly, at the time of the August Greenbook, we had already received data on China’s nearly 15 percent real growth in the second quarter, so the developments underlying this upward revision arose outside China. Our forecast calls for real growth in the emerging-market economies to slow to a more sustainable pace of nearly 5 percent over the forecast period from the very rapid second-quarter outcome. We judge that, going forward, the upward boost provided by faster activity earlier this year is about offset by the implications of the weaker outlook for the United States and other industrial country economies, and so our projection for real expansion in the emerging world is about unchanged from August. At this time, we do not see sufficient evidence of financial stress in these countries to warrant incorporating into the forecast restraint from credit channels or from confidence effects. We do recognize that there are risks to the moderately strong forecast we have for the emerging-market economies. On the upside, with the pace of growth so strong in China, we may once again find that the government is unable to put in place sufficient restraint to cause a discrete step-down in real output growth there. However, Chinese stock prices have continued to rise very sharply, and we see a possible downside risk to growth from a bursting of that bubble with consequent effects on real spending. It is also possible that we are underestimating the spillover of contractionary pressures from the industrial countries onto activity in the rest of the world. For example, one channel by which such forces could weaken activity in Mexico more than we now expect is through reduced remittances. With the U.S. construction sector particularly weak, earnings of immigrant labor and remittances to Mexico could be reduced, and the result could be a slowing of growth in Mexico by more than we have forecast. Another element of the forecast worth a brief mention is the price of crude oil. The price for spot WTI recently surged above $80 per barrel as recent data on U.S. inventories and some signs of hurricane activity led market participants to bid up prices for very near term oil. However, prices further out on the futures curve have moved down since August, and our overall path for the price of U.S. oil imports is little changed to down slightly by the end of 2008. With the futures curve showing pronounced backwardation, the spot price is very sensitive to unfolding news. Should a serious hurricane or some other factor threaten near-term production, we could see an outsized reaction in the spot price of crude oil. With the shock to the global economy this time arising largely in the U.S. economy, it is fitting that we might look to the rest of the world to provide some support to overall demand, some contribution to stabilizing global economic activity in general, and some help in damping rather than augmenting fluctuations in U.S. economic activity. As we now read the evidence, such an outcome is likely this time. Strength in the most recent data has led us to revise up projected real export growth in the third quarter. Although foreign GDP growth has been revised down a bit, thereby weakening exports, the dollar is on a path slightly lower than in August; and relative prices should provide a bit more boost to exports than we previously thought. All in all, the contribution to U.S. real GDP growth from exports should be somewhat more positive over the forecast period than we expected in August despite the global financial turmoil. If the Greenbook forecast is realized, net exports should make a positive arithmetic contribution to U.S. real GDP growth of about ⅓ percentage point during the second half of this year and about ¼ percentage point next year. Brian will now continue our remarks." 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. FOMC20050809meeting--180 178,CHAIRMAN GREENSPAN.," Further questions for Brian? If not, let me add my thoughts, wherever they may go. [Laughter] I thought it was quite interesting to hear the tone of this Committee’s view that the inflation rate is gradually moving up and that’s not particularly worrisome, except that basis points keep getting added to basis points and before you know it, the rate of inflation is higher than we want it to be. The undertone of resistance to that I thought was rather impressive and, I must say, it’s a view that I share as well. The rate is being boosted by a thousand little hits which eventually get you, and suddenly you say, “How in the world did we get here?” There are general concerns in the sense that the costs of national defense, homeland security, and the like are really quite substantial. But they don’t seem to have impacted the cost August 9, 2005 81 of 110 know, have considerable concern that the rate of productivity growth in the second quarter was going to slow appreciably and that in the third quarter it wasn’t going to move very much from that reduced pace. We thought that structural productivity might well be revised down and that, therefore, structural unit labor costs would increase, suggesting an acceleration in inflation. That apparently is not happening. That is, we are getting upward revisions in productivity on a month-by-month basis, so that concern is something we can basically put aside for the moment. On the other side, there was a general tone in the comments around the table of concern about the acceleration in economic activity. But I think we ought to be a little careful in making a judgment on that, given that the pause in the second quarter was to a very large extent reflective of inventory investment falling away at a fairly significant pace, though the extent of that was not something of which we were aware until after the fact. Currently, we’re seeing the reverse. Now, even though industrial production is not all that big a chunk of GDP, it is a significant aspect of the change in GDP. And the combination of motor vehicle output and non- motor vehicle inventory change suggests, as David pointed out, an automatic pop in the numbers. And that is what we’re seeing. Is it an implication of an acceleration in economic activity? I would say “not necessarily.” Were that the case, we would be seeing a tightening in markets. We’d see it in commodity prices, but we do not. We’d see it in delivery lead times, but we’re seeing only a marginal increase there. In other words, the anecdotal reports and other usual evidence of markets tightening up are not there. We’re not seeing the consequences of what inevitably has to be the case—that is, the loss of effective capacity as a result of increasing oil and natural gas prices. That’s going to happen at some point, but it’s not evident anywhere we August 9, 2005 82 of 110 increasingly of a tightening nature. But those changes are not showing up in any form that creates a sense of urgency to address them. There are two areas of the outlook about which I think we know a great deal less than we’d like. One is oil and the other is housing prices. On the oil side, the futures markets, as you know, show a flattening out of crude prices. But when any commodity price is going up, futures prices always show a flattening out. The reason is that futures markets, while they may be the best estimate that exists of the market’s expectation of prices in the future, are nonetheless a mechanism in which the demand in the immediate period is essentially spread out over the whole futures spectrum. And it’s reflected in the fact that the upper end of futures prices relative to the spot price cannot be more than the carrying charges. If it is, what happens is that the spot price gets pulled up in the process. So, at this stage what we’re looking at is the market’s best forecast of the longer-term outlook for oil prices. But as a quick look at history will tell us, the futures price has a terrible record as a forecast. Therefore, it’s not all that useful, especially when we’re looking at very odd underlying fundamentals here. If one looks at the production numbers and demand as currently measured, we’re running into a big increase in inventory accumulation in the second half of the year. And one would presume, as I guess Lee Raymond does, that that implies the markets are going down. But we also have the other side of this problem where all of the proved reserves are in areas with nationalized oil industries and, therefore, the ability to bring to bear financing from the international oil companies is very significantly limited. Indeed, in the case of Mexico, it is constitutionally prohibited. And as the populations in these oil-producing areas are growing August 9, 2005 83 of 110 welfare needs. So even though the prices are going up and the revenues and cash flows are going up, there appears to be a shortage of cash available to convert the proved reserves into effective operating capacity, meaning drilling and infrastructure. Even though the numbers look reasonably good, what we have had in the last few years, after a long period of very small increases in world oil demand, is that demand has suddenly tilted up as China and India have come on the scene. And after a fairly significant amount of non-OPEC production, which turns out to have been largely Russian, now we’re getting some evidence of nationalism in the Russian oil industry, and production growth there has slowed very materially. Hence, the outlook for any slack we generally might have is questionable. And one of the serious questions is: Are we underestimating long-term demand growth so that even though there may be production out there, the gap is closing from the demand side? But most of the concern, as Karen pointed out, is on the supply side because one can list a number of fragile oil-producing areas and a whole series of possible supply interruptions. Anything can go wrong. Indeed, one indication of how sensitive the market is can be seen in the reaction to every flicker of a potential hurricane in the Gulf of Mexico. That is not the biggest oil-producing area of the world, but when there’s even a hint of a hurricane in that region, crude prices pop. As a consequence, we may have a sense that we’re looking at a short-term glut, but the prices are seeing through the glut. That’s, indeed, the convergence of the long-term 6-year futures price to the spot price. For a long period of time we had a big surge in the spot price and the 6-year futures dragging along barely, with the gap opening up. In the last year that gap has closed very dramatically, which suggests that there’s a fundamental concern in the marketplace that the long-term capabilities of this market are not sufficient and that a price of $60 or $65 a August 9, 2005 84 of 110 today’s prices of $90 for WTI back in the 1970s. All we can say that’s fortunate about that comparison is the fact that the amount of oil used per unit of GDP is down very significantly. So, there is no basic long-term concern, but there is a short-term concern here, which I think raises questions about inflation and about the contractionary characteristics of oil price increases. So it’s a very difficult mixture. On the housing area, the real problem is not actually the boom or how far it’s going or whether it is a bubble or the like. The real issue is this: When it diffuses, as it will one way or the other, what are the implications? The serious problem that will arise when that happens relates to the question of what is the marginal propensity to consume out of housing wealth. The problem that I think we have is that the impact from a slowing or decline in house appreciation— or more explicitly the effect of housing capital gains on the one hand and of stock capital gains on the other—would be a far greater contraction in consumption than indicated by a standard reduced form system, which we currently have in our models—namely, the wealth effect. What bothers me is that we may, in fact, be looking at much higher marginal propensities to consume from housing capital gains. And, as housing turnover slows, cash-outs will slip and the amount of equity extraction will fall quite significantly. In fact, implicitly the Greenbook has a very substantial fall in equity extraction, as you know. Mortgage debt is shown to slow down very materially. The key question is: Is the marginal propensity to consume from equity extraction actually 0.3, which is the figure indicated in our surveys of cash-outs and other surveys? If one assumes that that’s the impact on consumption, that accounts for virtually all of the decline in the saving rate, and it would imply a reversal—a very significant rise—in the saving rate. And that is the other side of the question of what kind of consumption pattern we August 9, 2005 85 of 110 Implicitly our existing model, which endeavors to differentiate the marginal propensity to consume from wealth creation from stocks and wealth creation from housing, is incapable of distinguishing any difference in the marginal propensity to consume from those two sources. And instead of 0.3, the implicit number is well under 0.1. As a consequence, even though the Greenbook forecast has a significant implicit decline in mortgage debt expansion, we do not get the type of marginal slowdown in personal consumption expenditures—and I might add modernization expenditures—that is implicit in the survey data. The trouble is that we cannot know the answer at this stage to the question about the marginal propensity to consume out of housing wealth. International data are more suggestive of a higher propensity to consume. Australia’s PCE slowed down very dramatically with the slowing in house price appreciation there. The same was true in the United Kingdom. And that’s an issue about which I’m fearful we will not know the answer for the United States until we see it—when we find that equity extraction suddenly falls with a flattening of house prices and retail sales somehow begin to disappear. I’m not sure we can make judgments in advance as to how that will come out, but how it comes out may be the most difficult problem that we will be confronting. It doesn’t seem likely to be imminent. It’s certainly not the case that housing starts are falling off dramatically. Indeed, the backlog the large builders have on starts is still very high. It is flattening out a bit but is showing no signs of weakness. Conceivably, in the event of a weakening in prices, a lot of that backlog will disappear. That may occur without our knowing where it’s coming from, but people will just pull away from the housing market. So, we do have problems out there, and I don’t think we really have a great deal of August 9, 2005 86 of 110 impressive expansion in the economy. I’m certainly not arguing that I wish it were otherwise. This is as good an economy as one can get. It’s just that we have to look down the road and see what’s out there. And what I see are a couple of possibilities that should make us want to exercise some caution, although none of the potential problems, as best I can judge, is imminent, There’s nothing out there that indicates that something is about to fall apart. But as we get into 2006, I feel that the tranquility we are forced to exhibit—because the forecast is a point estimate in all of our projections—may be a bit overdone. In summary, I think we’re on the right path. I don’t think there’s any urgency to consider accelerating the path nor, of course, pulling it back. I share the view expressed by a number of you around this table in that I’m delighted that the futures markets have jacked up the implicit longer-term projection of the funds rate quite significantly, and I think certainly to the right dimension. And as I’ve said here before, my impression basically is that when the economy starts to change, the markets are going to be moving ahead of us and probably will conclude pretty much as we would conclude when we meet. If that is indeed the case, as I mentioned earlier, the most probable outlook is that the markets are going to tell us when we have finally reached the point where this program of increasing the funds rate is over and a pause is implied. It is conceivable that we may have to change the language abruptly, which will change the market’s expectations and cause some disruption. I think that probably will not happen. Judging from the way we and the markets have interacted, we’re all looking at essentially the same play book, and I think we are likely to come out with the same conclusions. If that’s the case, the period of about six weeks that we’re going to have between one meeting and another at the point we’re going to change is probably going to be enough time for the markets to adjust August 9, 2005 87 of 110 FOMC meeting.” And that, indeed, is likely to be what we’re going to want to do. We’re going to change the language. We’re going to change, in fact, the way we produce our statement. And hopefully we will have phased into the next stage of monetary policymaking in a less disruptive way than we probably fear—or at least that I fear. But that’s for the future. For now, I think the appropriate action is a move of 25 basis points and pretty much the alternative B statement that is shown in Brian’s table. So I’d like to put that proposal on this table and get your reactions. President Poole." CHRG-110shrg46629--104 STATEMENT OF SENATOR EVAN BAYH Senator Bayh. Thank you, Chairman Dodd. And thank you, Chairman Bernanke, for your presence here today and for your service. I, too, have a keen interest in some of the issues that have been raised today, particularly the currency valuation issue in China, which tends to have an impact on our manufacturing sector, which is concentrated in the Midwest. And also in the housing issue, which is having a tremendous impact on my home State right now. But I think that territory has been pretty thoroughly covered here today, so I will perhaps focus on some other things but I did not want anyone to think that my lack of questioning in those areas evinced any disinterest. This is, of course, the beginning or we are well into a political season and I do expect you to answer any political questions. But they are going to be a number of issues debated over the next year that are going have a pretty profound impact on the course of the American economic and financial policy. So, in general terms, I would like to raise a couple of those and get your take on them if that is OK. Our economy has done pretty well over the last decade or two, in terms of the macro level of growth. But there is a growing belief that the benefits of that growth have been disproportionately concentrated in the hands of the top 1 percent or so of the American people. There is at least one candidate who points out that about 50 percent of the wealth generated over the last couple of decades has gone to the top 1 percent in our country. So my question to you is are there things that can be done to try and more equitably distribute the fruits of the growth that our economy has been generating into the hands of the middle class in this country? " FOMC20050322meeting--99 97,MR. GUYNN.," Thank you, Mr. Chairman. Like others, I’ve been both somewhat surprised but certainly pleased at the steady and strong pace of real GDP and job growth we’ve been experiencing. This positive experience has been mirrored within our Southeast region. For example, regional retail sales growth in January was 7 percent on a year-over-year basis. This momentum also carried through into February, with inventory accumulation reported to be generally balanced. Factory orders are also continuing to increase. However, like the rest of the nation, one recent soft spot has been new vehicle sales, which remained weak except for some imports and luxury cars. In contrast, used car sales have improved and, as one might expect, prices of compact and more efficient cars have increased at a faster pace than those of SUVs. Our tourism and hospitality industry continues to give very positive reports, with rising hotel and motel occupancy rates. It’s clear that the weaker dollar has resulted in a surge in foreign tourists, who are not only visiting but also buying houses in Florida. Better job creation in our District continues, led by Florida, and the District unemployment rate edged down further in January March 22, 2005 31 of 116 Our banking contacts and supervisory people report continued consumer loan growth, high asset quality, and low past-dues. At the same time, our bank examiners are reporting a pickup in competition for commercial and real estate lending, especially from money center banks. We received one report of a regional bank losing out on what was essentially a BBB credit. The borrower was offered what amounted to AAA credit financing, at 20 basis points over Libor. Our bank directors have also expressed concern that the flat yield curve is driving lenders out the maturity spectrum where they are taking more risk in search of returns. I mentioned housing a moment ago. That sector continues to show strength in our region, with more and more anecdotal reports that can only reflect speculative activity along many parts of the Florida coast. Investors are making significant capital gains buying and reselling condo units before the contractor has even broken ground. But such speculation isn’t confined to multifamily condo units. We’re also seeing some of that same speculation in Florida single-family detached homes, a much larger part of the total residential market, although the very high levels of permits and sales per capita are partly explained by the underlying demand for such houses for relocation and second homes. Turning to developments at the national level, I find that I can almost repeat the points I made at last month’s meeting. The rates of real growth and job creation are very encouraging. My growing concern, which has been heightened slightly over the intermeeting period because of the continued reports of housing speculation and the potential underpricing of risk, is the inflation situation. It’s clear from the incoming information on prices—the surge in PCE and PPI data in some recent months, the changes in the Greenbook inflation forecasts, and recent changes in the trend patterns of key components comprising the measures of core CPI—that both goods and March 22, 2005 32 of 116 Are we at the point where it’s time to change the path of policy? I don’t think we are there yet. I continue to believe that we are on the right policy path, at least for now, and that we should resist the temptation at this meeting to deviate from it. While inflation pressures and potential pressures have clearly increased, much of the recent surge we’ve been seeing in core goods inflation is coming from the rise in used car prices, which we believe is driven by the pullback in new car incentives and the slowdown of used cars coming on the market. In addition, as of January, a large number of components of the core CPI—actually 20—still continue to show declines as compared with 32 components that are showing increases. Finally, while there has been some deterioration in short-term inflation expectations, longer- term expectations have not moved measurably. While I am comfortable with our current policy path, I believe that what we say in the statement has, in fact, become even more important and more sensitive. While our current policy path seems to me to address the risks as I see them today, I would like us to find the opportunity sometime soon to underscore the need for more flexibility to respond to incoming data. The inflation risks are worrisome and could deteriorate, and we may, in fact, need to use that additional flexibility before too long. I’ll comment more later about suggested changes to the statement language. Thank you, Mr. Chairman." FOMC20060510meeting--132 130,CHAIRMAN BERNANKE.," At this point I would normally try to summarize the remarks around the table. But since you have all just heard them and since my own views are not terribly different from many who have spoken, I think in the interest of time I will just go ahead and talk briefly on my own behalf about what I see the economy doing, and then we will turn to the policy go-round. First of all, with respect to growth, I think we are following the path laid out by the Greenbook toward greater moderation in the second half. The main difference is that, since our last meeting, the uncertainty around that prospective path has increased. Obviously, the key to this moderation is the housing market, and fundamental analysis would suggest that the combination of high prices and rising interest rates would make affordability a problem and would bring housing starts and housing prices down. So far we are seeing, at worst, an orderly decline in the housing market; but there is still, I think, a lot to be seen as to whether the housing market will decline slowly or more quickly. As I noted last time, some correction in this market is a healthy thing, and our goal should not be to try to prevent that correction but rather to ensure that the correction does not overly influence growth in the rest of the economy. I would also note that there are going to be some offsets to the decline in residential investment. We’ve noted increases in nonresidential construction, which is about half the size, as a share of GDP, of residential construction and, in terms of contribution to GDP, could make up something like a half of the direct impact of a decline in residential spending. We also have gotten a sense that capital spending is relatively strong, and world growth is also strong, which may enhance our exports. So there are some countervailing factors to help cushion the presumed decline in the housing market. But as we talk about the housing market, which is 6 percent of GDP, or nonresidential construction, which is 2.7 percent of GDP, we have to pay very close attention to consumption, which is 70 percent of GDP and which really is the center of the forecast for the rest of the year. The soft landing scenario viewed in the Greenbook requires that consumption grow the rest of the year at something around 3.4 percent, which is roughly what it has been doing in the last year or so on average. I think that is broadly plausible. There are factors on both sides of it. Supporting consumption, obviously, are some increases in compensation likely coming forward both in terms of hourly wages and in terms of hours worked, job availability, and to some extent maybe increases in stock prices. On the negative side, many people have pointed out the effect of rising interest rates and softening in housing prices. Energy is actually a bit of a mixed bag. Energy prices are obviously a negative for consumption in level terms, but we have had a big drag on consumption for the past two years from increasing energy prices, and so if energy prices do stabilize, the drag will actually be less in 2006 than in previous years. So, again, I do think that the slowdown that has been forecast by the Greenbook is plausible, but like a number of people around the table, I would note that so far it is largely a prospective slowdown and that the data have only begun to support that development. On the inflation side, I have somewhat more concern, like a number of people. Core inflation has been remarkably stable, and I do not think it is going to rise very much; but to the extent that there are risks, they are very largely to the upside. And I also have some concerns about the possible emergence of some inflation psychology, which is a very negative thing for our policymaking. The factors that support higher inflation are well known. First, energy and commodity prices. I would point out that, rather than being transitory, they have now undergone a long, sustained increase, which evidently must at some point get into the cost structure of firms. Second, the weakening dollar over the past month or so may be sufficient to add some pressure. Third, the effect of compensation, I understand, is a little ambiguous. There are some factors working in the other direction, including markups and productivity, but clearly the sense around the table is that compensation is beginning to move up somewhat, and the risks there I think are also to the upside. Finally, it is worth noting that, at a technical level, some of the components of the inflation indexes are moving upward—in particular, owners’ equivalent rent. It economically makes sense that, if house prices have risen so much, rents will begin to rise. Since that is a very large share of both the CPI and the PCE core measures, that is going to be an upside risk for us. Now, again, I do not want to overstate the problem. I think that core inflation will remain contained, to use our language, but I am concerned about those risks. Clearly, the markets have seen a strengthening of the economy and increased inflation risk. Despite all of our communication and language, it is summarized by an increase of about 25 basis points in where they think the federal funds rate is going to end up later this year. We have seen and already discussed the increase in inflation compensation and in other measures of inflation expectations. Much of our confidence that the pass-through from energy, from the dollar, and from labor costs to final goods inflation will be low is predicated on the view that inflation expectations are low and well contained. When that premise begins to break down, then all the other elements of the analysis also begin to come under pressure. Finally, as a number of people have noted, although we do not have an official definition of price stability, we are at the upper level of what might plausibly be called the region of price stability, and further increases will be difficult and potentially costly to reverse. So looking forward to the policy discussion, I think we are going to have to take into account the emerging inflation risk. At the same time, there is an awful lot of uncertainty about what is going on in the economy. It is going to be a difficult balancing act to try to maintain as much flexibility as possible so that policy can respond to new data as they arrive. At this point I would like to turn over the floor to Vincent, who will talk about the policy options." 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." fcic_final_report_full--15 We conclude that these two entities contributed to the crisis, but were not a pri- mary cause. Importantly, GSE mortgage securities essentially maintained their value throughout the crisis and did not contribute to the significant financial firm losses that were central to the financial crisis. The GSEs participated in the expansion of subprime and other risky mortgages, but they followed rather than led Wall Street and other lenders in the rush for fool’s gold. They purchased the highest rated non-GSE mortgage-backed securities and their participation in this market added helium to the housing balloon, but their pur- chases never represented a majority of the market. Those purchases represented . of non-GSE subprime mortgage-backed securities in , with the share rising to  in , and falling back to  by . They relaxed their underwriting stan- dards to purchase or guarantee riskier loans and related securities in order to meet stock market analysts’ and investors’ expectations for growth, to regain market share, and to ensure generous compensation for their executives and employees—justifying their activities on the broad and sustained public policy support for homeownership. The Commission also probed the performance of the loans purchased or guaran- teed by Fannie and Freddie. While they generated substantial losses, delinquency rates for GSE loans were substantially lower than loans securitized by other financial firms. For example, data compiled by the Commission for a subset of borrowers with similar credit scores—scores below —show that by the end of , GSE mort- gages were far less likely to be seriously delinquent than were non-GSE securitized mortgages: . versus .. We also studied at length how the Department of Housing and Urban Develop- ment’s (HUD’s) affordable housing goals for the GSEs affected their investment in risky mortgages. Based on the evidence and interviews with dozens of individuals in- volved in this subject area, we determined these goals only contributed marginally to Fannie’s and Freddie’s participation in those mortgages. CHRG-110shrg50369--79 Mr. Bernanke," I think there is an argument for being aggressive in general, but I would just decline, if you would permit me, to endorse that particular action. I am really at this point focused on FHA and GSE reform as being two useful steps in the direction of helping the housing market. And we should continue to think about alternatives. But at this point I do not have, good additional measures to suggest to you. Senator Bayh. Well, I do not want to put you in the business of getting into the debate between the legislative and executive branches here, but I do think at this moment, as we have all recognized, this is a perilous moment for the economy. It seems to me that there are risks on either side, but the balance here, it seems to me, lies on being a little more aggressive than less. And that ought to apply to all aspects of our policy, not just one particular subset. We have had a big discussion here about inflation versus growth. Again, I think you have your priorities right in that regard. You have pointed out that the core rate, while modestly above target, has--the principal thing driving this in the near term has been food and energy costs, and that you do not see any persistent rise in the core over the longer term. My question, Mr. Chairman, is: What indicia of economic stability or greater growth would alleviate your concerns and would allow you to then perhaps pivot and focus on the inflation concern more than we currently are? " FOMC20071031meeting--11 9,MR. SHEETS.," Although the foreign economies appear to have grown at a moderate pace during the third quarter as a whole, indicators for September and October suggest that the recent financial turmoil may yet leave an imprint on activity in some countries. Perhaps the most striking evidence on this score has been the ECB’s survey of euro-area bank lending. In the third quarter, this survey showed the sharpest shift toward tightening in its five-year history, along with evidence of more- stringent credit standards for business and housing loans. In addition, we have seen downward moves in surveys and measures of sentiment in the euro area, particularly in Germany, although these indicators have generally remained in expansionary territory. In the United Kingdom, the growth of mortgage lending continued on a downward path in September, and a recent Bank of England survey suggests a tightening of corporate credit conditions. All in all, we see this (admittedly fragmentary) evidence as broadly consistent with our assumption in the September Greenbook that fallout from the financial turmoil is likely to exert some drag on growth over the next several quarters in the euro area, the United Kingdom, and Canada. This assessment, however, is marked by significant upside and downside risks—as it is still too soon to gauge these effects with much confidence. As in our previous forecast, we do not see the turmoil weighing directly on activity in Japan or the emerging-market economies. More generally, the contours of our forecast remain similar to those in September. Recent data have confirmed our expectation that average economic growth abroad declined to about 3½ percent in the third quarter, cooling from the very rapid rate in the first half of the year. We see growth edging down further in the current quarter, to just over 3 percent, and remaining at about that pace in 2008 and 2009. After the Greenbook went to bed, we received Chinese GDP data, which according to our seasonally adjusted quarterly estimate grew at an annual rate of just over 8 percent in the third quarter—a little slower than we had expected and down from the 14 percent rate in the first half of the year. This deceleration appears to have been led by a slowing in investment and a smaller contribution from the external sector. Going forward, economic growth in China should remain below its previous double-digit pace, as the Chinese authorities take further action to cool the country’s booming real estate market and the rapid growth of bank lending. In addition to uncertainty about the eventual effects of the financial turmoil on real activity, other risks to our generally favorable foreign outlook are worth noting. First on this list is the possibility of a softer-than-expected performance from the U.S. economy. Although there is talk in some quarters about so-called decoupling—that is, that the foreign economies may now be less linked to developments in the United States than has been the case in the past—the jury is still out on this point. Although domestic demand does appear to have firmed in some foreign countries in recent years, a marked slowing in U.S. growth would affect the rest of the world through trade channels (particularly Canada, Mexico, and emerging Asia) and, as highlighted by the recent turmoil, probably through financial channels as well. As a second risk, house-price valuations in many advanced economies appear elevated. Given that, a correction in housing markets abroad—with potentially sizable accompanying wealth effects—strikes us as an important downside risk for some countries. Third, although we see average foreign inflation remaining well behaved, at near 2½ percent over the next two years, inflation risks cannot be dismissed. After several years of exceptionally strong economic growth, the foreign economies on average are now operating near potential, and resource constraints may be more binding than we currently envision. In addition, food prices have moved up in many countries, and the prices of oil and other commodities are at high levels. Indeed, recent developments in oil markets seem to pose intensified risks. The spot price of WTI is trading today at nearly $92 a barrel, up $5 since the Greenbook went to bed. Since your last meeting, the spot WTI price has climbed $13 per barrel, while the far-futures price has increased about $10 per barrel. It suffices to say that underlying supply-demand conditions in the oil market are exceptionally tight. Over the past several years, as the global economy has expanded briskly, oil production has increased only sluggishly—reflecting both OPEC supply restraint and diminishing production from OECD countries. Against this backdrop, the price of oil has been driven up further in recent weeks by reports of decreasing inventories (at a time of year when such stocks are typically on the rise) and by intensified concerns about the stability of Middle East oil production, triggered by tensions between Turkey and Iraq and by concerns about U.S. relations with Iran. We see OPEC’s plans to expand production 500,000 barrels per day beginning on November 1, even if fully implemented, as unlikely to go very far in defusing the tightness in the market. Futures markets call for WTI prices to remain elevated, in the neighborhood of $80 per barrel, through 2015. I conclude with some upbeat news on U.S. external performance. Exports continue to surprise on the upside, having shown exceptional strength in the July and August trade data, as exports of aircraft, autos, and agricultural products have all expanded briskly. Consequently, as Dave mentioned, real exports of goods and services are now thought to have surged at a pace of 17 percent in the third quarter, up 3½ percentage points from the last forecast. We estimate that real imports in the third quarter grew at a comparatively modest rate. Taken together, these data suggest that net exports made an arithmetic contribution of 1¼ percentage points to U.S. real GDP growth in the third quarter. Going forward, we see export growth moderating to just under 8 percent in the current quarter and proceeding at a solid 6½ percent average rate through the next two years. Relative to our September forecast, the path of export growth is up nearly 2 percentage points in the fourth quarter and by lesser—but still sizable—amounts in 2008 and 2009. This higher projection reflects stimulus from recent declines in the dollar, which have exceeded our previous projections. The broad dollar index has dropped more than 3 percent since your last meeting. But in addition to support from the weaker dollar, we now see greater underlying strength in exports than we had previously thought. Our projected path for imports, in contrast, is little changed from the last Greenbook. Import growth is slated to bounce up in the current quarter, largely because of a seasonal rebound in oil imports. Thereafter, the projected strengthening of U.S. growth and a deceleration in core import prices should provide increasing support to imports. All told, we see the external sector making a neutral contribution to U.S. real GDP growth in the fourth quarter, contributing 0.4 percentage point to economic growth next year, and returning to neutrality in 2009 as imports accelerate. Thus, to the extent that our forecast materializes, large negative contributions from net exports might very well be a thing of the past. Brian will now continue our presentation." 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." 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-111shrg51290--63 PREPARED STATEMENT OF PATRICIA A. McCOY George J. and Helen M. England Professor of Law University of Connecticut School of Law March 3, 2009 Chairman Dodd and Members of the Committee: Thank you for inviting me here today to discuss the problem of restructuring the financial regulatory system. I applaud the Committee for exploring bold new approaches to financial regulation on the scale needed to address our nation's economic challenges. In my remarks today, I propose transferring consumer protection responsibilities in the area of consumer credit from Federal banking regulators to a single, dedicated agency whose sole mission is consumer protection. This step is essential for three reasons. First, during the housing bubble, our current system of fragmented regulation drove lenders to shop for the easiest legal regime. Second, the ability of lenders to switch charters put pressure on banking regulators--both State and Federal--to relax credit standards. Finally, banking regulators have routinely sacrificed consumer protection for short-term profitability of banks. Creating one, dedicated consumer credit regulator charged with consumer protection would establish uniform standards and enforcement for all lenders and help eliminate another death spiral in lending. Although I examine this issue through the lens of mortgage regulation, my discussion is equally relevant to other forms of consumer credit, such as credit cards and payday lending. The reasons for the breakdown of the home mortgage market and the private-label market for mortgage-backed securities are well known by now. Today, I wish to focus on lax lending standards for residential mortgages, which were a leading cause of today's credit crisis and recession. Our broken system of mortgage finance and the private actors in that system--ranging from mortgage brokers, lenders, and appraisers to the rating agencies and securitizers--bear direct responsibility for this breakdown in standards. There is more to the story, however. In 2006, depository institutions and their affiliates, which were regulated by Federal banking regulators, originated about 54 percent of all higher-priced home loans. In 2007, that percentage rose to 79.6 percent.\1\ In some states, mortgages originated by State banks and thrifts and independent nonbank lenders were regulated under State anti-predatory lending laws. In other states, however, mortgages were not subject to meaningful regulation at all. Consequently, the credit crisis resulted from regulatory failure as well as broken private risk management. That regulatory failure was not confined to states, moreover, but pervaded Federal banking regulation as well.--------------------------------------------------------------------------- \1\ Robert B. Avery, Kenneth P. Brevoort & Glenn B. Canner, The 2007 HMDA Data, Fed. Res. Bull. A107, A124 (Dec. 2008), available at http://www.federalreserve.gov/pubs/bulletin/2008/pdf/hmda07final.pdf.--------------------------------------------------------------------------- Neither of these phenomena--the collapse in lending criteria and the regulatory failure that accompanied it--was an accident. Rather, they occurred because mortgage originators and regulators became locked in a competitive race to the bottom to relax loan underwriting and risk management. The fragmented U.S. system of financial services regulation exacerbated this race to the bottom by allowing lenders to shop for the easiest regulators and laws. During the housing bubble, consumers could not police originators because too many loan products had hidden risks. As we now know, these risks were ticking time bombs. Lenders did not take reasonable precautions against default because they able to shift that to investors through securitization. Similarly, regulators failed to clamp down on hazardous loans in a myopic attempt to boost the short-term profitability of banks and thrifts. I open by examining why reckless lenders were able to take market share away from good lenders and good products. Next, I describe our fragmented financial regulatory system and how it encouraged lenders to shop for lenient regulators. In part three of my remarks, I document regulatory failure by Federal banking regulators. Finally, I end with a proposal for a separate consumer credit regulator.I. Why Reckless Lenders Were Able To Crowd Out the Good During the housing boom, the residential mortgage market was relatively unconcentrated, with thousands of mortgage originators. Normally, we would expect an unconcentrated market to provide vibrant competition benefiting consumers. To the contrary, however, however, highly risky loan products containing hidden risks--such as hybrid adjustable-rate mortgages (ARMs), interest-only ARMs, and option payment ARMs--gained market share at the expense of safer products such as standard fixed-rate mortgages and FHA-guaranteed loans.\2\--------------------------------------------------------------------------- \2\ A hybrid ARM offers a 2- or 3-year fixed introductory rate followed by a floating rate at the end of the introductory period with substantial increases in the rate and payment (so-called ``2-28'' and ``3-27'' mortgages). Federal Reserve System, Truth in Lending, Part II: Proposed rule; request for public comment, 73 Fed. Reg. 1672, 1674 (January 9, 2008). An interest-only mortgage allows borrowers to defer principal payments for an initial period. An option payment ARM combines a floating rate feature with a variety of payment options, including the option to pay no principal and less than the interest due every month, for an initial period. Choosing that option results in negative amortization. Department of the Treasury et al., Interagency Guidance on Nontraditional Mortgage Product Risks: Final guidance, 71 Fed. Reg. 58609, 58613 (Oct. 4, 2006).--------------------------------------------------------------------------- These nontraditional mortgages and subprime loans inflicted incalculable harm on borrowers, their neighbors, and ultimately the global economy. As of September 30, 2008, almost 10 percent of U.S. residential mortgages were 1 month past due or more.\3\ By year-end 2008, every sixth borrower owed more than his or her home was worth.\4\ The proliferation of toxic loans was the direct result of the ability to confuse borrowers and to shop for the laxest regulatory regime.\5\--------------------------------------------------------------------------- \3\ See Mortgage Bankers Association, Delinquencies Increase, Foreclosure Starts Flat in Latest MBA National Delinquency Survey (Dec. 5, 2008), available at www.mbaa.org/NewsandMedia/PressCenter/66626.htm. \4\ Michael Corkery, Mortgage `Cram-Downs' Loom as Foreclosures Mount, Wall St. J., Dec. 31, 2008. \5\ The discussion in this section was drawn, in part, from Patricia A. McCoy, Andrey D. Pavlov, & Susan M. Wachter, Systemic Risk through Securitization: The Result of Deregulation and Regulatory Failure,__Conn. L. Rev. __(forthcoming 2009) and Oren Bar-Gill & Elizabeth Warren, Making Credit Safer,__ U. Penn. L. Rev. __ (forthcoming 2009).---------------------------------------------------------------------------A. The Growth in Dangerous Mortgage Products During the housing boom, hybrid subprime ARMs, interest-only mortgages, and option payment ARMs captured a growing part of the market. We can see this from the growth in nonprime mortgages.\6\ Between 2003 and 2005, nonprime loans tripled from 11 percent of all home loans to 33 percent.\7\--------------------------------------------------------------------------- \6\ I use the term ``nonprime'' to refer to subprime loans plus other nontraditional mortgages. Subprime mortgages carry higher interest rates and fees and are designed for borrowers with impaired credit. Nontraditional mortgages encompass a variety of risky mortgage products, including option payment ARMs, interest-only mortgages, and reduced documentation loans. Originally, these nontraditional products were offered primarily in the ``Alt-A'' market to people with near-prime credit scores but intermittent or undocumented income sources. Eventually, interest-only ARMs and reduced documentation loans penetrated the subprime market as well. \7\ FDIC Outlook, Breaking New Ground in U.S. Mortgage Lending (Summer 2006), available at www.fdic.gov/bank/analytical/regional/ro20062q/na/2006_summer04.html. --------------------------------------------------------------------------- If we unpack these numbers, it turns out that hybrid ARMs, interest-only mortgages, and option payment ARMs accounted for a growing share of nonprime loans over this period. Option payment ARMs and interest-only mortgages went from 3 percent of all nonprime originations in 2002 to well over 50 percent by 2005. (See Figure 1). Low- and no-documentation loans increased from 25 percent to slightly over 40 percent of subprime loans over the same period. By 2004 and continuing through 2006, about three-fourths of the loans in subprime securitizations consisted of hybrid ARMs.\8\--------------------------------------------------------------------------- \8\ See generally McCoy, Pavlov & Wachter, supra note 5; FDIC Outlook, Breaking New Ground in U.S. Mortgage Lending (Summer 2006), available at www.fdic.gov/bank/analytical/regional/ro20062q/na/2006_summer04.html. --------------------------------------------------------------------------- Figure 1. Growth in Nontraditional Mortgages, 2002-2005\9\--------------------------------------------------------------------------- \9\ FDIC Outlook, Breaking New Ground in U.S. Mortgage Lending (Summer 2006), available at www.fdic.gov/bank/analytical/regional/ro20062q/na/2006_summer04.html. As the product mix of nonprime loans became riskier and riskier, two default indicators for nonprime loans also increased substantially. Loan-to-value ratios went up and so did the percentage of loans with combined loan-to-value ratios of over 80 percent. This occurred even though the credit scores of borrowers with those loans remained relatively unchanged between 2002 and 2006. At the same time, the spreads of rates over the bank cost of capital tightened. To make matters worse, originators layered risk upon risk, with borrowers who were the most at risk obtaining low equity, no-amortization, reduced documentation loans. (See Figure 2). Figure 2. Underwriting Criteria for Adjustable-Rate Mortgages, 2002- 2006 FOMC20070509meeting--73 71,MR. LOCKHART.," Thank you, Mr. Chairman. Since the last meeting, aggregate economic activity in the Sixth District has expanded moderately. Employment momentum in most areas of the District continues to exceed that of the nation overall. Florida is our exception. Most areas of Florida now lag the nation. Similarly, the housing downturn, as measured by sales and permits, remains less severe in the District than for the nation, except for much of Florida. The housing downturn in Florida has shown little sign of bottoming out, as builders continue to expect even lower levels of construction. Permit issuance continues in steep decline, down over 50 percent from March a year ago. We are not inclined to suggest that there is significance for the nation as a whole in the Florida developments. We have heard anecdotal views from Florida that there was a run-up in speculative activity in the second-home market in 2004 and 2005. Buyers were bidding up prices in anticipation of flipping properties at higher prices. So Florida is idiosyncratic. It is idiosyncratic also in the state’s ongoing insurance cost problem related to hurricane risk. However, in the Atlanta region, the conversations we’ve had with homebuilders about the housing market raised concern of a steepening decline in sales of new homes. Atlanta has generally tracked the nation, so we are carefully watching housing-sector developments in Georgia, particularly in Atlanta. Despite these negatives in the housing sector, we continue to find only limited evidence of spillover from the residential real estate adjustment to other sectors of the regional economy. Labor markets appear to have remained very tight in the District. The measured unemployment rate is around 4 percent for the District versus 4.4 percent nationally. Even the demand for skilled building tradesmen appears strong, as builders—and this may be relevant to the earlier discussion—seem to be taking the opportunity to upgrade the quality of their staffs. Trends in state sales tax revenue support the view that consumer spending has been relatively unaffected by the housing downturn. Again, the exception is Florida, where sales tax revenues in the first quarter were substantially below year-ago levels. Our perspective on the national economy is that significant uncertainty remains about the overall outlook for 2007 and for the path of inflation. Our economic staff uses three models to forecast the key macroeconomic measures. Our average forecast for real GDP growth is generally in line with the Greenbook forecast, and neither suggests that a recession is a risk. There are minor differences between our composite forecast and the Greenbook on unemployment. The only significant difference is the declining path of inflation in the Greenbook versus our inflation forecast that holds steady around 2.3 percent for the forecast period. So, to summarize, we harbor greater doubt than the Board staff that the inflation rate will come down as projected in 2007." FOMC20060510meeting--124 122,MS. BIES.," Thank you, Mr. Chairman. In preparing for the meeting, one of the things I focused on was the graph that I like that tracks the staff forecasts over time because I am really torn between where I see growth going and where I see inflation expectations. In looking at the graph, one can clearly see, if you look back through Greenbooks to September ’05, that staff forecasts of core PCE inflation have been basically flat whereas real GDP growth forecasts for this year have increased quite a bit. The ’07 numbers are stable at a lower inflation rate and a lower growth rate. But what troubles me so much, and somebody already mentioned it, is how much the various indicators of core inflation have picked up over recent periods in the actual data. As President Lacker mentioned, we have core PCE up 2.4 percent in the past couple of quarters. We have core CPI up 2.7 percent. If you look at core GDP prices over the whole of last year, you are running at just under 3 percent over that period; and that is without what we cannot quite measure yet, which is how much energy prices are passing through. The longer companies see that energy prices are going to remain high or go even higher—instead of being just a one-shot hurricane effect—the more likely we are to see some of these prices being passed through. So I am getting concerned about whether the lagged effects of the monetary policy changes so far are going to be enough to moderate the inflation that we are now observing to reach the goal of lower core inflation numbers in ’07. On the real side, one area that I think is critical is the housing market. As you all know, I have continued to worry about what is going on in housing and mortgages and have wanted to give you another perspective on what we are observing. Most of you are well aware that we put out some supervisory guidance for comment awhile back on nontraditional mortgage loans, which include various forms of interest-only, adjustable-rate, negative-amortization mortgages. If you look at the 2005 earnings reports of the large mortgage banks and the large savings and loans that do mortgage lending, these institutions have a really striking amount of interest rate risk embedded in their negative amortization loans. As you know, most of the product is securitized and sold. So the relative share of these products originated in the last couple of years that are on the banks’ books is small overall. But the numbers have gotten so bad that now the setters of accounting standards want banks to disclose how much interest income they are recognizing as income that they have not collected, through this negative amortization. In other words, they bill the customer for this interest, but instead of making the customer give them the cash every month, they just add the amount to the outstanding balance and it creates negative amortization. For some of these big organizations, the amount represents 5 or 10 percent of net income from last year. So the number is growing, and we are looking to make sure that banks are appropriately putting aside reserves for the portion that may not be collectible. In the past few weeks, I have become aware that the rising interest rates are creating more problems for customers in servicing debt. What President Hoenig has observed in Colorado in interest-only adjustable-rate mortgages is just the beginning. The Greenbook showed how much the subprime sector is going up; and we know, because ARMs are a big chunk of those mortgages, that it is starting to be felt. As we go forward and more of these ARMs, especially those that have three-year lock-in periods, start to reprice, we will be seeing more of it. Now, the mortgage industry, ever creative and ever worrying about the ability of homeowners to pay amid rising rates, has now decided to create negative-amortization, fixed-rate mortgages. What these mortgages do is say, “Just borrow for your house. You have a monthly payment, no amortization of principal, and you do not even have to pay the full fixed rate. We will just continue to add to your principal, and you pay what you can afford every month versus what you really owe us on the fixed rate every month.” This process just continues, and one thing that bothers me for the long run is the extent to which housing could slow this year and slow the economy. I just wonder about the consumer’s ability to absorb shocks. The buildup of home equity and the ability to borrow against it have helped individual homeowners when they have had layoffs, medical problems, divorces—all the things in life that create month-to-month problems for cash flow. With the growth of negative amortization, home equity is not being built up anymore. Negative amortization clearly helps consumer spending because consumers, in effect, have a smaller amount of their take-home pay that has to go to the mortgage payment every month, and so it is available to be spent elsewhere. It is probably a more pernicious type of home equity withdrawal because you don’t take an action to withdraw it. Now it is planned that you will have negative amortization. It clearly changes the way we look at the role of savings as a precautionary balance to get the consumer through bad times, and it also has long-run implications regarding the importance of asset values vis-à-vis default rates both for the banking sector and for the household sector. So the growing ingenuity in the mortgage sector is making me more nervous as we go forward in this cycle, rather than comforted that we have learned a lesson. Some of the models the banks are using clearly were built in times of falling interest rates and rising housing prices. It is not clear what may happen when either of those trends turns around." CHRG-109shrg30354--32 Chairman Bernanke," Thank you. Mr. Chairman and Members of the Committee I am pleased to be here again to present the Federal Reserve's Monetary Policy Report to the Congress. Over the period since our February report, the U.S. economy has continued to expand. Real gross domestic product is estimated to have risen at an annual rate of 5.6 percent in the first quarter of 2006. The available indicators suggest that economic growth has more recently moderated from that quite strong pace, reflecting a gradual cooling of the housing market and other factors that I will discuss. With respect to the labor market, more than 850,000 jobs were added, on net, to nonfarm payrolls over the first 6 months of the year, though these gains came at a slower pace in the second quarter than in the first. Last month, the unemployment rate stood at 4.6 percent. Inflation has been higher than we has anticipated in February, partly as a result of further sharp increases in the prices of energy and other commodities. During the first 5 months of the year, overall inflation, as measured by the price index for personal consumption expenditures, averaged 4.3 percent at an annual rate. Over the same period, core inflation--that is, inflation excluding food and energy prices--averaged 2.6 percent at an annual rate. To address the risk that inflation pressures might remain elevated, the Federal Open Market Committee continued to firm the stance of monetary policy, raising the Federal funds rate another three-quarters of a percentage point to 5.25 percent in the period since our last report. Let me now review the current economic situation and the outlook in a bit more detail, beginning with developments in the real economy and then turning to the inflation situation. I will conclude with some comments on monetary policy. The U.S. economy appears to be in a period of transition. For the past 3 years or so, economic growth in the United States has been robust. This growth has reflected both the ongoing reemployment of underutilized resources as the economy recovers from the weakness of earlier in the decade, and the expansion of the economy's underlying productive potential, as determined by such factors as productivity trends and the growth of the labor force. Although the rates of resource utilization that the economy can sustain cannot be known with any precision, it is clear that, after several years of above-trend growth, slack in resource utilization has been substantially reduced. As a consequence, a sustainable, noninflationary expansion is likely to involve a modest reduction in the growth of economic activity from the rapid pace of the past 3 years to a pace more consistent with the rate of increase in the Nation's underlying productive capacity. It bears emphasizing that, because productivity growth seems likely to remain strong, the productive capacity of our economy should expand over the next few years at a rate sufficient to support solid growth in real output. As I have noted, the anticipated moderation in economic growth now seems to be underway, although the recent erratic growth pattern complicates this assessment. That moderation appears most evident in the household sector. In particular, consumer spending, which makes up more than two-thirds of aggregate spending, grew rapidly during the first quarter but decelerated during the spring. One likely source of this deceleration was higher energy prices, which have adversely affected the purchasing power of households and weighed on consumer attitudes. Outlays for residential construction, which have been at very high levels in recent years, rose further in the first quarter. More recently, however, the market for residential real estate has been cooling, as can be seen in the slowing of new and existing home sales and housing starts. Some of the recent softening in housing starts may have resulted from the unusually favorable weather during the first quarter of the year, which pulled forward construction activity, but the slowing of the housing market appears to be more broad-based than can be explained by that factor alone. Home prices, which have climbed at double-digit rates in recent years, still appear to be rising for the Nation as a whole, though significantly less rapidly than before. These developments in the housing market are not particularly surprising, as the sustained run-up in housing prices, together with some increase in mortgage rates, has reduced affordability and thus the demand for new homes. The slowing of the housing market may restrain other forms of household spending as well. With homeowners no longer experiencing increases in the equity value of their homes at the rapid pace seen in the past few years, and with the recent declines in stock prices, increases in household net worth are likely to provide less of a boost to consumer expenditures than they have in the recent past. That said, favorable fundamentals, including relatively low unemployment and rising disposable incomes, should provide support for consumer spending. Overall, household expenditures appear likely to expand at a moderate pace, providing continued impetus to the overall economic expansion. Although growth in household spending has slowed, other sectors of the economy retain considerable momentum. Business investment in new capital goods appears to have risen briskly, on net, so far this year. In particular, investment in nonresidential structures, which had been weak since 2001, seems to have picked up appreciably, providing some offset to the slower growth in residential construction. Spending on equipment and software has also been strong. With a few exceptions, business inventories appear to be well aligned with sales, which reduces the risk that a buildup of unwanted inventories might act to reduce production in the future. Business investment seems likely to continue to grow at a solid pace, supported by growth in final sales, rising backlogs of orders for capital goods, and high rates of profitability. To be sure, businesses in certain sectors have experienced financial difficulties. In the aggregate, however, firms remain in excellent financial condition and credit conditions for businesses are favorable. Globally, output growth appears strong. Growth of the global economy will help support U.S. economic activity by continuing to stimulate demand for our exports of goods and services. One downside of the strength of the global economy, however, is that it has led to significant increases in the demand for crude oil and other primary commodities over the past few years. Together with heightened geopolitical uncertainties and the limited ability of suppliers to expand capacity in the short-run, these rising demands have resulted in sharp rises in the prices at which these goods are traded internationally, which in turn has put upward pressure on costs and prices in the United States. Overall, the U.S. economy seems poised to grow in coming quarters at a pace roughly in line with the expansion of its underlying productive capacity. Such an outlook is embodied in the projections of Members of the Board of Governors and the Presidents of Federal Reserve Banks that were made at around the time of the FOMC meeting late last month, based on the assumption of appropriate monetary policy. In particular, the central tendency of those forecasts is for real GDP to increase about 3.75 percent to 3.5 percent in 2006 and 3 percent to 3.25 percent in 2007. With output expanding at a pace near that of the economy's potential, the civilian unemployment rate is expected to finish both 2006 and 2007 between 4.75 percent and 5 percent, close to its recent level. I turn out to the inflation situation. As I noted, inflation has been higher than we expected at the time of our last report. Much of the upward pressure on overall inflation this year has been due to increases in the prices of energy and other commodities and, in particular, to the higher prices of products derived from crude oil. Gasoline prices have increased notably as a result of the rise in petroleum prices as well as factors specific to the market for ethanol. The pickup in inflation so far this year has also been reflected in the prices of a range of nonenergy goods and services, as strengthening demand may have given firms more ability to pass energy and other costs through to consumers. In addition, increases in residential rents, as well as the imputed rent on owner-occupied homes, have recently contributed to higher core inflation. The recent rise in inflation is of concern to the FOMC. The achievement of price stability is one of the objectives that makes up the Congress's mandate to the Federal Reserve. Moreover, in the long-run, price stability is critical to achieving maximum employment and moderate long-term interest rates, the other parts of the Congressional mandate. The outlook for inflation is shaped by a number of factors, not the least of which is the course of energy prices. The spot price of oil has moved up significantly further in recent weeks. Futures quotes imply that market participants expect petroleum prices to roughly stabilize in coming quarters; such an outcome would, over time, reduce one source of upward pressure on inflation. However, expectations of a leveling out of oil prices have been consistently disappointed in recent years, and as the experience of the past week suggests, possible increases in these and other commodity prices remain a risk to the inflation outlook. Although the cost of energy and other raw materials are important, labor costs are by far the largest component of business costs. Anecdotal reports suggest that the labor market is tight in some industries and occupations and that employers are having difficulty attracting certain types of skilled workers. To date, however, moderate growth in most broad measures of nominal labor compensation and the ongoing increases in labor productivity have held down the rise in unit labor costs, reducing pressure on inflation from the cost side. Employee compensation per hour is likely to rise more quickly over the next couple of years in response to the strength of the labor market. Whether faster increases in nominal compensation create additional cost pressures for firms depends in part on the extent to which they are offset by continuing productivity gains. Profit margins are currently relatively wide, and the effect of a possible acceleration in compensation on price inflation would thus also depend on the extent to which competitive pressures force firms to reduce margins rather than pass on higher costs. The public's inflation expectations are another important determinant of inflation. The Federal Reserve must guard against the emergence of an inflationary psychology that could impart greater persistence to what otherwise would be a transitory increase in inflation. After rising earlier this year, measures of longer-term inflation expectations, based on surveys and on a comparison of yields on nominal and inflation-index Government debt, have edged down and remained contained. These developments bear watching, however. Finally, the extent to which aggregate demand is aligned with the economy's underlying productive potential also influences inflation. As I noted earlier, FOMC participants project that the growth in economic activity should moderate to a pace close to that of the growth of potential both this year and next. Should that moderation occur as anticipated, it should also help to limit inflation pressures over time. The projections of the Members of the Board of Governors and the Presidents of the Federal Reserve Banks, which are based on information available at the time of the last FOMC meeting, are for a gradual decline in inflation in coming quarters. As measured by the price index for personal consumption expenditures excluding food and energy, inflation is projected to be 2.25 percent to 2.5 percent this year, and then to edge lower, to 2 percent to 2.25 percent, next year. The FOMC projections, which now anticipate slightly lower growth in real output and higher core inflation than expected in our February report, mirror the somewhat more adverse circumstances facing our economy, which have resulted from the recent steep run-up in energy costs and higher-than-expected inflation more generally. But they also reflect our assessment that with appropriate monetary policy and in the absence of significant unforeseen developments, the economy should continue to expand at a solid and sustainable pace and core inflation should decline from its recent level over the medium-term. Although our baseline forecast is for moderating inflation, the Committee judges that some inflation risks remain. In particular, the high prices of energy and other commodities, in conjunction with high levels of resource utilization that may increase the pricing power of suppliers of goods and services, have the potential to sustain inflation pressures. More generally, if the pattern of elevated readings on inflation is more protracted or more intense than is currently expected, this higher level of inflation could become embedded in the public's inflation expectations and in price-setting behavior. Persistently higher inflation would erode the performance of the real economy and would be costly to reverse. The Federal Reserve must take account of these risks in making its policy decisions. In our pursuit of maximum employment and price stability, monetary policymakers operate in an environment of uncertainty. In particular, we have imperfect knowledge about the effects of our own policy actions as well as of the many other factors that will shape economic developments during the forecast period. These uncertainties bear importantly on our policy decisions because the full influence of policy actions on the economy is felt only after a considerable period of time. The lags between policy actions and their effects imply that we must be forward-looking, basing our policy choice on the longer-term outlook for both inflation and economic growth. In formulating that outlook, we must take account of the possible future effects of previous policy actions--that is, of policy effects still ``in the pipeline.'' Finally, as I have already noted, we must consider not only what appears to be the most likely outcome but also the risks to that outlook and the costs that would be incurred should any of those risks be realized. At the same time, because economic forecasting is far from a precise science, we have no choice but to regard all our forecasts as provisional and subject to revision as the facts demand. Thus, policy must be flexible and ready to adjust to changes in economic projections. In particular, as the Committee noted in the statement issued after its June meeting, the extent and timing of any additional firming that may be needed to address inflation risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by our analysis of the incoming information. Thank you. I would be happy to take questions. " CHRG-110shrg50409--24 Mr. Bernanke," Well, first, of course, I would like to revise and extend my remarks from March of 2007. The issue was that the subprime crisis triggered a much broader retreat from credit and risk taking, which has affected not just subprime lending but a wide variety of credit instruments. And that is why it has become a much bigger element in the situation than, frankly, I anticipated at that time. The housing market is still under considerable stress and construction is still declining. I do believe that we will start to see stabilization in the construction of new homes sometime later this year or the beginning of next year, and that will be a benefit because the slowing construction pattern has been subtracting about 1 percentage point from the growth of the GDP going back now for some time. So that will be a benefit. House prices may continue to fall longer than that because of the large inventories of unsold homes that we still face. And then I would have to say that there is uncertainty about exactly what the equilibrium level that house prices will reach is. Unfortunately, it is that uncertainty, which is generating a lot of the stress and risk aversion we are seeing in financial markets. It is for that reason--the need to find a footing, to find stability in the housing market--that I do think that action by this Congress to support the housing market through strengthening the GSEs and FHA and so on is of vital importance. Senator Menendez. Let me talk about the other major driver, then, of what is happening to our economy, and that is the whole question of energy prices and oil. You know, I appreciate in your answer to the Chairman and in your testimony, because we have had testimony before the Congress by all executives who say that the difference between supply and demand over the last 2 years would largely lead us to a concern that, in fact, speculation may have driven the price of oil up an additional $50 a barrel. You have the view that that may not be the most significant thing in prices, but you do take the view that useful steps can be taken to improve the transparency and functioning of future markets. Are you ready to say to the Committee today what some of those useful steps are? Or are you still depending upon that Committee that you are meeting with to look at that? Because we do not have a lot of time here. " CHRG-109hhrg31539--9 Mr. Bernanke," Thank you. Mr. Chairman, and members of the committee, I am pleased to be here again to present the Federal Reserve's Monetary Policy Report to the Congress. Over the period since our February report, the U.S. economy has continued to expand. Real gross domestic product is estimated to have risen at an annual rate of 5.6 percent in the first quarter of 2006. The available indicators suggest that economic growth has more recently moderated from that quite strong pace, reflecting a gradual cooling of the housing market and other factors that I will discuss. With respect to the labor market, more than 850,000 jobs have been added, on net, to nonfarm payrolls in the first 6 months of the year, though these gains came at a slower pace in the second quarter than in the first. Last month the unemployment rate stood at 4.6 percent. Inflation has been higher than we anticipated in February, partly as a result of further sharp increases in the prices of energy and other commodities. During the first 5 months of the year, overall inflation, as measured by the price index for personal consumption expenditures, averaged 4.3 percent at an annual rate. Over the same period, core inflation, that is, inflation excluding food and energy prices, averaged 2.6 percent at an annual rate. To address the risk that inflation pressures might remain elevated, the Federal Open Market Committee continued to firm the stance of monetary policy, raising the Federal funds rate another three-quarters of a percentage point to 5\1/4\ percent in the period since our last report. Let me now review the current economic situation and the outlook in a bit more detail, beginning with developments in the real economy and then turning to the inflation situation. I will conclude with some comments on monetary policy. The U.S. economy appears to be in a period of transition. For the past 3 years or so, economic growth in the United States has been robust. This growth has reflected both the ongoing reemployment of underutilized resources as the economy recovered from the weakness of earlier in the decade and the expansion of the economy's underlying productive potential as determined by such factors as productivity trends and growth of the labor force. Although the rate of resource utilization that the economy can sustain cannot be known with any precision, it is clear that after several years of above-trend growth, slack in resource utilization has been substantially reduced. As a consequence, a sustainable noninflationary expansion is likely to involve a modest reduction in the growth of economic activity from the rapid pace of the past 3 years to a pace more consistent with the rate of increase in the Nation's underlying productive capacity. It bears emphasizing that because productivity growth seems likely to remain strong, the productive capacity of our economy should expand over the next few years at a rate sufficient to support solid growth in real output. As I have noted, the anticipated moderation in economic growth now seems to be under way, although the recent erratic growth pattern complicates this assessment. That moderation appears most evident in the household sector. In particular, consumer spending, which makes up more than two-thirds of aggregate spending, grew rapidly during the first quarter, but decelerated during the spring. One likely source of this deceleration was higher energy prices, which have adversely affected the purchasing power of households and have weighed on consumer attitudes. Outlays for residential construction, which have been at very high levels in recent years, rose further in the first quarter. More recently, however, the market for residential real estate has been cooling, as can be seen in the slowing of new and existing home sales and housing starts. Some of the recent softening in housing starts may have resulted from the unusually favorable weather during the first quarter of the year which pulled forward construction activity, but the slowing of the housing market appears to be more broad-based than can be explained by that factor alone. Home prices, which have climbed at double-digit rates in recent years, still appear to be rising for the Nation as a whole, though significantly less rapidly than before. These developments in the housing market are not particularly surprising as the sustained run-up in housing prices, together with some increase in mortgage rates, has reduced affordability and thus the demand for new homes. The slowing of the housing market may restrain other forms of household spending as well. With homeowners no longer experiencing increases in the equity value of their homes at the rapid pace seen in the past few years, and with the recent declines in the stock prices, increases in household net worth are likely to provide less of a boost to consumer expenditures than they have in the recent past. That said, favorable fundamentals, including relatively low unemployment and rising disposable incomes, should provide support for consumer spending. Overall, household expenditures appear likely to expand at a moderate pace, providing continued impetus to the overall economic expansion. Although growth in household spending has slowed, other sectors of the economy retain considerable momentum. Business investment in new capital goods appears to have risen briskly, on net, so far this year. In particular, investment in nonresidential structures which had been weak since 2001 seems to have picked up appreciably, providing some offset to the slower growth in residential construction. Spending on equipment and software has also been strong. With a few exceptions, business inventories appear to be well aligned with sales, which reduces the risk that a build-up of unwanted inventories might actually reduce production in the future. Business investment seems likely to continue to grow at a solid pace, supported by growth in final sales, rising backlogs of orders for capital goods, and high rates of profitability. To be sure, businesses in certain sectors have experienced financial difficulties. In the aggregate, however, firms remain in excellent financial condition, and credit conditions for businesses are favorable. Globally, output growth appears strong. Growth of the global economy will help support U.S. economic activity by continuing to stimulate demand for our exports of goods and services. One downside to the strength of the global economy, however, is that it has led to significant increases in the demand for crude oil and other primary commodities in the past few years. Together with heightened geopolitical uncertainties and the limited ability of suppliers to expand capacity in the short run, these rising demands have resulted in sharp rises in the prices of which these goods are traded internationally, which in turn has put upward pressure on costs and prices in the United States. Overall, the U.S. economy seems poised to grow in coming quarters at a pace roughly in line with the expansion of its underlying productive capacity. Such an outlook is embodied in the projections of members of the Board of Governors and the presidents of Federal Reserve Banks that were made around the time of the FOMC meeting late last month, based on the assumption of appropriate monetary policy. In particular, the central tendency of those forecasts is for real GDP to increase about 3\1/4\ percent to 3\1/2\ percent in 2006, and 3 percent to 3\1/4\ percent in 2007. With output expanding at a pace near that of the economy's potential, the civilian unemployment rate is expected to finish both 2006 and 2007 between 4\3/4\ percent and 5 percent, close to its recent level. I turn now to the inflation situation. As I noted, inflation has been higher than we expected at the time of our last report. Much of the upward pressure on overall inflation this year has been due to increases in the prices of energy and other commodities, and in particular to the higher prices of products derived from crude oil. Gasoline prices have increased notably as a result of the rise in petroleum prices as well as factors specific to the market for ethanol. The pickup in inflation so far this year has also been reflected in the prices of a range of goods and services as strengthening demand may have given firms more ability to pass energy and other costs through to consumers. In addition, increases in residential rents as well as in the imputed rent on owner-occupied homes have recently contributed to higher core inflation. The recent rise in inflation is of concern to the FOMC. The achievement of price stability is one of the objectives that make up the Congress' mandate to the Federal Reserve. Moreover, in the long run, price stability is critical to achieving maximum employment and moderate long-term interest rates, the other parts of the Congressional mandate. The outlook for inflation is shaped by a number of factors, not the least of which is the course of energy prices. The spot price of oil has moved up significantly further in recent weeks. Futures quotes imply that market participants expect petroleum prices to roughly stabilize in coming quarters. Such an outcome would, over time, reduce one source of upward pressure on inflation. However, expectations of a leveling out of oil prices have been consistently disappointed in recent years, and as the experience of the past week suggests, possible increases in these and other commodity prices remain a risk to the inflation outlook. Although the costs of energy and other raw materials are important, labor costs are by far the largest component of business costs. Anecdotal reports suggest that the labor market is tight in some industries and occupations, and that employers are having difficulty attracting certain types of skilled workers. To date, however, moderate growth in most broad measures of nominal labor compensation and the ongoing increases in labor productivity have held down the rise in unit labor costs, reducing pressure on inflation from the cost side. Employee compensation per hour is likely to rise more quickly over the next couple of years in response to the strength of the labor market. Whether faster increases in nominal compensation create additional cost pressures for firms depends in part on the extent to which they are offset by continuing productivity gains. Profit margins are currently relatively wide, and the effect of a possible acceleration in compensation in price inflation would also depend on the extent to which competitive pressures force firms to reduce margins rather than to pass on higher costs. The public's inflation expectations are another important determinant of inflation. The Federal Reserve must guard against the emergence of an inflationary psychology that could impart greater persistence than what could otherwise be a transitory increase in inflation. After rising earlier this year, measures of expectations, based on surveys and on a comparison of yields on nominal and inflation-indexed government debt, have edged down and remain contained. These developments bear watching, however. Finally, the extent to which aggregate demand is aligned with the economy's underlying productive potential also influences inflation. As I noted earlier, FOMC participants project the growth in economic activity should moderate to a pace close to that of the growth of potential both this year and next. Should that moderation occur as anticipated, it should help to limit inflation pressures over time. The projections of the members of the Board of Governors and the presidents of the Federal Reserve Banks, which are based on information available at the time of the last FOMC meeting, are for a gradual decline in inflation in coming quarters. As measured by the price index for personal consumption expenditures excluding food and energy, inflation is projected to be 2\1/4\ percent to 2\1/2\ percent this year and then to edge lower to 2 percent to 2\1/4\ percent next year. The FOMC projections, which now anticipate slightly lower growth in real output and higher core inflation than expected in our February report, mirror the somewhat more adverse circumstances facing our economy which have resulted from the recent steep run-up in energy costs and higher-than-expected inflation more generally. But they also reflect our assessment that with appropriate monetary policy, and in the absence of significant unforeseen developments, the economy should continue to expand at a solid and sustainable pace, and core inflation should decline from its recent level over the medium term. Although our baseline forecast is for moderating inflation, the committee judges that some inflation risks remain. In particular, the high prices of energy and other commodities in conjunction with high levels of resource utilization that may increase the pricing power of suppliers of goods and services have the potential to sustain inflation pressures. More generally, if the pattern of elevated readings on inflation is more protracted or is more intense than currently expected, this higher level of inflation could become embedded in the public's expectations and in price-setting behavior. Persistently higher inflation would erode the performance of the real economy and would be costly to reverse. The Federal Reserve must take into account these risks in making its policy decisions. In our pursuit of maximum employment and price stability, monetary policymakers operate in an environment of uncertainty. In particular, we have imperfect knowledge about the effects of our own policy actions as well as of the many other factors that will shape economic developments during the forecast period. These uncertainties bear importantly on our policy decisions because the full influence of policy actions on the economy is felt only after a considerable period of time. The lags between policy actions and their effects imply that we must be forward-looking, basing our policy choices on the longer-term outlook for both inflation and economic growth. In formulating that outlook, we must take into account the possible future effects of previous policy actions, that is, of policy effects still in the pipeline. Finally, as I have noted, we must consider not only what appears to be the most likely outcome, but also the risks to that outlook and the costs that would be incurred should any of those risks be realized. At the same time, because economic forecasting is far from a precise science, we have no choice but to regard all of our forecasts as provisional and subject to revision as the facts demand. Thus, policy must be flexible and ready to adjust to changes in economic projections. In particular, as the committee noted in the statement issued after its June meeting, the extent and timing of any additional firming that may be needed to address inflation risks will depend on the evolution of the outlook for both inflation and economic growth as implied by our analysis of the incoming information. Thank you. I would be happy to take questions. " 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 FinancialCrisisInquiry--8 Fourth, assets at certain institutions weren’t valued at their fair market value, the price at which willing buyers and sellers transact. One consequence was that losses weren’t seen early enough, so risks weren’t curtailed. A second consequence was that bank balance sheets became suspect. As a result, lending between counterparties froze. Fifth, financial institutions simply didn’t have enough capital to meet the extraordinary market environment that arose after a long period of benign conditions. Lastly, the role we play in the capital markets is to support economic growth. Some of the activities we undertook contributed to the prevailing mood of the time. We didn’t know it then or even today when it actually crossed over into bubble territory. But we lent money out too cheaply and in certain loans, without the traditional safeguards. We didn’t recognize early enough that risk was being mispriced. We made too many liquid investments, particularly in real estate. And we were too concentrated in certain areas, namely leveraged loans. Given the competitive focus on maintaining market share, we didn’t see as clearly as I would have hoped the excesses, so we didn’t raise a hand and ask whether some of those trends and practices that became commonplace really served the financial system’s interests. Going forward, I hope that one of the improvements made will be the creation of a mechanism by which the industry and regulators can step back, try to assess if markets have gone too far and consider what needs to be done. In light of these lessons, it is important to consider principles for our industry and for policy makers as we move towards reform. Risk and control functions need to be completely independent from the business units. And clarity as to whom risk and control managers report is crucial to maintaining that independence. To increase overall transparency and help ensure that book value really means book value, regulators should require that all assets across a large financial institution with a capital markets business be accounted for on a fair value basis. Also, all of the exposures of a financial institution should be reflected through its P&L. In this vein, valuation of capital standards across risky assets, regardless of the form or legal entity in which they are held, must be consistent. FOMC20070509meeting--51 49,MR. MOSKOW.," Thank you, Mr. Chairman. Conditions in the Seventh District have improved modestly since my last report. The overall pace of business activity is still rather restrained, but we have seen some pickup in our manufacturing sector. The key issues regarding the national outlook are the same as the ones the last time we met. How will the residential investment puzzle settle out, and can we explain this puzzling weakness in business fixed investment? Based on the data that we’ve received since March and my contact calls this round, I’ve become somewhat more optimistic about investment and somewhat more pessimistic about housing. At the same time, higher gasoline prices have the potential to weigh on consumer spending. So on balance our growth projection for ’07 and ’08 is a bit lower than it was in March. We now think that growth will average moderately short of potential over the remainder of ’07 and then run close to potential in 2008. However, our GDP numbers are a bit higher than the Greenbook’s, reflecting both a smaller shortfall from potential this year and a somewhat higher assumption about the rate of potential output growth. Indeed, there has been some good news regarding the near-term outlook. First, the international outlook continues to improve. Many of our contacts noted exceptionally strong demand from abroad, particularly for capital goods. Second, although we’ve been actively looking for spillovers from the problems with subprime mortgages, we have not yet seen major effects on pricing or the supply of credit in other markets. That is not to say that we have not heard of any effects. One of our directors, the CFO of a major national homebuilder, noted that tighter underwriting standards are reducing housing demand somewhat outside the subprime sector. Consumers still appear to have ample access to financing. For example, the head of GM noted that banks were making more auto loans with six- or seven-year maturities in order to lower monthly payments for liquidity-strapped consumers. Finally, as I noted earlier, we feel a bit more confident in our assumption that the weakness in BFI will turn out to be relatively transitory. I don’t want to make too much out of one month’s noisy data, but the latest readings on capital good orders and the PMI (purchasing managers’ index) were encouraging, and most of the comments from my business contacts have been positive in this regard. The impression I have from these discussions is that the pause in investment spending is showing early signs of ending; but this is very early, and we clearly need to keep monitoring developments carefully. Beyond the near-term cyclical developments, the changes in structural productivity in the Greenbook highlight an important source of risk to the longer-run outlook for sustainable non- inflationary growth, as Janet just discussed. There is a lot of uncertainty about the components of structural productivity. In our view, we haven’t seen enough evidence yet to mark down structural productivity as much as the Greenbook has. Consequently, our estimate of potential output growth is a bit higher than that of the Greenbook. With regard to inflation, the incoming information has caused the forecasts from our indicator models to come down a bit. They now project that core PCE prices will rise 2¼ percent this year and 2.1 percent in ’08. But we do not see any progress beyond that. If we carry our models out to ’09, they have inflation staying at 2.1 percent, higher than my preferred range. Furthermore, I see some upside risks to this forecast. Neither our GDP projection nor the Greenbook’s generates any meaningful resource slack over the projection period, and then there are the higher costs for energy and other commodities and increases in import prices. So we will be relying heavily on stable expectations to keep inflation in check. I believe we are currently achieving some implicit tightening of policy by keeping rates on hold during this period of sluggish activity, but this restraint will wane if the real economy returns to potential by early next year as we expect. So I continue to think that the risks to price stability dominate the risks to sustainable growth." CHRG-109shrg30354--89 Chairman Bernanke," Senator, the two interact because if there was just a one-time pass-through and the public were completely convinced that the Fed would keep inflation low and expectations were low and the Fed were perfectly credible, then that inflation would be just a temporary thing and would come back down. So the risk is the interaction of the two. The risk is that inflation will go up because of energy prices, because of greater pass-through, and that will feed into inflation expectations, which then will feed into a round of additional price increases and the like. You really cannot get a permanent increase in inflation unless people increase their inflation expectations. That is why the Fed's credibility is, I think, such a major asset of the United States. Senator Sununu. It seems to me to the extent that you are in the midst of a little bit of a dilemma it is as follows. Right now, inflation is above what has been stated in different ways your target range. We have still got high energy prices. So that would suggest that the absolute level of inflation remains a concern. On the other hand, you have a forecast for moderating growth. You have a slowdown in the housing industry. So while the inflation numbers may push you toward a rate increase, the moderating growth that has been forecast might encourage you to pause or to forgo further rate increases. That is a dilemma. I think we all understand that. To what extent is the fact that you now find yourself in this dilemma the result of a slowness or a delay to action in beginning this cycle of rate increases? " FOMC20070321meeting--217 215,CHAIRMAN BERNANKE.," Thank you. Has everyone spoken? Well. [Laughter] Let me try to find a consensus here. First, I agree with the sentiment around the table. I recommend no action today. We should continue to emphasize inflation risk—I think there’s a strong feeling that it remains the greater risk. There is acknowledgement that uncertainty and risk have increased on both sides of the dual mandate, but the balance of risks does not seem to have changed very much. Supporting the idea of keeping the rate where it is is that, as best we can tell, the level of the rate currently seems about right to foster our objectives. Also as people have noted, by standing pat, we have considerable ability to tighten de facto as market expectations move toward our actual revealed behavior. So I would counsel patience on the rate and maintain the rate at its current level today. Let me take a stab at the statement. I think we all agree on section 1. [Laughter] On section 3, let me note the suggestion of, I think it was President Stern. I’m sympathetic. I didn’t hear much support, however, and again, it’s a change. So I would recommend that we stay with the current section 3. On section 4, first a small point. I think the mild preference was for “predominant” over “principal” as consistent with my testimony. To the extent that we’re trying to lean against easing of expectations, if “predominant” is slightly stronger, it would be beneficial in that respect. So let me propose that change. I recognize the risk that the second sentence in section 4 has the potential to mislead the market a bit. My concern is that the second sentence that we have been using is simply not literally true anymore. The implication is that we are certain that the next move is going to be an increase, and it’s only a matter of when and how much. We have been trying for some time to get out of that language and to get to something that is more descriptive. The benefits of the second sentence are, first, that it does create more flexibility and, second, that it refers only to things on the right-hand side of the Taylor rule—that is, inflation and output—and doesn’t make a statement about future policy actions, which most people seem to prefer avoiding whenever possible. Again, although it will be viewed as a small step toward balance or flexibility, we are fairly strong in our statement of inflation risk. In particular, we’ve introduced here not just that we think there are inflation risks but that our specific concern is that inflation will not moderate, which is a different and somewhat stronger statement than we have had. I acknowledge that there may be some market rally based on this, but with President Poole, I think that the data will dominate as we go forward. Indeed, the endogeneity of interest rates and their stabilizing effects are very important assets that we have in policy. With respect to the description in section 2, the intention was, given that the first sentence is relatively negative, to give some modest rationale for our thinking that the economy seems likely to continue expanding. Let me try one more suggestion. Perhaps we can find a solution. One reason that a quick summary is difficult is that the story for recovery is, in fact, fairly complicated. It involves certainly the ending of the housing correction but also assumptions of inventory correction, of investment coming back at a moderate pace, and of a number of other things. The notion here was to look at more fundamental factors that would be underlying the assumption of growth, such as income, which has grown rapidly, and supportive financial conditions. But I hear the concerns. The Greenbook forecast calls for moderate growth in essentially all of the components except for housing. In particular, it expects consumption to grow more than 2 percent; investment, more than 2 percent; support from government spending and net exports; and so on. So something along the lines of “supported by growth in nonhousing components of final demand” might be a descriptive way of saying that we think that, although housing will be a drag, the other components of the economy will support moderate growth. That’s a suggestion." 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-110hhrg44901--52 Mr. Bernanke," Well, as the earlier questioner mentioned, dealing with these kinds of problems is multi-dimensional. Monetary policy is one element. Lending is one element. Regulatory policy, both initiated by the regulators and by Congress, is another element. I think we need to address the Fannie Mae/Freddie Mac situation to try to strengthen the mortgage markets. There are many other steps. We have done the fiscal stimulus package. So I absolutely agree that there is no single solution. If there were, of course we would have used it by now. What we need to do is have a sensible, coordinated, and proactive approach that is going to allow us to get through this difficult period and return to the strong underlying growth of this economy, in which I have great confidence. Ms. Velazquez. Okay. Many believe that the losses from the housing market could spill over into consumer and business credit, indicating that the worst may be yet to come. What is your take on that? " CHRG-111hhrg53244--62 Mr. Bernanke," Well, the purpose of our limited program was to address private credit markets, Congressman. When we complete the $300 billion program that we announced, we will have less treasuries on our balance sheet than we did 2 years ago, because we sold off a lot of treasuries in order to make room for these other things we were doing. Secondly, after we complete that $300 billion, our share of outstanding treasuries will be at one of the lowest points in the post-war period. So we are not taking a significant portion of U.S. Treasuries. And we are not actively intervening or actively trying to make it easier for the government to issue debt. Dr. Paul. So you are saying, if you buy $300 billion worth of U.S. Government debt, that is not inflationary. The true definition of ``inflation'' is when you increase the money supply. And the immediate consequence is it sends out false, bad information to the marketplace. So whether it is when the bubble is being formed or afterwards, all you are doing is inflating constantly. You have doubled the money supply; interest rates are artificial. People make mistakes. So it seems to me that you are in the midst of massive inflation. But I guess you have a different definition. When you double the money supply, that is not inflation itself? Or are you looking at only prices? " 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-109shrg30354--127 PREPARED STATEMENT OF BEN S. BERNANKE Chairman, Board of Governors of the Federal Reserve System July 19, 2006 Mr. Chairman and Members of the Committee, I am pleased to be here again to present the Federal Reserve's Monetary Policy Report to the Congress. Over the period since our February report, the U.S. economy has continued to expand. Real gross domestic product (GDP) is estimated to have risen at an annual rate of 5.6 percent in the first quarter of 2006. The available indicators suggest that economic growth has more recently moderated from that quite strong pace, reflecting a gradual cooling of the housing market and other factors that I will discuss. With respect to the labor market, more than 850,000 jobs were added, on net, to nonfarm payrolls over the first 6 months of the year, though these gains came at a slower pace in the second quarter than in the first. Last month, the unemployment rate stood at 4.6 percent. Inflation has been higher than we had anticipated in February, partly as a result of further sharp increases in the prices of energy and other commodities. During the first 5 months of the year, overall inflation as measured by the price index for personal consumption expenditures averaged 4.3 percent at an annual rate. Over the same period, core inflation--that is, inflation excluding food and energy prices--averaged 2.6 percent at an annual rate. To address the risk that inflation pressures might remain elevated, the Federal Open Market Committee (FOMC) continued to firm the stance of monetary policy, raising the Federal funds rate another \3/4\ percentage point, to 5\1/4\ percent, in the period since our last report. Let me now review the current economic situation and the outlook in a bit more detail, beginning with developments in the real economy and then turning to the inflation situation. I will conclude with some comments on monetary policy. The U.S. economy appears to be in a period of transition. For the past 3 years or so, economic growth in the United States has been robust. This growth has reflected both the ongoing reemployment of underutilized resources, as the economy recovered from the weakness of earlier in the decade, and the expansion of the economy's underlying productive potential, as determined by such factors as productivity trends and growth of the labor force. Although the rates of resource utilization that the economy can sustain cannot be known with any precision, it is clear that, after several years of above-trend growth, slack in resource utilization has been substantially reduced. As a consequence, a sustainable, noninflationary expansion is likely to involve a modest reduction in the growth of economic activity from the rapid pace of the past 3 years to a pace more consistent with the rate of increase in the Nation's underlying productive capacity. It bears emphasizing that, because productivity growth seems likely to remain strong, the productive capacity of our economy should expand over the next few years at a rate sufficient to support solid growth in real output. As I have noted, the anticipated moderation in economic growth now seems to be under way, although the recent erratic growth pattern complicates this assessment. That moderation appears most evident in the household sector. In particular, consumer spending, which makes up more than two-thirds of aggregate spending, grew rapidly during the first quarter but decelerated during the spring. One likely source of this deceleration was higher energy prices, which have adversely affected the purchasing power of households and weighed on consumer attitudes. Outlays for residential construction, which have been at very high levels in recent years, rose further in the first quarter. More recently, however, the market for residential real estate has been cooling, as can be seen in the slowing of new and existing home sales and housing starts. Some of the recent softening in housing starts may have resulted from the unusually favorable weather during the first quarter of the year, which pulled forward construction activity, but the slowing of the housing market appears to be more broad-based than can be explained by that factor alone. Home prices, which have climbed at double-digit rates in recent years, still appear to be rising for the Nation as a whole, though significantly less rapidly than before. These developments in the housing market are not particularly surprising, as the sustained run-up in housing prices, together with some increase in mortgage rates, has reduced affordability and thus the demand for new homes. The slowing of the housing market may restrain other forms of household spending as well. With homeowners no longer experiencing increases in the equity value of their homes at the rapid pace seen in the past few years, and with the recent declines in stock prices, increases in household net worth are likely to provide less of a boost to consumer expenditures than they have in the recent past. That said, favorable fundamentals, including relatively low unemployment and rising disposable incomes, should provide support for consumer spending. Overall, household expenditures appear likely to expand at a moderate pace, providing continued impetus to the overall economic expansion. Although growth in household spending has slowed, other sectors of the economy retain considerable momentum. Business investment in new capital goods appears to have risen briskly, on net, so far this year. In particular, investment in non-residential structures, which had been weak since 2001, seems to have picked up appreciably, providing some offset to the slower growth in residential construction. Spending on equipment and software has also been strong. With a few exceptions, business inventories appear to be well-aligned with sales, which reduces the risk that a buildup of unwanted inventories might act to reduce production in the future. Business investment seems likely to continue to grow at a solid pace, supported by growth in final sales, rising backlogs of orders for capital goods, and high rates of profitability. To be sure, businesses in certain sectors have experienced financial difficulties. In the aggregate, however, firms remain in excellent financial condition, and credit conditions for businesses are favorable. Globally, output growth appears strong. Growth of the global economy will help support U.S. economic activity by continuing to stimulate demand for our exports of goods and services. One downside of the strength of the global economy, however, is that it has led to significant increases in the demand for crude oil and other primary commodities over the past few years. Together with heightened geopolitical uncertainties and the limited ability of suppliers to expand capacity in the short run, these rising demands have resulted in sharp rises in the prices at which those goods are traded internationally, which in turn has put upward pressure on costs and prices in the United States. Overall, the U.S. economy seems poised to grow in coming quarters at a pace roughly in line with the expansion of its underlying productive capacity. Such an outlook is embodied in the projections of members of the Board of Governors and the Presidents of Federal Reserve Banks that were made around the time of the FOMC meeting late last month, based on the assumption of appropriate monetary policy. In particular, the central tendency of those forecasts is for real GDP to increase about 3\1/4\ percent to 3\1/2\ percent in 2006 and 3 percent to 3\1/4\ percent in 2007. With output expanding at a pace near that of the economy's potential, the civilian unemployment rate is expected to finish both 2006 and 2007 between 4\3/4\ percent and 5 percent, close to its recent level. I turn now to the inflation situation. As I noted, inflation has been higher than we expected at the time of our last report. Much of the upward pressure on overall inflation this year has been due to increases in the prices of energy and other commodities and, in particular, to the higher prices of products derived from crude oil. Gasoline prices have increased notably as a result of the rise in petroleum prices as well as factors specific to the market for ethanol. The pickup in inflation so far this year has also been reflected in the prices of a range of nonenergy goods and services, as strengthening demand may have given firms more ability to pass energy and other costs through to consumers. In addition, increases in residential rents, as well as in the imputed rent on owner-occupied homes, have recently contributed to higher core inflation. The recent rise in inflation is of concern to the FOMC. The achievement of price stability is one of the objectives that make up the Congress's mandate to the Federal Reserve. Moreover, in the long run, price stability is critical to achieving maximum employment and moderate long-term interest rates, the other parts of the Congressional mandate. The outlook for inflation is shaped by a number of factors, not the least of which is the course of energy prices. The spot price of oil has moved up significantly further in recent weeks. Futures quotes imply that market participants expect petroleum prices to roughly stabilize in coming quarters; such an outcome would, over time, reduce one source of upward pressure on inflation. However, expectations of a leveling out of oil prices have been consistently disappointed in recent years, and as the experience of the past week suggests, possible increases in these and other commodity prices remain a risk to the inflation outlook. Although the costs of energy and other raw materials are important, labor costs are by far the largest component of business costs. Anecdotal reports suggest that the labor market is tight in some industries and occupations and that employers are having difficulty attracting certain types of skilled workers. To date, however, moderate growth in most broad measures of nominal labor compensation and the ongoing increases in labor productivity have held down the rise in unit labor costs, reducing pressure on inflation from the cost side. Employee compensation per hour is likely to rise more quickly over the next couple of years in response to the strength of the labor market. Whether faster increases in nominal compensation create additional cost pressures for firms depends in part on the extent to which they are offset by continuing productivity gains. Profit margins are currently relatively wide, and the effect of a possible acceleration in compensation on price inflation would thus also depend on the extent to which competitive pressures force firms to reduce margins rather than pass on higher costs. The public's inflation expectations are another important determinant of inflation. The Federal Reserve must guard against the emergence of an inflationary psychology that could impart greater persistence to what would otherwise be a transitory increase in inflation. After rising earlier this year, measures of longer-term inflation expectations, based on surveys and on a comparison of yields on nominal and inflation-indexed government debt, have edged down and remain contained. These developments bear watching, however. Finally, the extent to which aggregate demand is aligned with the economy's underlying productive potential also influences inflation. As I noted earlier, FOMC participants project that the growth in economic activity should moderate to a pace close to that of the growth of potential both this year and next. Should that moderation occur as anticipated, it should help to limit inflation pressures over time. The projections of the Members of the Board of Governors and the Presidents of the Federal Reserve Banks, which are based on information available at the time of the last FOMC meeting, are for a gradual decline in inflation in coming quarters. As measured by the price index for personal consumption expenditures excluding food and energy, inflation is projected to be 2\1/4\ percent to 2\1/2\ percent this year and then to edge lower, to 2 percent to 2\1/4\ percent next year. The FOMC projections, which now anticipate slightly lower growth in real output and higher core inflation than expected in our February report, mirror the somewhat more adverse circumstances facing our economy, which have resulted from the recent steep run-up in energy costs and higher-than-expected inflation more generally. But they also reflect our assessment that, with appropriate monetary policy and in the absence of significant unforeseen developments, the economy should continue to expand at a solid and sustainable pace and core inflation should decline from its recent level over the medium term. Although our baseline forecast is for moderating inflation, the Committee judges that some inflation risks remain. In particular, the high prices of energy and other commodities, in conjunction with high levels of resource utilization that may increase the pricing power of suppliers of goods and services, have the potential to sustain inflation pressures. More generally, if the pattern of elevated readings on inflation is more protracted or more intense than is currently expected, this higher level of inflation could become embedded in the public's inflation expectations and in price-setting behavior. Persistently higher inflation would erode the performance of the real economy and would be costly to reverse. The Federal Reserve must take account of these risks in making its policy decisions. In our pursuit of maximum employment and price stability, monetary policy makers operate in an environment of uncertainty. In particular, we have imperfect knowledge about the effects of our own policy actions as well as of the many other factors that will shape economic developments during the forecast period. These uncertainties bear importantly on our policy decisions because the full influence of policy actions on the economy is felt only after a considerable period of time. The lags between policy actions and their effects imply that we must be forward-looking, basing our policy choices on the longer-term outlook for both inflation and economic growth. In formulating that outlook, we must take account of the possible future effects of previous policy actions--that is, of policy effects still ``in the pipeline.'' Finally, as I have noted, we must consider not only what appears to be the most likely outcome but also the risks to that outlook and the costs that would be incurred should any of those risks be realized. At the same time, because economic forecasting is far from a precise science, we have no choice but to regard all our forecasts as provisional and subject to revision as the facts demand. Thus, policy must be flexible and ready to adjust to changes in economic projections. In particular, as the Committee noted in the statement issued after its June meeting, the extent and timing of any additional firming that may be needed to address inflation risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by our analysis of the incoming information. Thank you. I would be happy to take questions. FOMC20060808meeting--60 58,MR. LACKER.," Thank you, Mr. Chairman. The Fifth District’s economy remains generally strong, though overall growth appears to have moderated in recent weeks. Retail sales have been lackluster, especially for big-ticket items. Manufacturing shipments and new orders picked up in July, however, and our early readings for August are even stronger in suggesting additional momentum going forward. District labor markets remain tight, with workers in some skill categories hard to find in urban areas and temporary workers in demand. The housing market continues to slow generally, although markets differ significantly across our District. Current and expected price trend measures remain very elevated, according to our surveys, as they have been for most of the year. Turning to the national economy, I focused at our last two meetings on my concerns about the deteriorating outlook for inflation, and the news over the intermeeting period has heightened those concerns. But today I think it is important that we also assess carefully the outlook for output and employment. I’m pretty sure that I can safely do so without danger of being viewed as an output nutter. [Laughter] GDP growth has been choppy in recent quarters; but over the past year and a half, output has been growing at about 3½ percent. You get the same 3½ percent growth rate if you average over the past three and a half years. We have substantially reduced the overhang of underutilized resources over that period. Employment has grown about 1½ percent a year, and the labor force has grown at just a little over 1 percent. I think the evidence is now fairly persuasive that resources are approximately fully utilized in the sense that significant amounts of idle labor or capital do not seem to be awaiting the return of better times. What sorts of growth rates for output or employment are sustainable over the next two years? The labor force appears likely to grow at about 1 percent—that is, about 110,000 jobs per month. Labor productivity has been trending around 2½ percent over the past couple of years, but I would be a bit more conservative going forward and expect about 2¼ percent per year, closer to the long-run average. As a result, it seems reasonable to put the center point of an estimate of a sustainable real growth rate at about 3¼ percent, with perhaps some extra above that if you’re more optimistic about productivity growth. Is this trend our best near-term forecast? Several factors could contribute to weaker real growth. Residential investment will contract in the coming quarters as the housing market cools, and lower average housing-price appreciation will reduce household wealth gains and damp consumption growth. The upward sweep in energy prices has taken a bite out of real disposable income as well, but I would expect real household spending to track real household income going forward because both the housing-price adjustment and the energy-price run-up, so far at least, look more like one-time reductions in household wealth and income and not like sources of ongoing erosion extending out more than a year. So I think it is reasonable to expect consumption to grow at close to 3 percent, down a bit from the average of 3½ percent over the past several years. Other factors seem likely to bolster growth. Business fixed investment spending has been expanding quite strongly in this recovery. It is up at an annual rate of close to 7 percent since the beginning of 2003, despite the sluggishness of structures until this year. In the second quarter, BFI was up 6.8 percent year-over-year, and the most recent high-frequency indicators remain on track. BFI spending as a share of GDP is still quite low by historical standards; and as the Greenbook points out, the fundamentals—business balance sheets and output growth—look quite solid. So it seems reasonable to expect business investment to continue to expand at a rate close to 7 percent. Putting everything together, I expect growth over the next year and a half to be just under 3 percent, or just more than ¼ percentage point below potential. The Greenbook forecast is weaker—GDP growth at about 2¼ percent for the next six quarters—mainly because the Board staff sees lower business investment spending and a pronounced reversal in the household saving rate. I think that a healthy respect for the uncertainty involved suggests that reasonable confidence intervals around each of these forecasts—the Greenbook’s and my own and the others I’ve heard today, for that matter—would include all the other point estimates and, more important, would include the possibility that growth proceeds at potential over the forecast period and beyond. So though it is reasonable to expect growth at or less than potential in the near term, my sense is that it’s hard to be too certain that it will be much below for long. As I said at the outset, the inflation picture has only worsened. The surge in core inflation that began in March has continued into June. The monthly pattern—3.7 percent in March at an annual rate, 2.7 in April, 2.8 in May, and 2.9 in June—makes this episode look less and less like a temporary bulge and more and more like a sustained increase. It is worth noting that the current acceleration in core inflation is broadly based, as the Greenbook emphasizes and President Poole ably articulated, and not attributable to any narrow set of special factors. The annual revisions to the national income and product accounts once again raised inflation for past years, although not that much this time, as President Yellen noted. It now appears that year-over-year core PCE inflation has exceeded 2 percent every month since April 2004. Perhaps the most striking change in the annual revisions, however, was in wages and salaries. The puzzle of compensation growth bulging in 2005 and slowing in 2006 is now gone, and it is now clear that compensation is on a broad upswing. The Board staff estimates that nonfarm business compensation per hour accelerated from a trend around 4 percent to something over 5½ percent. In fact, 5.4 percent was today’s release. Unit labor costs have deteriorated accordingly and now show an annual rate of increase of 4.2 percent in the second quarter, according to today’s release, and they are up 3.2 percent year over year. Before the NIPA revisions, the behavior of unit labor costs suggested that the current increase in inflation was not being incorporated into nominal wage compensation, but the labor cost data now show exactly the opposite—that the acceleration of inflation in recent months has induced a broad acceleration in nominal wages. I find it hard to be confident that a surge in unit labor costs is likely to be absorbed by falling markups. Measured markups have been trending up for some time, and I think they still do after the revision. Our economic understanding of the determination of markups, especially at the macroeconomic level, is still quite limited. In many models, the markup is entirely a real phenomenon and thus would be invariant with respect to purely nominal accelerations in costs. The main exceptions are the sticky-price models, but these don’t provide much comfort because in them a high markup is a forecast of accelerating nominal marginal cost—that is to say, an upswing in inflation. So I don’t take much comfort from the high level of markups. Combining the growth and inflation outlooks, it is worth thinking carefully about the extent to which we can expect slowing growth to bring inflation down. There have been a number of skeptical comments about that hypothesis around the table today. The relationship between output gaps and inflation is quite tenuous, as the staff rightly emphasizes whenever the subject comes up. Empirically, the ability to discover this relationship relies heavily on recessions and, thus, is much less reliable as an indicator of the effects on inflation of a small widening of the gap. Indeed, at our last meeting and again today, David Wilcox characterized the effect of the expected path of the output gap on inflation over the forecast period as tiny. The combination of uncertainty about the relationship between output gaps and inflation and the uncertainty about the degree to which growth is likely to fall short of potential should, I think, leave us deeply skeptical about whether we can rely on expected moderation in growth to bring inflation down. It is unfortunate that so many commentators placed so much weight on that in response to our last statement. Let me add a comment or two about President Yellen’s most excellent statement. I think the insights she articulated about backward-looking inflation models breaking down and the different inflation dynamics in forward-looking models is very important for our policy deliberations. Her staff apparently has documented that inflation now looks more as though it’s fluctuating around a sample average—I’ll say, a trend—and less as though it’s driven by output gap measures. She concludes that we may see inflation fall faster than the Greenbook forecasts do. I want to register a couple of observations. The first is that, with forward-looking expectations, inflation behavior is far more sensitive to changes in the public’s beliefs about our behavior than in models in which inflation expectations formation is backward looking. I’d register just the possibility that the long-run expected inflation that the public believes applies has been drifting around and may, in fact, account for some of the swings of measured inflation around sample averages. Finally, certainly taking the point of view that inflation expectations are formed in a forward-looking manner makes more likely the possibility that inflation will come down faster than the Greenbook states. But with inflation looking forward, it becomes our responsibility to bring that about. So that happy outcome could require our action and our strong communication, but I would welcome inspecting, if I could, the work of President Yellen’s staff, and I welcome her contribution." 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 " FOMC20070131meeting--224 222,MS. YELLEN.," Thank you, Mr. Chairman. I support Bluebook alternative B. I think we should maintain the current stance of policy because it is likely to foster an economy that gradually moves toward a soft landing. At the same time, the upward bias in the risk assessment is consistent with my view that upside risks do predominate for both growth and inflation. My best guess still is that this year’s growth will be slightly below trend with the current stance of policy. But as I indicated yesterday, for me the risks have shifted more to the upside given recent news. Housing remains a concern, but I think the prospects for a really serious housing collapse that spreads to consumer spending have diminished substantially. I am focused, as I said yesterday, on upside risks to activity, possibly coming from consumer spending. On the inflation front, the news has been good, and I continue to think for a variety of reasons, including my views on persistence, that core inflation will edge down over the year; but clearly it is too soon to conclude that a new trend has set in. To me, the upside risk to inflation seems palpable, especially because labor markets have tightened. Although I agree with President Plosser that the Phillips curve has certainly appeared to flatten in recent years, most estimates that I have seen of Phillips curves suggest that the relationship between changes in unemployment and changes in inflation, even though it may have become smaller, is still significant. The lags may be long so that its effect might not show up very much over the next couple of years, but it is a significant source of long-term risk. I’m pleased with the language suggested for alternative B. I think it effectively updates developments since our last meeting, and I favor keeping the same wording on the risk assessment that we used last time. That wording still conveys a sense of upside bias. I don’t see a compelling reason to change, and I think it still works." FOMC20060510meeting--122 120,MR. KOHN.," Thank you, Mr. Chairman. I agree with many of the rest of you that inflation risks rose over the intermeeting period, though I think I see a more limited rise than I sensed from some of the comments I have heard. Several factors do suggest higher inflation risk. Stronger growth than expected has left resource utilization a little higher than we thought—only a touch, I think, but still higher. The core CPI and PCE data were disappointing—were higher than anticipated. That, however, did follow several months in which those data came in lower than we had expected. And if you look at the Greenbook’s 2006 projection, it reverses a downward revision from last time. That is not to say it is not worrisome, but we were revising down for a while, and now we have had an upward revision. I think the commodity price increases are hard to understand, especially outside the energy area, where you can think about supply disruptions. Both the energy prices and the commodity prices could feed through to a limited extent into headline inflation. I think they do indicate, at the very least, that global demand has continued to be quite strong. In that regard, they would add to global inflation risks. The decline in the dollar is a bit worrisome. The pass-through to import prices has been very, very small over recent decades. But to the extent that the lower dollar is not passed through to import prices, it would be squeezing the profits of those people who are exporting to the United States, and I think, through either channel, this suggests at least a slight reduction in the competitive pressures on domestic producers— not big, but a slight reduction. We did have a small uptick in inflation expectations looked at through the markets or the Michigan survey. However, those expectations are still in the range of recent years, and I can recall a number of occasions post-Katrina and in the last few springs in which they have ticked up in similar situations and then come back down again, particularly after energy prices leveled out. None of these signs of higher inflation are very significant in and of themselves or if they were taken one by one; but taken together, they cannot be dismissed. They do suggest at least a small rise in inflation expectations and a small rise in inflation risk that could start pushing up underlying inflation further. That said, the data we have received over the intermeeting period should give us a little more confidence that conditions are being put in place or are in train to limit these risks and to keep the upside risk limited. The trajectory of information over the intermeeting period, especially on consumption and housing, points to quite a bit of moderation of growth in the second quarter. We are looking at 3-point- something, and the issue is what the point-something is; it is not 4-point-something or 5-point-something. Housing market information, I think, confirms that there is a slowdown in process that will restrain aggregate demand going forward. Sales have bounced around a lot, but inventories have risen substantially by any measure. That is going to be weighing on prices. The price data are ambiguous and hard to read. If you take a heroic leap and start seasonally adjusting the existing house prices on a month-by-month basis instead of a twelve-month basis, it looks as though they have been flattening out. But we will get better data later. If, indeed, prices are flattening out, we have not yet really seen that effect on consumption. So in that sense, the tightening of policy and the flattening-out of housing prices are still in the pipeline. Higher long-term interest rates: Some of that increase is an endogenous response to global growth and would require a higher path of short-term rates to keep inflation under control, but some of it is in the risk premium. The extent to which the risk premium has risen will damp demand for any given course of monetary policy. The energy-price increase will contribute to moderating growth of domestic demand, provided that we do not allow that energy-price increase to reduce real interest rates. Like some others here, I am kind of encouraged by the data on labor compensation. They are mixed, but I have interpreted them on balance to suggest that pressures on businesses from labor cost developments are muted. The ECI is certainly consistent with that, and so are four-quarter changes in compensation per hour and unit labor costs. The markup of price over unit labor cost actually increased from a very high level to an even higher level. I agree with President Poole that businesses will not voluntarily give up that markup, but we do have a recent experience if you look in the late ’90s. That markup peaked at the end of ’97, I believe, and dropped very, very sharply in ’98 and ’99, despite the fact that the economy was growing with some vigor. You can see that on page 39 of the Greenbook. So perhaps we need to think about that episode and how it happened. Certainly we have a precedent for vigorous growth and declining markup absorbing rising compensation costs. So where does that leave me overall? I agree with the staff. The most likely outcome—given the structure of interest rates, financial conditions, markets, and a flattening of energy prices—is for stable underlying inflation, core PCE to stay in the neighborhood of 2 percent, where it has been since early 2004. But I am a little more nervous about the stability than I was at the last meeting. Thank you, Mr. Chairman." FOMC20070321meeting--55 53,MR. STOCKTON.," Thank you, Mr. Chairman. On the whole, the staff forecast has survived the economic news and financial events of the past seven weeks reasonably well. Although we revised down our projection for the growth of real activity, we don’t really see the fundamentals of the economy as having changed significantly over the intermeeting period. Indeed, our forecast for the growth of real GDP for 2007 has been fluctuating in the 2 to 2¼ percent range since last August, and this latest revision has only returned us to the lower end of that relatively narrow range. Still, I’ll admit that I’ve been experiencing something like the pangs of a nervous flier. For the most part, my anxieties have been held in check by an economic ride that has proceeded relatively smoothly along the anticipated flight path. But each episode of turbulence seems to trigger the panicked thought that economies, like planes, really do crash from time to time. Don’t worry. I will spare you another episode of self-psychoanalysis [laughter], loosen my grip on the armrests, and concentrate this afternoon on a dispassionate analysis of recent events and their implications for the economic outlook. I must say, we have had some important developments with which to contend— weaker economic data, higher oil prices, problems in subprime mortgage markets, and a drop in equity valuations. Among the weak reports, one that was not a surprise to us was the downward revision in the BEA’s estimate of fourth-quarter GDP. As you will recall, one of the major differences between our January forecast of a 2½ percent increase in fourth-quarter real GDP and the BEA’s advance estimate of a 3½ percent increase was their much higher figure for inventory investment. While I am certain that it was more luck than skill, the incoming inventory data for the fourth quarter were very close to our expectations and far below the BEA’s figures— accounting for a sizable fraction of their downward revision to real GDP. That was important because a central element in our story is that, although some inventory buildups have developed in recent months, production adjustments are occurring promptly enough to prevent the emergence of a full-blown inventory cycle that could cause a period of subpar growth to morph into an economic downturn. Inventory-sales ratios rose noticeably over the second half of last year, as the growth of final demand shifted down. The problems were most apparent in the motor vehicle industry. But aggressive cuts in motor vehicle assemblies in the second half of last year and early this year combined with a reasonably stable pace of sales in the neighborhood of 16½ million units appear to have put this problem largely behind us. Judging by the increases in production scheduled for the second quarter, the automakers seem to share that view. Inventories also backed up in a wide variety of construction-related industries, and substantial cuts in the production of construction supplies occurred in the fourth quarter. But we still see inventory problems lingering here. More recently, some signs of excess stockbuilding have extended beyond motor vehicles and construction supplies, most notably in machinery, electrical equipment, appliances, and furniture. As a consequence, we expect manufacturing output to remain quite tepid in the first half of this year. That forecast seems consistent with the generally lackluster results from national and regional surveys of business activity. Still, we don’t see the current situation as precipitating a cyclical downturn in aggregate activity. I offer that observation with some trepidation. For some reason, I recall past humiliations more vividly than successes, perhaps because they have occurred with much greater frequency. [Laughter] But I recall sitting here in the autumn of 2000 telling President Poole that we did not see a serious inventory overhang in the tech sector. Looking back on that episode, it wasn’t that we weren’t looking carefully enough at the data in hand, rather we were led astray by our failure to anticipate how rapidly final demand for these goods would crumble. If you were inclined to worry on that score, the recent data on final demand might not be encouraging, as we have had more surprises to the downside than the upside. In that regard, one of the most noteworthy areas of downside surprise has been equipment spending. The January figures on orders and shipments for nondefense capital goods were weaker than we had expected, and those readings came on the heels of considerable softness late last year. Demand for high-technology goods seems to have been well maintained, and although transportation investment has been weak, that had largely been expected. The principal surprise has been equipment investment outside high-tech and transportation, which now seems poised to fall about 7 percent at an annual rate this quarter after having fallen about 5 percent in the fourth quarter—both figures well below our earlier expectations. To be perfectly honest, we’re not entirely sure what to make of the magnitude and extent of this softness in capital spending. We don’t think that it is entirely a statistical mirage because we have seen a noticeable weakening in our industrial production measures of business equipment, which for the most part are independent observations. To be sure, much of the slowing has occurred for equipment related to the motor vehicle and construction industries. But just like the inventory data, the recent information on capital spending suggests weakness beyond these two areas. Our best guess is that businesses may have become a bit more cautious and possibly scaled back or put on hold some capital spending plans while they gauge the extent to which the economic landscape may have shifted over the past six months. If so, it may be a while before those concerns fully abate; accordingly, we have marked down our forecast for the growth in real E&S in 2007, to 2¾ percent, from the 5¼ percent pace we were projecting in January. We do, however, expect spending growth to pick back up to a rate of about 5 percent in 2008, only a bit below our previous forecast. We don’t think a more aggressive adjustment—such as the one we highlighted as the business pessimism scenario in the Greenbook—is yet warranted. Financial conditions remain favorable, corporate balance sheets generally look healthy, capital spending surveys have been upbeat, and business sentiment has softened a bit but not seriously sagged. We just don’t see the preconditions for a serious retrenchment in capital spending in coming quarters. In addition to E&S spending, the other major source of downward revision in our projection was housing. Two factors led to the further downward adjustments that we made to our housing forecast. First, the actual data on housing starts and building permits came in below our expectations in January and suggested to us that the pace of activity in coming quarters was likely to be more subdued than we had earlier expected. The data that we received this morning on starts and permits was a mixed bag. Starts of single-family homes rose 10 percent in February, in contrast to the 2 percent increase that we had projected. But adjusted permits, a less noisy indicator of activity, fell 2 percent last month, close to our expectations. Taken together, the February readings have little consequence for our projection. The second factor weighing on our housing forecast was the rapid intensification of problems in the subprime market. In this projection, we made an explicit adjustment to our forecast of sales and starts for what we now expect to be a significant pullback in nonprime originations in the period ahead. As we noted in the Greenbook, we estimate that the easing of lending standards may have elevated nonprime originations by an amount equal to 10 percent of total home sales in 2005 and 7 percent of sales in 2006. We have lowered the level of our forecast of starts and sales a further 3 percent to account for a more abrupt pullback in nonprime originations in the months ahead. This would be roughly consistent with a decline of about 35 percent in nonprime originations this year. In revising this aspect of our forecast, we have assumed that the increase in foreclosures associated with subprime difficulties will have only a small negative effect on overall house prices. We take some comfort from the fact that futures prices on the Case-Shiller house price indexes have edged only slightly lower in the past couple of weeks as this issue gained attention. We have also assumed that there is little spillover from subprime difficulties into the prime portion of the market. We have for some time been assuming that, as newly issued loans seasoned and as rates reset on adjustable-rate mortgages, some gradual deterioration would occur in loan performance, and that is still our view. In sum, the combination of the weaker incoming data and the problems in subprime lending led us to mark down our residential investment forecast enough to take about ¼ percentage point off the growth of real GDP this year. Obviously, this area will require continued scrutiny in the period ahead. Elsewhere in the household sector, consumer spending has been coming in very close to our expectations. Last week’s retail sales report was read by many as weak, but it was right in line with our forecast. To be sure, sales increases have trailed off in recent months, but that pattern is consistent with the marked slowing in consumption growth that we are forecasting for the second quarter. Although the data have been in line with our expectations, the fundamentals for consumer spending have weakened since the January Greenbook. In particular, the trajectory of oil prices is about $5 per barrel above our previous forecast, and this should take a bite out of purchasing power going forward. In addition, we now have equity prices running about 4 percent below our previous projection, which along with slightly weaker house prices, suggests a bit less impetus to spending from wealth. All told, real PCE is expected to increase at an annual rate of 2½ percent this year and next, down about ¼ percentage point from our previous forecast. This might sound like a pretty gloomy report. But there have been some positives, too. Karen will discuss the external sector, which is expected to be a smaller drag on output in this forecast compared with our previous one. Also, fiscal policy, most notably defense spending, seems likely to impart more impetus to growth than we had earlier expected. Moreover, the labor market continues to flash stronger signals than would be expected from an economy in which growth has slowed below the pace of its potential. The unemployment rate fell back to 4.5 percent in February and has been basically trendless since last fall. If payroll employment gains have slowed at all in recent months, they have slowed just a bit. There have been a few developments of late that hint of a slowing in labor demand. Initial claims have averaged a higher level in recent weeks, and insured unemployment has moved up. Moreover, job losers unemployed less than five weeks—a proxy for the layoff rate—have increased, and surveys of hiring plans have turned a bit less positive. We still think a slowdown in labor demand will become more evident in the coming months, but you’ve heard me say that before. In the end, there were more minuses than pluses over this intermeeting period, and we marked down our forecast for the growth of real GDP by ¼ percentage point both this year and next, to 2.1 and 2.3 percent, respectively. But we consider these to be incremental adjustments to a story that remains basically unchanged. Housing is currently exerting a considerable drag on aggregate economic activity. That drag should lessen in the second half of this year, and the pace of expansion should pick up somewhat. However, the reacceleration of activity seems likely to be limited. The slowdown in house prices implies a diminishing impetus from household wealth and the normal multiplier-accelerator consequences of the current hit to home construction should restrain the growth of consumption and business investment. With growth projected to remain below potential, the unemployment rate is expected to drift up to 5.1 percent by the end of next year, a bit above our previous projection. As for inflation, we have had only minor changes in our forecast of its key determinants. As I noted earlier, the path of oil prices is up about $5 per barrel, and this adds about ¼ percentage point to overall PCE inflation this year, boosting our forecast to 2½ percent for 2007 and leaving 2008 unchanged at about 2 percent. The indirect effects of higher oil prices add a few basis points to our forecast of core PCE inflation, but those effects were roughly offset by the slightly larger GDP gap and the slightly higher unemployment rate in this forecast. After the forecast closed last week, we received the CPI and the PPI for February. The core CPI increased 0.2 percent last month, right in line with our projection. However, a jump in the PPI series on physician services suggests that core PCE prices could be up about 0.3 percent in February, a tenth above our forecast. If this estimate is close to the mark, we will revise up our forecast of core PCE inflation in the first quarter to about 2½ percent. We are not inclined, however, to accord much signal to one monthly reading, and for now, we are sticking with our forecast for core PCE inflation of 2¼ percent this year and 2 percent in 2008. One reason for keeping the inflation forecast unchanged despite this news on prices is that we have had some low readings on labor compensation. The ECI and average hourly earnings have come in below our forecast; after we adjust for the transitory influence of a jump in bonuses and stock options, the growth of nonfarm business hourly compensation looks to be running below our previous forecast. Looking at the big picture, pressures on inflation do not appear to us to be intensifying, but they also don’t seem to be abating much either. For the most part, that is what we had been expecting to see at this juncture. I will now turn the floor over to Karen to sum up developments in the other 190 economies of the world. [Laughter]" FinancialCrisisReport--372 Investors contacted by the Subcommittee reported that they had lost all or most of their investments. In June 2008, M&T Bank wrote down the value of its Gemstone 7 securities to about 2% of their original value – from $82 million to $1.87 million. 1487 Wachovia Bank told the Subcommittee that its $40 million investment in Gemstone paid out approximately $3 million from 2007-2010, but is currently worth nothing. 1488 Standard Chartered Bank told the Subcommittee that, in 2008, it liquidated its Gemstone investment and received approximately 25-30% of its initial $224 million investment. 1489 Commerzbank told the Subcommittee that its initial $16 million investment in Gemstone is currently worth nothing. 1490 (6) Other Deutsche Bank CDOs Gemstone 7 was only one of many CDOs that Deutsche Bank assembled and underwrote as the mortgage market deteriorated in 2007. From December 2006 through December 2007, Deutsche Bank issued 15 new CDOs with assets totaling $11.5 billion. 1491 The Subcommittee did not examine these CDOs, but a brief discussion of a few shows that the bank’s issuance of high risk mortgage related assets was not confined to Gemstone 7. Magnetar CDOs. Magnetar is a Chicago based hedge fund that, according to press reports, worked with several financial institutions to create CDOs with riskier assets and then bet on those CDOs to fail. 1492 Deutsche Bank underwrote one of those CDOs and served as trustee for two other Magnetar CDOs. According to press reports, Magnetar’s investment strategy was to purchase the riskiest portion of a CDO – the equity – and, at the same time, to purchase short positions on other tranches of the same CDO. 1493 Thus, Magnetar would receive a large return on the equity if the security did well, but would also receive a substantial payment from its short positions if the securities lost value. This strategy was dubbed by some as the “Magnetar Trade.” It apparently generated large profits for Magnetar. By the end of 2007, when the market was in turmoil, Magnetar’s Constellation Fund was up 76% and its Capital Fund was up 26%. 1494 Mr. Lippmann disapproved of the Magnetar CDOs. 1495 In August 2006, when an investor asked Mr. Lippmann about Magnetar, he responded that it was a “Chicago based hedge 1487 M&T Bank Corporation v. Gemstone CDO VII , (N.Y. Sup.), Complaint (June 16, 2008), DB_PSI_00000027- 79, at ¶ 52. For a list of customers and their allocations of Gemstone 7, see Gemstone VII Summary, DB_PSI_00711305. 1488 11/19/2010, 11/23/2010 emails from counsel of Wachovia to Subcommittee staff. 1489 Subcommittee interview of counsel of Standard Chartered (11/23/2010). 1490 12/7/2010 email from counsel of Commerzbank to Subcommittee staff. 1491 ABS CDOs Issued by DBSI (between 2004 and 2008), PSI-Deutsche_Bank-02-0005-23. 1492 See, e.g., “The Magnetar Trade: How One Hedge Fund Helped Keep the Bubble Going,” ProPublica (4/9/2010), http://www.propublica.org/article/the-magnetar-trade-how-one-hedge-fund-helped-keep-the-housing-bubble-going. 1493 Id. 1494 “Magnetar’s Exit: A Deal So Bad Even a Credit-Rating Agency Balked,” ProPublica (4/9/2010), http://www.propublica.org/article/magnetars-exit-a-deal-so-bad-even-a-credit-rating-agency-balked. 1495 Subcommittee interview of Greg Lippmann (10/18/2010). fund that is buying tons of cdo equity and shorting the single names .… [T]hey are buying equity and shorting the single names … a bit devious.” 1496 CHRG-111hhrg61852--98 Mr. Foster," Thank you, Madam Chairwoman. Just one comment about why businesses are not reexpanding. As a former businessman, when you have gone through layoffs, it is such a searing experience that you will do anything to protect yourself against the possibility of having to repeat that quickly. I think a big part of that is just psychological. And one of the joys of economics is that it is not as predictable as physics. One of the things I wanted to ask your opinions on is part of the balance across the paradox of thrift that we have to get through with consumers is the balance between spending resuming and savings resuming. The numbers that I saw in this book that we just got today from Chairman Bernanke show that actual personal consumption has--consumer spending has now exceeded pre-crisis levels by a small amount for the first time, which I regard as a very good sign, and that similarly the savings has increased. It now just looks like for the last year been averaging some number about 4 to 5 percent, which is significantly above where it was in the bubble years. And I was wondering if you feel that is a reasonable balance point for consumer behavior or whether we are still out of balance, that consumers are spending too much, saving too much. Or is that pretty healthy behavior? Mr. Koo? " FOMC20061025meeting--57 55,MR. BARRON.," Thank you, Mr. Chairman. Data releases and reports we have gathered over the intermeeting period do not indicate much change since the Committee last met, so far as the Sixth District is concerned. Overall growth has been moderate, with the index of District economic activity showing a year-over-year increase of about 2.7 percent, and reports of activity varied considerably among sectors of the District economy. Retail sales have been mixed, and the outlook for tourism is reasonably optimistic. Auto sales remain sluggish, and the housing market—even beyond Florida, where both prices and sales have declined significantly— continues to show additional signs of some slowing. On the positive side, construction is shifting somewhat from residential to commercial. However, the lack of availability and the high cost of home and business insurance in Florida and along the Gulf Coast is a serious concern for our region. Manufacturing activity appears stable. Prices of some commodities are reported lower. Although gasoline prices are lower, fuel surcharges remain in place. As in the national economy, the slowdown in housing and moderation in overall activity have shown little signs of spilling over into the labor market. Employment gains through September softened somewhat. However, all states in the District, except Georgia, added jobs, and together accounted for 20,000 of the nation’s 51,000 jobs added during the month. The overall unemployment rate in the District, accordingly, moved down to 3.9 percent. Shortages of skilled labor continue to be reported in some areas, and overall labor quality, as Tom Hoenig noted, continues to be a problem, both of which I interpret as indicating a relatively firm labor market. We had a meeting this past week of our Advisory Council on Small Business, Agriculture, and Labor. Nearly to a person, participants reported things were good—not great but good—and the common problem was finding qualified workers willing to work. Most council members were willing to hire if they found the right people, but at the same time, they would forgo expanding their businesses if it meant hiring individuals who were less than qualified. One member from the construction sector noted that an individual walking around a job site with a piece of pipe, without doing anything else, would fully meet the requirements for continued employment—that is, they were carrying something, and they were moving. [Laughter] Concerning the national economy, opinions differ as to how much of a slowdown we will see this quarter and how long it will last. Most professional forecasters, as well as our own in-house models, suggest that growth will slow in the third quarter and then gradually accelerate thereafter. On the positive side, the labor market is very healthy. Corporate earnings continue to be healthy, business investment is supportive, and equity markets not only are at record highs but show no signs of letting up. At the same time, our headline inflation has come down, in the most part because of the decline in energy prices. Core inflation, especially in the service price component, continues to drift upward. Further, it’s not clear that the energy price increases have played a major role in explaining the increase in core inflation, so it may be problematic to assume that the recent decline will provide a significant downward impetus to core inflation, at least in the near term. Federal funds futures prices, the TIPS spread, and inflation expectations seem to be saying that the Fed’s credibility remains intact and are consistent with the belief that the Committee will get policy right, rather than signaling that slower growth is ahead in the foreseeable future. Thank you." fcic_final_report_full--174 MORTGAGE FRAUD: “CRIME FACILITATIVE ENVIRONMENTS” New Century—where  of the mortgages were loans with little or no documenta- tion  —was not the only company that ignored concerns about poor loan quality. Across the mortgage industry, with the bubble at its peak, standards had declined, documentation was no longer verified, and warnings from internal audit depart- ments and concerned employees were ignored. These conditions created an environ- ment ripe for fraud. William Black, a former banking regulator who analyzed criminal patterns during the savings and loan crisis, told the Commission that by one estimate, in the mid-s, at least . million loans annually contained “some sort of fraud,” in part because of the large percentage of no-doc loans originated then.  Fraud for housing can entail a borrower’s lying or intentionally omitting informa- tion on a loan application. Fraud for profit typically involves a deception to gain fi- nancially from the sale of a house. Illinois Attorney General Lisa Madigan defines fraud more broadly to include lenders’ “sale of unaffordable or structurally unfair mortgage products to borrowers.”  In  of cases, according to the FBI, fraud involves industry insiders.  For ex- ample, property flipping can involve buyers, real estate agents, appraisers, and com- plicit closing agents. In a “silent second,” the buyer, with the collusion of a loan officer and without the knowledge of the first mortgage lender, disguises the existence of a second mortgage to hide the fact that no down payment has been made. “Straw buy- ers” allow their names and credit scores to be used, for a fee, by buyers who want to conceal their ownership.  In one instance, two women in South Florida were indicted in  for placing ads between  and  in Haitian community newspapers offering assistance with immigration problems; they were accused of then stealing the identities of hun- dreds of people who came for help and using the information to buy properties, take title in their names, and resell at a profit. U.S. Attorney Wilfredo A. Ferrer told the Commission it was “one of the cruelest schemes” he had seen.  Estimates vary on the extent of fraud, as it is seldom investigated unless proper- ties go into foreclosure. Ann Fulmer, vice president of business relations at Inter- thinx, a fraud detection service, told the FCIC that her firm analyzed a large sample of all loans from  to  and found  contained lies or omissions significant enough to rescind the loan or demand a buyback if it had been securi- tized. The firm’s analysis indicated that about  trillion of the loans made during the period were fraudulent. Fulmer further estimated  billion worth of fraudu- lent loans from  to  resulted in foreclosures, leading to losses of  bil- lion for the holders. According to Fulmer, experts in the field—lenders’ quality assurance officers, attorneys who specialize in loan loss mitigation, and white- collar criminologists—say the percentage of transactions involving less significant forms of fraud, such as relatively minor misrepresentations of fact, could reach  of originations.  Such loans could stay comfortably under the radar, because many borrowers made payments on time. FOMC20060920meeting--131 129,MS. PIANALTO.," Thank you, Mr. Chairman. Since our last meeting, I made a special effort to talk with my directors and business contacts about two topics—developments in housing markets and inflation. My District has been growing at a slower pace than most other parts of the country; consequently, housing prices in the District never appreciated as much as those in the hot markets in the country. Nonetheless, a major Realtor in our region told me that houses in his market, which includes the northern half of Ohio and the western half of Pennsylvania, are taking longer to sell and that the average price of houses sold from January to August is down about 2 percent compared with the same period last year. His view is that nationally the housing market still has a way to go before conditions stabilize. Nevertheless, right now he sees only a limited possibility that the adjustment process will cause serious harm to the U.S. economy. Apparently people are not leaving much to chance. I heard a report yesterday morning that sales at religious stores for statues of St. Joseph have been soaring. [Laughter] It seems as though people who are trying to sell their homes are buying statues of St. Joseph because he’s the patron saint of real estate, and they’re burying him next to the “For Sale” sign. Unfortunately, there is no patron saint for central bankers. [Laughter] Some forecasters, like the Greenbook, are expecting strength in the commercial construction sector to offset much of the weakness in residential building. One of my directors, who represents a large national commercial construction firm, has indicated that commercial building in the past few years has been boosted by the growth of health and education sectors. His entire book of business increased 10 percent in real terms this year compared with last, and he is looking to next year to have the book of business increase 3 to 4 percent. However, he is expecting it to be flat in 2008, and his story squares with what I am hearing from bankers as well—namely, that the flow of commercial loans in the pipeline, although not rapidly falling off, is slowing, and it hasn’t been building as it was. The Greenbook baseline captures very well the pattern that I’ve been describing in its projection for nonresidential investment over the next few years. Now, turning to inflation, the two CPI reports that we received during this intermeeting period have not provided me with enough evidence that inflationary pressures have meaningfully diminished. The reports, however, have encouraged me to think that the forward momentum has been broken, but I’d like to see the next few CPI numbers be at least as good as those for July and August, if not better, to be convinced that that momentum has been broken. I’ve heard some hopeful comments regarding inflation in the past few weeks from several of my directors. Just a few months ago they were indicating that elevated energy prices and material prices had provided them with an opportunity to get more-generalized price increases, and they had wondered whether that was going to be a one-time catch-up opportunity or whether it would be persistent. Now it appears to have been a one-time opportunity, which is passing or has passed. Several of my directors reported last week that they have resorted to unbundling their prices to cope with the rising prices of energy and material costs. On their invoices, they are breaking out the price increases that are due to the increased cost of steel, copper, energy, and shipping in order to pass them on. Apparently, their customers are willing to accept price increases that are due to those increased energy and material costs. But the expectation on the part of both buyers and sellers is that, as energy and material costs dissipate, the ability to pass on price increases will be removed. Several of my directors said that they are not planning any price increases for the next year and that they suspect their commodity costs will be lower than they were this year as well. As others have mentioned, there has been some interest in the elevated unit labor costs in the second-quarter productivity and cost reports. As Dave noted, the compensation growth underlying unit labor costs was boosted when the BLS took on board the first-quarter unemployment insurance tax records. There is some suspicion that the dramatic increase in compensation had a lot to do with stock options and incentive pay, but the underlying data are not available yet, so we don’t know for sure. My staff was able to get some summary figures for Ohio. Compensation has been growing steadily in Ohio over the past several years, but the preliminary figures are flat for the first quarter of 2006. However, there was double-digit growth in three sectors—management of companies, finance and insurance, and utilities. These sectors are often the ones that show substantial growth in the first quarters because they pay out stock options and that’s often when those stock options are realized. So at least in my District there is no evidence of any broad-based acceleration in compensation, and I tend to agree with the staff’s view that it’s too early to incorporate those higher unit labor costs into the inflation outlook. At our last meeting, I expressed the opinion that whatever weakness we would see in GDP was more likely to reflect demand factors than supply factors, and therefore I saw risks to both our objectives. The current Greenbook baseline projection for GDP is even lower than it was at the time of our last meeting because of revisions, as Dave mentioned, to both supply and demand factors. I still think that, if the Greenbook projection comes true, softer demand is likely to be the more dominant explanation. Nevertheless, I would like to see further evidence that inflationary pressures have been checked, if not actually reversed, before I would conclude that the risks to our objectives are evenly balanced. Thank you, Mr. Chairman." FOMC20070131meeting--181 179,CHAIRMAN BERNANKE.," Thank you. This was an exceptionally interesting, useful discussion. I thought I would try to summarize what I heard around the table. If you have comments on that, please give them to me, and then I’ll add a few comments of my own. Members noted considerable economic strength during the intermeeting period. Labor markets remain taut, with continuing wage pressures in some occupations. Consumption grew strongly in the fourth quarter, with some momentum into the first quarter, reflecting a strong job market, lower energy prices, and higher profits. Overall, investment seems likely to grow at a moderate pace given good fundamentals. Business people seem generally optimistic, and financial markets are robust. We still have what people have been characterizing as a two-track economy. Housing, although a drag for now, does show some tentative evidence of stabilization. However, some warned about drawing too strong a conclusion about housing during the winter months. Some also noted issues of credit quality. The general view was that housing would cease to subtract from growth later this year. Some softness in parts of manufacturing, especially in industries related to housing and automobiles, still exists. But in part this weakness may be an inventory correction that may be reasonably far advanced at this point. Despite the weakness in housing and some parts of manufacturing, there are yet no signs of spillover into employment or consumption, although some raised the possibility that we may see those later on. Some, but not all, members agree with the contour of the Greenbook that has economic growth somewhat slower in the near term, strengthening later this year, with a modest increase in unemployment. The Committee is generally more optimistic about potential growth than the Greenbook, mostly because the members assume that labor force growth will be greater than the Greenbook assumes. Overall, downside risks to output appear to have moderated, while an upside risk has emerged that growth will not moderate as expected. On the inflation side, people noted that recent readings have been favorable, although there was disagreement about the cause, whether it was energy prices, well-anchored inflation expectations, less structural inertia, or perhaps just statistical noise. Most still expect gradually slowing inflation but are cautious and consider upside risk significant, perhaps even greater than late last year. The primary upside risk to inflation is economic growth above potential in tight labor markets, which may lead to inflation in the future if not in the near term. Others noted that inflation expectations may be too high to allow continued progress against inflation. So overall, the general tone was for a somewhat stronger economy, perhaps a slightly improved outlook on inflation, but, in any case, a clear view that the upside risks to inflation are predominant. Are there any comments? Let me add just a few points. Everything has really been said, but not everyone has said it, as they say. [Laughter] Our goal has been, in some sense, to achieve a soft landing, and the question is whether we have missed the airport. [Laughter] We have seen a good bit of strength in the intermeeting period, and I think the real crux of the issue is what’s going to happen to the labor market. If the labor market continues where it is or strengthens further, we will see both stronger growth, because of the income effects and job effects, and continued pressure on inflation. Again, the central issue will be whether we will see enough cooling in the economy to have a bit of easing in the labor situation. This is, obviously, difficult to say. I do believe that the most likely outcome for the first half of this year is for some moderation in growth, perhaps to modestly below potential. If you look at the various components of spending and production, you note, for example, that personal consumption expenditures are likely to slow from the very high levels we have just seen recently. In particular, a lot of the spending recently was for durable goods, which tend to be more negatively auto-correlated—that is, they tend to drop more quickly when they are high in the short run. We have seen some moderation in investment, in both equipment and structures. Net exports were a major contributor to growth at the end of the year; that should probably reverse, as the Greenbook notes. A special factor there is that the good weather reduced oil imports, which led people to spend on domestic production rather than on foreign production. If that situation reverses and we go back to normal net exports, that will subtract from GDP. Also, the staff noted some likely reversals in government spending. So my sense is that we’re likely to see something a little less hectic in the first half of this current year. I think it also remains reasonable that growth will return close to potential later this year. There is certainly uncertainty about that. Clearly, we have seen some signs of stabilization in the housing market. I was going to note the effects of the winter months and the weather. I think that we should acknowledge that stabilization but not ignore the possibility that we may see further deterioration there. Against the view that growth may moderate this quarter, or next quarter perhaps, there is opposing evidence that consumption and employment are awfully strong. Economists tend to think of consumption, in particular, as being a very forward-looking variable, and it’s consistent with views that we see, for example, in consumer sentiment that people do feel reasonably optimistic about the labor market and about the state of the economy. So I agree that there is certainly some risk that the economy will be stronger going forward than we have been projecting. I don’t have an answer other than to say that we obviously have to monitor the situation very carefully and continue to be willing to reassess our views as the data arrive. Let me say a bit about inflation. Recent readings have been favorable. A couple of aspects of inflation I do find encouraging. First is that the moderation we’ve seen in inflation the past few months has happened despite the lack of any substantial moderation in shelter costs. Owners’ equivalent rents are actually a constructed, imputed variable. They are not seen by anybody. Nevertheless, they are essentially the entire reason that inflation is remaining above our target zone at this point. I know it’s a bit of a joke that I always refer to the short-term inflation numbers, but I’ll do it again anyway. [Laughter] Just to illustrate, over the past three months, core CPI inflation excluding just owners’ equivalent rent was 0.2 percent at an annual rate. Over the past six months, it was 1.20 percent at an annual rate. Over the past twelve months, it was 1.82. We also get numbers for PCE core inflation excluding owners’ equivalent rents that are all below 2 percent. Obviously that is just carving the data, and there are lots of problems with doing that. But to the extent we think that rents will continue to moderate, and I think there is scope for them to do that, that’s one factor that should make us a little more comfortable. Another factor is that there is a fairly broad-based slowing. I won’t take a lot of time to go through the evidence, but particularly in the CPI there are some encouraging developments on the services side in terms of inflation to go along with the slowing in goods prices. Now, I am the first to acknowledge that lots of interpretations of the recent developments are possible. We hope that favorable structural factors are at work. One possibility certainly is that the wage increases are a catch-up for previous productivity gains and that we’re seeing a normal restoration of capital-income/labor-income relationships. In that case, this may be in some sense a transitory adjustment that will restore those relationships and not necessarily contribute to inflation going forward. Another possibility is that energy price effects are somewhat larger than we thought. There seems to be some evidence that they are. A third possibility is that what we saw earlier last year was, as Governor Kohn mentioned, a transitory upside, some of which has simply passed, and we are going back to the more fundamental rate of inflation. So there are some structural reasons that inflation might be moderating. My having said that, we should certainly acknowledge the statistical noise that is inherent in these measures. The monthly standard deviation of core inflation in 2006 was about 8 basis points. If the true underlying inflation is 0.2 percent, then you have a very good chance of getting either 0.3 or 0.1. Therefore, we and the financial markets ought to be braced for the possibility that we will get 0.3—I hope not worse—in the next few months. I agree with the view that has been expressed that the trend has not yet been established, and we’ll have to follow its development. Another very important point that has been raised—President Moskow, I think, was the first to raise it—is that, given the lags from economic activity to inflation that we see in standard impulse-response functions and so on, these improvements may be real but nevertheless temporary and the underlying labor market pressures and so on may lead to inflation problems a year or eighteen months from now. I agree that it is a concern, and it goes back to my point earlier that we need to be very alert to changes in the pattern of aggregate demand going forward. As President Poole mentioned, one element that will help us is the endogeneity of financial conditions. We haven’t done anything since the last meeting, but long-term real interest rates rose about 30 basis points. The yield curve is still inverted by about 30 basis points. So I think even the markets themselves have the ability to raise real rates quite significantly, enough certainly to make a difference in the mortgage market if the data continue to be strong and if inflation does not continue to subside. Then we would have a bit more latitude as we try to determine whether the fourth quarter was a blip or a trend. I think that’s still an open question. So let me just say that I broadly agree with what I heard. The economy does look stronger. That is an upside risk to which we need to be paying close attention. Inflation looks a bit better, at least in the short term, but there are some long-term considerations that we need to keep in mind. Finally, the basic contours of the outlook are not sharply changed, but I agree with the sentiment around the table that upside risk to inflation remains the predominant concern that the Committee should have. Are there comments? Yes, President Poole." FOMC20060920meeting--129 127,MR. HOENIG.," Mr. Chairman, I’d characterize the Tenth District’s economy as quite healthy right now. As you know, the Tenth District has benefited perhaps disproportionately from the rise in energy prices over the past few years, and this is providing considerable stimulus to the local and state economies in the District. We are also seeing strong manufacturing activity driven by exports of District products. Although the housing markets across the District can be characterized as soft, we have no reports of serious declines in prices anywhere in the region. Retail sales, excluding autos, also are holding up pretty well for us. The other soft spot for us is agriculture, and that is tied pretty much to the drought that we continue to experience. Regarding the national economy, the economic information received since the last meeting confirms a further slowing of economic activity this quarter. Moreover, weakness in housing and auto production suggests that the fourth quarter could be a little bit weaker as well. At the same time, we have recently experienced the sizable and largely unexpected declines in energy prices that we have talked about here, which, if maintained, could provide some stimulus over the balance of the year to offset some of that weaker information. Currently, I expect growth to slow to a range of 2 percent to 2½ percent in the second half of the year and to rebound to above 2½ percent or to 3 percent next year. Generally speaking, I am more optimistic than the Greenbook, especially with regard to housing and consumer spending, and I’m not nearly as pessimistic as the Greenbook on potential output. As to housing, we are in fact, as all have noted, squeezing out of that sector the speculative excesses that developed with the low interest rates of recent years—and doing so is unavoidable if we want to correct the sector. The adjustment process has obviously been painful for some, and it has not yet run its course. However, we perhaps see ourselves getting a little closer to the bottom than we might think right now, and that’s related to the fact that credit remains available at reasonable rates for most homebuyers, as suggested by the recent information on mortgage applications. So, yes, it is painful, and yes, we are going through it; but I don’t think it is necessarily long lasting in terms of the consumer’s position. For the consumer more generally, the situation is obviously mixed. On the one hand, consumption will likely receive less stimulus going forward from the withdrawal of home equity, and with slower house-price appreciation, wealth effects will likely be lower as well. On the other hand, higher labor compensation and lower energy bills should provide support to the consumer in terms of confidence and the ability to spend. Overall, I continue to believe that there are somewhat more downside risks than upside risks to the outlook over the next quarters, but I think we are moving in a fairly consistent way as far as GDP growth goes. Finally, let me provide my perspective on the inflation outlook. My overall views on inflation have not changed materially since the last meeting. I continue to expect core PCE inflation to moderate from about 2.3 percent this year to 2.1 percent next year on the course we have right now. The big negative on inflation, of course, is the higher trajectory for labor costs, which has been mentioned. Although the recent revisions to compensation are perhaps somewhat unsettling, such concerns are partly offset by the recent more-favorable monthly inflation numbers and by the significant fall in the prices of oil, gasoline, and natural gas in recent weeks. Although the recent inflation data have not caused me to alter my inflation outlook, I am in one sense more confident in the forecast of moderation than I was a month ago or so. On balance, as we look at all this, I agree that we still have some upside risks to inflation that we have to remain aware of as we look to the policy discussion ahead. Thank you." CHRG-111hhrg56847--201 The Cost of the Financial Crisis: The Impact of the September 2008 Economic Collapse By Phillip Swagel\1\ The United States pulled back from a financial market meltdown and economic collapse in late 2008 and early 2009--but just barely. Not until we came to the edge of catastrophe were decisive actions taken to address problems that had been building in financial markets for years. By then it was too late to avert a severe recession accompanied by massive job losses, skyrocketing unemployment, lower wages, and a growing number of American families at risk of foreclosure and poverty.--------------------------------------------------------------------------- \1\ Phillip L. Swagel is visiting professor at the McDonough School of Business at Georgetown University, and director of the school's Center for Financial Institutions, Policy, and Governance. This paper was prepared for, and initial results were presented at, the March 18, 2010 public event, ``Financial Reform: Too Important to Fail,'' sponsored by the Pew Financial Reform Project.--------------------------------------------------------------------------- This paper quantifies the economic and budgetary costs resulting from the acute stage of the financial crisis reached in September 2008. This is important on its own, but it can be seen as well as giving a rough indication of the potential value of reforms that would help avoid a future crisis. On a budgetary level, the cost of the stage of the crisis reached in mid-September 2008 is the net cost to taxpayers of the policies used to stem the crisis. This includes the programs undertaken as part of the Troubled Assets Relief Program (TARP), as well as steps taken by the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) to guarantee bank liabilities. Actions to support Bear Stearns and the two government-sponsored entities, Fannie Mae and Freddie Mac, were taken before the worst part of the crisis, but their costs continued past September and are considered by many to be part of the fiscal costs of the crisis. The costs of the crisis to society, however, go beyond the direct fiscal impacts to include the effect on incomes, wages, and job creation for the U.S. economy as a whole. The crisis reduced U.S. economic growth and caused a weaker job market and other undesirable outcomes. A key challenge in quantifying such a macroeconomic view of the costs of the financial crisis is to identify the particular effects of the crisis and to separate those impacts from other developments. The broadest perspective would look at the overall changes in the economy from the start of the crisis to the end, and perhaps even include an estimate of the long-run future impacts. Implicit in such a calculation would be a decision to include both the effects of the crisis itself and any offsetting impacts from policy responses such as easier monetary policy or fiscal stimulus. A broad accounting of the costs of the crisis could also include the decline in government revenues resulting from the crisis, enactment of policies such as the 2008 and 2009 stimulus packages, as well as the impacts of regulatory changes that came about in the wake of the crisis. Under such a view, the financial crisis had large and long-lasting impacts on the U.S. economy. The Organisation for Economic Co-operation and Development (OECD), for example, estimates that the financial crisis will lead to a 2.4 percent reduction in long-term U.S. GDP, anticipating that both the reduction in employment and the increased cost of capital resulting from the crisis will last far into the future.\2\--------------------------------------------------------------------------- \2\ OECD, 2010. Going for Growth, Chapter 1, Box 1.1, pp. 18-19, March.--------------------------------------------------------------------------- The approach taken in this paper is narrower: to distinguish and quantify costs incurred so far that are directly related to the crisis and, in particular, to focus on the impact of events from the collapse of Lehman Brothers in the middle of September 2008 through the end of 2009. This is the period in which the grinding slowdown associated with the credit disruption that began in August 2007 turned into a sharp downturn. This approach produces smaller estimates for the cost of the crisis than the broad view, because the calculations quantify the costs of the acute phase of the crisis between September 2008 and the end of 2009, and not the overall impact of events both preceding and following that time period. Both approaches are valuable, and this paper is best seen as a complement to the literature on the overall cost of financial crises. This distinction is revisited in the conclusion. The results in this paper complement economic research by Reinhart and Rogoff (2009) that assesses the broad overall costs of banking crises across countries.\3\ Reinhart and Rogoff find that deep economic downturns ``invariably'' follow in the wake of crises; they quantify the average impact across countries on output, asset prices, the labor market, and government finances. Their results are also discussed below.--------------------------------------------------------------------------- \3\ Carmen M. Reinhart and Kenneth S. Rogoff, 2009. ``The Aftermath of Financial Crises,'' American Economic Review, vol. 99(2), pages 466-72, May.--------------------------------------------------------------------------- The cost of the crisis as measured here includes both the fiscal cost and the effects on economic measures such as output, employment, wages, and wealth. The difficulty in quantifying these economic impacts is to isolate the effects of the most acute stage of the crisis--the severe downturn in consumer and business spending that took place following the failure of Lehman Brothers in September 2008. The U.S. economy was already moving sideways in the first half of 2008 and most forecasters expected slow growth to continue for the balance of the year and into 2009. But the events of the fall and the plunge in economic activity that resulted were unexpected. This paper isolates the impact of the acute phase of the crisis by comparing the Congressional Budget Office (CBO) economic forecast made in September 2008, just before the crisis, with actual outcomes. The approach is to compute the difference between the decline in GDP in late 2008 and 2009 and the forecast published by CBO in its ``Budget and Economic Outlook: An Update,'' published on September 9, 2008--the Tuesday before Lehman filed for bankruptcy on Monday, September 15. The difference between actual GDP in the five quarters from October 2008 to December 2009 and the CBO forecast made just on the cusp of the crisis is taken as the unexpected impact of the crisis on GDP. This GDP impact is then used to calculate the impact of the crisis on other measures, including jobs, wages, and the number of foreclosures. The accuracy of CBO economic forecasts is similar to that of the Blue Chip consensus.\4\--------------------------------------------------------------------------- \4\ Congressional Budget Office, 2006. ``CBO's Economic Forecasting Record,'' November 2006.--------------------------------------------------------------------------- While this approach works to isolate the impacts of events from September 2008 forward, it is necessarily imprecise because it is impossible to know a) how accurate the CBO forecast would have been absent the crisis; b) whether the relationships between growth and other economic variables such as employment changed during the crisis; and c) the impact of other events from September 2008 forward that are not related to the crisis. Moreover, the calculations in the paper start with the fourth quarter of 2008 and thus do not attribute to the crisis any output or jobs that were lost in the two weeks of September immediately following the collapse of Lehman Brothers (these are still counted and appear in the charts below, but not as part of the cost of the post-Lehman crisis). The results in the paper should thus be taken as providing a rough approximation of the impact of the crisis. This is hugely meaningful, however, with American families suffering thousands of dollars of losses in incomes and wages and enormous declines in the value of their assets, including both financial assets, such as stock holdings, and real estate properties, such as family homes. These losses run into the trillions of dollars and on average come to a decline of nearly $66,000 per household in the value of stock holdings and a loss of more than $30,000 per household in the value of real estate wealth (though the inequality in wealth holdings means that the losses will vary considerably across families). These impacts on incomes, jobs, and wealth are all very real effects of the crisis. Finally, the paper looks briefly at broader impacts on society, notably the effect of the crisis in boosting foreclosures and potential impacts on human factors such as poverty. direct costs to taxpayers of financial interventions A host of government interventions were aimed at stabilizing banks and other financial sector firms, ranging from loans from the Federal Reserve to the outright injection of public capital into banks through the Treasury's Troubled Assets Relief Program (TARP). The direct budgetary cost of the crisis is taken to equal the expected net losses of these programs. The fiscal impact of the crisis considered here does not include the lower revenues and increased government spending that followed the crisis. Instead, the focus is on the costs of interventions undertaken in direct response to the acute phase of the crisis that began in September 2008, notably the cost of the TARP and related programs to guarantee bank liabilities put into effect by the Federal Reserve (Fed) and the Federal Deposit Insurance Corporation (FDIC). These costs are tallied in Tables 1 and 2, below. These cost estimates are from the January 2010 CBO estimate of TARP commitments and expected losses, and the February 2010 estimate by the Congressional Oversight Panel of the Fed's commitment to several programs run jointly by the Treasury and the Fed (the table provides references to the sources). The TARP authority was part of the Emergency Economic Stabilization Act of 2008 (EESA) enacted on October 3, 2008; this was used by the Treasury Department for a variety of purposes, including capital injections into banks, guarantees for assets of certain banks, foreclosure relief, support for the AIG insurance company, and subsidies to prevent foreclosures. CBO estimates that $500 billion of the $700 billion capacity of the TARP will end up being used or committed, with programs now in existence having a $73 billion net cost to taxpayers. As shown in Table 1, the TARP was used to support a range of activities, including the purchase of stakes in banks under the capital purchase program (CPP); special assistance to Citigroup, Bank of America, and AIG; support to automotive industry firms; support for programs to boost securitization of new lending through the Term Asset-Backed Securities Loan Facility (TALF) run jointly with the Fed; the Public-Private Investment Partnerships (PPIP) to deal with illiquid ``legacy'' assets such as subprime mortgage-backed securities; and the Home Affordable Program aimed at reducing the number of foreclosures. TARP assistance to banks on the whole is projected to generate a $7 billion profit for taxpayers (even though some banks that received TARP funds have failed or stopped paying dividends to the Treasury). Other programs, notably aid to auto firms, AIG, and homeowners at risk of foreclosure, are projected to result in substantial losses of TARP funds, with an overall net cost of $73 billion. As part of the Congressional budget process, the CBO estimates as well that there could be future uses and losses involving TARP resources, but they would not be directly related to the crisis of September 2008. In addition, the Federal Reserve lent $248 billion as part of TARP-related programs to support AIG and to foster securitization through the TALF. These Fed loans are generally well-secured--indeed, Fed lending related to AIG is now over-collateralized (the TARP having replaced the Fed in the risky aspect of the AIG transaction)--but it is possible in principle that there could be future losses and thus further costs. table 1: direct costs of the tarp ($ billions) Sources: Congressional Budget Office, ``The Budget and Economic Outlook: Fiscal Years 2010 to 2020,'' January 2010, Box 1-2, pp. 12-13, and TARP Congressional Oversight Panel ``February Oversight Report,'' February 10, 2010, pp. 176-177. Treasury commitments and costs or profits are from the Congressional Budget Office; Federal Reserve commitments as of December 31, 2009 are from the Congressional Oversight Panel February 2010 report. The $68 billion reported by the Congressional Oversight Panel represents the amount of AIG-lending extended by the Federal Reserve, but not the net cost of this lending. The Federal Reserve Bank of New York reports that the outstanding balance of Federal Reserve lending related to AIG as of September 30, 2009 totaled $36.7 billion with a fair market value of $39.7 billion for the collateral behind the lending, implying that the lending is overcollateralized on a mark-to-market basis. In effect, resources from the TARP replaced part of the initial Fed lending to AIG, leaving the TARP with losses and the Fed's remaining loans over-collateralized. Table 2 also shows certain direct budgetary costs related to the crisis that commenced before September 2008, notably Federal Reserve lending related to the collapse of Bear Stearns in March 2008, and cost to the Treasury of support for the two housing-related GSEs, Fannie Mae and Freddie Mac. These are not directly the result of the September 2008 stage of the crisis, but are shown since they are closely related to those financial market events. The financial rescue of Fannie Mae and Freddie Mac cost taxpayers $91 billion in fiscal year 2009 (October 2008 to September 2009), according to the Congressional Budget Office, and CBO forecasts a total cost to taxpayers of $157 billion through 2015 (these figures are from Table 3-3 in the CBO January 2010 Budget and Economic Outlook). These costs are related to the broader financial crisis, since the activities of the two firms underpinned parts of the housing market that were at the root of the crisis. There is a sense, however, that these costs were the result of losses that largely predated the events of September 2008--namely losses on mortgages guaranteed by the two firms, and losses on subprime mortgage-backed securities they purchased prior to the failure of Lehman Brothers. While the costs grew as a result of the September 2008 crisis and the subsequent economic collapse, it is likely that much of the losses were built into these firms' balance sheets before September 2008. As shown in Table 2, Fed lending related to Bear Stearns involves a loss of $3 billion on a mark-to-market basis--this is the net of the $29 billion in non-recourse lending from the Fed minus the estimated value of the collateral behind those loans as of September 30, 2009 (the most recent date for which estimates are available). table 2: other financial commitments related to the crisis ($ billions) Sources: FDIC: TARP Congressional Oversight Panel ``February Oversight Report,'' February 10, 2010, pp. 176-177. FDIC Temporary Loan Guarantee Program is the amount of senior bank debt covered by FDIC guarantees. Federal Reserve purchases are from www.federalreserve.gov/monetarypolicy. These figures are total (gross) amounts of liabilities guaranteed by the FDIC and assets purchased by the Federal Reserve; they do not provide the net cost or gain to taxpayers. The FDIC and Federal Reserve programs are all likely to make positive returns. Treasury costs for GSEs are from Congressional Budget Office, ``The Budget and Economic Outlook: Fiscal Years 2010 to 2020,'' January 2010, Box 3-3, p. 52. The Federal Reserve Bank of New York reports a fair market value of $26.1 billion for the collateral behind the $29.2 billion loan balance related to Bear Stearns as of September 30, 2009, implying a $3 billion loss on a mark-to-market basis. Other monetary policy actions undertaken by the Federal Reserve in the fall of 2008, such as programs to support commercial paper markets and money market mutual funds, are not included in this tally. These might well have positive budgetary impacts as the Fed collects interest and fees from users of these liquidity facilities. Similarly, the stimulus packages enacted in early 2008 and early 2009 were both arguably brought about because of the impact of the financial crisis on the economy, but these did not directly address financial sector issues and are not included here. In sum, the direct budget costs from efforts to stabilize the financial system following the events of mid-September 2008 are meaningful--with net costs of $73 billion and hundreds of billions of public dollars deployed or otherwise put at risk of loss. These figures, however, are only a modest part of the cost of the financial crisis. The larger impacts are those that affected the private sector as a result of the significant decline in economic activity that followed the crisis. These are tallied by calculating the impact of the September 2008 financial crisis on output, employment, wages, and wealth. economic costs: lost wages, incomes, jobs, and wealth The U.S. economy was already slowing in the first half of 2008, as the slide in housing prices that began in 2006 and the tightening of credit markets from 2007 both weighed on growth. High oil prices added another headwind in 2008. The economy entered a recession in December 2007; while this was not yet announced when the crisis became acute in mid-September 2008, it was clear that growth would remain subdued even under the best of circumstances while the U.S. economy worked through the challenges of housing, credit, and energy markets. Even so, the financial crisis in September 2008 clearly exacerbated the pre-existing economic slowdown, turning a mild downturn into a deep recession. In effect, the events of September and October 2008 were a severe negative shock to American confidence in the economy, and in the ability of our government and our political system to deal with the crisis. All at once, families and businesses across the United States looked at the crisis and stopped spending--even those who had not yet been directly affected by the mounting credit disruption that started in August 2007 put a hold on their plans. Families stopped spending, while firms stopped hiring and paused investment projects. As a result, the economy plunged, with GDP falling by 5.4 percent and 6.4 percent (at annual rates) in the last quarter of 2008 and the first quarter of 2009--the worst six months for economic growth since 1958. Assessing the economic costs associated with the acute phase of the crisis in September 2008 requires separating the impacts of the events of fall 2008 from the pre-existing economic weakness. While this is not possible to do with precision, one practical approach is to take as a baseline the GDP growth forecast published by the CBO on September 9, 2008--just before the crisis. The difference between actual GDP, and the CBO forecast for GDP in the balance of 2008 and over all of 2009, is then taken to reflect the ``surprise'' impact of the crisis. This is an imperfect measure since there is no reason to expect the CBO forecast to have been completely accurate had it not been for subsequent events such as the collapse of Lehman. With these caveats in mind, the September 2008 CBO forecast remains plausible as a guide for what would have happened absent the financial crisis of September 2008. The CBO forecast 1.5 percent real GDP growth in 2008 as a whole, followed by 1.1 percent growth in 2009. With the first half of the year already recorded, 1.5 percent growth for the year as a whole implies that CBO expected GDP to decline at a 0.25 percent annual rate in the second half of 2008.\5\ That is, CBO expected growth to be weak and even slightly negative in the latter part of 2008 but then pick up in 2009--indeed, the CBO forecast implies quite strong growth by the end of 2009.--------------------------------------------------------------------------- \5\ GDP data for 2008 have been revised since the CBO forecast was made; the implied negative GDP growth of 0.25 percent at an annual rate is computed using the GDP data that were available to the CBO in September 2008.--------------------------------------------------------------------------- Figure 1 plots actual real GDP against GDP as implied by the CBO forecast from September 2008 and the CBO's calculation of potential GDP--the level of GDP that would be consistent with full utilization of resources.\6\ As shown on the chart, GDP plunged at the end of 2008 and into early 2009, falling by 5.4 percent and 6.4 percent in the last quarter of 2008 and the first quarter of 2009, against CBO expectations of a nearly flat profile for output over this period. The difference between the CBO forecast and the actual outcome for GDP comes to a total of $648 billion in 2009 dollars for the five quarters from the beginning of October 2008 to the end of December 2009, equal to an average of $5,800 in lost income for each of the roughly 111 million U.S. households.--------------------------------------------------------------------------- \6\ The CBO forecast uses the growth rates in the September 2008 CBO forecast, adjusting the past levels of GDP for subsequent revisions to GDP data that were known prior to September 2008.--------------------------------------------------------------------------- figure 1: impact of the crisis on economy-wide output Note: GDP as plotted in the chart is in billions of 2005 (real) dollars at a seasonally adjusted annual rate. The dollar figures in the boxes, however, are translated into 2009 dollars. The hit to GDP was matched as well across the economy, with declines in jobs, wages, and wealth. The next step is to translate the unexpected GDP decline into an impact on the labor market. To calculate the impact on employment, a statistical relationship is estimated between percent job growth in a quarter and real GDP growth over the past year. The four-quarter change in output is used to capture the fact that the job market is typically a lagging indicator, responding after some delay to an improving or slowing overall economy. The relationship is estimated as a linear regression for quarterly data from 2000 to 2007, capturing a complete business cycle. This regression provides an empirical relationship between GDP growth and job growth--an analogue of what economists term ``Okun's Law.'' The estimated regression is not a structural model, but an empirical relationship that can be used to back out employment under different GDP growth scenarios. The GDP figures corresponding to the CBO forecast are then used to simulate the level of employment that would have occurred with the CBO forecast made before the September 2008 crisis. Figure 2 shows the impact of the acute stage of the crisis on employment: 5.5 million jobs were lost in the five quarters through the end of 2009 as a result of slower GDP growth compared to what would have been the case under the CBO forecast made in September 2008. Slow growth in the first three quarters of 2008 had left employment 1.8 million jobs lower than potential, and the CBO forecast for continued weak growth in the rest of 2008 and 2009 would have meant job losses until the last quarter of 2009, but at a much more moderate pace than actually occurred. Under the CBO forecast, employment by the end of 2009 would have been 4.0 million lower than with growth at potential, but the additional negative shock to GDP from the crisis knocked off another 5.5 million jobs, leaving employment at the end of 2009 9.5 million jobs lower than the potential of the U.S. economy. figure 2: impact of the crisis on employment Note: Employment in thousands. Figure 3 shows that the GDP hit and job losses correspond to lost wages for American families--a total of $360 billion of lost wages in the five quarters from October 2008 through December 2009 as a result of slower growth following September 2008. This equals $3,250 on average per U.S. household. Wage losses are calculated by taking actual wages with the lower growth and adding back both the wages for the jobs that would have existed with stronger growth and the increased wages per job for all jobs had growth not plunged in the fall and dragged down average wages. The additional wage growth per job is calculated using the trend wage growth before the crisis. figure 3: impact of the crisis on wages Note: Wages in billions of 2009 dollars. The value of families' real estate holdings declined sharply over the crisis as well, with a loss of $5.9 trillion from mid-2007 to March 2009, or a loss of $3.4 trillion from mid-2008 to March 2009. These correspond to wealth losses of more than $52,900 per household in the longer period, or $30,300 per household for the shorter one. The modest rebound in the housing market in the latter part of 2009 has meant that the wealth loss from mid-2008 through the end of 2009 is $1.6 trillion, or $14,200 per household. Unlike the economic variables of output, employment, and wages, the wealth measures are not adjusted for the unexpected impact of the events of September 2008. This is because market-based measures of asset values in principle should already reflect the expectation of slower growth from the perspective of mid-2008. The unexpected plunge in the economy in late 2008 and into 2009 would not be reflected in asset values, however, making these valid measures of the impact of the acute stage of the crisis on household wealth. Figure 4 shows that the financial crisis exacted an immense toll on household wealth. The value of families' equity holdings fell by $10.9 trillion from the middle of 2007 to the end of March 2009--the longest period of decline in the value of stock holdings. This equals a loss of $97,000 per household. Looking at the decline in the value of stock holdings only from the middle of 2008 to the end of March 2009 gives a loss of $7.4 trillion, or about $66,200 per household. The measure of stock market wealth includes both stocks owned directly by families and indirectly through ownership of shares of mutual funds. Data on wealth holdings are from the Federal Reserve's Flow of Funds database and are available quarterly. The wealth declines are thus measured starting from the end of June 2008 since the next quarterly value is for the end of September of that year and thus after the acute stage of the crisis had already begun. Stocks have rebounded over 2009, with the value of household equity holdings at the end of the year back to the same level as at the end of June 2008. figure 4: impact of the crisis on household wealth Note: in billions of dollars. Table 3 summarizes the economic impacts of the acute stage of the crisis that began in September 2008. By all measures, the acute phase of the financial crisis had a severe impact on the U.S. economy, with massive losses of incomes, jobs, wages, and wealth. table 3: economic and fiscal impacts of the crisis the human dimension of the crisis Beyond dollars and cents, the financial crisis had substantial negative impacts on American families both at present and, likely, for decades to come as the hardships faced by children translate into changed lives into the future. The poverty rate, for example, increased from 9.8 percent in 2007 to 10.3 percent in 2008, meaning that an additional 395,000 families fell into poverty. There is not a simple relationship between economic growth and poverty, and poverty data are not yet available for 2009, but the weaker growth that resulted following the events of September 2008 surely sent thousands of additional families into poverty. And the crisis will have attendant consequences for other economic outcomes including the future prospects for employment and wage growth of those facing long spells of unemployment. While it is not possible to count all of the ways in which the crisis affects the United States, a glimpse of the human cost of the crisis can be seen in the number of additional foreclosures started as a result of the severe economic downturn that began in September 2008. Millions of foreclosures were already likely even before the acute part of the crisis--the legacy of the housing bubble of these years was that too many American families got into homes that they did not have the financial wherewithal to afford. For other families, however, a lost job as a result of the severe recession translated into a foreclosure, and this can be estimated using a similar methodology as for the economic variables above. figure 5: impact of the crisis on foreclosure starts With the economy projected to remain weak in the second half of 2008 and into early 2009, and with many people deeply underwater with mortgages far greater than the value of their homes, there would still have been millions of foreclosure proceedings started. But the weaker economy following the acute phase of the crisis worsened the problem, layering the impact of an even weaker economy on top of the already difficult situations faced by many American families on the downside of the housing bubble. conclusion The financial crisis of 2007 to 2010 has had a massive impact on the United States. Millions of American families suffered losses of jobs, incomes, and homes--and the effects of these losses will play out on society for generations to come. This paper quantifies some of these impacts, focusing on the aftermath of September 2008 and attempting to isolate the effects of the crisis from other developments. The result was hundreds of billions of dollars of lost output and lower wages, millions of lost jobs, trillions of dollars of lost wealth, and hundreds of thousands of additional foreclosures. An alternative perspective would be to look at the overall impacts of the crisis from start to finish. This would be a broad view but a less well defined calculation: one could calculate economic impacts, for example, from the start of the housing bubble or from its peak. Or one could seek to exclude the offsetting impact of monetary and fiscal policy measures taken in response to the crisis and attempt to isolate the impact of the crisis alone. These are different (and difficult) calculations to make, but some evidence can be garnered on the broader impacts of the crisis from start to finish. The International Monetary Fund, for example, estimates that U.S. banks will take total writedowns of just over $1 trillion on loans and asset losses from 2007 to 2010, including $654 billion of losses on loans and $371 billion of losses on securitized assets such as mortgage-backed securities. The policy response to the crisis has involved massive fiscal costs, with U.S. public debt up substantially due to lower revenues and higher spending in response to the crisis, and this increase is forecast to continue under current law over the years to come. The declines in output and asset values and increases in U.S. public debt mirror the experience of other countries. As discussed by Reinhart and Rogoff (2009), banking crises across countries lead to an average decline in output of 9 percent, a 7 percentage point increase in the unemployment rate, 50 percent decline in equity prices, 35 percent drop in real home prices, and an average 86 percent increase in public debt. Figure 1 of this analysis provides evidence connecting the results of this paper to this broader literature. One measure of the overall economic impact of the crisis is the output gap between actual and potential GDP. In 2008 and 2009 combined, this gap comes to $1.2 trillion, or $10,500 per household. This is a loss of nearly 5 percent of potential GDP in total over the two years--less than the 9 percent average loss across countries found by Reinhart and Rogoff, but the costs of the crisis calculated in this paper cover only part of the crisis and only through the end of 2009. As shown in Figure 1, GDP looks to remain below potential for years into the future, implying higher overall costs of the crisis. The financial crisis of the past several years has had a massive economic cost for the United States--trillions of dollars of wealth and output foregone, millions of jobs lost, and many hundreds of thousands of families suffering hardship. These costs demonstrate the importance of taking steps to avoid future crises, and the value of reforms that help achieve this goal. " 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." CHRG-110hhrg46593--292 Mr. Feldstein," Thank you, Mr. Chairman, fellow classmate. I am very worried about the U.S. economy. I think this financial crisis and the economic downturn are mutually reinforcing and that, without further action from the Congress, this recession is likely to be longer and more damaging than any that we have seen since the 1930's. The fundamental cause was the underpricing of risk and the creation of excess leverage. But the primary condition that now threatens the economy is the expectation that house prices will continue to decline, leading to more defaults and foreclosures. And those foreclosures put more houses on the market, driving house prices down further. This potential downward spiral reflects the fact that in the United States, unlike every other country in the world, home mortgages are no-recourse loans. If someone stops paying his mortgage, the creditor can take the home but cannot take other assets or look to the individual's income to make up any unpaid balance. This no-recourse feature gives individuals whose mortgages exceed the value of their homes an incentive to default and to rent until house prices stop falling. Because the number of defaults is now rising rapidly and expected to go on increasing, financial institutions cannot value mortgage-backed securities with any confidence. That is what stops interbank lending and lending by financial institutions that cannot judge the value of their own capital. The actions, I think, of the Federal Reserve and the FDIC have done a lot to prevent a runoff of funds from the banks and from the money market mutual funds and to maintain the commercial paper market. In contrast, I believe that the TARP, itself, has not done anything to resolve the basic problem of the financial sector. The Treasury's original plan to buy impaired loans as a way of cleaning the bank's balance sheet simply couldn't work. Even $700 billion is not enough to deal with more than $2 trillion of negative-equity mortgages. The plan to buy impaired assets by reverse auction couldn't work because of the enormous diversity of those securities. And even if the Treasury had succeeded in removing all of the toxic assets from the banks' portfolios, that would have done nothing to stop the flow of new impaired mortgages and the fear of more such toxic assets in the future. It was good that the Treasury abandoned this asset purchase plan. Injecting capital into selected banks is also not a way to resolve the problem and get lending going again. A bank like Citigroup has a balance sheet of $2 trillion. Injecting $25 billion of government capital does not provide a significant amount of loanable funds, nor does it give anyone confidence that Citi would have enough capital to cover any potential losses on its mortgage-backed assets. Although it does raise Citi's Tier 1 capital, that was not a binding constraint. So it was good that the Treasury abandoned the equity-infusion plan, as well. Last week, Secretary Paulson announced that he will now concentrate on propping up credit for student loans, auto loans, and credit cards. He didn't say how that would be done. But doing so will not stop the lack of confidence caused by the expected continuing meltdown of mortgage-backed securities that is driven by the process of defaults and foreclosures. In light of this poor record, the Treasury's announcement yesterday that it will not seek any of the remaining $350 billion of the original $700 billion TARP funding seems to me to be quite appropriate. What needs to be done? Stopping the financial crisis and getting credit flowing again requires ending the spiral of mortgage foreclosures and the expectation of very deep further house price declines. To do that, I think, requires two separate new programs, one for homeowners with positive equity and another for homeowners with negative equity. Here, briefly, is a possible way of dealing with each of these two groups. Consider first the problem of stopping homeowners who have positive equity from falling into negative equity as house prices decline to the pre-bubble level. Earlier this year, I suggested that the government offer all homeowners the opportunity to substitute a loan with a very attractive low interest rate but with full recourse for 20 percent of the homeowner's existing mortgage. This mortgage-replacement loan from the government would establish a firewall so that house prices would have to fall more than 20 percent before someone who now has positive equity would decline into negative equity. The key to preventing further defaults in foreclosures among the current negative-equity homeowners is to shift those mortgages into loans with full recourse, allowing the creditor to take other assets or a fraction of wages if the homeowner defaults, as banks and other creditors do in Canada, in Britain, and, indeed, in every other country in the world. But the offer of a low-interest-rate loan is not enough to induce a homeowner with a substantial negative equity to forego the opportunity to default and, thus, escape his existing debt. Substituting a full-recourse loan requires the inducement of a substantial write-down in the outstanding loan balance. Creditors now do have an incentive to accept some write-down in exchange for the much greater security of a full-recourse loan. The government could bridge the gap between the maximum write-down that the creditor would accept and the minimum write-down that the homeowner requires to give up his current right to walk away from his debt. And I described this plan in some more detail in an op-ed piece in today's Wall Street Journal that is attached to the written testimony. If these two programs are enacted, the financial sector would be stable, and credit would again begin to flow. But while that is a necessary condition for getting the overall economy expanding again, I am afraid it is not sufficient. To achieve economic recovery, the Nation also needs a program of government spending for at least the next 2 years to offset the very large decline in consumer spending and in business investment. To be successful, it must be big, quick, and targeted at increasing production and employment. I am, as you know, a fiscal conservative. I generally oppose increased government spending and increased fiscal deficit. But I am afraid that is now the only way to increase overall national spending and to reverse the country's economic downturn. If these two things are done--that is, stopping the incentive to default on home mortgages and increasing government spending--I will be much more optimistic about the ability of the economy to begin expanding before the end of next year. Thank you, Mr. Chairman. [The prepared statement of Dr. Feldstein can be found on page 173 of the appendix.] " 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. " FOMC20050809meeting--143 141,MR. STERN.," Thank you, Mr. Chairman. The District economy continues to track the national economy quite closely, as it has for a long time. And as I commented at the last meeting, what is striking about the District economy right now is the breadth of the economic expansion. Virtually all sectors are either strong or improving, and I won’t go through a review August 9, 2005 46 of 110 improving employment conditions, wage increases still remain quite modest, as best I can judge. And inflationary pressures haven’t changed, as best I can assess the situation. As far as the national economy is concerned, we’re now almost four years into the current economic expansion and, overall, things look quite good to me. That in a way is remarkable in and of itself, as I think of the conversations we’ve had around this table over the last four years and the variety of concerns and issues that were raised. To be sure, policy has played a role in supporting this economic performance but, as I’ve commented before, I think once again we are observing the fundamental soundness, resilience, and flexibility of the economy. The situation is starting to resemble in broad terms, in my mind at least, the long expansions of the ’80s and ’90s. In fact, without stretching too far, I think one could perhaps make the case that the situation is even a little better than a few years into those expansions. After all, today we have low interest rates, low inflation rates, well-anchored inflationary expectations, for the most part a fairly well-balanced domestic economy, and what I might call a promising international economy. I call it promising not because I’m thinking about Europe or Japan, but because I’m thinking about China and India and some of their smaller brethren. There are some issues, to be sure. One is oil prices, which have already been mentioned today. The federal budget situation is another one, although I think that’s more a secular than a cyclical problem. And then there are housing prices. All I would say there is that even if there is a bubble, and even if it bursts, the quantitative significance of that remains quite unclear, as far as I’m concerned. I do think we need to pay considerable attention, as we have been, to the inflation situation, but my sense of the situation is that there is no significant deterioration under way or August 9, 2005 47 of 110 forecasting inflation. It has worked remarkably well for a good number of years now. [Laughter] Having said that, I do think it’s appropriate to continue with the policy path we’ve been on. That seems, given the way the economy has evolved, fully appropriate to me." FOMC20060920meeting--167 165,MR. KOHN.," Thank you, Mr. Chairman. I’m in favor of maintaining the current stance of policy. I think that is the best chance we have at this juncture for having growth modestly below the growth rate of potential and inflation gradually ebbing. I am not as dissatisfied with that path as maybe some others around the table. After the inflation surprise of earlier this year partly related to an energy shock, a gradual decline in inflation is about as good as we can expect to do, and I do not think that is going to impair our credibility if people see that happening. Now, I admit that that credibility may be built around a slightly higher inflation rate than others want to see. In that regard, I think we are in desperate need of the conversation we want to have at the next meeting about what our targets should be; how we should enunciate them; and once we are away from any target if we do enunciate it, how we should get back. But at this point I do not see any risk to our credibility from something that looks like the path that I expect to happen with keeping policy unchanged for now. Until housing weakens further and begins to spill over into other sectors, the risk to our dual mandate comes primarily on the inflation side. So I am very comfortable with the inflation risk language. I do not think our reference to housing in section 2 undercuts our sense that we are worried about inflation and would act against it. I think it helps explain section 3, which says why we think inflation would moderate. So it does not bother me that much. I am somewhat puzzled by the behavior of financial markets with respect to the expected policy. I am not puzzled so much by the downward tilt. That is roughly consistent with growth below potential and a gradual retreat of inflation and is not all that different from some of the Taylor rule simulations in the Bluebook, including some of those with a 1½ percent inflation target. It is also consistent with the Committee’s past actions judging from the forecast-based rule. But it does not seem to give much weight to the upside inflation risk that we sense or to the Committee’s priority of seeking assurance that inflation is moderating. More perplexing—and I think Vice Chairman Geithner brought this up—is the apparent certainty with which market participants seem to view this expected path; they do not seem to share our uncertainty or at least my uncertainty about the future course of policy. At some point, expected volatilities will rise, and some market participants will suffer losses; but for now the implied path of rates or the low expected volatility is not really impeding our ability to achieve our goals, and I would not attempt to use the announcement to change expectations in markets. I do not think they are so far off that they’re stopping us from getting where we want to go. So I would not favor B+. I would favor the language of B. Thank you." FOMC20070628meeting--197 195,CHAIRMAN BERNANKE.," Thank you. Well, we appear to be in considerable agreement about the policy action. [Laughter] It is a good thing, I guess. Not only are we in agreement, but also the bond market is in agreement. [Laughter] I would just note that, in fact, the bond market is acting as an automatic stabilizer, responding to news, as we have discussed before. I think we are in a very good place, and our forecasting process has served us very well. In that respect, I think this might be an appropriate time to congratulate the staff, including Dave Stockton, Karen Johnson, Vincent Reinhart, and the research directors at the Reserve Banks who are here, for their tremendous contributions to this process, which has really been instrumental in helping us find the right level of policy and in building a lot of credibility in the market. So thank you very much for your outstanding work. With respect to the statement also, I didn’t hear a lot of dissent. First of all, let me say that I think Governor Kohn’s amendments in section 3 are very much to the point— so that would be “a sustained moderation in inflation pressures.” First, the word “pressures” dilutes to some extent the attention to the monthly numbers. Second, as a number of people have said, it is a broader concept, and it can be construed as including some of the headline issues and the oil, commodities, and so on prices that we are concerned about. So I think it is definitely an improvement, and so I would like to recommend it. On section 2, just a couple things. One is that I would hesitate to try to indicate growing strength in the second half, for a couple of reasons. First, at least in terms of the Greenbook, that acceleration is relatively modest—certainly not at all a definite uptick. By continuing to use the language of “moderate pace,” I think we signal that we are not going to take the second quarter as necessarily indicating a new reacceleration of growth. We think that the second quarter represents, at least partly, a transitory increase in the growth rate. Second, Professor Minehan [laughter] was correct about the quality of writing in the section. The last statement began with the term “economic growth.” I am kind of ambivalent about whether or not to do this, but we could say, “Economic growth appears to have been moderate during the first half of this year, despite the ongoing adjustment in the housing sector.”" CHRG-111hhrg54872--295 Mr. Yingling," Congressman, I just want to say I agree with you completely. I think that our industry--I will speak on behalf of the ABA--made a big mistake. We didn't look at this hard enough, we didn't look at it more globally. We looked at it previously on what does it mean for our regulatory burden on banks. And not to justify but to explain it, it is because we have such a heavy burden that we get paranoid about it, sometimes for good reason, but we should have been more aggressive in looking at this bad lending and looking at the trends and seeing what was happening in communities. And we should have worked with you at the State level; we should have worked with the Fed earlier on to say, look, something is wrong here and it is going to blow us up. One of the lessons for the future is we can't just look at what is going on in our narrow interest, but we have to look at what is going on in the economy and in neighborhoods like yours. So your criticism is justified. Going forward, we need to sit down and figure out how to make this work so we do have more focus on consumer protection, so we don't have the bubbles and bad actors that eventually gobble up all of us. And you have our pledge we are going to work with you to help solve this. We do have concerns about how it is done, but we need to make sure we have protections in place. " CHRG-111hhrg51698--160 Mr. Gooch," The insurance companies did historically for a long time sell debt insurance, but it is not a dynamic marketplace. You can get the debt insurance on an entire issue from an insurance company, but you don't have the ability, therefore, to tap additional pools of capital that are willing to effectively be synthetic lenders if you restrict it to just insurance companies. What I would say has occurred, in that respect, is that this is innovation in the marketplace. Throughout history we have had innovation. We had stock market crashes in the 1920s. We had the introduction of futures in the early 1970s. The over-the-counter markets are five times as big as the future markets. This is all innovation that has helped contribute to the prosperity of the free world. That is why I am a free marketeer. Now I do recognize that there is always the time in any free market where you will have certain speculative bubbles. I mean, I do agree with this Committee in looking to bring regulation and transparency to that market. We are totally, 100 percent, in support of transparency and also in order--not order limits but limits on the degree of risk-taking that entities are allowed to take subject to their balance sheets. " FOMC20060629meeting--98 96,MS. MINEHAN.," New England’s economy remains in relatively good shape, though not particularly vibrant or reflective of great strength going forward. Employment growth has been positive but slow in comparison to the nation. New England usually has a lower unemployment rate than the nation does, but for the first time in a decade or so the region’s unemployment rate has converged, mostly because the national rate dropped, but the region has flattened out over the past several months. Local measures of year-over-year inflation are about on track with the nation as well, though growth of local fuel and utility costs is considerably higher. Many business people talk about their efforts to limit their energy costs by upgrading capital equipment and facilities to be more energy efficient and by looking into alternative sources of energy. They also report mild success in passing along increased costs to consumers. Perhaps reflecting this, the rising price of gasoline, or even the consistently rainy weather over the past couple of months, consumer confidence has sagged a good deal. But not all the news is gloomy. Business sentiment, as suggested by surveys and our meetings with our Small Business Advisory Group, remains positive overall as businesses report solid growth and positive hiring plans. Many continue to note how hard it is to find the skilled labor they need. Class A office vacancies have declined in both downtown and suburban markets, and rents are rising a bit. State tax collections, in particular sales and personal income taxes, are exceeding budgets in every state except Rhode Island, which appears to be experiencing an extended, though as yet unexplained, soft spot. In general, I sense a good deal of optimism among my business contacts about their own firms but uncertainty as well when they look at the evolution of both the regional and the national economies. Indeed, both the coincident regional index done by the Philadelphia Fed and the leading index for Massachusetts that’s done by the University of Massachusetts indicate that the regional economy is likely to grow only at a modest pace over the next year or so, buoyed by a resurgence in worldwide demand for high-tech and biotech products but weighed down by subdued consumer spending in the midst of high energy costs and declines in local housing markets. I just want to reflect a bit on regional residential real estate markets. Here various data sources—and there are lots of them—suggest that regional markets have slowed, with sales falling in April and to a lesser degree in May, and unsold inventories continuing to rise, with the number of months’ supply growing from about 8.7 in May of last year to more than 11 in May of this year. However, prices, depending on whether you look at median sales or repeat sales, either have fallen only slightly or have risen at about half the pace they had been rising. Most analysts see this as a soft landing or a period of stabilization after several years of strong price appreciation. Thus, while the local media and many pundits, national as well as local, wring their hands over the potential for major real estate problems, at least up to now the market correction in New England appears to be proceeding in a fairly benign way. Turning to the national scene, incoming data have served to reinforce a sense of risk on both sides of the Greenbook forecast. As I noted earlier, that forecast is not markedly different from our own, so when I talk about risk it will be the risk to our own forecast as well. To some degree, both slower growth and higher inflation were expected in the forecasts that we’ve made over the past six months or so, but recent data may be exceeding those expectations. On the growth side, residential construction has slowed a bit more rapidly than we thought. Consumer confidence has fallen off. Weaker equity markets, higher gas prices, and somewhat lower housing prices have likely affected consumer spending, and recent data on job growth have been slower. But there continue to be a good number of supports to growth. Household wealth remains high. Growth abroad remains solid. Financial conditions outside equity markets are accommodative. Businesses remain highly profitable and cash rich as reflected in the mini-boom in investment in nonresidential structures, and productivity growth remains strong. Indeed, if one averages Q1 and Q2 expected growth, it’s a bit above our earlier forecast, though clearly one needs to be mindful of the fact that the first half started with a bang and its recent momentum has been considerably cooler. Does this recent cooling portend a faster and steeper slowdown for the rest of ’06 than reflected in the current Greenbook forecast or our own? Or could there be enough underlying strength to take us back to the growth scenario of our earlier projections? In particular, I wonder a bit about the slow rate of job growth that is embedded in the Greenbook forecast for 2007. I don’t know what the possibility is of some surprise on the upside to the Greenbook’s current ’06 and, particularly, ’07 projections, but I think there may well be some. The incoming data have been more disquieting on the price front. I’m not a person who believes that a given level of inflation is bad in and of itself, within reason of course. I think it’s important to assess the level of inflation against everything else going on in the economy. So at times a level of 2 percent and change might be fine; at other times it might bear watching. And as far as I know, it’s been hard to prove that specific low levels of inflation—let’s say, below 3 percent—are bad in and of themselves. But I do believe that a rapid increase or decrease in the rate of inflation growth can portend debilitating change in the economy. Such increases or decreases need to be monitored carefully and figure importantly in the policy discussion. Thus, I have viewed the six- and three-month changes in core CPI and PCE with some alarm as the rate of change has been faster than I am comfortable with and certainly faster than our forecast expected. Looking at the first half of this year, and using the Greenbook forecast for Q2, we see that core inflation is nearly 50 basis points higher than what we, in Boston at least, had expected. Our analysis suggests that most of the reason for this surge in inflation over the past couple of years has been higher energy costs. Barring untoward geopolitical events, that should mean that inflation growth will moderate. But given the small to nonexistent output gap we see currently reflected in the low unemployment rate, there is more than a minor risk that resource pressures could begin to play a role in inflationary growth. The Greenbook forecast suggests that slower growth will provide a moderating influence on inflation. That’s our best bet as well, but prudent risk management might suggest some hedging of that bet. Thank you." FOMC20080625meeting--166 164,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. I just want to say at the beginning that I think the way you framed your remarks yesterday had perfect pitch and balance, and it is really important that we not get ahead of ourselves in taking too much comfort from the fact that the first half was not as bad as we thought and think that the risks on the growth front are definitively behind us. The improvement in financial markets that many of you spoke of is not as significant as we think or hope; we have had a lot of false dawns over this period. A lot of what you see as improvement is the simple result of the existence of our facilities in the implied sense that people infer from our actions that we are going to protect people from a level of distress that we probably have no desire, will, or ability to actually do. It is sort of like waking up in the hospital and having them say, ""You are not dead yet, but we are not sure you're going to live."" It is not as good an improvement, and there has been a material erosion over the past four weeks. It is very unlikely that you will have a substantial improvement in overall confidence in markets, a durable improvement in market functioning, and a substantial reduction in those spreads until there is more clarity about the likely path of the economy going forward, house prices in particular, and therefore the cash flows associated with the huge amount of credit that was extended over the past five years. Again, it is going to be very hard for us to have a better feel for the balance of risks on growth front and the financial sector until we think we see signs ahead of some significant deceleration in the rate of decline of housing prices, if not some actual bottom. On the basis of everything we know, that is still several quarters ahead. Maybe it is going to surprise us on the upside and maybe we are going to see a big improvement in housing demand, but I think that the sense of a bottom looks to be several quarters ahead of us still. I would say that the risks are still acute. Sure, the markets are a little more confident that we are going to successfully avoid a systemic financial crisis, but I wouldn't take too much comfort from that. I think it is also plausible that oil will be at $150 or $200 over the next six months or so. There is some material probability that the set of challenges on that front is going to get worse. So all that is just in favor of a fair amount of care and caution now, given the scale of the uncertainty out there and how fat the tail risks are on both sides of our mandate going forward. I like, and fully support, the language in alternative B. I would not--as you might sense from my comments--take out the word ""considerable"" from the characterization of stress. I am pretty comfortable with the framework laid out here, and, more important, Mr. Chairman, with the broad balance and strategy that you outlined yesterday. " FOMC20070131meeting--142 140,MR. LACKER.," Thank you, Mr. Chairman. Economic activity in our District lost a bit of momentum in January. Retail sales contracted in recent weeks as automobile dealers noted waning interest and buyers of big-ticket electronic goods stayed home, perhaps to watch the big screens they purchased during the holidays. [Laughter] Another source of slowing was a further pullback in the factory sector. I should mention new orders in our District slipped in recent weeks, on top of December’s modest contraction, and factory hiring edged lower for the second straight month. On the plus side, services firms continued to report moderate growth in revenues and employment. Despite this mixed picture, however, a wide variety of firms remained optimistic about their prospects six months out. District labor market conditions remained tight, and skilled workers continued to be in strong demand in large metropolitan areas. Businesses tell us that they are pushing up wages as a result. Real estate activity is, on balance, hanging in there. Anecdotal reports indicate fairly firm home sales across many areas in December, and we’re hearing more reports of pockets of strength in some suburban housing markets around D.C., though assessments from other areas continue to be somewhat downbeat. We have also heard that homebuilding activity rose somewhat in a number of District metropolitan areas in recent weeks. Commercial real estate prospects remained relatively bright, with leasing activity firm and a solid number of projects on the books for ’07. Price pressures at District firms seem to have moderated somewhat, confirming the national trends. The national data flow since our last meeting has been encouraging. The Greenbook now predicts a higher trajectory for real GDP. I agree with the Greenbook’s short-term outlook. Declining housing construction is still depressing the real growth rate now, but demand has stabilized, I think, and inventories may be topping out. Each batch of housing data has bolstered my confidence in the trajectory we sketched out last fall—namely, that the drag from housing will mostly disappear by midyear with spillover having been relatively limited. Consumer spending has been quite resilient. Evidently, favorable income prospects have trumped weakening housing prices. The fundamentals for business investment remain favorable with the cost of capital low and profitability high; and the latest news—that unfilled orders for capital goods are continuing to increase—fits in well with the view that equipment investment is likely to be a source of strength going forward. The Greenbook has real growth later this year and into next year returning to trend, driven by strength in business investment and solid consumer spending. I agree with that outlook with the caveat that my estimate of trend growth is higher than the Greenbook’s. The inflation news since the last meeting has been encouraging as well. Core CPI inflation was 1.8 in the fourth quarter, and core PCE inflation was estimated to have been 2.1 percent. It’s tempting to extrapolate this favorable news forward as the Greenbook does and forecast a gradual downward drift without further overt action by the Committee. That outcome is certainly plausible, especially if oil prices cooperate and remain contained within recent trading ranges. But I remain apprehensive. First, core inflation has exhibited fairly substantial high-frequency swings over the past couple of years. So it will take many more months for me to be very confident that inflation is trending down. Second, and related, over the past three years large swings in energy prices have been followed by swings in core inflation with a short lag. Indeed, the cross-correlation between core and energy components of the PCE price index seems to have increased in the past few years. The recent dip in core inflation may therefore be the transitory effect of last summer’s decline in energy prices, and the December uptick in core CPI may signal that it’s behind us now. A downward drift in inflation thus is likely to depend critically on the absence of upward movements in energy prices. Note that the staff follows the futures market in assuming, as I calculated it, a 13 percent rise in oil prices by the end of 2008, which suggests continuing upward pressure on core inflation. Third, expectations could well exert a gravitational pull in an upward direction rather than the downward direction as claimed recently in a popular newsletter and also as the staff indicated underlies their forecast. Personally, I place the center of gravity a little higher, above 2 percent. The twelve-month change in core PCE inflation has been above 2 percent, as we all know, since March 2004, and none of the usual measures of expectations either from surveys or TIPS markets are much below 2½ percent for the CPI. So even though the recent inflation news has been comforting, I think there’s a good reason to continue to worry about it." FOMC20070131meeting--178 176,MR. KROSZNER.," Thank you very much. Well, the data have come in so far according to plan, and you can thank Chairman Bernanke for doing that. I think he has some special relations with the BEA and others. [Laughter] Exactly as we had hoped they would and said they would, the data show moderation in growth with a prospect for accelerating growth through 2007 and moderation in inflation—again, according to plan. I think my views are similar to those that President Stern put forward: The economy has shown an enormous amount of resilience. I want to talk about a few possible puzzles in the way the data have evolved and could perhaps deviate from plan as we go forward. One puzzle is the great strength of the consumer. The consumer has been very, very strong for the past five years, and it seems that no matter what has happened—whether a housing downturn, an equity-market downturn, or a September 11— the consumer has come through rather strongly and continues to be strong. We certainly have had a slowdown in the housing market, and maybe we’re waiting to see its effect on the consumer, as Don Kohn mentioned. But it may just be that some special factors have come in; for example, we have had very strong international economic growth, and perhaps that will persist. When you talk to officials and business people outside the United States, whether in emerging market economies, in the Gulf region, or in industrial economies, they are extremely optimistic, much more so than I have ever before seen, and that may continue. Obviously, there is a risk factor here. The recent strengthening in equity markets perhaps offsets some of the reduction in the asset values of homes. Lower consumer energy prices, of course, have been an offsetting factor, and labor market strength and increases in compensation have been very important. But there’s an upside risk that we will continue to have very, very strong consumption instead of having our error correction go back toward more saving. Second, with respect to investment, we have had orders above shipments for quite some time, but we have had investment actually declining, or at least not growing as we would expect. Overall in this recovery we have had weaker investment growth, and we have had very high profitability. That raises another puzzle for me: Why have we seen somewhat weak investment over the long run and especially more recently, given that most measures of consumer confidence and business confidence have been positive, equity markets seem to be positive, spreads seem to be low, and so forth. Why are we not seeing more investment? Investment may turn around in the next quarter or so, and then we’ll be out of the woods. But I think the conditions that we predict will lead to an investment turnaround have been there for quite some time, and we haven’t seen the investment turnaround; and that is a puzzle to me. Third, with respect to inflation, obviously we are all pleased that the numbers have been coming out with greater moderation. But I have a discomfort about exactly what is driving that moderation. We have good short-term stories about how the slowdown in energy prices in the second and third quarters and some other temporary factors with respect to owners’ equivalent rent could be bringing down inflation. But when we consider a longer period and try to look at the systematic data, we don’t see those kinds of relationships. Are we just in some sort of regime shift? Are those correlations not very good because we just haven’t had a lot of variation in the data over the past ten to twenty years, and so those forces are actually there, but we just find it very difficult to pull them out econometrically? For me that is a puzzle, to be able to tell a short- term story with each of these pieces, but when I go to the staff and ask, “Well, what is the systematic evidence on it?” they say, “Well, it really isn’t there.” That is a bit disturbing for me in trying to figure out where things are likely to go. Things have moved in a benign way. I don’t think there’s a strong expectation that they would move in a nonbenign way. But I don’t have a lot of confidence that I understand why they have moved as they have. So my concern is that various shocks or other factors could come in to move them in a way that is not nearly so benign. Broadly, however, I share the views that most people have expressed around the table that we have good growth prospects going forward and so far reasonable moderation of inflation. But precisely because we have those good growth prospects and because we may have had some temporary factors that have kept down inflation, we have to be ever mindful of the upside risk to inflation." FOMC20060629meeting--77 75,MR. STERN.," Thank you, Mr. Chairman. I continue to think the outlook for the national economy is reasonably positive. As best I can judge, housing activity is slowing largely as expected. The pace of increases of home prices is decelerating. Prices may be declining in some markets, but surely if we had put confidence intervals around our earlier forecasts of housing activity and of price behavior, what we are currently observing would have fallen within those intervals. Other components of aggregate demand look reasonably well maintained to me. In this regard, comments from our directors and from others with whom I have talked indicate that, except for the agricultural sector, persistently high energy prices are having at most a modest negative effect on business activity. Moreover, and equally important in my mind, the respective paths of productivity and of aggregate hours suggest to me that the economy should continue to expand at a respectable pace going forward. To sum up, my forecast of real activity is for slightly more growth than the Greenbook this year, and there is a wider positive divergence between my forecast and the Greenbook forecast for 2007. In this regard, I have tended at these meetings to emphasize the underlying resilience and flexibility of the economy. I still have a lot of confidence in those characteristics, and I think they augur well for the longer-run performance of the economy. But I have been asking myself whether I am too sanguine about this. Is there more to the second-quarter slowing in growth or to persistently high energy prices or to the housing situation—is there more to be concerned about than my previous statements might suggest? My tentative answer to that question is that I think we should not be overly concerned at the moment about the economic outlook in terms of growth for several reasons. As I already suggested, the effects of persistently high energy prices, although not trivial, do not appear to be devastating either. Furthermore, the financial system remains sound and flexible. Interest rates for the most part are still relatively favorable, and those factors should help to sustain demand both from households and from business. I think it is worth recalling that situation at this point; certainly bankers report, at least typically, fierce competition for customers in the current environment. Finally, the low levels of initial claims for unemployment insurance as well as anecdotes, from our District at least, suggest continued expansion in employment. On the price front, however, current circumstances and the outlook do not now appear to me to be favorable. Earlier I had thought that the acceleration in core inflation that we were observing was likely to be similar to the experience in early 2004, when we had an acceleration but it was relatively quickly reversed. But a quick reversal doesn’t look all that likely to me at the moment for several reasons. First of all, as people have already commented, the recent surprises have been on the upside, and in light of that, I have to conclude that there is a bit more underlying momentum to inflation than I earlier thought. I have the sense that other central banks around the world are seeing and responding to the same thing. If this assessment is correct and there is more inflationary momentum, then the bulk of the analytical work that has been done seems to suggest rather strongly that arresting that momentum or reversing it is not going to be easy in the short run. Inflationary expectations apparently have not deteriorated recently, and here I am referring to the past couple of years, but I am not sure I would make the same statement with regard to the path of inflationary expectations relative to the earlier years of this decade. Overall, I have the impression that, on the margin, a little more inflation is both characterizing the economy and being accepted by households and by businesses." fcic_final_report_full--335 COMMISSION CONCLUSIONS ON CHAPTER 17 The Commission concludes that the business model of Fannie Mae and Freddie Mac (the GSEs), as private-sector, publicly traded, profit-making companies with implicit government backing and a public mission, was fundamentally flawed. We find that the risky practices of Fannie Mae—the Commission’s case study in this area—particularly from  on, led to its fall: practices undertaken to meet Wall Street’s expectations for growth, to regain market share, and to ensure generous compensation for its employees. Affordable housing goals imposed by the De- partment of Housing and Urban Development (HUD) did contribute marginally to these practices. The GSEs justified their activities, in part, on the broad and sustained public policy support for homeownership. Risky lending and securiti- zation resulted in significant losses at Fannie Mae, which, combined with its ex- cessive leverage permitted by law, led to the company’s failure. Corporate governance, including risk management, failed at the GSEs in part because of skewed compensation methodologies. The Office of Federal Housing Enterprise Oversight (OFHEO) lacked the authority and capacity to adequately regulate the GSEs. The GSEs exercised considerable political power and were suc- cessfully able to resist legislation and regulatory actions that would have strength- ened oversight of them and restricted their risk-taking activities. In early , the decision by the federal government and the GSEs to increase the GSEs’ mortgage activities and risk to support the collapsing mortgage market was made despite the unsound financial condition of the institutions. While these actions provided support to the mortgage market, they led to increased losses at the GSEs, which were ultimately borne by taxpayers, and reflected the conflicted nature of the GSEs’ dual mandate. GSE mortgage securities essentially maintained their value throughout the crisis and did not contribute to the significant financial firm losses that were cen- tral to the financial crisis. FOMC20060131meeting--110 108,VICE CHAIRMAN GEITHNER.," I’d like the record to show that I think you’re pretty terrific, too. [Laughter] And thinking in terms of probabilities, I think the risk that we decide in the future that you’re even better than we think is higher than the alternative. [Laughter] With that, the economy looks pretty good to us, perhaps a bit better than it did at the last meeting. With the near-term monetary policy path that’s now priced into the markets, we think the economy is likely to grow slightly above trend in ’06 and close to trend in ’07. We expect underlying inflation to follow a path close to current levels before slowing to a rate closer to 1.5 percent for the core PCE sometime out there. Relative to the Greenbook, we’re a little softer on growth in ’06 and a little stronger in ’07, but our inflation outlook is similar. The uncertainty around this forecast still seems considerable, perhaps more than the market has priced in. On the positive side, consumer and business confidence still seems pretty high, with employment growth solid and compensation growth likely to pick up. We think that household income growth is likely to be pretty strong. Investment may be strengthening, and it could surprise us with more strength. The tone of the anecdotal to us seems more positive, less cautious than it has been. And just to cite our Empire survey, the six-month-ahead numbers show a fair amount of optimism. Overall, financial conditions, of course, still seem quite supportive of continued expansion. Global growth has strengthened. And like the staff, the market seems to have looked through the negative surprises in the fourth-quarter numbers and priced in a bit more, rather than less, confidence about the strength of demand growth going forward. On the darker side, we have the familiar concerns about potential adverse shocks, energy supply disruptions, terrorism, et cetera. But even in the absence of these events, we face a fair amount of uncertainty about key elements of the forecast. The prevailing expectation of a gradual moderation in housing prices and a relatively small increase in the saving rate could prove too optimistic. Private investment growth could slow further, productivity growth could disappoint, risk premiums could rise sharply. And, of course, that could happen even in the absence of a major deterioration in the growth or inflation outlook. But this, on balance, still leaves us with what looks like a relatively balanced set of risks around what is still a quite favorable growth forecast. The inflation outlook still merits some concern—I think modest concern—about upside risk. Underlying inflation is still somewhat higher than we would be comfortable with over time. The core indexes are running above levels said to define our preference over time. Other measures of underlying inflation are running above the core rates. The behavior of inflation expectations at longer horizons has been reassuringly stable in the face of the elevated headline numbers, but the levels are still at the higher end of comfort. With the economy near potential, unit labor cost growth should accelerate. And, of course, although profit margins still show ample room to absorb more unit cost increases, their behavior suggests continued pricing power. The strength of global demand, the continued rise in commodity prices, other input costs, and the latest increase in energy prices all suggest a possibility of further upward pressure. With this outlook and this set of risks, we believe some further tightening of monetary policy is necessary with another small move today and a signal that some further tightening is probable. We’re comfortable with how the market’s expectations have evolved over the past few weeks and with the present forecast of perhaps one—maybe slightly more than one—move beyond today. It’s hard, though, to understand why the market attaches so little uncertainty to monetary policy in the second half of the year. And this underscores the fact that one of our communication challenges ahead is to make sure we convey enough uncertainty about our view of the outlook and its implications for monetary policy. In this regard, I want to compliment the recent innovations to the Bluebook presentations and hope that they persist." fcic_final_report_full--493 Lower-income and minority families have made major gains in access to the mortgage market in the 1990s. A variety of reasons have accounted for these gains, including improved housing affordability, enhanced enforcement of the Community Reinvestment Act, more flexible mortgage underwriting , and stepped-up enforcement of the Fair Housing Act. But most industry observers believe that one factor behind these gains has been the improved performance of Fannie Mae and Freddie Mac under HUD’s affordable lending goals. HUD’s recent increases in the goals for 2001-03 will encourage the GSEs to further step up their support for affordable lending . 62 [emphasis supplied] Or this statement in 2004, when HUD was again increasing the affordable housing goals for Fannie and Freddie: Millions of Americans with less than perfect credit or who cannot meet some of the tougher underwriting requirements of the prime market for reasons such as inadequate income documentation, limited downpayment or cash reserves, or the desire to take more cash out in a refinancing than conventional loans allow, rely on subprime lenders for access to mortgage financing. If the GSEs reach deeper into the subprime market, more borrowers will benefit from the advantages that greater stability and standardization create . 63 [emphasis supplied] Or, finally, this statement in a 2005 report commissioned by HUD: More liberal mortgage financing has contributed to the increase in demand for housing. During the 1990s, lenders have been encouraged by HUD and banking regulators to increase lending to low-income and minority households. The Community Reinvestment Act (CRA), Home Mortgage Disclosure Act (HMDA), government-sponsored enterprises (GSE) housing goals and fair lending laws have strongly encouraged mortgage brokers and lenders to market to low-income and minority borrowers. Sometimes these borrowers are higher risk, with blemished credit histories and high debt or simply little savings for a down payment. Lenders have responded with low down payment loan products and automated underwriting, which has allowed them to more carefully determine the risk of the loan. 64 [emphasis supplied] Despite the recent effort by HUD to deny its own role in fostering the growth of subprime and other high risk mortgage lending, there is strong—indeed irrefutable—evidence that, beginning in the early 1990s, HUD led an ultimately successful effort to lower underwriting standards in every area of the mortgage market where HUD had or could obtain influence. With support in congressional legislation, the policy was launched in the Clinton administration and extended almost to the end of the Bush administration. It involved FHA, which was under the direct control of HUD; Fannie Mae and Freddie Mac, which were subject to HUD’s affordable housing regulations; and the mortgage banking industry, which— while not subject to HUD’s legal jurisdiction—apparently agreed to pursue HUD’s 62 63 64 Issue Brief: HUD’s Affordable Housing Goals for Fannie Mae and Freddie Mac, p.5. Final Rule, http://fdsys.gpo.gov/fdsys/pkg/FR-2004-11-02/pdf/04-24101.pdf. HUD PDR, May 2005, HUD Contract C-OPC-21895, Task Order CHI-T0007, “Recent House Price Trends and Homeownership Affordability”, p.85. 489 policies out of fear that they would be brought under the Community Reinvestment Act through legislation. 65 In addition, although not subject to HUD’s jurisdiction, the new tighter CRA regulations that became effective in 1995 led to a process in which community groups could obtain commitments for substantial amounts of CRA-qualifying mortgages and other loans to subprime borrowers when banks were applying for merger approvals. 66 CHRG-110shrg50409--82 Mr. Bernanke," Well, of course, fundamentally the market will do it. The free market will do it. But there are things that we can do. The Federal Reserve has already tried to address, some of the regulatory aspects of high-cost mortgage lending. We and our fellow regulators are also looking at the treatment of mortgages by banks and other lenders in terms of their capital and how they manage that. I think the banks and the private sector themselves are rethinking the standards, the underwriting standards, the loan-to-value ratios, those sorts of things as they go forward. So, I anticipate that we will have a healthy recovery in the housing market once we have gone through this necessary process. But it will probably be less exuberant than we saw earlier with somewhat tougher underwriting standards, more investment due diligence, probably less use of securitization or complex securitized products. But I am confident that, with the appropriate background--I probably include here the GSEs and FHA--the housing market will recover, and it will help be part of the economy's return to growth. Senator Carper. One of my colleagues asked you earlier about the drop in the value of the dollar and asked you quantify that. I will not ask you to do that again. But we have seen the dollar drop, whether it is 20 percent or 30 percent or some other number. We have seen exports, conversely, rise, but yet we have seen a continued loss in manufacturing jobs in this country. I think the last month I noticed maybe 30,000 or 40,000 additional manufacturing jobs had been lost. When do we see that turn around? And what do we need to do to turn it around, the loss of manufacturing jobs, that is? " 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. 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." FOMC20061025meeting--55 53,MR. HOENIG.," Mr. Chairman, I’ll start with the District this time, and I will tell you that conditions in the District remain generally good. Energy activity remains strong, both in the traditional sectors, such as gas, oil, and coal, and in our new sector called ethanol. [Laughter] They are booming, I’m afraid. Despite the recent decline in energy prices, we are not yet hearing, in talking to different producers in the region, about any significant pullback in energy production. In part, this situation reflects a prevailing view right now among those producers that the weakness in energy prices is likely to be temporary. However, if energy prices remain at current levels or move lower at a sustained rate, I think we will then see some pullback in retail activity and so forth—more than we’ve seen so far. In other areas of the District economy, we saw some softening in manufacturing activity in the third quarter, but our manufacturing survey shows that businesses remain mostly optimistic about future hiring and capital expenditure plans. Housing activity has certainly slowed across the District. However, we have received few reports of unusual weakness in our recent meetings with directors and economic advisory council members. So it is slowing but shows no sign of collapse, at this point anyway. We have also seen, with the decline in energy prices, strengthening in District retail sales activity and a sharp rebound in expectations for retail activity in the fourth quarter—except for domestic auto sales. Labor markets remain firm across the District. Unemployment rates are low, and our directors and other contacts continue to report shortages of skilled labor across the District. District agricultural conditions remain rather mixed. Drought continues to affect much of the western part of our region. However, livestock and crop prices have been supported by strong world demand and lower supply, so those farmers who are able to bring in a crop are doing quite well. Turning to the national economy, I think that the recent decline in energy prices will provide important support to the near-term outlook. Currently, I see second-half growth of around 2 percent, rebounding to between 2½ and 3 percent as we get into next year. Generally speaking, I am more optimistic than the Greenbook, both in the near term and for the next year. Indeed, with the current financial conditions that others have talked about, I don’t envision the pullback in consumer spending and business investment spending that the Greenbook has projected at this point. One area that is worth discussion—and Dave talked about it a bit in responding to a question—is the employment outlook, an area for which the Greenbook continues to have, as Dave said, a different perspective. Although demographic forces will clearly work in the direction of slower labor force growth in the coming years, I’m not as convinced that the slowdown will be as sharp or as sudden as the Greenbook suggests right now. I say that because I want to be cautious about viewing the recent slowing in monthly employment growth as being driven by these demographic factors. I believe the recent slowing in employment largely reflects some employer caution about the economic outlook, combined with the effects of weakness in housing and retail sales. Support for this view can be found in the recent slowing of growth in temporary help that has been reported to us. Should the economic growth pick up, as I anticipate, we should begin to see some stronger employment numbers as we get into next year. As to the effects of demographics—again, I think they are going to play a very important part, but another significant factor to keep in mind is the educational composition of the labor force and the skills composition as we move forward in terms of labor demand, because that’s the shortage we’re always hearing about. Now, returning to the near-term outlook, the recent decline in energy prices has helped to counter the effects of housing weaknesses. Consequently, the downside risk to the outlook has diminished somewhat. However, because we have not necessarily seen the bottom of the housing market, I do believe that that is an important downside risk to the economy. Finally, let me share some of my perspective on the inflation outlook. My overall views on inflation have not changed materially since the last meeting. I continue to expect core CPI inflation to moderate from about 2.8 percent to about 2.5 percent next year and, similarly, core PCE inflation to moderate from about 2.3 percent to 2.1 percent. A significant fall in prices for oil and gasoline and natural gas in recent weeks has already begun to show through to overall inflation. I believe this is a positive development in helping to ensure that inflation expectations remain anchored and perhaps in helping to moderate core inflation next year. Although the decline in energy prices has reduced the upside risk to inflation somewhat, I agree with others that core inflation does remain too high, and I think we have to keep that in mind as we consider our policy options. Thank you." FOMC20050322meeting--104 102,MR. LACKER.," Thank you, Mr. Chairman. In recent weeks, we have received evidence of a continuation in the slowing growth in our District that we noted in our Beige Book report. Retail sales, which in the Beige Book were reported as having leveled off, began declining in early March by our indicators. A slump in big-ticket sales has evidently dragged down retail activity in recent weeks. District manufacturing activity continued to expand but at a slower pace than in February. Our March diffusion index, to be released this morning, came in at about neutral, which is down a bit from February. Interestingly, hardly any of our textile and apparel industry contacts are citing the surge in imports from China as an important factor for them. Their reports on shipment trends are fairly evenly split between expanding and declining. We continue to receive reports of substantially higher raw materials prices across an array of industries. The housing market remains quite strong in several areas in our District. Concerns over so- called bubble conditions are widespread among our real estate contacts, especially in Northern Virginia and in coastal areas, although prices seem to have topped out in several high-end coastal March 22, 2005 39 of 116 In banking, the CEO of a community bank operating in North Carolina and the western portion of Virginia said business is as strong as train smoke. Not being very familiar with train smoke, I asked him how strong a reading that represented. He noted about the only thing stronger was battery acid. [Laughter] Turning to the national picture, the economy looks noticeably stronger today than it did at the end of January. The Greenbook now estimates that real GDP grew at 4.3 percent in the fourth quarter of last year, substantially higher than the previously estimated 3.5 percent. First-quarter real GDP growth has been revised up substantially. Expected future real GDP growth is essentially unchanged. And there is little revision to the path of potential output over the forecast period. The slowly improving labor market suggests that the output gap is still on track to continue diminishing in the near future. On the inflation front, unit labor costs continue to be well behaved. The recent spurt in energy and import prices has elevated the overall indexes, but any spillover into the core indexes seems likely to abate. So I’d expect core PCE inflation to return to near 1½ percent after not too long. The Greenbook forecast is conditioned on a path for the fed funds rate 50 basis points higher than in January, a path that nearly matches the market’s expectation over the forecast horizon. All in all, I think this is a good outlook. In my view the most likely risk is that inflation expectations will be driven higher—by a more sustained increase in oil prices, by a sharper depreciation of the dollar, or by a more rapid closing of the output gap than we expect. The most worrisome evidence of rising inflation expectations is the change in market measures of near-term inflation compensation. For example, the TIPS five-year inflation March 22, 2005 40 of 116 third of a percentage point since the last FOMC meeting. We would expect large oil price increases to generate some movement in these compensation measures based on anticipations of pass-through to consumer energy prices. So the recent increase in the five-year TIPS spread may reflect merely a sort of expected arithmetical pipeline of future CPI increases. And, consistent with this, chart 1 of the Bluebook shows that a substantial portion of the increase is attributable to the first year of the five-year horizon and that compensation for years four and five hasn’t moved much. On the other hand, the Bluebook also shows that significant increases have occurred over the intermeeting period in forward inflation compensation two and three years out, and these movements seem hard to rationalize based on the current pipeline effects alone. Of course, these expectations pertain to the headline CPI figure, which is going to be elevated only temporarily above core inflation, I think. Indeed, the Greenbook calls for core CPI inflation to remain anchored at close to 2 percent, and that’s a projection I’m quite comfortable with. All this suggests that inflation expectations, although they have been creeping up, are not yet a problem. We’ll have to adapt our plans, however, if inflation expectations behave in a way that is inconsistent with our intentions. We can start by making sure that our behavior is not exacerbating the problem. The public learned from the minutes of our February meeting that we had deferred specifying a quantitative target range for inflation. That left open the question of how much more inflation we would be willing to tolerate. If we’re not willing to specify a numerical target or upper bound for inflation, then we should find some other way to signal our determination to hold the line on inflation somewhere, preferably before that line is crossed. Thank you. March 22, 2005 41 of 116" fcic_final_report_full--570 Chapter 6 1. Figures represented the compound average growth rate and FCIC staff calculations from CoreLogic National Home Price Index, Single-Family Combined (SCF); CoreLogic Loan Performance HPI August 2010. 2. Inside Mortgage Finance, The 2009 Mortgage Market Statistical Annual, vol. 1, The Primary Market (Bethesda, Md.: Inside Mortgage Finance, 2009), p. 4, “Mortgage Originations by Product.” 3. Federal Reserve Board press release, May 27, 2004. 567 4. Fed Governor Ben S. Bernanke, “The Great Moderation,” remarks at the meetings of the Eastern Economic Association, Washington, D.C., February 20, 2004. See also Olivier Blanchard and John Si- mon, “The Long and Large Decline in U.S. Output Volatility,” Brookings Papers on Economic Activity, no. 1 (2001): 135–64. 5. Fed Governor Ben S. Bernanke, “Deflation: Making Sure ‘It’ Doesn’t Happen Here,” remarks before the National Economists Club, Washington, D.C., November 21, 2002. 6. FCIC staff calculations from Board of Governors of the Federal Reserve System, H.15 Selected In- terest Rate release, 3-month AA Nonfinancial Commercial Paper Rate, WCPN3M (weekly, ending Fri- day); U.S. Department of Treasury, Daily Treasury Yield Curve Rates, 1990 to Present. 7. This example assumes that the homeowner is able to come up with a larger down payment to cover 20% of the higher-priced home. Here, the difference would be about $13,000. 8. Federal Housing Finance Agency, “Data on the Risk Characteristics and Performance of Single- Family Mortgages Originated from 2001 through 2008 and Financed in the Secondary Market” (Septem- ber 13, 2010), Table 2a: Share of Single-Family Mortgages Originated from 2001 through 2008 and Acquired by the Enterprises or Finances with Private-Label MBS by Loan-to-Value Ratio and Borrower FICO Score at Origination, Adjustable-Rate Mortgages, p. 22. Prime borrowers are defined as those whose mortgages are financed by the government-sponsored enterprises. 9. Yuliya Demyanyk and Otto Van Hemert, “Understanding the Subprime Mortgage Crisis” (Decem- ber 5, 2008), table 1: Loan Characteristics at Origination for Different Vintages, p. 7. 10. FCIC staff calculations from CoreLogic/First American, Home Price Index for Single-Family Combined State HPI data, last updated August 2010, and CoreLogic State Home Price Index, provided to the FCIC by CoreLogic. Staff calculations of all annual growth rates are compound annual growth rates from January to January. 11. U.S. Census Bureau, “Housing Vacancies and Homeownership, CPS/HVS,” Table 14: Homeowner- ship Rates for the US 1965 to Present. 12. Brian K. Bucks, Arthur B. Kennickell, and Kevin B. Moore, “Recent Changes in US Family Fi- nances: Evidence from the 2001 and 2004 Survey of Consumer Finances,” Federal Reserve Bulletin (2006): Tables 8A and 8B, pp. A20–A23, A8. 13. Congressional Budget Office, “Housing Wealth and Consumer Spending,” Background Paper, Jan- uary 2007, p. 15. 14. Mortgages may have been refinanced more than once in that year. 15. FCIC staff calculations with updated data provided by Alan Greenspan and James Kennedy, whose data originally appeared in “Sources and Uses of Equity Extracted from Homes,” Finance and Eco- nomics Discussion Series, Federal Reserve Board, 2007-20 (March 2007). 16. CBO, “Housing Wealth and Consumer Spending,” p. 2. 17. Fed Chairman Alan Greenspan, “The Economic Outlook,” prepared testimony before the Joint FinancialCrisisInquiry--57 What a stress test does, it just says don’t tell me that this is unlikely; what if it did happen? But it’s not going—what if it did? What I’ve learned after so many years in the markets is, given enough time, not everything can happen, but everything will happen. And, therefore, implementation of more stress tests. HOLTZ-EAKIN: So you’ve done that as a firm? BLANKFEIN: Yes, constantly. HOLTZ-EAKIN: And are these essentially of the type that we saw the Treasury conduct? BLANKFEIN: No. It’s a little bit different. So you read in the paper, some anxiety over whether the emerging markets are having a bubble. So we look at that—we may read it in the paper, we may feel this swelling up, we may see it in the pricing of some assets. And it’s far on the horizon because, actually, we’re quite positive in our research about emerging. But we said, OK, what if—what are the knock-on effects? What are our exposures to those places? What are our exposure to those places that have exposures to those places? And we go through a process of going around and assembling—OK, assume this happens. And we constantly, through our risk committee are doing those kinds of things which both help us to avoid problems but also tells us what to do if something happened. It won’t be the first time we’ve considered it. HOLTZ-EAKIN: And the stress test process would be audited in the usual fashion? Disclosed? FOMC20080130meeting--194 192,VICE CHAIRMAN GEITHNER.," I'm going to end dark, but it's not all dark. The world still seems likely to be a source of strength. You know, we have the implausible kind of Goldilocks view of the world, which is it's going to be a little slower, taking some of the edge off inflation risk, without being so slow that it's going to amplify downside risks to growth in the United States. That may be too optimistic, but the world still is looking pretty good. Central banks in a lot of places are starting to soften their link to the dollar so that they can get more freedom to direct monetary policy to respond to inflation pressure. That's a good thing. U.S. external imbalances are adjusting at a pace well ahead of expectations. That's all good, I think. As many people pointed out, the fact that we don't have a lot of imbalances outside of housing coming into this slowdown is helpful. There's a little sign of incipient optimism on the productivity outlook or maybe a little less pessimism that we're in a much slower structural productivity growth outlook than before. The market is building an expectation for housing prices that is very, very steep. That could be a source of darkness or strength, but some people are starting to call the bottom ahead, and that's the first time. It has been a long time since we've seen any sense that maybe the turn is ahead. It seems unlikely, but maybe they're right. In the financial markets, I think it is true that there is some sign that the process of repair is starting. We have seen very, very substantial adjustment by the major financial institutions; very, very substantial de-leveraging ahead as the institutions adjust to this much, much greater increase in macroeconomic uncertainty and downside risk; very, very substantial early equity raising by major firms; pretty substantial improvement in market functioning; and easing of liquidity pressure. Those are useful, encouraging things. There is a huge amount of uncertainty about the size and the location of remaining credit losses across the system. But based on what we know, I think it's still true that the capital positions of the major U.S. institutions coming into this look pretty good relative to how they did in the early 1990s. Of course, as many people have said many times, there's a fair amount of money in the world willing and able to come in when investors see prices at sufficiently distressed levels. One more encouraging sign, of course, is that the timing, content, and design of the stimulus package look as though the package will be a modest positive. It could have been a worse balance of lateness and poor design, but I think it looks to be above expectations on both timing and design, and it will help a little on the downside and take out some of the downside risk. Having said that, though, I think it is quite dark still out there. Like everyone else, we have revised down our growth forecast. We expect very little growth, if any, in the first half of the year before policy starts to bring growth back up to potential. The main risk, as has been true since August, is the dangerous self-reinforcing cycle, in which tighter financial conditions hurt confidence and raise recession probability, causing people to behave on the expectation that recession probably is higher, reinforcing the financial headwinds, et cetera. The dominant challenge to policy is still to arrest that dynamic and reduce the probability of the very adverse outcome on the growth side. Of course, we have to do that without risking too much damage to our inflation credibility and too much damage to future incentives and future resource allocation. Like many of you, I think the inflation outlook for the reasons laid out in the Greenbook is better than it was. It's not terrific, but it's better. The risks are probably balanced around the inflation outlook. Our inflation forecast still has core PCE coming down below 2 percent over the forecast period. There's obviously a lot of uncertainty around that, but I really think that you can look at inflation expectations in the markets as somewhat reassuring on the credibility front to date. So again, I think the key question for policy is how low we should get real short-term rates relative to equilibrium, and our best judgment is that we're going to have to get them lower even with another 50 basis points tomorrow. We're still going to need to try to reinforce the signal that we're going to provide an adequate degree of accommodation or insurance against this very dangerous risk of a self-reinforcing cycle in which financial weakness headwinds reinforce the risk of a much deeper and prolonged decline in economic activity. " FOMC20060629meeting--91 89,MR. GUYNN.," Thank you, Mr. Chairman. While recent data show that Sixth District economic activity was solid in the early spring, anecdotal reports for May and June point to some definite deceleration. The deceleration is particularly evident in housing, where an orderly slowing is now noted for the first time in areas outside Florida. Reports from Florida, especially from the hotter markets, of significantly weak single family and multifamily sales have also continued during the intermeeting period. It is especially noteworthy that both residential and nonresidential construction in hurricane-prone areas is now being severely affected by insurance problems. Underwriters are increasingly unwilling to write insurance, and those who will write it are asking for gigantic increases in premiums. Housing prices are not falling quite as much as the decline in sales and the rise in unsold inventories might suggest. We are getting reports that builders are now making concessions and providing upgrades, such as marble countertops and other extras, and in one case even throwing in a free Mini Cooper to sweeten the deal [laughter] rather than reducing prices. So real house prices may be declining more than the data suggest. The insurance problems are affecting existing businesses as well. We are getting reports that premiums for wind damage coverage are more than double, and in some areas we have heard reports of increases substantially larger than that. Some slowing is also evidenced in other areas besides housing. Consumption appears to be less strong than it was in the early spring, with most of the recent deceleration in consumer spending appearing to be focused on lower-end retailers. The most frequently heard explanation is the higher price of gasoline. Manufacturing remains mixed, and for the first time in years, some building-supply producers outside hurricane areas are expecting business to slow in coming months. Price increases continue to be noted at the producer level, especially for construction materials, petroleum products, metals, and fuels—even with the decline in natural gas prices. Firms are raising their final prices as much as they can, given the competitive environment, and fuel surcharges remain in place; but in short, this is more of the same on the price front. Redevelopment from last fall’s major hurricanes along our Gulf Coast region and in New Orleans continues to have important consequences for our region’s economy. In the Lake Charles area of Louisiana, which is the westernmost part of the state, recovery is showing the usual patterns that we’ve seen after other hurricanes over the years. Growth is now slightly above that of last year. Employment led by construction is up about 2 percent over levels a year ago. Parts of the Mississippi coast are on a similar track. The big shipyard in Pascagoula, Mississippi, which suffered more than $1 billion in damages, is back in production and is now employing about 12,000 people, compared with 13,000 before the storm. Other parts of the Mississippi coast are recovering more slowly because of a shortage of housing and the slowness in getting casinos back on line. Employment gains are dependent on the gaming industry, but it looks as though it will be late this year before most of the casinos will be able to reopen. New Orleans is still lagging. The levees have been brought back to pre-Katrina status, but significant rebuilding has not yet begun, and most people who left have not yet returned. The area did add 24,000 jobs from the low point, but this number pales in comparison with the 191,000 jobs that were lost between April 2005 and April 2006. The area will continue to languish until the political and regulatory issues surrounding rebuilding are resolved and federal money begins to flow in significant amounts next year. Finally, with respect to energy, repair to the damaged Gulf Coast region drilling platforms, pipeline, and refineries has progressed, and the shut-in rates in May are now down to 20 percent for oil and about 10 percent for natural gas. With the big Mars platform back fully on line, these shut-in figures should soon show additional improvement. Turning to the national economy, GDP growth has clearly slowed, but it is also beginning to exhibit increased volatility from quarter to quarter that is more characteristic of what we saw in the 1990s rather than the uncharacteristically steady quarter-to-quarter pattern of the past several years. The volatility makes extracting signals about the likely growth path from recent data more difficult, as reflected in the wide error bands around the near-term growth projections provided in the Greenbook. My own forecast for growth in employment submitted for this meeting is slightly more optimistic than that in the Greenbook but is well within the forecast error bands. Of greater concern to me, however, is the inflation outlook. Three issues related to inflation are particularly troublesome. First, core inflation has been outside the range that many of us have publicly stated we would prefer, and some of us have been expressing increased concern about the more recent data. Some of the work my staff has done in attempting to decompose signal from noise in these numbers implies that much of the recent rise in the three-month and six-month CPI that has gotten so much attention is noise. But this implication in no way blunts the fact that even the signal component of inflation has been on an upward trend for a while and that the trend shows little sign of abating. Second, many have noted that the most recent jump in core CPI was driven by an increase in owners’ equivalent rent. Again, work my staff has done decomposing the core CPI, looking back at the period of very low inflation as well as at the more recent period, clearly implies that the recent increase in owners’ equivalent rent should not have been a surprise because the number is driven by the fundamentals of demand for homeownership relative to rental demand. With interest rates so low during the immediate post-recession period, we estimated that the preference shift for new homes relative to rental units accounted for almost half of the 1.6 percent decline that occurred in core CPI during the November 2001 to December 2003 period. Since then, with a rise in our policy interest rate, housing demand has slowed, and demand for rental units has increased with commensurate increases in rents. The point is that this movement in core CPI prices has a lot to do with our own policy shift. Putting the proper measurement debate aside, this raises the difficult question of under what circumstances we should respond to cyclical price movements that are themselves temporary responses to previous policy rate increases. My third and last concern relates to our ability, or perhaps our willingness, in the near term or the medium term to engineer core inflation, however measured, down to the 1 percent to 2 percent range, and the risk that our continued adherence to that much-talked-about, very specific, and very tight objective without more explanation of how we plan to take such a range into account in our policy setting may soon paint us into a difficult policy corner. But I’ll leave further thoughts on that to the policy discussion tomorrow. Thank you, Mr. Chairman." FOMC20051101meeting--140 138,MR. KOHN.," Thank you, Mr. Chairman. Unlike President Geithner, I view the incoming information over the intermeeting period as having mixed implications for what might be required from us to keep inflation in check. On the one hand, demand and output, as he noted, appear to be continuing to grow at a pace that over time is likely to gradually put added pressure on resources. Apparently, the tightening of monetary policy, the rise in energy prices, and the appreciation of the dollar in the first half of the year were not enough to slow growth to trend in the third quarter. And the September employment report and October data on initial claims suggest that the underlying pace of job creation has been maintained going into the fourth quarter. Moreover, demand over the next few quarters, as many of you pointed out, should be boosted by the ramping up of rebuilding efforts. Still, conditions do seem to be in place for a moderation in growth over the intermediate term. Financial conditions have tightened. Interest rates have moved higher; in response the exchange rate has firmed and stock prices have dropped a little. All of the increase since the last meeting was in real interest rates, and most of the rise didn’t seem to be in response to data, but rather to our own speeches, making it unambiguously restraining. In addition, volatilities have backed up a little and risk spreads have widened just a little since the middle of the summer, suggesting that investors are a bit less confident about the future, even if they’re still too confident. Data and anecdotes on housing markets hint at some moderation, and that began even before the recent rise in rates, perhaps as a consequence of the earlier increases in interest rates as well as the elevated level of house prices relative to incomes. Home equity loans at banks actually fell last month, suggesting that equity extraction is no longer so attractive. But as best we can tell, without a November 1, 2005 66 of 114 slowed, while price increases for condos have moderated very little and remain quite high. All in all, we seem to have reached an inflection point in the housing market, fortunately. And house price increases, working through the wealth channel and as an inducement to construction, should be less of a stimulus to demand in the future, though how much and how fast is a very open question. Higher energy prices could take something off of consumption, even after gasoline prices decline in coming months. Natural gas prices will be elevated through the winter heating season. And the negative results of consumer sentiment surveys—which persisted into October, even as gas prices declined—could be suggesting a more marked response than we’ve seen over the past few years of increases. In the staff forecasts these forces slow the economy to a rate of growth slightly below its potential, even with a slight easing of financial conditions as policy firms less than the market has built in. It’s as good a guess as any and better than any forecast I might make. Given the range of uncertainty, however, the important point for us at this meeting is that growth is likely to slow to closer to the rate of growth of potential, but it’s probably going to take at least a couple more policy firmings. The news on prices and costs has been more favorable for the inflation outlook. Core inflation has been damped, despite substantial increases in energy prices before the hurricanes. Because the increases in the prices of petroleum and petroleum products have been large and sustained, they are more likely to show through to core prices than at any time since 1980. But I’m encouraged by the lack of much response so far this year. And energy prices themselves have eased off much more than expected when we last met. Pass-through effects of past increases in energy prices in the staff forecast are magnified and November 1, 2005 67 of 114 results of the Michigan Survey are cautionary, but long-run forward measures of inflation compensation in the market have risen only modestly, and they do remain well below their levels of last year and the early part of this year. I suspect that household inflation expectations will ease back if gasoline prices retreat, as they are expected to. Business labor costs are probably not putting much upward pressure on prices. The trend in ECI compensation continues to be favorable, including wages and salaries increasing at a 2½ percent rate for several quarters now. The lack of upward pressure is especially noteworthy in the face of huge increases in consumer energy costs, and it seems inconsistent with tightness in labor markets that might begin to escalate costs at prevailing levels of resource utilization. And productivity growth in the third quarter was strong, holding down the rise in unit labor costs. In the Greenbook, compensation and core prices accelerate noticeably over coming quarters. In my view, incoming price and compensation data raise the odds that the pickup could be a bit smaller, with inflation settling at a slightly lower level if output follows the Greenbook path. On attitudes, we’ve had competing anecdotes at this meeting. Most of you—I think the majority of you—seem to suggest that businesses are sensing some increased pricing power. That would, if it’s true, support the staff forecast; but it hasn’t shown through in actual prices paid by consumers as of yet. Because the economy seems to have a good deal of forward momentum at a time when resource utilization is high, and because higher energy prices do threaten to feed through to core prices and inflation expectations, we need to continue firming until we have some better indications that conditions are in place to keep inflation restrained. Underlying trends in output and employment will be obscured by the effects of the hurricanes, including the onset of rebuilding efforts, and this circumstance probably amplifies the already November 1, 2005 68 of 114 neutral federal funds rate, will be in reducing the risk of overshooting. They do provide a rough guide that we’re in the neighborhood, but I don’t think they’re a very precise measurement. In that regard, I myself am not uncomfortable retaining the “accommodative” language until we decide we don’t need to tighten anymore. I’ve defined accommodative for my own purposes as too low [laughter]—too low to accomplish my objectives. I think we can mitigate the risk of overshooting in policy by keeping our eyes on the underlying drivers of resource utilization and demand—such as housing prices and household reaction to energy prices, as well as cost pressures and inflation expectations. And I do think the “measured pace” of tightening has been helpful in this regard as well, in contrast to 1994 and 1995 when tightening picked up at the end and I think the risk of overshooting increased. I’m comfortable with tightening again at this meeting and signaling that we do not think we are finished removing accommodation. But just what we should signal about our expectations for the future will require a fresh look at each meeting, and I support the general sentiment that we need to look at our language very, very carefully going forward. Thank you." FOMC20081007confcall--71 69,MR. KROSZNER.," Thank you very much. With the intermeeting move that we had back in January--10 months ago, which now of course seems like 10 years ago--we spoke a lot about the possibility of a regime shift--that there's a growth state and a contraction state and there could be a nonlinear movement between the two. Unfortunately, over the past few weeks we've seen some evidence of that nonlinear shift, both in the real economy and in financial markets. In particular, we're seeing that globally--we are seeing a very, very sharp change internationally in growth prospects, and that's being reflected in the financial markets. One reason that we're seeing some of the problems in the financial markets, as mentioned by a number of participants, is the concern about insufficient capital. Well, one reason for the concerns about insufficient capital and the heightening of those concerns is what losses are going to be faced. Obviously the real economy has to do with how the housing market is going to evolve, which has to do with wealth, which has to do with unemployment, and I think that's part of what's feeding what's going on. That's why I think a significant move now, especially coordinated internationally, could be helpful in trying to reduce some of that macroeconomic tail risk. We are seeing reasonable evidence that we're shifting into a contraction regime, if you will, rather than a growth regime. I think we were fighting hard against that with our earlier rate cuts and with our liquidity facilities. I think we were able to hold that shift at bay for a while. But now we have some evidence that we've moved into this other regime, and I think that is partly what is feeding the problems in the financial markets. That's why it's extremely important that we make this move and make it in a coordinated, international way. As others have also mentioned, we're starting to come close to running out of ammunition. So if we are going to take a shot, we had better make it as powerful as possible. Doing it in an internationally coordinated way is to make it as powerful as possible. So I very much support the actions. " CHRG-111hhrg48867--266 Mr. Silvers," Well, you know, one of my observations from being on the Oversight Panel for TARP, which I think is, sort of, what you are getting at, is that what is a healthy institution can be a puzzling thing. Every recipient, with the exception of AIG, of TARP money has in some respect been designated a healthy institution by the United States Government. So perhaps your question is, well, we are just giving money to healthy institutions already. I am not sure that is a very plausible statement, but it is, more or less, what the record shows. The question of increasing lending, I think, is complex. There is no question that there is a need for more credit in our economy right now. On the other hand, the levels of leverage we had in our economy during the last bubble are not ones we ought to aspire to returning to or sustaining. Getting that balance right is extremely important. And, furthermore, it is also the case, I believe, that allowing very, very large institutions to come apart in a chaotic fashion would be very harmful to our economy. The punch line is I think that we have not learned enough about to what extent TARP's expenditures have produced the increased supply of credit that your question indicates and to what extent that is because of, I think as you put it, the fact that a majority of that money has gone to a group of very large institutions. Those are questions that I know the Oversight Panel is interested in and questions that I am very interested in. I can't tell you what I believe the answer to them to be today. " FOMC20070131meeting--207 205,MR. BARRON.," Thank you, Mr. Chairman. Let me say at the outset that I was truly impressed with your summary of everyone’s comments yesterday. If I had known that you were listening so intently, I might have scrutinized my own comments a little more. [Laughter] Many participants, as you summarized, reported an improved outlook in housing and, perhaps to a lesser extent, an improved outlook for inflation. To play off our immediate past Chairman’s phrase, I think it might be appropriate to guard against what I might call “premature exuberance” on both fronts with regard to the bottoming out of housing and the improvement in inflation. I don’t think we gain much at this point in the business cycle by declaring victory on the housing front, and I didn’t hear anyone say that. But I think we have to be cautious in our comments as it could well prove to be a drag going forward. For the overall economy, my own take is that we have more upside potential than perhaps we have seen so far, putting aside this morning’s report. Corporate balance sheets remain extremely strong. Although I do not anticipate that profits in 2007 will match the levels that we saw in 2006, I see no reason that they would drop below trend, and perhaps they will even come in above trend. With that as a backdrop, the job outlook might even be brighter than we’ve discussed. If the job market remains firm, I would have every reason to believe that the level of participation outlined in the Greenbook might be understated, and so we could well have more positive income effect from the consumer going forward than we’ve witnessed or that we are thinking of for the future. A final point relates to exports. Yesterday evening I looked back over the information we had with regard to the consistency of a high level of performance of all the economies of the world. I couldn’t find a time in which we had all the economies of the world performing at the level they are today. If you take that into consideration and put aside, as Dave so eloquently noted, the special factors that we had in the fourth quarter in exports, we could well see a more positive effect going forward in net exports. On balance, though, I still have a concern that the effect of housing going forward will be a drag. However, I fully anticipate that, at the national level at least, we will be able to bounce back in the second half. If we do bounce back in the second half in housing, then GDP growth could well exceed what we are forecasting now. All of that said, I’m very comfortable with the current stance of policy. I’m not going to try to wordsmith on the fly. My own bias is to be somewhat supportive of alternative B as presented this morning. Thank you." CHRG-111hhrg51698--75 Mr. Buis," Well, thank you, Congressman. I was enthralled by the debate that was going on here, and certainly trying to follow along on those credit default swaps. Things on the farm are not good, and this deregulatory approach, or the lack of oversight by CFTC, has led to it. Farmers thought they were going to get good prices. They were precluded from the market, and Mr. Damgard is right, they ran up against their credit limits. But what they don't tell you is that those markets were going up, not because of market fundamentals, but because of the tremendous amount of Wall Street money that came into those markets. And everyone saw this as a great opportunity to make money. As a result, you gave false hopes to the grain farmers that they were going to get these prices. They were precluded. You gave false hopes or big scares to the livestock industry because they thought the prices were going to continue to go higher and higher, so they locked in feed costs. You gave false hope to the ethanol industry, the biodiesel industry, all the processors that, to hedge themselves, they paid higher prices because the big fear was that it was going to continue. And when the bubble burst, and when commodity prices collapsed, it has virtually impacted every aspect of agriculture. " 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." 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. " CHRG-111shrg61513--13 Mr. Bernanke," Well, currently Senator, inflation looks to be subdued. We are not expecting inflation to rise significantly in the near or medium term. On the one hand, the unemployment and the low use, utilization, the low rate of utilization of labor has been a force keeping wage gains very lower, which, of course, from a worker' perspective is a problem. From the perspective of employers, they are seeing both very slow wage growth and because of all the cuts and cost-cutting measures, they are also seeing very strong increases in productivity, which are quite remarkable. So the combination of slow wage growth and high productivity gains means that the unit labor costs, the costs of production are, if anything, falling for most firms. So that, together with very weak demand in many industries, means that firms have very little ability or incentive to raise prices, which would, of course, tend to moderate inflation. On the deficit, the impact on inflation in the near term I think is limited. Of course, it is important that Congress, the Administration, find solutions to our longer-term debt problems. Otherwise, it is conceivable--and I am not anticipating anything in the near term, but it is conceivable that it could lead to a loss of confidence in aspects of the U.S. economy. It could affect interest rates. It could affect the value of the dollar. And those things could directly or indirectly affect the state of the economy, the recovery, and, of course, the rate of inflation. Senator Johnson. As the Federal Reserve begins to wind down purchases of mortgage-backed securities, what steps, if any, are needed to ensure stability in the housing market during this transition? " FinancialCrisisReport--268 The evidence shows that analysts within Moody’s and S&P were aware of the increasing risks in the mortgage market in the years leading up to the financial crisis, including higher risk mortgage products, increasingly lax lending standards, poor quality loans, unsustainable housing prices, and increasing mortgage fraud. Yet for years, neither credit rating agency heeded warnings – even their own – about the need to adjust their processes to accurately reflect the increasing credit risk. Moody’s and S&P began issuing public warnings about problems in the mortgage market as early as 2003, yet continued to issue inflated ratings for RMBS and CDO securities before abruptly reversing course in July 2007. Moody’s CEO testified before the House Committee on Oversight and Government Reform, for example, that Moody’s had been warning the market continuously since 2003, about the deterioration in lending standards and inflated housing prices. “Beginning in July 2003, we published warnings about the increased risks we saw and took action to adjust our assumptions for the portions of the residential mortgage backed securities (“RMBS”) market that we were asked to rate.” 1036 Both S&P and Moody’s published a number of articles indicating the potential for deterioration in RMBS performance. 1037 For example, in September 2005, S&P published a report entitled, “Who Will Be Left Holding the Bag?” The report contained this strong warning: “It’s a question that comes to mind whenever one price increase after another – say, for ridiculously expensive homes – leaves each succeeding buyer out on the end of a longer 1036 Prepared statement of Raymond W. McDaniel, Moody’s Chairman and Chief Executive Officer, “Credit Rating Agencies and the Financial Crisis,” before the U.S. House of Representatives Committee on Oversight and Government Reform, Cong.Hrg. 110-155 (10/22/2008), at 1 (hereinafter “10/22/2008 McDaniel prepared statement”). 1037 See, e.g., 6/24/2010 supplemental response from S&P to the Subcommittee, Hearing Exhibit 4/23-108 (4/20/2005 Subprime Lenders: Basking in the Glow of A Still-Benign Economy, but Clouds Forming on the Horizon” S&P; 9/13/2005 “Simulated Housing Market Decline Reveals Defaults Only in Lowest-Rated U.S. RMBS Transactions,” S&P; and 1/19/2006 “U.S. RMBS Market Still Robust, But Risks Are Increasing and Growth Drivers Are Softening” S&P). “Housing Market Downturn in Full Swing,” Moody’s Economy.com (10/4/2006); 1/18/2007 “Special Report: Early Defaults Rise in Mortgage Securitization,” Moody’s ; and 9/21/2007 “Special Report: Moody’s Subprime Mortgage Servicer Survey on Loan Modifications,” Moody’s. See 10/22/2008 McDaniel prepared statement at 13-14. In addition, in March 2007 Moody’s warned of the possible effect that downgrades of subprime mortgage backed securities might have on its structured finance CDOs. See 3/2007 “The Impact of Subprime Residential Mortgage-Backed Securities on Moody’s-Rated Structured Finance CDOs: A Preliminary Review,” Moody’s. and longer limb: When the limb finally breaks, who’s going to get hurt? In the red-hot U.S. housing market, that’s no longer a theoretical riddle. Investors are starting to ask which real estate vehicles carry the most risk – and if mortgage defaults surge, who will end up suffering the most.” 1038 FOMC20061025meeting--242 240,CHAIRMAN BERNANKE.," Thank you. Well, thank you all very much for a very useful, very informative discussion. My bottom line is that we have not had a great deal of information in the past five weeks on which to base a sharp change either in policy or in this statement. Therefore, I would propose that we make no change in the federal funds rate target today. Many of the issues that were raised yesterday were in some sense prospective. Will the housing market decline further or stabilize? Will labor markets strengthen or weaken? Will growth slow or return to potential? Over the next six or seven weeks, until the next meeting, we’ll be seeing the employment cost index, the third-quarter GDP, two employment reports, and a raft of data on housing prices and other key indicators. So I think it would be sensible to think very hard in December about whether a course adjustment is necessitated both in terms of policy and in terms of the statement. I would just say that Governor Warsh’s comment about the markets was one that I’ve thought about myself. If the markets disagree with you, do you try to persuade them or not? I think the ideal thing is, again, to convey strongly what our views are—in particular, both our objective function and our outlook—but in general not to try to directly influence the position of the yield curve because doing so makes us lose an important source of information about the economy. However, in the intermeeting period we can continue with our verbal tightening in the sense that we can emphasize our ongoing concern about inflation and the pace of change in inflation, and we can convey, those of you who believe this, that the risks to lower growth seem to have been at least somewhat moderated. With respect to the language, I’ve been trying to keep track here, [laughter] but I think I have a clear majority in the third section to strike “and of the prices of energy and other commodities.” I heard no disagreement there. The Kohn amendment seems to have a majority. Governor Warsh raised some of the issues that I thought about in trying to distinguish the third quarter from the fourth quarter. I guess I’m okay with Governor Kohn’s suggestion. Is there anyone who would like to re-enter this discussion after hearing the whole thing? If not, I take the general thrust to be in favor of making that change." FOMC20060629meeting--93 91,MR. STONE.," Thank you, Mr. Chairman. Economic activity in the Third District is also moderating in the second quarter. Our pattern is similar to that of the nation, but the District had less acceleration in the first quarter and less deceleration in the second quarter. Payroll employment growth in our three states is slowing. The unemployment rate has edged up slightly over the past several months, but the unemployment rate in most of the District’s labor markets is still lower than a year ago. Our business contacts still report some difficulty in filling open positions, and a quarter of the respondents to a special question in our Business Outlook Survey of Manufacturers say that the increases in wage rates needed to attract new hires this year are higher than they were last year. Regional manufacturing activity continues to expand at a moderate pace, but the indexes for new orders and shipments were up noticeably after a one-month slump in May. Despite this improvement, our manufacturers’ expectations about future activity have deteriorated. While they still plan to add to payrolls and expand capacity over the next six months, they have moderated these plans since the beginning of the year. At the last meeting, I reported that, in contrast to other Districts, retailers in our region did not express much concern that higher gasoline prices would eat into their sales; that view has changed. Conditions in our construction sector are similar to what I reported at our last meeting. Nonresidential construction continues to strengthen, but the acceleration doesn’t appear to be as strong as elsewhere in the nation. In contrast, residential construction in our three states has been flat this year, and home sales are down. Thus far the slowing in our region looks to be an orderly process. Unfortunately, consumer prices in the Philadelphia region appear to be increasing at a faster pace than those in the nation as a whole, primarily because of a larger increase in housing costs in the Philadelphia metropolitan area than in the nation. In addition, our manufacturers report that industrial price pressures have increased in recent months. Fortunately, we do not see a similar acceleration in labor costs, although the increases we are seeing in the Northeast are somewhat higher than in other parts in the country. In summary, current conditions and the outlook in our region continue to be positive, but the rate of expansion is expected to be somewhat more modest than we’ve seen over the past year. Price pressures continue to be a concern in our region. Turning to the national front, I would characterize the outlook in a similar way. Our growth forecast is similar to the Greenbook’s for 2006. We expect a significant slowing in activity in the second quarter followed by a pickup during the second half of the year to a pace that is slightly below potential. The slowdown in housing and high gasoline prices contribute to a slowdown in consumer spending, and the lagged effects of rising short-term interest rates and higher oil prices keep real growth slightly below potential. Our forecast for 2007 differs somewhat from the Greenbook. We see growth in 2007 slightly below that in 2006, whereas the Greenbook sees growth slowing appreciably. In our view, there has been more underlying strength in the economy. For example, we attribute more of the second-quarter slowdown to temporary factors. We are more optimistic than the Greenbook about employment growth. We see nonfarm payroll growth averaging a good deal more than the Greenbook forecast. We see unemployment rising to 5.1 percent by the fourth quarter of next year. Our inflation outlook is less optimistic than the Greenbook’s partly because we see less slowing of aggregate demand. We do not see core PCE inflation decelerating next year. We think the economy has been operating and will continue to operate slightly beyond full employment over the next several quarters and that foreign price competition will ease as the dollar depreciates. So despite our view that the indirect effects of the sharp rise in energy prices will wane in 2007, we expect core inflation not to decelerate. We do see some deceleration in 2008, but that is because we built in a slightly higher path for interest rates than that in the Greenbook forecast. Of course, there are risks to the forecast. Most of them have been mentioned; but in our view, the risks to growth, even at our higher level of growth, are roughly balanced. In contrast, the inflation risks are slightly to the upside. As people have noted, core inflation has accelerated in recent months, and it is above the range I consider consistent with price stability. Should aggregate demand moderate less than expected, there is a risk that strong inflation pressures could emerge. At this point, I believe that longer-run inflation expectations remain anchored, and our forecast is predicated on monetary policy ensuring that the recent high inflation readings do not raise longer-term expectations. This is likely my last meeting, but for sure I’ll be watching carefully as we go forward. I have confidence that the Committee, along with the new Philadelphia president, will do a good job to make sure that inflation expectations remain anchored. I’d like to thank the Chairman, the participants, and the rest of this staff for how well you have treated me over the past three meetings. I have to remember that I made the statement in June 2000 that it would be my last meeting, so I say “in the foreseeable future” [laughter] it will be my last meeting. Thank you very much." FOMC20061212meeting--103 101,MR. KROSZNER.," Last time several of us noted that there would be an avalanche of data between the last meeting and this one [laughter]—two employment reports, two rounds of ISM, GDP, ECI, compensation revisions, all of that. But it seems from the discussion here that we’ve actually gotten very little new information, with one exception, and that relates to Dave Stockton. We heard that not long ago he was on the psychiatrist’s couch dealing with a schizophrenia issue of whether the economy is going up or going down. But now we know that he is on his death bed. [Laughter] I hope this does not bode ill for the economy going forward, but I did want to note that one very important change, Mr. Chairman. We’ve had the same discussion of a two-tiered economy, with housing and autos being slower and the rest of the economy moving forward, and continuing concerns about the risk of spillovers; but the central tendency seems to be that we’ll be moving ahead perhaps a little below potential, with some reasonable chance of getting back to something closer to potential by the end of next year. Continuing the discussions of labor market tightness and some concerns about shortages in certain areas, I think that we certainly have seen some softness in construction, but that’s an area for which we’ve probably underestimated employment growth and perhaps employment falloff because, as I think many of us know, many of the subcontractors in residential as well as nonresidential housing have a lot of undocumented workers, and they tend to be undercounted both on the upside and on the downside. So there may be a little more softness in the labor market than we’re seeing, at least in the construction sector; however, in the higher-skilled sectors, we’re seeing continued tightness. Consumer spending continues to be strong. There has been just an amazing persistence of consumer spending, no matter what has happened over the past five years. Whether the stock market has crashed, whether the housing market has boomed, whether we’ve had September 11, or whether we’ve had concerns about spillover effects, the consumer seems to have been very, very persistent, and it seems as though that’s the case now. We’ve talked about challenges in the energy markets, and we did see a little slowing. Energy prices were higher, and energy prices are lower, but these aspects of the macroeconomy seem still to have little effect on consumer spending. We continue to have concerns about some upside risks to inflation. So I’ll just mention quickly a few issues and then talk about some international issues that Dino and Tim touched on earlier. Regarding housing, we know we have terrible price data, but it seems as though there’s a little more flexibility and nimbleness in the housing market than there was in the past. So the past data on housing may not be too useful. Although we know we don’t get good data on effective prices, we do seem to be seeing more evidence that people, rather than just holding things on the market longer, are providing the marble bathroom, the Lexus, the Hyundai, the Kia, the Yugo, or whatever they’re providing. In New Jersey, where I grew up, it would be a Yugo. [Laughter] So I think there’s more flexibility on that side. Also, because of the way the housing market has developed, a lot of residential construction is no longer at just the local level. The large national builders are better diversified and, as has been discussed, have options on land, and then, if they see the market turning down, they give up those options. So they have a much greater ability to shift both down and up in production much more quickly. Prices, too, are a little more flexible, which is one reason that we’ve seen a sharper correction in the housing market. But that flexibility, with the recent data indicating that certain things may be flattening out, may mean that, though the correction may have been sharper, it won’t necessarily persist— that the correction has occurred in a shorter time, rather than being dragged out longer and having more potential for negative spillover, confidence effects, and so forth. Well, what has changed? As Governor Kohn mentioned, inventory accumulation is a bit of concern: It seems to be ticking up. It always seems a bit odd when a positive effect on GDP results from businesses being unable to sell the things that they’ve purchased. That doesn’t strike me as necessarily a positive thing for a GDP report. We’ve gotten some more, probably confusing, numbers on productivity. Is productivity slowing or not? We are getting some data that may be suggesting that it is, although I would agree with Dave and the staff that it’s much too early to say. I think the evidence both anecdotally, as a number of people have mentioned, and more broadly is that productivity is likely to continue to go forward. Another thing that changed, as Dino and others discussed, was the yield curve. But this phenomenon is very much an international one. Long rates have come down more—since the last meeting, they have fallen a fair amount and not just in the United States. The three-month versus the ten-year in Europe has fallen about 40 basis points, so the spread is about 7 basis points now. On average, since the euro has been around, it has been about 40 to 50 basis points. In the United Kingdom, which tends on average to have very flat yield curves, the inversion has steepened about 25 basis points to 65 basis points. Japan is little changed, but Japan is sui generis. Emerging markets have also seen this. In Mexico, for example, the ten-year versus the three-month has dropped about 60 basis points. Clearly, this is not just a U.S. phenomenon, and I think it’s telling us not just about U.S. growth, unless you think that U.S. growth is driving world growth and so it’s really all about the United States. I think that’s a bit extreme, even though, as was mentioned, some correlations suggest that when the United States goes down, there is a lagged effect and the rest of the world tends to go down. But I think it’s suggesting that some other factor is occurring and that we shouldn’t read too much into it. Also, interestingly, if you look at the real short and long rates around the world—at least for the industrial countries—real rates tend to be about 1½ to 2½ percent, which is very much where we are. Thus there has been a convergence of real rates around the world. So I would be wary of taking too much information from the bond market as referring to something that’s specific to the United States rather than to some factors that are common worldwide. Just quickly on inflation—we’ve talked about how energy prices have gone up and down but core inflation hasn’t been affected that much. Labor market tightness doesn’t seem to have had much of an effect. As for output gaps—if you like output gaps—when you look at the data, it’s hard to find much evidence of an effect of output gaps on core inflation. Also, given the discussion that we’ve had, it doesn’t seem that the gap will be too wide or, even if you believe it will be wide, that you’d be getting much effect from it in the near term. We talked about some temporary factors like owners’ equivalent rent that may have boosted measured inflation for a while and is now coming down. I don’t think there will be much effect on inflation from the dollar. The United States still is just not that open an economy. Even to the extent that it is open, the pass-through of exchange rate changes to domestic prices is very slow and very partial—typically, over a three-year to five-year period, barely 50 percent. The evidence suggests that the pass-through is decreasing. Even if the dollar went down further, I don’t see much of an effect there. That said, it’s hard to see exactly what forces are moving inflation in one way or another right now. A reasonable scenario is that it could drift down slowly, but it’s hard to point to clear evidence of where it’s going to go. To the extent that there is information in the yield curve, the markets clearly do not expect inflation to take off, and it’s likely that inflation will be moving lower or at least staying contained where it is. So we have much data and relatively little information. I see risks on both the upside and the downside to growth and have continuing concern about upside risks to inflation precisely because I don’t see an easy path to lower core inflation going forward. I think that lower core inflation in the future is reasonable but uncertain, particularly given that it’s hard to see a lot of systematic evidence of factors that are occurring now that would be correlated with that result. Thanks." FOMC20070807meeting--63 61,MS. PIANALTO.," Thank you, Mr. Chairman. The reports that I am hearing from business leaders in the Fourth District lead me to conclude that the pace of economic activity hasn’t changed a great deal since our last meeting. However, the uncertainties surrounding the business climate seem to have risen measurably. The troubled housing sector is still weighing on the region, as it is nationally. I now have little doubt that this theme is going to recur throughout the balance of the year and perhaps well beyond. My view of the housing sector conforms closely to the way housing is depicted in the Greenbook baseline, but I have had many conversations in the past few weeks with anxious industry insiders, who believe that housing markets are likely to worsen substantially over the balance of the year with the possibility of significant spillovers to other sectors of the economy. The stories they tell me sound a lot like the greater housing correction scenarios that are depicted in the Greenbook. Indeed, casualties in the mortgage markets are rising, and I am hearing more and more that the fallout from housing is affecting deals in other sectors of the economy. For example, I talked with a CEO who runs a large national real estate development company. He told me that some of his projects are being held up by his investment banker’s inability to price deals and to bring them to market. Where the deals can be priced, risk spreads have widened across a range of issuers and financial instruments. This CEO’s comments are very much in line with the points that Bill Dudley made in his report earlier this morning. Because of these uncertainties in financial markets, some of my contacts confirm that they have been reevaluating their capital formation plans. They are trimming their projections of some of the projects that they are going to put on the books, and that led me to trim my projection for business fixed investment accordingly. Even with this adjustment, however, I am concerned that the pattern of business investment that I have incorporated into my GDP projections for this meeting may still be somewhat optimistic. This is a risk to the outlook that was not on my radar screen at our last meeting. The June retail price measures gave us more evidence that the inflation trend may be coming down. Inflation moderated in the second quarter, as measured by the median CPI and the 16-percent trimmed mean that we produce at the Cleveland Fed. I am not yet persuaded that this progress will be sustained, but the patterns in the June data were promising. My projection for inflation in the outyears of the forecast are actually a little more favorable than what is in the Greenbook baseline, primarily because I still expect a bit more potential GDP growth than the Greenbook envisions. So I am feeling more comfortable about the inflation risks than I have felt for a while but less comfortable about the real-side risks. My overall risk assessment is moving closer into balance. Nevertheless, I still think that inflation is the predominant risk we face today. Thank you, Mr. Chairman." FinancialCrisisReport--269 Internal Moody’s and S&P emails further demonstrate that senior management and ratings personnel were aware of the deteriorating mortgage market and increasing credit risk. In June 2005, for example, an outside mortgage broker who had seen the head of S&P’s RMBS Group, Susan Barnes, on a television program sent her an email warning about the “seeds of destruction” in the financial markets. He noted that no one at the time seemed interested in fixing the looming problems: “I have contacted the OTS, FDIC and others and my concerns are not addressed. I have been a mortgage broker for the past 13 years and I have never seen such a lack of attention to loan risk. I am confident our present housing bubble is not from supply and demand of housing, but from money supply. In my professional opinion the biggest perpetrator is Washington Mutual. 1) No income documentation loans. 2) Option ARMS (negative amortization) ... 5) 100% financing loans. I have seen instances where WAMU approved buyers for purchase loans; where the fully indexed interest only payments represented 100% of borrower’s gross monthly income. We need to stop this madness!!!” 1039 Several email chains among S&P employees in the Servicer Evaluation Group in Structured Finance demonstrate a clear awareness of mortgage market problems. One from September 2006, for example, with the subject line “Nightmare Mortgages,” contains an exchange with startling frankness and foresight. One S&P employee circulated an article on mortgage problems, stating: “Interesting Business Week article on Option ARMs, quoting anecdotes involving some of our favorite servicers.” Another responded: “This is frightening. It wreaks of greed, unregulated brokers, and ‘not so prudent’ lenders.” 1040 Another employee commenting on the same article said: “I’m surprised the OCC and FDIC doesn’t come downharder [sic] on these guys - this is like another banking crisis potentially looming!!” 1041 Another email chain that same month shows that at least some employees understood the significance of problems within the mortgage market nine months before the mass downgrades began. One S&P employee wrote: “I think [a circulated article is] telling us that underwriting fraud; appraisal fraud and the general appetite for new product among originators is resulting in loans being made that shouldn’t be made. … [I]f [Eliot] Spitzer [then-New York Attorney General] could prove coercion this could be a RICO offense!” A colleague responded that the 1038 “Economic Research: Who Will be Left Holding the Bag?” S&P’s RatingsDirect (9/12/2005). 1039 7/22/2005 email from Michael Blomquist (Resource Realty) to Susan Barnes (S&P), “Washington Mutual,” Hearing Exhibit 4/23-45. 1040 9/2/2006 email from Robert Mackey to Richard Koch, “Nightmare Mortgages,” Hearing Exhibit 4/23-46a. 1041 9/5/2006 email from Michael Gutierrez to Richard Koch and Edward Highland, “RE: Nightmare Mortgages,” Hearing Exhibit 4/23-46b. head of the S&P Surveillance Group “told me that broken down to loan level what she is seeing in losses is as bad as high 40’s – low 50% I’d love to be able to publish a commentary with this data but maybe too much of a powder keg.” 1042 CHRG-110hhrg44901--63 Mr. Bernanke," Well, Congressman, first I would like to respond quickly to something about your initial statement. You talked about outsourcing and the like. Probably the key source of the job loss we have had is the decline in the housing market, which has laid off construction workers and has had spillover effects through the financial system and so on. At this moment, our trade sector is actually one of the bright spots in our economy that is creating new opportunities for exports and job growth. With respect to whether this is a recession or not, that is a technical determination that a group of economists will make at some point in the future. It has to do with the various criteria. I think I agree with the premise of your question, which whether it is a technical recession or not is not all that relevant. It is clearly the case that for a variety of reasons, families are facing hardships in terms of higher energy costs, declining wealth, and all of the things that you mentioned. So this is clearly a rough time. Whether it is a recession or not, as you point out, is not-- " FOMC20080625meeting--88 86,MR. STERN.," Thank you, Mr. Chairman. Well, like some others--maybe many others--I, too, have raised my forecast for growth for this year, basically just extending what's happening in the first half of the year, and I've raised my projection for growth next year marginally as well. Still, I must admit to some significant reservations about doing that. As I look at the outlook and as Larry Slifman pointed out, there are a number of weaknesses, concerns, or downsides that you can pretty readily identify--tight or tightening credit conditions, a still significant decline in housing activity, a decline in housing values and the negative wealth effects associated with that, the run-up in energy prices, and so forth. Many of those will adversely affect the consumer, it seems to me. When we have that high a number of what I would call identifiable negatives, I wouldn't be surprised if we had one or more quarters of significant economic contraction still ahead of us despite the recent relatively good news on the growth side. At the same time, the news on inflation hasn't been particularly positive from my perspective, and that's particularly true if the Greenbook is right and some of the relatively favorable recent readings on core inflation are likely to prove transitory. I'm struck by the volume of questions I get and concerns expressed about inflation when I'm out talking with business groups or giving a speech to a more general audience. Now, a lot of this, of course, is focused on or stems from what's happening to energy prices and food prices, which are highly visible and which people experience directly and frequently. Nevertheless, I'm concerned that all of that makes inflation expectations a bit more vulnerable, maybe more than a bit more vulnerable, than they have been to this point. My reading of inflation expectations per se is that they, at least the longer-term expectations--and I'm relying mostly on the TIPS data here--have been remarkably well anchored so far. Perhaps a partial explanation for that is that core inflation really hasn't moved much since 2003�04. That's a bit of a double-edged sword because it has locked in a bit higher than I might have preferred. Nevertheless, stability that has been maintained is there. Perhaps it goes some distance to explain our continuing, or what appears to be our continuing, credibility on that issue. Now, the Greenbook does have some inching up of core inflation from here. If they're right and that's all we get, then I would be surprised if that led to a real deterioration in inflation expectations. But that may prove to be a big ""if."" As far as extending the projections goes, I'm in favor of doing that. I don't think there will be a huge payoff, but I think it will provide some additional information to us internally and to the public. I don't have a strong preference about which alternative we go with. Maybe the trial run will point out some advantages or disadvantages that we didn't anticipate. At the moment, if I had to vote, I'd probably vote for the second alternative, which would be to split the difference, put down the fifth year, and let it go at that. " FOMC20060808meeting--56 54,MR. GUYNN.," Thank you, Mr. Chairman. In our last meeting I reported that, while our Southeast economy still seemed reasonably solid, we were beginning to pick up anecdotal signs that activity might be slowing. Well, that sluggishness is now gradually showing up in the data as well. The slowing is perhaps most noticeable in our labor markets. Although we are still hearing that businesses in some sectors are having problems finding workers, especially in areas such as construction, accounting, and housekeeping, payroll employment figures for June in our states were disappointing. They showed seasonally adjusted contraction with absolute declines reported in Georgia, Tennessee, and Mississippi and less-than-expected job growth in Florida. Employers seem to be trying their best to hold the line on staffing, given the sense that they have of a slowing in the pace of growth and an uncertain outlook. Manufacturing activity in our region is mixed. Consumer spending remains softer than earlier in the year, and the tourism outlook is reported to be guardedly optimistic. The bright spot in some ways is the Gulf Coast outside New Orleans, where the demand for most construction materials and labor and for replacement household and personal goods is strong; but that pocket of elevated spending is not enough to offset the sluggishness elsewhere. The big semiannual apparel and gift mart show in Atlanta, where buyers just came to place their major orders for expected year-end holiday sales, was reported to have been slow. The regional bankers are reporting slowing in loan demand, particularly in the consumer housing sectors. However, the experience in C&I lending is more mixed. At the same time, credit quality, in the words of two bankers with whom we talked, was “unsustainably” or “embarrassingly” good. Banks are also pulling back on their lending into the softening housing market. Our data indicate that single-family construction remained relatively strong in the District. Home sales have slowed, and there now have been sharp corrections in some markets, especially coastal Florida. Perhaps the most-talked-about new worry in our region, and something I mentioned for the first time at our last meeting, is the growing problem of obtaining affordable wind, flood, and related insurance in our coastal areas, resulting from the huge losses incurred by insurance companies from hurricanes in recent years. Some carriers have quit offering coverage at any price, and costs of policies that are available have increased at extraordinary rates. That problem is affecting residential construction and sales and causing some businesses to pull up stakes and move elsewhere. Together, the various developments that I have just ticked off have taken considerable momentum out of the strong economic growth and outlook we were seeing in our region earlier in the year. Our sense of what’s happening at the national level is much the same. It now seems reasonably clear that we have settled into a pattern of slower and probably subpar growth. We saw evidence of that in the second-quarter GDP data and in the markedly slower employment gains in recent months. The several models that our Atlanta staff now employs to forecast real growth are suggesting somewhat slower growth in the 2½ percent to 3 percent range as being most likely over the second half of this year and through 2007. Getting a good handle on the inflation outlook is a bit harder. Our most recent Atlanta modeling work produces a somewhat encouraging inflation path over the next 18 months, which suggests that core inflation should stop its upward drift and gradually begin to move back toward 2 percent. That optimistic outlook is consistent with the most likely path laid out in the Greenbook and with the central tendency of the forecasts we all submitted for the recent congressional testimony. At the same time, even those optimistic forecasts do not seem to indicate that core inflation is likely to move comfortably to within the ranges many of us have indicated we would like eventually to see. Of course, these encouraging longer-term or medium-term, as some have been calling it, outlooks are very much at odds with the discouraging headline numbers and the increasingly higher core inflation readings in recent months. There seems to be good reason to expect that some of the coming near-term inflation data could well be disappointing before we begin to see the expected improvement, and these current data help to shape inflation expectations. In one of our recent briefings, an economist humbly observed that, despite all the work that has been done and continues to be done in the profession, our models for forecasting inflation are still less than stellar as judged by past experience. So we go into the policy discussion with some encouraging inflation forecasts but having to acknowledge wide error bands and considerable uncertainty around those forecasts. I look forward, I think, to an interesting but probably difficult policy discussion. [Laughter] Thank you, Mr. Chairman." FOMC20070628meeting--113 111,MR. STERN.," Thank you, Mr. Chairman. Regarding the national economy and real growth, it seems to me that recent developments are unfolding to a considerable extent largely as anticipated. Growth was positive but subdued over the four quarters ending in the first quarter of this year. It apparently snapped back discernibly in the current quarter, and my forecast is for sustained growth around trend going forward. In examining the twelve-month period spanning the last three quarters of last year and the first quarter of this year, it is apparent that the slowing of aggregate demand went beyond the housing sector and, in fact, was fairly broadly based. To be sure, residential construction activity contracted persistently and substantially over those four quarters. In addition, spending on equipment and software barely advanced, federal government outlays were soft in real terms, and there was a significant inventory correction. In most cases, with the likely and perhaps obvious exception of residential construction, there are reasons to believe, based on some of the indicators that David Wilcox covered this afternoon as well as materials distributed before the meeting, that these components of demand—that is, spending on equipment and software, federal government outlays, and inventories—will strengthen going forward. I thought it was particularly heartening, as noted in Part 2 of the Greenbook, that apparently the inventory overhang in construction supplies and in autos has been worked off, which suggests that we should see improvement in those sectors going forward. As I have commented before at recent meetings, I think the outlook for nonresidential construction, for net exports, and for consumer spending remains positive, although not unduly exuberant. All of this fits reasonably well with my view of what we should expect from productivity gains going forward, as well as increases in employment and hours worked. So, overall, I think the outlook for the real economy is promising and favorable. As to inflation, there has been, as everybody has noted, some moderation in the core measures recently. I expect this performance to continue, not necessarily on a month-by-month basis but over time. Overall, my reading of monetary policy is that it is moderately restrictive. As a consequence, that should feed into a further, gradual diminution of inflation along with ebbing of some of the transitory factors that pushed it up for a time. I would add that anecdotes from our business contacts don’t suggest any changes in pricing power or acceleration of inflation at this point. Now, of course, risks to the outlook abound, as they always do, and many have already been mentioned. Several relate, of course, to housing—construction activity, home prices, mortgage-related paper, and so forth. Then, you can add uncertainty associated with energy prices, the run-up in long-term interest rates that has already occurred, and I am sure a few things that I haven’t enumerated. I wouldn’t want to sound overly complacent or sanguine, but I would observe that many of these risks are not new. Many of them are already built into the Greenbook or other forecasts. In any event, if one of them were to occur in isolation, I would doubt that it would have a profound effect on the outlook that I have described. Thank you." CHRG-111shrg51395--14 Mr. Coffee," Well, good morning, and thank you, Chairman Dodd, Ranking Member Shelby, and fellow Senators. I have prepared an overly long, bulky, 70-page memorandum for which I apologize for inflicting on you. It attempts to synthesize a good deal of recent empirical research by business school scholars, finance scholars, and even law professors, about just what went wrong and what can be done about it. I cannot summarize all that, but I would add the following two sentences to what Senators Dodd and Shelby very accurately said at the outset. The current financial crisis is unlike others. This was not a bubble caused by investor mania, which is the typical cause of bubbles. It was not a demand-driven bubble; rather, it was more a supply driven bubble. It was the product of a particular business model, a model known as the ``originate-and-distribute model,'' under which financial institutions, including loan originators, mortgage lenders, and investment banks, all behaved similarly and went to the brink of insolvency and beyond, pursuing a model. What is the key element of this originate-and-distribute model? You make lax loans. You make non-creditworthy loans because--because you do not expect to hold those loans for long enough to matter. You believe that you can transfer these loans to the next link in the transmission chain before you will bear the economic risk. When everyone believes that--and they correctly believed that for a few years--then all standards begin to become relaxed, and we believe that as long as we can get that investment grade rating from the credit rating agencies, we will have no problem, and weak loans can always be marketed. There is no time for statistics here, but let me add just one. Between 2001 and 2006, a relatively short period, some of the data that I cite shows you that low-document loans in these portfolios went from being something like 28 percent in mortgage-backed securities in 2001 to 51 percent in 2006--doubling in 4 or 5 years. Investment banks and credit rating agencies are not responding to that change. That is the essential problem. This gives rise to what I will call and economists call a ``moral hazard problem,'' and this moral hazard problem was compounded by deregulatory policies that the SEC and other institutions followed that permitted investment banks to increase their leverage dramatically between 2004 and 2006, which is only just a few years ago. This is yesterday we are talking about. They did this pursuant to the Consolidated Supervised Entity Program that you have already been discussing, and it led to the downfall of our five largest, most important investment banks. All right. Essentially, the SEC deferred to self-regulation, by which these five largest banks constructed their own credit risk models, and the SEC deferred to them. The 2008 experience shows, if there ever was any doubt, that in an environment of intense competition and under the pressure of equity-based executive compensation systems that tend to be very short-term oriented, self-regulation alone simply does not work. The simplest way for a financial institution to increase profitability was to increase its leverage, and it did so to the point where they were leveraged to the eyeballs and could not survive the predictable downturn in the economic weather. So what should be done from a policy perspective? Well, here is my first and most essential point: All financial institutions that are too big to fail, which really means too entangled to fail, need to be subjected to prudential financial oversight, what I would call ``financial adult supervision,'' from a common regulator applying a basically common although risk-adjusted standard to all these institutions, whether they are insurance companies, banks, thrifts, hedge funds, money market funds, or even pension plans, or the financial subsidiaries of very large corporations, like GE Capital. In my judgment, this can only be done by the Federal Reserve Board. That is the only person in a position to serve as what is called the ``systemic risk regulator.'' I think we need in this country a systemic risk regulator, and specifically to define what this means, let me say there are five areas where their authority should be established. The Federal Reserve Board should be authorized and mandated to do the following five things: One, establish ceilings on debt-to-equity ratios and otherwise restrict leverage for all major financial institutions. Two, supervise and restrict the design and trading of new financial products, including, in particular, over-the-counter derivatives and including the posting of margin and collateral for such products. Three, mandate the use of clearinghouses. The Federal Reserve has already been doing this, formulating this, trying to facilitate this, but mandating it is more important. And they need the authority to supervise these clearing houses, and also if they judge it to be wise and prudent, to require their consolidation into a single clearinghouse. Four, the Federal Reserve needs the authority to require the writedown of risky assets by financial institutions, regardless of whether accounting rules mandate it. The accountants will always be the last to demand a writedown because their clients do not want it. The regulator is going to have to be more proactive than are the accounting firms. Last, the Federal Reserve should be authorized to prevent liquidity crises that come from the mismatch of assets and liabilities. The simple truth is that financial institutions hold long-term illiquid assets which they finance through short-term paper that they have to roll over regularly, and that mismatch regularly causes problems. Now, under this ``Twin Peaks'' model that I am describing, the systematic risk regulator--presumably, the Federal Reserve--would have broad authority. But the power should not be given to the Federal Reserve to override the consumer protection and transparency policies of the SEC. And this is a co-equal point with my first point, that we need a systemic risk regulator. Too often, bank regulators and banks have engaged in what I would term a ``conspiracy of silence'' to hide problems, lest investors find out, become alarmed, and create a run on the bank. The culture of banking regulators and the culture of securities regulators is entirely different. Bank regulators do not want to alarm investors. Securities regulators understand that sunlight is the best disinfectant. And for the long run, just as Senator Shelby said, we need accounting policies that reveal the ugly truth. We could not be worse off now in terms of lack of public confidence. This is precisely the moment to make everyone recognize what the truth is and not to give any regulator the authority to suppress the truth under the guise of systematic risk regulation. For that reason, I think SEC responsibilities for disclosure, transparency, and accounting should be specially spelled out and exempted from any power that the systematic risk regulator has to overrule other policies. Now, two last points. As a financial technology, asset-based securitization, at least in the real estate field, has decisively failed. I think two steps should be done by legislation to mandate the one policies that I think will restore credibility to this field. First, to restore credibility, sponsors must abandon the originate-and-distribute business model and instead commit to retain at least a portion of the most subordinated tranche, the riskiest assets. Some of them have to be held by the promoter because that is the one signal of commitment that tells the marketplace that someone has investigated these assets because they are holding the weakest, most likely to fail. That would be step one. Step two, we need to reintroduce due diligence into the process, into the securitization process, both for public offerings and for Rule 144A offerings, which are private offerings. Right now Regulation AB deregulated; it does not really require adequately that the sponsor verify the loans, have the loan documentation in its possession, or to have examined the creditworthiness of the individual securities. I think the SEC can be instructed by Congress that there needs to be a reintroduction of stronger due diligence into both the public and the private placement process. Last point. Credit rating agencies are obviously the gatekeeper who failed most in this current crisis. The one thing they do not do that other gatekeepers do do is verify the information they are relying on. Their have their rating methodology, but they just assume what they are told; they do not verify it. I think they should be instructed that there has to be verification either by them or by responsible, independent professionals who certify their results to them. The only way to make that system work and to give it teeth is to reframe a special standard of liability for the credit rating agencies. I believe the Congress can do this, and I believe that Senator Reed and his staff are already examining closely the need for additional legislation for credit rating agencies, and I think they are very much on the right track, and I would encourage them. What I am saying, in closing, is that a very painful period of deleveraging is necessary. No one is going to like it. I think some responsibility should be given to the Federal Reserve as the overall systematic risk regulator, but they should not have authority to in any way overrule the SEC's policies on transparency. Thank you. " FOMC20080625meeting--32 30,MR. MADIGAN.," 3 I will be referring to the separate package labeled ""Material for Briefing on FOMC Participants' Economic Projections."" The top two sections of table 1 show the central tendencies and ranges of your current forecasts for the first and second halves of 2008; central tendencies and ranges of the projections published by the Committee this past April are shown in italics. To facilitate comparisons, the Greenbook projections are shown in the bottom section. In your forecast submissions, most of you indicated that you saw appropriate monetary policy as entailing a path for the federal funds rate that lies above that assumed in the Greenbook. As shown in the first row, first column, of table 1, the central tendency of your real growth forecasts for the first half of 2008 has been marked up substantially since April. However, a number of you noted that recent upside surprises to consumer and business spending are likely to prove transitory and that falling house prices, tight credit conditions, and elevated energy prices will probably restrain growth over the remainder of 2008. Accordingly, some of you revised down a touch your growth expectations for the second half of this year (the second column) especially those of you who had previously anticipated the briskest 3 The materials used by Mr. Madigan are appended to this transcript (appendix 3). growth rates, as indicated by the downward revision to the upper end of the range shown in the middle section. Most of you think the economy will skirt recession. Nonetheless, your projections for the speed of recovery over the second half exhibit considerable dispersion: Four participants are projecting growth rates of real GDP between 2 and 2� percent, whereas an equal number are calling for growth at an annual rate of only around � percent, a pace similar to the one projected in the Greenbook, with many of you attributing the tepid growth partly to financial headwinds. The tendency for some clustering of your second-half growth forecasts at the extremes can be seen by noting the similarity between the central tendency and the range. As shown in the second set of rows in the top panel, your projections for headline PCE inflation in the second half of 2008 have been revised up more than 1 percentage point, to around 3� to 4� percent, largely as a result of the surge in prices of energy and agricultural commodities. However, in view of better-thanexpected news on core PCE inflation, the central tendency of your projections for core inflation during the second half (shown in the third set of rows) revised up only 0.1 percentage point. Looking ahead to 2009 (table 2, the middle column), you continue to expect growth to pick up as the drag from the housing sector dissipates and credit conditions ease. The midpoint of the central tendency of your forecast for real GDP growth next year is 2.4 percent, the same as in April and the same as the staff's current forecast. Your growth forecasts for 2010 (the third column) are a shade lower than in April, and the central tendency of your forecasts for the unemployment rate is a touch higher, perhaps because a number of you assumed more policy tightening over the forecast period in order to counter heightened inflation pressures. The midpoint of the central tendency of your projections for the unemployment rate edges down from about 5� percent in 2009 to about 5� percent in 2010. Your commentaries suggest that many, albeit not all, of you view those rates as a quarter-point to a half-point above your estimates of the NAIRU. The third and fourth sets of rows indicate that most of you see overall and core inflation staying above 2 percent next year; but by 2010, the extended period of economic slack and the assumed leveling-out of energy prices push down overall and core inflation to around 1� to 2 percent; for core inflation, the central tendency and range are a touch higher than you forecasted in April. For the first time since you started these projections last October, the upper end of the range of your projection of total inflation in 2010 exceeds 2 percent, albeit marginally. Thus, many of you project that, at the end of the forecast period, the economy will still be operating with some slack and real output growth will be slightly above the growth rate of potential. The continued presence of slack suggests that you anticipate that inflation will continue to edge lower in 2011 and, given the assumption of appropriate monetary policy, implies that you typically anticipate that inflation will still be a bit higher in 2010 than you see as consistent with price stability. Exhibit 3 presents your views on the risks and uncertainties in the outlook. As shown by the green bars in the top two panels, a large majority of you continue to perceive the risks to growth as weighted to the downside (the left panel), and many judge that the degree of uncertainty regarding prospects for economic activity is unusually high (the right panel), although the number of you seeing uncertainty about growth as elevated has declined slightly over the first half of the year. In your narratives, you attributed the downside risks primarily to the potential for steeper declines in house prices and persisting financial strains, which through a further tightening of credit conditions could exert an unexpectedly large restraint on household and business spending. Although your views of the risks regarding growth have shifted only modestly, the distribution of your perceptions of the risks regarding inflation (shown in the bottom two panels) has changed significantly so far this year. As shown in the lower left panel, about three-quarters of you now see the risks to the outlook for overall inflation as skewed to the upside. In your commentaries, you typically pointed to continued increases in energy and food prices and an upward drift in inflation expectations as the main reasons for the upside risks to inflation. In addition, as shown to the right, the number of participants who perceive the degree of uncertainty regarding the inflation outlook as larger than usual has risen considerably. Turning to exhibit 4, as I noted, your projections suggest that you do not see the economy as having fully settled into a steady state by 2010. The dynamics of the economy evidently are such that, following moderately large shocks, it can take quite a few years to converge back to steady state, a view that is captured by many econometric models such as FRB/US and is also reflected in the current Greenbook forecast. Thus, the three-year forecast horizon currently used by the Committee does not necessarily allow your forecasts to reveal fully your views of the steady-state characteristics of the economy and your views of the rate of inflation consistent with the dual mandate. Recognizing this, the Subcommittee on Communications recently sent the Committee a memo outlining several possible approaches to providing longer-term projections. The approaches are summarized in the lower panel. One option would be for participants to extend their entire set of projections out to, say, five years. Under this option, participants would be asked to submit projections for economic variables in year 4 as well as in year 5. You would also expand your individual forecast narratives to explain the trajectory of the economy and inflation over the five-year projection period. This approach would have the advantage of providing the basis for a complete presentation of the Committee's medium-term and long-term views. The principal disadvantage of this option is the relatively heavy burden it places on Committee participants to make projections covering five years. Another disadvantage is that in some circumstances--that is, following a very large shock--the economy still may not be in a steady state after five years. A second option is for participants to continue to submit economic projections and narratives out to three years as now but also to provide estimates of the values of output growth, unemployment, and inflation in year 5 under the assumption of appropriate monetary policy. Under this approach, you might wish to collect and publish long-term projections only for output growth, unemployment, and total inflation, and not for core inflation, in order to emphasize that total inflation rather than core inflation is the appropriate metric for the longer-run goal of price stability. This second approach presumably places less demand on your time than the first but it would make for a less integrated presentation. It would also suffer from the same defect as the first approach, in that the figures you submit might not reveal the steadystate characteristics of the economy after a large shock. In a third approach, you would augment your three-year projections with projections of the average values for output growth, unemployment, and total inflation over the period five to ten years ahead. This approach would have the advantage of more directly revealing your estimates of the key operating characteristics of the economy--that is, the parameters related to productive capacity and your inflation objective. It might also be less demanding of your time in the sense that you would need to project fewer time periods than in the first option. On the other hand, it might be more difficult in that you would need to consider likely trends in demographic variables and productivity further ahead than is ordinarily necessary for monetary policy making. Moreover, it is possible that some of the parameters you would be supplying for the period five to ten years ahead might take on different values than would apply to the medium term that is relevant for monetary policy. In your comments in the upcoming economic go-round, you may wish to express your views on whether you support publication of longer-run projections and, if so, which of the approaches you prefer. You might also wish to comment on the desirability of conducting a trial run with long-term projections--say, in October-- before going live with long-term projections, perhaps in January. That concludes our prepared remarks. " 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." 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-110shrg50369--15 Chairman Dodd," Thank you very much, Mr. Chairman. We will make these 7 to 8 minutes, and, again, I will not be rigid about the time constraints. Let me begin, Mr. Chairman, by going back to that old question that was asked more than, I guess, 30 years ago. I will sort of paraphrase on it, and that is, are we better off today to respond to this situation than we were--in this case I want to ask 7 years ago. The question that Ronald Reagan asked, I think, in 1980 in that campaign, Are we better off today than we were yesterday? And the reason I raise that is because I have been struck by the similarities between 2001 and that period going into, potentially falling into a recession, and here we are in 2008. The parallel seems striking to me in some ways, and I want you to comment on this, if you could. At both moments in this 7-year period, we are on the brink of a recession--at least it seems so. The Fed was cutting interest rates very aggressively. A major asset bubble--in this case, it was the high-tech community rather than housing--was bursting. Yet despite those similarities, the differences in the basic economic information seems to be very, very different as well. Americans had just experienced the greatest economic boom in a generation. Real wages had gone up substantially. Income inequality had narrowed. The Federal Government was in a surplus. In fact, on this very Committee, your predecessor came to a hearing--I do not know who else was on the Committee in those days, but he came and talked about the things we ought to think about by retiring the national debt entirely. There were some downsides to that, and we actually had a very good hearing with Alan Greenspan about that very question in 2001. The dollar was at record highs as well, and, of course, today we are in the opposite position, with the dollar at its lowest level since we began floating currencies in 1973. Inflation is at a 17-year high. Real wages are falling, and we are faced with record Government debt and deficits. A very different fact situation than was the case in 2001. In 2001, as well, one might argue that there were deliberate actions taken by the Federal Reserve to deal with rising inflation. So the steps were in response to inflation here. Obviously, what is provoking, I think, the action--and you can certainly comment on this--is a different fact situation. So the question appears in a sense: Are we in a--what would be your analysis? Are we in a--comparing these two periods in time of history, relatively close to each other, faced with similar situations, it would appear to me that we are not in as strong a position to respond to this as we were in 2001. And so the question is, Are we better off? And if so, I would like you to explain why. And if not, what should we be doing and what different steps should we be taking if we cannot rely on these basic underlying strengths that occurred in 2001 that helped us at that time as opposed to where we are today? " FOMC20080430meeting--56 54,MR. MADIGAN.," 2 I will be referring to the package labeled ""Material for Briefing on FOMC Participants' 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 published by the Committee last February are shown in italics. Regarding your monetary policy assumptions (not shown) about three-fourths of the participants envisage a moderately to substantially higher federal funds rate by late next year than assumed in the Greenbook, a path perhaps similar to the one incorporated in financial market quotes. Most of you conditioned your projections on a path for the federal funds rate that begins to rise either in late 2008 or sometime in 2009, in contrast to the Greenbook path, which remains flat through 2009. Many of you were less clear whether you differed from the Greenbook path 2 The materials used by Mr. Madigan are appended to this transcript (appendix 2). over the near term; but with a little reading between the lines, it seems fair to say that most of you assumed a slightly higher funds rate over the near term. As shown in the first set of rows and first column of table 1, the central tendency of your real economic growth forecasts for 2008 has been marked down nearly 1 percentage point since January. Most of you pointed to weak incoming data, tight credit conditions, falling house prices, and rising energy prices as factors that prompted you to lower your growth expectations for this year. About half of you forecast a decline in economic activity over the first half of the year (not shown), with another quarter of you seeing a flat trajectory over that period. However, only four of you used the word ""recession"" to describe the current state of the economy. None of you has a more negative first-half outlook than the Greenbook. The downward revisions to your growth forecasts are roughly equal across both halves of 2008, and so the contour remains one of a rising growth rate over the year. Members' projections for the speed of the recovery in late 2008 exhibit considerable dispersion, with some calling for a quick return to near-potential growth supported by monetary and fiscal stimulus, and others seeing a prolonged period of weakness owing partly to persisting financial headwinds. Most of you appear to expect growth to return to near its trend rate in 2009 (column 2) and to move slightly above trend in 2010 (column 3). The Greenbook forecast for real growth in 2008 is near the low end of the central tendency of FOMC members' projections, but it is at the high end in 2009 and 2010. The second set of rows indicates that you have revised up your projections for the unemployment rate throughout the forecast period. Of those of you who provided estimates of the natural rate of unemployment, most expect unemployment to remain above the natural rate in 2010 with the others seeing a return to the natural rate. As shown in the third set of rows, your projections for headline PCE inflation in 2008 have been revised up a full percentage point, largely due to the surge in the prices of energy and other commodities. Incoming information has also prompted a small upward revision to your projections of core PCE inflation this year (the fourth set of rows). The rate of decline of core inflation in 2009 is essentially unchanged from that in the January projections, presumably reflecting the offsetting effects of the higher unemployment rates in the April projections, on the one hand, and the lagged pass-through of this year's higher food and energy prices, on the other. By 2010 the prolonged period of economic slack pushes down core inflation to around the same rates that were projected in January. Although the central tendencies for headline inflation, the third set of rows, also decline markedly over the forecast period, overall inflation is projected to be about � percentage point higher next year than you anticipated in January. Nonetheless, by 2010, headline inflation is expected to be in essentially the same range of around 1� to 2 percent that you forecasted in January. Your inflation projections for 2010 are close to their values in January, but more than half of you raised your projections for the unemployment rate in 2010 significantly more than 0.1 percent. To the extent that the higher unemployment rate projections are viewed as implying an economy operating below its potential in 2010, outside analysts may infer that you expect inflation to edge down further beyond 2010. Turning to the risks to the outlook, as shown in the upper left-hand panel of exhibit 2, a large majority of you regard uncertainty about GDP growth as greater than normal. The upper right-hand panel shows that most of you perceive the risks to GDP growth as weighted to the downside. Correspondingly, the risks to unemployment, not shown, are seen as weighted to the upside. You typically attributed the downside growth risks to the potential for sharper declines in house prices and persisting financial strains. Overall, the distributions of your views on the uncertainties and skews regarding growth are little changed from January. However, as shown in the lower panels, your perceptions of the risks regarding inflation have changed noticeably since January. As shown in the lower left panel, only half as many participants now see the degree of uncertainty regarding the inflation outlook as historically normal, and twice as many see the uncertainties as larger than usual. As indicated to the right, fewer see the risks to their outlook for overall inflation as balanced, and more see the risks as skewed to the upside. Your narratives indicate that you see the upside risks to inflation as deriving from the potential for continued increases in commodity prices, further depreciation of the dollar, and an upward drift in inflation expectations. That concludes our remarks. " FOMC20080805meeting--126 124,MR. STERN.," Thank you, Mr. Chairman. Let me make just a few comments about the Greenbook forecast at this point, which I found quite useful for thinking about policy going forward only in part because it is quite close, at least in broad overview, to the forecast I submitted before the June meeting on the economic outlook, inflation, and so forth. In any event, given the alignment in these forecasts, I think there are several characteristics worth emphasizing. First, financial headwinds persist--we have talked about this for quite a while--and the Greenbook now assumes more stress and more persistence than it assumed earlier. Second, the inventory overhang in housing persists with negative implications for activity and for prices in that sector. Third, real growth is subdued over the next several quarters at least. Against the background of the Greenbook forecast, growth over the balance of this year in excess of 1 percent in real terms would have to be considered a positive surprise. Growth in excess of trend next year would have to be considered a positive surprise. Finally, with regard to inflation, headline inflation abates after the current quarter, although overall both headline inflation and core inflation remain above 2 percent through 2009. I realize that there's considerable uncertainty surrounding all of that and that not everybody shares that assessment, but I think it's worth emphasizing those features because we need to try to think several months and several quarters ahead in terms of the environment in which we will be making policy decisions. If these forecasts are at least in the ballpark--at the risk of perhaps belaboring the obvious--it seems to me that a major message of those forecasts is that the policy environment is likely to remain significantly challenging for several more quarters at least. I could put that another way. It seems that evolving readings on the economy and inflation are not likely to line up appreciably at all with either aspect of the dual mandate over the next several quarters. Thank you. " CHRG-110hhrg46591--198 Mr. Manzullo," I thank the chairman. In 2000, this committee, through the efforts of Richard Baker, began a more intensive focus on the potential systemic risk posed by Fannie and Freddie. In an effort to lobby against Mr. Baker's bill, Fannie Mae engineered over 2,000 letters from my constituents in my district concerned about the ``inside the Beltway'' regulatory reform bill. That was a reform bill in 2000. The problem was the letter campaign was a fraud. My constituents did not agree to send those letters. And what ensued was a confrontation with Mr. Raines in which he arrogantly claimed Fannie did nothing wrong in stealing the identities of 2,000 of my constituents. At that point, I threw the Fannie Mae lobbyists out of my office and said, ``You are not welcome to come back.'' That was 8 years ago. Then again in 2004, there was a confrontation between myself and the head of OFHEO over the fraudulent accounting motivated by executive greed and Mr. Raines, who took away $90 million. That led to a lawsuit, and he unfortunately had to give back only $27 million of that. And I cosponsored the reform bills in 2000 and 2004, and again--2003 and 2005. Dr. Rivlin, I have been one of your biggest fans, even though you don't know that, because you make astounding statements such as on page 3, ``Americans have been living beyond our means individually and collectively.'' You talk about personal responsibility. You also talk about commonsense regulations, that you should not be allowed to take out a mortgage unless you have the ability to pay for it and have proof of your earnings. My question to you today is, as we discuss restructuring and reform, what kind of changes or curbs should be placed upon GSEs in your opinion? Ms. Rivlin. I think you have a really hard problem with the GSEs, because the problem was that they were structured in such a way that they had very conflicting missions. They were told they were private corporations, owned by stockholders, responsible to those stockholders to make money, and they were also told that they had public responsibilities to support affordable housing. And they interpreted those--they came late to the party on subprime, but they came, as you pointed out, in a very big way. And that turned out to be part of fueling the collective delusion. And then they got caught in a really big way when the market--when the crash happened. I think the real problem going forward is how to unwind this untenable situation. Either you have to have Fannie and Freddie being truly private institutions with no government guarantee, in which case they have to be a lot smaller--that would take a long time to accomplish, but it is one model--or they have to be fully regulated, with the rules clear what they are to do in the mortgage markets, and that they should lean against the wind when a bubble seems to be getting out of hand. That is another possible model. But the thing that isn't possible is this combination of conflicting incentives. " FOMC20071031meeting--52 50,MS. YELLEN.," Thank you, Mr. Chairman. Over the past week or so, we have been following the devastating fires in Southern California. They have burned over 500,000 acres, destroyed nearly 2,000 homes, and inflicted seven deaths and sixty injuries. These were large fires, even by California standards, but they were by no means the largest in recent memory; and, of course, the loss of life and economic costs pale compared with Katrina. While the fires have seriously affected the lives of many individuals, they do not seem likely to show up in the macroeconomic data. Turning to the national economy, developments since we met six years—six weeks ago—actually, it seems like just two weeks ago—[laughter] generally have been favorable and the risks to the outlook for growth have eased somewhat. But I think it is too early to say that we are out of the woods. The inflation news has continued to be favorable, but some upside risks have become more prominent. With respect to economic activity, we have raised our forecast for growth in both the third and the fourth quarters in response to incoming data, even though the pace of deterioration in the housing sector has been more severe than we expected and the problems associated with housing finance seem far from resolution. We agree with Greenbook that residential investment is likely to continue its severe contraction for at least a few more quarters. We also agree with Greenbook that the rest of the economy has held up reasonably well, at least so far. Exports have been strong, and while business fixed investment seems to be slowing, it should still make a robust contribution to growth in the second half of this year. With respect to consumer spending, most aggregate data suggest only a modest deceleration so far. Such readings help to allay our concerns about potential spillovers from housing to consumption, but they don’t completely assuage them. Survey measures of consumer confidence are down sharply since the financial turmoil began, and most indexes of house prices show outright declines. Given the current state of the housing and mortgage markets, bigger declines going forward are a distinct possibility. Indeed, the Case-Shiller futures data for house prices point to larger declines in the months ahead. A sharp drop in house prices would likely crimp consumer spending over time through wealth and collateral effects. Some of my directors and other contacts are also raising warning flags about consumer demand. For example, the CEO of a large well-known high-end retailer said that the company’s sales are softening and that the company is having to work diligently to control inventories. In his view, the consumer has pulled back. The CEO of a Southern California bank observed a number of his clients talking about a drop in discretionary consumer purchases. The bottom line is that consumption spending seems to be all right for the time being, but there is a real risk that households may cut back on spending more than expected in response to higher oil prices, a slower economy, and economic uncertainty. I agree with President Rosengren’s assessment of financial markets. Strains appear to have eased a bit on balance since our September meeting, with interbank lending markets showing some improvement and spreads on asset-backed commercial paper declining. But structured credits related to mortgages remain quite troublesome, and liquidity conditions and Treasury bill markets are still at times strained. My impression is that, despite having moved in a positive direction over the past six weeks, these markets remain vulnerable to shocks, and so the economy remains at risk from further financial disruptions. Both survey evidence and anecdotal evidence have confirmed that banks are tightening lending standards across the board. Tighter terms and conditions are being applied to a range of business lending, including commercial real estate, and on most household lending from prime and nonprime mortgages to auto and home equity loans. The main financial variables that are commonly included in formal macroeconometric models appear to have changed since the onset of the financial shock—say, in late June—in ways that should have roughly offsetting effects. Oil prices are markedly higher, which should restrain consumer spending, and the stock market is roughly unchanged since June in spite of the financial turmoil. A weaker dollar should have a positive influence on growth. Mortgages rates on jumbo loans and the rates facing the riskiest corporate borrowers are higher, but many private borrowing rates are down because of the decline in Treasury yields. Of course, the current levels of Treasury yields, as well as the stock market and dollar, reflect at least in part the market’s expectation that the Committee will ease the stance of monetary policy at this meeting. Underlying our forecast is the policy assumption that the Committee will cut the funds rate another 25 basis points at this meeting. In assessing the appropriate path of the stance of policy, I took a number of considerations into account. First, core consumer inflation currently is at a level that I consider consistent with price stability. Second, unemployment is very near my best estimate of the full employment rate. In the context of a Taylor-type rule, these considerations imply that the real funds rate should be near its neutral level. In fact, any version of the Taylor rule you prefer, with whatever rates you want to put on inflation versus the gap, will give you the same recommendation because all the terms are zero and drop out, except for one—the equilibrium real rate. Of course, we cannot know the level of the real equilibrium rate with certainty. Defined in terms of the PCE price index, our best estimate is in the range of 2 to 2½ percent, which is well below the current real rate of about 3 percent. I would like to highlight two additional points here. First, the actual real rate has been boosted over the past six months or so by declines in short-term inflation expectations, whether one measures them by lagged inflation, by surveys of expected inflation over the next year or so, or by forecasts of inflation including the Greenbook forecast. Second, one important aspect of the financial turmoil is that it probably represents in part a movement toward a more reasonable pricing of risk, as seen in the rise in risk spreads. This development tends to push the equilibrium real funds rate down toward the lower portion of the range I just cited. The bottom line is that in my view, even without the contractionary effects of recent financial developments, an appropriate stance of monetary policy would involve further declines in the fed funds rate. I have assumed that the funds rate drops to 4½ percent by the end of this year and to 4¼ by the end of next year. My assumed path ends in the same place and embodies the same medium-term assumption concerning neutral as FRB/US, on which the extended Greenbook forecast relies. The only difference concerns timing. We assume a more rapid path to the long run than the Greenbook does. Our forecast shows real GDP growth gradually picking up to around 2½ percent, our estimate of potential, by the end of next year. However, given that the financial shock is not yet resolved, I think the downside risks to this forecast predominate. With regard to inflation, I expect core PCE inflation to remain around 1¾ percent over the next several years. The probable appearance of a small amount of labor market slack is likely to help hold down inflation. In addition, I expect that, with inflation remaining below 2 percent, inflation expectations will edge down as well, reinforcing our success. I hope that this result will be aided by the release of our extended forecasts and the greater awareness of where we would like to see inflation settle down. I see the risk to my inflation forecast as moderate and mainly to the upside in view of recent increases in oil and food prices, declines in the dollar, and a slower rate of structural productivity growth. So, in summary, I think the most likely outcome is that the economy will move forward toward a soft landing. I see downside risks to economic activity and some upside risks to inflation. But in view of continuing questions about the effects of the financial market shock, I am more concerned about the activity side of things right now." FOMC20060328meeting--84 82,MR. MOSKOW.," Okay. Well, most of my contacts this time were upbeat about current conditions. Though the Midwest continues to underperform the rest of the nation, the U.S. economy seems to remain on solid footing. So we tried to assess whether the strength in January and February was just a transitory bounceback from the fourth quarter or whether it represents some persistent forward momentum. And while a few contacts expressed concerns about higher energy prices and softening housing markets—as we were just discussing—most pointed to an economy with substantial staying power. A bit of good news is that the Chicago purchasing managers’ index, which will be released on Friday, will show a significant increase—from 54.9 to 60.4. The persistent momentum in the economy appears to be creating some pressure on resources. One example is the airline industry. Business and leisure travel are at very high levels, with strong bookings for the past few months. Load factors are at near-record highs, in part reflecting a reduced capacity in the industry. There continue to be more reports of fare increases, and surprisingly the increases are now being led by the low-cost carriers. We’re hearing about tightening labor markets. Manufacturers continue to have difficulty finding skilled workers. In the temporary-help area, Manpower—headquartered in our District— said that wage growth is accelerating nationally. Three months ago wages were basically flat on a year-over-year basis. Now they’re expecting increases of 4 to 5 percent in the second quarter of this year. Kelly Services, also headquartered in our District, reported steady nationwide increases in the 3 percent to 4 percent range. But both companies noted that labor markets were still nowhere near as tight as they were in the late ’90s. Speaking of labor markets, to update the GM–Delphi–UAW saga, Rick Wagoner, General Motors’ CEO, thinks that the GM buyout plan will take the heat off the poor Delphi–UAW relations, lessening the chance of a strike there. He expects a significant number of GM and Delphi workers to sign up for the plan. This will allow them to reduce the size of their workforce more quickly. One aspect of this agreement that parties are not publicizing widely, for obvious reasons, is that GM and Delphi should have more flexibility in hiring temporary workers and outsourcing in the future. The temporary workers will have lower wages, and they won’t have the full GM benefit package. Turning to the outlook, I feel that the near-term risks to the forecast have changed somewhat since our last meeting. On the growth front, I had previously thought that high energy prices and sticker shock from heating bills might damp spending substantially. And on the price front, I was concerned that pass-through of higher energy prices and other costs could boost core inflation and feed through to inflation expectations. Neither risk has materialized so far. Private domestic demand appears to be growing at a solid pace. The recent price news has been favorable, and inflation expectations have moved little. So what are the risks now? I do not see many immediate downside risks to growth; to the contrary, I personally think that the risk may have tilted to the upside. It’s true that housing appears to be moderating, but the softening seems to be happening much as we expected it to. In contrast, consumption growth continues to be quite strong. This may be a signal that households are more confident about their permanent income prospects, perhaps because of healthy labor markets and the strong underlying productivity growth. If so, then we could be in for some continued robust consumer spending. In addition, growth abroad has improved. Notably, Japan and Europe are showing some life. Thus, we could see more demand emanating from abroad. So in the short term, growth will likely exceed potential. But given a funds rate path like that in the Greenbook, which I would characterize as a touch restrictive, my outlook and the Greenbook’s get growth back to potential by 2007. Despite the recent good readings on inflation, the current strength of the economy is showing through in our simple indicator-based forecasts of inflation. We run about two dozen forecasting models that encompass common statistical indicators of future inflation. These are not structural models. They are simple regression forecasting models that use only current data, and they have no explicit conditioning assumptions regarding future policy, oil prices, or other such factors. And this contrasts with a more structural methodology like the FRB/US model. Nearly all of these indicator models predict some uptick in core inflation over the next two years—not a big one but to something a bit above 2 percent in 2007. Looking ahead, these projections would probably move down with a further string of good news about prices and more-balanced prospects for resource utilization. Nonetheless, given the models’ forecasts and the fact that we currently are operating with very little resource slack in the economy, I see a risk that inflationary pressures will be somewhat greater than what is currently built into the Greenbook." FOMC20070131meeting--234 232,MR. MOSKOW.," Thank you, Mr. Chairman. I agree with the sense of the Committee that we should not be raising rates today. However, I do think that, as we’ve all said, the inflation risks still dominate and that we’re approaching some very important decision points in the next couple of meetings. If we look back, of course, the primary risk to our growth forecast has been housing. We have seen an incredibly sharp decline, and many of us have the sense that housing is stabilizing now. There’s still some uncertainty about that, but it seems to be stabilizing. Once it stabilizes, our attention will shift to the other part of our dual mandate—to price stability. As I think we have all said, we’re uncomfortable with the current rate of inflation. There has been some improvement; we’ll take that to the bank. We’re happy with that. But there is still a lot of uncertainty about the future course of inflation, and the projections in the Greenbook and the Bluebook are not encouraging to me. My comfort zone is 1 to 2 percent, so I’m in the 1½ percent category. In view of that range, as Vince said, we have work to do. I agree with Tim and Sandy that we shouldn’t interpret alternative B as saying that each individual has a target of 2 percent. Our projection for inflation is 2¼ percent in both years, and that is clearly above that target. We have said we’re concerned about inflation—we said that last time, and I think it was well put. But we should make even stronger statements in the minutes about the costs of inflation running above forecast and about the damage it can do to the economy on a long-term basis. As I said, I don’t think we have the luxury of waiting until inflation rises before we act. We have to be forward-looking. The next couple of meetings are going to be important because we’ll know a lot more about whether housing really has stabilized further and what the inflation numbers will look like. In terms of the language, I’m comfortable with alternative B as it’s stated. I like the reference to the high level of resource utilization in section 3, so I would not change the language at this time." FOMC20070509meeting--15 13,MR. STOCKTON.," Thank you, Mr. Chairman. In this forecast round, you, as policymakers, were faced with an identification problem similar to that which we, as econometricians, so often confront. Although the Greenbook forecast is essentially the same as it was in March, several observationally equivalent hypotheses could explain this outcome. First, abject laziness on the part of the staff; second, brilliant prescience on our part; or third, what I assume is your working null hypothesis— dumb luck. [Laughter] Well, I can assure you that abject laziness can be ruled out. It took much agonizing, endless meetings, and a lot of hard work to do nothing. We are, after all, still part of the federal government. [Laughter] As for prescience and luck, they did combine to leave the outlook pretty much as it was at the time of the last Greenbook. We still believe that the economy has been growing at a pace less than its potential, held down by the ongoing slump in housing activity. As the drag from residential investment abates, growth of real output is expected to pick up. But that reacceleration of activity is limited by a diminishing impetus to consumer spending from housing wealth and a reasonably restrictive monetary policy. Let me begin by citing a few areas of the forecast in which developments have unfolded much as we had anticipated. I’ll then move on to some of the areas of notable surprise that luckily had offsetting effects on the outlook. First, the BEA’s advance estimate of real GDP in the first quarter showed an increase of 1¼ percent that was close to our forecast both on the total and in the particulars. As expected, the decline in residential investment took a significant bite out of first-quarter growth, as did net exports and defense spending. Outlays for equipment were also quite soft. We view the meager gain in real GDP posted in the first quarter as exaggerating the weakness early this year. In particular, we are anticipating defense spending to bounce back in the second quarter to a level more consistent with appropriations, and we expect net exports to largely reverse their first-quarter drop. As a consequence, we are projecting real GDP to advance at a pace of a bit more than 2½ percent in the second quarter. Smoothing through the temporary ups and downs, we believe that the economy probably has been expanding at a pace of about 2 percent in the first half of this year, the same rate that we had projected in the March Greenbook. A second major piece of our story that appears to be receiving support from the incoming data is our forecast that consumption growth would slow noticeably. A projected step-down in the growth of consumption is an important reason that in our forecast, even as the housing contraction eventually wanes, growth in real GDP remains below the pace of its potential. Although it is far too early to claim victory, consumer spending on goods has flattened out in recent months after sharp increases at the turn of the year. The shallow trajectory of spending as we move into the second quarter, a lower level of real disposable income, and sluggish chain store sales suggest that our forecast of 2 percent growth of real PCE in the current quarter is within comfortable reach. However, I would like it noted for the record that I am not characterizing this as a “slam dunk.” [Laughter] A third key element of our story in the last Greenbook was that, even though equipment outlays had weakened over the past few quarters, we did not believe that this weakness was the front edge of a more serious retrenchment in capital spending. In that regard, we received a bit of reassurance from an upturn in the shipments of nondefense capital goods in March and an even larger jump in new orders for these goods. Those data suggest that high-tech investment remains on a solid uptrend, whereas investment outside high tech and transportation seems poised for a modest upturn in the second quarter after sizable declines over the preceding six months. As expected, purchases of heavy trucks remain the area of most notable weakness. Needless to say, the data for investment are so volatile that we remain cautious about concluding that the downside risk to capital spending has abated much. But given our recent track record in this area, you might consider it good news when the staff reports no news. A fourth element of our story that, at least for now, seems to be panning out is that the inventory overhangs that emerged in the second half of last year would be worked off relatively smoothly, rather than cumulating into something more serious. In the motor vehicle sector, steep production cuts in the second half of last year and early this year, coupled with a moderate pace of sales, have brought days’ supply of light vehicles down to comfortable levels. Indeed, the automakers have scheduled some increases in production in the current quarter. Outside motor vehicles, manufacturers appear to have adjusted production reasonably promptly to the unintended buildup of stocks. Indeed, manufacturing IP excluding motor vehicles declined at an annual rate of 1½ percent in the fourth quarter and increased only a paltry 2 percent in the first quarter. Some book-value measures of inventory-sales ratios remain elevated, but measures of days’ supply from our flow-of-goods system have shown an improvement that parallels reports from purchasing managers of fewer inventory problems among their customers. Moreover, factory output increased sharply in March, and the available physical product data and the readings from the labor market report point to another sizable increase in April. So the evidence seems to suggest that the inventory correction is abating. I should note that yesterday’s figures on wholesale inventories in March came in below what was assumed by the BEA in the advance estimate of GDP. All else being equal, those data suggest a downward revision in first-quarter real GDP growth of about ¼ percentage point. In response, we’d probably add a similar amount to our second-quarter estimate of real GDP. Finally, another central element of our forecast has been that labor demand would slow in lagged response to the downshift in the growth of overall activity. We have been counseling patience in the face of data in this area that persistently surprised us to the upside. Last week’s labor market report provides at least a shred of evidence in support of our story. Private payrolls increased 63,000 in April, and there was a downward revision of 24,000 in February—leaving the level of employment below that incorporated in the May Greenbook. Gains in private payrolls have averaged about 90,000 per month over the past three months, and we expect that pace to be maintained over the remainder of the quarter. The unemployment rate increased to 4.5 percent last month, also in line with our projection. Putting these pieces together, we are feeling a bit more confident of our story that activity is increasing at a subpar 2 percent pace in the first half of the year. We are also a bit less worried about the upside risks posed by labor demand and consumption and about the downside risks posed by investment spending and inventories—but just a bit less worried. Our longer-term outlook has changed little as well. We have revised down our forecast for the growth of real GDP this year by 0.1 percentage point, to 2 percent, and revised up our forecast for 2008 by a similar amount, to 2.4 percent. I would like to argue that these very small adjustments are a testament to our prescience, but I’ll have to admit that we seem to have benefited more from dumb luck. In brief, the negative consequences of a weaker outlook for housing activity and higher projected oil prices were just about offset by the positive effects of higher equity prices and a lower foreign exchange value of the dollar. Turning first to the housing market, the surprise has not been in actual construction activity, where starts have exceeded our expectations a bit. Rather, the real news has been on home sales—in particular, the sales of new homes. Not only did new-home sales drop in March to a level below our expectations, sales were revised down in the preceding months as well. As a consequence, the months’ supply of unsold new homes has moved up sharply further in recent months instead of tipping down as we had earlier expected. Moreover, sales cancellations, which had appeared to be heading down, turned back up in March. Some of this further weakening may reflect the continuing fallout from the pullback in subprime lending. But we also think that housing demand more generally has continued to soften. With sales now projected to flatten out a lower level than we had previously thought and with the months’ supply of unsold homes at a higher level, we anticipate that the production adjustment will be deeper and longer than was incorporated in our March forecast. Moreover, these developments also led us to trim a bit from our house-price forecast. Another source of downward revision in our outlook for real activity was a $6 per barrel increase in the price of imported oil over the intermeeting period. As Karen will discuss shortly, oil prices have backed off some since the completion of the Greenbook, but they are still running above our March forecast. The effect of higher crude prices has been amplified by a jump in gasoline margins. Those margins have soared as both planned and unplanned refinery outages have resulted in a substantial drop in gasoline inventories. All else being equal, higher consumer energy prices will likely put a noticeable dent in household incomes and consumer spending in coming months. Of course, not all else has been equal. Stock prices are about 7 percent above the March Greenbook assumption, and in our forecast, the associated higher level of household net worth provides greater support to consumer spending and largely offsets the effects of lower real incomes. Another positive offset to weaker housing and higher oil prices is the lower projected path for the dollar. The dollar dropped about 2 percent over the intermeeting period and is expected to remain below our previous projection by about that amount. A lower dollar and the accompanying higher prices for imports provide added impetus to domestic production as foreign and domestic demands are shifted toward domestic producers. With near-term developments unfolding about as we had expected and our longer-term projection benefiting from some powerful crosscurrents, we continue to present you with a reasonably benign outlook. Growth slows but doesn’t falter as actual output moves into alignment with potential. In contrast to our forecast of real activity, we have made some notable changes to our projection of overall price inflation in the near term. In particular, the recent run- up in gasoline prices is leaving a clear imprint on headline inflation. A steep jump in consumer energy prices is projected to boost overall PCE price inflation, which ran at a 3¼ percent pace in the first quarter, to a rate of 4¼ percent in the current quarter— an upward revision of 1½ percentage points from our March forecast. Meanwhile, core inflation has, on net, come in right in line with our expectations. The core measure for February was 0.1 percentage point higher than we had expected and for March was 0.1 percentage point lower. For the first quarter as a whole, core PCE prices increased at a pace of 2¼ percent, the same pace that we had projected in the last Greenbook. We are anticipating a similar-sized increase in the current quarter. Looking ahead, I guess our luck with offsetting errors ran out when it came to the inflation forecast. We accumulated a number of small changes in the key determinants of our inflation projection, and for the most part, they pointed in the same direction. Higher energy costs, higher import prices, a bit tighter labor and product markets, and a slightly lower estimate of the growth of structural productivity suggest somewhat greater upward pressure on price inflation. Each of these influences was small, but taken together, they caused us to revise up our forecast for core PCE inflation by 0.1 percent in both 2007 and 2008. Despite these revisions, we continue to expect core price inflation to edge down next year, from 2.3 percent this year to 2.1 percent next year, as the effects of higher energy and import prices wane, as resource utilization eases a bit, and as inflation expectations hold roughly steady. Karen will continue our presentation." CHRG-110shrg50369--3 STATEMENT OF SENATOR RICHARD C. SHELBY Senator Shelby. Thank you, Chairman Dodd. Chairman Bernanke, we are pleased to have you again before the Committee to deliver the Federal Reserve's Semiannual Monetary Policy Report. I will keep my remarks brief this morning as we are all here to hear your views on the U.S. economy and other related issues. We also have the benefit of having read about your remarks before the House yesterday. Chairman Bernanke, the Federal Reserve has taken a number of steps over the past 6 months to address the tightening of credit markets and the slowdown in economic growth. In a bid to improve interbank liquidity, the Federal Reserve established the term auction facility in December of last year and has conducted, as I understand it, six auctions to date. Since last August, the Federal Open Market Committee has reduced the Federal funds target a total of 225 basis points, taking the target from 5.25 percent to 3 percent. Mr. Chairman, since monetary policy works with a lag, the full impact of this boost to the economy is not yet clear to you or to us. I know that we will spend time this morning discussing the length and the depth of the housing correction that Senator Dodd alluded to, and I think we should. I also want to make sure, however, that this Committee focuses on the risks associated with increasing inflation. The Labor Department, Mr. Chairman, reported this week, as you know, that wholesale price inflation hit a 26-year high in January. The January rise in the Consumer Price Index meant a 12-month change in the overall CPI of 4.3 percent, twice the pace of a year ago. In addition, gold and oil are at all-time highs. These numbers certainly raise questions, Mr. Chairman, as to how much more room the Federal Reserve will have to provide further monetary accommodation without threatening long-term price stability, which is very important to all of us. While it is difficult to see our Nation's economy experience minimal growth, the consequences of failing to restrain inflation will be far more painful and more difficult to unwind. Chairman Bernanke, we are pleased to have you with us this morning, and we look forward to your thoughts on this and other issues. " FOMC20070131meeting--154 152,MR. HOENIG.," Thank you, Mr. Chairman, now that I have everyone’s attention, [laughter] I’m going to start with some information on the District and then talk briefly about the national economy from my perspective. Let me begin by saying that the District’s activity did slow over the second half of 2006 in line with the national economy itself. The slowdown was most apparent in housing and manufacturing. However, the most recent data that we have from November and December indicate a pickup in some of the activity. Moreover, reports from our directors and our business contacts suggest a considerable degree of optimism among them going forward, more than we expected actually. One area in which we are seeing signs of improvement is housing itself. While new construction activity does remain subdued in our region, sales activity has picked up, and the inventory situation appears to be improving in our major markets. Nonresidential construction remains strong and is offsetting some of the weakness on the residential side. District employment growth has risen in recent months, and labor markets remain tight for us. In addition to continuing shortages of skilled workers in a large number of technical and professional areas, we have recently received reports that the hospitality and recreational sectors are experiencing difficulty in finding lower-skilled workers as well. We have also received numerous reports from directors in District businesses indicating higher year-end wage and salary increases. The situation in agriculture is somewhat mixed. The sharp increases in crop prices, especially corn, driven by exports of ethanol and exports of corn itself, have caused the USDA to boost estimates of 2007 farm income rather significantly. However, higher crop prices are also eroding profitability of livestock producers and processors in our region, which is a fairly important sector. One important sector in which activity appears likely to slow in 2007 is energy. The District economy has benefited tremendously over the past few years from the rise in energy prices, which has spurred increased production of traditional products—and that includes oil, gas, and coal—as well as alternative fuels like ethanol and biodiesel. According to reports from a couple of our directors, however, the recent decline in energy prices has already led to a reduction in drilling activity and is likely to cause some cutbacks in new investment in alternative fuels as well. Turning to the national outlook, I, like others, have noted the recent strength in the economy and have raised my estimates of growth for the fourth quarter and somewhat raised them for the first quarter. I continue to expect growth to rise over 2007 modestly toward what I think is potential, in the neighborhood of 3 percent. However, now I expect it to occur a little more quickly than I did at the December meeting. Accordingly, recent economic information has led me to reassess the balance of risks to the outlook. I believe the downside risks from the further slowing of housing have diminished somewhat. Moreover, I share the view that the recent weakness in manufacturing activity reflects a better balancing of production and inventories rather than a fundamental weakness. Going forward, the improved outlook for energy prices should support consumer spending by improving consumers’ disposable income, and we may see additional fiscal stimulus resulting from the more-favorable budget positions of the state and local governments. Finally, in terms of the inflation outlook, my views have not changed materially since the last meeting. I’ve been encouraged by the recent inflation data, and I continue to expect inflation to decline over the forecast period. I expect the core CPI to be in the 2.3 percent range and core PCE inflation to be about 2 percent for 2007. However, as others have noted, core inflation is too high, and considerable uncertainty remains about whether the recent progress will be sustained. Particularly, it is not clear how the opposing trends of lower energy prices and greater resource pressures may play out over the next few quarters. Consequently, it seems to me that there is upside risk to the inflation outlook. Thank you." FOMC20061025meeting--202 200,MS. YELLEN.," Thank you, Mr. Chairman. I support keeping rates unchanged. On the wording, I guess I lean slightly toward B+ over B, but it’s not a matter that I feel strongly about, and I could certainly accept either alternative. I remain quite uncertain about how the various forces in the economy are going to play out. As I said in the economic go-round, I think that, if we maintain the current stance of policy, most likely we will get the desirable features of a soft landing with inflation coming down gradually. But I do think there are substantial risks for output growth. I guess they’re balanced around moderate growth, but I remain concerned about a downside that would include a period of sustained and significant weakness. On the inflation front, I do think that the risks remain tilted in the direction of higher inflation both because I’m uncertain just how the inflation process is working and because, while I believe inflation will come down, I don’t have confidence in the scenario underlying it. If we don’t get the play-out of the downside housing risks, I think there is some probability that growth will actually be sufficiently strong that we’ll get some upward pressure on inflation from the labor market. We’re going to learn a lot by December. A lot of data are coming out that will bear on growth, inflation pressures, the labor market, and so forth. It clearly makes sense to wait. I guess I’m slightly attracted to B+ over B because I think the language more clearly suggests an upward bias for future rate changes and that does reflect my view of the risks to inflation and the likely path of policy. At a minimum, it seems to push back a bit against the market’s view that we’re going to be unwinding rather quickly. But I take the arguments that have been made around the table for B as opposed to B+. I’m not sure that there really is much to be gained by changing the language we have in place on this, and leaving it alone may be the wiser course at the end of the day. On section 2, I think that Governor Kohn made a good argument for changing that language. Again, I could go either way. Finally, on section 3, I prefer the wording in alternative A to that in alternative B. Referring to the high level of prices of energy and other commodities, given that we’ve had a substantial decline in energy prices, really does seem a bit out of date and a bit out of touch." FOMC20060629meeting--170 168,MS. BIES.," Thank you, Mr. Chairman. First, I support the 25 basis point increase at this meeting, and as several people have said, I think the real issue is what we signal going forward. Let me refer to some comments already made and respond to some of my colleagues. President Poole, I’m sort of right where you are: I’m thinking 50-50 going forward, and so I’m leaning toward the neutral language that leaves our options open. However, I’m troubled, too, as Governor Kroszner just said, about talking about our position as restraint at the moment. I see where we are as having removed the excess accommodation. I’m concerned that if we call this restrictive and if we want to backtrack, it might signal that we’re easing up again. I think we’re right in the sweet spot, and I don’t really want to characterize it one way or another because, again, I think we’re where we need to be. The other comment I would make is that we’re still seeing banks loosening lending standards. There’s plenty of liquidity out there. As Governor Warsh said yesterday, people are leveraging. Pricing may be restraining, but there is liquidity. Credit spreads are still very, very minimal. From that perspective, the market, given what they’re seeing day to day in deal-making, may react by asking how we can call it restrictive. I like President Moskow’s comment about moving up the first sentence of row 4, the first part about the moderation in growth, to the rationale. As we spoke around the table yesterday, we were trying to decide what to do with these signals of inflation—how much of this inflation is transitory and how much will be worked out as housing cools because, again, that is really where the slowdown is coming. The slowdown is coming from housing, but that’s what we really wanted to happen. By having the rates rise, we’ve pulled the hot sector down closer to where we want it to be. If you look at section 3 of alternative B, we really are laying out why we think inflation is headed in the right direction. Productivity gains are still good. Unit labor costs, therefore, have been held down. Inflation expectations are contained. We could add to those points that the moderation in aggregate demand will also help contain inflation. However, we still have other pressures. I think the sentence in row 4 supports that rationale, so I like the suggestion that we move it. I also agree with the suggestion that we take out the first word in the sentence, “readings on core inflation” and just say “core inflation.” I am open to saying “unwelcome”—it serves as a signal that we are anchoring expectations. Some numbers as high as 3.8 are very unwelcome to me, so I would be glad to stick the word “unwelcome” in there. The only other thing I would say is that in number 4 I would just put a period after “outlook for both inflation and economic growth.” To get everybody focusing on the outlook is what we’re all talking about. When we say “data dependent,” we mean that we need the data to validate our forecast or to modify it. I think the markets look at just the data, and I would just as soon put a period after “growth.”" CHRG-111shrg61513--51 Mr. Bernanke," Well, first, I agree that the economy is still very weak and very disappointing in that respect. I think low interest rates do tend to help, and I will give you a couple of examples. One, you mentioned the durable goods. Notwithstanding--I have not had a chance to get into those numbers in detail this morning, but investment, actually equipment investment, equipment and software investment has been something of a bright spot and has been growing. And part of the reason for that is that larger firms at least have pretty good access to credit at reasonable rates in the corporate bond market, for example, and that has supported the investment rebound, which is a big part of what we are seeing in the recovery. Another example is that the Fed's actions, interest rate actions and our purchases of mortgage-backed securities, have helped bring down mortgage rates. That has helped to some extent to stabilize demand for housing and helped--as you may know, house prices seem to have flattened out and begun to rise a bit, which is very important for consumers in terms of their wealth, in terms of the risk of foreclosure, and in terms of, you know, restarting activity in the residential construction sector. So those are two examples where we see growth. We did have 4-percent growth in the second half of 2009. I think the issue we face is will the growth be fast enough to materially reduce the unemployment rate at a pace that we would like to see, and that is a big uncertainty right now. But we are getting some output growth at this point. Senator Johanns. Mr. Chairman, thank you. Senator Johnson. Senator Brown. Senator Brown. Thank you, Mr. Chairman. Mr. Chairman, nice to see you. We all know for most of our Nation's history--I am going to go in a bit different direction. For most of our Nation's history, manufacturing and agriculture and transportation drove our economy, whether it is steel in Youngstown or agriculture around places like Lexington, Ohio, or the Port of Cleveland shipping raw materials and finished goods all over the Midwest. As an expert on--as an economic historian, as you are, and an expert on the Great Depression, you are aware, obviously, of the role of manufacturing, especially a historic role, in pulling our Nation out of recession. As many Ohioans can tell you, can painfully tell you, manufacturing steadily declined over the last three decades. At the same time, we know that the financial industry has rapidly expanded. As recently as the 1980s, manufacturing made up 25 percent of GDP; financial services made up less than half of that, in the vicinity of 11 or 12 percent. Those numbers crossed in the 1990s. Now it is almost a direct flip. Manufacturing, 12 percent; financial services, 20 or 21 percent. Wall Street's output, put another way, was equal to all the Farm Belt States and the Industrial Belt States combined. In 2004, 44 percent of all corporate profits in the United States came from the financial sector compared with 10 percent from manufacturing. And I say that as a preface to my question for this reason: Kevin Phillips, the writer, has noted sort of the history of great nations in the last 400 years. Habsburg Spain, the United Provinces of Netherlands, and Imperial England, all three saw their economies go from manufacturing, shipping, agriculture--depending on which of each of the three--and energy into more and more emphasis on financial services. And the financialization in that sense is what probably cost those empires their empire. They were countries that never really recovered in the wealth creation. It really is the fact that banking is not an independent source of wealth. It does not cause our prosperity. The success of banking is created by our success and our ability to create wealth. Then I hear people, when I talk about manufacturing policy, I hear your predecessors say this, I hear advisers in the White House, regardless of party, say we cannot have a manufacturing policy, we cannot pick winners and losers. Well, it is pretty clear in the 1980s that this country, this Government, your predecessors, and the Treasury Department picked winners and losers. They decided that financialization, the financial services sector should be the winner as we got rid of usury laws, as we changed rules and deregulated and all those things. So we put ourselves in a position where, as Kevin Phillips said, finance is the chosen sector of the U.S. economy. So my question is this: As your role, your statutory role, a mandated target of 4-percent unemployment, it is at least twice, maybe three times that right now. When I look at a building on the Oberlin College campus 20 miles from my house, fully powered by solar energy, the largest solar-powered building on any college campus in America, about 8 years it was built. All the panels were built in Germany, a country that had an industrial policy that stimulated demand and supply and have built clean energy jobs way better than we have. You read the articles in the paper about what China is about to way outcompete us on alternative energy, solar and wind turbines. We know all that. We still sit with no manufacturing policy. So my question is this: As the economic historian that you are, are you troubled by the fact that the financial sector is now twice the size of the manufacturing sector? And I put parentheses around the next part of that, that no country that I can see in economic history has done well when that happened. Are you troubled by that? And if you are troubled by that fact that the financial industry is twice the size of manufacturing, flipping what it was, what should we do about it and what are you doing about it? " FOMC20070131meeting--118 116,MS. YELLEN.," Thank you, Mr. Chairman. Recent data on economic activity have been loaded with upside surprises for most spending categories and also for labor markets. Our response, like the Greenbook, has been to boost our estimate of growth last quarter and our forecast for growth this quarter. For 2007 as a whole, we have revised up our projection for real GDP growth about ¼ percentage point, to about 2¾ percent, which is just a bit below our estimate of the trend, which is a bit higher than the Greenbook. This performance continues to reflect the so-called bimodal economy with weakness in housing and autos coupled with strength almost everywhere else. Looking beyond the first quarter, we interpret recent data as suggesting that the drag from both weak sectors is likely to diminish, providing impetus for an acceleration of activity later this year. Even so, the Greenbook forecasts, and we agree, that other factors will likely offset this acceleration so that GDP will grow slightly below trend in 2007. In particular, the Greenbook hypothesizes that the growth of consumer spending will slow, with the saving rate rising from minus ¾ percent at the end of last year to plus 1 percent at the end of next year. This forecast strikes us as quite reasonable. House-price appreciation has slowed dramatically, and the impetus it has given consumption should diminish over time. In addition, the Greenbook notes, and Larry emphasized, that consumer spending has grown more rapidly than fundamentals can explain, and it’s sensible to predict some unwinding of this pattern. Such an outcome, however, would represent a noticeable change in the trend of the saving rate. So to me the possibility that the saving rate will not, in fact, rebound to the extent anticipated in the Greenbook constitutes a serious upside risk to the outlook. Of course, the staff has emphasized this. An alternative simulation in the Greenbook illustrates that if spending instead advances in line with income, the unemployment rate would decline noticeably further from a level that is already low. It is precisely because we are starting from a situation in which labor markets are already arguably tight that the upward revisions to growth during the intermeeting period particularly concern me. Some period of below-trend growth may ultimately be necessary to address inflationary pressures emanating from the labor market. In December, I emphasized the puzzle presented by the combination of an apparently sluggish economy and a robust job market. Upward revisions to estimated growth in the fourth and first quarters resolve a portion of that discrepancy. Even so, Okun’s law still suggests that the excess demand in labor markets as reflected in the low unemployment rate is abnormally large relative to that in goods markets as reflected in estimates of the output gap. The current low unemployment rate may turn out to have benign implications for inflation. For example, labor market tightness may well diminish somewhat over time, given that the lags between output growth and labor market adjustments can be quite variable. Another benign possibility is that the unemployment rate may be overstating the tightness of labor markets. For example, some indicators of labor market conditions, like the Conference Board index for job market perceptions, suggest a bit of softening. Indeed, available indexes of labor compensation do not provide compelling evidence of cost pressures emanating from the labor market. However, compensation data are mixed, and I must admit that the signal from them is somewhat confusing. While I remain concerned about the risk that labor market pressures could boost inflation over time, I’m still fairly optimistic about the outlook for inflation overall. Core inflation has come down in recent months, which is welcome, although we must be careful not to overreact. Recent favorable data could reflect the dissipation of pressures from energy prices and owners’ equivalent rent; these sources of disinflation are inherently transitory, and once they are fully worked through the system, we will be left with the influence of more-enduring factors, such as the extent of excess demand or supply in labor and product markets. If these markets are, in fact, unduly tight, we could eventually see rising inflation. Inflation expectations also matter for the inflation outlook, and I see the stability of inflation expectations as contributing to a favorable inflation prognosis. As I previously mentioned, my staff and other researchers find some evidence that inflation has become less persistent over the past decade, a period during which inflation and inflation expectations have been low and stable. Both survey and market-based estimates suggest that longer-term inflation expectations remain stable and well anchored. So to sum up, I continue to view a soft landing with moderating inflation as my best-guess forecast, conditional on maintaining the current stance of policy. We expect core PCE price inflation to edge down from 2¼ percent last year to about 2 percent in 2007. While there are risks on both sides of the outlook for growth, I’m a little more focused on the upside risks after the recent spate of strong data. It’s encouraging that the recent inflation news has been good. However, there’s a great deal of uncertainty about inflation going forward, and to me these risks remain biased to the high side." 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-109hhrg23738--180 Mr. Garrett," Yes. Thank you, Mr. Greenspan. I appreciate your being with us today, and also the times in the past. Just one question, which is a follow-up question with regard to the GSE reform. And I also appreciate your opening comment saying that when you first arrived, that you had a hard time getting your hands around exactly how they operate. So if you have that difficulty, then I feel a lot better myself, trying to figure out how they operate. You had indicated already to one question with regard to the portfolio size your concerns about that and the concerns about this committee's lack of passing legislation that would address the growth in portfolio size. And the question by Mr. Hensarling was regarding another significant portion of that bill, and that is that 5 percent portion, as far as adding to the housing stock in the country. My question to you is: How do these two issues dovetail? And that is to say, with that 5 percent provision in there, is that just going to exacerbate the portfolio problem by putting any pressure or impetus on the industry to grow their portfolios so they---- " fcic_final_report_full--480 PMBS rely on a classification and subordination system known as “tranching” to provide some investors in the pool with a degree of assurance that they will not suffer losses because of mortgage defaults. In the tranching system, different classes of securities are issued by the pool. The rights of some classes to receive payments of principal and interest from the mortgages in the pool are subordinated to the rights of other classes, so that the superior classes are more likely to receive payment even if there are some defaults among the mortgages in the pool. Through this mechanism, approximately 90 percent of an issue of PMBS could be rated AAA or AA, even if the underlying mortgages are NTMs that have a higher rate of delinquency than prime loans. In theory, for example, if the historic rates of loss on a pool of NTMs is, say, five percent, then those losses will be absorbed by the ten percent of the securities holders who are in the classes rated lower than AAA or AA. Of course, if the losses are greater than anticipated—exactly what happened as the recent bubble began to deflate—they will reach into the higher classes and substantially reduce their value. 48 It is not clear whether, in 2007 or 2008, mortgage delinquencies and defaults had actually caused cash losses in the AAA tranches of PMBS, but the rate at which delinquencies and defaults among NTMs were occurring throughout the financial system was so high that such losses were a distinct possibility—obviously a matter of great concern to investors. This means that investors in PMBS and government-backed Agency MBS had different experiences when the bubble began to deflate. Those who invested in Agency MBS did not suffer losses (the U.S. government has thus far protected all investors in Agency MBS), while those who invested in PMBS were exposed to losses if the losses on the underlying mortgages were so great that they threatened to invade the AAA and AA classes. Even if no cash losses had actually been suffered, the holders of PMBS would see a sharp decline in the market value of their holdings as investors—shocked by the large number of defaults on mortgages—fled the asset- backed market. So when we look for the direct effect of mortgage failures on the financial condition of various financial institutions in the financial crisis we should look only to the PMBS, not the MBS issued by the Agencies. In addition, the default and delinquency ratios on the loans underlying the PMBS were higher than similar ratios among the loans held or guaranteed by the Agencies. Many of the loans which backed the PMBS were the self-denominated subprime loans (that is, made by subprime lenders explicitly to subprime borrowers) and were classified in the worst-performing categories in Table 3. In part, the better- performing characteristics of the NTMs held or guaranteed by the Agencies was due to the fact that the Agencies were not buying for economic purposes—to make profits—but only to meet government requirements such as the AH goals. They did not want or need the higher-yielding and thus more risky mortgages that backed the PMBS, because they did not need higher yields in order to sell their MBS. In addition, because of their lower cost funding, the Agencies could pay more for the NTMs they bought and thus could acquire the “best of the worst.” 48 A thorough description of the tranching system, and many more details about various methods of protecting senior tranches, is contained in Gary B. Gorton, Slapped By the Invisible Hand: The Panic of 2007, Oxford University Press, 2010, pp. 82-113. 475 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. " CHRG-110hhrg46593--80 Mr. Bernanke," Well, they are both a symptom and a cause. Now that the house prices are falling and that the economy is weakening, people don't have the income to make their payments, the house foreclosures are going up. So that is a symptom of the downturn. But it is also a cause, because it is weakening house prices, it is hurting the value of mortgages, which hurts financial institutions. So it is part of the mechanism which is causing the economy to weaken. Ms. Velazquez. So can you tell me how much of the more than $1 trillion spent by the Treasury and Fed in the bailout has gone to prevent individual foreclosures? " FOMC20061212meeting--84 82,MR. PLOSSER.," Thank you, Mr. Chairman. The economic picture in our region has changed little since our last meeting. The coincident indicators in our Business Outlook Survey suggested that economic activity continues to expand at a moderate pace in each of our three states, and the business contacts expect that pace to continue. I’m beginning to feel as though I’m reading the same chapter of the book again. It’s like Yogi Berra—it’s déjà vu all over again. The weakest sector in our region, as in the nation, is of course housing, which continues to decline. Sales and permits continue on a downward trend, and cancellations rose significantly in November; but builders have been able to resell, albeit at lower prices, homes whose initial purchasers have reneged. However, our survey of smaller homebuilders suggests that conditions on average in the housing market in our District seem somewhat better than in the nation as a whole. None of the builders we polled reported low inventories of unsold homes. Interestingly enough, 86 percent of them said their inventories were about right; only 14 percent said inventories were high; and no one reported that they were extremely high. In comparison, across the nation, 51 percent of builders reported that inventories were either low or about right, and 49 percent reported either high or extremely high inventories. Certainly some areas in our District have had a sharp drop in housing activity. The most notable is the Jersey Shore. But generally, based on what I’m hearing from firms in our District, I would continue to characterize the decline in housing in our region as an orderly one. Commercial real estate continues to perform very well. We’ve had some downturn in the value of nonresidential building contracts in the last month, but these data are very volatile, and the revisions tend to be upward as new contracts are reported over time. Our contacts in that sector continue to be among the most optimistic in our region. Office vacancy rates continued to decline in the past few months both in Center City Philadelphia and in the suburbs, and the net absorption of office space continues to be positive. Rents have risen, and the increase in occupancy has led to a scarcity of large blocks of available space, which bodes well for construction. Manufacturing activity in our region has been softening this fall, and we haven’t seen much of an increase since then. After two negative readings in September and October, the general index of economic activity in our business outlook survey turned positive in November, but its level of slightly above 5 suggests that that’s really not much change in the outlook. New orders and shipments were modestly weak. Shipments were actually strong. Orders were a little weaker, but the recent weakness is consistent with softness in national manufacturing and, as we’ve seen, in the purchasing managers’ index. Optimism for future capital spending actually rebounded last month— so the picture there is very mixed. Consumer spending continues to hold up well. Auto dealers and retailers reported strong sales in November and are optimistic about the holiday season. Labor market conditions in the District have changed little. Payroll employment growth in our three states is up at an annual rate of about 0.7 percent, which is slower than the national rate, but that’s just a fact of the population growth in our District. Unemployment rates remain low, near or below the national rates. Business contacts continue to cite difficulty in finding qualified workers, especially for skilled and professional positions. Area employers indicate that, over the past few months, wages have been steadily rising at a pace higher than earlier this year. I also want to mention some anecdotal information that I find interesting. Last week I met with a number of mostly manufacturing CEOs from my District. An observation that one of them made, which many agreed with, was that from their perspective money was almost free. This observation is consistent with what some others have been saying around the table. They thought that there was plenty of liquidity and that interest rates were not limiting them particularly in any way. This observation is also consistent with the views that mortgages rates are still relatively low and that credit spreads show less stress on businesses at this point. I take these observations to indicate that monetary policy is not particularly restrictive at this point. Also on the anecdotal side, the several manufacturers who participate as suppliers to both homebuilding and commercial real estate lamented their housing-related business, whether plumbing, cabinetry, or flooring, which were the three industries represented. On the residential side, the markets were terrible. Business was very bad. However, they all said that the commercial side was booming so much that it more than made up for their weakness on the residential side so that business tended to still be pretty good. In contrast to President Poole’s comment about trucking, I had one trucking CEO who said actually that business was good. It was weak in the Northeast—shipments were down there—but in the South and West their business was picking up and doing pretty well. He also made an interesting comment that I had not really thought about. He said that part of the change in trucking is that, while volumes may be down and they are having trouble finding drivers, there has also been a revolution in packaging. In fact, even though trucking volumes are down, the value of products and goods being shipped is actually up. As an example, they used to ship the big boom boxes that people listened to music on; now they’re shipping iPods. So as packaging has become more efficient and more protective, the truck volume is less, but the value is actually higher. He said that this was an ongoing trend in the trucking industry and that one had to be careful about interpreting volumes. On the inflation front, manufacturers continue to report higher production costs, but these cost increases have been less widespread than recent surveys indicated. Indexes of prices paid and prices received have continued to climb, and they’re still above where we’d like to see them. On the national side, my outlook has changed very little since our last meeting. Compared with earlier this year, growth has weakened, as we all know and have discussed. Housing slowed a little faster than perhaps we anticipated but—I agree with President Lacker—the prospects of spillovers remain relatively low. Again, as Bill applauded Janet’s wonderful one-handed/two- handed presentation, the labor markets are sending a completely different signal. As I said earlier, manufacturers and employers in our region continue to find scarcity in the labor market, both skilled and unskilled. If we thought that the economy were weakening and we expected growth to remain appreciably below potential and weak for a number of additional quarters, it might be important to allow short-term interest rates to move down—but not because I think the Fed can do much to prop up growth in those circumstances, that is, to ride some kind of Phillips curve. After all, businesses say there’s ample liquidity, and mortgage rates remain relatively low. But because equilibrium market rates may be lower over a sustained period, we might want to see a fed funds rate that’s consistent with that. This would be particularly relevant if we were sanguine about inflation. However, in my view, we’re not in that situation yet. As has been alluded to, many market commentators have pointed to the inversion of the yield curve as an indicator that recession is probable, but as suggested by the Chairman and the research that has been done, some of it by the Board staff, the predictive power of changes in the slope of the yield curve depends on why the slope of the yield curve changes. The change in the slope of the yield curve suggested by the research that was alluded to earlier has been about 100 basis points, but about half of that has been in the risk premium associated with long-term rates. At the same time, the predictive content of that risk premium change for recession or GDP growth is much less than absolute changes in real rates. So I take that research to say that the inversion of the yield curve may be forecasting slower growth but not a recession to date. Thus, inflation remains a significant concern to me. Recent readings on headline inflation have shown some encouraging downward movement, and inflation expectations have remained stable. But the level of core inflation continues to be higher than what I consider to be consistent with price stability. Moreover, the forecast does not show us reestablishing price stability in the near future. That’s a reasonable, although unwelcome, forecast to the extent that very accommodative monetary policy over the past five years helped fuel the acceleration of inflation and that monetary policy and financial markets have not tightened much and aren’t expected to tighten much over the coming period. The Bluebook indicates that the current real fed funds rate is within the range of model-based estimates of the equilibrium rate—that is, policy is not terribly tight—and, as I suggested earlier, long rates including mortgage rates are at relatively low levels, suggesting ample liquidity in the market. I’m not convinced that price stability will be achieved without further action on the part of the Fed, and I’d feel more comfortable after seeing a few more months or even another quarter or two of deceleration. The slight deceleration in core inflation that we have seen, coupled with the slower economic growth, has meant that implicit firming of policy even without a change in the nominal funds rate might be in the cards, and that would be a welcome change. I’m not convinced that the recent decline in energy prices will provide the relief we would like to see in core inflation. As suggested by Jeff and my question earlier, I’m concerned that, if oil prices stabilize around $60 a barrel, we will see core inflation begin to creep back up once the temporary benefits of the decline have disappeared. Indeed, gasoline prices have already risen somewhat in the past few weeks from the lows that we saw in late September and early October. As has been mentioned, the sharpest increases in the components of inflation that we’ve looked at over the past few months seem to be in those elements that are least likely to be influenced by energy prices. In addition, as Jeff said, I’m very dubious that the gap measures that we allude to periodically are going to act as much of a constraint on price increases going forward. The bottom line is that I’m not hopeful that energy prices or the output gap will provide us with much of the inflationary relief that we’re looking for. Thank you, Mr. Chairman." fcic_final_report_full--91 Despite this diffusion of authority, one entity was unquestionably authorized by Congress to write strong and consistent rules regulating mortgages for all types of lenders: the Federal Reserve, through the Truth in Lending Act of . In , the Fed adopted Regulation Z for the purpose of implementing the act. But while Regu- lation Z applied to all lenders, its enforcement was divided among America’s many fi- nancial regulators. One sticking point was the supervision of nonbank subsidiaries such as subprime lenders. The Fed had the legal mandate to supervise bank holding companies, in- cluding the authority to supervise their nonbank subsidiaries. The Federal Trade Commission was given explicit authority by Congress to enforce the consumer pro- tections embodied in the Truth in Lending Act with respect to these nonbank lenders. Although the FTC brought some enforcement actions against mortgage companies, Henry Cisneros, a former secretary of the Department of Housing and Urban Development (HUD), worried that its budget and staff were not commensu- rate with its mandate to supervise these lenders. “We could have had the FTC oversee mortgage contracts,” Cisneros told the Commission. “But the FTC is up to their neck in work today with what they’ve got. They don’t have the staff to go out and search out mortgage problems.”  Glenn Loney, deputy director of the Fed’s Consumer and Community Affairs Division from  to , told the FCIC that ever since he joined the agency in , Fed officials had been debating whether they—in addition to the FTC—should enforce rules for nonbank lenders. But they worried about whether the Fed would be stepping on congressional prerogatives by assuming enforcement responsibilities that legislation had delegated to the FTC. “A number of governors came in and said, ‘You mean to say we don’t look at these?’” Loney said. “And then we tried to explain it to them, and they’d say, ‘Oh, I see.’”  The Federal Reserve would not exert its authority in this area, nor others that came under its purview in , with any real force until after the housing bubble burst. The  legislation that gave the Fed new responsibilities was the Home Owner- ship and Equity Protection Act (HOEPA), passed by Congress and signed by Presi- dent Clinton to address growing concerns about abusive and predatory mortgage lending practices that especially affected low-income borrowers. HOEPA specifically noted that certain communities were “being victimized . . . by second mortgage lenders, home improvement contractors, and finance companies who peddle high- rate, high-fee home equity loans to cash-poor homeowners.”  For example, a Senate report highlighted the case of a -year-old homeowner, who testified at a hearing that she paid more than , in upfront finance charges on a , second mortgage. In addition, the monthly payments on the mortgage exceeded her income.  HOEPA prohibited abusive practices relating to certain high-cost refinance mort- gage loans, including prepayment penalties, negative amortization, and balloon pay- ments with a term of less than five years. The legislation also prohibited lenders from making high-cost refinance loans based on the collateral value of the property alone and “without regard to the consumers’ repayment ability, including the consumers’ current and expected income, current obligations, and employment.”  However, only a small percentage of mortgages were initially subject to the HOEPA restrictions, be- cause the interest rate and fee levels for triggering HOEPA’s coverage were set too high to catch most subprime loans.  Even so, HOEPA specifically directed the Fed to act more broadly to “prohibit acts or practices in connection with [mortgage loans] that [the Board] finds to be unfair, deceptive or designed to evade the provisions of this [act].”  fcic_final_report_full--179 DISCLOSURE AND DUE DILIGENCE: “A QUALITY CONTROL ISSUE IN THE FACTORY ” In addition to the rising fraud and egregious lending practices, lending standards de- teriorated in the final years of the bubble. After growing for years, Alt-A lending in- creased another  from  to . In particular, option ARMs grew  during that period, interest-only mortgages grew , and no-documentation or low-docu- mentation loans (measured for borrowers with fixed-rate mortgages) grew . Overall, by  no-doc or low-doc loans made up  of all mortgages originated. Many of these products would perform only if prices continued to rise and the bor- rower could refinance at a low rate.  In theory, every participant along the securitization pipeline should have had an interest in the quality of every underlying mortgage. In practice, their interests were often not aligned. Two New York Fed economists have pointed out the “seven deadly frictions” in mortgage securitization—places along the pipeline where one party knew more than the other, creating opportunities to take advantage.  For example, the lender who originated the mortgage for sale, earning a commission, knew a great deal about the loan and the borrower but had no long-term stake in whether the mortgage was paid, beyond the lender’s own business reputation. The securitizer who packaged mortgages into mortgage-backed securities, similarly, was less likely to retain a stake in those securities. In theory, the rating agencies were important watchdogs over the securitization process. They described their role as being “an umpire in the market.”  But they did not review the quality of individual mortgages in a mortgage-backed security, nor did they check to see that the mortgages were what the securitizers said they were. So the integrity of the market depended on two critical checks. First, firms pur- chasing and securitizing the mortgages would conduct due diligence reviews of the mortgage pools, either using third-party firms or doing the reviews in-house. Sec- ond, following Securities and Exchange Commission rules, parties in the securitiza- tion process were expected to disclose what they were selling to investors. Neither of these checks performed as they should have. Due diligence firms: “Waived in” As subprime mortgage securitization took off, securitizers undertook due diligence on their own or through third parties on the mortgage pools that originators were selling them. The originator and the securitizer negotiated the extent of the due dili- gence investigation. While the percentage of the pool examined could be as high as , it was often much lower; according to some observers, as the market grew and originators became more concentrated, they had more bargaining power over the mortgage purchasers, and samples were sometimes as low as  to .  Some secu- ritizers requested that the due diligence firm analyze a random sample of mortgages from the pool; others asked for a sampling of those most likely to be deficient in some way, in an effort to efficiently detect more of the problem loans. 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." FOMC20070807meeting--122 120,MS. YELLEN.," Thank you, Mr. Chairman. I think the inflation news has continued to be encouraging, but the risks remain on the upside. With respect to growth, the prospects have worsened, and I think there is greater downside risk for the reasons that we have discussed. I think the market response to these events is not inappropriate. They perceive a greater likelihood that we will need to cut the fed funds rate sooner and more deeply than seemed likely only a few weeks ago, and I think we should essentially try to leave those expectations in place today to indicate that we intend not to respond to asset prices or to the problems of particular dealers or financial institutions directly but to assess the economic consequences of the turmoil. So the question is, What is the right language to do that? The alternative B language that is proposed is trying to achieve exactly what I think is appropriate. So I agree with the goal of alternative B. I’m simply concerned about some of the actual language that is proposed. Particularly I worry about the language in paragraph 4. When you say “although the downside risks to growth have increased somewhat, the Committee’s predominant policy concern remains the risk that inflation will fail to moderate,” that’s like saying—perhaps because I respond so strongly to the word “predominant”—that, yes, we see greater downside risk, but we don’t care; we remain totally focused on inflation. [Laughter] That bothers me. That’s how it comes across to me. I don’t think the intention is to make it that way. So I would make two proposals to soften it. I think what we need to do is dial it down, but I do think that inflation risk remains to the upside. I would second two suggestions that have already been made. I would second President Fisher’s suggestion that we remove the word “predominant” from paragraph 4. We might say, “The Committee remains concerned about the risk that inflation will fail to moderate as expected.” Now, I do think the downside risk has increased on the growth side. I’m not sure it is actually necessary to say so explicitly, and I think dialing down paragraph 4 by simply removing “predominant,” along with the additional language that is proposed in line 2, might be sufficient. But I think that we actually do agree that downside risks have increased. If we want to express that, I would endorse President Poole’s suggestion that we move the language about downside risks to paragraph 2, saying something after “for some households and businesses, and the housing correction is ongoing.” We could then say, “Although the downside risks to growth have increased somewhat, nevertheless the economy seems likely to continue to expand at a moderate pace.” So we would get it in there. Basically we would say that we see it, but nevertheless we think most likely the economy will grow at a moderate pace. If financial turbulence diminishes and markets stabilize, not having downside risks to growth in paragraph 4 and continuing to express some asymmetric bias, some worry about inflation, we’ll be comfortable living with that going forward, and it is a good summary of where we are. So those are my suggestions." FOMC20070321meeting--75 73,MR. MOSKOW.," Thank you, Mr. Chairman. Conditions in the Seventh District are similar to what I reported last time. Business activity continues to expand at a modest pace. However, while my contacts expressed some increased uncertainty, most of them maintained a positive view about the outlook for the second half of the year. As we know, the two sectors that generated the most uncertainty this round are housing and business investment, and so I want to concentrate some of my comments on those two areas. On the housing front, my contacts continue to be unsure about how soon the turnaround will be. A director from Pulte Homes saw hints of a better tone in the market but acknowledged that signs were still tentative. He did say that the larger builders have reduced their stock of speculative homes. Another director, who is CEO of U.S. Gypsum, thought it would be a couple of months before he had a better idea whether the market had hit bottom. Furthermore, he thought that, even after the market hits bottom, it would be quite a while before building materials recovered to normal sales levels. As we were discussing, the subprime situation could be a serious problem for the macroeconomy in a couple of ways. One would be a major spillover to house prices—it’s too soon to tell about this now, but new spring listings should shed some light by our next meeting. The other would be significant fallout to other credit market segments, and we don’t see this yet either. I contacted both GM and Ford, and they said that the subprime mortgages held by their credit subsidiaries had deteriorated, but they had not seen increased defaults in other portions of their portfolios. Notably, they had not seen any unusual problems in auto loans, and we generally heard this sentiment of a lack of spillover from bankers as well. On the supply side, given the ample liquidity in financial markets, it seems unlikely that the subprime problem will cause major changes in overall credit availability or pricing. Turning to business investment, none of my contacts reported any major changes in capital spending plans one way or the other. That said, I did sense that businesses had become a bit more cautious, as David mentioned. A CEO of a major bank thought that some of this caution was due to the news in the subprime market, but he didn’t think that this was impinging on spending in a meaningful way. As noted by the head of a major private-equity firm, who is on our board, the recent volatility in financial markets has not significantly altered the availability or terms for financing, even for riskier projects. Private-equity firms continue to raise large sums, as Janet discussed. So although I’m more concerned about the outlook, I don’t see the forces in play that would generate a major retrenchment in capital spending. Inventories are another factor that has weighed on growth recently. We’ve heard mixed reports from District contacts about how far along they are in the inventory-adjustment process. In steel, the process seems to be taking longer than expected, but in motor vehicles, both GM and Ford now are generally comfortable with their inventory positions and currently are not planning any major changes in their assembly schedules. Finally, some sectors of the economy appear to be on good footing. Healthy labor markets continue to support solid gains in consumer spending, and as Karen discussed, growth abroad continues to support export demand. After balancing all the factors, we marked down our near-term forecast for GDP a bit but retained the basic contours of our previous projection. The most important difference between our forecast and the Greenbook is that we do not see as much short-term weakness, but the uncertainty surrounding this forecast has increased. By itself, the change to the growth outlook this round would suggest slightly less inflation risk, but other factors point to continued concern about inflation. The past couple of readings on consumer prices have been disappointing. Oil prices are higher than at our last meeting, and unit labor costs accelerated noticeably over the past year. Furthermore, labor markets remain tight. So while the benefits of some factors, notably the earlier declines in energy costs, will be transitory, pressures from high labor costs are likely to persist. Markups remain high enough to absorb some cost increases, but these margins could evaporate quickly, as they did in the late ’90s. In the end, we did not materially change our outlook for inflation. We continue to project that core PCE prices will increase about 2¼ percent both this year and next. This inflation rate is too high for my taste, and I think for many of us, and I’m not confident that inflation will moderate adequately as we move into 2009. One reason for my concern is highlighted in the Bluebook—namely, that the private sector seems to be betting that our inflation objective is 2 percent or higher. So I continue to think that over the forecast period as a whole the risks to price stability exceed the risks to sustainable growth." FOMC20071211meeting--48 46,MR. EVANS.," Thanks. Dave, I have two questions, I suppose. The first one is that the Greenbook GDP forecast has come down a good bit since October. At the same time, the Greenbook-consistent short-run equilibrium real funds rate was revised down ¾ percentage point. How much independent information is there between these two observations? I mean, the equilibrium real funds rate is the rate which, if maintained for some period of time, would get us back up to potential growth. So the fact that you have marked that down suggests that you would have a lower real rate. The second question is this: We were expecting the economy to slow during the current period. Expectations of slowing versus slowing that is revealed in the data are very important for how we think about the outlook—maybe you said this, but I don’t recall it. Could you give me an idea of how in the Greenbook your assumptions have evolved since October with regard to prospective losses due to mortgage foreclosures and the write- downs that the banks are expected to take or have announced on this? Do you have some numbers in mind on how things have changed in that regard and how that might be influencing your housing outlook? Thank you." CHRG-111hhrg54869--161 Mr. Miron," Thank you, Mr. Chairman, Ranking Member Neugebauer, and committee members. Let me begin by expressing my thanks for the opportunity to present my views on this matter. The question I will address is whether Congress should adopt Title XII of the proposed Resolution Authority for Large Interconnected Financial Companies Act of 2009. This Act would grant the FDIC powers for resolving insolvent financial institutions similar to those that it currently possesses for revolving banks. My answer to this question is an emphatic, unequivocal ``no.'' Let me explain. The problem that resolution systems attempts to address is that when our financial system fails, the value of the claims on that institution's assets exceed the value of the assets themselves. Thus, someone must decide who gets what, and it is impossible, by virtue of the assumption that we are dealing with a failed institution, to make everyone whole. The size of the pie owned by the failing institution has shrunk so those who are expecting a slice of that pie collectively face the necessity of going somewhat or substantially hungry. The resolution authority decides who gets what, but the reality is that someone has to go wanting. It is in society's broad interest to have clear, simple, and enforceable procedures for resolving failed institutions, principally to ensure that investors are willing to commit their funds in the first place. If the rules about resolution were arbitrary and ever-changing, investors would be loathe to invest and economic investment productivity and growth would suffer. A well-functioning resolution process is part of a system for defining and enforcing property rights, which economists agree is essential to a smoothly functioning capital system. The crucial thing to remember here is that someone has to lose. Just as importantly, it is valuable to society as a whole, although not to the directly-harmed parties, that those invested in the failed institutions suffer economic losses. This releases resources to better uses, provides signals about good and bad investments and rewards those who have made smart decisions. The flip side of the fact that standard resolution systems, like bankruptcy, impose an institution's losses on that institution's stakeholders, is the fact that a standard of resolution authority, such as the courts, puts none of its own resources into that institution. The resolution authority is resolving claims and dividing the pie but is not adding any more pie. Under the bill being considered, however, the FDIC would have the power to make loans to the financial institutions to purchase its debt obligations and other assets, to assume or guarantee obligations and so on. This means the FDIC would be putting its own, that is, taxpayers' skin in the game, a radical departure from standard bankruptcy and an approach that mimics closely the actions that Treasury took under TARP. Thus, this bill institutionalizes TARP for bank holding companies. A crucial implication of this departure from standard bankruptcy is the taxpayer funds foot the bill for the loans, asset purchases, guarantees, and other support that FDIC would provide to prevent failing institutions from going under. These infusions of taxpayer funds come with little meaningful accountability, and it would be hard to know when they have been paid back and often that will not occur. The proposed new authority for the FDIC also generates the impression that society can avoid the losses that failure implies, but that is false. The proposed FDIC actions would merely shift those losses to taxpayers. The new approach is institutionalized bailouts, plain and simple. Thus, under the expansion of FDIC authority to cover nonbank financial institutions, bank holding companies will forever more regard themselves as explicitly, not just implicitly, backstopped by the full faith and credit of the U.S. Treasury. That is moral hazard in the extreme and it will be disastrous for keeping the lid on inappropriate risk taking. The right alternative to expanding FDIC authority is good old-fashioned bankruptcy. It has become accepted wisdom that bankruptcies by financial institutions cause great harm, and it is asserted in particular that letting Lehman Brothers fail was the crucial misstep last fall. In fact, nothing could be further from the truth. As I explain in more detail in my written testimony, the ultimate causes of the financial crisis were two misguided Federal policies; namely, the enormous subsidies and pressure provided for mortgage lending to non-creditworthy borrowers and the implicit guarantees provided by both Federal Reserve actions and the U.S. history of protecting financial institution creditors. These forces generated an enormous misallocation of investment capital, away from plant and equipment towards housing, created the bubble, and established a setting where numerous financial institutions had to fail because their assets were grossly overvalued relative to fundamentals. Lehman's failure was one part of this adjustment, and it was a necessary part. If anything, too few financial institutions failed since the massive interventions in credit housing markets that have occurred in the past year have artificially propped up housing prices, delaying the adjustments. Thus, the better way to resolve nonbank financial institutions is bankruptcy, not bailout. That is not to say existing bankruptcy law is perfect. One can imagine ways it might be faster and more transparent, which would be beneficial, nor should one assume that had bankruptcy been allowed to operate fully in the fall of 2008, the economy would have escaped without any pain. A significant economic downturn, in particular, was both inevitable and necessary given the fundamental misallocation of capital that occurred in the years before the panic, but nothing in the data, historical data or recent experience, suggests these bankruptcies would have caused anything worse than what we experienced and broader bankruptcies would have helped eliminate more hazards going forward. In light of these assessments, I urge the members of this committee to vote against this bill since it codifies an approach to the resolution that is fundamentally misguided. We need to learn from our mistakes and trust bankruptcies, not bailouts, going forward as we should have done in the recent past. [The prepared statement of Mr. Miron can be found on page 66 of the appendix.] " 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." FOMC20070509meeting--47 45,MR. REINHART.,"2 Yesterday afternoon, we posted to the secure document server a summary of the economic projections that you submitted. The material should be in front of you with a cover memo from Debbie Danker. I will use the table directly behind that cover to review briefly the key features of those projections, and then I will outline the schedule for the trial run going forward. As shown in table 1, the central tendency of the projections suggests that most of you anticipate that GDP growth will be somewhat soft this year but will pick up a bit over 2008 and 2009. Participants generally anticipate that core PCE inflation will edge a little lower over the forecast period and that the unemployment rate will inch up to the vicinity of 4¾ percent. The federal funds rate path associated with this projection for the economy (not shown) is fairly flat over this year and next and moves slightly lower in 2009. The width of the 70 percent confidence bands for economic variables suggests a wide range of outcomes for growth, inflation, and the unemployment rate over the forecast period. As noted by the memo lines, the central tendency forecasts prepared for the May meeting, relative to the forecast prepared for the January FOMC meeting, indicate a somewhat weaker path for economic growth in the near term and a somewhat higher trajectory for the unemployment rate. The central tendency for core PCE inflation has changed little. In your accompanying description of the key forces shaping the economic outlook, most of you cited continued weakness in the housing sector—with residential construction viewed as likely to remain a drag on growth for some time and the softness in home prices noted as a factor damping the rise in wealth and consumer spending. Against this backdrop, GDP growth was expected to remain somewhat below trend for a while, resulting in a small rise in the unemployment rate. It was also noted that labor hoarding in some industries over recent months had likely 2 Material used here by Mr. Reinhart is appended to this transcript (appendix 2). masked an underlying easing in labor market conditions that would become more apparent over the remainder of this year. Generally accommodative financial conditions and solid growth abroad were seen as supporting GDP growth. While most participants looked for core PCE inflation to edge lower, some related that the rise in energy prices and import prices, coupled with recent sluggish productivity readings, would put upward pressure on prices over the near term. As a group, you tended to be a bit more optimistic about the prospects for aggregate supply than the staff. Several participants noted that their forecasts were premised on a higher rate of potential output growth than projected in the Greenbook, owing in part to assessments (relative to the staff outlook) that labor force participation rates would not decline as much or that structural productivity growth would be stronger. Some participants also pointed out that their forecasts incorporated a lower NAIRU than did the staff outlook. As for the process from here on, if you would like to change your forecast in light of the discussion at this meeting or data received since you prepared your projection, we ask that you submit your revision to the Secretariat by the opening of business tomorrow. The staff will draft a minutes-style narrative description of the economic projections. This will be a standalone document that will circulate with the draft minutes on the regular schedule. That means you will see a first draft on May 17, a second one on May 22, and a final version on May 24. We ask that you comment on these drafts as if the final version were to be published—but it won’t be, nor will you be asked to vote on the document." 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. " fcic_final_report_full--206 Ira Wagner, the head of Bear Stearns’s CDO Group in , told the FCIC that he rejected the deal when approached by Paulson representatives. When asked about Goldman’s contention that Paulson’s picking the collateral was immaterial because the collateral was disclosed and because Paulson was not well-known at that time, Wagner called the argument “ridiculous.” He said that the structure encouraged Paulson to pick the worst assets. While acknowledging the point that every synthetic deal neces- sarily had long and short investors, Wagner saw having the short investors select the referenced collateral as a serious conflict and for that reason declined to participate.  ACA executives told the FCIC they were not initially aware that the short investor was involved in choosing the collateral. CEO Alan Roseman said that he first heard of Paulson’s role when he reviewed the SEC’s complaint.  Laura Schwartz, who was re- sponsible for the deal at ACA, said she believed that Paulson’s firm was the investor taking the equity tranche and would therefore have an interest in the deal performing well. She said she would not have been surprised that Paulson would also have had a short position, because the correlation trade was common in the market, but added, “To be honest, [at that time,] until the SEC testimony I did not even know that Paul- son was only short.”  Paulson told the FCIC that any synthetic CDO would have to invest in “a pool that both a buyer and seller of protection could agree on.” He didn’t understand the objections: “Every [synthetic] CDO has a buyer and seller of protec- tion. So for anyone to say that they didn’t want to structure a CDO because someone was buying protection in that CDO, then you wouldn’t do any CDOs.”  In July , Goldman Sachs settled the case, paying a record  million fine. Goldman “acknowledge[d] that the marketing materials for the ABACUS -AC transaction contained incomplete information. In particular, it was a mistake for the Goldman marketing materials to state that the reference portfolio was ‘selected by’ ACA Management LLC without disclosing the role of Paulson & Co. Inc. in the port- folio selection process and that Paulson’s economic interests were adverse to CDO investors.”  The new derivatives provided a golden opportunity for bearish investors to bet against the housing boom. Home prices in the hottest markets in California and Florida had blasted into the stratosphere; it was hard for skeptics to believe that their upward trajectory could continue. And if it did not, the landing would not be a soft one. Some spoke out publicly. Others bet the bubble would burst. Betting against CDOs was also, in some cases, a bet against the rating agencies and their models. Jamie Mai and Ben Hockett, principals at the small investment firm Cornwall Capi- tal, told the FCIC that they had warned the SEC in  that the agencies were dan- gerously overoptimistic in their assessment of mortgage-backed CDOs. Mai and Hockett saw the rating agencies as “the root of the mess,” because their ratings re- moved the need for buyers to study prices and perform due diligence, even as “there was a massive amount of gaming going on.”  Shorting CDOs was “pretty attractive” because the rating agencies had given too much credit for diversification, Sihan Shu of Paulson & Co. told the FCIC. Paulson established a fund in June  that initially focused only on shorting BBB-rated tranches. By the end of , Paulson & Co.’s Credit Opportunities fund, set up less than a year earlier to bet exclusively against the subprime housing market, was up . “Each MBS tranche typically would be  mortgages in California,  in Florida,  in New York, and when you aggregate  MBS positions you still have the same geographic diversification. To us, there was not much diversification in CDOs.” Shu’s research convinced him that if home prices were to stop appreciating, BBB-rated mortgage-backed securities would be at risk for downgrades. Should prices drop , CDO losses would increase -fold.  CHRG-110hhrg41184--188 Mr. Garrett," I thank the gentleman for yielding, and I thank the Chairman for being here. I would like to preface my question to the Chairman today by first of all voicing my strong concerns with the plan that has been put out recently by the leadership of this committee and others, that would allow the Federal Housing Administration to purchase over 1 million homes over a 5-year period. The conservative cost projections in the committee's budget and the review's estimates that this would at the very least have the Federal Government in the house-buying business to the tune of $15 billion, and this is on top of another proposal that is being worked on right now that would provide as much as $20 billion in the forms of loans and grants, maybe a combination of the two, for the purchase of foreclosed or abandoned homes at or below the market values. Now, there is some justification that has been put out on this in the press by them, that says that there's some public mention that a similar proposal to this was enacted back in the 1930's during the Depression to help distressed homeowners and families. And I know we've heard testimony today and recently, experiencing the rough economic times and the slower-than-expected economic growth, maybe even a recession now or in the future. But based on what I've read and heard, including the witnesses that have come before the committee, I haven't heard anyone saying that we're anywhere near a Depression. So this leads me, Chairman, to this question. If we're going to go and consider such Depression Era ideas as these during these economic downturns, what could we possibly consider if the economy grows even worse than it is today? " 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. " CHRG-110shrg46629--129 Chairman Dodd," Thank you, Senator Shelby. And just on that point alone, obviously we are going to looking at that and trying to get a bill done fairly soon. Again, the realization here, I just have to add two cents on this. And that is, of course, the presence of the GSEs in this area, I think many would agree, have created a possibility. One of the unique opportunities we offer in our economy is that 30-year more fixed rate mortgage which provides great stability and great wealth creation for an awful lot of people, in the absence of which it would be very difficult to achieve. So striking the balance here, the points you have raised here, and seeing to it we do not move away from the opportunity that those vehicles provide is something very important to all of us. Let me raise a quick question if I can, as well, with you here. The hedge fund industry is obviously an important wealth creator in the country. It has done an awful lot of worthwhile things in terms of a valuable role in capital markets. The President's Working Group, which you are a part of, back in February released a set of principles and guidelines. I would just quote, it says ``To guide U.S. financial regulators as they address public policy issues associated with the rapid growth of the private pools of capital, including hedge funds. The agreement concentrates on investor protection and systemic risk concerns.'' The President's Working Group, at that point, determined that additional regulation was not needed. Let me raise the issue that has been raised by others. You had a piece in the Chicago Tribune recently talking about the Amaranth situation, which many people pointed out, given the size of it, it did not create that much of a bubble unless you were in San Diego and had a pension fund and then $100 million was lost. So from your perspective, from stepping back from a macro standpoint, it had seemingly very little effect. And yet if you were dealing with the pensions in San Diego, it was a rather significant effect. There was then a story in, I think it was Business Week, that I was not aware of. A lot of smaller colleges are now moving aggressively into hedge funds, according to this article. It identified colleges that had invested between 60 and 82 percent of their endowments in hedge funds. They said they may be putting their endowments in jeopardy. That was the conclusion of this Business Week article. Again, they are just two newspaper stories here. I just wonder, in light of all of this, do you have any additional recommendations about this? What did the President's Working Group want market participants to do differently after the release of the principles than they were doing before? How were the Working Group agencies overseeing the impact of this new guidance that they put out? And last, do you feel that additional regulation of hedge funds is needed to avoid concerns about systemic risk? " 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-111shrg57322--1213 Mr. Blankfein," I do. Senator Levin. OK. This is what you told your Board in September, you were going back, and on page 4, you will see the first quarter. What did you do in the first quarter? You ``shut down all residential mortgage warehouses.'' You ``reduced [your] loan position.'' You ``increased protection''--that means going short--``on disaster scenarios.'' In the second quarter, you ``shut down all [your] CDO warehouses.'' You ``took significant mark to market losses.'' You ``reduced [your] loan purchases.'' You ``reduced counterparty exposure.'' And then in quarter two and three, here is what you said. You ``positioned [the] business tactically.'' And this, by the way, is under the heading, ``The business has taken proactive steps to position the firm strategically in the ensuing mortgage credit and liquidity crisis.'' Perfectly proper, what you did. That is not the issue. You ``shorted synthetics.'' You ``shorted CDOs and RMBS.'' You ``reduced [your] long inventory.'' You were short, short, short. You shorted like crazy. It is clear from all these documents. Mr. Blankfein, you can say publicly that there was no direction here, but your documents show otherwise. The words are used even to the Board that you ``shifted''--changed your position from long to short. You told the Board repeatedly what you were doing to focus on the short position. So there is clearly a directional change. It was so sharp, I think you may have been the only bank like yourself that made money when the housing bubble burst. You made--maybe you don't think it is a lot of money, maybe it is not the amount of money you usually make in a month or a year, but according to your own records, it was a billion dollars net, after all of your long losses in that year. You say it is a half-a-billion. OK. Your records show it is a billion, but we won't quibble over half-a-billion dollars. You came out ahead in 2007 in a market which crashed, and you did it because you went short, big time, big short, in your own words, Mr. Viniar's words. You don't want to acknowledge that, I know, but that is what your own documents show. I am not sure, again, why it is that you are saying these things publicly, like there was no directional change and that you weren't big net short in 2007 when you were. These are big net short positions. I know you are saying those are net short, and they are. If you just looked at the short side, they would be huge. But you don't want to look at the short side, and that is okay. You want to look at the net short side. You were up to $13 billion net short and there wasn't a day that year, until the end of December, when you actually had anything other than a net short position. So you want folks to trust you. You basically want folks to trust you, but here is the way I have seen it. We have been through this business of selling securities to people and in that same deal not telling them that you were betting against those securities. We have gone through that---- " CHRG-109hhrg31539--146 Mr. Paul," But if you accept the principle, as it seemed to be in this quote, that if you are worried about inflation, you slow up the economy, and then inflation is brought down, it is lessened, it infers that inflation is caused by economic growth, and I don't happen to accept that, because most people accept the fact that inflation is really a monetary phenomenon. And it also introduces the notion that growth is bad, and yet I see growth as good. Whether it is 3 or 4 or 5 or 6, if you don't have monetary inflation, we don't need to worry, because if you have good growth in the marketplace rather than artificial growth, that it is this growth that causes your productivity to increase. You have an increase in productivity, and it does help bring prices down, but it doesn't deal with inflation. And I think what I am talking about here could relate to the concerns of the gentleman from Massachusetts about real wages. There is a lot of concern about real wages versus nominal wages, but I think it is characteristic of an economy that is based on a fiat currency that is just losing its value that it is inevitable that the real labor goes down. As a matter of fact, Keynes advocated it. He realized that in a slump, that real wages had to go down, and he believed that you could get real wages down by inflation, that the nominal wage doesn't come on and keep the nominal wage up, have the real wage come down and sort of deceive the working man. But it really doesn't work because ultimately the working man knows he is losing, and he demands cost-of-living increases. So could you help me out in trying to understand why we should ever attack economic growth. Why can't we just say economic growth is good and it helps to lower prices because it increases productivity? " FOMC20060629meeting--89 87,MR. HOENIG.," Thank you, Mr. Chairman. My view of the outlook has not changed significantly since the last meeting. Generally speaking, I agree that, while we will have continued growth in GDP, we also will experience the beginning of a decline and below-trend growth probably through some of the remainder of this year and into 2007. Indeed, in my view, there are increasing signs that the combination of tighter monetary policy and higher energy costs is beginning to slow the economy’s momentum. There are clear signals that housing has begun to weaken. Moreover, the behavior of asset prices and risk premiums in financial markets suggests that credit costs have risen and market liquidity is at least beginning to see some pressure. Also, it is worth noting that many other central banks are moving to a more-restrictive policy stance, suggesting that slower growth is the likely outcome for other countries as well as ours over the period ahead. As we discuss the economic outlook and monetary policy, I believe we must understand how our policy actions might affect the economy. Oftentimes we do focus on the long end of the yield curve. Certainly I do. However, I believe it is also important to focus attention on the shorter side. Longer-term rates continue to be unusually low. Short-term rates have risen in lockstep with the fed funds rate. Consequently, many consumers and many small businesses that have loans tied to prime have seen sharply higher rates over the past couple of years. In response, consumers have scaled back their use of home equity loans fairly significantly over the past few months. In addition, the repricing of low-rate adjustable loans continues to affect household discretionary spending, and it will begin to show up in pressure on small businesses. Evidence from the Tenth District is generally consistent with the national economic trends. Through May, District business activity continued to be strong, as others have said, especially in manufacturing and in energy, of course, for us. Labor markets in much of our District remain tight. However, while businesses are experiencing strong cost pressures for materials and wages, they have, as far as we can see in some of our responses, been unable to really push higher prices as much as they would like. As a result, some profit margins are under pressure, and our most recent manufacturing survey indicates that many firms have scaled back some of their capital spending plans from earlier projections. As in the national economy, the District’s housing activity has begun to slow. Housing permits have dropped sharply over the past several months, and the inventory of unsold homes has risen notably in many of the metro areas of our region. Turning to the inflation outlook, I find the recent pickup in core measures of inflation to be troubling. However, I continue to think that much of the recent increase reflects long-past actions in monetary policy and some of the other resulting combinations of pass-through energy costs and the weaker dollar. Consequently, although we are likely to see more months of elevated inflation readings, I believe that inflation will likely decline over the forecast period, assuming that we are holding at a firm—I should say a slightly firm—monetary policy. Under these assumptions, I would expect core PCE inflation to decline from about 2.4 this year to 2.1 next year. The topic of inflation expectations has received considerable attention, but I see little evidence that expectations have changed significantly, at least so far. Long-run survey measures of expected inflation remain anchored around 2½ percent for CPI. Moreover, although the TIPS data suggest that inflation risk premiums are somewhat higher than they were earlier this year, these premiums do remain low by historical standards. Thank you." 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." FOMC20051213meeting--75 73,MR. LACKER.," Thank you, Mr. Chairman. On balance, economic activity is growing at a solid pace in the Fifth District, though auto sales are faltering and housing markets are cooling. On the upside, employment conditions have been strengthening, with signs that the job numbers are increasing even at District factories. Outside of autos and big-ticket items though, retail sales strengthened substantially this month. Retailers indicate that holiday sales are solid, and they’ve become more optimistic about prospects for the first half of ’06. Auto sales are weak, though, and December 13, 2005 41 of 100 revenues and employment growing over the last two months. Home sales remain at high levels but we are receiving widespread reports that activity is decelerating, particularly in northern Virginia where markets have been quite robust in recent years. A number of independent reports describe “a return to normalcy” in residential real estate markets, with houses actually being on the market and not getting multiple bids on the first day. Manufacturing continues to hold its own. Although shipments and new orders were softer in early December, the hiring index was up for our District, and firms have become notably more optimistic about their early ’06 prospects. District price pressures seem to have eased somewhat in December. Although retail prices were reported to have advanced at the same strong pace as in November, outside the retail sector services’ prices have decelerated from October to December. Manufacturing price gains peaked in November in our series, and our preliminary numbers show that both prices paid and prices received slowed sharply this month. Turning to the national economy, we’ve received a string of favorable data since our October meeting, suggesting both that the economy had considerable momentum prior to this fall’s storms and that the effects of the storms on economic activity outside the affected region and the energy sector have not been as large as feared. I’m particularly encouraged by the continued strength in business investment spending in the present quarter, as evidenced by capital goods orders and the ISM numbers. I’m also encouraged by anecdotal reports of a cooling in District and national housing markets. These reports are consistent with a continuing handoff from residential to business investment. That said, I’m tempted to paraphrase Solow, though, and say that the slowdown in housing appears to be visible everywhere but in the housing activity data. [Laughter] Consumer spending has held up quite well. My sense is that the most important source of this December 13, 2005 42 of 100 reason, given the Greenbook forecast for income growth in the near term, I would not expect a flattening of housing prices to seriously dampen consumer spending. Rather, I expect, consistent with the Greenbook, consumer spending growth to come in on the strong side going forward, with the saving rate rising only slowly. The inflation picture has also improved notably since our last meeting, in my mind. The October core PCE number was heartening, and inflation expectations have been well behaved. Both survey measures and TIPS compensation spreads have come down off the post-Katrina highs they reached earlier this fall. While the inflation picture is somewhat better, it does leave some room for concern, in my view. This Greenbook forecasts a 2.2 percent core inflation rate for the first half of ’06, less than the last Greenbook, but it still makes me somewhat uncomfortable. With oil prices appearing to have found a stable range in the neighborhood of $60 a barrel and with natural gas prices remaining high and volatile, I think it will be several months before the risk of pass-through can be completely put to bed. As for the econometric evidence about pass-through, I’d note that expectations regarding our policy response represent a latent variable that of necessity is omitted in most econometric exercises. I take less comfort from the econometric evidence than you do, President Yellen. Our preemption may be required for the pattern you found in the ’90s to actually continue to be confirmed in the data. In the meantime, I think we need to ensure that the public understands our resolve with regard to inflation. And the real funds rate in the neighborhood of 2 percent is very likely too low for an economy that’s in a sustained expansion with relatively full resource utilization. So I think it’s appropriate to follow through today with a 25 basis point increase in the funds rate. December 13, 2005 43 of 100" 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." FOMC20061025meeting--53 51,MS. PIANALTO.," Thank you, Mr. Chairman. For a while now, I’ve been somewhat more pessimistic than most of the Committee about the downside risk to the real economy. I was beginning to get worried that this might be the perpetual disposition of someone from Ohio. [Laughter] As a prominent member of our business community said to me not too long ago, it’s not the weather, it’s the climate. [Laughter] Since our last meeting, I’ve become more comfortable with the idea that substantially weaker-than-forecast growth is less probable—partly because we’re now a little further down the road without any signs that the worst-case scenarios are materializing and partly because my directors and my business contacts seem more positive about the economic outlook. Specifically, as I listened to some of my business contacts in construction, retail, and even real estate, the expectations that things will get substantially worse just aren’t there. Also, the demand for labor seems to be growing at a moderate pace. On the price side, my contacts are not indicating much of an impetus for higher final goods prices. Although projected compensation growth seems to be firming just a bit, my contacts are telling me that they think productivity gains will keep costs in check. With the declining energy and material costs, I don’t hear much about the potential for accelerating pressures on prices. When I combine what I’m hearing from my District contacts with the aggregate data that have come in since our last meeting, I sense that we have weathered the worst in softness on the real side for now. In September I noted that my biggest concern was the possibility that the inflation trend would worsen. It does not appear that this is happening at this point. However, we have yet to see lower rates of core inflation, and I’m sensitive to the fact that core measures of inflation are being held up by the contribution to owners’ equivalent rent from the rising rents and falling utility bills. Although more-stable energy prices will make the latter effect go away, it’s not clear that the rent part of the picture will quickly fade, as rents continue to converge toward still high housing prices. When we look at the distribution of prices in the CPI, excluding energy, food, and owners’ equivalent rent, prices seem to be either rising rapidly or falling. There isn’t much in the middle, and that makes the underlying movements in the inflation trend hard to interpret. It seems to me that the key risk on the real side of the economy has been that the housing market would decline much faster and more deeply than we had forecast and that the effect on consumption spending would be greater than we anticipated. So far, as others have commented, the collateral effect on consumption appears to have been contained. Furthermore, we expected that other forms of spending would hold up as the housing sector slumped, and those expectations appear to be on track for now. I recognize that we’re not out of the woods yet, but the downside risks to the real economy appear somewhat more benign than they did at both the August and the September meetings. In regard to the inflation risks, the probability of accelerating inflation has decreased, in my opinion, but the risk that inflation will remain higher than I personally desire hasn’t really changed. Thank you, Mr. Chairman." 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. " 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. " FOMC20070321meeting--79 77,MR. HOENIG.," Mr. Chairman, I’ll spend a little time on the District. I think you can describe it as almost robust, recognizing that we are a District that exports a lot of raw materials and byproducts of raw materials. We have had solid job gains led by further tightening in our labor markets, and recent revisions suggest that 2006 job growth was stronger than we had previously thought. Mining led the job growth, but we also saw strong gains in professional and business services and in leisure and hospitality. In fact, our ski season this year was a record, as the snow was also a record. Besides shortages of skilled labor, of which we are constantly getting reports, we are seeing also shortages of some lower-skilled workers as well—in the temporary employment area, for example. It is also noteworthy that our manufacturing activity has been strengthening. We have received good reports from our directors and advisory council members that it actually strengthened in February. Lower inventories of finished goods led to a surge in order backlogs, and most industries reported robust activity led by machinery and high-tech equipment production. In addition, plant managers expressed greater optimism about the outlook for employment and capital spending as they look forward, not as they’re looking right now. Turning to real estate, housing activity may have stabilized. We have suffered like the rest of the country in that area, especially in our Denver market, where we have had record levels of foreclosure. But beyond that—and even there—we have seen some stabilizing in our housing market, and our commercial activity remains really quite solid. Housing permits and the value of new residential construction held steady in February. In addition, the buildup of home inventories has actually slowed, and District contacts expect inventories to decline gradually in the coming months, as they are now seeing things turn. Nonresidential construction remains strong, with absorption of office space increasing in most cities and vacancy rates continuing to decline throughout our region. Commercial real estate contacts expect more new construction in the months ahead. They are actually seeing it come on the drawing board. They also reported that office prices and rents increased further, even though sales were somewhat flat over the last month or so. Farm financial conditions have improved overall, with increased crop prices that are being driven by the expanded ethanol production. USDA forecasts that net farm income will rise about 10 percent this year. Strong income prospects have boosted land prices—significantly, I might add, in some parts—and solidified farm balance sheets. One piece of information I would note is that ethanol is a boom industry right now in the region—not in just our region but in the area around Nebraska and Iowa. In that area, 100 plants are producing; there are 50 on the drawing boards, but we are seeing some backing away from that. Three projects have been pulled back in Oklahoma recently, and one more in Kansas. But still, a lot are going forward, and it gives me some pause because it has the tone of too much, too quickly, and the real economy will suffer if it backs away from that development. Anyway, on balance, the regional economy is very strong right now. Turning to the national outlook, I would say that, on balance, although I have revised my outlook down somewhat in 2007, I still have it projected as growing on the whole for the year better than 2½ percent. So my outlook is more optimistic than that of the Greenbook. There are some reasons for that, at least that we’re thinking through. Like others, we see housing stabilizing, perhaps taking a little longer to come back, but inventories seem to have stabilized. As those inventories are worked off through the first half of this year, we think housing should improve through the rest of the year, at least given where the fixed interest rates lie. We’re also seeing that the secondary effects of the slowing of the housing market seem contained at the moment, so that slowing is not spilling over, and the containment is being strengthened by the facts that personal incomes are actually continuing to improve and that we have a good labor market. So those factors are important. Also, as we discussed earlier, foreign demand is strong, and the outlook seems to be good. Finally, federal spending—the fact is that we’re fighting a war, and you tend to spend more over the course of a war—is picking up I think. Coffers are strong, and states are spending at a fairly rapid rate. So a lot of factors are affecting demand, and therefore I think that this economy will pick up as the year goes on. I recognize very clearly that there are some risks to keep in mind. One is that the housing market could worsen, and there could be further spillovers. I’m very mindful of that. But on the other side, I do share some of the concerns raised by others in terms of the inflation outlook. Inflation has not come down as much as we had hoped, although I’m still projecting that it will so long as we keep the rates at their current levels. But there are some upside risks with the tighter labor market and strong demand, and we could see energy prices putting more pressure on it. So it’s a mixed bag perhaps with, on balance, some upside risk as well as downside risk to this economy. Thank you." FOMC20060920meeting--108 106,MR. MOSKOW.," Thank you, Mr. Chairman. My contact calls and director reports this round point to moderate growth in overall economic activity. Both nationally and in our District, housing is weak. Domestic auto production is slowing from last year, but activity in other sectors remains on a solid footing. Starting on the downside, one of our Detroit directors from Pulte Homes characterized the slowdown in housing as broad and deep, and he said that they face a rocky road for the next year or two. With regard to motor vehicles, GM noted that their lower production in the fourth quarter largely reflected the retooling of five plants for their new truck platform, reduced low-margin sales to rental fleets, and lowered desired inventory holdings by dealers because of higher interest rates. Both GM and Ford are trying to reduce their reliance on sales to rental fleets. In contrast, a wide array of capital goods manufacturers reported continued strong growth. The two major temporary help firms headquartered in the District pointed to modest but steady growth in billable hours. Importantly, no contact was worried about a protracted slowdown in the economy. Indeed, my directors were quite optimistic. This is an important change from six weeks ago, when we were hearing comments that the expansion had become long in the tooth and concerns that we were headed for a period of sustained weakness. This more upbeat assessment was in line with the sentiments I heard at the International Manufacturing Technology Show, which was held in Chicago earlier this month with over 90,000 attendees from more than 100 countries. Now, I did not have a chance to talk to all of them, [laughter] but the ones I did talk to were quite optimistic about increasing demand for U.S.-made high-tech capital equipment. The most amazing and impressive new technology that I saw was something that looked like a large ink-jet printer, but it spit out metal dust to fabricate intricate parts without traditional tools or dies. This was really quite unusual and impressive. Turning to inflation, there was little change in most reports regarding price pressures. Labor compensation continued to increase at elevated rates. Our contacts from temporary help firms noted a further step-up in wages for highly skilled workers, whereas our retail contact said he was paying 8 to 10 percent more for entry-level sales personnel. Of course, the energy picture on the cost side looks better. Several contacts expressed relief at the recent declines and hoped that they would lead to reductions in fuel surcharges and related costs. Turning to the national outlook, we agree with the Greenbook’s assessment that growth in the third quarter appears to be somewhat weaker than we anticipated at the time of the August meeting. However, in contrast to the Greenbook, we do not think the sluggishness will persist for long. Current financial conditions do not appear to be a restraint on activity. Labor markets are in good shape, so growth in jobs and wages should continue to support household spending. We are getting a welcome boost to real incomes from lower energy prices; and given the increase in business optimism that I noted earlier, I am less concerned that cautious animal spirits will cause businesses to pull back on spending. Housing remains the major downside risk, but I get the impression that thus far the weakness in residential investment is not spilling over to the other sectors of the economy. Of course, we have talked about this at great length. So our overall assessment is that by early next year growth will be much closer to potential than the Greenbook projects. Accordingly, we do not think that any meaningful resource gaps will emerge to restrain inflation. Indeed, our inflation models based on data since 1967 look for core PCE inflation to be 2.7 percent in ’07 and 2.6 percent in ’08. The models that use data only since 1984 come out somewhat lower, at 2.4 in ’07 and 2.3 in ’08. In thinking about the differences between these forecasts, I found the background paper that Dave circulated quite useful, as several others have said. Our models allow for permanent shocks to the level of inflation, and as the paper noted, such shocks appear to have been much smaller since 1984. But as also discussed in the paper, we have no way of knowing whether these permanent shocks will be small in the future. I think the most likely interpretation of the reduction in the volatility of these permanent shocks is that policy has done a better job of anchoring inflation expectations. The public is more convinced than they were in the past that we will maintain low and stable inflation. But if our actions fail to confirm this belief, we would lose credibility, leading to higher inflation expectations and imparting more persistence to the current inflation shock. An inflation shock that is permanent rather than transitory is our responsibility. Our forecasts remind me of this risk. True, so far this is just a risk. We have not yet seen any broad-based increases in long-run inflation forecasts by private-sector economists or in the five-year to ten-year TIPS inflation compensation. Indeed, TIPS have even moved down recently. This news is welcome. But even if inflation expectations have not moved up, another concern is the level of long-run inflation expectations—and I thought Jeff Lacker raised a good point last time in reminding us about it. Long-run inflation expectations of around 2½ percent for the CPI translate into a core PCE rate well above the middle of my comfort zone of 1 to 2 percent. Even the Greenbook expects core PCE inflation to be above 2 percent through ’08. I am concerned that even now the public could be questioning our resolve to bring inflation into what many of us have said is our comfort zone. I am already hearing this sentiment from some market analysts. Even without an increase in expectations, it is not clear to me that inflation will settle back to a level that I view as being consistent with price stability without further policy action." FOMC20050630meeting--374 372,VICE CHAIRMAN GEITHNER.," Thank you. We’re somewhat more confident in the strength and sustainability of the expansion than we were in May. Our view is very similar to the staff forecast. We expect real GDP growth to average roughly 3½ percent over the forecast period. We expect core PCE to follow a somewhat higher path and to end the forecast period slightly higher than we expected in May, at just under 2 percent. This forecast assumes that we’ll continue to tighten monetary policy, perhaps by a bit more than foreseen in the staff forecast and than is currently priced into the market. To us, the risks to this forecast seem roughly balanced. We see no new sources of potential risk. This is not to say June 29-30, 2005 138 of 234 daunting. It’s worth noting, though, that these risks—from a cliff in housing prices to a sharp increase in household saving, to a larger and more sustained oil shock, to less favorable future productivity outcomes, to a sharp increase in risk premia or to declines in asset prices—in general are risks that we can’t really mitigate substantially ex ante through monetary policy. However, by making sure we get the real fed funds rate up to a more comfortable level we can help. The alternative strategy, to oversimplify it, would be to follow a softer path for monetary policy to provide a preemptive cushion against the negative effects on employment of a fall in housing prices, a rise in risk premia, some rise in saving and a fall in consumption, and so forth. This would, I believe, be a less prudent strategy. Although there have been persistent concerns about the vulnerability of this expansion and about some of its less robust characteristics, the two most remarkable aspects of this recovery are encouraging. The first is its resilience. So far, each episode of incipient softness has proved to be shallow in depth and short in duration. Despite very prolonged and substantial headwinds in the context of an oil shock, a large ongoing drag from net exports, a significant tightening of financial conditions, a modest withdrawal of fiscal stimulus, etc., quarterly GDP growth—as Janet said— has shown impressive stability around a 3½ percent annual rate over the last year and a half. And this is a dramatic reduction in realized macroeconomic volatility. It makes the much-heralded “great moderation” look turbulent. The second positive feature of this period has been the behavior of underlying inflation and inflation expectations. Of course, underlying inflation seems to have moved up a bit, but large changes in oil and commodity prices and import prices have produced periods of substantial acceleration in headline inflation without, at least to this point, causing more than short-lived June 29-30, 2005 139 of 234 The behavior of productivity growth and expectations about future productivity growth explain some of this. Also important, of course, is the credibility engendered by the record of the FOMC. Changes in the structure of the financial system must matter, too. There are almost surely other factors—luck for one—that are at work. Among the choices in Vincent Reinhart’s note on interest rates, I’m inclined to support the more benign assessment of the recent behavior of forward interest rates and term premia, even though these factors can’t fully explain those moves, and even though the future may prove to be more volatile and adverse than the markets now seem to expect and than those explanations would imply. So what about monetary policy going forward? There are two salient dimensions of the forecast. One, of course, is growth slightly above trend from a starting point where the remaining amount of resource slack, if any, is substantially diminished. The other is an underlying inflation rate—just to focus on the core PCE—that now seems to be running at a modest margin above 1.5 percent and that we expect will end the forecast period above 1.5 percent. And inflation expectations, at the horizon over which monetary policy operates and with reasonable adjustments to translate them into a view on the PCE deflator, are still some margin above 1.5 percent. We don’t consider this inflation forecast a cause for serious concern. We anticipate upward pressures on inflation from some firming of compensation growth and from higher unit labor costs. We expect those pressures will face the countervailing forces of relatively moderate inflation expectations, strong competitive pressures, still substantial profit margins, the potential for some increase in the labor force participation rate, and pretty strong expected future productivity growth. And yet it should matter to us that, even in a world where the nominal fed funds rate peaks June 29-30, 2005 140 of 234 meaningfully above 1.5 percent. The range of estimates in the forecasts and model simulations before us, and the expectations we can derive from the market, place the terminal rate of the nominal fed funds rate now between 3½ and 4½ or between 3¾ and perhaps 4¼ percent. These estimates have moved down a bit over the last few months, but the shape of the path has steepened a bit. I don’t think we really know how much confidence we can have in these estimates, even if the forecast unfolds as we expect today. But my view remains that we are better off following a path that would put us at the higher end of these estimates than in taking the risk of doing too little and stopping prematurely or trying to manage the communication challenges of a temporary pause when we still believe we have further to go. Thank you." FOMC20071031meeting--39 37,MR. PLOSSER.," Thank you, Mr. Chairman. There has been little change in the District economic conditions since our September meeting. Except for housing, activity is expanding at a modest pace, somewhat below trend. Our business contacts are cautious, generally expecting slow growth to continue over the next quarter, but they remain fairly optimistic for business conditions six to twelve months out. Payroll employment continues to expand at a slow pace in our three states, which partially reflects slow population growth, and so the unemployment rate remains slightly below that of the nation. Retail sales have generally held up, but there are divergent views among retailers regarding holiday sales. High-end stores expect a very strong finish to the year; lower-end merchants are more cautious. Housing construction and sales continue to decline, but the pace of that decline is in line with the expectations at our last meeting. The value of nonresidential building contracts has declined more sharply in our region than in the nation as a whole. Nevertheless, I would characterize nonresidential real estate markets as firm. That office vacancy rates are declining and commercial rents are rising suggests a positive outlook for commercial construction going forward. According to our business outlook survey, manufacturing activity in the District has been increasing at a modest pace for the past several months. The general index of economic activity moved down slightly, from 10.9 in September to 6.9. Shipments and new orders also weakened slightly. Staff analysis suggests that our manufacturing index, which precedes the release of national industrial production numbers, provides useful information in forecasting monthly manufacturing IP and total IP. That forecasting model is predicting a rise in both manufacturing IP and total IP in October. About two-thirds of the District manufacturers and service-sector firms we have polled said that recent changes in financial conditions have not prompted any change in their capital spending plans, and the other firms are about evenly split as expecting a slight decrease or a slight increase over the next six to twelve months compared with the past six to twelve months. However, in speaking with my business contacts, I do hear a sense of continuing caution among businesses in their capital spending plans. The manufacturers seem to be a bit stronger than the service firms, perhaps reflecting a more robust export market, which many of them are participating in. District bankers, in general, continue to express concern over housing and mortgage lending but see commercial and industrial lending as fairly stable and proceeding about as they had expected. There has been little change in the District’s inflation picture since our last meeting. Firms continue to report higher benefit costs, but other wage pressures have moderated. Our manufacturers reported having to pay higher prices for many inputs, particularly energy-related inputs and petroleum-based products as well as agricultural commodities. They have passed on many of those increases in terms of higher prices to their consumers. While retailers report only modest price increases for many products, food prices are generally higher. In summary, since our last meeting, there has been little change in the economic conditions in the District or in the outlook for the region. Overall, business activity in the region is advancing at a fairly modest pace, and most of our contacts expect that pace to continue for the next quarter or so. But in general, firms in the District remain optimistic about business six to twelve months from now. Turning to the nation, the economy appears less vulnerable to me than it did at the time of our last meeting. Financial markets have improved somewhat, as Bill Dudley was telling us. Conditions are not back to normal yet in all segments of the market, but the markets that are still under stress are the same ones that were under stress last month. Subprime and jumbo mortgages and asset-backed commercial paper are the ones that still are struggling. Price discovery still plagues many of these markets, and I suspect it will take some time before the markets can sort things out and trading returns to normal. That does not mean that the ultimate agreed-upon market prices for some of these assets will bear any resemblance to what they looked like before August. Indeed, they probably won’t, but that’s not necessarily a bad sign or a cause for concern; it may even be a healthy development. We haven’t seen disruption spread to other asset classes for the most part, and the level of stress in financial markets seems to have fallen even as volatility remains high. The spread of jumbo over conventional mortgage rates remains elevated, reflecting some concern, I think, about the risk that expensive homes may face greater price declines than other homes, but the premium is less than it was in September. Both investment-grade and non-investment-grade corporate bond issues have increased. Financial institutions have begun to write off some of their investments and take the losses. This has weighed heavily on equity markets, but I view the write-downs as a necessary part of the process toward stabilization in the markets. Earnings reports from nonfinancial firms have actually been pretty favorable. I’m not saying that we are out of the woods yet, but in my view the risks for a serious meltdown in financial markets have lessened somewhat since our last meeting. The news on general economic activity has improved somewhat since our last meeting as well. Indeed, some of the data have come in better than expected. Employment was revised up, and retail sales data suggest that consumer spending remains resilient, despite the downturn in housing. Like the Greenbook, my outlook for the economy has changed little since our last meeting, when we acted preemptively and lowered rates to “forestall some of the potential adverse effects of financial market disruptions and the expected intensification of the housing correction on the broader economy.” Housing investment and sales continue to decline but about as expected in our forecast. After all, the rapid reduction in subprime lending is exacerbating the decline in housing demand and thus home sales, contributing to the slower recovery of that sector. Other sectors of the economy have performed about as I expected, with little evidence as yet of any major spillovers from housing. Oil prices have moved higher than expected since our last meeting, as has been discussed, but it is unclear to me yet how permanent that increase will be or how much of a drag it might be on activity. The oil price rise is likely to show through to headline inflation in the coming months. Although core inflation measures have improved since the beginning of the year, the rise in energy prices has the potential to put upward pressure on core inflation. Thus, while inflation and inflationary expectations have been stable to date, I suspect that inflation risks are now more to the upside than they were in September. The forecast is an important context for our policy, in my view. We have stressed in the past year that we are data driven and respond to the evolution of our forecast. In general, like the Greenbook, as I said, my forecast of the economy going forward is little changed from my September view. I see that growth returns to trend, which I estimate to be about 2.7—a little higher than the Greenbook—late in 2008 as the housing correction runs its course and the financial market turbulence unwinds. Core PCE inflation remains slightly below 2 percent next year and moderates toward my goal of 1½ percent by 2010. I built in a 25 basis point easing sometime in early 2008 to bring the funds rate back down to a more neutral level, and in my baseline forecast I assume a constant funds rate thereafter. That forecast, however, is contingent on inflation and inflationary expectations remaining well behaved. Having said that, I repeat my caution that inflationary pressures are somewhat elevated at this point, and we run the risk that inflationary expectations may become unhinged if the markets suspect that we have lessened our commitment to keep inflation contained. Thus, I don’t rule out the possibility that we may have to reverse course and tighten policy sometime in 2008 or 2009 in order to achieve consistency between my target rate of inflation of 1½ and inflationary expectations. Thank you, Mr. Chairman." FOMC20070628meeting--136 134,MR. KROSZNER.," Thank you very much. The last time we met, there seemed to be a bit of increased uncertainty about a potential downdraft on economic growth, and now some of that concern about that downturn seems to be no longer there. Some intermeeting data have come in a little more on the upside, and obviously the markets have changed their expectations and seem to agree with that. I think the strength in the labor market and in consumption, although facing some challenges, is still at a reasonable level. It does seem that we are getting some signs that investment is coming back. Recent durable goods numbers, which came out today, perhaps raise some questions of that. We have had a couple of good months and now a bit more of a challenge. But when you smooth through, I think, exactly as Governor Kohn suggested, that we’ll have moderate growth going forward, a forecast that I think is consistent with the Greenbook forecast. Strength in nonresidential construction, as we have heard around the table, has also provided us with a bit more optimism for investment in general. But investment is obviously closely tied to where productivity is going because, if we don’t have investment, particularly in the high-tech areas rather than just in the construction sectors, it is going to be hard to sustain high productivity growth. When we get the revised numbers on July 27 and we also get advance GDP, we’re going to get a lot of information about that, and I think there is still a lot of uncertainty as to exactly where productivity is going. So I will defer my comments until the next meeting because we will have those numbers by then. Regarding consumption, we have been having the offsetting wealth effects of the recently robust equity asset market and much less robust housing asset market, continuing strength in the labor market, and as the Greenbook points out, increasing disposable income because we’re having incomes grow faster than productivity growth, at least right now. That suggests that we might maintain a reasonable support for consumption growth, but again, as Governor Kohn said, there are potentially some challenges here. But now I want to discuss the big challenge that everyone keeps talking about, which is the housing market. It has become obvious that the transition is going to be quite a long one and potentially a painful one, perhaps more in individual pockets and for individual families than for the macroeconomy. It will not just disappear after the third quarter of the year or even the fourth quarter of the year. I would think in four different ways about how housing can have a broader effect on the economy. First is obviously the direct effect on prices. The Case-Shiller ten-city index suggests that the prices will fall about 3 percent over the next year. Now, that’s roughly where the market was just before the issues in subprime arose at the end of February, and it is actually better than it was last fall. So the markets don’t think that there will be an enormous challenge with respect to prices, at least in these ten markets. But as President Poole mentioned, sometimes the prices even in these improved indexes, like the Case- Shiller index, may lag what’s going on and may not accurately reflect the underlying actual values that people can realize. So there still may be more challenges even though the index suggests that house prices are down only 3 percent. It is also interesting to look at the delta, the change in the index. We haven’t really seen much from that, which I think is heartening, but it is still something that we have to watch out for. Second are the indirect effects, the wealth effects. As I mentioned, there have been offsetting wealth effects from the equity markets and the housing market. More broadly, there can be confidence effects on spending and on saving behavior. So far we haven’t seen a lot of evidence of that. As Vice Chairman Geithner mentioned, there have been anecdotal reports of challenges in other areas of consumer credit, although so far no real systematic data suggest that. Even if there is a little movement up, in almost all the typical indexes we use, many of which were mentioned in the briefing, we are at lows or are much lower than usual historically. So even with the small movement up, there are not necessarily enormous challenges; but these effects also have to be watched. A third very important potential effect of this long transition is a response by us or by lawmakers that could make the transition even longer and more difficult. As a number of you know—and all of you have been facing pressure on some of these things—we will be putting out the subprime adjustable-rate mortgage guidance that we put out for comment just at the end of February. Our timing couldn’t have been better for getting that out—we did it just as the problems were becoming more of an issue publicly. I hope the guidance will be out by the end of this week. We are proposing guidance that subprime adjustable-rate mortgages have underwriting at the fully indexed rate. I do not think that’s going to be much of a shock to the markets. The markets have largely moved there already. This was true from some early statements by Freddie Mac and Fannie Mae. Also, some of the major players who were not underwriting at the fully indexed rate are simply not there anymore— they are bankrupt—and some of the other players who were not doing it have changed their standards. As we know from the survey of senior loan officers, standards have been rising. That is not to say that it won’t have some effect, but relative to where the market has already moved, the effect is not going to be significant. The other major guidance is for giving a prepayment penalty grace period of sixty days so that people will have at least sixty days before the reset to refinance their mortgage. It’s unclear from the studies we have done at the Board and from looking around how much of an effect that will have on the initial rate or the so-called teaser rate. It seems that changing their ability to do that from zero to thirty to sixty days is unlikely to have an enormous effect on the teaser rate, but that is something that is uncertain. There are some states that already outlaw prepayment penalties or have restrictions on them. There is not a lot of evidence suggesting that it is more difficult to get financing in those states. Again, these guidelines are untested, but I don’t think they will have an enormous effect on the market, but they are obviously something to watch. As you well know, we have put out an interagency letter suggesting that servicers and lenders work very closely with distressed borrowers to try to work things out and keep people in their homes. Doing so is in the interest of the people in the homes; it is virtually always in the fiduciary interest of the loan servicer and of the lender. I think we have been making progress on accounting issues that have been making it difficult for some servicers to do this, and we are working very closely with the SEC and with FASB on some of these things. We may be making progress in giving comfort to the servicers who want to do some restructurings that would help keep people in their houses and would ultimately be better for the individuals and for the owners of the securities. We have also had the HOEPA hearings here in which we talked about the potential for rule writing in several areas, such as requiring escrow for taxes and insurance, some regulation or restriction of prepayment penalties, and various other things. That would be down the line, but again, we are thinking that this is unlikely to have a major effect relative to where the markets have already moved. Fourth and finally, there has been a lot of interest in the effect of subprimes in the housing market not only on the mortgage market but also more generally on the financial markets, as Governor Warsh and Vice Chairman Geithner pointed out. Fortunately it seems that liquidity is largely being maintained in the mortgage origination market. There are still fairly robust amounts of subprime and alt-A originations occurring. They obviously are going to be declining over time because there are fewer being made; but they were at an unusually high level in 2006, and so it’s a natural part of the transition process that they would go down. There has been a very significant increase in spreads, as has been mentioned by the previous speakers, and there’s much more tiering of risk. It is not just that the Bs are all the same; it is where they originate. The markets are looking through the packages to see what’s in them, which is very, very valuable. Increased volatility and higher pricing in these markets and the higher long-term interest rate will be a bit more of a challenge for people doing refinancing, although we’re now down to about 5.08 for the ten- year, off 20 to 25 basis points from the high of the other week, and so it may not be quite as much of a challenge. But there is also a legal risk in this market because, if some problems become larger, there could be concern about what the new instrument really means and what you have actually purchased. If legal risk is there, the markets will start to run away from these things. Then you may have some severe liquidity problems. I do not think that we see those challenges yet, but it is one indirect effect on the financial market of some of these issues. Just quickly on inflation—most people have said that we’ve seen some moderation. It is a little too soon to declare victory. As we said in the initial briefing, when we drill down into the components and look at owners’ equivalent rent, we may get some nasty surprises going forward. Some numbers have gone down, but owners’ equivalent rent may come back up a bit. So I don’t think we can say that the temporary elevation in that area has passed and that we can move on. I think some challenges are still there. Fortunately, expectations still seem reasonably well contained. But I think that there may be some challenges going forward as the economy continues to grow at least at a moderate pace, and some of the temporary factors are not necessarily completely behind us. We still have to look for potential price pressures going forward. Thank you." 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." FOMC20070628meeting--128 126,MR. PLOSSER.," Thank you, Mr. Chairman. Since our last meeting, the news in the Third District economy has been mixed but, on balance, slightly more positive than the previous report. The District continues to grow at a moderate pace, and we expect that pace to continue. The bright spot since our last meeting is a rebound in regional manufacturing activity, which had been flat for the past six months. In June, the Philadelphia Business Outlook Survey index of current activity rose sharply—18 percentage points—from a level of 4.2. This is the highest level it has obtained since April 2005. The index of new orders also showed a sizable jump, and capital spending plans firmed in the survey. Respondents also expected further improvement in manufacturing activity over the coming months. Job growth in the region, however, was somewhat slower over the past two months compared with earlier in the year, but we really didn’t expect much since payrolls seemed to rise much more rapidly than expected during the first quarter. Year-to-date payroll growth is running about 0.6 percent at an annual rate. That rate is slower than the national average but is fairly typical of our region, where population growth is rather flat. Labor force participation is rather flat as well. Unemployment rates, however, remain low in our three states, and firms still report having difficulty finding both skilled and unskilled workers. It is no surprise, as everyone has said, that residential construction in our region continues to decline and remains weak. The value of contracts for residential buildings has fallen more than 30 percent in the region during the first five months of this year compared with last year at this time—but that, we have to remember, was near the peak. Real estate agents and homebuilders generally report slowing of sales in May. While the number of existing homes for sale on the market has increased, average selling prices have not changed much. I would characterize the nonresidential real estate market in the region as fairly firm, although construction is not as strong as last year. Office vacancy rates continue to fall, and in Center City Philadelphia, they dropped to 10 percent. They were about 17 percent just around eighteen months ago. Real estate firms report that overall demand for industrial space continues to be robust and that vacancy rates for this type of space are near record lows in some markets. Rental rates continue to rise, particularly for warehouse space, and rents are at a record high in those areas. I take these reports as indications of continued expansion in economic activity going forward. Interestingly enough regarding building, I had two observations from CEOs. One is CEO of a building supply company that manufactures throughout the United States and has sales of almost $10 billion. He said that, remarkably, even with what is going on with homebuilding, his sales are holding up very, very strongly and they are doing very, very well this year. Another CEO, whose company produces products mostly for residential cabinetry and other types of things, one of the largest in the country, says that, while new home sales for his work are way down, they have largely been offset by remodeling activity—people have substituted remodeling for buying a new home. As long as I’m reporting anecdotes here, I will pass on one other anecdote, for what it is worth, about trucking. I listened to President Fisher and President Poole talk about volumes in trucking. Just as an observation, an executive who runs a trucking company throughout the country told me that one thing that has happened in trucking is that, rather than shipping boom boxes, they are shipping iPods. [Laughter] That is true of a lot of consumer goods. Instead of shipping large CRT screens, they now ship flat panel displays. So even while the volume of goods is being reduced, gasoline prices are high, and they are laying off truckers and downsizing the volume, the value of what they are shipping has been maintained pretty well. So he was noting a dynamic of value versus volume here, which I thought was very interesting. On the inflation front in the District, prices for industrial goods continue to increase, but retail price increases have not been widespread. However, many of our business contacts continue to express concern over rising energy costs and food prices and the effect on their businesses and the consumers. I interpret this to mean that they continue to be puzzled by our focus on core inflation when they see that overall inflation is what affects the consumer and their businesses, and they seem to doubt core inflation’s value as a policy objective or a measure of underlying inflation. They may be wrong in that, but it tells me that, if they continue to be confused by how we view core inflation and what we use it for, we might need to improve our communication to the public about how we think about it and why we focus on it. On the national level, I have become more comfortable with the economic situation as the year has progressed. At our meeting in May, we were beginning to see some positive signs regarding both real economic activity and inflation. Durable good orders were up, allaying some concerns about the first quarter’s weakness in business investment. Improved ISM numbers were signaling that the slowdown in manufacturing might be ending; and although housing markets remained weak, there were limited signs of any significant spillovers to other sectors. Labor markets remained firm. At that time there were signs that core inflation might be moderating. As a consequence, I expressed hope that in the coming months those data would be reinforced. Fortunately, from my perspective, those hopes have been largely realized. Coming into this meeting, we have received more positive news on the economy, and I have become somewhat more confident that the economy is on track to return to near-trend growth later this year as the effect of the housing correction moderates, albeit very slowly. Indeed, data received to date suggest that we will see a substantial rebound in real GDP growth this quarter, as the Greenbook has noted. After several months of stagnation, manufacturing activity seems to have picked up, and business fixed investment is moderately strengthened. Labor markets remain firm, and yet in recent quarters we have noted a seeming disconnect between strong labor markets and weaker GDP growth. However, we now may be getting some hints that this puzzle is more apparent than real, and I want to reinforce the point that President Yellen made earlier in that I think two factors suggest this. First, from December to May the household survey showed almost no employment growth whatsoever, whereas the establishment survey showed 1.2 percent annual growth during that period. Second— and again as President Yellen noted—the Business Employment Dynamics report came out. It was only for the third quarter of last year, but it showed about 155,000 fewer jobs created in the third quarter than we thought. What is important about that report is that it arguably does a better job of tracking the birth and death of firms in the data, and so there is some reason to believe that, while this is suggestive, the payroll employment that we have been seeing may not be as strong as perhaps we thought, and that may make some of this puzzle less of a concern. Moreover, as President Yellen pointed out, it is also relevant for the longer term because, if employment wasn’t as strong as we thought, productivity is going to end up being higher than we thought, and it will help resolve some of that slowdown in productivity. So I think there are various hints that that may be the direction that we are headed. In my own forecast, I see slightly more underlying strength and so a somewhat faster return to trend growth than the Greenbook does. The current stance of monetary policy is maintained. I see strength in personal income, a strong balance sheet (as we saw earlier today), strong equity markets, and a resiliency already shown by consumers despite the lower home equity values and higher gasoline prices, suggesting that there is probably slightly more momentum in consumer spending than suggested in the Greenbook. I am modestly more optimistic about the labor market than the Greenbook—modestly, as I anticipate less of a downturn in labor force participation rates than is built into that forecast. The rise in long-term interest rates reflects the market’s upgrading of its assessment of the economy’s strength going forward. Indeed, as has been noted a couple of times, that uptick in long-term interest rates has been, I won’t say a worldwide phenomenon, but certainly widely spread in many countries around the world, which may be saying that global growth is more stable, predictable, and positive than perhaps we thought. Now, this is not to say that I do not see risks around this growth forecast. Of course, as everyone else does, I see housing as the biggest downside risk that we face. There is still considerable uncertainty out there, and I do not want to underestimate the risk. Housing inventories remain high, and I do not see any strong evidence of pickup in demand. Despite the problems in subprime lending markets, however, I think the financial sector remains healthy—healthier now than it was perhaps in the early ’90s with the previous housing boom. I am more comfortable with the notion that there will be no spillovers into other parts of the economy, and thus I have become more comfortable with forecasts of return-to- trend growth in the second half of this year and into ’08. On the inflation front, higher energy prices have led to an acceleration of headline inflation, but there has been some improvement in core inflation measures in recent months. The three-month growth rates in the core CPI and the core PCE have been decelerating since February. Although these developments in inflation are encouraging, I remain cautious about extrapolating too much from recent data. During this cycle we have seen periods of deceleration reversed a couple of months later. Indeed, the Greenbook expects that much of the favorable readings on core PCE inflation will prove transitory. So I remain concerned that our core inflation rates may not continue their recent drift down. I would also caution that headline inflation, as I noted earlier, has remained stubbornly high. Thus, in approaching my forecast, I have assumed that the appropriate policy path was one that would return the economy to steady-state growth and to my inflation target by the end of the forecast period. Given my outlook on the underlying strength of the economy and an inflation goal of 1.5 percent for the PCE, it should not be surprising that my forecast incorporates a slightly tighter policy path than the Greenbook does. In particular, in my forecast the federal funds rate rises 50 basis points, to 5.75 percent, by early ’08. As progress is made on bringing down inflation starting in the second half of ’08, the fed funds rate moves down, ending at about 5 percent by the end of 2009. This policy path reflects my view that, unless we take further action by additional firming or an announcement or both that commits us to an inflation goal that is lower than the market currently expects, which seems to be about 2.5 percent, I believe it will be difficult to sustain an inflation rate that is in keeping with my view of price stability. I believe this can be accomplished with relatively little effect on real growth in 2008. My assumption in the model with which I’m working is that, once we begin to raise rates, the markets will quickly recognize our commitment to lower inflation and expectations will move down accordingly, mitigating the real output effects of this modest tightening. The movement down in expectations could be expedited by the Committee’s explicitly announcing the target. This view of expectations formation is more heavily weighted to forward-looking elements than to distributed-lag elements of past inflation. By the way, I want to applaud the staff for their work on inflation dynamics. I thought it was an excellent piece of work. I found the discussion very helpful and a step in the right direction, both conceptually and empirically. In any event, the bottom line for my forecast is that I anticipate that the economy will grow just below trend of 3 percent in 2008 and at trend of 3 percent in 2009, and we achieve an inflation goal of 1.5 percent by the end of the period. Of course, this forecast is based on my desired inflation objective, which may not be representative of other members of the Committee. If there were a common objective that differed from my own view, then my presumed appropriate policy path might be different. Given this observation and the lack of an agreed-upon goal, I think we need to be concerned about how the public will interpret these forecasts, but I will save my thoughts on that for the next go-round." FOMC20080625meeting--90 88,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. I think we face an extended period of relatively weak economic growth, quite weak domestic demand growth, and overall growth significantly below trend. I think this is both likely and necessary. It's likely because we have more weakness ahead as the housing drag continues, financial headwinds remain acute, the economy adjusts to the very large and sustained energy price shock, the saving rate increases, and global demand moderates. It's necessary to achieve a reasonable inflation outcome over the forecast period. Our central projection has the U.S. economy growing, though at a rate significantly below potential, and then recovering gradually toward trend over the next year. This is our modal forecast; and in this forecast, the economy just skirts a recession. The output gap begins to narrow over the forecast period. Housing prices begin to stabilize only late in '09, after a cumulative peak-to-trough drop of roughly 12 percent, using the OFHEO repeat sales purchase-only index. Net exports provide a significant, though fading, boost to GDP growth this year and next. We project a very gradual, very modest moderation in core inflation over the forecast period. Of course, this forecast depends on a lot of things happening. It depends on expectations remaining reasonably well contained, energy and commodity prices following the futures curve, the dollar only modestly weaker, somewhat diminished pressure on resource utilization here and around the world, and continued moderate growth in compensation and unit labor costs. Our policy assumption builds in significant tightening--a significant move up in the fed funds rate over the forecast period--though not as soon as the market now expects. The uncertainty around and risks to this central projection are substantial. On the growth front, although we believe the risks of a very deep, prolonged economic downturn have diminished--not on their own but because of the force of the policy response so far--we still think the risks are weighted significantly to the downside. The main risks remain: the ongoing stress on financial markets; the risk that this further restricts the supply of credit, exacerbates financial conditions, pushes home prices and other equity prices down more further tightening credit conditions, et cetera; a steeper-than-expected rise in the saving rate; and the adjustment to the ongoing drag from energy prices. On the inflation front, we--I think like the rest of you--see the risks ahead tilted somewhat to the upside for many obvious reasons. I think it's true that, looked at together, the mix of measures of inflation expectations suggests that private agents may have less confidence in the FOMC's commitment to price stability than they did in previous periods when total inflation was running significantly above core. So this is going to be a very challenging period for policy. It's not all terrible. Productivity growth is a little higher than we thought. Underlying inflation and long-term inflation expectations certainly could already have been showing signs of a more compelling, immediate danger. Spending has been somewhat stronger than confidence measures would have suggested. The current account balance has narrowed significantly. We are seeing very substantial changes in behavior across the U.S. economy in the consumption of energy. So there are good things to point to. But in the two dangerous areas--in the financial sector and in the global inflation environment--I think things are materially worse than at our last meeting. Again, the risk of inflation is readily apparent. Apart from the numbers, I agree with many of you who said that the alarm and concern is materially higher and materially different today across a broad range of firms in different industries than it was even as recently as two months ago. We have to be worried about intensified pressure on compensation growth even with the degree of slack that we now see in the labor market. Although firms are absorbing in margins a significant part of the increase in unit costs--and a lot of the complaining that we hear is about margins that are coming down and those that are expected to come down--I do think that firms are demonstrably able to pass on more than they would have been before. Of course, what makes it very hard for us is that the pressure on resources is coming largely from outside the United States and the other major economies, from countries that are growing significantly above trend with central banks that are not independent and are running very expansionary monetary policies. I think we are really seeing an alarming acceleration in inflation rates in large parts of the world for the first time in a couple of decades. If these countries do not tighten monetary policy sufficiently and reduce energy price subsidies materially, then we will have to be tighter than we otherwise would have to be. In the financial world, although I think it's true that the market believes there has been some significant reduction in the risk of an acute systemic financial crisis, I think we have a long period of acute fragility ahead. We're in the midst right now of more material erosion in sentiment, spreads, asset prices, balance sheet pressures, and liquidity in some markets. Overall financial conditions are probably somewhat tighter than when we last met. The financial headwinds have intensified again, and they are likely to remain intense for some time. Again, I think this is going to be a very challenging road ahead. It is important to recognize that the current stance of policy embodies not just the fed funds rate today, relative to our best measure of equilibrium, but also the expectations about policy that are now built into the Treasury curve. That policy today does not look that accommodative. If you look at the Bluebook charts and at a range of measures of real fed funds rates today relative to different measures of equilibrium, policy is less accommodative just on that simple measure than it was at the most accommodative point of the last two downturns. That said, we're going to have to tighten monetary policy, and the question is when. My sense is soon but not yet. Right now we still face a very delicate, very fine balance and have to be careful not to declare victory prematurely on the growth front or on the financial front. I think it's going to be hard for us to do that until we see that we are closer to the point at which we can confidently say that we start to see the bottom in housing prices. Also, we have to be careful not to raise expectations too much that we're on the verge of an imminent, significant tightening in policy. It is a difficult balance. We should take some comfort from the fact that the market believes we will do enough soon enough to keep those expectations down. On the projections front, I have a complicated view, Mr. Chairman. I apologize. If we are going to change, we should focus on stuff that will change things significantly. I don't see huge gains from the changes in these options to our current communication regime. If we're going to change, a trial run in the fall is fine. But I think the fall is too soon to change. We need to get through this thing. We have a very challenging period with a lot of stuff going on, and I think we need to use every molecule of oxygen in the System to get through this mess. I don't think this projections change materially helps the communication challenge in getting through this mess and may complicate it in some ways. If we are going to do something beyond our current regime, I would favor doing something slightly different from this. I would favor at least considering publishing the average of our individual views on what the desirable long-run rate of inflation is, an average of our judgments of what trend growth is today, and maybe what the natural rate of unemployment is today. We know very little about what those latter variables--trend growth and the natural rate of unemployment-- are five to ten years ahead. It is very hard for us individually to put much confidence on whatever the path is toward that point. Our current regime for aggregating our forecasts the way we do, tossing out the individuals, makes our basic forecast not particularly useful as a prism. So I would focus on doing something slightly different to change the regime, and I wouldn't do it this soon. If we're going to change, let's debate the big things and not spend too much time on things at the margin, which fundamentally aren't going to offer too much promise relative to the level of ignorance we have or relative to the complexity that people face in reading any particular meaningful value in the aggregation of our forecasts the way we now do them. " FOMC20060328meeting--88 86,MS. YELLEN.," Thank you, Mr. Chairman. May I say it’s a great pleasure to see you back at the table. And while I hesitate to wish your predecessor’s eighteen years of service on anyone, I look forward to many interesting and productive meetings under your leadership. The latest monthly data show significant strength in activity for the quarter just ending, and I agree with the Greenbook’s assessment that this strength represents a temporary catch-up after the weak fourth quarter. I anticipate that growth will likely settle back to trend as the year progresses, especially as the lagged effect of tighter financial conditions damps interest-sensitive sectors. The current risks to this scenario are by now a well-known litany—housing, energy prices, the saving rate, foreign demand, and term premiums. Overall, I judge the risk to the growth forecast to be pretty well balanced. I did want to comment briefly on the risks associated with housing. This is the sector that obviously bears close watching because it can represent the leading edge of the effects of the monetary tightening. Thus far, published data on housing starts and permits provide rather little evidence of a significant weakening in construction activity, although other indicators such as home-buying attitudes and new home sales, along with a growing amount of anecdotal evidence, suggest that tighter financing conditions are finally exacting a toll. I think one possible reason that starts and permits have remained so strong is that the inventory margin is taking up some of the slack in demand. Indeed, the stock of unsold homes on the market has now reached quite high levels. I noted a similar phenomenon in talking to a real estate developer in what has been the sizzling Phoenix housing market. In that market, demand has been so strong that builders couldn’t build houses fast enough to satisfy buyers. So delivery times for new homes were very long. And as the demand for new homes has slowed recently, we haven’t seen a noticeable change in building activity, but there has been a significant decline in delivery times. As this margin, like unsold inventories, returns to more historical norms, I think that we’ll see the moderation in demand show up in new construction numbers as well. Turning to inflation, I think it’s worth stressing how good recent readings have been. Over the past twelve months, core PCE prices are up 1.8 percent, the market-based component 1.5 percent, and the core CPI just 2.1 percent. As I’ve noted in previous meetings over the past six months, we have been more optimistic than the Greenbook about the prospects for core inflation during 2006. For quite some time now, we have been on the order of several tenths of a percentage point lower. And I continue to think that core PCE price inflation will come in at about 1.8 percent this year. As the Greenbook forecast drifts down, I think maybe my stubbornness is paying off. My relative optimism partly reflects my view, based on econometric evidence using data after the early 1980s, that there is little pressure for higher inflation coming from the pass-through of energy prices to labor compensation or core prices. Another important element in my optimistic inflation outlook is inflation expectations, which I consider to be well contained and unlikely to provide significant upward impetus to inflation. At the same time, I think it’s important not to ignore the potential adverse inflationary consequences from a resurgent economy. I realize the link between resource utilization and inflation is a contentious topic. Actually, the Philadelphia Fed’s Survey of Professional Forecasters asked its respondents whether they used the concept of a natural rate of unemployment in their macroeconomic projections, and the replies indicate a split of about 50–50. About half the economic forecasters, in other words, use such a rate, and the other half don’t. And my guess is that there is also a considerable difference of opinion around this table. Personally, I’m persuaded that excess demand in a market does tend to push up prices and that the domestic labor market is no exception to this rule. I think that the econometric evidence supports that view. President Fisher has been arguing, and perhaps some others would agree, that what matters is not just U.S. productive capacity but worldwide capacity. I do agree that the world—or, more accurately, the aggregate supply curve—has probably become flatter. But while globalization has had a profound impact on the U.S. economy in a number of ways, I think that there are a number of reasons to doubt that it will overturn, at least completely, the normal historical relationship between domestic labor market slack and inflation. The first point here is simply that many goods and most services still must be produced in the United States, and so foreign capacity isn’t an issue. The second point is that, in order to utilize productive capacity in foreign countries, we do need to run a trade deficit; in principle, such deficits eventually put downward pressure on our exchange rates, which tends to raise the prices paid for imports in the United States. I’m sure this is a topic we will be discussing in a lot more detail going forward. Of course, the measurement of aggregate excess demand or slack is difficult, and I’m sympathetic to the view that there is no bright red line for the unemployment rate that, once crossed, triggers higher inflation. But by examining a variety of indicators, I think it’s possible to get a useful notion of aggregate resource utilization. I would judge that these measures currently fall in a range from a modest amount of slack to a modest amount of excess demand. Specifically, the unemployment rate, the vacancy rate, the employment–population ratio, capacity utilization, and other measures are all within a few tenths, in unemployment rate terms, of full employment. Looking ahead, with the unemployment rate already at 4.8 percent, I think it’s logical to worry that wage and price inflation will rise over time if resource slack diminishes further. And with GDP growth forecast at 3¾ percent this year, a naïve calculation based on Okun’s law suggests that the unemployment rate could fall to 4½ percent by the fourth quarter. In contrast, the Greenbook assumes that the unemployment rate will remain unchanged. The Greenbook inflation projection is, accordingly, more optimistic than a forecast based on the naïve model. Now, given the importance of the behavior of unemployment to one’s forecast of inflation, my staff has been looking at the performance and fit of Okun’s law—namely, the relationship between output growth and the change in the unemployment rate. And I think their analysis provides support for the Greenbook assessment. Using a dynamic version of Okun’s law that fits exceptionally well after 1961, my staff finds evidence of an error correction between the output and the unemployment gaps. During 2005, unemployment declined substantially more than a simple version of Okun’s law would have predicted. And this dynamic model suggests that, even with fast economic growth, the unemployment rate will likely be pushed up a bit this year, as this unusual decline in 2005 is reversed. So to sum up, I see steady growth and few pressures for price acceleration." FOMC20070628meeting--130 128,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. The outlook looks a little better, I think. The United States looks okay, and the world looks very strong. Housing here seems as though it will get worse before it gets better, but the rest of the economy seems to be doing reasonably well—with output and investment spending perhaps a bit firmer than we thought they would be and employment growth and income growth looking reasonably good. We have not significantly changed our central projection. We still see an economy growing around 3 percent over the forecast period, about our estimate of potential, with core PCE inflation falling just below 2. This assumes a path for the nominal fed funds rate that is flat for several more quarters, essentially the same as in the Greenbook and in the market now. The risks to this outlook, though, have changed. We see less downside risk to growth but still believe the risks to our growth forecast are weighted toward the weaker outcomes. Although the recent inflation numbers have been good, they probably exaggerate the moderation of underlying inflation, and we see, therefore, continued upside risk to our inflation forecast. I still think this latter risk should remain our more consequential concern. Relative to the Greenbook, we have a bit more growth because of our higher estimate of growth in the labor force and a bit less inflation, but these differences are small, smaller than they have been, and they do not have significant implications for our views on monetary policy. The markets’ perceptions of fundamentals have in some respects moved in our direction in the past few weeks. I say “in some respects” because we need to be attentive to the rise in implied inflation that you see in TIPS. Our view and the markets’ view of the expansion, the risk to the outlook, and implications for monetary policy have converged. This means that the effective stance of monetary policy is a little tighter than it was. A few important issues going forward: On the growth front, I still think that the probability of weakness exceeds that of strength. There is still a significant risk that we will see a more substantial adjustment of house prices, perhaps drawn out over a sustained period of time with greater adverse effects on confidence and spending. Of course, if employment and income growth stay reasonably strong, the effects of that potential scenario should be manageable. If not, we will have more to worry about. I note that some major financial institutions are now starting to report signs of rising delinquencies in consumer credit products outside mortgages such as automobile loans and leases. This is the first time that I have heard that report in a significant sense, and maybe it is a sign of some vulnerability ahead. The strength of demand growth outside the United States has been helpful, and we agree with the Greenbook that it looks likely to continue for some time. But things could be kind of bumpy out there, particularly in places like China, and monetary policy in much of the world is only now starting to move short-term real rates higher into positive territory. On the inflation front, it seems early to declare satisfaction or victory, not particularly because of the recent reacceleration in headline inflation but just because of the role of transitory factors in the recent moderation in core and the rise in breakevens in TIPS. We cannot be fully confident yet that a constant nominal fed funds rate at current levels will deliver an acceptable inflation forecast. We do not, in my view, need to try to induce right now a further tightening of financial conditions to push core inflation down further and faster. But we need more time before we can justify shifting to a more balanced risk assessment of inflation or something equivalent, something that would have the effect, for example, of indicating satisfaction with current levels or of suggesting that the risks are balanced around the path of inflation that we see in our central tendency projections. With financial markets, we are at a delicate moment. The losses in subprime are still working their way through the system. Rating agencies are likely to downgrade a larger share of past issues, more than they have already. The marks that people show indicate that both hedge funds and dealers in a lot of this stuff may still have a way to go to catch up with the movement in market prices. This dynamic itself could induce a further reduction in willingness to finance new mortgages. You could see pockets of losses in the system, liquidity pressures in hedge funds and their counterparties, and further forced liquidations. It is possible that we will still have a bunch of that effect ahead of us, even if no big negative shock to demand occurs and induces a broader distress in consumer credit. We could also see it spread to commercial real estate. We could see a broader pullback from CDOs and CLOs as well, either from a general erosion of faith in the rating models—as Bill said, it is a possibility—or from just concerns about liquidity in those instruments. We could see a sharp, substantial widening of credit spreads provoked by an unanticipated default or two or just a general reassessment of risk at current prices. A very large amount of LBO financing that is yet to be closed, distributed, and placed is still working its way through the system. As in the past, we could see a deal or two get hung, the music stop, and that force some broader repricing. People get stuck with stuff they don’t want to hold or did not expect to hold. I think we now see more sensitivity in markets about the prospect of a diminished appetite among the world’s savers and central banks to increase their exposure to the United States, or at least we see more sensitivity to the perception out there that the dynamic might be unfolding. You can see a bit of all this in some spreads, in some reports of resistance to further erosion in covenants, in some reduced appetite for new bridge book exposure to leveraged lending. You can see it in some changes in margin terms in some instruments vis- à-vis some counterparties. For now I think it is a relatively healthy, still pretty modest, and quite contained shift toward a more cautious assessment of risk, but these things generally don’t tend to unfold gradually. On balance, though, I think we are in a pretty good place in terms of policy, in terms of the market’s expectations about policy now, and in terms of how we have been framing the balance of risks to the outlook." CHRG-109shrg30354--3 STATEMENT OF SENATOR PAUL S. SARBANES Senator Sarbanes. Thank you very much, Chairman Shelby. I welcome Chairman Bernanke before the Committee. I think it is fair to say this hearing comes at a particularly pivotal time for monetary policy. The economy is slowing down and the run-up in oil prices is contributing to that slowdown. An oil price spike has preceded a number of recessions since 1973, but some spikes have occurred without a subsequent recession. We look to the Federal Reserve to help avoid a recession this time around. There are a number of signs of economic weakness. Job growth has been anemic for the last 3 months, averaging just over 100,000 jobs per month. The pace is less than 1 percent a year. Over the last half century we have tended to have such slow job growth when we are going into or coming out of a recession. It is less than half the pace of job growth for the 10 years of expansion from March 1991 to March 2001. Not only are jobs growing slowly, but also all the measures of wages and compensation show gains below inflation over the last year. Total compensation, including wages and benefit costs, have risen 2.8 percent in the last year. Such pay gains are not putting upward pressure on inflation because they are almost entirely offset by productivity gains, which are up 2.5 percent. Unit labor costs, which adjust hourly labor costs for productivity gains, are up by a negligible 0.3 percent in the last year. That is shown rather dramatically in this chart, which shows compensation, productivity, and unit labor costs. Unfortunately, the only people with pay gains that are keeping ahead of inflation are those at the top of the ladder. By this stage in previous business cycle expansions, people at the middle and bottom of the wage ladder have typically been enjoying healthy pay gains. This was certainly the case from 1995 to 2000. We need to keep the expansion going so that those at the middle and the bottom of the pay scale can finally share in the exceptional productivity gains that they have helped to create. With the higher cost of fuel and little room to cut back on fuel use, consumers have been forced to cut back on other types of spending and they go into debt. Consumer spending has risen at less than a 2 percent rate over the last 4 months. To manage even that modest increase, households have had to reduce savings and increase borrowing. The household savings rate has plunged to an unprecedented minus 1.7 percent. Where is the rise in inflation coming from? Although higher prices for oil and other commodities have contributed, much more important is the surge in profit margins. At this hearing 2 years ago, Chairman Greenspan drew attention to this, stating ``from an accounting perspective, between the first quarter of 2003 and the first quarter of 2004 all of the 1.1 percent increase in the prices of final goods and services produced in the nonfinancial corporate sector can be attributed to a rise in profit margins rather than cost pressures.'' He predicted at the time that competition to create new capacity and hire more workers would bring down the profit share to more normal levels, but that has not happened. In fact, the profit share of GDP hit 12.7 percent in the first quarter, the highest profit margin since 1950. With inflation racing ahead of wages and rising interest rates, we see a serious downturn in the housing industry. The housing affordability index has plunged to the lowest level since 1989 when declining housing led to a recession in 1990. New home sales so far this year are running 11 percent below the rate for the same period last year. With sales down, builders have cut back on new home construction. They are obtaining permits at a rate of more than 1.7 million a year for 5 months last year, but that rate fell below 1.5 million in the latest months. We are now down below 1.4 million. This is new single family home permits, and it shows a rather marked decline over the last year. Last week's report on the consensus of blue chip economic forecasters should also give Federal Reserve policymakers pause. The consensus expects growth below the trend line starting with the just-completed second quarter through the end of 2007. In addition, the blue chip economic forecasters expect inflation to slow down to about 2.5 percent next year. I am hopeful that this morning Chairman Bernanke can put to rest some troubling concerns about monetary policy. The Fed's statements that future changes in interest rates will depend on new data, not an all together unreasonable statement I might say, but it has been interpreted by some commentators to mean that the Federal Reserve will raise interest rates at every meeting until inflation comes down. The headlines of the last two weekly reports from Goldman Sachs are ``The Stance of Monetary Policy, Enough is Enough.'' And the other one ``Bernanke Preview, Monetary Policy Begins to Bite.'' Two recent headlines from Merrill Lynch state that its ``getting tougher for the Fed to justify what it is doing'' and ``nearly every indicator showing signs of a slowdown.'' Merrill Lynch Economist David Rosenberg, in a report last Friday entitled, ``To Pause Or Not To Pause: That Is The Conundrum,'' expressed this concern: ``The Fed has managed to elevate a pause to something that is a pretty major event. What was normal in prior cycles, up or down, is now something that grabs headlines. The Fed paused twice in the 1999-2000 cycle and three times in the 1994 cycle, and it elicited a yawn from the markets. This time around a `pause' is being treated as an `ease,' which has basically put the Fed in a pickle.'' The 17 Fed rate hikes over the last 2 years are having an effect. You can see that in the housing sector, job growth, the blue chip forecast. Both for subdued growth and for falling inflation over the next year. I look forward to the opportunity to pursue these concerns with the Chairman in the question period. I also, just to send a warning, hope to be able to ask you about the Basel II situation which I think is a matter that calls for very close attention, which I do not think it has been receiving. Thank you very much, Mr. Chairman. " CHRG-109shrg21981--15 STATEMENT OF SENATOR DEBBIE STABENOW Senator Stabenow. Thank you, Mr. Chairman, and welcome, Mr. Chairman. It is wonderful to see you, again, and I want to join my colleagues in thanking you for your leadership and service over the last 16 years. We truly have appreciated and relied on your judgments and your thoughts, and I have appreciated, also, the opportunity to talk with you both privately in my office, as well as on other occasions, about what we are facing in terms of out-of-control deficits. I know you have warned us, since I was in the House of Representatives, and, by the way, I was very proud of the fact, coming into the U.S. House in 1997, that we balanced the budget for the first time in 30 years. We, unfortunately, now have gone from the largest surpluses in the history of the country projected in 2001 to the largest deficits, and that is deeply, deeply disturbing, and I am very interested in your current thinking as it relates to our economic environment with the deficit and the sustainability of that and, in fact, the ethic and responsibility that we all have to address that. I view that as a major moral issue. The President would have us believe that Social Security, in 13 years, is going bankrupt even though we know that is not accurate. We do know that there is a gap, 40 or 50 years down the road, and I am confident that working with my colleagues that we will address that. But what we are hearing from the President is that his suggestion as a way to fix it is to hoist an additional $5 trillion of national debt on American families over the next 20 years, and he calls it an ownership society. I would argue that what every man, woman and child will own is an additional $17,000 in debt, on top of what we already have as a birth tax right now of $15,000. Every time a child is born, that is our gift to them, in terms of the current national debt. So, I am extremely concerned about where we are going and the sustainability of that. Right now, it will require decades for this debt to be fully offset, and the projected savings being talked about in terms of the savings and the market growth, in terms of privatization of Social Security, ironically, is the same growth that would take care of the Social Security gap if, in fact, it materialized. And so I would be interested in your thoughts about that as well. I am very interested in your discussion in terms of the national debt, our chronic deficit and, also, what has been raised by my colleagues as troubling trade deficits, which are exploding, and particularly when we look at China and what is happening in terms of our inability to enforce trade laws and to address the trade imbalances that we have that are causing great havoc in my home State with manufacturers and others that are asking us for a level playing field so that they can keep and create more jobs. So, I thank you, Mr. Chairman. " FOMC20060920meeting--127 125,MR. PLOSSER.," Thank you, Chairman Bernanke. Overall, economic activity continues to expand in the Third District. The consensus in the regional business community is for moderate growth in the months ahead, but some sentiment has turned more cautious in the intermeeting period. We have seen a slowdown in regional manufacturing activity over the past month. Our business outlook survey, which remains confidential until noon tomorrow, weakened somewhat in September with general activity falling just barely into the negative area, at -0.4, from an 18.5 number in August. This is the first negative reading we’ve seen since April 2003. The diffusion indexes for shipments, new orders, and unfilled orders also turned slightly negative. I don’t want to read too much into one survey. The April 2003 dip was very short-lived, and we saw a similar pattern in our survey in the mid-1990s, when growth slowed but then picked back up again fairly quickly. Part of the slowdown in manufacturing is at firms that supply the housing industry, reflecting a slowdown in residential real estate, which has become more pronounced in our District since our last meeting. Building permits and home sales were down in July and August. Inventories of homes on the markets, like much of the nation, continue to increase. House-price appreciation has slowed, but we have not yet seen outright declines. Despite an increase in cancelled sales of new homes, builders generally indicate that their backlogs will keep them relatively busy through the rest of the year. However, some real estate contractors have begun to lay off employees in anticipation of slower activity. A pickup in activity in nonresidential real estate markets has been helping to offset the decline in residential construction. Office vacancy rates continue to edge down, and net absorption of office space continues to be positive. However, over the next year, some moderation in nonresidential building construction in our three states is expected. In response to a special question in our manufacturing survey this month, about one-third of the firms report that they plan to lower their expenditures on new structures next year compared with this year. Only one-tenth of our firms expect to raise spending on structures. When we asked a similar question a year ago, about half the firms expected to raise their expenditures on structures in 2006, and, in fact, we did see that this year. For other categories of capital spending, however, firms by a large margin anticipate expenditures in ’07 to be the same as or higher than those in ’06. At some small banks in our District there has been a recent pickup in nonperforming loans, which is concentrated in their commercial real estate portfolios. Conditions in other sectors of our region are little changed since our last meeting. Retail sales of general merchandise edged up, but sales of back-to-school merchandise, especially fall apparel, did not seem to meet manufacturers’ expectations. Payroll employment continues to expand in our three states at a somewhat slower pace than in the nation as a whole, which is typical of the region. The unemployment rate, which had edged down slightly in June, edged back up in July but remains below 5 percent. While many employers continue to report difficulties in filling positions, the Philadelphia staff’s forecast is for employment in our region to grow at a pace of about 1 percent over the next year, slightly lower than this year. Unemployment rates in the region are expected to increase modestly maybe over the next year. Growth continues at a moderate pace, but we see little indication of receding price pressures in the District. The index of prices received in our manufacturing survey edged up in September. There was some minor moderation in prices paid, but that index remains at an extremely high level. Employers in a number of industries in the region report that wage and salary levels have been moving up at a somewhat faster pace than they did a year ago. Turning to the national economy, my view is not much different than it was at our last meeting. My main concern remains the outlook for inflation and the risk it poses for our credibility. In my view, the Fed’s most important contribution to a healthy economy is achieving and maintaining price stability. As expected, incoming data continue to indicate a moderation in growth to potential or somewhat below potential. On the negative side, housing has weakened more sharply than many expected, and auto production seems to be turning down for the rest of the year. On the positive side, as has already been mentioned by a number of others, business investment and corporate profits remain firm. Employment continues to rise at a moderate pace. The revised wage and salary data are now more consistent with the strength in consumer spending that we’ve seen, and continued growth in income and perhaps lower gas prices will help offset the possible negative effect that we may see from a deceleration in housing prices. On balance, I am somewhat more optimistic than the Greenbook about the growth side of the economy. I, too, see growth somewhat below potential over the next four quarters, but that’s driven predominantly by a slowdown in the near term—that is, in 2006. Then I see a return to potential more or less in 2007, although my estimate of potential is probably slightly higher than the Greenbook’s estimate. Now, given the level of precision of our output measurements and forecast of potential GDP growth, I’m really not overly concerned about the forecast at this point. The adjustment in the housing sector to more-sustainable levels is forecast to occur without triggering a recession and without triggering much of an increase in unemployment. I believe we should not attempt to stand in the way of that happening. It’s a mistake to think that the forecasted moderation in growth will bring inflation back to a level consistent with price stability. Indeed, the Greenbook’s baseline forecast of core PCE inflation remains above 2 percent through the end of 2008. Even in the alternative Greenbook simulation of a slump in housing, in which aggregate demand weakens and real GDP growth slows to just 0.6 percent in 2006 and barely above 1 percent in the first half of 2007, core inflation hardly changes and remains above 2 percent in 2008. Thus, it seems to me that language from us in the press that indicates that moderating growth will help to restrain inflation is not really consistent with our forecast. I think it imputes a degree of precision to an estimated Phillips curve that we just don’t have. Over the intermeeting period, we have had some hopeful news on the inflation front. Core CPI inflation has not accelerated further in the past two months, and oil prices seem to be down. Thus, headline inflation, as I pointed out, is likely to be way down in September, and we will seem quite omniscient. The measure of expected inflation over the ten-year period in our Survey of Professional Forecasters has not changed—it remains at 2½ percent. The August rise in the Michigan survey of one-year-ahead inflation expectations seems to have been reversed in the preliminary September numbers, largely because of the decline in oil prices. However, both compensation per hour and unit labor costs have been trending up, not down as the earlier data suggested, although I will note that the usefulness of the compensation numbers in predicting inflation is quite weak. Although core inflation has stabilized, its level is still above our so-called comfort zone. To my mind, the inflation outlook is quite uncertain. We do not yet know if the positive developments in oil prices will stick or not. I hope they will, but certainly we’ve seen energy prices retreat only to move back up again, and the hurricane season isn’t over yet. Thus, we should not become too sanguine about inflation from one or two data points. Moreover, we do not know if the upward revision to labor compensation will pass through to core inflation, as built into the Greenbook baseline, or if measures of medium-term inflation expectations will continue to decrease. What we do know is that core inflation has been above 2 percent for two and a half years and is expected to be there, according to the forecast, for another two years. Put another way, there is little evidence in the forecast that policy actions to date will bring core inflation back below 2 percent before sometime in 2009. I think that should concern us. I see two inflation scenarios as being plausible, and I struggle with which one I believe to be the correct one. In the first scenario, core inflation is elevated primarily because of transitory factors, like the pass-through of higher oil prices, and reflects an adjustment to these changes in relative prices. As oil prices stabilize, assuming that they do, we’d expect to see core inflation presumably fall and fall faster than indicated in the baseline Greenbook forecast. The Greenbook forecast appears to me to incorporate an assumption of relative price stickiness that is inconsistent with some recent studies on microdata. Thus, in this scenario, I see inflation falling, perhaps more in line with the Greenbook’s alternative scenario of less persistent inflation. This story is appealing and plausible to me, but it rests on the transitory nature of the current measures of inflation. Even in this most desirable of scenarios—seeing inflation fall back to 2 percent or slightly less in 2007—we have to recognize that we will have essentially ratified a higher price level driven by oil price increases, and we should ask ourselves whether or not we are comfortable with that. In the other scenario, stimulative monetary policy during the past five years has been a major contributor to the rise in core inflation. In this case, we wouldn’t expect to see a deceleration of core inflation until monetary policy has firmed enough to take out the cumulative effects of that accommodation. The Committee has now moved rates up considerably from historical levels. If potential growth is now lower, as the staff indicates, the equilibrium real rate may be slightly lower, suggesting that monetary policy may be slightly firmer now than previously thought. Even so, it has only recently reached that level. But given the imprecision with which we estimate potential output or equilibrium real rates, I really don’t take much comfort from such measurements. Thus, to my mind, there is a significant risk that policy is not yet firm enough to achieve the desired outcome. Regardless of which of these two scenarios you think more likely, I think we must be concerned that our credibility and the consequences of allowing inflation to remain above our comfort zone for so long are at question. If scenario 1 comes to pass and inflation falls faster than suggested by the Greenbook baseline, then we would all breathe easier. But that scenario seems largely a bet on oil prices and on the presumption that past accommodative policy is not playing any role, and that makes me nervous. I would much prefer to believe that scenario 1 is the operational one. However, again, I find it hard to believe that a four-year to five-year period is transitory, so I have to consider the alternative. If the first scenario is wrong and inflation evolves as in scenario 2, then our credibility is seriously at risk if we fail to take further steps to curtail price increases. We might be lucky. But we might risk finding ourselves in a situation in which inflation expectations become unhinged, making it more costly to bring inflation back down. As has been mentioned, in the Greenbook alternative forecast in which inflation expectations become unanchored, inflation remains near 3 percent with only a slight decline in 2008, and growth slows below 1¾ percent next year and remains well below trend through the forecast period. To me, 3 percent inflation and 1½ percent real growth is not a comfortable place to be and would make restraining inflation in the future even harder for us. I’d like to conclude my remarks by thanking the Board staff for their research on inflation dynamics and the possible reduction in the level of persistence in recent years. I think this is an important area for research, but I encourage the staff to continue its work to try to identify structural models of these dynamics in addition to reduced-form models. I agree with the staff that the monetary policy implications of the reduced-form findings presented in the memo depend on how one chooses to interpret them. The results presented by the staff and others suggest that, since 1990, inflation has become less persistent and appears to be less related to other macro variables as well. We do not know whether these changes are due to a more aggressive stance of monetary policy against inflation and to our credibility or to fundamental changes in the domestic or world economy. If we suppose that lower inflation persistence is due to enhanced policy credibility, then it is incumbent upon this Committee to maintain that credibility. That is, we should not expect inflation persistence to remain low if the Fed acts in a manner that is inconsistent with its commitment to price stability or risks its credibility by neglecting to take actions that return the economy to price stability in a reasonable period of time. We shouldn’t ignore the fact that the longer we allow deviations from price stability to persist, the higher is the risk to our credibility and the higher is the risk that recent high inflation readings will raise longer-term expectations, thereby putting us in a very awkward position a year from now. Thank you." CHRG-111shrg55117--27 Mr. Bernanke," It is difficult to know, and we have had false dawns before, but the recent data have been mildly encouraging. We have seen demand fairly stable now for some months in terms of housing. We have seen some increase, actually, in construction and permits. The data on house prices, there are a number of different series, and they don't always agree, but there seems to be, at least for the moment, there seems to be some leveling off in house prices. And, of course, in part because of the Federal Reserve's actions, mortgage rates are a good bit lower than they were last fall, and indeed housing affordability right now is the highest it has been in many, many years. So there are some positive indicators on the housing front. That being said, we still also have problems of foreclosures coming on the market which will put downward pressure on prices, and so we can't get guarantee by any means that the price declines are over, but we are seeing a few positive indicators in the housing market. Senator Johnson. Thank you, Chairman Bernanke. " 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 FOMC20060328meeting--134 132,MR. LACKER.," Thank you, Mr. Chairman. While we had some softer readings on our District’s economic performance early in the year, recent measures have been noticeably stronger. Our survey results from March have come in since the Beige Book, and they show continued strength in service-sector revenue growth, along with a sharp rebound in shipments, new orders, and employment for the manufacturing sector. The retail sector, in contrast, has been weaker in February and March. Some of the weakness is in furniture and may reflect cooling housing markets. However, other retailers suggest that they are still experiencing givebacks following the extraordinary sales growth they saw in January, and many remain optimistic about sales prospects going forward. Several District businesses we talked to plan to increase investment in the months ahead. Their plans include not only computers and technology but also factory machinery. Labor markets in our District seem to be getting tighter. In January, Districtwide unemployment stood at 4.1 percent, and we hear scattered reports of shortages of skilled workers, as you mentioned earlier, along with some complaints that worker shortages are constraining production. I had heard occasional references to worker shortages in past months, going back into last year, but this chatter has picked up noticeably in recent weeks. Not only have the number of reports increased somewhat, but some now come from outside the traditionally strong urban areas. We’re hearing it now in the manufacturing-dependent Carolinas, for example. Price growth measures moderated in our March survey results. District businesses report that input price increases slowed, but they continued to express concerns about future cost pressures. Our respondents also reported slower growth in their output prices, and this was broadly based across all sectors we survey. In addition, expected price increases for the next six months generally lessened. Our regional economic indicators on production, employment, and price pressures seem broadly consistent with the national picture. The data point to a strong rebound in GDP growth this quarter, perhaps stronger than had been anticipated by the Greenbook and private forecasters. While household residential investment is slowing, business investment and spending appear to be strong, suggesting that firms are adding to capacity in anticipation of healthy demand growth. The prospects for income growth, driven by continued employment gains and respectable growth in compensation, give me some confidence that overall consumer spending should hold up well, even as housing market activity moderates. Inflation has come in a bit lower than expected, and I’m increasingly comfortable with the idea that we’ve gotten beyond the risks to inflation presented by the shock associated with last year’s hurricanes and run-up in energy prices. Core PCE inflation averaged 2.3 percent from August through November but has averaged 1.8 percent from November through January. Although market-based measures of longer-run inflation expectations rose briefly last fall, they soon subsided and have remained steady since. So while I’m not entirely sanguine about the inflation outlook, I think the immediate risk of pass-through has probably passed us by. Looking back over this episode, and how we and many others feared that things might have unfolded, I think it illustrates the challenges we face in trying to understand inflation dynamics. As energy prices rose sharply last fall after the hurricanes, the fear was that a sustained increase in core inflation and inflation expectations would work its way through the economy in the first half of 2006. This bulge now appears to have been small and short-lived. A common approach to forecasting the effect of energy-price shocks on core inflation is to rely on relationships estimated over historical periods that include seemingly similar episodes. Such an exercise implicitly treats the empirical relationship between energy prices and core inflation as structural, as in models in which wages or prices are set in a backward-looking fashion. But as President Yellen and others have emphasized, this relationship is not stable in the historical data. It has largely disappeared since the late 1980s. This underscores the pitfalls of forecasting inflation based on a backward-looking approach that relies on pass-through correlations or, for that matter, Phillips curve correlations between measures of slack and inflation. In contrast, to the extent that price-setting is forward looking, these correlations must embed expectations regarding our policy behavior and so will not generally be stable across changing policy regimes. This perspective suggests that the limited magnitude of the pass-through from last fall’s energy-price shocks was influenced by the public’s confidence that we would focus on preventing broader inflationary spillovers. In other words, we may have gotten less pass-through than we feared because we were more credible than we realized, and the public’s behavior was more forward looking than we thought. Again, this is not to say that I’m complacent about inflation. The initial response to last fall’s shocks embodied expectations of a lower path for the funds rate and a greater rise in inflation. Fortunately, the combination of communication by FOMC participants and the Committee’s steady actions appears to have brought these expectations back in line. I bring all of this up because in the months ahead we are likely to see tighter resource utilization if the Greenbook is correct, and we will be concerned about the extent to which that would put upward pressure on inflation and inflation expectations. So the question of the extent to which inflation dynamics are backward looking or forward looking is going to be front and center for us." CHRG-110hhrg34673--12 Mr. Bernanke," Mr. Chairman, first of all, policy is going to respond to new information. We are going to be continually reassessing our outlook and responding appropriately as we see the economy evolving. Policy also has to respond to risks. There are risks in both directions. On the real side, I talked about housing as a downside risk, but there is also some upside risk. We have seen very strong consumer spending numbers. We have seen some strong income growth which suggests that the economy may be stronger than we think. It is possible. And in a sense, aggregate spending may exceed our capacity and put pressure on product markets, and that would be a concern. The other issue is on inflation. We have had a period where inflation has been above where we would like to see it as far as consistency with price stability is concerned. In order for this expansion to continue in a sustainable way, inflation needs to be well-controlled. If inflation becomes higher for some reason, then the Federal Reserve would have to respond to that by raising interest rates. That would not contribute to the continued-- " FOMC20060920meeting--125 123,MR. LACKER.," Thank you, Mr. Chairman. The Fifth District’s economy has grown at a somewhat faster pace in recent weeks, reflecting a solid uptick in manufacturing. Preliminary results from our September survey are showing increases in all manufacturing measures, with a particularly strong performance of shipments and new orders. The six-months-ahead outlook measures are also coming in broadly stronger. Growth in the District services sector continues at a moderate pace. Retail sales remain somewhat sluggish, however, held down by soft big-ticket sales, which we understand were mainly in auto and building materials. The residential real estate market shows signs of further cooling, especially in Maryland and Northern Virginia. As has been the case for several months, however, real estate activity varies widely across the District, with the Carolinas, which were less affected by the boom, reporting continued strength. Labor market conditions remain taut, with job growth generally reported to be solid. Complaints that skilled workers are hard to find continue to be heard, and survey evidence suggests continued wage pressures. Recent reports regarding District price pressures generally tilt toward the firm side on balance. Early reports for September for the manufacturing sector show a notable acceleration in both current prices paid and current prices received and large increases in six-months-ahead expectations for both. Reports on service-sector prices are more mixed. Our respondents from the retail sector report moderation in current price trends but see more-rapid six-months-ahead price gains than they did last month. Our other service-sector firms report no change in current price trends but expect some moderation in coming months. Regarding the national economy, since our last meeting we have received largely positive news pertaining to the outlook for consumer spending. There was a sizable upward revision to the current level of labor income, which improves the outlook for real disposable income growth. Lower energy prices should provide an additional, though one-time, boost to consumer spending. So on net I find myself, again, a bit more optimistic than the Greenbook on consumption. The housing data certainly have been weaker than anticipated, and I now expect a somewhat steeper decline, as does the Greenbook. Forecasting this housing adjustment is particularly difficult because, as President Minehan pointed out, we have only one or two episodes for comparison in the post-Reg Q regime, and as David Wilcox pointed out, they don’t seem to closely resemble our current situation. I find this Greenbook’s more pessimistic outlook for housing itself plausible, but I’m still fairly skeptical of large indirect spillover effects on employment or consumption. For overall activity, I expect real GDP growth to be somewhat below trend, especially this quarter, but above the Greenbook through the end of next year. My views on the inflation situation have not changed much since our last meeting. The lower reading on July’s core PCE was encouraging, and the easing of energy prices is clearly providing some relief on headline inflation. However, July’s lower numbers were not particularly broad based, and the August CPI report shows a significant rebound in core inflation, as President Fisher noted. While labor compensation numbers have been hard to interpret, they also appear to point in the direction of greater price pressures, which I take it to be the staff’s view. The downward movement in TIPS inflation compensation since the last meeting has been quite striking—more than 30 basis points at the five-year horizon. I’ve made a lot of comments on TIPS inflation compensation spreads in past meetings, and it’s not clear that this downward movement signals much of an improvement in the outlook for core inflation in the near term. I pointed out earlier that the Bluebook shows that the fall in near-term inflation compensation has occurred mainly at a three-month or four-month horizon. Compensation for the period running from October/November this year to the same period next year has hardly fallen at all, and this to me suggests no significant change in the rate at which the public expects core inflation to moderate over the next year or two. Moreover, one-year-forward expected inflation rates five and ten years out have not fallen much, so I do not view the recent fall in TIPS inflation compensation as terribly comforting. Overall, regarding inflation, I’m quite apprehensive about waiting for core inflation to decline as slowly as it does in the Greenbook or about letting a new reduced-form model do our work for us." CHRG-111hhrg53245--21 Mr. Zandi," Thank you, Mr. Chairman, and members of the committee for the opportunity to be here today. I am an employee of the Moody's Corporation, but my remarks today reflect only my own personal views. I will make five points in my remarks. Point number one: I think the Administration's proposed financial regulatory reforms are much needed and reasonably well designed. The panic that was washing over the financial system earlier this year has subsided, but the system remains in significant disrepair. Our credit remains severely impaired. By my own estimate, credit, household, and non-financial corporate debt outstanding fell in the second quarter. That would be the first time in the data that we have all the way back to World War II, and highlights the severity of the situation. I think regulatory reform is vital to reestablishing confidence in the financial system, and thus reviving it, and thus by extension reviving the economy. The Administration's regulatory reform fills in most of the holes in the current system, and while it would not have forestalled the current crisis, it certainly would have made it much less severe. And most importantly, I think it will reduce the risks and severity of future financial crises. Point number two: A key aspect of the reform is establishing the Federal Reserve as a systemic risk regulator. I think that's a good idea. I think they're well suited for the task. They're in the most central position in the financial system. They have a lot of financial and importantly intellectual resources, and they have what's very key--a history of political independence. They can also address the age-old problem of the procyclicality of regulation; that is, regulators allow very aggressive lending in the good times, allowing the good times to get even better, and tighten up in the bad times, when credit conditions are tough. I also think as a systemic risk regulator, the Fed will have an opportunity to address asset bubbles. I think that's very important for them to do. There's a good reason for them to be reluctant to do so, but better ones for them to weigh against bubbles. They, as a systemic risk regulator, will have the ability to influence the amount of leverage and risk-taking in the financial system, and those are key ingredients into the making of any bubble. Point number three: I think establishing a consumer financial protection agency is a very good idea. It's clear from the current crisis that households really had very little idea of what their financial obligations were when they took on many of these products, a number of very good studies done by the Federal Reserve showing a complete lack of understanding. And even I, looking through some of these products, option ARMs, couldn't get through the spreadsheet. These are very, very difficult products. And I think it's very important that consumers be protected from this. There is certainly going to be a lot of opposition to this. The financial services industry will claim that this will stifle innovation and lead to higher costs. And it's true this agency probably won't get it right all the time, but I think it is important that they do get involved and make sure that households get what they pay for. The Federal Reserve also seems to be a bit reluctant to give up some of its policy sway in this area. I'm a little bit confused by that. You know, I think they showed a lack of interest in this area in the boom and bubble. They have a lot of things on their plate. They'll have even more things on their plate if this reform goes through. As a systemic risk regulator, I think it makes a lot of sense to organize all of these responsibilities in one agency, so that they can focus on it and make sure that it works right. Point number four: The reform proposal does have some serious limitations, in my view. The first limitation is it doesn't rationalize the current alphabet soup of regulators at the Federal and State level. That's a mistake. The one thing it does do is combine the OCC with the OTS. That's a reasonable thing to do, but that's it. And so we now have the same Byzantine structure in place, and there will be regulatory arbitrage, and that ultimately will lead to future problems. I can understand the political problems in trying to combine these agencies, but I think that would be well worth the effort. The second limitation is the reform does not adequately identify the lines of authority among regulators and the mechanisms for resolving difference. The new Financial Services Oversight Council, you know, it doesn't seem to me like it's that much different than these interagency meetings that are in place now, where the regulators get together and decide, you know, how they're going to address certain topics. They can't agree, and it takes time for them to gain consensus. They couldn't gain consensus on stating simply that you can't make a mortgage loan to someone who can't pay you back. That didn't happen until well after the crisis was underway. So I'm not sure that solves the problem. I think the lines of authority need to be ironed out and articulated more clearly. The third limitation is the reform proposal puts the Federal Reserve's political independence at greater risk, given its larger role in the financial system. Ensuring its independence is vital to the appropriate conduct of monetary policy. That's absolutely key; I wouldn't give that up for anything. And the fourth limitation is the crisis has shown an uncomfortably large number of financial institutions are too big to fail. And that is they are failure risks undermining the system, giving policy makers little choice but to intervene. The desire to break up these institutions is understandable, but ultimately it is feudal. There is no going back to the era of Glass-Steagall. Breaking up the banking system's mammoth institutions would be too wrenching and would put U.S. institutions at a distinct competitive disadvantage, vis-a-vis their large global competitors. Large financial institutions are also needed to back-stop and finance the rest of the financial system. It is more efficient and practical for regulators to watch over these large institutions, and by extension, the rest of the system. With the Fed as the systemic risk regulator, more effective oversight of too-big-to-fail institutions is possible. These large institutions should also be required to hold more capital, satisfy stiffer liquidity requirements, have greater disclosure requirements, and to pay deposit and perhaps other insurance premiums, commensurate with the risk they take and the risks that they pose to the entire financial system. Finally, let me just say I think the proposed financial system regulatory reforms are as wide-ranging as anything that has been implemented since the 1930's Great Depression. The reforms are, in my view, generally well balanced, and if largely implemented, will result in a more steadfast, albeit slower-paced, financial system and it will have economic implications. And I think that's important to realize, but I think necessary to take. The Administration's reform proposal does not address a wide range of vital questions, but it is only appropriate that these questions be answered by legislators and regulators after careful deliberation. How these are answered will ultimately determine how well this reform effort will succeed. Thank you. [The prepared statement of Mr. Zandi can be found on page 86 of the appendix.] " CHRG-111shrg62643--66 Chairman Dodd," Thank you, Senator. Let me just say here, if we were in the status quo and had not passed this bill and the tools that existed 2 years ago, we would be a lot more vulnerable today than we are without this, so I thank you. Senator Bayh. Senator Bayh. Mr. Chairman, this may be my last opportunity to interact with you in this capacity, and I just want to take this moment to thank you for your service to our country once again and to say it has been a pleasure working with you on some of these issues. My first question has to--there have been a lot of comments here about our budget deficits and debt, which is accurately described, as you pointed out, as unsustainable. I would like to ask about another unsustainable disequilibrium, and that is our current account deficit and the corresponding current account surpluses in China and other parts of the developing world. Many observers believe that it was this disequilibrium that gave rise to a glut of global capital that undergirded the asset bubble that led to some of the problems that we have seen. There were some signs it was beginning to be self-correcting. Savings rates in our country were going up. Consumption in China is rising. But the most recent data suggests that perhaps the current account imbalance is once again on the rise. So my question to you is: How concerned about this should we be? And given the apparent return to the status quo ante in terms of the gap, is this going to be self-correcting, or do other measures need to be taken? " 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? " fcic_final_report_full--420 For children, a repossessed house—whether rented or bought—is destabilizing. The impact of foreclosures on children around the country has been enormous. One- third of the children who experienced homelessness after the financial crisis did so because of foreclosures of the housing that their parents owned or were renting, ac- cording to a recent study.  One school official in Nevada told the Commission about the significant challenges to the educational system created by the economic crisis.  All around, the demand from people who need help is outstripping community resources. Coast to coast, communities are trying to stretch housing aid budgets to help people displaced by foreclosures. In Nevada, for example, Clark County, which contains . million people living in and around Las Vegas, was forced to cut its Fi- nancial Housing Assistance program, despite the clear needs in the community. Gail Burks, the president and chief executive of the Nevada Fair Housing Center, told the Commission that her group finds that many they counsel through the foreclosure process are in despair. “It’s very stressful. There are times that the couples we are helping end up divorcing, sometimes before the process is over. . . . We’ve also seen threats of suicide.”  And the stories continue. Karen Mann, the appraiser from Discovery Bay, Cali- fornia, testified to the Commission about her family’s circumstances. Her daughter and son-in-law refinanced their mortgage into an adjustable-rate mortgage. When the time came for the rate to adjust upward, new financial troubles made the pay- ments more than the family could afford. Because the market value of the home was nearly equal to their mortgage debt, the family’s attempts to get the mortgage modi- fied were fruitless. They lined up a buyer for a short sale, but the deal was nixed. Then, when medical problems created yet another challenge, the couple and their four children moved in with Mann. “The children were relocated to new schools, and the adults dealt with the pain and emotional suffering while they were trying to rebuild their lives,” Mann said. The couple filed for bankruptcy. Two months after the bankruptcy was completed, the lender asked them if they wanted to modify their mortgage.  In Cape Coral, Florida, Dawn Hunt and her husband, a mailman, and their two children live in an attractive ranch-style home they bought for about , more than a decade ago. It was a quiet, -year-old subdivision where most of the residents were homeowners. In  and , builders rushed to the area and threw up dozens of new homes on empty lots. Homebuilder Comfort Homes of Florida LLC broke ground for a house across the street from the Hunts, but did not complete it. This fall, the house sat vacant, an empty shell. No stucco was ever applied to the con- crete block exterior, and the house had no interior walls. A wasp nest decorated the electrical box near the front door. The untended grass had grown four feet high. Sharp sand spurs in the brush made it difficult to approach the property. Two doors down from the Hunts, another house was also vacant, left empty when a family split up and moved a year earlier. They abandoned a car in the garage. The roof leaked, and a blue plastic tarp put in place to keep the rain out now flaps in the breeze. The Hunts called the police after vandals broke into the house one night; intruders have been back twice more in the daylight.  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." fcic_final_report_full--466 Table 2. 23 Troubled Mortgages, Western Europe and the United States ≥ 3 Month Arrears % Impaired or Doubtful % Foreclosures Year Belgium 0.46% 2009 Denmark 0.53% 2009 France 0.93% 2008 Ireland 3.32% 2009 Italy 3.00% 2008 Portugal 1.17% 2009 Spain 3.04% 0.24% 2009 Sweden 1.00% 2009 UK 2.44% 0.19% 2009 U.S. All Loans 9.47% 4.58% 2009 U.S. Prime 6.73% 3.31% 2009 U.S. Subprime 25.26% 15.58% 2009 Source: European Mortgage Federation (2010) and Mortgage Bankers Association for U.S. Data. The underlying reasons for the outcomes in Professor Jaffee’s data were provided in testimony before the Senate Banking Committee in September 2010 by Dr. Michael Lea, Director of the Corky McMillin Center for Real Estate at San Diego State University: The default and foreclosure experience of the U.S. market has been far worse than in other countries. Serious default rates remain less than 3 percent in all other countries and less than 1 percent in Australia and Canada. Of the countries in this survey only Ireland, Spain and the UK have seen a significant increase in mortgage default during the crisis. There are several factors responsible for this result. First sub-prime lending was rare or non-existent outside of the U.S. The only country with a significant subprime share was the UK (a peak of 8 percent of mortgages in 2006). Subprime accounted for 5 percent of mortgages in Canada, less than 2 percent in Australia and negligible proportions elsewhere. …[T]here was far less “risk layering” or offering limited documentation loans to subprime borrowers with little or no downpayment. There was little “no doc” lending…the proportion of loans with little or no downpayment was less than the U.S. and the decline in house prices in most countries was also less…[L]oans in other developed countries are with recourse and lenders routinely go after borrowers for deficiency judgments. 24 The fact that the destructiveness of the 1997-2007 bubble came from its composition—the number of NTMs it contained—rather than its size is also illustrated by data on foreclosure starts published by the Mortgage Bankers 23 Dwight M. Jaffee, “Reforming the U.S. Mortgage Market Through Private Market Incentives,” Paper prepared for presentation at “Past, Present and Future of the Government Sponsored Enterprises,” Federal Reserve Bank of St. Louis, Nov 17, 2010, Table 4. 24 Dr. Michael J. Lea, testimony before the Subcommittee on Security and International Trade and Finance of the Senate Banking Committee, September 29, 2010, p.6. 461 CHRG-109hhrg31539--126 Mr. Castle," Thank you. It just seems to me there is a little more uncertainty than usual. But let me change subjects because time is going to flee here. I want to talk about--when you talk about the housing market, not just now, but in general, I always get a little confused about what we are specifically talking about. Is it the economic--I know you were talking about the housing market as a whole, and you are going to say all of these components, but is it the new basic housing market, that is, the home builders and the banks and the others, who would profit from that, or is it the resale? I mean, a lot of people in this room have houses, and they are worried about the resale of their houses going down, which may only benefit a limited number of brokers and a few other people, but not the housing market per se. When we talk about housing, you have indicated a couple of times not housing per se, but other construction, which could be anything, I mean, offices, shopping malls, whatever it may be. My question to you is when you say the housing market having strengthened in recovery of the economy and slowing down, are you talking about all of these items, or are you talking about more specifically the new housing market? Can you break out the housing market a little more? " fcic_final_report_full--421 Now  of the homes in the Hunts’ neighborhood are in default, are in the fore- closure process, or have been taken back by the bank.  Most of the other houses in the community are occupied by renters whose absentee landlords bought the houses when the homeowners lost their homes to their banks. The Hunts’ house has lost two-thirds of its value from the peak of the market. Nonetheless, even though the neighborhood is not as lovely as it used to be, Dawn Hunt told the FCIC, “I’m not leaving.”  COMMISSION CONCLUSIONS ON CHAPTER 22 The Commission concludes the unchecked increase in the complexity of mort- gages and securitization has made it more difficult to solve problems in the mortgage market. This complexity has created powerful competing interests, in- cluding those of the holders of first and second mortgages and of mortgage ser- vicers; has reduced transparency for policy makers, regulators, financial institutions, and homeowners; and has impeded mortgage modifications. The resulting disputes and inaction have caused pain largely borne by individual homeowners and created further uncertainty about the health of the housing market and financial institutions. FOMC20060629meeting--71 69,MR. LACKER.," Thank you, Mr. Chairman. Economic growth in the Fifth District eased off the throttle a bit since our last meeting. Our June manufacturing survey released yesterday morning continued to show nearly flat activity. Indexes for shipments and new orders were barely positive, essentially unchanged from May, and down from strong readings for March and April. The service sector, on the other hand, continues to display solid growth, with overall services revenues right on their three-month average and retail sales rebounding after a dip in May. However, our big-ticket index, which is dominated by car sales, remained weak. Employment indexes for both services and manufacturing were positive in June, with a slight decline in the services sector but a substantial gain in manufacturing. District housing markets remained reasonably strong. Sales and construction activity have continued to slip from last year’s levels in many areas, but our contacts do not seem surprised or panicked, and we continue to get reports of a pickup in commercial construction activity. Price pressures remain elevated in the Fifth District, and expectations for manufacturing price trends during the next six months remain about where they have been since last fall, roughly 3 percent for prices paid and 2 percent for prices received. In the services sector, expected price increases for the next six months exceeded 3½ percent for the second month in a row, setting a new record high for this twelve-year-old index. Turning to the national economy, the Greenbook presents, as President Moskow noted, a distinctly different picture from six weeks ago, perhaps most notably with regard to consumer spending. Lower growth of household income since the middle of last year has led the staff to reduce its estimate of the level of real disposable income this quarter 1 percent, and they have reduced their estimate of consumption this quarter 0.4 percent. The Greenbook also marks down consumption growth ½ percent in the second half of ’06 and ¼ percent in ’07. Now, it is certainly reasonable to expect lower current income to affect current consumption expenditures, but I am inclined to revise my outlook for consumption growth by less than the Greenbook. Growth in real disposable income is forecast to bounce back in the second half. So the first-half decline looks more like a permanent reduction in the level of income than a permanent reduction in the growth rate of income. I would have expected a corresponding effect on the path of consumption, a one-time reduction in the level, with less of a reduction in forecast growth rates. The same reasoning for me applies to the downward revision that has been made to current household wealth. This quibble aside, the outlook for the real side of the economy is softer than at the time of our last meeting, but it still strikes me as broadly consistent with sustained growth fluctuating around a trend near 3 percent. True, housing market activity has fallen more rapidly since the last meeting than many, including the Greenbook authors, had expected, but the rate of decline has not fallen outside a range that at the beginning of the year would have seemed plausible. While the recent weaker-than-expected employment reports suggest slower job growth going forward, the Greenbook employment forecast seems reasonably well aligned with demographic and labor force participation trends. So on the whole, I would say that, despite the recent evolution of the economic outlook as implied by incoming information, the real side of the forecast does not seem out of the ordinary or terribly unsatisfactory to me. The inflation picture, on the other hand, does stand out and demand some attention. We have just seen our worst three-month performance on the core CPI in more than eleven years, 3.8 percent, and the core PCE numbers are likely to be equally unfavorable. I agree with the Greenbook’s assessment that special factors, such as owners’ equivalent rent, do not excuse recent CPI behavior. Fortunately for us, inflation expectations have declined recently. The survey measures and TIPS spreads have moderated somewhat since our last meeting. Still, inflation expectations appear to be fluctuating around a level suggesting PCE inflation above 2 percent. Moreover, the Greenbook forecast now has year-over-year core PCE inflation remaining at 2.2 percent throughout the forecast period. To me this forecast is unacceptable. To forecast a bulge to 2½ percent followed by a return to below 2 percent, as the Greenbook used to earlier this year, is one thing, but a plan for core inflation of more than 2 percent a year and a half from now is another thing entirely. Surely in an eighteen-month period we can improve that outcome, but I will leave until tomorrow a discussion of our policy options. For now I just want to note that recent events provide some striking evidence that I think is likely to have an important bearing on our strategy in the near term. Leading up to our last meeting, there were several instances in which markets had responded to incoming news by marking up expected inflation and marking down the expected policy path, which I took as evidence of instability in market participants’ views about our intentions regarding inflation. Similar instability was evident in the immediate aftermath of Hurricane Katrina as well. Since the last meeting, increases in the expected policy path have coincided with communications by the Committee via statements, minutes, speeches, and interviews. This was documented in this week’s Board briefings. The same appears to be true of reductions in expected inflation, I think. I take this recent history as evidence that expectations regarding inflation and the conduct of monetary policy are to a significant extent forward-looking and can be influenced by our communications. As I pointed out earlier this year, the extent to which expectations are viewed as forward-looking or backward-looking could well influence the desirability of various policy options, especially how ambitious one wants to be about bringing inflation back in line. I also take the recent history as suggesting the importance of clarifying the public’s understanding of how we intend to conduct policy, even if we cannot provide definitive advance guidance about the numerical value of future policy rate settings. Thank you." FOMC20061212meeting--90 88,MR. STERN.," Thank you, Mr. Chairman. Two or three developments in the District economy are worth noting, and they seem consistent, by the way, with what’s happening at the national level. First, overall, the labor markets, excluding construction, appear to be continuing to improve. Hiring is expanding, and the availability of jobs appears to be growing. Some of that growth is no doubt seasonal, but my impression is that it goes beyond the typical seasonal increase of this time of year. Second, housing sales of both new and existing homes appear to be stabilizing in year-over-year comparisons. That is clearly a favorable development. However, I think the adjustment in residential construction activity likely still has some considerable distance to go. Numerous projects are under way; many of them are in midstream. So the inventory of unsold homes, particularly of condominiums, is likely to remain high for the foreseeable future, and I think the implication is that no sizable new projects will be getting under way any time soon. As far as the national economy is concerned, I agree with the pattern in the Greenbook of gradually improving growth in economic activity after the current and perhaps the next quarter. But I continue to expect such growth to be a bit higher than expressed in the Greenbook for the reasons I’ve cited recently—sustained gains in employment, rising equity values, lower energy prices, moderate interest rates, and overall generally sound financial conditions. Similarly, I wouldn’t quarrel very much with the Greenbook trajectory as far as it pertains to core inflation. I think that, if this outlook is achieved, the outcome would not be at all bad, particularly if inflation diminishes a bit more quickly than it does in the forecast. Unfortunately it’s hard at the moment to see the precursors of such a development, and the lower dollar is not likely to help. However, I’m not alarmed by the unemployment rate at 4½ percent, and I wonder if we’re getting another test of the ex-ante value of the NAIRU in forecasting inflation. [Laughter] As to the risks to economic growth, some of the recent data, although not those pertaining to the labor market, have been on the soft side relative to my expectation. The persistent inversion of the Treasury yield curve has my attention as well, perhaps belatedly. But it’s hard to know with any confidence what to make of the latter factor, given hypotheses about saving gluts, asset shortages, and so forth. Moreover, other approaches beyond analysis of the yield curve to estimate the probability of recessions generally provide figures that are quite low. The underlying resilience of the economy adds to my confidence that business activity is likely to improve rather than deteriorate from here. I would add that I am not hearing any of the negative anecdotes that I heard in late 2000 before the onset of the 2001 recession. Thank you." 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." FinancialCrisisInquiry--711 ZANDI: Well, I—I would say housing in its totality, so that would include housing transactions, home sales. That’s demand, house prices ... and, obviously, housing construction. January 13, 2010 CHRG-111hhrg74090--42 CONGRESS FROM THE STATE OF OHIO Ms. Sutton. Thank you, Chairman Rush, and thank you for holding today's very important hearing on the newly proposed Consumer Financial Protection Agency. As Elizabeth Warren aptly stated in describing the need for an agency like this, ``It is impossible to buy a toaster that has a one in five chance of bursting into flames and burning down your house but it is possible to refinance an existing home with a mortgage that has the same one in five chance of putting the family out on the street, and the mortgage won't even carry a disclosure of that fact to the homeowner.'' Unfortunately, many people in my district who were preyed upon by so many unscrupulous companies, people know this all too well. The well-known and tragic case of one of my constituents, Addie Polk, is a shocking example of a financial product that not only caused someone to almost be homeless but caused someone to attempt to take their own life. At the age of 86, Ms. Polk was given a new 30-year mortgage on a house she already owned and for an amount greater than the value of her house. Let me say that again. At the age of 86, Ms. Polk was given a new 30-year mortgage on a house she already owned and for an amount greater than the value of her house. Less than 4 years later, Ms. Polk, probably of no surprise to the person who sold the mortgage to her, began to have trouble making her payments and her house fell into foreclosure. Feeling trapped and without options, Ms. Polk shot herself rather than lose the house she lived in for 40 years. No one ever should be in Ms. Polk's position. Now is our chance in honor of Ms. Polk and countless other Americans who have found themselves the unfortunate owners of financial products with indecipherable terms, smoke-and-mirror-like provisions and gotcha fees to truly support strong consumer protection. I look forward to hearing from the panel about how we make sure we provide the needed protection, and I yield back. " FOMC20071031meeting--41 39,MR. ROSENGREN.," Thank you, Mr. Chairman. The Boston forecast is very close to that of the Greenbook. With the constant federal funds rate assumption, the economy is very close to full employment, and core inflation is close to 2 percent at the end of 2008. Such an outcome is consistent with what I would hope to achieve with appropriate monetary policy. However, while this is an expected path that seems quite reasonable, the distribution of risks around that outcome for growth remains skewed to the downside. Our forecast, like that of the Greenbook, expects particularly weak residential investment. Problems in financing mortgages, expectations of falling housing prices, and more-severe financial stress for homebuilders are likely to weigh heavily over the next two quarters. In fact, our forecast for residential investment has become sufficiently bleak that there may actually be some upside risk to it. [Laughter] Somewhat surprising to me has been the lack of spillover to the rest of the economy from the problems in residential investment. I remain concerned that falling housing prices will further sap consumer confidence and cause a pullback in consumption, though to date there is little evidence of a significant effect of the housing problems on consumer spending. Similarly, I would have expected the financing problems that have aggravated the housing situation to have caused a sharper reduction in investment in general and in nonresidential structures in particular. However, so far these remain risks rather than outcomes. Thus, while I am worried about the downside risks, I am reminded that forecasters have frequently overestimated the consequences of liquidity problems in the past. On the financial side, there have definitely been improvements in market conditions, though markets remain fragile. Particularly worrisome has been the announcement of significant downgrades of tranches of CDOs and mortgage-backed securities with large exposure to the subprime mortgage market. Not only have the lower tranches experienced significant downgrades, but a number of the AAA and AA tranches have been downgraded to below investment grade. Some investors cannot retain below-investment-grade securities and are forced to sell these securities in an already depressed market. The number of the downgrades, the magnitude of the downgrades, and the piecemeal ratings announcements all are likely to call into further question the reliability of the ratings process. If many high-grade securities tied to mortgages are downgraded to below investment grade, some investors may conclude that repricing of even high-graded tranches does not reflect a liquidity problem but rather a substantial reevaluation of credit risk. Thus, I am concerned that continued widespread downgrades may make recovery in the securitization market more difficult, particularly for nonconforming mortgages, with a consequent increase in the financing cost of these assets. I also remain concerned that the asset-backed commercial paper market remains fragile. While investors seem to be distinguishing between conduits whose structure or underlying assets are quite risky, my sense is that money managers are watching the market quite closely. I continue to hear concerns over the possibility that some money market funds will experience losses that will not be supported by their parents, resulting in increased investor concern with the safety of money market funds more generally. On balance, the data both on the real economy and on financial markets have improved since our September meeting. That improvement makes it more likely that the economy will continue to recover gradually from the financial turmoil. However, both the real and the financial risks remain skewed to the downside." 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." FOMC20050322meeting--128 126,MR. KOHN.," Thank you, Mr. Chairman. Activity has come in somewhat stronger in recent months, and price pressures have been a bit more intense than anticipated at the last FOMC meeting. Evidently, continued good growth in income and high profits are keeping household spending rising briskly and eroding any remaining business caution. The fact that surprises have been concentrated in investment in both business equipment and housing may also suggest that the low long-term rates—the conundrum—have been having an effect. If, as seems likely, those rates have been reduced in part by declining term premiums, as President Yellen was discussing, and not just by an expected lack of vigor in demand here or abroad, their depressed real level would represent a net stimulus to demand most especially for business borrowers who are facing very low risk premiums. In fact, business borrowing has strengthened considerably in the fourth and first quarters. And after an extended period in which cash flows have exceeded business investment, low interest rates and ebbing caution have produced a positive business financing gap in the fourth quarter, which is projected to continue for the first quarter. Moreover, the U.S. economy is not the only one in which growth has picked up; the strengthening of demand seems widespread globally after the disappointments in the second half of last year. And I agree with others who have noted that the sharp upward movement in energy and other commodity prices probably reflects in part this global pickup in demand. The surprise in core PCE prices was only for one month and was small relative to our March 22, 2005 66 of 116 prices, and import prices could be passing through to consumer prices more than anticipated. This, coupled with the rise in near-term inflation expectations, does elevate the risk of second-round effects from such relative price movements. And those relative price adjustments have continued in recent weeks. Still, a number of factors seem to be working to restrain tendencies for inflation to move higher, and we can’t ignore those. Importantly, productivity growth was stronger in the fourth quarter, and, apparently, in the first quarter, than anticipated. Whether that suggests faster structural productivity growth than the staff has built in remains to be seen, but revisions to actual productivity growth will help keep pressures off of labor costs and markups. Partly as a consequence, markups in the nonfarm business sector remain at extraordinarily high levels, giving ample scope for future cost increases to be at least partly absorbed in reduced margins. And wage and compensation growth remain essentially flat, indicating to me that slack in labor markets persists, given the upward pressures on compensation that would otherwise be anticipated from rising headline inflation and the rapid productivity growth of recent years. Bond rates have risen noticeably. To be sure, the upward movement seems mostly to reflect higher inflation expectations, but higher nominal rates could have a noticeable effect on housing markets where buyers seem sensitive to the cash flow implications of their monthly obligations. House price increases should slow quite a bit, in any case, holding back the rise in wealth and boosting incentives to save out of current income. In addition, GDP hasn’t been revised up as much as demand. As the trade deficit continues to surprise on the high side, the staff forecast has net exports turning from a drag on activity to a more neutral influence. But until we see the data confirming that shift, I think the possibility of more demand being drained abroad remains a March 22, 2005 67 of 116 The final and most important force that ultimately will constrain inflation is tightening monetary policy. And the narrowing output gap and the possible emergence of greater inflation pressures do raise questions about how we need to adapt our strategy to keep inflation low and the risks in balance. Two possible responses: One would be to count on extending the gradual path of rate increases to go for longer before slowing or stopping. The other approach would be to increase the incline—prepare to raise rates by 50 basis points soon. For the most part, extending the measured path seems preferable to me. At the same time I think we should make it clear to markets that we are prepared to extend that path, should circumstances call for it, and that we have no firm preconceived notion regarding where our tightening should stop. The gradual approach should enable us to better gauge the ongoing effects of our actions in an uncertain world. It will give us more opportunities to assess the effects of past tightening moves when we know that those effects can vary and will occur with a lag. Hence it will give us more opportunities to calibrate our actions better to the needs of the economy. To date, announcing that we expect to remove accommodation at a measured pace hasn’t materially impeded the markets from responding meaningfully and appropriately to incoming data. Over the last intermeeting period, they extended the anticipated series of gradual rate increases— forward rates two and three years out are up by more than 50 basis points over that period, and this seems completely appropriate to me. The structure of interest rates still seems to be consistent with achieving our objectives. The staff forecast has inflation declining with about the policy tightening that is built into the market. Even if we’re not quite as optimistic on price pressures as the staff, gradual increases in the funds rate in line with market expectations should provide some insurance against rising inflation. March 22, 2005 68 of 116 participants expect that the policy actions they now anticipate will be enough to insulate the longer- term trajectory for prices from near-term increases in inflation. As a consequence, “measured” is still my best guess as to how policy rates will evolve, and that’s what I would continue to indicate to the public. Nonetheless, our expectation of a measured pace of firming has always been conditional. And one essential condition that we have articulated and emphasized in the last sentence of the announcement is that inflation and its expectations remain well behaved. In my view, that would be consistent with the rate of growth of core PCE prices stabilizing at levels close to or not very much above the experience of the last year. If doubts about our willingness to maintain price stability emerge, I can see the potential for a very difficult self- reinforcing feedback loop through declining confidence in policymaking in the United States and accelerated dollar depreciation. Incoming information suggesting that core prices will continue to accelerate, or that the output gap is closing rapidly, or that longer-run inflation expectations are deteriorating, could well call for deviating from the measured pace with a larger firming action. If the signs were serious enough, I think we could, and should, do that as soon as the next meeting, even if the “measured pace” language remains in place. After an expression of concern about inflation pressures, as suggested in alternative B, the market should not be entirely surprised by such an action under those circumstances. Thank you, Mr. Chairman." FOMC20070807meeting--96 94,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. The balance of risks has changed since our last meeting—significantly, in my view. Overall spending by households and businesses is weaker. Housing, of course, is significantly worse, and the underlying pace of productivity growth and potential growth seems lower. In addition, financial market developments have deteriorated with a very broad based increase in risk premiums, decline in some asset prices, pockets of liquidity pressures, and some disruption in mortgage markets and high-yield corporate credit markets. These developments in financial markets, even though they represent a necessary adjustment, a generally healthy development, have the potential to cause substantial damage through the effects on asset prices, market liquidity, and credit; through the potential failure of more-consequential financial institutions; and through a general erosion of confidence among businesses and households. If this situation were to materialize and these effects were to persist, they could have significant effects on the strength of aggregate demand going forward. The process now under way in financial markets could take some time to resolve, and finding a new balance could take a while. We have modified our forecast in ways similar to the changes to the Greenbook. We have a slightly weaker second half of ’07 and a slightly lower estimate of growth in ’08 and ’09, reflecting a downwardly revised estimate of potential growth. Our growth numbers for ’07, ’08, and ’09 look roughly like 2½ rising to 2¾ percent. Our inflation forecast is essentially unchanged, with core PCE inflation moderating to slightly under 2 percent over the forecast period. Our differences with the Greenbook are not trivial, but they seem well within the somewhat greater uncertainty we now face about the outlook for growth. The negative skew in our view of the risks to the outlook suggests a somewhat downward slope to the path of the fed funds rate going forward, to the appropriate stance of monetary policy, rather than the flat path assumed by the Greenbook. So even if financial market conditions stabilize and credit markets, particularly the mortgage markets, find equilibrium relatively soon and start to open up again, the growth risks have shifted a bit more to the downside around the lower expected path. In contrast, if the disruption in credit markets persists and liquidity markets are further impaired, then we face the prospect of a significantly weaker path to aggregate demand. Inflation risks in our view, however, remain slightly tilted to the upside, but these types of risk are very different. The inflation risks are modest and manageable. We characterize them as skewed to the upside in part because of the differences across the Committee as to our desired individual long-run views about the inflation level, in part because of our differences as to what’s an acceptable period for bringing core inflation down to that objective, and in part because of different views about the structure of inflation dynamics in this economy. The risks to markets and ultimately to growth are very different. There’s a much longer negative tail in terms of the range of potential outcomes, and those risks are going to be harder for us to manage, partly because they depend on confidence. Because of these differences, I think it’s hard to counterpoise these two risks against each other and assess the balance between them. Of course, as always, we should weigh each by their probability, their effects, and our capacity to manage those effects. I think that the probability of a bad inflation outcome has diminished from what we would have said two quarters ago and the probability of an adverse growth outcome has increased. As I said, the latter risk is interesting and complicated in part because it might be harder to manage. I want to make two points in this regard. First, a number of you have said that we want to see more evidence of adverse effects on aggregate demand before we change our view about the appropriate path of monetary policy. I don’t really think that’s the right way to think about this. If we took that approach, we’d inevitably be too late. Just as we think about inflation risks by looking forward and looking at expectations, we need to be forward looking and thinking about the potential implications of these dynamics of financial markets on the growth outlook. The information we have now about what’s happening in markets and about the implications for credit markets and ultimately for confidence and demand is very stale and uneven. My second observation about this challenge is that what makes it hard is partly that you are seeing a combination of things. You are seeing a loss of confidence in the capacity of investors to assess underlying risk in mortgage markets in part because of uncertainty about what housing prices are going to do and in part because of uncertainty about correlations in losses across households. You are also seeing a collapse in confidence, as Bill described it, in how to value complex structured credit products, probably from the loss of faith in ratings and from the changes ahead in ratings methodology and in actual ratings. You’re also seeing the difficulties that investors and counterparties now have in evaluating the risk in exposure to financial counterparties, and you’re seeing in some ways reflecting all of this a diminished willingness to finance what’s relatively high quality paper. We live in a system in which risk has been transferred much more broadly, but a lot of that risk has gone to leveraged funds that have much less capacity to absorb this kind of shock without facing a lot of liquidity pressures. The combination of these things means that you’re seeing some impairment in the natural dynamic by which, when prices adjust, you have new people coming in willing to buy at those low prices. But these challenges in information and in diagnosing what’s happening in markets mean that the process is not working as quickly as you might have thought in mortgages and in high-yield corporate credit. You can see this sort of skew in the risks reflected, I think sensibly, in the change of market expectations about the fed funds rate. You can see this balance in the distribution that Bill described, where you see a sharply negative skew in expectations about the path on the downside, and you see that come also in the context of relative stability of inflation expectations. That shift of mean expectations, in the distribution, does not come with any sense that the consequence might be some erosion in confidence about our capacity to keep inflation expectations down. Now, in terms of policy, I personally wouldn’t want to lean against the change in market expectations that we’ve seen so far, even though it has moved a long way in a short time. It’s really important to give ourselves more flexibility than we now have to respond to what could be a rapidly deteriorating overall environment; that’s just pragmatically essential, given that the range of foreseeable monetary policy actions we’re likely to confront has broadened very substantially relative to where we were a quarter ago. The challenge, of course, is to figure out a way to acknowledge and to show some awareness of these changes in market dynamics without feeding the concern, without overreacting, about underlying strength in the fundamentals of the economy as a whole or in the financial system. That is a difficult balance, but I think it requires some softening of the asymmetry in our assessment of the balance of risks now. An advertisement in response to a bunch of points made so far, including by President Fisher—the Morning Call that Bill Dudley’s staff runs from New York is a very good, fairly textured prism of what’s happening across these markets. They do a good job of trying to integrate a bunch of the anecdotes and the facts, and it’s the most efficient device any of us have to check in about that evolving balance. It won’t satisfy everybody’s demand to have as much information as is out there, but it’s a fairly efficient way to get a pretty good picture, and so I commend that to you. It’s a really good, thoughtful, and reasonably deep collection of wisdom in the markets today." CHRG-110hhrg46591--279 Mr. Yingling," I just want to say your analysis of the cause of the problems was exactly right. One of the things that is not talked about much is when the unregulated side did these things--and this happens all the time--they ended up blowing up the regulated side. So this has had a very negative effect on good banks that did not do any of this. I would also say that it just seems to me that some part of the stimulus package ought to be devoted to what caused the problem. That is housing--keeping people in their houses and helping some of those homes be taken, perhaps, by entrepreneurs who would turn them into rental housing. " FinancialCrisisInquiry--30 I think these are important matters. I think this is one of the most critical questions that are resolving around here. CHAIRMAN ANGELIDES: OK. And then I have a question to follow up on this. BLANKFEIN: No, I understand. We are sitting here today with people commenting in the press, gee, the equity market is being driven by more bubbles because of the liquidity in. Others are saying the equity market is right and we’re in the recovery. No one really knows, yet people are coming to us as a market maker—I want exposure to the equity market; I don’t want exposure to the equity market. We are dealing—we have to make sure the products do what the products say, that they’re honest, that their disclosure and their laws—but we are dealing—we are an institutional firm, and this is the highest part of the institutional market. Even today, by the way, people are coming to us for exposure to these very instruments, not at a hundred cents on the dollar but $0.08 on the dollar because they think it’s going to be worth $0.12 and other people are saying it because they think, at $0.08, it’s going to be to $0.04. That’s what a market is. And our role as a market maker creates the... CHAIRMAN ANGELIDES: I do know what a market is, but I want to ask you this question. Did you always disclose to every investor that, in fact, you were taking the contrary positions? Or are you just— just yes or no? Is that consistently disclosed? BLANKFEIN: We were selling as a principal. When we sold, we were selling something that we had owned. CHAIRMAN ANGELIDES: Then let me ask you one final question. CHRG-109hhrg23738--155 Mr. Hensarling," Thank you, Madam Chair. Chairman Greenspan, I do not know if you feel like you are being eulogized this morning, but please allow me to add my voice to those thanking you for your service to your country. It has truly been a significant and positive impact on our nation's history. Mr. Chairman, I have seen a report from CBO, dated January of 2005, that says that Medicare over the next 10 years will grow by 9 percent, Medicaid by 7.8 percent, and Social Security by 5.6 percent a year. I have also seen a GAO report, dated early March, entitled, ``Budget Process: Long-Term Focus Is Critical.'' It states that as of today, if we do nothing, that we are on a collision course to either double taxes or cut federal spending by 50 percent by the year 2040. Many of us may not be here in 2040, but we certainly hope and pray our children and grandchildren may be. There are many in this body who have shown no inclination for handling or dealing with the spending side of the equation. You testified before the House Budget Committee on March 2nd of this year, and you said, ``Tax increases of sufficient dimension to deal with our looming fiscal problems arguably pose significant risk to the economic growth and the revenue base.'' So I have a two-part question. If you were familiar with the GAO and CBO reports that I allude to, do you agree with their numbers? If you do not agree with their numbers, do they get the essential thrust and trend lines correct? And if so, what does the world look like in 2040 if we double taxes on the American people? What does that mean to housing? What does it mean to job creation? What does it mean to standard of living? " FOMC20071211meeting--39 37,MR. STOCKTON.," Thank you, Mr. Chairman. We had a great deal to contend with over the intermeeting period, and the forecast has changed in some important ways. Nevertheless, the basic story underlying our projection remains largely unchanged. The fallout from the slump in the housing sector, the ongoing turbulence in financial markets, and elevated energy prices result in subpar growth over the next several quarters. With some further easing of monetary policy, a leveling-off of oil prices, and a gradual improvement of financial conditions, growth picks back up toward potential in 2009. The gap in resource utilization that opens up over the next several quarters, in combination with the anticipated flattening-out of energy prices, puts total and core inflation on a mild downtrend over the longer haul. Overall, our forecast could admittedly be read as still painting a pretty benign picture: Despite all the financial turmoil, the economy avoids recession and, even with steeply higher prices for food and energy and a lower exchange value of the dollar, we achieve some modest edging-off of inflation. So I tried not to take it personally when I received a notice the other day that the Board had approved more- frequent drug-testing for certain members of the senior staff, myself included. [Laughter] I can assure you, however, that the staff is not going to fall back on the increasingly popular celebrity excuse that we were under the influence of mind- altering chemicals and thus should not be held responsible for this forecast. No, we came up with this projection unimpaired and on nothing stronger than many late nights of diet Pepsi and vending-machine Twinkies. While our basic story hasn’t changed much, the events of the past six weeks have resulted in a considerable darkening of our outlook for activity over the next year. In particular, the incoming data have been weaker than expected, the projected path of household net worth has been revised down owing to lower prices for both equities and houses, oil prices average about $7 per barrel higher than in our previous forecast, and the brief improvement in financial conditions that we experienced in September and October has been reversed in recent weeks. As a consequence, we now project that real GDP will be about flat in the current quarter after having increased at an annual rate of 5 percent in the third quarter. Although the sharp swing in activity from the third to the fourth quarters is exaggerated by some wide fluctuations in inventory investment, we are reading the incoming data as suggesting that there has been a greater downshift in the underlying pace of growth than we had previously anticipated. Furthermore, we expect activity to remain sluggish next year, growing 1¼ percent, nearly ½ percentage point less than in our October projection. In 2009, real GDP is projected to grow at a 2.1 percent pace, a touch below our previous forecast. Most of the disappointing news that we have received over the past six weeks has centered on the household sector, most especially on residential construction. Single- family housing starts came in a bit below expectations, and permits plunged, suggesting some further intensification of the decline in construction activity in the months immediately ahead. Moreover, substantial downward revisions to estimates of new home sales for earlier months indicate that housing demand has been weaker than we previously thought. Meanwhile, conditions in mortgage markets have deteriorated further and appear likely to remain impaired longer than we had projected in October. Nonprime markets remain moribund, spreads on jumbo mortgages have widened further, and spreads on conforming mortgages to Treasuries have increased. These developments along with the weaker incoming data on sales and starts led us to mark down our housing forecast once again. We now expect that sales and starts will post a further drop of nearly 10 percent by early next year. Moreover, we have delayed our projected recovery in starts until 2009. As a consequence, the contraction in residential investment is now expected to subtract over ½ percentage point from the growth of real GDP next year, about ¼ percentage point more than in our October projection. In addition to these softer readings on housing activity, the incoming data on consumer spending also have surprised us to the downside. Real outlays are now estimated to have been nearly flat between August and October, rather than increasing modestly as had earlier appeared to be the case. That subdued pace seems consistent with the slump in consumer sentiment that has followed in the wake of the increased financial turbulence. We now project that real PCE increased at a 1¼ percent pace in the current quarter, 1 percentage point less than in the October Greenbook. I don’t want to overstate the strength of our case that a noticeable slowing in consumer spending is under way. Light motor vehicle sales ran at a 16.2 million unit pace in November, an observation that creates a bit of tension with the survey reports of bummed-out consumers. Moreover, it wouldn’t take much more than a few modest upward revisions to earlier months or a pop in spending in December to undermine this part of our story. That said, the picture doesn’t seem likely to us to brighten much soon. The recent jump in oil prices, coupled with a restoration of currently narrow gasoline margins, points to steep increases in retail energy prices that will take a bite out of the purchasing power of household incomes and further restrain overall consumer spending in coming months. Furthermore, with the lower level of the stock market and a downward revision to our house-price forecast, household net worth is expected to exert more of a drag on consumer spending over the next two years than in our previous forecast. While we don’t expect a dramatic shift, we are anticipating that households will face tighter standards and more-expensive terms for consumer credit. All told, we are projecting real PCE to increase 1½ percent in 2008, about ¼ percentage point less than in our October projection. In contrast to the almost uniformly weaker-than-expected data on the household sector, the information that we have received on business spending has been more mixed. Investment in high-tech equipment has been well below our expectations, especially for communications equipment. That observation squares with some reports we have heard that orders for high-tech gear from financial institutions have fallen off. Other equipment spending has come in close to our expectations, with the recent data on orders and shipments consistent with our projection for some modest slowing in capital spending. The data also have been mixed for nonresidential structures. As I noted at the last meeting, the GDP data for the third quarter pointed to stronger drilling activity than we had earlier anticipated, and we have revised up our projection for this category in response to both the incoming data and the higher projected path for energy prices. For nonresidential buildings, the October data for construction put in place were a bit below our expectations, and we have lowered our near-term projection of activity in this sector. Beyond the near term, we have reduced our forecast for both equipment spending and nonresidential investment. Most of that revision reflects an expected endogenous response of investment to the slower growth of final sales and business output in this projection. But we also have made some small allowance for what we expect to be less favorable financing conditions and greater uncertainty over the next year. Taken as a whole, the spending data have clearly fallen short of our expectations. It might appear that, like the spending data, last week’s labor market report was also a downside surprise for us; after all, we noted in the Greenbook that we had penciled in an increase of 100,000 for private payrolls in November. However, we did that only grudgingly after seeing the ADP survey last Wednesday morning, and basically we did not allow that change to alter any other important aspect of our forecast. In fact, the payroll employment figures are slightly stronger than we expected at the time of the October Greenbook. Indeed, I still see the generally firm conditions in labor markets as suggesting some upside risk to our view that the economy is in the process of slowing sharply. Let me now turn to the inflation forecast. Total PCE prices are projected to increase at an annual rate of 3½ percent in the current quarter, about ¾ percentage point above our previous forecast. Most of that revision reflects higher retail energy prices. But we have also raised our projection of core PCE prices for the third and fourth quarters by ¼ percentage point. That adjustment resulted from the upward revisions made by the BEA to nonmarket prices in earlier months. As you know, we had been consistently surprised by the mild increases in nonmarket prices that had been reported since the spring. As a concession to those persistent errors, a couple of forecast rounds ago, we pushed off the reacceleration of those prices into 2008. Well, we should have stuck with our earlier story because the revised data now show that those prices picked back up in late summer and early fall. Our slight upward revision to core PCE prices in 2008, from 1.9 to 2.0 percent, reflects the indirect effects of the higher oil prices in this projection. We continue to believe that the pass-through of energy prices is small, but not zero. The other major influences on our price projection have remained relatively tame. Although the exchange value of the dollar has fallen a bit, global prices for non-oil commodities have revised down as well, leaving the forecast for core non-oil import prices roughly unchanged. Increases in labor compensation remain subdued. And taken as a whole, readings on inflation expectations have not changed much. The Michigan survey measures of inflation expectations are up some, the Survey of Professional Forecasters was flat, and inflation compensation as inferred from TIPS has edged down slightly. With some slack emerging in labor and product markets in the second half of next year and with energy and import prices projected to decelerate, we are forecasting a slight drop in core price inflation from its projected pace of 2 percent this year and next to 1.9 percent in 2009. In contemplating our forecast, you might be concerned that our relatively benign muddle-through scenario is increasingly looking like the average of two considerably less benign outcomes—one in which the economy proves considerably more resilient, growth bounces back more quickly, and inflation picks up by more than we are projecting and another in which we drop below stall speed and the economy experiences outright recession. While I would readily acknowledge those risks, I still see something like our forecast as the more plausible outcome at this point. At the September meeting, I quoted from the Greenbook of March 1999, in which we had raised the white flag of surrender on our story that the financial turbulence of the autumn of 1998 would significantly restrain the growth of the economy. We could be making that mistake again, but it seems less likely to me now. In particular, one important feature of the episode of the late 1990s was that we were almost immediately fighting the incoming data, much of which came in well above our expectations over the final months of 1998 and early 1999. By contrast, as I have noted today, the recent data seem to be lining up comfortably with our projection of slower growth ahead. I also noted in September the possibility that we could be facing a situation similar to the fall of 2000, when we were forecasting a period of muddling through but were, in fact, on the brink of a mild recession. Again, this possibility certainly can’t be ruled out. But here, as well, there are some noteworthy differences from that earlier episode. In particular, through the fall of 2000, we were receiving increasingly grim stories, especially from manufacturers, about the dismal state of order books and a sharp shift in business psychology. At the time, we didn’t have the conviction to embrace those anecdotes given the strength of the official data. I’ll be interested to hear your reports today, but my sense is that the anecdotes from businesses, while mixed, are not sharply at variance with the data at present. Both seem to be pointing to slower growth but not to a serious retrenchment in activity. For these reasons, we are inclined to stick with our muddle-through story for now. Nathan will continue our presentation." CHRG-111shrg50814--77 Mr. Bernanke," Well, Senator, you are absolutely right. Your point is very well taken. The short story is that for the last decade or so, Americans have been made wealthy by either their stockholdings if they had a 401(k) or by the value of their house. And if the value of your home goes up, you feel richer, but you do not save more because you feel richer. Your house is saving for you in some sense. And as a result, over that period, as asset prices were rising, Americans saved less and borrowed more from abroad. Now, earlier Senator Dodd asked me about asset values. As those asset values have come down, that means there has been a very painful adjustment. People, in order to rebuild their balance sheets, are going to have to save again. And in a way, that is good because we will turn over the next few years to a higher rate of national saving, less foreign borrowing, lower current account deficits, and that is a desirable place to go. The transition, though, is very difficult because as people switch from being high-spending to trying to save, the decline in consumer spending has contributed to this great weakness in the economy, and we have a situation where instead of saving more, we are just getting a deeper and deeper recession. So we have currently an emergency situation that includes both a very severe recession and a significant financial crisis, which must be addressed or else we will not have the kind of growth we need to support saving and investment going forward. So we need to address that in the short term, but as we do that, we also have to keep a very close eye on the need to reestablish fiscal discipline, to increase Americans' savings, to reduce our current account deficit. And in doing all those things, over time we will be able better to address those issues that you referred to. But we are in the middle of a transition where, frankly, if we were to try to balance the Federal budget this year, it would be very contractionary and probably counterproductive. " FOMC20060629meeting--116 114,CHAIRMAN BERNANKE.," Thank you. If I could try your patience for a few more minutes at the end of a long afternoon, I’d like to summarize what I’ve heard today and then just add a few comments of my own. While I’m doing that, Brian, would you distribute table 1? Table 1 in the Bluebook shows the three alternative suggestions for the statement. Since the Bluebook, we have received some suggestions, and we’ve done some wordsmithing—we’ve actually responded to a few things we heard today. The general tone of the three statements is the same, but we wanted you to see where it was today, so that you could think about it overnight and so that it would help you for your discussion tomorrow. That’s going to be coming around. Let me just briefly summarize what I heard. Certainly, a central theme of the speakers today was the increase of uncertainty and risk in the environment. It’s getting more and more difficult to forecast, and there are certainly risks both to the upside and to the downside. The central tendencies with respect to output seem to be that output is slowing to something close to potential. Some felt growth would be stronger than the Greenbook suggested; others, like the Greenbook, thought it would be falling somewhat below potential. A few people saw downside risks from previous tightening. There was some disagreement on the extent to which financial conditions are supportive of the economy, and some disagreement on consumption, although there was a view that lower-income consumers were going to do worse than higher-income consumers. Housing is certainly slowing. Some took the view that it was slowing more or less as expected, whereas some thought the slowing was somewhat worse than expected—certainly that’s a source of downside risk. The view of the labor market is that it remains reasonably healthy, that it’s difficult to find skilled workers, but there are still few signs of wage pressures in the economy. The business-sector evaluations were much more upbeat, with ongoing expansion, good sentiment, and capital investment. Finally, there seems to be considerable unease about recent inflation developments. Everyone considered these recent developments to be unwelcome. Some felt that the recent increase in inflation might be temporary. Others saw it as more persistent. But there certainly was a sense that it’s a risk to the economy. Let me add just a few thoughts about the situation. The situation is, I think, exceptionally complicated because at least three different things are going on. First of all, there’s a cyclical transition from a period of above-trend growth to what we would hope would be a period of trend growth, the normal soft-landing problem. Second, we essentially have a supply shock. It’s not exactly a supply shock because it has complicated elements to it, but oil prices and commodity prices are rising significantly, and that is creating a worsened tradeoff. Third, we are having a housing cycle that has a certain autonomous component to it because it’s like any other asset-price correction taking place on its own schedule, so to speak, and it is interacting with the other two forces. So given these three things occurring at the same time, the situation is obviously very complicated. Now, the ideal situation would be for us to move to a steady, sustainable pace without inflation. Right now, the biggest risk to that steady pace seems to be the pickup that we’ve seen recently in inflation. The main point I want to make about inflation—many points have already been made—is that it really is quite broad-based. I think there are good reasons to downweight, to some extent, owners’ equivalent rent. It is arguably a cost of living; however, the effects of monetary policy on this kind of cost of living are somewhat ambiguous. So we could get ourselves into a bad situation if we focus on it too much. But having said that, if you slice, say, core PCE in any other way—if you look, for example, at core PCE prices excluding OER, at core goods, at core PCE services excluding OER, at market-based core PCE less OER, at any of these ways of slicing inflation—you get a similar pattern in terms of the three-month, six-month, and twelve-month averages, which suggests a broad-based acceleration and one that I think we should be concerned about. We should also note that the three-month total PCE inflation rate is 5.2, which is significant because it influences inflation expectations overall. Now, a concern that we all have—and many people expressed—is that we don’t fully understand why this sudden acceleration is taking place. Some of the possibilities are, first, the supply-shock increases of energy prices; second, the tight product markets; and third, changes in inflation psychology, perhaps related to headline inflation. I guess I would just raise the possibility that these three things are interacting. Perhaps with tighter product markets it’s easier to pass through your energy costs or your commodity costs. That pass-through interacts with higher inflation psychology, and there’s maybe a vicious cycle there. The thing we should be concerned about is whether those higher prices then lead to higher wage pressures in an inverse kind of spiral. So I do have concerns about inflation, although I don’t want to exaggerate. I think we’re still looking at numbers that are historically not extremely high. The other big issue is the housing cycle. I’m going to give us a bit of perspective. It is a good thing that housing is cooling. If we could wave a magic wand and reinstate 2005, we wouldn’t want to do that because the market has to come back to equilibrium. The level of activity now is about a third bigger than it was in during the boom in the late 1990s. The housing construction industry is large, bigger than historically normal, and a controlled decline in housing obviously is helpful to us at this stage in bringing us to a soft landing in the economy. But as people have pointed out, the cooling is an asset-price correction. Like any other asset-price correction, it’s very hard to forecast, and consequently it is an important risk and one that should lead us to be cautious in our policy decisions, as we’ll talk about tomorrow. Another potential nonlinearity is in financial markets, as we’ve seen recently. We don’t have a good understanding of how changes in interest rates are affecting risk reduction and positions in financial markets right now. Just a bit of commentary on consumption: A lot of our uncertainty—I guess you’d call it model uncertainty—is the question about how a decline in housing prices will affect consumer spending. The range of views is wide, some arguing that, because of equity withdrawal and so on, the effect would be very large. I don’t know the answer to that question, obviously, but I think there are some positive factors that will support consumption going forward. To name a few, the job market remains good, unemployment insurance claims are low, unemployment is low, and I suspect that wages and incomes will start to rise sometime soon. Consumer confidence is not that bad. Gasoline prices are likely to come down. In part, they are reflecting high ethanol prices, which will come down over time. We’ve seen before that consumer confidence can be very sensitive to gasoline prices. Balance sheets remain reasonably healthy. Even if housing prices flatten out, people have accumulated a lot of equity, and the implication of that is that they can smooth their consumption through rough times, if necessary, by drawing on that equity. Finally, Kevin and Randy, I think, gave different sides of the surge in tax collections, but on the whole it is probably a positive sign. It probably suggests there is more economic activity than we are capturing. So let me just conclude by reiterating that we find ourselves in an extraordinarily complicated situation because we have these different themes—the cyclical turning point, the supply shock, and the housing cycle. The implication is that, whatever we do, we’re going to have to be very deliberate and careful; but I think we cannot ignore the inflation side of this equation. Any other comments? Well, thank you again for your patience in a long afternoon. I’m glad this is a two-day meeting. [Laughter] Everyone should have table 1; I don’t expect significant changes before tomorrow. I’ll see you tonight at the British Embassy, and we will reconvene tomorrow morning at 9:00. [Meeting recessed] June 29, 2006—Morning Session" FOMC20061025meeting--22 20,MR. MOSKOW.," Thank you, Mr. Chairman. Dave, I want to ask you a question about residential housing markets and the effect of this slowdown that we’ve seen on the prices of housing. As you mentioned in your comments, we’ve seen the rate of increase slow. In one of the alternative simulations, you actually plugged in a major reduction in housing prices. Are you aware of any empirical work that has been done, or have you done any work to show us what the time lags would be here that we could expect to see from the drop in housing to some effect on housing prices going forward?" FOMC20061025meeting--191 189,MR. HOENIG.," Thank you, Mr. Chairman. My preference also is to maintain the rate at 5¼ percent. For the near-term outlook, I think an important recent development that has been noted is the decline in energy prices. As I said yesterday, lower energy prices do help cushion the effects of the housing slowdown, and they do reduce the downside risk to growth over the near term. At the same time, by lowering headline inflation, I think they help contain some of the inflationary expectations. So if that rate is maintained, I think we will, in fact, contribute to lower core inflation. By reducing both the downside risk to growth and the upside risk to inflation, the decline in energy prices makes it more likely that we can continue to maintain the fed funds rate at what I’ve described as its current moderately restrictive level until core inflation returns to more a acceptable level. At the same time, I continue to believe that the upside risk to inflation does remain. The recent monthly pattern in core inflation, while encouraging, does not firmly establish a downward trajectory, which I think is very important to establish. Consequently, I would be prepared to leave the fed funds rate at that level and have it naturally firm as mentioned by others, and I would support additional tightening should inflation reverse course. Let me very briefly talk about the statement. While downside risks to growth remain, I would not want to convey to the markets the impression that any near-term easing of policy is likely at all. As markets have only recently understood the message in the last press statement, I believe we can best accomplish this by updating the rationale section using the wording suggested in alternative B, section 2. I’m comfortable with the word “moderate.” I think Vince gave a good definition of it—at or slightly less than potential. I don’t think that word would be harmful at all. But then I would go alternative A for section 3, and I would maintain the wording of the assessment of risk that was used last time. I would not be in favor of modifying the language of the risk assessment in an attempt to get the markets to alter their current views of the expected policy path. Thank you." 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-111hhrg48874--205 Mr. Hunkler," Thank you. I would like to express my gratitude to Chairman Frank and Ranking Member Bachus and the committee for the opportunity to be here today and to speak on behalf of the Financial Services Roundtable and Western & Southern Financial Group. The role of the financial services industry, including nonbanking institutions, needs to be a significant component of your work in expanding credit to consumers and commercial enterprises. The financial services industry invests in all types of consumer loans, including mortgages, credit cards, auto loans, student loans, and many others. The primary investment vehicle for these loans for nonbanking institutions is through securitization. The amount of consumer lending financed by nonbanking institutions is critically important to maintaining adequate lending capacity for the broader economy. Unfortunately, though, there have been many problems with these assets for the financial services industry as a whole. As such, the industry has been adversely impacted by a lack of regulation, oversight, and clarity of the securitization process. Certainly the economic conditions, such as high unemployment and falling housing prices, have adversely impacted the collateral of these assets, but other noneconomic factors that could have been avoided also have contributed to the losses. As noted in many media reports, this includes rampant fraud in the mortgage origination and underwriting process, poor underwriting standards that overemphasized rising housing prices and did not adequately consider borrower creditworthiness, monoline insurers whose risk exposures were too highly correlated, inadequate analysis and stress testing from the rating agencies resulted in over-inflated ratings, and a lack of transparency relating to the underwriting collateral--underlying collateral and deal structure which contributed to inefficient price discovery. In addition to the liquidity--I'm sorry. The issues are--these issues are specific primarily to the nonagency mortgage markets. The industry has also been adversely impacted by lack of transparency and regulatory oversight of the student loan market, where investors who purchased auction rate preferred securities for short-term liquidity needs, are now stuck with illiquid long-term securities with uncertain payment provisions. Some of these issues have been resolved for consumers but not large institutions like insurance companies. In addition to the liquidity and valuation challenges, mark-to-market accounting has compounded the problems for the financial services industry. Some institutions generally hold whole loans that are not required to be fair valued, while others, including institutions companies, hold mostly securities which are required to be mark-to-market. These are the areas I ask Congress to focus on going forward so that when economic conditions improve, institutions will return to the securitization markets. The industry has raised the issue of mark-to-market accounting concerns since the first major application of market value accounting in FASB Statement Number 115. At the time of early deliberations on FAS 115 in the late 1980's, interest rates were at all time highs, primarily Treasury rates. The insurance industry had extraordinary unrealized losses on its investment portfolios, and most, if not all, insurance companies would have reflected negative book values at that time. The industry on the whole question of usefulness or the meaning of reflecting negative book values due to high interest rates having a long-term cashflow-oriented investing strategy allows insurers to manage through periods of interest rate volatility. Today, excessive speculation in the markets has made market prices potentially deceptive when reflected in the equity of financial statements. Market participants speculate more on assets--can speculate more on assets' ability to increase or decrease in value than on its inherent ability to provide future cashflows. This speculation has led to market bubbles and busts. Adding market values to financial statements in this environment can be misleading. During market bubbles, financial statements can illustrate a false wealth effect. This can lead to excessive risk-taking and over-leveraging nonexistent equity. During periods of market declines, the opposite is true. As the market values decline, reported losses in excess of real losses can lead to restricted risk-taking and capital preservation. This can lead to irrational exuberance in bubble periods, irrational fear during the bust. While markets can accommodate, potentially accommodate this type of volatility, the sanctity of the Nation's financial institutions needs to be immune to it. To address the issue of procyclicality, some would suggest providing a countercyclical regulatory capital model and retaining market values and other procyclical indicators in reported financial statements. I do not believe this represents a sound approach. Reported financial statements that show excessive volatility and potentially negative book values can fuel adverse consumer activity. If regulatory reporting shows strong financial strength through this reporting mechanism, it has the potential to be dismissed, or even worse, it can discredit the regulatory model altogether. Market prices do, though, provide beneficial information for financial statement users. They provide an objective source of value and can, during normal market cycles, be a proxy for value. Also, market prices are the value that can be exchange of assets or required to be liquidated. In addition, some assets are acquired for purposes of trading and should therefore reflect market prices in the financial statements. Investors have spoken clearly that fair value accounting does provide meaningful information. But the desire for objective financial data has led to the replacement of principles of prudence and conservatism in accounting with fair value accounting. Therefore, I believe the primary measurement should be cost for cashflow investors. Losses should be recorded when cashflows are impaired, up to the amount of the impaired cashflows. Then to accommodate the needs of investors and to provide transparent financial information, fair value supplements can be provided to investors that would accompany earnings releases and reported results. These fair values could represent exit values and reflect the impact of liquidating financial instruments if required. While the FASB may have a more than adequate due process in the exposure and issuance of new standards, the problem is that the preparer concerns have had little weight in the ultimate decision on the issuance of new standards. Investor concerns, primarily the voices of large investor organizations, have driven the FASB agenda in support of fair valuing all financial instruments, and other nonfinancial instruments. What is interesting, though, is as the FASB has continued to introduce new fair value measurement requirements, equity analysts continue to guide companies to exclude the results of these fair value changes from the core operating earnings they report in their earnings release. What equity analysts are interested in is understanding run- rate earnings and growthin earnings so that they can determine the fair value of the company, as opposed to reflecting the results on the balance sheet. Congress could potentially play a role in the oversight of the FASB due process, but I think we want to stress the importance of independence in the standard-setting model. We do believe that is critical, but we would welcome some oversight to ensure that preparer concerns are adequately reflected in the due process of FASB. It's a good due process but doesn't always result in all concerns being adequately addressed. I appreciate the opportunity to be here and welcome any questions you have. [The prepared statement of Mr. Hunkler can be found on page 112 of the appendix.] " Mr. Perlmutter," [presiding] We will now hear from Michael S. Menzies, Sr., president and chief executive officer of Easton Bank and Trust Company on behalf of the Independent Community Bankers of America. Mr. Menzies? STATEMENT OF R. MICHAEL S. MENZIES, SR., PRESIDENT AND CHIEF EXECUTIVE OFFICER, EASTON BANK AND TRUST COMPANY, ON BEHALF OF THE INDEPENDENT COMMUNITY BANKERS OF AMERICA (ICBA) " 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. ______ CHRG-111shrg57321--115 Mr. Raiter," Yes. stated income loans were there. They were known as ``liar loans,'' ``NINAs.'' When they started using the stated income loan concept in the late 1990s, it was applied to the highest credit borrowers--doctors, lawyers, self-employed people. As they started developing in the subprime arena, again, you started out with the top of the subprime market with the initial loans that were coming into the bonds. By 2004 and 2005, with the new hybrids and the stated numbers, you were stepping down to much lower FICO scores, much lower credit quality of the borrower, and there was evidence starting to bubble up that brokers were impacting the way stated income was put on the various applications, that there were questions about appraisals, whether they were accurate or not. So when they first started out with the no-income, low-doc kind of loans, we did have modeled in the ratings process higher credit enhancements for those loans, and as we tried to collect data on the new products that were developing and how they performed or were expected to perform, we were factoring that into the models. And, again, I hate to beat a dead horse, but we had a 2.8 million loan set that was used to build the Version 6.0 of the model, and at that time it had the most information we had collected on the hybrid loans. And the next data set that we were trying to collect had almost 10 million loans in it, and it was even more powerful. Senator Kaufman. Right. " CHRG-109shrg30354--26 STATEMENT OF SENATOR CHUCK HAGEL Senator Hagel. Mr. Chairman, thank you. Chairman Bernanke, welcome. Just a comment regarding your testimony and the questions that will follow. As you have heard and as you know because you live with this every day and have for many years, the strength of our economy has essentially revolved around, over the last few years, high productivity, strong housing market, strong consumer spending, and in my opinion over the last few years since 2001, tax cuts. Now the reality is, as has been noted here this morning, we are facing significantly rising and unstable energy costs. There is some question about continuation of a strong housing market. As has been noted this morning, record high personal debt, record low savings, continued deficit spending by Government, and I would add to all of this, a rather dangerous and unstable world environment today. And I do not think it is isolated just in the Middle East. I happen to believe the Middle East represents the most combustible time since 1948, where we are today. Now I would hope in your testimony that you would give this Committee some sense of proportion and balance in how all of this is mixing, and some of these realities are going to affect, in your opinion, our economy and our growth over the next year or two, realizing that you cannot predict. That is not your job. We do want you to do that. But I do think we need to integrate all these dynamics that are in play, as well as you can, into a comprehensive economic fabric as to how you are approaching this at the Fed, as how you are intending to deal with these things on a comprehensive monetary policy basis. I know you understand these things and I would hope that you could integrate these issues and will in your testimony. I know we will get to some of these things during the question-and-answer period. Thank you very much, Mr. Chairman. Thank you. " FOMC20060920meeting--153 151,CHAIRMAN BERNANKE.," Thank you. Let me just summarize quickly what I heard around the table, and then I’d like to make some additional comments of my own on the economy. The sense is that, on the real side, there’s a two-tier economy. There’s the housing sector and maybe autos, and there’s everything else. On housing, there’s agreement that a significant correction is occurring, but the views of the risks vary among participants. In particular, some feel that this still could be a quite deep correction, and others say that the fundamentals, such as incomes, interest rates, and so on, will ultimately support housing. With respect to the rest of the real economy, there were some mixed reports; but on the whole, people characterized it as a full employment economy. We’re generally more optimistic than the Greenbook both for later this year and for 2007. In particular, people noted higher incomes and stock prices and lower oil prices, which should support consumption growth and business activity. At least for now, I heard only a few participants being particularly concerned about the possible knock-on effects of housing on consumption and investment. The labor market remains solid, and as we’ve been noting for a number of meetings, attracting more highly skilled workers remains difficult. On inflation, some noted somewhat better intermeeting news, with the possible exception of the higher compensation data. But a lot of uncertainty was expressed about where inflation will go, reflecting in part our incomplete knowledge of the determinants of inflation and also some mixed anecdotal evidence. However, I hear very clearly a definite unhappiness with the level of core inflation and with the amount of time that is projected to return it to a level of less than 2 percent. The principal concern is that our credibility will be damaged if inflation remains too high for too long. So I would summarize the discussion—I hope reasonably accurately—by saying that inflation remains the predominant risk but there is still quite a bit of uncertainty about the evolution of the economy in the next few quarters. Let me add a few comments to this—first about inflation and then about the real economy. I do believe that the intermeeting news on inflation was more good than bad, particularly relative to the fact that inflation is a lagging indicator and that it would not have been incredibly surprising if we had gotten 0.3 readings the past two months. I’ll talk first about some of the positive news, and then I’ll address some of the risks going forward. First, there is evidence that the momentum of inflation has reversed. When I gave my speech on June 5, which many of you followed up on, I emphasized the three- and six-month rates of inflation as indicating that an acceleration, a rising inflation pattern, was occurring. It now appears that the three-month rate of inflation peaked in May. So, for example, in May, the core PCE was 3.06 on a three-month basis; in July, it was 2.24. The market-based core PCE was 3.00 in May, and in July it was 2.11. The core CPI was a high 3.79 in May, and as of the last reading in August, it was 2.95. So in some sense the direction has turned, and the momentum has been broken, and I think that has been reflected in views in the marketplace. Now, there hasn’t been much discussion of the details of this inflation report, and I think it’s actually quite significant. In particular, a very important factor in both the level and the change in inflation is owners’ equivalent rent (OER); we’ve discussed this issue before. OER is 41 percent of core CPI and 19 percent of core PCE. Although OER has been decelerating recently, it’s still at a three-month rate of 4.4 percent, relative to an annual rate of 2.66 percent in 2005. So that difference accounts for a great deal of the change between where we are today on a three-month basis versus where we were in 2005. The good news is that OER and other measures of rent of shelter have been coming down more quickly than many outside economists expected but in line with what our staff more or less expected; indeed, the number was 3 percent for August. So if it just stayed there or came down a bit more, we would see better short-term numbers for inflation going forward. Other positive news on inflation obviously includes energy and commodity prices. For energy the dominant factors are supply-side factors over which we have no control—hurricanes or the lack thereof and geopolitical factors. But it’s also interesting that metals and some other commodities are off their peaks. That suggests to me that, at least on the margin, some prospect of slowing economic activity and rising interest rates around the world may have taken a bit of the pressure off the commodity prices. We also have had some indication since the last meeting that the economy will be slower than we thought. Clearly, the news on autos and housing was in a negative direction, and granting the flatness of the Phillips curve, all else being equal, that will take some pressure off utilization and pricing power. Finally, I would argue that expectations are, in fact, really quite well contained. Around this table, we’re getting used to talking about core inflation. The inflation that people see, of course, is headline inflation, and ultimately that should be our target as well. Over the past year or two, headline inflation has gone well above what we would consider reasonable levels, and yet TIPS indicators, survey indicators, and outside forecasters have not markedly changed their long-term inflation forecast. So I take the credibility issue very seriously, but I don’t think that there is much evidence yet that our credibility has been seriously impaired. On the negative side, the main piece of news was the higher compensation in the first and second quarters. There is not yet much evidence that labor costs are affecting inflation. We’ve already discussed the issues with the measurement of compensation per hour. Let me just note that, if you look at the components of inflation that have moved the most, you get things like rent, airfares, used cars, and things of that sort. You don’t see much movement in services, for example, which are more labor intensive. So I don’t think that labor costs have yet infected the inflation rate; indeed, we know there’s a weak correlation between these labor cost measures and inflation. However, and let me be clear about this, I think that the key risk to our inflation forecast is that markets will be tighter, labor markets will be tighter, and wages will grow more quickly, and that will produce more inflation than we would like. So I would summarize the inflation situation as having had some modest improvement, some encouragement, but I certainly agree with the general sentiment around the table that the level of core inflation is certainly too high. On the real side, we paused at the last meeting to observe the lagged effects on real activity of our previous interest rate moves. The evidence suggests that, indeed, interest- sensitive sectors did worsen over the intermeeting period. We saw the second significant markdown in a row by the Greenbook for housing, and we’ve seen autos decline as well. To this point, I agree that the economy except for housing is reasonably strong and that there are factors supporting consumption particularly, going forward. So as we look forward, I think there are two issues. The first is how severe the contraction in housing will be. To be honest, we don’t really know. We’re talking, again, about an asset price correction, and it’s difficult, in principle, to know how far that will adjust. The second issue is how much spillover there will be from any housing correction to the rest of the economy. I don’t have quite as much confidence as some people around the table that there will be no spillover effect. Any spillover effect would be a lagged effect, and it remains to be seen how much effect there might be. But I agree that the economy except for housing and autos is still pretty strong, and we do not yet see any significant spillover from housing. Please look at the figure that was distributed.2 I want to talk a bit about the risks in both directions as we think about policy. Let me just describe the two panels to you and then draw a conclusion from them. The top panel shows the four-quarter difference in the unemployment rate—that is, the unemployment rate in the fourth quarter of this year minus the unemployment rate in the fourth quarter of last year, going back to about 1950. The blue bars show recession periods. The dashed line is at zero, and the solid horizontal line is at 0.3 percentage point. What you see is that, without exception, every time since 1950 that the unemployment rate has risen as much as 0.3 percentage point over a year, it has continued to rise, and we’ve seen a recession. That suggests that having unemployment rise just a few tenths and keeping it there is not quite so easy as our linear models might suggest. In the bottom panel, you see four-quarter changes in the growth of real GDP. The dotted line shows zero, and the solid line arbitrarily shows 2 percent real growth. Again, these are four-quarter differences. With the minor exception of 1956, again in no case was real GDP growth below 2 percent sustained for four quarters without an NBER recession. I think a very interesting case is 1995-96—the famous soft landing that was engineered in the mid-1990s. You’ll notice the line just touches the 2 percent zone without crossing it. [Laughter] 2 The figure to which Chairman Bernanke refers is appended to this transcript (appendix 2). So what am I saying here? I’m only saying that, if we believe that we need to have output below potential to help arrest inflation pressures, it is a delicate operation, and we may have a very narrow channel to navigate as we go forward. We should pay very close attention to how the economy is evolving at this particular moment because I think the uncertainty and the potential nonlinearity at this juncture are greater than what we normally face. I’ll stop there, and we can begin our second round. Oh, I’m sorry—Vincent. [Laughter]" CHRG-110hhrg34673--136 Mr. Bernanke," Well, I have not done any analysis of that particular issue. I would reiterate what I said before, which is I think, that it is important for the GSE's to support affordable housing. The way I would recommend it would be to tie their portfolios to affordable housing products, for example, by holding MBS that are based on affordable housing mortgages, for example. That would seem to be a direct way to both create some limits, some limitation on the rapidity of the expansion of their portfolio, while still having a direct impact on the affordable housing. I have not taken a position on the Housing Fund, and I am afraid, if I do so, it will be portrayed as a change in position, because the Fed is focused very much on the safety and soundness and the systemic risk implications of the portfolios, and I think that is where the Federal Reserve needs to keep its focus. " FOMC20070918meeting--103 101,MR. ROSENGREN.," Thank you, Mr. Chairman. Most of the economic data we have for this meeting reflect the economy before the liquidity issues in August. The employment report, while probably not wholly reflective of the problems and affected by some anomalous seasonals, nonetheless provides evidence that labor markets were slowing at the outset of the financial problems. Given the layoffs that are being announced by financial services firms and the potential for continued difficulties in construction, some further easing of labor markets seems quite likely. Although we do not have housing starts and permits for August, the outlook for the second half of 2007 is likely to deteriorate further than forecasters had predicted before the liquidity issues. There is good reason to believe the staff forecast that residential investment will remain weak well into 2008. Stock prices of all the major homebuilders have continued to decline since our last meeting, and the credit derivative swaps for several of the largest homebuilders are at levels that reflect a very high probability of default. The news from the financial markets has improved marginally from the last meeting, but I still have some significant concerns. Certainly, some of the financial anomalies have abated, such as the extremely low rates for short-term Treasury securities, and there are some tentative signs of improving liquidity. However, these improvements are tenuous, and the ability to raise funds in a number of short-term financial markets remains quite difficult. I would just highlight a few of the financial anomalies that are reflective of the situation. Usually, the overnight Eurodollar trades very close to the overnight fed funds rate. Both are overnight dollar loans between financial institutions on an unsecured basis. Over the past month, the funds for overnight Eurodollars have frequently been trading much higher than overnight fed funds. This highlights the difficulty that some European financial institutions are having borrowing in dollars and the unwillingness of many financial institutions to arbitrage these spreads if they involve credit exposures to European financial institutions, even for overnight. These difficulties worsen when the maturities extend out to one to three months. Both the one-month and three-month LIBOR rates have remained very elevated, particularly given that the fed funds futures during this period have indicated a market expectation of falling federal funds rates over the next three months. The elevated LIBOR rate tightens credit for a variety of domestic borrowers and could affect areas that are already troubled. For example, many subprime mortgages are tied to the LIBOR rate as are many loans that have been used to finance leveraged buyouts. A second example is the significant swelling of bank assets in August. The monthly growth rate for bank C&I loans was 2.6 percent and for other loans and leases was 6.3 percent. These are among the largest monthly increases in thirty years. As in other periods of liquidity strain, bank balance sheets become particularly important. As banks honor loan commitments and agreements to provide liquidity support, their balance sheets grow. My concern is that bank obligations will continue to expand bank balance sheets in September and crowd out other investment opportunities. Many financial market participants are very concerned about the next two weeks, despite some recent easing of conditions. Some investors are not willing to lend except overnight. The asset-backed commercial paper market has remained under stress, and the rollovers have been for shorter maturities. There is significant concern that holders of commercial paper may be reluctant to hold asset-backed commercial paper on their balance sheets at the end of this month, and rumors abound about whether money market funds and other short-term investors will continue to hold commercial paper for structured products, particularly of the SIVs. So we have a situation of a very weak housing sector, some evidence of slowing employment growth, and a period of extended illiquidity that may get worse before it gets better. The tail risk of liquidity problems and economic problems has grown, and we clearly want to avoid outcomes by which declines in prices for houses and for financial assets tied to the housing sector could create more-severe economic outcomes. The fact is that we do not have much experience with periods of extended illiquidity, especially when the housing sector is so weak. So taking out insurance against these risks seems entirely appropriate. The decision is made easier, in my view, because I see the risk of unacceptably high inflation resulting from such an action as being quite low. My hope is that with appropriate easing of policy the liquidity issues will abate as we start the fourth quarter." CHRG-110shrg38109--92 Chairman Dodd," Thank you, Senator. Senator Menendez. Senator Menendez. Thank you, Mr. Chairman. Chairman Bernanke, I want to start where I started off in my opening comments to you. I am very concerned about the economic squeeze that has been put on the middle class, particularly since the turn of the 21st century. Since the beginning of 2001, middle-class families have experienced increased levels of debt, anemic growth in real wages, all the while essential costs for food, housing, and medical services have increased at levels drastically higher than inflation. As a result, the financial security of middle-class households has suffered, and more and more American families are unable to afford life emergencies such as an unexpected health problem or unemployment. Employment opportunities are at their lowest level since the Great Depression. Since the recession ended in November 2001, job growth has averaged a mere eight-tenths of a percent per month, less than a third of the 2.7 percent average growth we experienced in previous recovery periods since World War II. For the first time since the 1950's, job opportunities have actually decreased from a 16-percent growth rate in the 1990's to a 14-percent decrease since March 2001. I look at that and I add to that factor that families seems to me to be living on thin ice. I hear these stories of families in New Jersey that they are only one unexpected illness or lay-off away from sinking into perpetual debt. I think one measure of this economic insecurity is the percentage of middle-class families who have at least 3 months of their salary in savings. The percentage of middle-class families who had 3 or more months salary in savings rose 72 percent from 16.7 percent in 1992 to 28.8 percent in 2001. So middle-class families are becoming more secure year by year. But, unfortunately, in the span of less than 4 years, that percentage dropped by over 36 percent, down to 18.3 percent in 2004. Finally, I noted with interest in your written statement, you said, ``Consumer spending continues to be the mainstay of the current economic expansion.'' That is true, but when you add that reality to anemic growth in wages and sharp increases in the cost of necessities, household debt in America has risen to record levels over the past 5 years. By the third quarter of 2006, outstanding household debt was 130 percent relative to disposable income. That means that the average family is in debt of over $130 for every $100 it has to spend. And, additionally, the average household savings rate has actually been negative for the past seven quarters, averaging about a negative 1 percent rate for 2006. So, I look at all of this, and I say to myself, you know, I have my friends and colleagues who are heralding this great economy. I do not get the sense that people back at home and in other parts of the country feel that good about it. You see it in every poll of the barometer of their feelings. They feel really squeezed and really put upon. And so my question to you is: Aren't these indicators a real cause for concern as it relates to the struggle that the middle-class families in this country are facing? And how do we create an economy that is more inclusive and which the macro benefits end up being achieved by those who are the great center of those who keep this country afloat? " FOMC20050630meeting--247 245,MR. OLINER.,"7 We have received a fair amount of data since we closed the Greenbook. Just this morning, BEA reported that real consumer expenditures, shown in the top left panel, were flat in May. This was actually a bit stronger than we had expected, but there was also a small downward revision to April. For the second quarter as whole, shown in the inset box, we project that real PCE increased at a 3.1 percent rate, unchanged from the Greenbook forecast. Meanwhile, housing activity continues to be robust, with sales of new and existing homes (shown to the right) having remained at historically high levels in May. Turning to business spending, we received new data on orders and shipments of nondefense capital goods after the Greenbook closed. As shown by the red line in the middle left panel, shipments edged up in May, while orders (the black line) softened a bit. These data were nearly spot on the Greenbook estimate and point to a moderate rise in real E&S [equipment and software] spending this quarter. Looking ahead, the results of the Reserve Bank queries on capital spending plans appear broadly consistent with a solid upward track for outlays. As shown in the panel to the right, 42 percent of the respondents expect to increase their spending over the next six to 12 months, while only 12 percent plan to decrease spending, similar to the results in January. Moving to the lower left panel, the data on initial claims released this morning showed that the four-week moving average (the red line) edged down to about 325,000, a level that we estimate to be consistent with moderate growth in payroll employment. Rounding out this review of recent indicators, we received new data this morning on PCE prices. As shown in the inset box to the right, the core index rose 0.2 percent in May, a tenth below our Greenbook forecast. Also, the increase in March was revised down a tenth, although that revision was confined to the nonmarket part of the index. The latest data leave the 12-month change in the core PCE index at 1.7 percent. Your next exhibit briefly describes the key background factors for our projection. As shown in the upper left panel, we assume that the federal funds rate (the black line) will gradually rise to 3¾ percent by the end of next year, very similar to the path June 29-30, 2005 80 of 234 in the April Greenbook. Long-term Treasury rates (the red line) are expected to hold about steady through next year, following a path just a shade below that assumed in April. As shown to the right, the impetus from fiscal policy steps down this year to ¼ percent of GDP and remains at about that level in 2006; these fiscal assumptions are essentially unchanged from the April Greenbook. Among the other key background factors, we have taken on board the upward surprises during the intermeeting period for equity prices (the middle left panel) and house prices (the panel to the right), which raised the assumed path for household wealth. In contrast, the higher oil prices in this projection (the lower left panel) and the recent appreciation of the dollar (shown to the right) were negatives for our growth forecast. On balance, the revisions to these background factors had little net effect on our projection of real GDP. The next exhibit summarizes our forecast of growth and inflation. As shown by the black dashed line in the top left panel, we project that real GDP will expand roughly 3½ percent this year and again in 2006, just a bit faster in both years than the growth of potential. As you can see in the table to the right, since January we have revised down the forecast of GDP growth about ¼ percentage point in both 2005 and 2006. On our current forecast of GDP growth, we expect that the unemployment rate (the middle left panel) will hold steady at its current level of 5.1 percent through the end of the forecast period. As shown to the right, the projected path for the unemployment rate has not changed much since the January Greenbook. With regard to inflation, the lower left panel shows that we project core PCE prices to rise a bit more than 2 percent this year and a tad less than 2 percent in 2006, up from the 1½ percent increase recorded last year. The table to the right shows that the projections for this year and next are each up half a percentage point from the January Greenbook. Dave Wilcox will now continue our presentation." CHRG-110hhrg46593--378 Mr. Bachus," And without any assurance that they would become competitively viable, any loan would actually be very risky. So I agree with you totally. Mortgage foreclosures--let me ask you three or four things. The basic thing that I am struggling with is, mixed up with this issue of mortgage foreclosure mitigation is this idea of, ``stabilizing housing prices.'' And I am very skeptical that the government, number one, can stabilize housing prices and, even if they could, that it would be beneficial. Now, I understand that preventing a foreclosure--you know, a house in a neighborhood diminishes housing values. But, you know, the reason we are coming down and housing prices are coming down is, for decades, you loaned money to people about 3 times their income. And then 10 or 15 years ago, we lost our way and we started loaning 4 and 5 and 6 times as much. And then the closing costs went from 2 percent to 5 percent to sometimes 15 percent. And these were loans that they simply--I mean, they couldn't afford these properties on their income. So is supporting housing prices even--is it realistic that-- " CHRG-110hhrg45625--9 Mr. Hensarling," Thank you, Mr. Chairman. I now have more sympathy for the people who sit here and can't figure out how to turn on the microphone. I certainly appreciate you, Mr. Chairman, for allowing members to speak out on what for many of us may be one of the most important votes that we are asked to cast in our congressional careers. On the one hand, we may have financial peril. On the other hand, we may have taxpayer bankruptcy for the next generation and many of us view a slippery slope to socialism, where the fundamental role of the Federal Government in a free enterprise economy is irrevocably changed. People who thought that such a profound decision would be made in 72 hours were simply naive. I believe there is at least broad agreement on both sides of the aisle that, although we hear the term ``crisis'' on a daily basis in this institution, this one is for real. Inaction is not an option. However, the Paulson plan is not the only option that should be on the table. Now, I feel quite confident that the leaders of our party and the President of the United States, the two presidential nominees, can go to the American public and say that Members of Congress will work this out. It is not a matter that has to be undertaken in a matter of hours. It is a matter that does need to be taken up in a matter of days to weeks. I believe, Mr. Chairman, that there are a number of options that should be considered by this committee and by other committees and we should certainly look to history as our guide. Some say that the taxpayer may actually gain in this transaction. And you know what, Mr. Chairman? That may be true. I can put a gun to my neighbor's head, take his college fund for his children, place a bet on a roulette table in Las Vegas and maybe--maybe I will triple his money. But, Mr. Chairman, that is not a risk that my neighbor voluntarily undertook. This is not a risk that the taxpayer wishes to voluntarily undertake. Now, it is not a perfect parallel, Mr. Chairman, but when we look at the model of the Resolution Trust Corporation and the S&L debacle of the 1980's, I just had a conversation in the Budget Committee with CBO Director Orszag and he said that it did cost the taxpayer $150 billion to $200 billion. So the most recent historic precedent says that we could have quite a challenge. I think there are two main challenges that we are facing as we see our credit market seething. And I will say that anybody who tells you they have the answer today is probably either naive or disingenuous. But on a bipartisan basis we better find it and find it fast. I do think that there is a huge psychological component to the panic in our markets and a huge challenge in having illiquid markets as well. House conservatives have put forth alternatives that we believe should be debated, that we believe should be on the table. We are not naive about who controls the institution. But we believe that if you would have a temporary suspension of the capital gains tax, that you would have as much as a trillion dollars of liquidity that could come into the market and help supply needed funds for our financial institutions and, more importantly, to help struggling homeowners stay in their homes. In addition, Mr. Chairman, again not necessarily within the purview of this committee, but many view the mark-to-market rule that was imposed, I believe, in 1993 that serves us well in normal times has a pro-cyclical tendency to lead us to perhaps the irrational exuberance of the dot-com bubble, but can also lead to a credit crunch death spiral that we are seeing today. And House conservatives have called for a suspension of the mark-to-market rule as well. We believe that other options have to be looked at. I know this committee will debate it. Many of us believe if you peel away the layers of the onion, that none of this would have happened but for Fannie Mae and Freddie Mac. And until you deal with the root cause of the problem, you have not dealt with the problem. So I have legislation that I have introduced that ultimately will take away the monopoly powers of Fannie and Freddie. And certainly, last not but least and I will wrap up, Mr. Chairman, there are options that would have secured loans by the taxpayers that I believe is probably a preferable option that needs to be explored as well. My final comment, since I would like to have on the record the few times that I might actually agree with my friend from California, I would like to say that House conservatives are in total agreement that if the taxpayer is going to be asked to bail out these Wall Street firms, compensation limits absolutely, positively, unequivocally have to be a part of the equation. With that, Mr. Chairman, I appreciate your giving me this opportunity and I yield back. " CHRG-110shrg38109--111 Chairman Bernanke," So, in particular, over the economy as a whole, the average loan-to-value ratio for homes is about 50 percent. That is, the mortgage companies own half the housing stock and the public owns half the housing stock. But there are certainly segments of the population who are facing very high debt loads, either through their mortgage borrowing or through credit card revolving debt, and for them it is obviously a hardship. " CHRG-111shrg57322--323 Mr. Birnbaum," Well, typically when people are talking about the housing market declining or going up, they are talking about housing prices. So we all have publicly available information on housing prices that is released, typically monthly, sometimes quarterly, and if that is what you are referring to---- Senator Tester. So the housing decline was based on housing prices around the middle to end of 2006. It was not based on subprime or--it was based on that pattern. I am not trying to set you up for anything. " fcic_final_report_full--35 At Citigroup, meanwhile, Richard Bowen, a veteran banker in the consumer lend- ing group, received a promotion in early  when he was named business chief underwriter. He would go on to oversee loan quality for over  billion a year of mortgages underwritten and purchased by CitiFinancial. These mortgages were sold to Fannie Mae, Freddie Mac, and others. In June , Bowen discovered that as much as  of the loans that Citi was buying were defective. They did not meet Citi- group’s loan guidelines and thus endangered the company—if the borrowers were to default on their loans, the investors could force Citi to buy them back. Bowen told the Commission that he tried to alert top managers at the firm by “email, weekly reports, committee presentations, and discussions”; but though they expressed concern, it “never translated into any action.” Instead, he said, “there was a considerable push to build volumes, to increase market share.” Indeed, Bowen recalled, Citi began to loosen its own standards during these years up to : specifically, it started to pur- chase stated-income loans. “So we joined the other lemmings headed for the cliff,” he said in an interview with the FCIC.  He finally took his warnings to the highest level he could reach—Robert Rubin, the chairman of the Executive Committee of the Board of Directors and a former U.S. treasury secretary in the Clinton administration, and three other bank officials. He sent Rubin and the others a memo with the words “URGENT—READ IMMEDI- ATELY” in the subject line. Sharing his concerns, he stressed to top managers that Citi faced billions of dollars in losses if investors were to demand that Citi repurchase the defective loans.  Rubin told the Commission in a public hearing in April  that Citibank han- dled the Bowen matter promptly and effectively. “I do recollect this and that either I or somebody else, and I truly do not remember who, but either I or somebody else sent it to the appropriate people, and I do know factually that that was acted on promptly and actions were taken in response to it.”  According to Citigroup, the bank undertook an investigation in response to Bowen’s claims and the system of un- derwriting reviews was revised.  Bowen told the Commission that after he alerted management by sending emails, he went from supervising  people to supervising only , his bonus was reduced, and he was downgraded in his performance review.  Some industry veterans took their concerns directly to government officials. J. Kyle Bass, a Dallas-based hedge fund manager and a former Bear Stearns executive, testified to the FCIC that he told the Federal Reserve that he believed the housing se- curitization market to be on a shaky foundation. “Their answer at the time was, and this was also the thought that was—that was homogeneous throughout Wall Street’s analysts—was home prices always track income growth and jobs growth. And they showed me income growth on one chart and jobs growth on another, and said, ‘We don’t see what you’re talking about because incomes are still growing and jobs are still growing.’ And I said, well, you obviously don’t realize where the dog is and where the tail is, and what’s moving what.”  fcic_final_report_full--228 With over  metro areas representing nearly one-half of the na- tion’s housing stock experiencing or about to experience price declines, national house prices are also set to decline. Indeed, odds are high that national house prices will decline in .  For , the National Association of Realtors announced that the number of sales of existing homes had experienced the sharpest fall in  years. That year, home prices declined . In , they would drop a stunning . Overall, by the end of , prices would drop  from their peak in .  Some cities saw a particularly large drop: in Las Vegas, as of August , home prices were down  from their peak. And areas that never saw huge price gains have experienced losses as well: home prices in Denver have fallen  since their peak. In some areas, home prices started to fall as early as late . For example, in Ocean City, New Jersey, where many properties are vacation homes, home prices had risen  since ; they topped out in December  and fell  in the first half of . By mid-, they would be  below their peak. Prices topped out in Sacramento in October  and are today down nearly . In most places, prices rose for a bit longer. For instance, in Tucson, Arizona, prices kept increasing for much of , climbing  from  to their high point in August , and then fell only  by the end of the year.  One of the first signs of the housing crash was an upswing in early payment de- faults—usually defined as borrowers’ being  or more days delinquent within the first year. Figures provided to the FCIC show that by the summer of , . of loans less than a year old were in default. The figure would peak in late  at ., well above the . peak in the  recession. Even more stunning, first payment de- faults—that is, mortgages taken out by borrowers who never made a single payment— went above . of loans in early .  Responding to questions about that data, CoreLogic Chief Economist Mark Fleming told the FCIC that the early payment de- fault rate “certainly correlates with the increase in the Alt-A and subprime shares and the turn of the housing market and the sensitivity of those loan products.”  Mortgages in serious delinquency, defined as those  or more days past due or in foreclosure, had hovered around  during the early part of the decade, jumped in , and kept climbing. By the end of , . of mortgage loans were seriously delinquent. By comparison, serious delinquencies peaked at . in  following the previous recession.  Serious delinquency was highest in areas of the country that had experienced the biggest housing booms. In the “sand states”—California, Arizona, Nevada, and Florida—serious delinquency rose to  in mid- and  by late , double the rate in other areas of the country (see figure .).  CHRG-111hhrg53238--103 Mr. Kanjorski," And I understand that. You know, I really want to get to a more fundamental problem of why I worry about where we are going and how we are going to get there. Did anybody who is on the panel, the eight witnesses, did you see this coming, and what actions did you take in terms to warn us of this eventuality? I remember very distinctly Alan Greenspan testifying here, a direct question as early as 2005, I think. I asked him a question: ``Is there any foreseeable problem in the real estate bubble?'' And he clearly said, ``No, we have it all under control. There is nothing to worry about.'' Now, you all do not handle all real estate, although the mortgage people sort of cover the unbanked portion of it. Who did see it and did not take action--or of you who did not see it? And is that not what we want to get to, what is the next calamity and how is it going to be handled? And God knows, there is going to be another calamity. All we are arguing is whether we are going to get a rather comprehensive regulatory reform that will last 75 years, as the last set of regulations lasted, or whether we are going to get a financial crisis every 25 years as the history of the Republic reflected for its first 200 years or first 150 years of existence. But if you could give me that fundamental question, because I am hearing from that side of the aisle that this all occurred from CRAs. How many of you believe that? Was that a major contributor to our problem? How many of you believe that, except for Fannie Mae or Freddie Mac, this disaster would not have occurred? Well, there go your two propositions, Randy. Ms. Leonard. One of the things that we saw was the fact that there was a need for licensing, there was a need for increased professional standards, and we advocated for that and with the SAFE Act that has now come into play. That is one of the things that we believe will help long term with some of the problems that did exist. " CHRG-110shrg50369--144 RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM BEN S. BERNANKEQ.1. Increases in the GSE/FHA Conforming Loan Limits: The stimulus bill recently passed by Congress includes an increase in the conforming loan limit amount for mortgages that the Government Sponsored Entities (GSEs) and the Federal Housing Administration can guarantee. Do you believe that increasing these loan amounts adds to the systemic risks associated with the GSEs' operations? While these increases are only temporary, some have raised the idea of permanently increasing the amounts. Are there additional risks associated with a permanent increase?A.1. Temporarily raising the conforming loan limit allows the GSEs to securitize an expanded range of mortgage loans and likely would increase liquidity in the secondary market for loans covered by the expansion. The GSEs should be strongly encouraged to rapidly use this authority, even if it requires that they raise substantial amounts of capital. Over a longer horizon, it is important to realize that raising the conforming loan limits extends the implicit government-backing of the GSEs into a larger portion of the mortgage market. While the jumbo mortgage market has experienced substantial liquidity problems during the past year, this market historically has operated efficiently and functioned well without GSE involvement. Moreover, prime quality homeowners who use jumbo mortgages are, in general, the highest income and wealthiest members of our society. Extending the reach of the GSEs to these borrowers would do little to expand homeownership or to extend mortgage credit to those that cannot obtain mortgages otherwise. Thus, raising the conforming loan limit involves the larger question of how far to extend government guarantees, either explicit or implicit, to resolve short-term liquidity problems in secondary asset markets. Temporary expansions of the safety net, such as those undertaken by the Federal Reserve, can boost short-term liquidity without distorting private market credit analysis. In contrast, permanent expansions of the safety net, such as raising the conforming loan limit permanently, may well cause greater problems in the long-run. There are many reasons for the recent breakdown in private market credit analysis, but it is not clear to me that the best approach to rectify the current situation is simply to substitute implicit government guarantees for much needed private market discipline. If private markets are unable to provide a secondary market for some assets, we should first endeavor to understand why this is the case rather than immediately turn to a broader expansion of GSE guarantees. Any permanent expansion of GSE guarantees must, be accompanied by comprehensive GSE reform to mitigate further systemic risks. In particular, capital standards for the GSEs must be significantly toughened and clear and credible receivership procedures for the GSEs should be established. Moreover, the role and function of the GSE portfolios should be clearly articulated by Congress. As has been evident in recent months, this portfolio is managed mainly to meet needs of GSE shareholders and not to fulfill public policy objectives.Q.2. International Liquidity Coordination: Chairman Bernanke, as of the minutes of the last Federal Open Market Committee meeting, the Federal Reserve reaffirmed their commitment to working with foreign central banks to coordinate international monetary policy. Please describe for us the details of the Federal Reserve's agreements with foreign central banks, such as the European Central Bank and the Bank of England for exchanging assets into dollars. Why have these agreements been made and are financial institutions using these tools?A.2. The Federal Open Market Committee (FOMC) established swap lines with the European Central Bank (ECB)and Swiss National Bank (SNB) in conjunction with the establishment of the Term Auction Facility (TAF) on December 12, 2007. These swap agreements were requested by the ECB and SNB and allowed them to draw a maximum of $20 billion and $4 billion respectively, for a period of up to 6 months. Under the agreements, both central banks are allowed to purchase U.S. dollars with their foreign currencies based on the prevailing spot exchange rate, and they pay interest on the foreign currency received by the Federal Reserve. Given the strong financial position of the ECB and SNB, the swap lies involve virtually no credit risk to the Federal Reserve. The Federal Reserve has also maintained longstanding swap facilities with the Bank of Mexico and the Bank of Canada as part of the North American Framework Agreement. Those facilities amount to $2 billion with the Bank of Canada and $3 billion with the Bank of Mexico. The agreements with the ECB and SNB were established to allow dollar funding problems faced by European and Swiss banks to be addressed directly by their respective home central banks. In the absence of such agreements, European and Swiss banks were believed to be more likely to seek dollar funding in U.S. markets, potentially increasing volatility and adding to term funding pressures in U.S. markets. By providing dollars to the ECB and SNB to use in their efforts to address term dollar funding problems abroad, the FOMC believed that it would assist U.S. credit markets. Both the ECB and SNB have used their swap agreements. The first use of these swap lines was on Monday, December 17, when the ECB drew upon $10 billion and the SNB drew upon $4 billion for a 28-day period. The two central banks used the funds to auction dollar funding to their eligible depository institutions; the ECB offered funds to its eligible depository institutions at the 4.65 percent rate set in the Federal Reserve's TAF auction, and the SNB auctioned $4 billion at a weighted average rate of 4.79 percent. The ECB drew upon a further $10 billion on Thursday, December 20, in conjunction with the second TAF auction held by the Federal Reserve. At the expiration of its first use of its swap line, the ECB renewed its draws in conjunction with the January 14 and January 28 TAF auctions, offering $10 billion in 28-day dollar funds both times at a rate equal to the rate set in the TAF auction. The SNB also renewed its draw of $4 billion on its swap line to participate in the January 14 auction of dollar funds. On March 11, the FOMC announced that it would increase its temporary swap line to the ECB from $20 billion to $30 billion and its line to the SNB from $4 billion to $6 billion, extending the swap lines through September 30, 2008. Both central banks have signaled that they would draw upon the lines to offer 28-day dollar funding in auctions to be held on March 25.Q.3. Sovereign Wealth Funds and Systemic Risk: Chairman Bernanke, recently we have seen an influx of capital into our domestic financial institutions from foreign governments, specifically sovereign wealth funds. Previous foreign direct investments have usually been in smaller quantities and from private investors, rather than governments. These investments may be under the threshold of control for each sale, but collectively could represent a large proportion of U.S. financial services firms. Is there a danger of systemic risk from one or more Sovereign Wealth Funds holding noncontrolling stakes many financial firms?A.3. The recent prominent equity investments by sovereign wealth funds in large U.S. financial institutions permanently increased the capital of these firms, enhancing their soundness and the soundness of the U.S. financial system. These investments also support the ability of the financial institutions to provide credit to businesses and consumers. It is difficult to envision circumstances under which non-controlling equity stakes in financial institutions, could increase systemic risk in a financial system. Sovereign wealth funds have been relatively stable investors. The funds generally are neither highly leveraged nor exposed to liquidity risk arising from investor withdrawals or redemptions. Sovereign wealth funds often use professional private fund managers who are tasked with seeking higher returns and greater diversification--relative to official reserves--for a portion of a country's foreign exchange assets. Because sovereign wealth funds are government owned, there has been concern, however, that these funds have the potential to be motivated by political reasons To the extent these funds make only smaller, noncontrolling investments, the ability of a sovereign wealth fund to have an effect on the operation, strategic direction or policies of a banking organization are minimal. If two or more companies with noncontrolling investments in a U.S. bank or bank holding company were to agree to act together in an attempt to influence the operations of a U.S. bank or bank holding company, the Federal Reserve has the authority to combine the companies' shareholdings and treat the group as one company (an ``association'') for purposes of the Bank Holding Company Act (BHC Act). If the combined shareholding were significant enough, the association could be treated as a bank holding company subject to the requirements of the BHC Act. To date, the Board has not found that sovereign wealth funds from different countries have in fact acted together to control a U.S. financial institution. Another important safeguard applies to the U.S. banking organization itself. U.S. banking organizations themselves are subject to the supervisory and regulatory requirements of U.S. banking law. For example, federal banking agencies are required under the Federal Deposit Insurance Act to establish certain safety and soundness standards by regulation or guideline for all U.S. insured depository institutions. These standards are designed to identify potential safety and soundness concerns and ensure that action is taken to address those concerns before they pose a risk to the Deposit Insurance Fund. Thus, the Federal banking agencies may monitor and require action by the U.S. banking organization to maintain its financial health regardless of the owner of the banking organization.Q.4. Is there a Bernanke ``Put''? Chairman Bernanke, some economists speculate that market participants became willing to take greater risks because monetary policy under Chairman Greenspan protected investments by cutting interest rates in response to economic shocks. This phenomenon came to be called the Greenspan ``put''--referring to the financial instrument that guarantees its owner a certain return if prices fall below a specified level. Now critics are wondering if there is also a Bernanke put, given the recent significant drop in rates. How do you respond to these observations? How do you balance responding to slower economic growth while at the same time allowing the market to follow a normal business cycle? Do you have any concerns that the 225 basis point drop in interest rates since last August creates moral hazard for market participants?A.4. In conducting monetary policy, the Federal Reserve is guided by its statutory mandate to promote maximum employment and stable prices over time. I do not believe that monetary policy actions aimed at these goals are a significant source of moral hazard. To be sure, in carrying out its mandate, the Federal Reserve takes account of a broad range of factors that influence the outlook for economic growth and inflation, importantly including financial asset prices, such as the prices of equity shares and houses. Financial asset prices are important for the economic outlook partly because they affect household wealth and thus consumer spending on goods and services and therefore ultimately influence output, employment, and inflationary pressures. Depending on overall circumstances, declines in asset prices may adversely affect the outlook for aggregate demand, and consequently the stance of monetary policy may need to be eased in order to cushion the effect on aggregate demand. It is important to recognize that such a response of monetary policy is not designed to support financial asset prices themselves but to foster overall economic growth and to mitigate the risks of particularly adverse economic outcomes. It is also worth noting that past Federal Reserve efforts to buoy economic growth in the face of declining asset prices have not insulated from substantial losses investors who made poor investment choices. This point is evidenced by the very large losses suffered by investors in the tech sector early this decade despite considerable monetary policy easing, and by the losses experienced by investors in many subprime-related mortgage products more recently even as the stance of monetary policy was eased.Q.5. Term Auction Facility: Chairman Bernanke, the Federal Reserve created a new Term Auction Facility to help ensure that American banks have adequate liquidity. What has been the response to the auctions thus far and for how long will they continue? What type of collateral are banks posting in these auctions? What happens if that collateral, particularly AAA-rated mortgage backed securities, is downgraded?A.5. The demand for TAF credit from depository institutions has been ample. All eight auctions conducted to date have been oversubscribed, with resulting interest rates in each case above the minimum bid rate. The Federal Reserve will continue to conduct TAF auctions for at least the next 6 months unless evolving market conditions clearly indicate that such auctions are no longer necessary. TAF borrowing is collateralized by the same pool of assets as pledged against other types of discount window loans. For all types of discount window loans, Federal Reserve Banks will consider accepting as collateral any assets that meet regulatory standards for sound asset quality. Commonly pledged assets include residential and commercial real estate loans, consumer loans, business loans, and a variety of securities. The standards applied to each type of collateral are available on the Federal Reserve discount window Web site at www.frbdiscountwindow.erg. Collateral that is downgraded below Federal Reserve eligibility standards is given no value and must be withdrawn. The likelihood that the downgrade of a portion of a depository institution's collateral will affect a TAF loan is reduced by the requirement that, at the time of bidding, the sum of the aggregate bid amount submitted by a depository institution and the principal amount of TAF advances that the same depository institution may have outstanding cannot exceed 50 percent of the collateral value of the assets pledged by the depository institution.Q.6. Value of the Dollar: As you know, the U.S. dollar declined against most major currencies over the past year. The dollar has lost 10.4 percent again the Euro and 5.7 percent versus the yen in 2007. What does it mean for our economy if foreign countries turn away from holding the dollar as their reserve currency or even if they diversify, which has already begun? Are there dangers that we will be more constrained in the actions we are able to take domestically, including selling Treasury securities, to finance our deficit?A.6. The dollar's status as a reserve currency reflects investor confidence in the sophistication and liquidity of U.S. financial markets and the relative stability of our macroeconomic environment. To date, there is little evidence of a shift in foreign official holdings away from dollar denominated assets. U.S. data show further growth in foreign official holdings of U.S. assets. Data reported to the IMF also show continued growth in dollar assets in foreign official reserves. While the IMF data show a decline in the dollar share of reported reserves, this decline is entirely attributable to the depreciation of the dollar, which has raised the dollar value of the other currencies held in the reserve portfolios. In response to a private survey conducted by the Royal Bank of Scotland, several reserve managers indicated they planned to increase the weight of non-dollar assets in future investments, but there was again no evidence of a general shift out of the dollar on the part of these respondents. In principle, a shift in foreign appetite away from U.S. securities toward foreign securities might be expected to lower the value of the dollar and to raise U.S. interest rates; however, these effects are difficult to measure and appear to be modest. Furthermore, while it is true that foreign official institutions hold a significant fraction of U.S. Treasury securities outstanding, it is important to note that these holdings represent less than 5 percent of the total debt outstanding in U.S. credit markets. As such, U.S. credit markets could likely absorb a shift in foreign official allocations away from dollar assets without undue difficulty. In the event that such a shift were to occur and put undesired upward pressure on U.S. interest rates, the Federal Reserve has the capacity to increase available credit to maintain a level of short-term interest rates consistent with our domestic economic goals. Any effect of reduced foreign demand on the term premium between short-term and long-term interest rates could affect the cost of long-term borrowing by the Federal Government; however, this impact is likely to be relatively small and is unlikely to materially constrain the U.S. government's ability to finance its deficit.Q.7. Slow Growth and Rising Inflation: Mr. Chairman, there is some evidence of contradictory forces at play in the economy right now. In the middle of the present economic downturn, commodity and food prices have increased. What do you judge to be the threat of slow growth continuing, with inflation remaining above the Federal Reserve's comfort level?A.7. The FOMC, in the statement released at the conclusion of its most recent meeting on March 18, noted that the outlook for economic activity has weakened further in recent weeks and that downside risks to growth remain. At the same time, inflation has been elevated, uncertainty about the inflation outlook has increased The actions taken by the Federal Reserve since last August, including measures to foster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, the Federal Reserve remains attentive to the risks to the outlook for activity and inflation, and it will act in a timely manner as needed to promote sustainable economic growth and price stability.Q.8. Capital: The ongoing turmoil in our financial markets vividly demonstrates the wisdom of prudent capital requirements for our financial institutions. If our financial institutions hold sufficient capital, they are much more likely to weather the inevitable economic storms that occur as part of the business cycle. Because a healthy banking system is one of the best defenses against a severe economic downturn, one of the most important responsibilities of our financial regulators is ensuring that financial institutions are adequately capitalized. Chairman Bernanke, what is your assessment of the current capital levels in our banking system? As part of your answer, would you explain the steps your agency has taken over the past year to make sure that our banks are adequately capitalized?A.8. As you how a bank is deemed to be well capitalized under Prompt Corrective Action rules if it has a tier 1 risk-based capital ratio of 6 percent or greater, a total risk-based capital ratio of 10 percent or greater, a leverage ratio of 5 percent or greater and is not subject to any written directive issued by the Federal Reserve Board. As can be seen in the summary table below, the majority of U.S. commercial banks have substantial buffers over the well capitalized requirements (as of year-end 2007), which should prove helpful during these difficult times. However, capital ratios in banking organizations can erode rapidly during downturns, depending on the rate of increase and amounts of write-downs and additions to the allowance for losses and the extent to which these cannot be offset by the retention of earnings or raising of new capital. Summary Average Data for Insured Commercial Banks------------------------------------------------------------------------ Ratios Avg. 1997-2007 2006 2007------------------------------------------------------------------------Equity Capital/Assets............... 9.2 10.2 10.2Leverage............................ 7.8 8.1 7.9Tier 1 Ratio (Risk-Based)........... 9.7 9.8 9.4Total Ratio (Risk-Based)............ 12.4 12.4 12.2% Deemed Well Capitalized........... 98.3 99.3 98.9------------------------------------------------------------------------Source: Summary Profile Report, Dec. 2007, BS&R, Federal Reserve Board of Governors. The Federal Reserve Board, together with the other banking agencies, is currently reviewing several elements of its regulatory capital requirements to ensure that banking organizations have sufficient capital levels to weather losses during difficult times and to ensure a high standard in the quality of capital (i.e., its ability to absorb losses effectively) being issued by these organizations. In addition, our ongoing supervisory activities include monitoring banking organizations' asset quality, market exposures, quality of earnings, capital management plans, effectiveness and adequacy of provisioning, and valuation policies, all of which directly impact the banking organizations' capital standing. In December 2007, the Federal Reserve Board, together with the other banking agencies, approved final rules implementing the Basel II advanced risk-based capital rules--for large, internationally active banking organizations--that more closely align regulatory capital requirements with actual risks and should further strengthen banking organizations' risk-management practices. The improvements in risk management under Basel II will be valuable in promoting the resiliency of the banking and financial systems. Under the Basel II rules, banking organizations must have rigorous processes for assessing their overall capital adequacy in relation to their total risk profile and publicly disclose information about their risk profile and capital adequacy. We will continue to assess the Federal Reserve Board's capital rules to ensure that banking organizations' capital requirements remain prudent.Q.9. Role of Credit Rating Agencies for Capital Requirements: Many financial institutions and pension funds are only permitted to hold assets with an ``investment grade'' rating. Chairman Bernanke, what steps is the Fed taking to ensure that banks monitor the quality of assets on their balance sheets and that financial institutions are not outsourcing their due diligence requirements to credit rating agencies?A.9. Many investors and financial firms relied too heavily on ratings assigned by credit rating agencies in their risk management activities, particularly with regard to structured credit instruments. The Federal Reserve has long stressed to bankers the importance of proper due diligence and independent analysis in making credit risk assessments. A recent analysis of several global financial institutions by supervisors from the United Kingdom, Germany, France, and the United States--including staff from the Federal Reserve--demonstrated that principle in the current environment. Those institutions that had developed robust internal processes for assessing risks of complex subprime-related instruments were able to more quickly identify declines in value and the heightened risks of these instruments. Accordingly, these institutions were less vulnerable to the underestimates of risk made by the credit rating agencies on these instruments, less likely to underestimate the volatility of these instruments, and better able to analyze the effects of changing market conditions on their credit and liquidity risk profiles. \1\--------------------------------------------------------------------------- \1\ Senior Supervisors' Group, ``Observations on Risk Management Practices During the Recent Market Turbulence,'' March 6, 2008.--------------------------------------------------------------------------- We are reminding institutions that they should conduct independent, thorough, and timely credit risk assessments for all exposures, not just those in the loan book. Their processes for producing credit risk assessments should be subject to periodic internal reviews--through financial analysis, benchmarking and other means--to ensure that these assessments are objective, accurate and timely. Supervisors are also redoubling efforts to ensure that institutions do not rely inappropriately on external ratings. We continue to emphasize that for any cases in which U.S. banks rely on third-party assessments of credit risk, these institutions should conduct their own assessments to ensure that they are sound and timely and that the level and nature of the due diligence should be commensurate to the complexity of the risk. In addition, the Federal Reserve and the other members of the President's Working Group on Financial Markets (PWG) have recommended a review of existing regulations and supervisory policies that establish minimum external ratings requirements to ensure they appropriately take account of the characteristics of securitized and other structured finance instruments. The PWG also has endorsed plans by the Basel Committee on Banking Supervision and the International Organization of Securities Commissions to reconsider capital requirements for complex structured securities and off-balance-sheet instruments that are keyed to ratings provided by credit rating agencies. The PWG further has recommended changes in the oversight of credit rating agencies and their required disclosures to improve the comparability and reliability of their ratings, and expressed support for recent initiatives by the credit rating agencies to improve their internal controls and ratings for structured finance instruments. \2\--------------------------------------------------------------------------- \2\ The President's Working group on Financial Markets, ``Policy Statement on Financial Market Developments,'' March 12, 2008.Q.10. HOEPA Rulemaking: During this period of correction in the housing market, I believe it is incredibly important that we do not overreact and restrict access to credit to individuals who need it the most. In December of last year, the Federal Reserve produced a proposed rule under its Homeownership Equity Protection Act (HOEPA) authority. That rule is currently out for notice and comment. Mr. Bernanke, can you comment for the record on some of the steps that the Fed took to ensure that an appropriate balance was struck between eliminating many of the mortgage market excesses that created many of the problems we face today while ensuring that borrowers have adequate access to credit?A.10. Our goal in proposing new regulations under the authority of the Home Ownership and Equity Protection Act (HOEPA) was to produce clear and comprehensive rules to protect consumers from unfair practices while maintaining the viability of a market for responsible mortgage lending. To help us achieve this goal, we gathered substantial input from the public, including though five public hearings we held on the home mortgage market in 2006 and 2007. We also focused the proposed protections where the risks are greatest by applying stricter regulations to higher-priced mortgage loans, which we have defined broadly so as to cover substantially all of the subprime market. As an example of the Board's approach, the rules would prohibit a lender from engaging in a pattern or practice of making higher-priced loans that the borrower cannot reasonably be expected to repay from income or from assets other than the house. The proposal is broadly worded to capture different ways that risk can be layered even as the practices that increase risk may change. It would not set numerical underwriting requirements, such as a specific ratio of debt to income, but would provide some specific guidance for lenders to follow when assessing a consumer's repayment ability. For instance, creditors who exhibited a pattern or practice of not considering consumers' ability to repay a loan at the fully-indexed rate would be presumed to have violated the rule. Another proposed rule would require lenders to verify the income or assets they rely on to make credit decisions for higher-priced loans. Creditors would be able to rely on standard documents to verify income and assets, such as W-2 forms and tax returns. However, to ensure access to credit for consumers, such as the self-employed, who may not easily be able to provide traditional documentation, the rule would allow creditors to rely on any third-party documents that provide reasonably reliable evidence of income and assets. For example, creditors could rely on a series of check cashing receipts to verify a consumer's income. We believe these proposed rules will help protect mortgage borrowers from unfair and deceptive practices. At the same time, we did not want to create rules that were so open-ended or costly to administer that responsible lenders would exit the subprime market. So, our proposal is designed to protect consumers without shutting off access to responsible credit.Q.11. Housing Market: Chairman Bernanke, the current downturn in the housing market is not the first that we've seen, and is unlikely to be the last. What has been the average length of time from peak to trough in previous housing market downturns? How does the current downturn compare to previous ones?A.11. Although there are considerable differences across episodes and measures of housing market activity, the trough usually occurs between 2 and 3 years after the peak. Thus far, the current downturn in residential investment has lasted eight quarters, similar to the average of previous downturns. As measured by single-family housing starts, the decline in activity so far in this cycle has been greater than average, although not quite as large as the contraction that occurred in the late 1970s and early 1980s.Q.12. Home Prices and Inflation: Chairman Bernanke, a commonly watched measure of inflation is the core-CPI. Housing constitutes almost a third of core-CPI. To what extent has the recent decline in housing prices moderated recent increases in the core-CPI? What would be the trend in core-CPI if house prices were excluded?A.12. The CPI for owner-occupied housing is not directly affected by changes in housing prices. The Bureau of Labor Statistics (BLS) uses a rental equivalence approach to measure changes in the price of housing services from owner-occupied units. This approach defies the implicit rent of an owner-occupied unit as the money that would be received were it to be rented out (that is, the opportunity cost of owning, as opposed to renting, the unit). As a result, the BLS uses observations on tenants' rents (after making adjustments for landlord-provided utilities) to construct the CPI for owner-occupied housing. It is reasonable to expect that tenants' rents should be related over time to the affordability of owner-occupied housing, which would depend in part on home prices. The BLS does not publish an index for the core CPI excluding owners' equivalent rent. However, one can gain some insight with regard to its limited contribution to core CPI inflation of late from the fact that the CPI index for all items less food and energy rose 2.3 percent over the 12 months ending in February 2008, while the index for owners' equivalent rent of primary residence increased 2.6 percent.Q.13. Housing Wealth: Chairman Bernanke, the recent decline in home prices in many parts of the country followed several years of extraordinary home price appreciation. What has been the overall impact of the housing bubble, and its burst, on household wealth? Is a family that purchased a home in 2002 or 2003 still better off? Of those families who purchased homes earlier this decade, and have seen substantial overall appreciation, how have their spending patterns been affected by the declining market?A.13. Nationwide, according to the Office of Federal Housing Enterprise Oversight (OFHEO) purchase-only house price index, house prices peaked in mid-2007 and have since fallen about 3 percent; according to the more volatile S&P/Case-Shiller house price index, house prices peaked in mid-2006 and have since fallen about 10 percent. Both indexes show major regional disparities, with house prices peaking earlier, and falling more, in California, Nevada, some New England states, and Michigan and Ohio. Indeed, according to OFHEO's measure, home prices in Michigan have fallen, on net, since 2001. In all other states, families that purchased their homes in 2003 or earlier continue to have seen a net appreciation in their home's value. According to the Federal Reserve's flow of funds accounts, housing wealth peaked at $20.3 trillion in 2007:Q3 before falling about $170 billion in 2007:Q4. Estimates by academic economists of the direct effect of housing wealth on consumption vary widely, from as little as 2 cents on the dollar to as high as 7 cents on the dollar. These effects tend to be spread out over roughly a 3-year period, so that current spending is still being supported to some extent by earlier house price gains, and the effects of the current declines will only be fully felt over the next couple of years. In addition to directly affecting spending by reducing family wealth, falling house prices may affect a family's spending indirectly through credit market channels. Borrowing against home equity is often the lowest-cost form of finance available to a household; falling house prices can decrease the collateral value of a home, forcing borrowers to turn to costlier forms of finance, such as credit cards. These indirect effects, which are extremely difficult to quantify, probably are a factor that has increased the size of some of the larger published estimates of the effect of falling house prices on consumer spending.Q.14. Covered Bonds: Chairman Bernanke, recently FDIC Chairman Bair indicated that covered bonds were a ``front burner issue'' at the FDIC as they continued to look for ways to improve liquidity in the mortgage market. I understand that Europe has a mature, $2 trillion covered bond market. Do you think there could be a benefit to fostering such a market in the United States? What distinctions do you see between the European market and the status of the U.S. market?A.14. As long as banks and their counterparties are safe and sound, efforts to provide more financing opportunities to banks and bank holding companies, particularly under current market conditions, should be taken seriously. Such actions may make it more likely that the financial markets will be able to provide the necessary credit to sustain and enhance economic activity. In general, the European markets appear to be useful additions to their financial markets, successfully providing liquidity and credit for some assets under most market conditions. Covered bonds have been available in Europe for many years, and such programs differ greatly across countries. Much could be learned by studying the merits of each country's program and applying these lessons to creating a unique program in the United States. Creating a covered bond market in the United States, however, may be difficult without Congressional discussion and legislation. Covered bonds raise many issues related to the safety net provided to banks in the United States, including issues related to the bank deposit insurance fund. The legal structure provided for covered bonds in European countries resolves many of these issues. With regard to creating a covered bond market in the United States, all parties should seek to distill the best practices from the European markets and work towards the establishment of a robust and well-designed covered bond market that includes safeguards to ensure that the safety net provided banks would not be measurably extended further." FOMC20060920meeting--112 110,MR. FISHER.," Mr. Chairman, the Eleventh District economy remains strong and continues to grow at a stronger pace than the rest of the country, with employment growth continuing at roughly twice the nation’s pace. Incidentally, home sales have not turned down in our District, so we haven’t been singing yet what we call the “coastal blues” as far as the homebuilding market is concerned. I think that’s enough said about Texas and the Eleventh District. I would like to talk about what I have learned this time from my usual soundings of some two dozen CEOs and CFOs. I have added a new one, by the way—the largest truck dealer in the country, which does $2.8 billion in sales of heavy trucks. Just as a footnote, what is driving some of what President Poole reported are the changes in emission standards that are being enforced as of January; other than that, they do not see much turndown in volume. To summarize the reports of these interlocutors, I am going to borrow from Mark Twain’s great quip about the music of Wagner. According to these business contacts, the outlook for economic growth is better than it sounds, whereas the dynamic of inflation is worse than it sounds. Just a few anecdotes here for, if not similitude, verisimilitude. By the way, all the interlocutors are fully aware of the shape of the yield curve—these individuals are sophisticated— and they are especially aware of what is happening in the housing market. As one CEO told me, the only subject that has been more analyzed than the housing situation is the birth of Brad Pitt’s baby. [Laughter] According to this view, if we have not discounted what has been happening in the housing market, we have been living on Mars, and I think that is an important point to take into account. If you remember, Dave, I have been more pessimistic than the staff in terms of the depth of the housing downturn. Well, very quickly, according to the CFO of Frito-Lay, he and his counterpart CFOs in consumer goods companies do not see an appreciable slowing of growth from the second quarter to the third quarter. The CFO of UPS reports that, while business is tougher, third-quarter growth is running at a rate of 3 percent, the same as the second quarter, and their business projections indicate GDP growth “in the high 2 percent or low 3 percent area” for the rest of the year. The CEO of Burlington Northern Santa Fe reports that, despite a 17 percent year-over-year falloff in lumber shipments through last week, business overall “has actually firmed since the second quarter.” From my usual report on the Panamax shipping charter rates, it is noteworthy that since our last meeting, when the round-trip booking rate was $23,000 a day, the rate has soared to $31,000 a day. By the way, the rates for carrying back finished products like steel from China, in the so-called handymax fleet, has risen to $27,300 from $23,000 a day, where it was at our last meeting. All the retailers I talked to—from 7-Eleven to JCPenney to Costco to Home Depot—report that they feel that they have bottomed out and that things are picking up, with one exception. That exception is Wal-Mart, and I think some of that situation relates to the internal dynamics of the way Wal-Mart is positioning itself in the market. I think Bill’s report was very accurate on Wal-Mart. There are some tempering contra-indicators. The book-to-bill ratio for Texas Instruments and other semiconductor firms has fallen to 1 or slightly below, and advanced bookings for airlines are somewhat weaker. Herb Kelleher of Southwest Airlines, who has to be the most entertaining interlocutor I talk to, tempered that by saying when we met last time the advanced booking curve “index” was, say, 100. It has now eased to somewhere around 95—a noticeable but not dramatic drop. The CEO of EDS summarized the growth side of the economy much as did the majority of the CEOs I spoke to for this go-round when he said, “We were all expecting things to be worse. They haven’t gotten worse.” They were all expecting things to get tougher, and they haven’t gotten tougher, except for one area—the procurement of labor. There is a shortage of bank tellers and mechanics. By the way, a wrench bender, as they call the job in California now—a simple mechanic without the completion of a high-school diploma—gets $100,000 a year. There is a shortage of truck drivers, of oil field hands, of chemical engineers, and even of unskilled workers such as retail store cashiers in Houston; and for the first time I have heard from the major hoteliers of a shortage of hotel maids. To illustrate the point, one CEO mentioned that, whereas his company regularly used to get 300 applications for 100 truck driver jobs, they now get 3. So the bottom line is that our contacts are feeling more optimistic than the economists’ forecasts. They are worried about some constraints on domestic labor. As one contact said, the economy feels like a full employment economy. I want to spend just a minute on the inflation picture. I’m not going to go through anecdotes from the CEOs, though it pains me greatly as the son of an Australian to note that Anheuser-Busch has told its retailers that it is going to raise the price of beer 3 percent starting in January 2007. But I do want to explain why our board voted 7 to 1 to raise the discount rate. As you know, we measure inflation at the Dallas Fed by the trimmed mean. Our numbers show trimmed mean inflation running at 3.1 percent in July and a twelve-month rate of 2.7 percent and, not unimportantly, with 57 percent of the component elements increased at a rate of 3 percent or more. Now, of course, we cannot update those numbers until the next PCE number comes out, so you might argue that they are very stale. But the recent CPI release was not comforting. Dave, you mentioned 0.2 percent. Taking that at face value, you can say that consumer inflation is unchanged from July. But if you really look at those numbers, the rate for July was 0.19 percent, and the rate for August was 0.24 percent. If you annualize those numbers, that is a difference between 2.36 percent and 2.9 percent. So we need to keep in mind that the August CPI reading is about midway between July’s low reading and the elevated readings over the previous four months. At an annual rate of roughly 3 percent, it is better than earlier this year, but it is still uncomfortable. I take President Moskow’s point about our credibility, particularly against the background of the trimmed mean, Cleveland’s median rate of 3.4 percent, and then our six-month trimmed mean rate running at about 2.9 percent, I believe. I mention this simply to urge the Committee that—not only in our deeds, to take President Moskow’s point, but also in our words—we need to continue engendering confidence about inflation expectations and be very careful in the way we state ourselves. We cannot take it for granted that inflation has been completely conquered. Thank you, Mr. Chairman." CHRG-110shrg50414--200 Secretary Paulson," I would say that is a major cause. I have called it the root cause, the housing correction. Senator Bunning. OK. Then why did I read in the paper this morning that we are now going to include student loans and credit card debt? How does that fit the housing? " CHRG-111hhrg61852--37 Mr. Watt," You didn't finish the question before your time expired. The gentlelady from New York, Mrs. McCarthy, is recognized for 5 minutes. Mrs. McCarthy of New York. I am sorry that I was detained and wasn't here to hear your testimony, though we did go through the testimony when we received it. I guess the question I have is actually for all three of you. This morning, listening to Chairman Bernanke's testimony, highlighted very important factors that could jeopardize economic growth: bank lending; employment rates; the housing market; and retail commercial activity. We have taken many legislative steps here in Congress to move those areas mentioned in the Chairman's testimony towards positive development; however, some feel that the tax cuts alone are the solution. In reading your testimonies, I know there is even confusion here--or not confusion, but difference of opinions. So I guess--probably to continue on some thoughts of the questions already--that I would like to hear your thoughts and views on the success of the measures currently enacted as well as any future measures we should be thinking about. Mr. Koo, could you start? " FOMC20061212meeting--29 27,MR. STOCKTON.," Thank you, Mr. Chairman. As I worked my way through a final reading of the Greenbook this weekend, I was reminded of the old joke about the man who is told by his doctor that he has only six months to live. The doctor recommends that the man marry an economist and move to North Dakota. The man asks whether this will really help him live any longer than six months. The doctor says, “No, but it sure will feel a lot longer.” [Laughter] Part 1 of the Greenbook was its usual twenty pages, but with lengthy discussions of motor vehicle mismeasurements, PPI inventory deflator anomalies, income revisions, and footnotes on errors in Okun’s law, it sure read as though it were a lot longer than twenty pages. So, in the kinder spirit of the season, I thought that I would jump straight to the bottom line of this forecast. The bottom line is that our outlook for economic activity has not really changed much from the one presented in the October Greenbook—or for that matter, the September Greenbook. The economy still appears to us to have entered a period of below-trend growth that will eventually relieve some of the pressures on resource utilization that we believe have developed over the past few years. As in our previous forecast, the current and expected weakness in aggregate activity is being led by a steep contraction in homebuilding. Indeed, the recent readings on housing starts and building permits were a little softer than we had been forecasting, and we have marked down our forecast of residential investment a bit further. We currently estimate that the drop in residential investment is taking about 1¼ percentage points off the annualized growth of real GDP in the second half of this year, and we are expecting a similar-sized subtraction from growth in the first quarter of next year. We were also surprised to the downside by the October reading on construction put in place in the nonresidential sector. As you may recall, we had been expecting some slowing to become apparent by early next year as a deceleration of business sales, smaller employment increases, and less-rapid growth of equipment spending reduced businesses’ needs for space. Moreover, while fundamentals have improved in commercial real estate markets in recent years, they are best characterized as only moderately favorable; vacancy rates for office and industrial buildings are still elevated by historical standards, and rental income has been rising at only a tepid rate. All told, we have interpreted the softer readings of the past couple of months as suggesting that the slowdown in nonresidential construction has arrived a bit sooner than expected, but we don’t see an outright slump as the most likely outcome in this sector. Business spending on equipment has unfolded pretty much as we had expected. The report on durable goods orders was widely read by others as surprisingly weak. In part, that weakness resulted from a 25 percent drop in orders and shipments of computers that we are extremely skeptical about and that the BEA will significantly downweight in estimating investment spending. Among the pieces that actually matter for gauging capital outlays, the report was close to our forecast. We have been expecting some slowing in real spending for equipment and software in the current quarter, and it looks as though that is what we are getting. But with order backlogs still ample, corporate balance sheets flush with cash, and the cost of capital low, we continue to anticipate modest gains in equipment spending in the near term. Meanwhile, the consumer appears to be chugging along. Our forecast for 3 percent growth in real consumer spending in the current quarter is unchanged from the October Greenbook and close to the average pace of the past few years. Steady gains in employment and income, the drop in energy prices that has occurred since the summer, and higher stock prices appear, at least to date, to have offset any restraint coming from higher borrowing costs and decelerating house prices. We have had a few upside surprises as well. In particular, government spending, at both the federal and the state and local levels, has been somewhat stronger in the second half than anticipated in our October forecast. Also, as Steve will be discussing shortly, net exports are expected to make a slightly larger contribution to current-quarter growth of real GDP. On net, we read these data as suggesting that growth in aggregate output in the second half of this year has been slightly weaker than in our previous projection, largely on account of the softer construction figures. That’s not easy to see in our top-line forecast of real GDP because of some serious problems with the BEA’s measurement of motor vehicle output. As you know, we simply don’t believe the BEA’s estimate that motor vehicle output added ¾ percentage point to the growth of real GDP in the third quarter, in light of the fact that vehicle assemblies fell 600,000 units at an annual rate. By our estimates, the BEA’s faulty methodology caused the growth of real GDP to be overstated about 1 percentage point in the third quarter. We expect that the unwinding of some of that glitch in the fourth quarter will trim real GDP growth about ½ percentage point. So, we believe that, on net, the published growth of real GDP will be overstated about ¼ percentage point in the second half of this year. Adjusting for the measurement problems, we estimate that real GDP probably rose at an annual rate of 1½ percent in the second half, about ¼ percentage point less than in our previous forecast and noticeably below our estimate of the growth of potential. Our view that there has been a perceptible slowing in the pace of activity has received some independent support from our measures of industrial production. Factory output increased at an annual rate of about 5 percent over the first half of the year but seems likely to increase at roughly half that pace in the second half. The cutbacks in auto production and construction, in addition to their direct effects on aggregate output, are leaving an imprint on the production in upstream industries. Even beyond these two areas, industrial activity appears to have weakened some of late. The recent slowing in IP has occurred amid signs of some backup of inventories. Whereas a few months ago any problems seemed to be confined largely to the motor vehicle sector, there are now more widespread signs of unwanted inventory accumulation—most notably for steel, fabricated metals, mineral products, wood, paper, and plastics. The impression left by the hard data is reinforced by purchasing managers, more of whom report that their customers’ inventories are too high than was the case a few months ago. Our forecast envisions that a relatively brief period of soft manufacturing output will be sufficient to clean up these problems. But we will need to monitor this area closely in coming months because what appears relatively benign today could turn worrisome in a hurry. For now, we are reasonably comfortable that the data on both spending and production are more consistent with aggregate activity running modestly below the pace of its potential than with a more serious slowdown. Moreover, it would be a mistake to focus only on the downside risks because there are some prominent upside risks to our forecast as well. To my mind, the performance of the labor market continues to provide the clearest challenge to our view that the growth of activity has slipped below its potential. To be sure, last Friday’s labor market report came in very close to the projection in the December Greenbook. But the last two labor market reports taken together were stronger than we were expecting back in October. Payroll employment gains have slowed from the more rapid rate seen over the past few years, but only to a pace consistent with something close to trend growth in output—not the below-trend pace that we estimate has prevailed over the second half of this year. Moreover, the unemployment rate has declined about ¼ percentage point in recent months, an outcome more consistent with above-trend growth than with below-trend growth. Our forecast assumes that signs of greater weakness in labor demand will become more apparent in the months immediately ahead, with increases in private payrolls slowing to about 75,000 per month in the first quarter and the unemployment rate returning to 4¾ percent. The recent modest backup in initial claims gives some support to this expectation. But slowing in labor demand is, for now, just a forecast. We considered another possible interpretation of recent labor market developments, which is that, despite the downward adjustments that we have made to our estimates of the growth of structural productivity and potential output, we remain too optimistic in our outlook. The unemployment rate has been moving lower despite growth in real GDP that we estimate to have been below 2 percent. We have been surprised again by the weakness in labor productivity. We have not bought into this interpretation largely because the tensions between the labor market signals and GDP are relatively recent and are not especially large. So we are inclined to gather a bit more evidence before making any further adjustments to the supply side of our forecast. But the recent readings do point to a bit more downside risk than upside risk to our estimates of structural labor productivity and potential output. Moving beyond near-term developments, we continue to expect that the period of below-trend growth will extend through the middle of next year. As in our previous forecast, the weakness in activity is led by large ongoing declines in residential investment. Moreover, we are expecting the deceleration in home prices to weigh on the growth of consumption next year through the typical wealth channel. With final sales and output slowing, the usual accelerator effects put some brakes on outlays for consumer durables and business investment spending. Those influences are reinforced in this forecast by a modest backing up of long-term interest rates, as financial market participants come to realize that monetary policy will not be eased on the timetable that they currently envision. We see forces at work that, by the middle of next year, should result in a gradual reacceleration of activity back to a pace in line with the growth of the economy’s potential. Importantly, we are expecting some lessening of the contraction in residential investment. Housing starts have now fallen by enough that, if home sales stabilize at something around their recent pace—and I recognize that this is a big if— homebuilders will be able to make substantial headway in clearing the backlog of unsold homes. As they do, we expect construction activity to level off in the second half of 2007 and then to stage a mild upturn in 2008. Another factor working in the direction of some acceleration in activity is a diminishing drag on spending and activity from the earlier run-up in oil prices. By our estimates, the rise in oil prices has held down growth in real GDP by about ¾ percentage point this year but should be a roughly neutral factor for growth in 2007 and 2008. On balance, our forecast is identical to that in the October Greenbook, with the growth of real GDP projected to be 2¼ percent in 2007 and 2½ percent in 2008. There were, however, a few modest offsetting influences. A stronger stock market and a lower foreign exchange value of the dollar would, all else being equal, have resulted in a somewhat stronger projection for real activity. But those effects were counterbalanced by the substantial downward revisions that the BEA made to its estimates of labor compensation in the second and third quarters. As you know, we had been expecting about half of the first-quarter surge in labor compensation to be reversed in subsequent quarters. But in the event, it was completely reversed, leaving the level of real income about $60 billion below our previous forecast. In response, we lowered our consumption projection, just as we had raised it earlier when income had been revised up. On balance, the effects of the lower income offset the influences of a stronger stock market and lower dollar, and our GDP projection was left unchanged. Like our forecast for real activity, our forecast for inflation also has changed little over the past seven weeks. As we had anticipated, this autumn’s drop in consumer energy prices has resulted in outright declines in headline consumer prices. Core consumer prices came in close to expectations as well—though the core CPI was bit below our forecast and the core PCE a bit above. I wouldn’t make much of either surprise. Our miss on the CPI was concentrated in apparel, used cars, and lodging away from home—all components characterized by low signal-to-noise ratios. Core PCE came in only a couple of basis points above our forecast, with the surprise here mostly in the nonmarket component of medical care costs, specifically the BEA’s estimate of Medicare hospital reimbursement rates—all in all, pretty small potatoes. Our longer-term outlook for inflation also remains unchanged. The slightly tighter labor market incorporated in this projection, along with the lower dollar and higher attendant import prices, would have led us to mark up a bit our inflation projection. But the downward revision to labor compensation implies smaller gains in labor costs and a noticeably higher level of the price markup, suggesting a little less prospective upward pressure on prices. As in our past forecasts, we expect a gradual slowing in core consumer prices over the next two years as the pass-through of higher prices for energy and other commodities runs its course and as the current tightness in labor and product markets diminishes and a small gap in resource utilization eventually opens up. Both the CPI and PCE measures of core prices are currently running a bit below the pace of this past spring—by enough to encourage us in our view that core inflation is more likely to fall than to rise over the next two years but not by nearly enough to cinch the case for our position. I have so much more to say, but I’d better stop here, or you will think that we’ve begun our honeymoon together in North Dakota. Steve Kamin will continue our presentation." CHRG-111shrg57321--253 Mr. McDaniel," For the sector I was talking about, I do stand by it. Senator Levin. Ratings kept churning out with poor models. Now, I will use your words. I think that the agencies really went overboard here and really went off the deep end, and here is the reason. You had poor models for these new structures. You had too few resources you were willing to commit. You had too much pressure from investment bankers. And the nuts didn't end until these mass downgrades of July 2007, when it cratered the market for structured finance. This is what one of your managing directors said at that Town Meeting, Exhibit 98, and this is what he or she wrote. ``[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.'' And then he said, what happened in 2004--he asked then, too, for the leaders to be candid and to acknowledge what the problems were and what had happened, and I think you have a long way to go in acknowledging what happened to your agencies. And this is what he is saying, and I happen to agree with him, that ``Moody's franchise value is based on staying ahead of the pack.'' I would apply this, though, to both. It just happened you guys had a Town Meeting at Moody's. I think the truth of this manager applies to both. He said, ``Moody's franchise value is based on staying ahead of the pack on credit analysis and instead we are in the middle of the pack. I would like more candor from senior management about our errors and how we will address them in the future.'' That is one of the best comments that I have seen, and I hope you would see it that way, but I could understand that may not be the case. The SEC, Ms. Corbet, I think is conducting an investigation of S&P. They conducted an investigation. They found many problems, including staffing levels may have impacted various aspects of the ratings process. Is that true, that the SEC made that finding? Ms. Corbet. I don't know, sir. Senator Levin. OK. They found that S&P made changes to its rating criteria without publishing those changes, that S&P, like Moody's, had undocumented policies--I am quoting here--``and procedures for rating RMBSes and CDOs.'' Were you familiar with that finding of the SEC? Ms. Corbet. I am not familiar with that finding, no. Senator Levin. The SEC found relative to Moody's that you had inadequate staffing levels which impacted the rating process, that Moody's analysts were using unpublished models, that Moody's analysts could be influenced in their rating by the fees charged to the issuers, that they were unable to find all the records surrounding a Moody's rating, that Moody's failed to retain or document certain significant steps in the rating process which made it difficult for the staff to assess compliance with its rating policies and procedures, and to identify the factors that were considered in developing a particular rating. Are you familiar with that? " FOMC20070509meeting--69 67,MR. STERN.," Thank you, Mr. Chairman. My outlook for the economy, which is essentially for sustained growth near trend and for a modest diminution of core inflation over time, hasn’t changed appreciably. To be sure, I have marked down my forecast for this year, largely in recognition of reality—that is, the weak first quarter, and I anticipate some further sluggishness in the second quarter as well. But after that, I expect growth to accelerate to near trend. Underpinning that anticipated performance is productivity improvement of something like 2¼ percent a year or maybe a little less, and employment gains in the neighborhood of 0.6 to 0.8 percentage point per year. On the demand side, I expect sustained increases in consumer spending; in business investment, including structures; and in net exports. I don’t think the outlook for the housing sector has really changed appreciably recently, at least relative to what I had been expecting. Given that inventory levels were and are still high, I think that it will be some time before we see any meaningful improvement in residential construction. My confidence in this general view of the outlook is heightened by my interpretation of history. The economy grew 3 percent or better over the four years from 2003 through 2006. More important and more broadly, if you think about the performance of the economy over the past two and a half decades, it hasn’t been wise to make major bets against sustained, healthy growth. So that’s what I’m really expecting. As for inflation, because I view the current stance of monetary policy as moderately restrictive—and the basis for that is some versions of the Taylor rule, estimates of the real federal funds rate relative to its equilibrium, and some rules of thumb that we have—I do expect that core inflation will gradually slow from here, assuming that we maintain the approximate stance of policy that we have adopted. I think that another reason is that some of the uptick in core inflation was transitory. I would add that, if you look at the latest three-, six-, and twelve-month increases in core CPI or core PCE, you do in fact see some waning of inflation. Of course, the waning is due in part to the favorable numbers we got in March, but it doesn’t appear to be exclusively due to the March numbers. In any event, if inflation is going to slow, it has to be in the latest numbers. [Laughter] I mean, there is no other way for that to occur. With that, I will conclude." FOMC20051213meeting--73 71,MS. MINEHAN.," Thank you very much, Mr. Chairman. I think a fair reading of New England’s economy is that it continues to be a bit weaker than the nation’s as a whole. To be sure, this sense is skewed by conditions in Massachusetts, which alone accounts for about half of the region’s employment. Nonfarm employment declined again in October after a somewhat bigger drop in September, softening the region’s year-over-year job growth rate to about half of the nation’s as a whole. But Massachusetts accounted for more than the recent net losses, with job gains in all of the other states acting to offset drops in the Bay State. Other indicators of state health show similar patterns. In particular, the Philadelphia Fed’s coincident index shows growth in Massachusetts flattening while growth in the other five states is accelerating. A question one could ask, and one that I’ve been asking myself, is whether employment data and indices derived largely from measures of job growth correctly provide the best sense of the overall climate of a regional economy—and in the case of Massachusetts, a state economy—that is driven increasingly by high value-added industries whose employment patterns reflect cycles of innovation more than traditional business cycles. Contacts in the high-tech, biotech, and software worlds all indicate that business is solid and that money to expand is freely available. Depending on the product, growth is either occurring or in the works, but often the related hiring is planned for lower-cost states outside New England or other countries. These businesses want their headquarters to remain in New England. They want to strengthen their links to the research being done in the December 13, 2005 39 of 100 hard to find and increasingly expensive. But when they expand more broadly, they are choosing to expand elsewhere. Thus, there are areas of strength and weakness in some of the regional data. The states of the region seem to be doing pretty well fiscally, and that reflects the profitability of many of these high- tech types of businesses. But businesses that thrive on growing job counts, like commercial office markets, seem quite slow. And personal income tax collections are lagging a bit, at least relative to what the states have projected in their budgets. Somewhat surprisingly, consumer confidence has ticked up a bit despite the flat job picture, and residential real estate markets still seem strong, though the high end has lost a bit of steam. Travel and tourism has its tos and fros. The fall wasn’t particularly good for leaf peeping, but the winter looks not bad because there has been some early snowfall for skiing. The region is going to bear the brunt of high energy costs this winter, given its dependence on heating oil and expensive natural gas for electricity generation. That probably is the reason why overall business confidence has softened a bit. In my expectation, the region may well continue to lag the nation in job growth, but should prove resilient through the winter months. I think the mix of its industries is not only providing resilience to the region but also an ongoing impetus to the productivity growth we see for the nation as a whole. Incoming data since the last Committee meeting were on the high side of our expectations and provided welcome assurance that at least for the time being the energy shock, hurricane destruction, and slight softening in housing markets did little to impede the underlying forward momentum of the national economy. And the recent robust data on productivity growth provide even more assurance that this pace of underlying momentum is occurring at a time when there may be more rather than less December 13, 2005 40 of 100 Greenbook projection, which is certainly in the realm of the possible, available capacity could be even greater. Our forecast is perhaps not quite as optimistic as the Greenbook’s, but it does see the same two rather distinct economic phases over the forecast horizon. In the near term, after a bit of a dip in the fourth quarter, which may not be much of a dip at this point, growth accelerates as hurricane rebuilding proceeds, federal spending increases, energy price growth rates flatten, and inventories are rebuilt. Then by mid-2006, the economy slows, as tighter monetary policy puts a crimp in real estate markets, the personal saving rate ticks up, as we hope it does, and the fiscal impulse wanes. During the near term, inflation pressures are expected to be more significant, with some pass-through of high energy costs to core inflation. Over the medium term, these pressures ease. It’s certainly possible for surprises on either side of this baseline. That is, we could see inflation around longer than we now expect or, on the opposite side, we could see demand falter, with consumer retrenchment in the face of slower hiring. I continue to believe that managing the risks of rising prices reduces the potential cost of mistakes, and that suggests some further tightening. But how long that will be necessary, in my view anyway, is uncertain." FOMC20060808meeting--81 79,MR. KROSZNER.," Thank you very much. As the comments indicate, this is probably the most challenging time that we have had before us in my long history here at the FOMC. [Laughter] The mix of continuing inflation pressures and decelerating growth are providing more concerns on both fronts than I have heard around the table and than I myself have had since I’ve been here. First let’s think about some of the growth prospects. I broadly share the Vice Chairman’s view that the fundamentals are in place for reasonable growth going forward. Certainly there are some risks. But whether we are looking at survey-based measures, at orders and shipments, or at a variety of different things, we don’t really see signs of very significant deceleration or contraction. We see more a moderation that would be either in line with the Greenbook or a bit lower than the Greenbook. Certainly a key risk to growth that a lot of people have discussed is residential investment. If you look at where we are in residential investment, we’re back only to mid-2003; 2004 and 2005 were incredibly strong years. So being in 2003 is not that bad. If you look at the graph, residential investment falls off rather precipitously to get us back to 2003 with great rapidity. The question I have is whether it will flatten out or whether it will go down further. The Greenbook forecasts have gradually been moving down and now reflect more downward pressure going forward. I think that we’re not seeing the full effects on house prices reflected in the numbers because in the housing market, for reasons I don’t think we fully understand, there tend to be queuing rather than just price changes. So it may take a while for the price data to actually reflect the lower effective prices that people are seeing. Obviously house prices will have a potentially important effect on the wealth effect and on consumption down the line, which I think the Greenbook does a good job of putting into place. Another challenge is elevated prices for energy and commodities. Energy prices, particularly, may be taking a little bite out of people’s disposable income. On the other hand, we have been seeing continued strong business fixed investment. A small concern I have is, if we continue to hear about slowing consumption and reports from Wal-Mart and others that retailing is really slowing, why are these businesses producing? Are they investing to produce goods that people will want to buy, or will we see in nine months or a year that maybe some misallocation of resources has occurred and that things aren’t as strong as we had thought? There’s no particular sign of such misallocation of investment. It just seems that there is a bit of tension between the discussions of continued strength of capital expenditures and the statements of business contacts that they are going to continue to invest even though they see a slowing coming down the line. This is a variation of what Governor Warsh was saying—it’s almost as though they are saying that some other sector will have that slowing, not their sector. In some sense, we should take very cold comfort from the fact that the economy may be slowing. We had quite a discussion about how there’s not much of an inflation–output tradeoff, but at least in this period there are real questions of whether you do get much benefit in terms of lower inflation from slower growth. There may be some benefit, but it seems to be attenuated compared with the past. Obviously some of the recent numbers on inflation continue to be worrisome, but fortunately both the survey measures and the market-based measures seem to be reasonably contained looking forward. Survey measures, whether of the man in the street or of the professional forecaster, seem to be quite flat. The TIPS rates for both the near-term forwards and the longer-term forwards have not moved up much. Some of the near-term forwards have moved up a bit, but that doesn’t seem surprising given the rise in energy prices that we have seen both from the Middle East and from issues in Alaska. The real key is looking forward as to what is likely to occur. Are the things we’re seeing now transitory factors or persistent factors? That’s a very, very difficult call. Reasonable arguments have been made that a number of these factors, particularly with respect to shelter services, are perhaps a bit more short-lived. Shelter services are about 19 percent of core PCE and about 30 percent of core CPI, and obviously they have been leading the band up. As many people have said, we have been seeing price increases in a lot of areas, but I don’t put quite as much stock in that because many of the categories in both the PCE and the CPI are arbitrary. The issue is really what the relative size and the relative importance are. Shelter services and owners’ equivalent rent, which composes a vast majority of shelter services, are an important piece. I think that there’s a reasonable chance that this factor is likely to be transitory, although it may last for several months and possibly quarters. But that is the key question—whether these forces are likely to be transitory or likely to be more persistent. Coming back to inflation expectations, that’s really where I see the markets both registering their view of persistence and telling us something about whether they believe that we will keep inflation well contained. At least so far, those expectations are suggesting that we will. It’s extremely important that we maintain those expectations. It’s very costly to try to regain credibility if credibility is lost. I think the markets are willing to say, “Well, there may be some transitory inflation, and we’re willing to wait and see whether to mark up our longer-term expectations.” Certainly once longer-term expectations are marked up, the situation becomes highly problematic because it’s very difficult to rein in the changes in expectations, particularly in behavior. So basically I think we need to keep a very, very watchful eye on where expectations are going. I’m heartened that they haven’t moved too far despite, as many people have said, high core PCE prices for a number of years and elevated levels in the most recent numbers. Thank you, Mr. Chairman." FOMC20080625meeting--99 97,CHAIRMAN BERNANKE.," Thank you, and thank you all. First, on the long-term projections, I think there's consensus that we should just go ahead and have a trial run. The staff should review the transcript and make gold out of straw there. We should consult with the subcommittee, and we should think about maybe even a couple of alternatives. Maybe we could try a couple of alternative ways of doing it in October. So let's go ahead and do something along those lines and keep thinking about how best to do it. Let me first, as I usually do, try to summarize the discussion around the table, and I'll add some comments of my own. Beginning with the summary, the incoming data were stronger than expected, notably for consumer spending but for some other components as well. As a result, economic growth in the second quarter, though not robust, was likely positive, continuing the pattern of weak but positive growth since the fourth quarter of 2007. However, to the extent that strength in consumption was transitory or due primarily to fiscal stimulus, some of the growth in the second quarter may have been borrowed from the second half. Participants generally saw growth continuing at a slow pace the rest of the year and improving in 2009. There was, however, some divergence of views, with some expecting a longer period of slow growth. Recent numbers on retail sales suggest that the consumer is holding up better than expected. Consumer finances may be better than feared, and the fiscal stimulus may already be having an effect. However, as many have noted, there are substantial drags on consumption going forward, including falling wealth and income, credit constraints, and the recent rise in energy prices. Sentiment has also fallen noticeably further. Weaker consumption may, thus, restrain growth later this year, particularly after the effect of the stimulus wanes. Labor markets continue to soften but at a relatively moderate pace. The peak in unemployment is projected to be between 5� percent and 6 percent. That's what I generally heard around the table. Prospects for housing continue weak, with falling prices, high inventories, and weak demand. Some saw a possible bottom forming but noted that the recovery of this sector is still some way off. As has been the case for a while, businesses are quite cautious, noting economic uncertainties and surging input costs, with one or two mentions of tighter credit, although that was not a dominant theme today. Real exports continue to grow and are partially offsetting weaker domestic demand, especially in the case of manufacturing. Financial conditions have been mixed since the last meeting, although the improvements from March have largely been maintained and the risk of systemic crisis may have receded to some degree. Funding markets are generally doing better. The concerns about credit losses have led the stock prices of banks, including regional banks and investment banks, to fall sharply. Capital raising continues, though at less favorable terms and with perhaps declining availability. As the economy continues weak and housing contracts further, more credit losses for banks may well be in store, adding to financial market stress and reducing the availability of new credit. Progress in the financial markets is likely to be slow as the deleveraging process will take a while. Stock prices in general are also lower. Financial conditions in the housing market remain important downside risks to growth, with the spurt in oil prices adding to those risks. Uncertainties about the growth prospects are great. However, tail risks may have moderated somewhat. Readings on core inflation have remained relatively moderate. However, the sharp rise in oil prices and some other commodity prices, in part reflecting flooding in the Midwest, is likely to lead to very high levels of headline inflation over the next few months. Gas and food prices have become perhaps the most important economic issue for consumers, and firms are feeling everincreasing cost pressures. Moreover, inflation pressures are global. There are increasing reports of firms being able to pass through these costs, which could lead to an increase in core inflation. On the other hand, slack may restrain core inflation increases. Measures of longer-term inflation expectations have been up a bit on net since April, depending to some extent on the measure chosen. Nominal wage growth is still slowing. Participants debated how much comfort to take from slow wage growth, some arguing that, by the time wages reflected higher inflation expectations, it would be too late. Most saw inflation risks as now to the upside, with the primary concern being the possibility that inflation expectations could rise further as headline inflation rises and more costs are passed through. That's my very, very quick summary. If anyone has any comments, I'd be happy to hear them. If not, let me just say a couple of words on my own views here. This may come as a surprise to some of you, but I am not a fine-tuner. I think that the objective of the Federal Reserve ought to be to avoid a very bad outcome, and so my concerns are primarily with tail risks on both sides of our mandate. I think that the evidence of the last month or so provides a bit of reassurance, on both the real side and the financial side, that the tail risks on the growth side of the mandate have moderated somewhat. That being said, I think they remain and are still significant. In particular, as I mentioned in the summary, I am at this point still suspicious of the strength that we saw in the second quarter. If we look at the fundamentals for consumption--including wealth, income, employment, and energy prices--and look at the plunge in sentiment, which is at remarkably low levels, I think there's a very good chance that consumers will weaken going forward and bring the rest of the economy along with them. In addition, of course, housing remains extremely uncertain. We are at best some distance from stabilization in that market. Even when residential construction begins to stabilize, we'll still see continuing declines in house prices, which will affect consumer spending and, importantly, will affect financial markets as well as the value of mortgages. With respect to financial markets, I agree certainly that the crisis atmosphere that we saw in March has receded markedly, but I do not yet rule out the possibility of a systemic event. We saw in the intermeeting period that we have considerable concerns about Lehman Brothers, for example. We watched with some concern the consummation of the Bank of America�Countrywide merger. We worried about a bank in the Midwest. Other regional banks are under various kinds of stress. We're seeing problems with the financial guarantors, with the mortgage insurers. So I think that those kinds of risk are still there, and we need to be very careful in observing them. Moreover, even if systemic risks have faded, we still have the eye-of-the-storm phenomenon--we may now be between the period of the write-downs of the subprime loans and the period in which the credit loss associated with the slowdown in the economy begins to hit in a big way and we see severe problems at banks, particularly contractions in credit extension. So I'm not yet persuaded that the tail risks are gone. I think it would be very valuable to have some more data, some more observations, to see how the financial markets and the economy are proceeding. But I want to say that I do agree that the developments in financial markets and the surprisingly strong data in the second quarter should lead us to feel somewhat better. I think we should take a little credit for our various efforts to support both the financial system and the economy. Now, what about tail risks on the other side--on inflation? The increase in oil prices that we've seen in the past six weeks is obviously very, very bad news. I think that the combination of the commodity price increases and what we're going to see as very ugly headline inflation numbers is beginning to generate a tail risk on that side of the mandate as well, and I am becoming concerned about that. Indeed, I think that it's now appropriate that we begin, as some of us already have, to move rhetorically toward acknowledging that risk and agreeing that it may be at the point where it even exceeds the risk that we see on the growth side, although I think we're very uncertain about that. Now, the concern I have is the following, which is that there has been a lot of talk about policy action. I don't think that a 25 basis point or even a 50 basis point move, if it's not viewed as being the start of a continued increase, is going to do very much on the inflation side, frankly. We had a good test of that over the intermeeting period. Partly because of our rhetoric and for other reasons, the dollar strengthened. The two-year rate rose 50 or 60 basis points, and oil prices went up $25. I do not think that with a small change in our stance we can do anything about commodity prices, and frankly, it's commodity prices that you're hearing about from your Board members and from people you talk to. It's the real change in the relative price of those commodities that is painful and the real change in the terms of trade coming through the dollar which is painful, and I don't think we can do very much about those in the short term. Our objective, of course, as everyone has noted, is to prevent that from becoming a sustained and persistent source of inflation. So the problem then is that a small amount of movement will not solve the problem. A small to moderate movement, however, might create some serious financial strains given the fragility of the system. I think what we need to do is to decide when we reach that tipping point. There will be a tipping point at which we're sufficiently confident that the system is stabilizing and that we can begin to turn in a serious way to the inflation concern. A partial one step, unless it signals a longer-term tightening program, could give us the worst of both worlds. We will just have to make the judgment about when we have reached the point of having to switch from our previous approach of supporting the economy and financial system to an approach that is aimed more at containing inflation. It's going to be a very difficult and delicate situation, but I want to express again my agreement with those of you who are worried about inflation and my belief that the time might be relatively soon. But it's going to be a very, very delicate decision and one that we have to make with great concern and consideration. A little anticlimactically, I would like to say just a couple of words about the 1970s because they keep coming up and I do think that these comparisons are a bit misleading. First, in the current episode, commodity prices--particularly oil prices--are basically most or almost all the inflation that we're seeing. That was not the case in the '70s. In particular, inflation rose considerably before the first oil price shock in 1973. PCE inflation was 5 percent in 1970, which prompted the wage� price controls, of course, which is an episode we're all familiar with; and in 1972, before the oil shock, average hourly earnings were growing between 7 and 8 percent. There was already a serious inflation problem before the oil price shocks came. Hence, credibility was already damaged at the time of the oil price shocks. That is not the case here. Second, the movement in wages and core inflation following the oil price shocks in the 1970s was very striking. From the time of the oil price shock right before the second quarter of 1973 until the first quarter of 1975, total inflation rose a little over 5 percentage points, reflecting the quadrupling of oil prices. During the same period, core inflation rose more than 6 percentage points. In other words, core inflation responded almost one for one to total inflation. Moreover, average hourly earnings rose more than 2 percentage points, and productivity and cost compensation rose 3� percentage points in that year and a half. So there was a very strong sensitivity of expectations and pass-through to these commodity price shocks. Obviously, we've been seeing oil price increases since 2003, and they have not yet shown anything like that effect on core inflation or on wages. The final observation I'd make about the 1970s is that we shouldn't forget that, even in that very bad situation with very poorly anchored inflation expectations, the slowing of the economy did do something to reduce inflation. In particular, core inflation fell 3� percentage points during 1975 following the 1973�75 recession. So while we cannot do much about oil prices, I do think that there is some hope that weakness in the economy is going to provide some restraint on core inflation, which of course will generate a more stable total inflation rate if and when commodity prices stabilize. So I've been very all over the map here. I apologize. I tried to organize my thoughts in the meeting. My bottom line is that I think the tail risks on the growth and financial side have moderated. I do think, however, that they remain significant. We cannot ignore them. I'm also becoming concerned about the inflation side, and I think our rhetoric, our statement, and our body language at this point need to reflect that concern. We need to begin to prepare ourselves to respond through policy to the inflation risk; but we need to pick our moment, and we cannot be halfhearted. When the time comes, we need to make that decision and move that way because a halfhearted approach is going to give us the worst of both worlds. It's going to give us financial stress without any benefits on inflation. So we have a very difficult problem here, and we are going to have to work together cooperatively to achieve what we want to achieve. The last thing I'd like to say is on communications. Just talking about communications following this meeting, I'd like to advise everyone, including myself, to lean, not to lurch. That is, we are moving toward more concern about inflation, but we still have concerns about economic growth and financial markets. We should show that shift in emphasis as we talk to the public, but we should not give the impression that inflation is the entire story or that we have somehow decided that growth and financial problems are behind us, because they are not. So if we can convey that in a sufficiently subtle way, I think we will prepare the markets for the ultimate movements that we're going to have to make. Again, I very much appreciate your insights and your attention today. We have a dinner at 7:30, and for that reason I think we should probably bring this to a close. We'll start tomorrow morning with Brian's presentation of the policy options. The statement is essentially the same as the Bluebook's. There won't be any surprises there. So we'll begin with that first thing in the morning. Thank you. [Meeting recessed] June 25, 2008--Morning Session " FOMC20080805meeting--144 142,MR. MADIGAN.," 2 Thank you, Mr. Chairman. If you prefer, in the interest of time, I can cut back my remarks to focus just on the policy statement and not the general background. I will be referring to the version of table 1 included in the package labeled ""Material for FOMC Briefing on Monetary Policy Alternatives."" This version incorporates some small revisions from the draft that was included in the August Bluebook. The table presents two policy alternatives. Under alternative B, the Committee would maintain its current policy stance at this meeting but in its statement would underscore its concerns about inflation. Under alternative C, the Committee would firm policy 25 basis points today and issue a statement indicating that the action was taken to better balance the risks to growth and inflation; the statement would be noncommittal about whether further rate increases were imminent. The language proposed for paragraph 2 of alternative B has been modified a little from that proposed in the Bluebook. Most important, the first clause is now in the past tense, referring to economic growth in the second quarter, thus avoiding an implication that the economy is continuing to expand in the current quarter. In a change relative to the June statement, exports as well as consumer spending are cited as factors that supported growth. Also, the sentence beginning with ""over time"" has been moved up from the risk assessment paragraph. That shift is likely to be seen as underscoring a view that policy is currently positioned to foster a gradual resumption of moderate economic growth, suggesting that further easing is not likely to be forthcoming. That sense may also be reinforced by the omission of the phrase ""to date"" after ""easing of monetary policy."" In paragraph 3, the inflation discussion for alternative B gives slightly greater emphasis than in June to the Committee's inflation 2 The materials used by Mr. Madigan are appended to this transcript (appendix 2). concerns, partly by starting with the flat statement that ""inflation has been high"" and by giving less prominence to the expectation that inflation will moderate. The slight change to the final clause in paragraph 3 is proposed for purely stylistic reasons. In paragraph 4, the first sentence of the risk assessment states that ""although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee."" While this sentence does not provide any explicit weighting of the two risks and does not suggest that policy firming is imminent, the statement as a whole probably would be read as giving a bit more emphasis to inflation concerns and a bit less to growth concerns than market participants now expect. Thus, even though the absence of a rate action today would be consistent with market expectations, the statement would likely be viewed by market participants as a bit more hawkish than they anticipated, and market rates could rise modestly in response. Turning to alternative C, concerns about upside risks to inflation could motivate the Committee to begin firming the stance of monetary policy at this meeting. The first three sentences of alternative C, paragraph 2, are identical to those of alternative B. However, the final sentence differs, partly by indicating explicitly that the Committee sees the current stance of monetary policy as accommodative. Also, by dropping the phrase ""over time,"" which appeared in paragraph 4 of the June version, the Committee would suggest that it sees moderate economic growth as resuming sooner rather than later. In paragraph 3, the Committee would still note that inflation is expected to moderate but, in the last sentence of the paragraph, it would explicitly cite the risk--and note its concern--that inflation might not fall as expected. Finally, the risk assessment, paragraph 4, would indicate that the Committee firmed policy today in order to better balance the upside risks to inflation and the downside risks to growth. However, the statement would avoid an explicit judgment about whether the risks were now balanced and would provide little information about whether further tightening was imminent. Even though the wording of the statement for alternative C would not indicate that policy was now on a steady firming march, market participants would likely conclude that the firming process had been accelerated considerably relative to their expectations. With the Committee having tightened amid bad news about financial institutions and in the immediate wake of the implementation of a number of additional Federal Reserve liquidity initiatives, investors would likely conclude that the Committee did not see financial stability considerations as raising a barrier to further policy tightening. They would view the Committee as adopting a more aggressive posture toward inflation. Because it has been historically rare for the Federal Reserve to implement a one-off tightening, investors would likely see fairly steady rate hikes over the course of future meetings, and thus short- and intermediateterm interest rates would, in all likelihood, move up sharply after this action. Yields on longer-term fixed-rate mortgages might rise particularly substantially, as premiums for interest rate and prepayment uncertainty increased and as mortgage investors hedged the increase in mortgage durations. Such a development could adversely affect the prices of financial assets that are closely tied to housing markets and mortgage performance. However, yields on long-term Treasuries could decline, particularly if market participants marked down their expectations for economic growth and inflation. " CHRG-110shrg50416--9 STATEMENT OF SENATOR CHARLES E. SCHUMER Senator Schumer. Thank you, Chairman Dodd, for holding this important hearing to focus on the financial crisis and the administration's response. As we made clear in our negotiations with the administration over the Emergency Economic Stabilization Act, congressional oversight is essential in order to make sure the taxpayers' money is being used well and wisely, and these hearings are a vital and important element of that oversight, and I salute you for having them in a timely way. The unfortunate truth is that the financial crisis we are facing today is not the result of an act of God or a natural disaster, some completely unforeseeable set of entirely unpredictable circumstances. It is the product of two completely avoidable failures: the failure of regulatory agencies to do their job and properly oversee the industries and firms under their purview, and the failure of banks, mortgage brokers, rating agencies, and other financial institutions to appropriately measure risk and to act accordingly. The collapse of the housing bubble, which is at the root of all of this, as Senator Dodd has mentioned, was not the shock that many people want to make it out to be. There was plenty of evidence we were in the midst of a bubble and plenty of warning from a lot of smart people that it was going to pop sooner or later. But what it comes down to is that too many people were making too much money too easily and too quickly. Mortgage and financial firms started to behave like spoiled teenagers whose parents were on vacation. Once the party started, they didn't want it to end. And if they trashed the house in the process, well, maybe the maid would come and clean it up tomorrow. And they were right about one part of it. Their parents weren't home, because with the exception of Chairwoman Bair, who has been the adult voice in all of this, the regulators who should have put a stop to all of this nonsense before it got out of hand were nowhere to be found. This was not an accident. The problem at its root was the lack of regulation. Certainly the Government can overregulate and snuff out all entrepreneurial vigor for which this country is known. But that was not the problem of this administration. The explicit policy of this administration for the last 8 years has been the view ``Deregulate, deregulate, deregulate.'' The administration even appointed an SEC Commissioner and tried to elevate him to Chairman of the FTC who wanted to repeal New Deal regulations. And when that is not possible, the administration tries not to enforce the regulations that are on the books all too often. We need thoughtful, smart, tough, and more unified regulation, which I know under Chairman Dodd and Senator Shelby's leadership we will endeavor to put in place early next year. Now, of course, we know who is stuck with the cleaning bill for this mess: the American taxpayers. If each of us was left to our own devices, each of us would have designed a different rescue plan. Unfortunately, when left with the choice between acting on this package or doing nothing, there wasn't really a choice at all. We had to act. And Secretary Paulson, Chairman Bernanke, and Chairwoman Bair all deserve credit for not letting the ideology of do nothing, complete laissez-faire, get in the way of working to bring us back from the brink of absolute disaster. But that does not mean my colleagues and I are happy about what we have had to do, nor does it mean we do not have serious questions remaining about how we are proceeding. I applaud Secretary Paulson for recognizing, despite his initial opposition, that the best approach to this crisis is the direct injection of capital into banks. I have argued from the very beginning that this is clearly the most effective way to support the banks and the financial system more generally. The history of our own Depression Era agency, the RFC, as well as experiences of both Japan and Sweden in the past decades have shown that, when done properly, capital infusions provide the best bang for the buck. But doing it properly is the key, and I continue to have a number of serious questions about how this program is being implemented. I remain especially concerned that in the Treasury's zeal to make the capital injection program easily digestible for the banks, we are feeding them a little too much dessert and not making them eat enough of their vegetables. Though you and I have spoken about this, Mr. Kashkari--and I very much appreciate your position and your rising to take this job at this crucial time--I am still not convinced that it makes much sense for banks that accept capital from the Government to continue paying dividends on their common stock. There are far better uses of taxpayer dollars than continuing the dividend payments to shareholders. And the program will only be effective if it is put to good use. With that in mind, I, along with my colleagues Senator Jack Reed and Senator Menendez, have been urging the Treasury Department to issue guidelines--not hard rules, not legal regulations, but standards that will help guide institutions' behavior now that taxpayer money has been invested. First and foremost, I believe there should be guidelines on the use of this capital. I would like the Treasury to set out goals, perhaps based upon an institution's previous lending history, for the amount of lending that each institution that receives capital injection should be doing. This will help prevent institutions from hoarding Government capital against future losses and get the money quickly out to Main Street, which has been our stated goal all along. On the flip side of that coin, I think Treasury and the financial regulators should issue guidance to discourage institutions from using this funding to engage in the kinds of risky and exotic financial activities that got us into this mess. We are not investing in these institutions just to see the financial wizards go back to playing their high stakes game, this time with some taxpayer money. Third, and finally, stronger standards of care for loan modifications are needed. Chairman Bair has led the charge on this front, and the rest of the regulators and Treasury should follow her lead. There should be a requirement that any institution receiving assistance under the TARP should have to adopt a systematic and streamlined approach to loan modifications, modeled on the approach that the FDIC has utilized in institutions that it controls. Declining home prices are the root cause of this economic crisis, and avoiding foreclosures through loan modifications is perhaps the single greatest step we can take to alleviate the current situation. Finally, last but not least, I would like to see stronger guidance issued to companies with regard to executive compensation. Even under the rules issued by Treasury, in some cases a great deal of discretion is left in the hands of the compensation committees of each institution. The Treasury Department should provide clarification and oversight for the implementation of its own rules and also begin the process of determining compensation best practices on a broader scale. Thank you, Mr. Chairman. " fcic_final_report_full--414 After falling  from their peak in  to the spring of , home prices have rebounded somewhat, but improvements are uneven across regions.  Nationwide, . million households, or . of those with mortgages, owe more on their mort- gages than the market value of their house (see figure .). In Nevada,  of homes with mortgages are under water, the highest rate in the country; in California, the rate is .  Given the extraordinary prevalence and extent of negative equity, the phenomenon of “strategic defaults” has also been on the rise: homeowners purposefully walk away from mortgage obligations when they perceive that their homes are worth less than what they owe and they believe that the value will not be going up anytime soon. By the fall of , three states particularly hard hit by foreclosures—California, Florida, and Nevada—reported some recent improvement in the initiation of foreclo- sures, but in November Nevada’s rate was still five times higher than the national av- erage. Foreclosure starts climbed in  states from their levels a year earlier, with the largest increases in Washington State (which has . unemployment), Indiana (. unemployment), and South Carolina (. unemployment), according to the Mortgage Bankers Association. In Ohio, the city of Cleveland and surrounding Cuyahoga County are bulldozing blocks of abandoned houses down to the dirt with the aim of creating a northeastern Ohio “bank” of land preserved for the future. To do this, authorities seize blighted properties for unpaid taxes, and they take donations of homes from the Department of Housing and Urban Development, Fannie Mae, and some private lenders.  Now, the county finds itself under increasing duress, having endured , foreclosures in .  After years of high unemployment and a fragile economy, the financial crisis took vulnerable residents and “shoved them over the edge of the cliff,” Jim Rokakis, Cuyahoga’s treasurer, told the Commission.  In a spring  survey,  of the responding mayors ranked the prevalence of nonprime or subprime mortgages as either first or second on a list of factors causing foreclosures in their cities. Almost all the mayors, , said they expected the fore- closure problems to stay the same or worsen in their cities over the next year.  “There has been no meaningful decline in the inventory of distressed properties found in the housing market,” Guy Cecala, the chief executive and publisher of Inside Mortgage Finance Publications, told a congressional panel overseeing the Troubled Asset Relief Program in October . “It is hard to talk about any recovery of the housing market when the share of distressed property transactions remains close to  percent.”  “Underwater” Mortgages FOMC20070628meeting--183 181,MR. LOCKHART.," Thank you, Mr. Chairman. I, too, favor alternative B and the current policy stance. My interpretation of the discussion around the table yesterday is that we see encouraging signs that the current policy appears to be producing the desired directional effects at least, or intermediate effects, so it seems to be working. There is still a fair degree of uncertainty, and based upon my long experience, I think it is a normal amount of uncertainty. So the current policy deserves being held. Regarding the policy statement, I favor the wording in revised alternative B that was distributed by Vince yesterday afternoon because I think it captures the key points— the ones that are important to me at least—and they are moderate growth prospects, mention of the housing sector, better inflation readings and prospects of continued moderation (though it is still too early to draw definitive conclusions), continued inflation pressures, and a continued weighting to inflation risks with no suggestion that the current levels around 2 percent are acceptable for the long term. So for that set of reasons, I favor the wording as presented." FOMC20050202meeting--154 152,MR. KOHN.," Thank you, Mr. Chairman. My forecast for economic activity in 2005 and 2006, like the rest of yours, was for growth a little faster than the trend rate of growth in potential. That reflects my judgment that the forces that had been holding back the economy in recent years have largely dissipated, allowing the effect of relatively stimulative financial conditions to continue to show through and raising the level of production relative to potential. My projection for growth in 2005 and 2006 is in line with the rate of growth in 2004. Yet energy prices, whose rise must have damped growth to some degree in 2004, are expected to be flat or somewhat lower. In addition, financial conditions have eased since the middle of the year, with bond rates and the exchange rate lower and stock prices a little higher. So, as I thought about my projection, the logical question seemed to be whether we were on the verge of a much stronger pace of economic growth. Although that’s a possibility, I see several factors that should keep growth to a moderate pace. Monetary policy and fiscal policy are at the top of the list. On the fiscal side, the partial-expensing provisions probably brought forward some capital expenditures from 2005 to 2004. For monetary policy, I assumed a continued gradual withdrawal of monetary stimulus along the lines built into the staff’s forecast or the market’s. That should lead to rising real intermediate- February 1-2, 2005 106 of 177 investment spending directly, take something off the increase in house and equity prices—holding down gains in wealth—and support the dollar. Of course, that hasn’t been the experience over the last six months or so, as President Lacker just pointed out. But longer-term real rates have fallen to such a low level that I find it difficult to believe they won’t rise from here, provided moderate growth is sustained. Indeed, I see an important downside risk to the forecast from the possibility of a sizable jump in longer-term real interest rates, which could have a pretty serious effect on house prices and consumption if it results from an unwinding of special factors or from a revision of unreasonably low expectations rather than from an unexpectedly faster pace of economic activity. Until those rates ratchet higher, however, their low level, along with the basically sideways movement of equity prices since late last year, would seem to suggest that caution among savers and spenders has not dissipated entirely. At the very least, the behavior of bond yields and stock prices seems inconsistent to me with a new more ebullient attitude that would presage boom-like conditions. In addition, the behavior of the trade deficit is likely to be damping the growth of demand on U.S. resources for a while. The staff forecast, which has net exports making a modest net negative contribution on average over the next two years, is itself premised on a pickup in foreign demand—a pickup we don’t yet see in the data. This suggests to me another source of downside risk. Over the long haul, as people become more reluctant to send us growing proportions of their savings, the deficit will have to fall. That will put considerable pressure on productive capacity in the United States, but it’s not at all clear when that will begin to happen. Finally, in making my forecast of real growth, I took account of my serial forecast errors. I’ve been overpredicting growth since I got on the Committee, so I used a sophisticated algorithm to compensate for this propensity: I decided what I really wanted to forecast and I took a little off! February 1-2, 2005 107 of 177 My projection for core PCE inflation for 2005 and 2006 that goes with this path of output is slightly higher than the staff forecast. I gave some weight to the market-based core PCE numbers, which have been running higher than the total core PCE, but that forecast remains below 2 percent, and it is stable at that level. For inflation, the question I wrestled with was: Why not further increases this year after the acceleration of 2004? In that regard, the recent data from the last part of 2004 have been supportive, I think, of a stable inflation forecast. With these data, every broad index of core inflation—from GDP prices to the CPI to PCE—grew less rapidly in the second half of last year than in the first— and significantly less rapidly, by at least ½ percentage point. This pattern is not consistent with accelerating prices. It reinforces the hypothesis that a good portion of the pickup in core inflation in the first half of 2004 was attributable to special factors: a reversal of the unexplainable undershoot in inflation in 2003 and the pass-through of higher energy, commodity, and other import prices from late 2003 and early 2004. At least in terms of energy prices—not imports, which are a big question mark—I think these upward pressures should not be a factor in 2005. In labor markets, increases in measures of compensation also slowed from the first half of the year to the second. Now, this is particularly noteworthy in that one might have expected the previous run-up in energy prices and the strength in productivity increases in recent years to put upward pressure on compensation gains. As a consequence, I think I’m a little less concerned than some others of you that slack has already been absorbed. I can only explain the recent pace of compensation data if appreciable slack is persisting in labor markets to balance these other upside pressures. In this environment, continued intense competitive conditions are likely to limit labor cost increases and the ability or willingness of firms to pass through shorter-term increases in unit labor costs into prices and thus risk market share. Finally, inflation came in lower in the second half of 2004 than I had expected. My projection was at the low end of our collective central tendency, so most of you were a little higher February 1-2, 2005 108 of 177 decline in the unemployment rate. But energy and import prices rose more than I had anticipated. Consequently, I also wondered whether at midyear I had given enough weight to the factors restraining inflation—slack, elevated markups, and stable inflation expectations. To be sure, slack should be diminishing, businesses will try to resist any squeeze on markups, and the economy may be closer to potential than it appears right now. If the dollar declines substantially, import prices will increase, reducing foreign competitive pressure. Or if trend productivity slows more than projected, firms could be more insistent and more successful in passing through costs than is consistent with keeping inflation in check. Still, for now, I think low, stable inflation is the most likely outcome for the next few years, provided policy continues gradually to firm, as slack slowly diminishes and output grows at a moderate pace. As for the balance of risks, I’ve always thought that that phrase applies primarily, or first and foremost, to the most likely path for inflation and output relative to our objectives at the assumed path for policy. And, in that context, the risks still seem to me to be balanced. The fact that I found myself asking these particular questions about the outlook suggests, perhaps, a slight skew to the distribution around these modal outcomes. But I think we should await further developments to assess whether those skews will become large enough to influence the central tendencies, the balance of risks, and the path on which we remove policy accommodation, or whether, as the market and the staff expect, we actually will need to slow the pace of tightening in the future. Thank you, Mr. Chairman." FOMC20050202meeting--164 162,MS. BIES.," Thank you, Mr. Chairman. To me, the forecasts presented in the Greenbook and the consensus forecast of those from the private sector paint a sound economic picture for 2005— February 1-2, 2005 118 of 177 I’m comfortable that the removal of policy accommodation at a measured pace that we’ve announced and have been implementing is supportive of this growth going forward. As some of you have mentioned, given such a good forecast, the question that arises is: What should we be worrying about in this picture? I’d like to mention two concerns that I’ve been focusing on lately. The first is the risk around inflation. This is not a huge risk, but when I look at the Greenbook projection compared to various private-sector forecasts, the Greenbook’s inflation forecast is at the lower end of the range of the Blue Chip forecasts. Hopefully, the Greenbook will be the right forecast on this, but the inflation numbers have shown a lot of volatility in the last two years. So in light of the recent volatility, even in the core measures of inflation, I think it’s important that we look carefully at incoming data every month and keep on top of what is happening to try to get a better understanding. The second concern has also been mentioned by a couple of you around the table, and that is the mystery of why long-term interest rates aren’t any higher than they are. My personal forecast a year ago would never have had long-term interest rates at the levels at which they’ve been sitting. If I look at various aspects of this, in trying to understand it, I can explain some things. For example, we know that corporations have been seeing record profit margins and, as a result, have been generating tremendous cash flow. That means that corporations have been able to fund a large part of their investment in inventory buildup through internal funds, as opposed to going to banks or to the markets. We also have seen fewer accounting scandals, which generated a lot of the uncertainty that widened credit spreads in 2002. Those spreads have really come back down again as we’ve had relatively fewer shocks to market confidence. We’ve also seen rating agencies worldwide reduce the number of downgrades relative to upgrades; so that has turned around, which is another good sign. And as Governor Olson mentioned, the bankers are very positive about current credit quality. But I would say again that we should recognize that we are probably at the sweet spot in that credit February 1-2, 2005 119 of 177 On the other hand, consumers have been borrowing like crazy, and they’ve been borrowing at the long end of the curve. In large part, this is a reflection of the fact that interest rates are historically low, and people are being very rational by locking in at long-term rates and borrowing all that they can. On net, though, we’ve seen that there’s been plenty of liquidity in the long market. So what could happen here if long rates do move up as we go forward? I guess I worry primarily about what that could do in terms of business investment. We know that there may be a narrowing in profit margins. And cash flow has changed to some degree, in that companies are beginning to look more to the outside for credit, especially as merger activity picks up, and that could affect the relative demand for credit from corporations. On the household side, we’re seeing that consumers have used these low rates to support consumption. They’ve done it through equity extractions as they refinance. They’ve also had the benefit of tremendously innovative mortgage products being offered by bankers and other lenders. For tax reasons, people want to borrow as much of their debt against their houses as they can, and lenders have accommodated them by innovations in ARMs [adjustable-rate mortgages] where borrowers can lock in a low rate for a period on the short end of the curve. But lenders have also offered interest-only loans and mortgages with very high loan-to-value ratios to provide more credit that is eligible for tax deductions. If interest rates rise, will consumers begin to slow their use of credit and, if so, what does that mean for consumption in the forecast? This is the issue I really want to focus on because, to me, consumers have been the mainstay of this whole economic cycle. To the extent that there is a wealth effect of housing, this could be a concern if people begin to purchase houses at a slower pace or even if housing construction stays at a high level but doesn’t grow. We’ve seen several private-sector forecasts of flat house prices next year. If suddenly the equity buildup and the net worth of households were to slow, that could have an impact for consumers. When we look at why the saving rate is so low today, we also have to look at the fact that the ratio of net worth to income is at record levels. Consumers have not had to save out of current February 1-2, 2005 120 of 177 income almost entirely to current consumption. But if net worth begins to stabilize and consumers are not able to increase cash flow through refinancings or home equity lines, that could slow the pace of consumer spending and result in less GDP growth than in the Greenbook forecast. Thank you." FOMC20070628meeting--115 113,MS. MINEHAN.," Thank you, Mr. Chairman. The pace of growth in New England, at least as measured by employment, remains below that of the nation. Indeed, since the trough of the last recession, New England’s jobs have grown at less than half the pace of the nation as a whole. Some of this is the traditionally slower pace of job formation in the region, and some is undoubtedly the result of the kind of industries— telecommunications and technology more generally—that were hardest hit in the 2001 recession and have yet to recover fully. But some of it also revolves around issues of supply. Almost every firm, large or small, comments on the difficulty of finding skilled labor. There is also reason to believe that, at least relative to the rest of the nation, the supply versus demand imbalance may be a particular issue in the region. This comes from the Conference Board’s online job-posting measure, which for some time has shown New England as having the highest number of advertised job openings relative to the size of the labor force. Contacts report that they are willing to offer—and do offer— higher pay to get the skills they need, but finding the workers is harder to do and takes longer than earlier in the cycle. Another issue that came up again in our round of contacts is the pervasive rise in the cost of almost any metal, but especially copper and aluminum. Contacts at one very large diversified company speculated about China’s stockpiling valuable metals. Whatever the cause, worldwide demand is strong, and prices are rising for all types of metal inputs. Some firms report progress in passing on those price increases. Indeed, larger manufacturing companies appear to be buoyed, if not driven, by strength in foreign markets. One firm reported that their booming aircraft business required such long hours and continued stress on skilled workers to figure out ways to meet demand that employee turnover had tripled. Not surprisingly, year-over-year manufactured exports for the region rose in the first quarter. Elsewhere, news in the region has been fairly positive, with business confidence rising and commercial real estate markets good and improving throughout. Residential real estate markets remain slow. Regardless of what measure is used, the region’s home prices appear to have slowed more than the nation’s. However, although we had led the nation—this is not something in which you want to lead the nation—in the rate of rising foreclosure initiations, especially for those related to subprime mortgages, the pace of this growth has subsided. Indeed, initiations of subprime foreclosures went down in the region most recently. Moreover, in the most recent data on home sales, the Northeast was a bright spot. I have speculated before that the New England residential real estate market could be bottoming out. Such thoughts may remain in the category more of a hope than a certainty, but perhaps the pace of decline is slowing. Finally, while consumer confidence has been bouncy recently, probably from concerns about gasoline prices, demand seems reasonably strong as gauged by local retailers. Software and IT firms are showing considerable strength, and at least in our region, so is temporary help. Coincident indicators of regional health also show solid growth for all six states. In sum, the region appears to be doing fairly well; and except for residential real estate, there are perhaps growing signs of price and resource pressures, in that regard not unlike the nation as a whole. Turning to the nation, I was pleased to see that incoming data validated the substantial pickup in second-quarter growth that we, along with the Greenbook, had forecasted. Indeed, outside of residential investment, incoming data have depicted an economy that is growing at a relatively healthy pace. Data on shipments and orders of capital goods have improved, consumer demand seems relatively well maintained despite high gas and soft home prices, and payroll data show little sign of dwindling labor demand. Markets have at last decided to adopt the Committee’s more positive outlook on economic prospects, and credit was repriced as a result. I view this event as healthy. It has tempered our GDP forecast slightly, but the continued ebullience of equity markets is an important offset. As I noted at our last meeting, we find ourselves a bit more optimistic than the Greenbook about trends in residential real estate, based on new housing starts and data on new home sales most recently, and we have moderated the pace of decline of residential investment for the second quarter just a bit relative to our May forecast. The April value of nonresidential construction put in place was a clear positive as well. The health of the rest of the world continues to surprise, and we, like the Greenbook, expect little drag from net exports over the forecast period. Turning to projections for 2008 and 2009, the factors shaping our outlook haven’t changed much. We continue to see output accelerating mildly as the housing situation moderates and more of the underlying strength of the economy shows through. This is tempered a bit both by rising long-term interest rates and by our expectations that consumers will mend their ways a bit—consume less and save more. This hasn’t shown signs of happening yet. By the end of 2009, GDP is about at potential, unemployment has ticked up a bit but remains below 5 percent, and core inflation moves down gradually to 2 percent—again, not much change and certainly within the central tendency of members’ forecasts. One obvious risk to this forecast lies in housing, as everybody has said. But as I noted at our last meeting, the longer there are no obvious spinoffs from the subprime problem to the wider economy, the more that particular risk seems to ebb. Indeed, as we have yet to see the saving rate pick up with the moderation in consumption over what would be expected by the fundamentals, there may be some upside to growth. Pressures from abroad—worldwide expansion of somewhat larger size than we expected—do raise some upside issues, both for growth and for inflation. On the inflation side, it is true that the April and May core data were encouraging. However, those numbers were dominated by temporary rather than permanent effects, at least in our view. So we haven’t moderated our forecast of core inflation, as have the Greenbook authors, albeit they moderated it only in a very minor way, and I remain concerned about upside risks. Headline CPI inflation has been strong. The unemployment rate and widening concerns about input costs suggest that pressures to raise prices might have grown, and strong growth worldwide affects not only input prices but the value of the dollar as well. If anything, since our last meeting, I think that risks related to growth have abated and have become more balanced and risks regarding inflation have grown. Thus, as we look over the next two and a half years, our forecast sees policy staying somewhat restrictive given the inflation risks and then easing a bit in late 2008 or 2009 to a level closer to its equilibrium rate. Finally, continuing some thoughts I began to articulate at our last meeting, as we think about policy, we also need to be concerned about financial stability. This is particularly true given what we’ve seen in the markets for credit derivatives. We’ve talked before about how high levels of liquidity and low interest rates worldwide cause much reaching for risk, much reaching for return, and related risk-taking. While the Bear Stearns hedge fund issue may well not have legs, the concerns regarding valuation of the underlying instruments do give one pause. Can markets adequately arrive at prices for some of the more exotic CDO tranches? What happens when the bottom falls out and positions thought to be at least somewhat liquid become illiquid? Is there a potential for this to spread and become a systemic problem? Maybe not, and I am not advocating our taking any action as a central bank. But I do think the size of the credit derivatives market, its lack of transparency, and its activities related to subprime debt could be a gathering cloud in the background of policy. Thank you." FOMC20060328meeting--195 193,MR. LACKER.," So it is consistent with the world in which the policy function we are expected to follow has nominal compensation growth not responding to productivity growth changes. Productivity growth changes, and it changes unit labor costs. It doesn’t change compensation growth. So it has inflation responding to changes in productivity costs." 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. " fcic_final_report_full--160 CDOs created by Goldman Sachs.  Because of such deals, when the housing bubble burst, billions of dollars changed hands. Although Goldman executives agreed that synthetic CDOs were “bets” that mag- nified overall risk, they also maintained that their creation had “social utility” be- cause it added liquidity to the market and enabled investors to customize the exposures they wanted in their portfolios.  In testimony before the Commission, Goldman’s President and Chief Operating Officer Gary Cohn argued: “This is no dif- ferent than the tens of thousands of swaps written every day on the U.S. dollar versus another currency. Or, more importantly, on U.S. Treasuries . . . This is the way that the financial markets work.”  Others, however, criticized these deals. Patrick Parkinson, the current director of the Division of Banking Supervision and Regulation at the Federal Reserve Board, noted that synthetic CDOs “multiplied the effects of the collapse in subprime.”  Other observers were even harsher in their assessment. “I don’t think they have social value,” Michael Greenberger, a professor at the University of Maryland School of Law and former director of the Division of Trading and Markets at the Commodity Fu- tures Trading Commission, told the FCIC. He characterized the credit default swap market as a “casino.” And he testified that “the concept of lawful betting of billions of dollars on the question of whether a homeowner would default on a mortgage that was not owned by either party, has had a profound effect on the American public and taxpayers.”  MOODY ’S: “ACHIEVED THROUGH SOME ALCHEMY ” The machine churning out CDOs would not have worked without the stamp of ap- proval given to these deals by the three leading rating agencies: Moody’s, S&P, and Fitch. Investors often relied on the rating agencies’ views rather than conduct their own credit analysis. Moody’s was paid according to the size of each deal, with caps set at a half-million dollars for a “standard” CDO in  and  and as much as , for a “complex” CDO.  In rating both synthetic and cash CDOs, Moody’s faced two key challenges: first, estimating the probability of default for the mortgage-backed securities purchased by the CDO (or its synthetic equivalent) and, second, gauging the correlation between those defaults—that is, the likelihood that the securities would default at the same time.  Imagine flipping a coin to see how many times it comes up heads. Each flip is unrelated to the others; that is, the flips are uncorrelated. Now, imagine a loaf of sliced bread. When there is one moldy slice, there are likely other moldy slices. The freshness of each slice is highly correlated with that of the other slices. As investors now understand, the mortgage-backed securities in CDOs were less like coins than like slices of bread. To estimate the probability of default, Moody’s relied almost exclusively on its own ratings of the mortgage-backed securities purchased by the CDOs.  At no time did the agencies “look through” the securities to the underlying subprime mortgages. “We took the rating that had already been assigned by the [mortgage-backed securi- ties] group,” Gary Witt, formerly one of Moody’s team managing directors for the CDO unit, told the FCIC. This approach would lead to problems for Moody’s—and for investors. Witt testified that the underlying collateral “just completely disinte- grated below us and we didn’t react and we should have. . . . We had to be looking for a problem. And we weren’t looking.”  fcic_final_report_full--190 Since the late s, Lehman had also built a large mortgage origination arm, a formidable securities issuance business, and a powerful underwriting division as well. Then, in its March  “Global Strategy Offsite,” CEO Richard Fuld and other executives explained to their colleagues a new move toward an aggressive growth strategy, including greater risk and more leverage. They described the change as a shift from a “moving” or securitization business to a “storage” business, in which Lehman would make and hold longer-term investments.  By summer , the housing market faced ballooning inventories, sharply re- duced sales volumes, and wavering prices. Senior management regularly disregarded the firm’s risk policies and limits—and warnings from risk managers—and pursued its “countercyclical growth strategy.” It had worked well during prior market disloca- tions, and Lehman’s management assumed that it would work again.  Lehman’s Au- rora unit continued to originate Alt-A loans after the housing market had begun to show signs of weakening.  Lehman also continued to securitize mortgage assets for sale but was now holding more of them as investments. Across both the commercial and residential real estate sectors, the mortgage-related assets on Lehman’s books in- creased from  billion in  to  billion in . This increase would be part of Lehman’s undoing a year later. Lehman’s regulators did not restrain its rapid growth. The SEC, Lehman’s main regulator, knew of the firm’s disregard of risk management. The SEC knew that Lehman continued to increase its holding of mortgage securities, and that it had in- creased and exceeded risk limits—facts noted almost monthly in official SEC reports obtained by the FCIC.  Nonetheless, Erik Sirri, who led the SEC’s supervision pro- gram, told the FCIC that it would not have mattered if the agency had fully recog- nized the risks associated with commercial real estate. To avoid serious losses, Sirri maintained, Lehman would have had to start selling real estate assets in .  In- stead, it kept buying, well into the first quarter of . In addition, according to the bankruptcy examiner, Lehman understated its lever- age through “Repo ” transactions—an accounting maneuver to temporarily re- move assets from the balance sheet before each reporting period. Martin Kelly, Lehman’s global financial controller, stated that the transactions had “no sub- stance”—their “only purpose or motive . . . was reduction in the balance sheet.” Other Lehman executives described Repo  transactions as an “accounting gimmick” and a “lazy way of managing the balance sheet as opposed to legitimately meeting balance sheet targets at quarter-end.” Bart McDade, who became Lehman’s president and chief operating officer in June , in an email called Repo  transactions “an- other drug we R on.”  Ernst & Young (E&Y), Lehman’s auditor, was aware of the Repo  practice but did not question Lehman’s failure to publicly disclose it, despite being informed in May  by Lehman Senior Vice President Matthew Lee that the practice was im- proper. The Lehman bankruptcy examiner concluded that E&Y took “virtually no action to investigate the Repo  allegations, . . . took no steps to question or chal- lenge the non-disclosure by Lehman,” and that “colorable claims exist that E&Y did not meet professional standards, both in investigating Lee’s allegations and in con- nection with its audit and review of Lehman’s financial statements.”  New York At- torney General Andrew Cuomo sued E&Y in December , accusing the firm of facilitating a “massive accounting fraud” by helping Lehman to deceive the public about its financial condition.  CHRG-111shrg54533--59 Secretary Geithner," Well, again, Senator, the way the FDIC mechanism works today, and we are preserving that basic balance, any action would require a vote by a majority of the Board of the FDIC, a majority of the Governors of the Board of Governors of the Federal Reserve System, and the concurrence of the Secretary of the Treasury, and institutions that have banks at their center. Again, we are preserving that basic balance. There is a carefully designed set of statutory criteria for exercising that authority which we think fundamentally we can replicate in this context. So I think that has a--again, it has an established record, good, well understood checks and balances, a lot of merit in replicating that basic structure. Senator Corker. I know my time is up and I know we are going to be talking about this a lot more. The one thing that was interesting, I looked at--you know, the 13(3) issue has been raised a couple of times and that jumped out. It is interesting, and I think a lot of people have asked sort of the questions about priorities. You know, the Fed, a lot of people think, and I am not necessarily in every one of these camps, but some people think that the Fed earlier on failed with monetary policy and helped create a bubble. Some people think the Fed actually failed somewhat supervisorally. And yet they did a pretty good job responding quickly to an emergency. And what you all have done here is actually sort of hamstrung them as it relates to dealing with an emergency, but yet on the other hand given them even greater supervisory authority. So it is just an interesting way that you all have gone about this and very different than what history has shown to be good practices at the Fed itself. " FOMC20070628meeting--107 105,MR. MOSKOW.," Thank you, Mr. Chairman. Conditions in the Seventh District have changed little since my last report. Overall activity in the District is lagging the nation, mainly because of the continued difficulties of what we now call the Detroit Three, formerly known as the Big Three, [laughter] and their suppliers. But other sectors of our region are doing better—notably, a number of manufacturers outside autos—and consumer spending is moving forward at a moderate rate. Looking at the outlook for the national economy, the Greenbook baseline forecast has growth recovering to potential and core inflation stabilizing at 2 percent. Our outlook is not much different. We see growth returning close to potential. Assuming that monetary policy maintains its slightly restrictive stance, we think inflation will edge a shade below 2 percent by 2009. That would be a good outcome, and I sure hope we get it. The biggest news since the May FOMC meeting is the adjustment in financial conditions. The change in fed funds futures brings market expectations into better alignment with what I think will be the appropriate path for monetary policy. I’m not sure, however, how much restraint we can expect from the increase in long-term interest rates. As the Chairman heard from our directors last week, the effects can be muted by ample liquidity in the financial markets. One of our directors, who heads a large private equity firm, says that he does not see much of a change in the lending environment. Financing for even high-risk projects continues to be readily available at quite favorable rates and terms. Notably, such loans are being made with few covenants and no automatic default triggers. Of course, the housing market remains a risk. Like the Greenbook, we continue to expect large declines in residential investment through the end of this year, and I remain concerned that builders may need to cut back even more to reduce the high inventory of unsold homes. Our Detroit Branch director, who is CFO of Pulte Homes, noted that two-thirds of their sales usually occur between the Super Bowl and Memorial Day. Sales this year in that period were sluggish and relatively unresponsive to price discounting. Accordingly, he is not looking for a turnaround in housing markets before ’08. Another director, the head of U.S. Gypsum, agreed that it would be ’08 before we could expect a pickup in housing. With regard to consumer spending more generally, some contacts noted the impact of higher gasoline prices. A developer of malls and shopping centers downgraded his expectations for the rest of 2007, but he is not overly pessimistic and is expecting retail sales in the second half to remain near their first-half pace. Both GM and Ford believe that the higher gasoline prices are holding down the overall level of motor vehicle sales in addition to moving the mix of sales away from SUVs and toward cars. At this point, they believe that higher interest rates are having only a marginal effect on demand. Both are predicting that total light vehicle sales will be about 16.5 million units in 2007. That is the same as the pace predicted by the participants in our annual outlook symposium that we held in Detroit earlier this month. But the rest of the manufacturing is doing better than autos. Producers of heavy machinery and agricultural equipment continue to report strong demand. The Chicago purchasing managers’ report, which is confidential until its release this Friday, was 60.2 in June; that reading is down only a bit from its very high one of 61.7 in May. Some of this strength reflects strong growth abroad, which is fueling the demand for U.S. products, as we talked about during the chart show. Indeed, I think that there may be some upside risks to the GDP forecast from faster-than-expected export growth. Labor markets continue to be strong, and we heard the usual stories about selected labor shortages and associated increases in wages. One exception is the soft demand for temporary workers, but this could be normal for a mature business cycle. Turning to prices, our contacts seem to be a bit more pessimistic about the prospects for inflation. We heard concerns that higher energy prices would boost transportation costs and that the demand for food stuffs from abroad and the booming domestic ethanol market are pushing up food prices. In contrast to the anecdotes, the incoming data on core inflation were better than expected. Our indicator models revised down a tenth or two from the last round; they now have core PCE inflation being about 2 percent this year and next and then edging down to 1.8 or 1.9 in 2009. Without any meaningful resource slack, this improvement would require a comparable adjustment in inflation expectations, which may be difficult given a prolonged period of core inflation at or above 2 percent. So I continue to think that the predominant risk remains that inflation will not moderate as expected." 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." CHRG-110hhrg38392--80 Mr. Hinojosa," Thank you, Mr. Chairman. Chairman Bernanke, thank you for giving us an update on the economy of the United States and abroad and for giving us an opportunity also to ask some questions that are of concern to us. I hope that in this brief time that we have, I can address housing, the NADBank, immigration, and possibly the college student loan industry as it refers to the for-profit entities. This week the House of Representatives passed two of my rural housing bills, authorizing funding for the Housing Assistance Council and the Rural Housing and Economic Development Program. I introduced those two bills in my capacity as chairman of the Congressional Rural Housing Caucus to improve the affordability and the availability and the quality of housing in rural America. What data can you share with us as to the economic wellbeing of rural America, and what types of Federal policy changes do you recommend to improve their livelihood? " FOMC20080625meeting--57 55,MR. SLIFMAN.," Yes. The way to think about it is that we switched into a low-growth period. Whether it is precisely a recession or just simply a low-growth period shouldn't be the demarcation point. We still think that the economy is operating in a low-growth period. There is probably not as much severity to that low-growth period, but we still think that is where it's operating. " FOMC20050202meeting--28 26,CHAIRMAN GREENSPAN.," Well, I think the original purpose of the actions that were taken in October 1979 was to break the back of that general structure. At the time, the evaluation of the evolving inflationary forces was—and I think quite accurately—that we were getting very close to a highly unstable system. The assessment was that if the general view of the business community about the capacity to pass on cost increases didn’t change radically, we were in for a very serious problem. And remember, what has happened in the period since is that we have effectively created an environment in which the level of prices is presumed to be generally stable and, therefore, profit can only come from true efficiencies. Clearly, from a macroeconomic point of view, that’s the ideal model. And for better or worse, I think we have arrived there. So I would say that the first principle we ought to agree with around this table is that the evidence, as best we can judge, conclusively indicates that a low-inflation environment has the highest probability of creating maximum sustainable long-term growth. We don’t know that as an unquestioned fact, but it’s about as close to a generic macroeconomic principle that we can have. Whatever else we do, I think we should not take that for granted. One of the questions I would have with respect to the proposition of even some soft form of inflation targeting—which is not what we are discussing today, as Governor Bernanke points out—is this: What could be the effect of changing the focus of the way we look at the world to emphasize a special view of price inflation, as distinct from a broad process in which a lot of forces are involved? I think doing so could very well skew our view away from an optimum analytical procedure. If, however, the evidence were quite clear—even half as good as the evidence on price inflation being conducive to long-term economic growth—then we have to go with where the evidence leads us. My own view is that I haven’t seen particular value in a specific numeric target, February 1-2, 2005 19 of 177 Now, whether it’s necessary to define price stability in terms of a specific index I think is less important than the broader question we’ve played with over the years, which is: Are we dealing solely with the prices of goods and services, or do asset prices enter into the evaluation? In other words, is macroeconomic stability, and specifically financial stability, a factor that must be taken into account as part of the overall process of our policy decisionmaking? If we decide, as I have a suspicion that future FOMCs will eventually come to decide, that asset prices are a relevant consideration—not necessarily to capture bubbles or what have you, but to try to mold a level of financial stability that cannot be achieved without advertence to asset prices—I suspect that that particular process will be coming onstream. So in the conversation, try to think about—or answer, if you can—the question of how you view that possibility in the context of a macroeconomic environment that is changing continuously before our eyes every week and every month. We all look at it differently. We restructure, and we have a different model. I think the important issue here is to recognize that we’ve had it relatively easy in recent years. We’ve somehow been able to capture an understanding of the key underlying forces that have driven inflation, unemployment, and productivity, and we knew as a consequence of that where monetary policy ought to go. I fear that this recent period may be a special case. I have never seen anything like this, as I mentioned to the Vice Chair and many others, since the middle of 1948— which is about how long I’ve been watching the economy on a day-by-day basis. I don’t recall our having the slightest clue about what is likely to happen in the way that we feel quite confident about it today. Unless human nature has changed beyond my expectations, I believe it’s extraordinarily unlikely that we will be as fortunate as we’ve been in recent years. And in the context of changing our procedures to the extent that we are talking about, I think we ought to keep that in mind. That’s all I have to say for the moment. Will somebody else please take the floor? February 1-2, 2005 20 of 177" CHRG-110hhrg34673--148 Mr. Bernanke," Ownership is very important because people then feel they have a responsibility for their community and for their home, and it is also valuable to try to develop a community, not house by house but in a broader sense, because unless you have a retail area and a school and a social area and other amenities, the house property values are not going to justify the cost. So you need to build a neighborhood rather than just an individual house. " CHRG-109hhrg28024--91 Mr. Bernanke," Yes, Congresswoman. We discuss it in our report. The housing market has been very strong for the past few years. Housing prices have been up quite a bit. Residential investment has been very strong. It seems to be the case, there are some straws in the wind, that housing markets are cooling a bit. Our expectation is that the decline in activity or the slowing in activity will be moderate, that house prices will probably continue to rise, but not at the pace that they had been rising. So we expect the housing market to cool, but not to change very sharply. If the housing market does cool more or less as expected, that would still be consistent with a strong economy in 2006 and 2007. In particular, capital investment and other forms of demand would take up the slack left by residential investment. Ms. Carson. Thank you very much, Mr. Chairman. " FOMC20080805meeting--32 30,MR. KAMIN.," For the next couple of weeks, millions of people around the world will be watching the Olympic games in Beijing. For those of us charged with forecasting the global economy, of course, China-watching is a year-round task. But notably, the most salient developments since your last meeting have arisen outside of China. Chief among them, of course, have been the precipitous fluctuations in the price of oil. When the last FOMC meeting concluded on June 25, the spot price of WTI crude oil was running at $134 per barrel. It soared to over $145 by mid-July before plunging to about $119 as of this morning. The $26 per barrel drop over a three-week period was the largest on record in nominal dollar terms, although in percent terms, the 18 percent decline we've seen has been exceeded on a couple of occasions in recent years. Notably, many other commodity prices, especially those for natural gas and many food crops, also declined sharply. It has been heartening, and a welcome change, to see oil prices undershoot rather than overshoot our previous forecast. But it would be premature to pop open the champagne. We've seen several other steep declines in oil prices in recent years that gave way to renewed upward surges, and it remains to be seen whether an important shift in the supply�demand balance has occurred. Saudi Arabia added a total of 400,000 barrels a day to its production of oil in May and June, and there are indications that its production rose in July, too. However, these increases bring total OPEC production up only to their level in early 2006, and the world economy has grown considerably larger since then. Analysts have cited gloomier forecasts of global economic growth, and thus global oil demand, as contributing to the weaker oil prices; but those forecasts have been coming down for the past year with little apparent effect. Although oil consumption in the industrial economies clearly has slowed over the past year, we have yet to see either a concerted buildup in U.S. oil inventories or any indications that oil demand among developing countries is slowing. Therefore, a further lurch upward in oil prices is a distinct possibility. Moreover, with spot and futures prices having first soared and then plunged since your last meeting, the relatively flat path of oil prices that we are projecting is only about $12 per barrel lower, on balance, than in the previous forecast. In the meantime, indicators of foreign growth have come in a bit weaker than we expected, and inflation readings have been on the high side. These gloomier aspects of the international outlook counterbalance, to some extent, the improved tone of oil and other commodity markets. Clearly, prospects appear weakest in the advanced economies. Consistent with our earlier forecasts of a sharp deceleration in activity, we estimate that growth in all four of our largest industrial country trading partners--Canada, the euro area, the United Kingdom, and Japan--came in below 1 percent in the second quarter. In the United Kingdom, a sharp contraction in the housing sector appears set to drag the economy into a mild recession in the second half of this year. The remaining major economies should skirt recession but remain quite weak in the near term amid slackening export performance, continued stresses in financial markets, tightening credit standards, and very sharp erosions in business and consumer confidence. Why are the foreign industrial economies slowing about as much as in the United States, when the subprime crisis originated in this country and the major drag on the U.S. economy is the slump in a nontradables sector, housing? Clearly, part of the story involves the international financial linkages that have led foreign markets and institutions to share in the stresses and losses induced by the U.S. subprime crisis. Another part of the story involves a common shock--the global boom in oil and food prices--that has cut into real household income and spending around the globe. Third, even as the persistent decline in the dollar since 2002 has buoyed U.S. exports and growth, this has come at the cost of trade performance and economic activity in our trading partners. Finally, the foreign industrial countries have enjoyed little or none of the substantial monetary and fiscal stimulus we've seen in the United States over the past year. We estimate that growth in the emerging market economies also slowed further in the second quarter, to a pace of roughly 4 percent, where we have it staying for the remainder of the year. Obviously, this is well above the growth rate of roughly 1 percent that we've penciled in for the industrial economies, but it is still below their likely potential rate as many developing countries struggle with softening export demand and rising food and energy prices. Notably, however, even after slowing in the second quarter, estimated Chinese growth powered on at about 10 percent. By 2009, we see both foreign advanced and emerging market economies accelerating as financial stresses ease, the U.S. economy picks up, and commodity prices stop restraining the growth of real household incomes. This recovery scenario depends crucially on our projection that headline inflation starts moving down within the next quarter or two, so that substantial monetary tightening is not needed. The recent decline in oil and other commodities prices provides some comfort that this scenario will materialize. However, we saw some surprisingly sharp increases in consumer prices in June, bringing 12-month headline inflation to around 4 percent in the euro area and the United Kingdom, 5� percent in Mexico, and 6 percent in Brazil. In most of our major trading partners, inflation excluding energy and food prices has remained better contained; and in China, headline inflation has actually moved down from its February peak of 8.7 percent, registering 7.1 percent in June. Even so, until we see several quarters in a row of declines in aggregate measures of inflation, we will not be out of the woods. So far, the imprint of slowing foreign growth and rising foreign inflation on the U.S. external sector has been limited but not negligible. Turning first to prices, core import price inflation has moved up sharply, from about 3 percent last year to 11 percent in the second quarter; this was the fastest quarterly increase since 1987. Most of this acceleration was concentrated in material-intensive goods, such as food and industrial supplies, and was likely due to rising commodity prices rather than to more-generalized pricing pressures abroad. However, inflation in imported finished goods also increased this year. As we noted in a special box in the Greenbook, prices of imports from China have been moving up briskly as a result of increases in domestic costs and in the value of the renminbi. This step-up in the so-called China price explains less than one-fifth of the overall acceleration of core import prices but about one-third of the run-up in inflation for finished goods imports. Even so, assuming commodity prices stabilize going forward, we expect changes in overall core import prices to slow quite substantially in coming quarters. So far, U.S. external sector performance has held up well in spite of the slowing global economy. Net exports added 2� percentage points to real GDP growth in the second quarter, the largest quarterly positive contribution since 1980. Admittedly, much of this reflected a 6 percent decline in imports, which were dragged down both by weak U.S. demand and the quirky seasonal pattern in the data on oil imports. Even so, exports expanded at a very healthy 9� percent, supported both by the depreciation of the dollar and by continued robust demand for commodities. Going forward, we anticipate export growth holding up at a still healthy 7 percent or so, as foreign economic growth picks up right around the time that the boost from previous dollar depreciation starts wearing off. The contribution of net exports to U.S. GDP growth should move down, but this will chiefly reflect a recovery in imports as the U.S. economy picks up. Thank you. David and I will now be happy to address your questions. " CHRG-110shrg50409--10 Mr. Bernanke," Mr. Chairman, I think that the central issue in the economic situation right now is the housing market. It is the continued uncertainty about house prices and housing activity which is creating financial stress, is affecting consumer wealth and consumer expectations and causing the stress we are seeing in the economy. So my suggestion would be in the near term to focus on issues related to housing. I understand that you have already passed a bill that would address, for example, GSE reform. We need the GSEs to continue to be active in supporting the mortgage markets, as well as FHA modernization and other steps that Congress determines would strengthen and support mortgage finance in the housing sector. I think that is the most critical central issue we face. On a second stimulus package, my own sense is that we are still trying to assess the effects of the first round. It appears that it does seem to be helping. But it might be a bit more time before we fully understand the extent to which additional stimulus may or may not be needed. If additional stimulus is, in fact, invoked, it would be important to find programs that would be, as in the first round, timely, temporary, and targeted, in particular, that would take place quickly and would put money into the economy relatively quickly. In the case of infrastructure, it is often well justified on its merits, but one would have to ask whether the flow of funding would go into the economy in a relatively prompt way, or would there be long delays associated with the planning process? " FOMC20050630meeting--145 143,MS. MINEHAN.," Thank you, Mr. Chairman. I also want to thank the authors of the papers—the international paper as well as all of the papers that were talked about today—because I found them very helpful and reassuring, along the lines that Michael Moskow was discussing. I also thought that Janet’s comments on the financial innovations were insightful. Despite the fact that it’s hard to sort out the U.S. experience vis-à-vis other countries, the whole point of this—to me anyway—is that we’re seeing a phenomenon in the housing markets. So the question is: Do the June 29-30, 2005 50 of 234 terms of changes in the fundamentals. So, to the extent that they’ve made many of the transactions in the housing market easier to do, that has to have had some impact on the underlying asset prices. So I thought that argument was a very interesting one, and it will be interesting to see if there is any way one can tease out the effects of that. My second point is that when you look at the relationship between rising prices on either the OFHEO or the constant-quality index against disposable income as opposed to median household income, you see an even more reassuring chart. And I would think there’s at least a little bit of logic to doing that, based on Dick Peach’s chart about the differences in house-price acceleration depending on income—with the value of higher-priced houses moving up faster than lower-priced houses. So I would think that there is some logic to looking at this with disposable income. I know that you have done those charts. I think we have every chart you could do! [Laughter] But it is interesting that one sees in that perspective somewhat less acceleration and a somewhat more reassuring picture. Finally, and this is more of a question, we talked about a 20 percent decline in house prices and what that would do in terms of the basic macroeconomic effects of it. But, of course, that wouldn’t happen overnight. Something would make it happen. And, as we consider our current policy stance, one of the conundrums—though I hate to use that word—is why haven’t the 10-year yield and, therefore, mortgage interest rates, taken the same upward path as rates at the short end of the curve. So a question I was asking myself—and I think it’s probably not so difficult to figure this out—was where the point is, as mortgage rates start to go up, when we look at that affordability curve and start to worry about households beginning to get into trouble. That would then have an impact on house prices. Obviously, higher interest rates would tend to level house prices off or take June 29-30, 2005 51 of 234 house that they’re in. How far do interest rates have to go up before that affordability curve starts to move in the direction that causes a problem in that regard?" FOMC20060808meeting--142 140,MR. PLOSSER.," I’m new to these language nuances about housing. It occurs to me, however, that one question you ought to ask is whether by including housing or continuing to include housing the Committee is putting itself in a position where it can’t raise rates until housing comes back. Are we unfairly locking ourselves in, or at least are the markets going to interpret it that way? That’s just another question to think about in deciding how to include it." CHRG-111hhrg51698--127 Mr. Damgard," Well, I was speaking specifically of the futures markets. The futures markets did work extremely well, and they worked very well under the rules that this Committee has established for the CFTC, and that doesn't mean that there wasn't speculation and that there weren't bubbles in some of these markets. Having been here for years and years, I have been here at hearings where our producers were angry when the price was high or the price is low, depending on what their producers, and users are just the opposite. We did have enormous volatility in the oil market. The CFTC study, as I recall, determined that most of the speculators were basically decreasing their positions in the first half of last year, number one; and, number two, they also indicated that most speculators had spread positions, which means that they were both long and short, and that suggests that there was an equal amount of pressure on buying and selling. So it may be that the oil speculators are being blamed for more than they should be blamed for. I don't know the answer to why that market went up, but I remember at the time that the criticism was that these funds had all moved out of equities, and they were so-called passive investors. Well, at $145 they got out of the market, so they weren't all that passive. Now we have $40 oil, and we have people that have pension funds that are complaining that somehow the decrease in the value of their pension fund is the direct result of speculators selling the oil price. So, I have gotten used to people complaining about high prices and low prices, and how that relates to the average family. I go back to the point that Mr. Gooch made, that the mortgage market and the drying up of credit are the root cause of what we are going through right now. I represent the futures market, which is the listed derivatives market, and Mr. Duffy and I don't always agree on everything, but I do want to say that people are using that market. They just had another record year. " FOMC20050920meeting--98 96,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. The balance of evidence since our last meeting still supports, in our view, a reasonably positive outlook for output and inflation. If we look through, as we should, the transitory effects of Katrina and the reconstruction, and if we factor in what the futures market tells us about the expected magnitude and duration of the rise in energy prices, we still see an economy growing slightly above trend with core inflation following a path somewhat, but not substantially, above our preferred range. The fundamentals still seem favorable to continued expansion with solid productivity growth, strong corporate balance sheets, reasonable growth in household income, and favorable financial conditions. And on the strength of this view, with real interest rates still quite low, we believe that we need to continue to tighten monetary policy at this meeting and beyond. At the September 20, 2005 73 of 117 Now, of course, the degree and balance of uncertainty has changed. We face a higher degree of overall uncertainty. It will be harder to assess over the next few quarters the underlying pace of demand growth. The rise of energy prices pre-Katrina—some of which remains even as the initial effects of the hurricane on expectations have washed out of energy markets, except for natural gas—creates some risk of a larger shock to confidence and behavior than seems to have been evident over the last two years. Damage from future hurricanes to energy and product output may prove harder to bridge through the release of international product reserves. Our capacity to discern the underlying rate of inflation is also somewhat diminished, perhaps less because of the effect of energy prices than the difficulty of sorting out what is actually happening to productivity growth and unit labor costs. Apart from reducing overall confidence around the forecasts, the balance of risks has probably shifted, too—shifted toward a somewhat higher probability of slower growth relative to the path of potential output and toward a greater risk of a larger and more persistent rise in core inflation. If the former risk materialized, the latter might be mitigated. These are risks across the spectrum of scenarios, rather than the most probable combination. But to acknowledge the change in uncertainty is not to suggest that it would be appropriate for us to stop or to push down the expected path of the nominal fed funds rate until we can better assess what we do not know now. The net effect of the changes to the outlook, on balance, probably does not alter the desirable path of the nominal fed funds rate relative to what we thought in mid-August. With the real rate still rather low, my inclination would be to continue to weight the upside risk to inflation as greater than the prospective risk of a significant September 20, 2005 74 of 117 growth is still only prospective. This implies that the slope of the expected fed funds rate should remain materially positive, even if we move today. And I think we would be better off after this meeting if the markets raised the expected path a bit than if the path were to fall from its pre- meeting trajectory. I think we probably know a little less today than we did in August about how far we are going to have to move, even if the economy appears to be following the path of our forecast. If we move today, all we know is that we’re 25 basis points higher than we were. The fact that we are that much closer to some point we can’t measure is a less valuable observation. We may even know less today about where equilibrium lies and whether that range has moved. And, of course, we still face some probability that we’ll have to move past it, or past what in retrospect we thought was equilibrium. Most of the hard questions we face look pretty much like they did at the last meeting. How strong and durable can we expect the expansion to be in the face of less optimism about future housing price gains or other factors that could cause household saving to rise and consumption to grow more slowly? Will this dramatic rise in energy prices over the past two years cause more substantial damage to business and consumer confidence? Will the world’s private savers continue to be willing to acquire claims on the United States at the higher rate implied by our current account forecast, and to do so on such favorable terms? Will business margins start to erode in a way that will portend slower investment and employment growth? Will the U.S. political system be able to make a credible effort in the near term to improve our medium-term fiscal position and sustain our relatively open trade policy? And, if not, do we risk September 20, 2005 75 of 117 These are all factors that could hurt future growth, but that doesn’t mean that monetary policy should be more accommodative than would otherwise make sense in anticipation of those negative effects or should try to preempt them. Rather, these familiar imbalances and concerns make the cost of any erosion in our credibility greater. Thank you." FOMC20060328meeting--130 128,MR. HOENIG.," Thank you, Mr. Chairman. A couple of things, first, on the region. Like the nation, our region continues to grow at a fairly robust pace. But one of the questions we kept asking in our discussions was whether it was strong but leveling out, or accelerating. I think, for the most part, the consensus is that it’s strong but leveling out. Turning to just a couple of examples, manufacturing activity did expand in February and, we think, in March on a preliminary basis, but at a somewhat slower pace than in January and even in December for us. Production and new orders rose only modestly in the February and early March period. Housing activity, as others have discussed, has shown some signs of leveling off, although it is still high by historical standards. Residential construction has edged down in most areas of our District, and builders to whom we’ve talked expect further easing in the months ahead. I think it is important, too, that home sales are showing little or no growth, with high-end sales softer than most of the other segments in our markets. Just to mention commercial real estate, it has actually improved somewhat in our region. Vacancy rates have continued to edge down in the Denver and Kansas City areas, so we have seen some pickup in activity. Energy activity continues to expand very rapidly, despite shortages of labor and equipment throughout the western part of our region. In some of our Rocky Mountain communities, concern has increased that the energy boom will drive away some of the other core business because of the costs of labor, land, and houses—it is really a boom environment there. I will talk quickly about inflation in our area. Wage pressures, in fact, remain mostly subdued. We have seen some backdown in wholesale prices, although retail prices have edged up. Manufacturers reported to us somewhat slower growth in raw material prices so far this year compared with last year. However, I would say they are also concerned that they cannot pass price increases on as they work through the process. Let me just say one thing on the auto industry in our region. I talked with one of the largest retailers-dealers in the region, in Denver—actually, he goes into Texas and some other areas. He told me that in just the first two weeks of March they’ve seen a general slowdown in some demand for their products, both domestic and foreign. But he said that, obviously, the domestic market is really suffering greatly. In fact, he has seen other dealers refuse to take inventory from the domestic auto dealers, which gives him real concern about that industry going forward. Turning quickly to the national outlook, I agree that, for the most part, it is very positive. I think that in the first quarter, maybe the first half, we will see a strong GDP number, perhaps as high as the Greenbook has indicated or even higher, which will then move back down toward the trend rate of growth over the course of the year. Like President Stern, I think part of this in the first quarter and first half is reflective of a couple of things. One is the bounceback from the year-end. Another is the last effects of accommodative policy that we had in the previous year, because a lot of money is still searching to be deployed right now but is beginning to be used up. And for the first time in a while, I’ve heard more and more businesses talk about the prime rate. I haven’t heard that in four years. They are much more sensitive to it. They’ve seen it go up, and now they’re negotiating around that, which I think tells you that some of the catch-up in terms of the policy effects of our past moves has begun, and I think you’ll see more of it in the coming months and quarters." FOMC20071031meeting--66 64,MR. EVANS.," Thank you, Mr. Chairman. The Seventh District economy appears to be expanding at a moderate rate, similar to what I reported at our last meeting. As we talked with business contacts, we heard mixed reviews regarding activity across different sectors of the economy. On the downside, everyone in the construction industry, from builders to suppliers, had grim assessments, and our contacts with the Detroit Three characterize the vehicle market as mediocre. Another negative is on the labor front. Our contact at Manpower reported that demand for temporary workers was down a lot. He said that the current market felt almost as it did in 2001. Kelly’s assessment was not quite so negative, although they did say that some indicators were flashing yellow. Of course, the BLS has been showing declines in temp help employment since early 2006, and most other indicators point to a healthy labor market. Indeed, we continue to hear about firms trying to cope with shortages of skilled workers. For instance, a couple of heavy- equipment manufacturers based in Illinois said that they were recruiting engineers from the Detroit area. That was encouraging. There were other upbeat reports on activity. United Airlines said that all their markets were quite good, apparently better than President Fisher was reporting earlier. They noted the bookings for business travel, which can be an indicator of business’s more general willingness to spend, remained strong in October and November. International bookings also were extremely good. We heard numerous reports of strong export demand—for example, for machine tool manufacturers and heavy-equipment producers. With regard to the financial situation, I continue to hear that there is a disconnect between Wall Street and Main Street. Importantly, except for construction, our contacts do not see nonfinancial firms being constrained by a lack of access to credit or by the pricing of credit. Turning to the macroeconomy, the news on economic activity that we’ve received over the past six weeks has been better than the downside scenario that we feared. Indeed, it has been better than what we had assumed in our baseline forecast in September. Like the Greenbook, we have raised our outlook for growth in the second half of 2007 about ½ percentage point. Residential investment does look a bit worse than we thought, but consumption came in a good deal stronger than we had expected. Also, the incoming news about labor markets, including the revisions to employment in August, points to continued support to household spending from growth in jobs and income. Unlike the Greenbook, we marked up the outlook for activity a bit in 2008 and 2009. Our current projection sees growth recovering to a little above potential in the second half of next year and in 2009. With regard to inflation, the incoming price data have been positive, and we have revised down our forecast for inflation a bit, to about 1¾ percent in 2008 and 2009. I think the risks to this forecast are two-sided. Some of our statistical models translate the incoming data into quite low forecasts for inflation in 2009 and 2010 if you take them at face value. But higher costs for energy and other materials, the weaker dollar, and potential pressures from resource utilization still pose some risk that inflation will come in higher than we currently are forecasting. For me, the positive inflation developments are an important ingredient allowing us to focus on risk management. Since risk-management considerations have played a key role in our policy decisions, it is important to think about how the risks to the forecast have changed since September. Last time and today, Dave Stockton cited several downside risks to watch for: an intensified fallout from the problems in mortgage finance onto housing demand; a substantial drop in consumer sentiment; and a spillover from financial market disruptions to business spending. These high-cost scenarios are possible, but I think their likelihood is smaller than they were in September. We have been pessimistic on housing for a while, and for once, despite Dave Stockton’s warning, I am encouraged that the Greenbook’s forecast for 2008 has not been marked down materially. It is a small comfort, but just a bit. The economy outside of housing seems to have entered the fourth quarter with more momentum than we had thought it would. Importantly, consumption growth has been solid even though there has been another downtick in sentiment. On the financial front, the Greenbook points to the special Beige Book capital spending questions and to the senior loan officer survey as signals that we could expect more spillovers to nonfinancial activity. Tighter standards for C&I loans are definitely news, but they are hardly surprising. The real news will be next quarter. Looking at previous surveys, we had one bad quarter in 1998, and then it came down, and then the later tightening was part of the increase in the fed funds rate. So I think that the next quarter will be very informative and important. In assessing how risks have changed, these surveys need to be balanced against the improvements we have seen in credit markets. While I continue to be concerned about collateral damage from the credit markets to real activity, I still think the problems in financial markets are likely to remain largely walled off from the nonfinancial economy. So on balance, the economic outlook has improved, and the risks of financial contagion have diminished somewhat since September, although they haven’t disappeared. Thank you, Mr. Chairman." FOMC20060131meeting--99 97,MR. HOENIG.," Mr. Chairman, in thinking about the status of the U.S. economy and the appropriate funds rate target at this meeting, I would start by suggesting that, in my judgment at least, the current funds rate is probably within the neutral range. Therefore, we should be mindful of not going too far, especially when it would appear that growth is slowing to trend. The most compelling reason for considering the move now is the continued drift upward in core inflation, but even in this case, I think we need to be especially aware of the past increases in the funds rate. We have yet to see their full effects on inflation. The fourth-quarter growth was surprising; but at this point, as others have said, it does not yet alter our long-term outlook. Like the staff, however, I revised upward my 2006 forecast ¼ percentage point and now expect that growth will be about 3¾ percent in 2006, about ½ percentage point above trend, and will return to trend in 2007. Turning to the inflation outlook, I expect core CPI inflation to be about 2½ percent this year, as higher energy prices are passed through to higher overall and core inflation. However, it is reasonable to expect that the increase will be temporary, as others have said, with core inflation likely to fall back to 2¼ percent in 2007. The reasons for this pattern have a familiar ring. Greater-than-trend growth reflects the lagged effects of past monetary accommodation and generally supportive financial conditions, whereas the prospective slowing growth reflects the removal of monetary accommodation and, in this instance, higher energy prices. Evidence from our District is consistent with an outlook of strong but slowing growth as well. Manufacturing production and new orders rose solidly. Expectations for future production remained high, and expectations for future orders actually surged. Hiring plans also rose strongly in December and January. However, for the District as a whole, hiring announcements were only slightly greater than layoff announcements. Finally, housing showed signs of leveling off, and consumer spending was solid, though not spectacular, during the holiday season. In fact, a number of our contacts said their holiday sales were below plan. Just quickly in the farm sector, there are concerns being voiced for 2006 following a generally good year in 2005, and they were mostly that drought may be reemerging in the District. Wage pressures in the District remain mostly subdued, and increases in raw material costs actually slowed somewhat. However, manufacturers continued to raise output prices in response to past increases in input costs, and a substantial number said they were raising wages more than normal for certain types of workers in short supply. Reports of retail prices said that increases were down somewhat from the last meeting but still higher than they were just last summer. Let me turn just briefly to the risks. I would submit that inflation risks are on the upside and output risks have become more on the downside recently, not exactly the kinds of risk that are friendly from a policy perspective. The outlook for core inflation is 2¼ to 2½ percent. This is higher than I would prefer. Moreover, the potential for even higher energy prices makes core inflation more likely to be higher rather than lower over the next several months. But at the same time, the risks to output are on the downside. First, forward momentum has certainly diminished. For example, real GDP grew about 2.6 percent during the last half of 2005, decidedly below trend. In addition, while the fourth-quarter slowdown was probably temporary, it could also be signaling a more fundamental slowdown. Finally, a possible increase in the term premium poses downside risks to growth. You know the term premium is far below the historical average. If the decline reverses faster than expected, both would be significantly weaker as shown by the Greenbook alternative scenario. As I see things then falling out, the choices are obviously difficult, but I think that the inflation risk for the time-being is the greater risk, and therefore I would be inclined to move at this meeting. But we should have the odds no greater than 50-50 that more upward changes are likely in the fed funds rate at the next meeting. And finally, Mr. Chairman, although I have not served as long with you as some others around this table, I have served among the longest with you, and I would like you to know it has been a real privilege." fcic_final_report_full--25 Cioffi’s investors and others like them wanted high-yielding mortgage securities. That, in turn, required high-yielding mortgages. An advertising barrage bombarded potential borrowers, urging them to buy or refinance homes. Direct-mail solicita- tions flooded people’s mailboxes.  Dancing figures, depicting happy homeowners, boogied on computer monitors. Telephones began ringing off the hook with calls from loan officers offering the latest loan products: One percent loan! (But only for the first year.) No money down! (Leaving no equity if home prices fell.) No income documentation needed! (Mortgages soon dubbed “liar loans” by the industry itself.) Borrowers answered the call, many believing that with ever-rising prices, housing was the investment that couldn’t lose. In Washington, four intermingled issues came into play that made it difficult to ac- knowledge the looming threats. First, efforts to boost homeownership had broad po- litical support—from Presidents Bill Clinton and George W. Bush and successive Congresses—even though in reality the homeownership rate had peaked in the spring of . Second, the real estate boom was generating a lot of cash on Wall Street and creating a lot of jobs in the housing industry at a time when performance in other sec- tors of the economy was dreary. Third, many top officials and regulators were reluc- tant to challenge the profitable and powerful financial industry. And finally, policy makers believed that even if the housing market tanked, the broader financial system and economy would hold up. As the mortgage market began its transformation in the late s, consumer ad- vocates and front-line local government officials were among the first to spot the changes: homeowners began streaming into their offices to seek help in dealing with mortgages they could not afford to pay. They began raising the issue with the Federal Reserve and other banking regulators.  Bob Gnaizda, the general counsel and policy director of the Greenlining Institute, a California-based nonprofit housing group, told the Commission that he began meeting with Greenspan at least once a year starting in , each time highlighting to him the growth of predatory lending prac- tices and discussing with him the social and economic problems they were creating.  One of the first places to see the bad lending practices envelop an entire market was Cleveland, Ohio. From  to , home prices in Cleveland rose , climb- ing from a median of , to ,, while home prices nationally rose about  in those same years; at the same time, the city’s unemployment rate, ranging from . in  to . in , more or less tracked the broader U.S. pattern. James Rokakis, the longtime county treasurer of Cuyahoga County, where Cleveland is located, told the Commission that the region’s housing market was juiced by “flip- ping on mega-steroids,” with rings of real estate agents, appraisers, and loan origina- tors earning fees on each transaction and feeding the securitized loans to Wall Street. City officials began to hear reports that these activities were being propelled by new kinds of nontraditional loans that enabled investors to buy properties with little or no money down and gave homeowners the ability to refinance their houses, regardless of whether they could afford to repay the loans. Foreclosures shot up in Cuyahoga County from , a year in  to , a year in .  Rokakis and other public officials watched as families who had lived for years in modest residences lost their homes. After they were gone, many homes were ultimately abandoned, vandalized, and then stripped bare, as scavengers ripped away their copper pipes and aluminum siding to sell for scrap. “Securitization was one of the most brilliant financial innovations of the th cen- tury,” Rokakis told the Commission. “It freed up a lot of capital. If it had been done responsibly, it would have been a wondrous thing because nothing is more stable, there’s nothing safer, than the American mortgage market. . . . It worked for years. But then people realized they could scam it.”  CHRG-111shrg57322--160 OPENING STATEMENT OF SENATOR COBURN Senator Coburn. Thank you, Mr. Chairman. I am going to take my privilege as Ranking Member to make my opening statement now, and I apologize to the panel that I was not here. I am working on another financial problem that is a little bit bigger than this one with the White House and the Debt Commission. Senator Levin, I want to thank you for this fourth and final hearing. I want to thank the staffs. I think they have worked well together, and I think we have done a good role of putting forward what the questions are. I also want to thank the witnesses for making themselves available to answer our questions. The hearing to me is particularly important because this week the Senate is trying to consider major financial reform legislation that could have profound effects on our economy. And we are hurrying these hearings. The Commission that the Congress commissioned to study this that is going to have a report due in December is not going to have a report, and yet we are going to pass a bill before we find everything, and that is somewhat concerning to me. But, nevertheless, there is a lot of evidence in front of us that needs to be clarified. In recent months, Congress and the American people have been debating the causes of our financial crisis and looking for solutions. Mr. Chairman, I commend you for advancing the discussion with our investigations of institutions like Washington Mutual, the Federal regulators, and particularly the Office of Thrift Supervision. We would have been fine without them ever being there because they actually did not do anything. What we have learned is that there are no easy answers. This is important to keep in mind when Congress debates major legislation. I certainly have my own views about what caused the financial crisis, but most honest observers would acknowledge that the roads of responsibilities lead to places like Washington and Congress as well as Wall Street. We also cannot forget that there are numerous causes to the financial crisis, not just one. In truth, we all took turns inflating the housing bubble. Today we are looking at the role of one investment bank, Goldman Sachs. My goal is simply to uncover the truth of what happened in several of these transactions. If we can understand this piece of the puzzle, we will be in a much better position to craft responsible legislation that addresses the real problem, not the symptoms of the problem. And more importantly, the American people will be better informed and more equipped to hold us accountable. The investigation into Goldman Sachs has given the Subcommittee an opportunity to dive into the firm's decisions regarding mortgage investments. Even though Goldman Sachs is the focus, I would suggest that the questions we are going to ask the witnesses today should also be asked of other leading investment banks. Congress has a responsibility to understand how widespread some of these complex financial transactions may be and the ethics and motivations behind them. The key question before us, I believe, is whether Goldman Sachs was making proprietary trades that were contrary to the financial interests of their customers. Sorting out these potential conflicts is central to understanding how we move forward with financial reform and also understanding that there is a role for a market maker who plays both sides of the market. And we cannot lose sight of that. Several instances, however, seem to show bankers and traders were focused on doing what was right for the firm rather than what was in the best interest of their clients. In an exchange over the Abacus deal, one employee remarked, ``The way I look at it, the easiest managers to work with should be used for our own priorities. Managers that are a bit more difficult should be used for trades like Paulson.'' Goldman employees knew that such tactics could hurt their reputation if they were uncovered. Markets can be complex, but they are built on three simple concepts: Truth, trust, and transparency. Without them, the cost of doing business is too high, and markets cannot function properly. I have several questions about these deliberations within Goldman Sachs. I am committed to withholding final judgment until all our hearings are complete. Some of what we uncovered paints a fairly dark picture of what was going on inside investment banks. To the witnesses, I would say this is your opportunity to explain to us and the American people what happened. And, again, I thank you for being here. Now I would like to move to my questions, Mr. Chairman. Mr. Swenson, if you would, would you turn to Exhibit 55b?\1\ This is a copy of your own performance evaluation for 2007, and I want to spend some time with you on that, with your own self-assessment, and I have some questions. You wrote this document, I believe. What was the purpose of this document?--------------------------------------------------------------------------- \1\ See Exhibit No. 55b, which appears in the Appendix on page 441.--------------------------------------------------------------------------- " CHRG-111shrg57321--186 Mr. McDaniel," And that is why the performance of the subprime mortgage securities, particularly in 2006 and 2007, is so frustrating to me as a CEO, among other reasons. Senator Kaufman. Well, I don't see why it would be frustrating, because basically, what happened was we had this housing market blow-up, and through no fault of our own, everything went south. There was nothing--you have not identified a single thing that was going on at Moody's other than just you guys got caught in a bad housing market, not in a bad business market, a bad housing market. " CHRG-109shrg30354--62 Chairman Bernanke," I think that job growth will continue to be close to what the labor force growth demands, in some sense. There has been a change in the last few decades in terms of the rate of growth of the labor force, in part because, for demographic and other reasons, the share of the population that participates in the labor force has flatted out and now looks to be declining. It therefore appears that the number of jobs we need to create each month to keep the unemployment rate roughly constant is lower today than it would have been, say, in the early 1990's. And so I think job growth will be lower than it has been over the last 15 years. But I think it will be close to where it needs to be to keep the unemployment rate at a healthy, low level. Senator Reed. But that is a function of the participation rates. And for some reasons, demographic rates, an older population you would have a lower participation rate. But you still have a significant number of Americans that are looking for both work or looking to move up. And with a job rate that simply replaces the new entrants in the job market, that is not going to provide the type of robust job growth that most people associate with a vibrant economy. " FOMC20070918meeting--52 50,MR. STOCKTON.," Thank you, Mr. Chairman. “This has been a far from placid time. Indeed, the intermeeting period has been marked by financial tumult of such a magnitude as to significantly alter the outlook for the economy. A deeper retrenchment in U.S. stock markets, more-cautious credit provision, and more-serious disruptions to economic growth abroad are now expected to combine to produce a sharper deceleration in output than we had projected in August.” These words were taken from the first page in the Greenbook of September 1998. [Laughter] While the particulars obviously differ in many important respects from that period, we once again face substantial financial turbulence; and once again, we have marked down our projection of real activity on the expectation that recent financial developments will impart considerable restraint on activity in the quarters ahead. Before explaining these changes, let me read to you from the first page of another Greenbook, and I quote: “[T]he economy has continued to exhibit remarkable dynamism, generating hefty gains in employment and income. We have tacked about ¾ percentage point onto our previous forecast of first-quarter real GDP growth, and the evident momentum of domestic demand has led us to elevate our projection for output growth over the near term a bit as well.” That passage was taken from the Greenbook of March 1999, just six months after the onset of that period of financial disturbance. Needless to say, the experience of that episode was not lost on us as we approached the construction of the current forecast. But neither were the episodes of the summer of 1990 and the fall of 2000, when we thought financial and other factors would result in a period of below-trend growth but that outright recession would be avoided. So the question is, Are we projecting too much or too little weakness in real activity over the next several quarters? Answering that question has two aspects. One is whether we have correctly gauged the magnitude of the potential restraint on real activity arising from the recent developments in mortgage and other credit markets. The other is whether we have appropriately assessed the underlying strength of the economy being subjected to those shocks. I think it’s fair to say that part of our mistake in 1998 was a failure to appreciate just how strong the U.S. economy was as we entered that period. Could we be making that mistake again? Possibly. The incoming data did lead us to revise up our estimates of the growth in real GDP in the second and third quarters by ¼ and ½ percentage point, respectively. Most notably, consumer spending has surprised us to the upside. Last Friday’s report on retail sales provided another positive innovation. Although the spending figures for August were right in line with our expectations, the upward revision to July suggests that the growth of real PCE in the third quarter will be about ¼ percentage point stronger than we projected in last week’s Greenbook. Elsewhere, the growth of exports has continued to outstrip our expectations, providing greater impetus to domestic production. That added impetus may help explain factory output, which has also been a bit stronger, on net, than anticipated in our August projection. Manufacturing IP excluding motor vehicles is estimated to have fallen 0.3 percent last month, but that decline came on the heels of upward-revised increases of 0.7 percent in June and July. We are now projecting manufacturing IP excluding motor vehicles to have increased 4¾ percent in the third quarter, a bit more than in our August forecast. Not all the news, however, has been favorable. Despite a rebound in motor vehicle sales in August, the automakers still found themselves with uncomfortably high inventories at the end of the summer and have announced substantial reductions in assembly schedules for the fourth quarter. In our projection, the cut in motor vehicle production lops ½ percentage point off the growth of real GDP in the fourth quarter, about ¼ percentage point more than we had earlier expected. The labor market report also was a bit weaker than we had penciled into our projection at the time of the August FOMC meeting. Private payrolls increased just 24,000 last month, which, combined with downward revisions in June and July, left the level of employment about 100,000 shy of our expectations. Nevertheless, we didn’t attach a great deal of signal to the employment report in terms of its implications for real activity. As you know, despite the fact that real GDP was coming in close to our expectations most of this year, we had been fairly consistently surprised to the upside by employment. For the most part, we had attributed that surprising strength to an unusual degree of labor hoarding that was resulting in a more-pronounced cyclical sag in productivity than is typical. Now that the employment figures have softened, we are inclined to let much of that softness show through in higher labor productivity rather than weaker output. Still, there is no denying that labor demand over the past three months now looks a bit weaker than we expected. We see the incoming data taken together as suggesting that there was a bit more strength to the expansion through the summer than we had earlier recognized. But we have seen little to suggest that the economy was either gathering any momentum or seriously faltering as we entered the period of increased financial turbulence. Obviously, getting the starting point right for the projection is important. But the main action in this forecast has been our reaction to developments in mortgage and other credit markets. I would love to dazzle you this morning with precise scientific estimates of the effects on spending and activity of difficulties involving subprime mortgages, structured-investment vehicles, leveraged loans, and the like. But, sadly, that will not be the case. Rather, because you seem to be on the brink of joining me in the humbling world of forecasting, I thought that I would invite you to don your hair nets and white butcher smocks and join me for a tour of the sausage factory. [Laughter] The difficulty we confronted in this forecast is that, even after decades worth of research on credit channels and financial accelerators—much of it done by economists at all levels in the Federal Reserve System—the financial transmission mechanisms in most of the workhorse macro models that we use for forecasting are still rudimentary. As a result, much of what has occurred doesn’t even directly feed into our models. But that doesn’t mean that it isn’t important. Indeed, the residuals in our main spending equations seem to be negatively correlated with measures of financial stress. In other words, our models tend to overpredict spending in periods of financial disturbance. To be sure, that general tendency is not evident in all episodes. Shortfalls in spending were sizable in the “headwinds” period of the early 1990s and in the aftermath of the stock market collapse in the early part of this decade. But we have found little evidence of any material effects on spending during the 1998-99 episode. In very broad terms, we were guided in our revisions to the forecast by the average historical tendency of these spending equations to overpredict in periods of financial stress. As for the specifics, we made adjustments in those areas that seem most likely to be affected in this particular episode. Housing, of course, is at the epicenter of the current financial shock. In response to the intensifying problems in mortgage markets and the increasingly bleak anecdotes, we slashed our housing forecast significantly further. We now expect new home sales to drop another 18 percent by the end of this year and single-family starts to drop another 25 percent by early next year. If this forecast comes to pass, this housing downturn will come close to matching in severity that of the late 1970s and early 1980s. Underlying this projection is an assumption that nonprime originations will remain virtually dead in coming months and stage only a modest and partial rebound over the next year and a half. We also expect some of the spillover that we have seen recently in prime jumbo mortgages to persist for a while, though the effects on housing demand from this part of the market are likely to be much smaller. Moreover, in contrast to the partial recovery in nonprime mortgage originations, we are expecting a full recovery in jumbo mortgages to occur by early 2009. Obviously, our estimates of the effects emanating from nonprime and jumbo markets are subject to considerable uncertainty—in terms of both depth and duration. As for the rest of the economy, we don’t think it will escape entirely unscathed by the recent turmoil in financial markets, and we have made some modest downward adjustments also to business investment and consumer spending. In particular, we have marked down a bit our forecast for nonresidential construction on the expectation that higher borrowing costs and tighter underwriting standards will hold down the volume of commercial real estate lending and construction activity in coming quarters. In that regard, we have already seen some increase in “busted contracts” for commercial property transactions. Like the effects in residential mortgage markets, the restraining influences on commercial construction are assumed to fade by the end of next year. We have also revised down our projection for equipment spending, but here the story is a bit different because we are not really anticipating a spillover that will result in significant funding problems for most nonfinancial firms. Rather, in previous forecasts, we had incorporated an extra dollop of spending growth to reflect the general strength of corporate balance sheets and the tendency of some of our models to underpredict equipment spending over the past few years. With heightened uncertainty and less favorable financial conditions, we have moved the E&S forecast down closer to the models in both our August and our September forecasts. Finally, we made a modest downward adjustment to our consumption forecast, in part to account for the likelihood of some tightening of terms and standards on consumer lending and for the possibility that weaker home prices may make it more difficult or expensive for households to finance consumption through the equity in their homes. We also assume that there will be some hit to consumer sentiment in an economy with a weakening labor market, ongoing strains in financial markets, and continuing downbeat news on house prices, home sales, and foreclosures. The restraint imposed by these factors is assumed to fade over the next year—again, on much the same schedule as we are expecting the financial restraints to lessen. I think we have the sign right here, but I must admit that this element of our forecast seems the most problematic to me. To be sure, we’ve already seen a fall in consumer sentiment that, if sustained, would imply a drag on spending going forward that is at least as large as is incorporated in our forecast. Still, the direct fallout of recent developments for the cost and availability of consumer credit could be quite limited, and consumer sentiment could recover more quickly than is assumed in the baseline. I would be more worried about the upside risks of this aspect of our projection if I didn’t also see some sizable downside risks to other elements of our baseline forecast. First, even with the 5 percent decline we have projected over the next two years, house prices will remain at historically high levels relative to rents. With foreclosures increasing, there is a clear risk that the drop in home prices could well be deeper and faster than we expect. Second, implicit in our forecast is the assumption that we are experiencing the worst of the financial turmoil now; there would seem to be more downside risk than upside risk to this assumption. Finally, we are still projecting what amounts to a very soft landing: The unemployment rate rises by a few tenths, growth converges to potential, and inflation levels out near current rates. Such an outcome would be nearly unprecedented. Turning to our inflation forecast, we did not receive any news that materially affected our outlook. Both headline and core PCE prices in July came in a bit lower than we had been forecasting. For the most part, the key conditioning factors governing our inflation projection changed little over the intermeeting period. Food and energy prices were nearly unrevised; nonoil import prices were a touch lower, reflecting lower commodity prices; and most measures of inflation expectations have been roughly unchanged. The only adjustment of note in our inflation forecast was the ¼ percentage point reduction that we made in our estimate of the NAIRU. We did so because of some tendency of our wage and price equations to overpredict inflation over the past few years and because we’ve seen a continuation of some of the structural forces in labor markets that we thought had lowered the NAIRU in earlier periods. The adjustment also better aligns our estimate of the NAIRU with other readings of labor market tightness. All told, some slack in resource utilization now emerges in this forecast. However, because the estimated slope of our aggregate supply function is quite flat and inflation expectations are expected to remain reasonably well anchored, this change is pretty small potatoes for our price forecast. Indeed, it trimmed only 0.1 percentage point from our forecast of overall and core PCE price inflation in both 2008 and 2009. That concludes my tour of the sausage factory. I hope it was somewhat revealing, though I recognize that sausage factories can test the convictions of even the most ardent proponents of full transparency. Karen will now continue our presentation." FOMC20060510meeting--96 94,MR. FISHER.," The two house builders together built 700,000 homes; as you know, that industry is consolidating. I asked them point blank whether the rates are killing them. Now, you have to take this with some skepticism, but they said no. The real issue here is that this highly speculative medium is becoming incredibly liquid. There is obviously a self-feeding mechanism, and the statistic that probably illustrates it best is Palm Beach, Florida. Last year, 6,000 homes were listed for sale. This year, as of last week, 17,000 homes are listed for sale. So what you have is a secondary market that is being speculated with, and advance liquidity provided by the financing mechanisms, and a lot of turmoil in that portfolio. This type of entrepreneur almost always sees things as better than they actually are, and I do pay very close attention to the kind of data that we’re seeing. But interest rates don’t seem to be the key issue, though obviously they kick in because of the way mortgages are priced. As far as the consumer is concerned—and Bill and I both talk to Wal-Mart in depth—they are obviously more worried about gas prices than they are about interest rates. So I have a bit of schizophrenia like David. David, schizophrenia beats dining alone. [Laughter] We can always talk to ourselves, when we can’t talk to anybody else. The net feeling is that growth is stronger than we’re forecasting, and inflation—I agree with President Lacker and the others—is making me feel uncomfortable." CHRG-110hhrg44901--204 Mr. Perlmutter," That was the time the market realized that housing prices weren't always going to go up. That is the way I would describe it. A lot of it was just based on increased housing prices over time. " FOMC20050202meeting--92 90,MR. SLIFMAN.,"3 Thank you, Mr. Chairman. We’ll be referring to the package of materials entitled “Staff Presentation on the Economic Outlook.” As you know from reading the Greenbook, the only material change in our forecast since the December FOMC meeting concerns prospects for the near term. So, after briefly reviewing some of the recent high-frequency indicators, I’ll focus my discussion on the fundamental forces that we see driving economic activity over the next two years. With regard to the very near-term outlook, your first chart shows a variety of data series that have informed our judgments. The upper panels highlight two “production side” indicators. As illustrated in the upper left, private nonfarm payroll employment rose 181,000 per month, on average, in the fourth quarter, a noticeable pickup from the third-quarter pace. In addition, the Board’s index of industrial production continued to show above-trend gains in manufacturing sector activity. Most forward-looking indicators of production, such as the regional business surveys conducted by the Reserve Banks and the ISM [Institute for Supply Management] manufacturing report that was released yesterday, also point to continued near-term gains, although perhaps not as robust as late last year. The data on private final sales also look quite favorable. Real PCE excluding motor vehicles (the middle left panel) rose rapidly in the fourth quarter, and motor vehicles (the panel to the right) continue to sell at a brisk pace. After the Greenbook was published, we received information on orders and shipments for nondefense capital goods. As shown by the inset box in the lower left panel, shipments excluding aircraft rose 2.2 percent and orders advanced 1.8 percent in December. These figures were about in line with our expectations. All told, our estimate of fourth-quarter real GDP growth, shown on line 1 of the table, was fairly close to BEA’s [Bureau of Economic Analysis]—especially after BEA factors in an error in the Canadian trade statistics that apparently depressed estimated U.S. exports. Karen will have more to say about the Canadian numbers shortly. In any event, we see no reason to alter our first-quarter forecast as a result of the BEA’s fourth-quarter GDP estimate. Your next chart presents an overview of the forecast. As described in the first bullet of the upper panel, our forecast is predicated on a continuing withdrawal February 1-2, 2005 69 of 177 of monetary accommodation over the next two years, with the federal funds rate reaching 3 percent in the fourth quarter of this year and 3½ percent in the latter part of 2006—a path quite similar to that implied by futures quotes. Regarding fiscal policy, we’ve reduced our deficit projection for fiscal year 2005 more than $20 billion, primarily reflecting stronger incoming data on corporate tax receipts; the deficit in 2006 is unchanged from the previous Greenbook. But the change to our deficit estimate has virtually no effect on our preferred indicator of fiscal stimulus, FI, which is designed to capture the macroeconomic effects of exogenous policy changes. FI is expected to be neutral in 2005 and to provide only a small positive impetus to GDP growth in 2006. Although oil prices have moved higher in recent weeks, the futures market continues to see the likely path as pointing downward from here forward, and, as usual, we have conditioned the forecast on their views. Karen and I will both have more to say about oil prices. And, as Karen will discuss, the staff expects the foreign exchange value of the dollar to drift down. As for asset values, stock prices are assumed to rise 6½ percent this year and next, which would roughly maintain risk- adjusted parity with the yield on long-term bonds, while the rate of increase in house prices is expected to slow considerably from last year’s torrid pace. As shown in the bottom panel, real GDP is projected to rise at a 3¾ percent rate, on average, over the projection period, about half a percentage point faster than our estimate of potential GDP growth. Spending on private consumption and fixed investment (line 2) is the main contributor to GDP growth, although some of the growth in that demand is expected to be satisfied by foreign producers (line 3). Domestic production is also boosted by export demand and government purchases (lines 4 and 5), while inventory investment is roughly neutral. Exhibit 3 examines the forces that we think will be working to produce two more years of above-potential growth. Monetary policy continues to be an important factor. As shown in the middle left panel, even with the assumed policy tightening over the next two years, the real funds rate is projected to remain below its long-run average and on the stimulative side of the short-run measures of r* shown in the Bluebook. February 1-2, 2005 70 of 177 As I noted earlier, after the rapid run-up last year, we expect oil prices to drift down over the next two years, which should be a small plus for domestic spending power and GDP growth. Turning to the final bullet in the upper panel, we estimate that the higher oil prices in 2004 reduced GDP growth by three-fourths of a percentage point last year. In our forecast, the negative effects wane to a quarter of a percentage point in 2005 as oil prices begin to recede; the projected decline in oil prices then boosts GDP growth a couple of tenths in 2006. Exhibit 4 focuses on the household sector. Consumption outlays (the blue bars in the upper left panel) grow at a 3¾ percent rate this year and next, a shade less than in 2004. We expect income growth (the red bars) to step up as the labor market strengthens. Moreover, household financial positions—as summarized by the financial obligations ratio, to the right—seem solid. However, the downdrift in household net worth relative to income that we project in the baseline forecast, and depicted by the black line in the middle left panel, imparts a slight drag on spending. In addition, the strength of consumer spending last year pushed the saving rate (not shown) to an unusually low level, and, as a consequence, consumer spending also is expected to be restrained a bit during the forecast period by a desire on the part of households to rebuild savings. One risk to the forecast that we discussed in the Greenbook is the possibility of a real estate slump. In the Greenbook alternative simulation, depicted by the red line in the middle right panel, we assumed that house prices fall a little more than 10 percent cumulatively over the next two years, leaving the level 20 percent below the baseline. Such an outcome, especially if accompanied by a drop in consumer confidence, would restrain PCE and GDP growth appreciably over the next two years. But, even with the implied loss of household wealth, the ratio of net worth to income that comes out of the alternative simulation (the red line in the middle left panel) is still quite high by historical standards. Accordingly, we don’t see this scenario as causing a serious debilitation of household sector financial health, on the whole. In the housing market, the lower panels, annual single-family starts are projected to remain close to the 1.6 million unit mark over the next two years. Favorable mortgage rates are expected to provide ongoing support to housing activity in our forecast. And, as with consumer spending, solid income gains also support housing demand. February 1-2, 2005 71 of 177 longer-run average. Demand is supported, in part, by a shrinking margin of unused capacity over the next two years, as depicted in the panel to the right. However, as shown in the middle left panel, the rate of return on capital is projected to ebb over the next two years, which tempers our forecast slightly. We interpret the results of the special questions on capital spending asked by the staffs at the Reserve Banks—summarized in the table to the right—as being broadly consistent with our view that this will be a pretty good year, on balance, for business equipment investment, although probably not quite as brisk as in 2004. The usual accelerator effects were the primary reason given by survey respondents for boosting capital spending this year; additionally, a sizable fraction of respondents pointed to replacement needs as an important consideration. The remainder of the chart highlights two of the risks to the forecast for equipment spending. An upside risk that we highlighted in the Greenbook is the possibility that we have been wrong about the effects of partial expensing. If so, the alternative simulation of FRB/US, shown by the blue bars in the lower left panel, suggests that equipment and software spending could increase considerably faster than in the baseline. One downside risk to the forecast for high-tech equipment, which Governor Ferguson noted in a speech recently, is the possibility that the pace of technical advancement in computers is slowing. As you know, the speed at which quality- adjusted computer prices fall is a rough indicator of the pace of technological progress for that equipment. The constant-quality price index for desktop computers that we use for constructing industrial production is shown in the lower right panel. The price declines are decomposed into declines that we attribute to improvements in production processes—for example, Michael Dell figuring out better ways to assemble boxes—and the price declines that we attribute to technological improvements—for instance, Intel designing better chips to go inside the boxes. As you can see from the red portion of the bars, this decomposition suggests that the rate of technological improvement for computers has slowed appreciably. A further slowing in the pace of innovation going forward would imply less spending for upgrades than is implicit in our forecast. However, recent announcements by Intel and AMD regarding introduction schedules for their next-generation chips give a hint that a return to a faster pace of technological improvements may be in train. If this speed-up in planned improvements to semiconductors is, in fact, realized, that should translate into faster technological progress for computers. Sandy will now continue our presentation. February 1-2, 2005 72 of 177 job creation last year. Businesses reportedly have become convinced that the economic expansion is on a solid footing, and we are anticipating that they will be hiring more aggressively. That said, we do not think firms are abandoning their focus on boosting efficiency. As shown in the upper right panel, we expect structural labor productivity to continue to rise at a brisk pace over the forecast period, albeit below that experienced from 2001 to 2003. Given our investment forecast, we expect a rising contribution from capital deepening (the blue shaded area), while the rate of multifactor productivity [MFP] growth slows from the extraordinary pace witnessed in recent years. We think a good part of the 2001-2003 acceleration reflected one­ time changes in the level of productivity, as firms implemented managerial and organizational changes, rather than a speed-up in the underlying rate of technological progress. Such organizational changes are expected to diminish in importance as the upswing proceeds, and we are forecasting structural MFP growth to move back towards its longer-run average. With this slightly slower rate of structural productivity growth and the pickup in hiring, we are projecting the level of actual labor productivity (the black line in the middle left panel) to move back into line with the level of structural productivity by the end of next year. We also are anticipating that the more favorable labor market conditions will begin to attract workers back into the labor force. As shown in the middle right panel, the labor force participation rate is projected to move up over the projection period after the large declines of recent years. However, the progress here is only modest, and the participation rate remains below its estimated trend. The combination of above-trend economic growth and rising participation rates is sufficient in our forecast to keep the unemployment rate (shown in the lower left panel) on a gradual downtrend, reaching 5 percent—our estimate of the NAIRU—by the end of next year. The ratio of employment to population—a measure of slack that combines movements in both the unemployment rate and the labor force participation rate—increases slightly over the projection period. February 1-2, 2005 73 of 177 middle left) have drifted upward slightly in response to the increases in energy prices, and we expect this to be reflected in wage demands this year. In addition, the lagged effects of the acceleration in structural labor productivity also should result in somewhat larger gains in compensation. Moreover, the depressing effect of labor market slack (shown in the middle right panel) is projected to diminish over the projection period. These forces are manifest in our projection of a somewhat faster rate of increase in the growth of wages (shown on the lower left), but this is offset by slower growth in benefits. This slowdown reflects smaller increases in employer contributions to retirement and saving plans, after these payments surged in 2004. Your next chart reviews recent price developments. As shown in the upper left panel, the 12-month change in consumer prices moved up sharply last year, mainly in response to higher energy prices (shown in the upper right panel). As you know, higher world crude oil prices and supply-driven fluctuations in domestic refining margins were responsible for the swings. Increases in food prices (the middle left panel) were relatively stable. As indicated in the middle right panel, the rate of increase in core consumer prices moved up to about a 1½ percent rate in early 2004 and held at about that pace for the remainder of the year. As indicated in the table on the lower left, all of this acceleration occurred in goods prices, where, in addition to a large, idiosyncratic swing in used cars, price increases were broad- based. In our view, the underlying acceleration in goods prices reflects the run-up in intermediate materials prices shown on the right, the pass-through to the retail level of higher energy costs, and the weaker foreign exchange value of the dollar. Your next chart presents the outlook for inflation. The rate of increase in total PCE prices (shown on the upper left) is expected to slow to a 1¼ percent pace in 2005 and 2006. Energy prices (shown on the upper right) are expected to retrace part of last year’s run-up over the projection period, while the rate of increase in food prices (not shown) slows by about ¾ percentage point. Core inflation (shown on the middle left) is projected to remain at a 1½ percent rate. This projected stability of core inflation reflects several offsetting factors. The slower pace of structural labor productivity is expected to result in somewhat faster growth in trend unit labor costs, and the declining margin of slack in labor and product markets is projected to exert less downward pressure on wages and prices. Offsetting these influences, the rate of increase in core, nonfuel import prices (shown on the middle right) is forecasted to fall back to zero in 2006, and the indirect effects of lower energy prices are expected to put downward pressure on retail prices. February 1-2, 2005 74 of 177 markup (shown on the lower left) at its present level. Under these circumstances, core PCE inflation (shown as the red line in the lower right panel) rises to almost 2½ percent in 2006. In the lower-inflation alternative, we assume that the rate of increase in structural multifactor productivity growth does not slow as in the baseline forecast but holds at a 2¼ percent rate over the 2004-2006 period. In implementing this simulation, we have assumed that financial markets have already incorporated this expectation, and thus there is no additional effect on asset prices. With the faster rate of structural MFP growth boosting aggregate supply, core PCE inflation slows to 1 percent in 2006. Karen Johnson will now continue our presentation." 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-110hhrg34673--145 Mr. Clay," Thank you, Mr. Chairman, and thank you for holding this hearing. Mr. Bernanke, welcome. I represent the First Congressional District of Missouri, which is comprised of north St. Louis City and north St. Louis County. Continuing with the same line of questioning as the gentleman from New Jersey about housing, in my district, and in many other districts across the country, we have a tremendous housing crisis. This must be addressed, and it must be done with urgency, especially when it comes to affordable housing. What changes in housing policy can be made that the United States can better foster an urban housing policy that puts people in homes in the inner cities so that they can build wealth through ownership and pass it on to future generations? What are your ideas on this, and what is your approach to this housing crisis? " FOMC20071211meeting--130 128,MR. LACKER.," Thank you, Mr. Chairman. I favor a ¼ point reduction in the funds rate and the language of alternative B. Perhaps more than usual I think it is important to preserve some flexibility now to respond to incoming information. I would not be surprised if we want to reduce the funds rate another ¼ point at the end of January, but I don’t want to send a signal that would encourage market participants to presume another cut then. So I guess I am in the “grudgingly” camp to which President Yellen referred. Besides, I would welcome a permanent move away from the balance-of-risk-assessment machinery. I do believe we face a good-sized risk of things unraveling and substantially weaker growth in the near term. But my sense is that the risk just isn’t large enough to make me want to support 50 basis points now. While I wouldn’t be surprised with a January rate cut, I don’t think it should be a foregone conclusion. I think we need to be more deliberate about such actions as we go forward. The magnitude of the fallout from our mortgage problems could be substantially clearer in the first half of next year. If the fallout turns out to be smaller and more manageable than we fear, the downside risks to growth prospects could dissipate, even though we still would be working through a bulge of mortgage resets and defaults. Some of us have given a warning that we may need to reverse course promptly and raise rates should conditions improve. You know, it is always attractive to comfort ourselves as we cut interest rates and to promise ourselves that we are willing to do so, but there always seems to be a reluctance to start a sequence of funds rate increases after a series of rate cuts. The usual thing is a fear of sort of an exaggerated reaction in the yield curve. These pressures are likely to be especially acute if, when the time comes, we are still in the midst of significant distress among subprime mortgage borrowers and the housing market. That seems likely. So I think we need to be realistic about prospects for reversing field. To the extent that such pressures would be hard to resist—and I think they would be—we should be very cautious, more cautious than we otherwise would be, about lowering rates. Another reason to be cautious is that overall inflation is well above our targets. As David Stockton pointed out, we have a record of forecasts for food and energy prices based on futures market prices coming in too optimistic over the past several years. I think we need to be concerned about that. I am concerned that market participants might have come to believe that we have placed our concerns about inflation entirely on hold for the duration of the housing market difficulties we face. Such a lexicographic reaction function is what led to the stop-go policy pattern in the pre-1979 era. So I believe it would be a mistake to take our eyes entirely off inflation right now. I am doubtful that a forceful restatement of our assessment of upside inflation risk will be very effective in that regard. We have been doing that, and I think it is falling on increasingly deaf ears. I think that we may come to believe that action is required to back up that sentiment. If inflation drifts up or overall inflation doesn’t come down, I think we need to be prepared to respond to real weakness less than we otherwise would have before. Thank you." FOMC20060629meeting--115 113,MR. KROSZNER.," Thank you, Mr. Chairman. At the last meeting I believe Dave Stockton, when he was describing the outlook, said that he was a bit schizophrenic about it. Given the comments of President Moskow, it is clear that he is no longer schizophrenic but that one side has taken over—the dark side. [Laughter] That does not seem to reflect exactly where everyone is, but I think the issues that have been brought out in the Greenbook are extremely important to consider. I, too, have knocked down my growth estimates a bit, although not quite as much as the Greenbook; and I, too, as many people have said, share a concern that some of the numbers coming in on both headline and core inflation are a bit higher than I had hoped, although I think they are still not out of a manageable range. Obviously, payroll employment growth is a bit less robust than in the previous forecast. Since that forecast, we’ve had a little more cooling in housing and some softening of retail demand. I take a slightly different view of the high tax receipts that have been pouring into the Treasury because they are not only corporate tax receipts but also individual tax receipts. In some sense that’s putting a bit of a drag on real disposable income because people seem to be paying a little more in taxes and, at the same time, labor costs and pay have not been going up. So taxes are potentially a bit of a drag, and the Administration seems able to pursue a tighter expenditure policy this year than it has in the past, so we won’t be getting as much of a boost on the fiscal side as we have had. A number of bright spots have been mentioned here, particularly related to business fixed investment, durable goods orders, and business confidence. But what are some of the key risks that we have before us? Obviously, housing has been discussed in great detail, and so I won’t go through it in more detail. I noted, as Governor Bies did, the importance of cancellations in suggesting a change in the way people are dealing with these markets. If cancellations go up significantly, then a lot more housing stock that is searching for a buyer could be left on the market. Anecdotally, I’ve heard the same kinds of things that President Guynn mentioned, that the equivalent of the toaster is perhaps being given out. Such incentives are not showing up in the reported housing price, but other adjustments are. I’m not quite as optimistic about world economic growth as the forecast is. I think a lot of uncertainties exist there. We have seen and are seeing a lot of elections, particularly in emerging markets. Mexico obviously has one coming up very soon, which could have a significant effect on a very important trading partner of the United States. Also, as a number of people have mentioned, we’re seeing a lot of policy tightening around the world. The obvious question is whether the central banks outside the United States are behind the curve or ahead of the curve. Well, wherever they are, they are moving along a curve, and they seem to be moving more aggressively than they have in the past. I think the tightening is going to have more of an effect than has been embedded in a number of the forecasts, not only here but also at the IMF. Another concern that I have relates to something that President Pianalto mentioned—a disconnect between the numbers that we’re seeing on consumption and business optimism about investment. My concern is about what’s going to be happening to demand for their products down the line. It’s certainly disconcerting to hear that one of the largest private institutions in the world—Wal-Mart—is missing its growth targets fairly significantly. They are a very important part of retail sales. One could even say that they effectively know what retail sales are before the numbers are reported because their sales are so highly correlated with overall retail sales. So my concern is that we’re having the economy do the right sort of thing by moving more toward business investment and a little away from consumption, but if we move too much away from consumption, the demand won’t be there to make the investment pay off. We saw a bit of this in the late 1990s as we moved much more in the investment direction, but the investment turned out not to have the kinds of returns that people were expecting. Now we’re in a very fortunate situation because, even if those returns decline dramatically, a lot of profitability is out there, as Governor Warsh said. So profits could drop quite significantly, but we’re not going to see a real problem in the corporate sector, as we might have in other circumstances. I don’t want to overemphasize this concern, but to me it’s a bit of a puzzle, and I see it definitely as a risk. Turning to the inflation outlook, people have mentioned both here and publicly a cavalcade of concerns about the upticks in PCE and CPI core numbers, which have helped in turn to reduce inflation expectations. Term premiums continue to remain low, and forward rates continue to remain low. Often inflation seems to have a bit of momentum—it continues to move up or stays elevated—even as the economy begins to slow a bit. We have to be careful in deciphering what will continue to move up and what is just inflation that is lagging a bit as the economy slows. We have seen a dramatic change in commodity prices since our last meeting. Basically, within a few days of the meeting on May 10, almost all the major commodities, whether copper, gold, or whichever one you want, came to a peak. Since then, oil has come down a little, although not all that much. I think it’s heartening for the inflation outlook going forward that those elevated levels didn’t stay that elevated. Although those commodity prices are much higher in 2006 than they had been previously, oil prices have not increased that much during 2006. So what’s going to happen to core inflation going forward? I think the excellent presentation that we had, in particular the discussion of the attempts to see how well we are modeling historical inflation and inflation going forward, shows that we have a long way to go and that we don’t really understand those dynamics very well. I share Governor Kohn’s intuition, for the reasons that he articulated, that core inflation going forward will soften a bit more than the Greenbook projects. I’m not going to repeat those reasons; but as Governor Kohn said, there’s a lot of uncertainty about them, and we don’t understand all that much. Ultimately, as a number of people have mentioned, it comes down a lot to the type of statements that we make, the credibility that we have. That’s true not only here but around the world, where we are seeing inflation rates and expected inflation rates come down quite a bit. That’s something that ultimately we control very directly. In today’s circumstances, when inflation is not really out of control but is moving up a little, being very clear about what our concerns are can have benefits in bringing down expectations and perhaps changing the inflation dynamic. Thank you, Mr. Chairman." FOMC20060510meeting--93 91,MR. FISHER.," Mr. Chairman, at the last meeting, I reported the comments of a CEO of a big box retailer who said the economy was “amazing.” I suppose the best summary of what I’m about to report to you in terms of my readings in the field—this time I assiduously talked to twenty-five CEOs and COOs, and I’ll give you that list separately so I won’t bore you with the details—the economy is even more amazing than it was before. That is, we see a shift taking place from consumption-driven to business-investment-driven growth, but also, unfortunately, we see evidence that inflation is raising its ugly head and that inflation expectations are higher as we go through time. Let me give you some specifics. According to reports from shippers that I’ve talked to, the shipping market for bulk and containers is stronger in the second quarter than it was in the first quarter. Karen, there is a report, which is why I would like to see a more definitive version, of fleet utilization running well over 90 percent and waiting time in ports increasing significantly. My rail contacts report that rail traffic as of April 22 is up 4½ percent for the year. They expect higher growth in the second quarter than in the first quarter. UPS is planning for “some moderation in volume” but “hasn’t seen any sign yet of a slowdown, discounting for the late Easter.” An airline with 80 million passengers reports very strong advance bookings through July in every region of the country. Some pressure from gas going over $3 at the pump has been reported, particularly in the past two weeks, by the retailers at every price point; and yet there’s an interesting shift taking place. For example, JCPenney now runs a billion dollars worth of sales through the Internet. That growth rate is increasing; it’s 23 percent. This way of presenting their products to the market helps to offset the oil price effect. In the IT sector, the book-to-bill ratio of the large semiconductors is still greater than 1. Companies like EDS and other “productivity enhancers” are seeing increased demand for their products, which they interpret as a vote of confidence. We’re also seeing increased demand for storage capacity, which many would interpret as a vote of confidence going forward in the business picture. From the largest bank in our District, the report is that volume is “so good you’re able to eat it.” They report, by the way—I don’t want to give offense to any sector of our economy—that the only people having credit problems are personal injury lawyers in Texas because of the reform that has taken place there. But other than that, the credits, as reported by banks, look to be in very, very good shape. In terms of the housing market, you may recall my last report from a large house builder who built 400,000 homes thus far. I’ve expanded that to another builder of similar size. The cancellation rate now, David, is up to 40 percent—a key indicator. However, it has shifted around the country, and in our state they report that you’d have to be a princess on a pea to feel any discomfort with the Texas housing market. It is booming, unlike the Florida market—which, as you know, is cascading. As far as cost-cutting capital expansion, it continues. Fluor reports a remarkable first-time-in- history statistic, which is that every single sector that they deal with, and every one of their product lines, is on the uptick. I want to report one particular project in summary that just puts things in perspective. Texas Utilities is about to announce a $10 billion coal-processing plant. This is conversion from coal to electricity. It will generate 40,000 jobs in our state to construct and 21,000 permanent jobs. But here’s the interesting statistic. It’ll take 12 million manhours and womanhours to construct. The CEO reports that ten years ago all those jobs would have been American jobs. Only 4 million of the manhours and womanhours to construct this project will be American jobs; the rest of the construction will be done in China or in Germany. Five years ago, it would have taken six years to build. According to the CEO, they’ll build it in three years, and to go to President Moskow’s point, yesterday the CEO of a large—as we used to say—“underwriting house” in New York offered to assume all the financing. They will finance at 100 percent nonrecourse. There’s a lot of liquidity in the system. We are concerned about prices. We see pricing power creeping upward in the reports we’re getting from the CEOs. As you know, our compass in Dallas is the trimmed mean PCE. It’s running at a rate of about 2.3 percent. At some point in the future, Mr. Chairman, I would like to provide a memo on that particular measure of inflation, which we consider to be a more reliable indicator of future inflation. But the point is that, in all of our soundings among these operators of businesses, they are feeling increasing price pressure, both at the intermediate level and at the consumer level. There are two little indicators that I found interesting. One is that Texas Instruments, which usually has 200 or 300 jobs maximum outstanding and looks for highly trained engineers, is now trying to fill 1,000 of those jobs and having trouble filling them. Second, at the other end of the range, 7- Eleven reports that in Florida, the Great Lakes District, and the Chesapeake Bay area, they cannot find $7- to $8-an-hour sales clerks. They are having to raise their prices. In short, we view this economy to be something like a 2006 BMW Z4 Roadster—Bluetooth- enabled, by the way. It’s complex, it’s highly integrated, it’s a technically advanced machine that apparently cannot help itself from exceeding the speed limit. [Laughter] Thank you." FOMC20060510meeting--21 19,MR. KOHN.," It’s in both the House and the Senate bills, but the House bill is a very different bill. It has controversial things in it." CHRG-110shrg50369--54 Mr. Bernanke," I could probably obtain such data. I am not sure that directly trying to stimulate specific types of house construction is necessarily the most efficient way to go about it. Probably the better thing is to try to ensure strong employment so people have the income and they can purchase the home they want to have, or they can rent if they prefer. But I do not have the data with me. Senator Bennett. Well, I would appreciate it if we could get some because I find this an intriguing idea. I know in Utah, which has not been hurt as badly by the housing problem as some other States--because we generate something like 30,000 new families every year that need houses. But in Utah, above a certain level, around $400,000, there is a glut of houses on the market and, therefore, nobody in that market or above can sell their house. But for houses in the $200,000 area, which we would now begin to think of as an affordable housing range, there does seem to be something of a shortage. So if you have any data on that that you could share with us, I would appreciate it. Because as we formulate the stimulus package, Mr. Chairman, this is something I think we ought to look at. It is a little more sophisticated and has drilled down through the data to a more granular level. But anything we can do to get the construction business started--you say, well, it is maybe too long term out, but there are a lot of jobs that people can get in the construction business if they are building the lower-priced houses that right now the construction workers do not have anything to do. " FOMC20050630meeting--8 6,MR. GALLIN.,"3 Thank you. My presentation begins on the third page of the handout you received. It seems that everybody is talking about house prices, and the upper panel of your first exhibit shows why: House prices, adjusted for general inflation, have risen at a rapid pace in recent years and did not even pause during the last recession. Indeed, the real rate of appreciation has increased, and the most recent readings have been at annual rates greater than 7 percent. By comparison, the average annual increase in real house prices during the past 30 years is only about 1¾ percent. The next two panels illustrate some of the eye-popping gains that have been recorded in selected metropolitan areas. For example, as shown in the middle left panel, real house prices increased about 16 percent in San Francisco and 30 percent in Las Vegas during the four-quarter period ending in the first quarter; as shown to the right, the most recent gain was 13 percent in New York and 20 percent in Miami. Rapid price appreciation has sparked debate about whether housing has become overvalued, and the popular press is filled with stories suggesting that it has. As summarized in the lower left panel, anecdotes suggesting that the housing market is overheated include those about increased speculation, purchase decisions that are perhaps too dependent on rosy assessments of future appreciation, and increased reliance on novel forms of financing without full recognition of the associated risks. Although these anecdotes are suggestive, they do not provide a benchmark for valuing housing. Two approaches that do provide a benchmark are listed to the right. One is to ask if housing is affordable for a typical family. Some analysts have argued that prices are too high relative to incomes, while others say low interest rates have kept required monthly mortgage payments affordable. Another approach is to ask if house prices are properly aligned with rents. I have pursued both approaches in my research, and have concluded that rents provide a preferable benchmark for valuing housing. I will therefore focus my prepared remarks on this approach. June 29-30, 2005 5 of 234 price of a house should reflect the appropriately discounted stream of expected rents; high prices could be justified by high rents or by low carrying costs, which include interest payments, net taxes, and depreciation. But if prices appear unusually high relative to rents and carrying costs, one might conclude that housing is overvalued. As highlighted to the right, I have implemented the framework using repeat- transactions price indexes from the Office of Federal Housing Enterprise Oversight [OFHEO] and Freddie Mac and the tenants’ rent index from the consumer price index. I made several adjustments to these series to address some of the shortcomings of the published data. As you will see in Dick Peach’s presentation, he and I disagree about the best way to measure house prices. I would be happy to discuss the issue during the question period. That said, the red line in the middle panel shows the estimated price-rent ratio for the stock of housing, and the black line shows the estimated real carrying cost of housing. The first point to note is that the measured price-rent ratio is currently higher than at any earlier time for which we have data. Moreover, the run-up in prices appears to be far greater than can be explained by carrying costs, at least if we use the historical relationship between the two series as our guide. Although theory suggests a tight link between carrying costs and the price-rent ratio, the data suggest that the actual link is more tenuous. At the simplest level, while the price-rent ratio is at a historical high, the carrying cost is not at a historical low. More formally, regression analysis suggests that prices are about 20 percent too high given rents and carrying costs. One might reasonably ask what this potential 20 percent overvaluation portends for house prices. The lower panel summarizes the historical experience on this question. The panel shows a scatter plot of the price-rent ratio (on the horizontal axis) and changes in real house prices over the subsequent three years (on the vertical axis); the panel also includes a fitted regression line. As I mentioned a moment ago, carrying costs are only slightly correlated with the price-rent ratio. Thus, their effects can be excluded from the chart without materially affecting the results. June 29-30, 2005 6 of 234 then, real prices actually increased more than 20 percent, and the price-rent ratio rose to about 27—literally off the chart. To give an impression of what has happened in local markets, the upper panel of your next chart summarizes housing-market conditions for four metropolitan areas: San Francisco, New York, Chicago, and Miami. The panel displays the deviation of each city’s price-rent ratio from its long-run level in the second quarter of 1979 (the red bars), the fourth quarter of 1989 (the black bars), and the first quarter of 2005 (the green bars). The numbers above the bars indicate their height. The first two episodes represent previous peaks of the price-rent ratio at the national level. The third episode is where we are now. The numbers below the red and black bars show the performance of real house prices in each city in the three years following each episode. For instance, as shown by the red bar, the price-rent ratio in San Francisco was 7 percent above its long-run level in the middle of 1979. During the subsequent three years, real house prices there fell 5 percent. At the end of 1989 (the black bar) the price-rent ratio in San Francisco was 15 percent above its long-run level, and real prices there fell 12 percent during the subsequent three years. The most recent reading for San Francisco indicates that the price-rent ratio is now further above its long-run level than in either 1979 or 1989. The price-rent ratios suggest that housing is overvalued in the other three cities as well, but to differing degrees. Although the price-rent ratio in New York is elevated, housing does not look much more overvalued there than it did in the late 1980s. House prices appear elevated relative to rents in Chicago as well, but it is Miami that stands out as the most overheated of the four markets shown here. June 29-30, 2005 7 of 234 The middle right panel shows the implications of these two models for the four- quarter percent change in real house prices at the national level during the Greenbook forecast period. The basic model—in green—suggests that house prices will decelerate in the coming two years, but that they will still rise faster than their long-run average of about 1¾ percent per year. Thus, even a model that ignores the long-run relationship between the levels of prices and rents predicts a slowdown in house-price appreciation. Still, housing would become slightly more overvalued relative to rents at the end of the forecast period. The error-correction model—in red—calls for prices to decelerate more in the coming two years, with real prices actually edging down a bit in 2006. In this scenario, housing would be about 15 percent overvalued at the end of the forecast period. Note that the June Greenbook forecast—the black line—lies between the two model simulations. To sum up, the statistical evidence that I have presented today provides support for the view that the price-rent ratio can be a useful tool for summarizing housing valuations. The price-rent ratio is currently very high by historical standards, suggesting that housing might be overvalued by as much as 20 percent. Historical experience suggests that the change in real house prices going forward will be slower than in recent years. Unfortunately, the evidence cannot rule out either further rapid gains in house prices for a time or a more rapid correction back to fundamentals. Just as the price-dividend ratio is an imperfect tool for forecasting stock prices, the price-rent ratio should be considered only a rough guide to valuations in the housing market. Thank you." CHRG-109shrg30354--52 Chairman Bernanke," Senator, on your first point about housing, we are watching housing market very carefully. I would point out that there have been some offsets in nonresidential construction, in exports, and in investment. So other parts of the economy are picking up to offset some of the weakness we see in the housing market. But we are watching that very carefully. Your point on owner-occupied equivalent rent is a good point and we are quite aware of it. Senator Sarbanes. Seventy percent of the housing in this country is owner occupied; correct? " FOMC20070321meeting--58 56,MR. POOLE.," Dave, I have a question related to housing. I gather that a good part of the projection that the drag from housing will work off by the end of this year comes from the belief that sales will gradually clean out the inventory of unsold homes and, once that happens, construction can return to the rate of sales. That’s the unsold inventory of recently built new homes that I guess have never been occupied. If you take the housing boom over, say, the three years ending in the middle of last year, was there an accumulation of houses that ran beyond the underlying demographics and income—and the financing costs, too? I’m interested in those longer-run determinants of the equilibrium stock of housing. Did we end up with a stock of housing that outran the underlying long-run determinants and has to be worked off—in the sense that the underlying determinants have to catch up to the stock that has already been constructed?" CHRG-110shrg50369--61 Mr. Bernanke," I will try. It is important for the U.S. economy to be strong and an attractive place for investment. And I think we are better off in the medium term trying to ensure good, strong growth in the economy to attract foreign investment than we are falling behind and allowing the economy to drop into a severe decline. So there is a balance there. We have to think about the short-term return, which is partly related to our interest rate decisions, but we also need to think about the medium term, where we want to make sure the economy is growing in a stable and healthy way which will attract foreign investment. Foreign investment, I should emphasize, continues to be strong. We are not seeing any significant shifts of out of dollars among official holders, for example. And I anticipate that we will continue to have the capital inflows we need, in part, going back to my earlier comments, because I do think that the world recognizes that the U.S. economy has underlying strengths and resilience that will bring us back to a strong growth path within the next couple of years. Senator Menendez. If then the Fed's decision at this point in time--of course, it always depends upon the point in time--is that dealing with the slowing economy is the present priority, and as the Chairman has said on more than one occasion, that if there is a great challenge in the economy, it stems from the mortgage meltdown, the housing market meltdown, are we--I have a real concern. You know, in March of last year, I and a few others said we are going to have a foreclosure tsunami, and everybody pooh-poohed that and said that is an overexaggeration. And, unfortunately, we are well on our way, and we have not even seen the totality of it. The question is, when I see the Center for Responsible Lending say that basically the present administration's plans will only deal with 3 percent of the properties, removing them from foreclosure, and I see Moody's saying that the experience of 2007 is largely around 3.5 percent of workout, at the end of the day is a 97-percent market correction something that we are willing to accept and something that we need to accept? Or is that a percentage that is far too high? " 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. " CHRG-109shrg24852--5 STATEMENT OF SENATOR WAYNE ALLARD Senator Allard. Thank you, Mr. Chairman, for holding this hearing, and I would like to join my colleagues in welcoming Federal Reserve Board Chairman Greenspan to the Committee today to discuss monetary policy and the state of the U.S. economy. I also look forward to the opportunity to hear from Chairman Greenspan. His expertise and insight is always helpful to the Committee. Chairman Greenspan, I was pleased to hear in your testimony before the House yesterday that the outlook for the U.S. economy is positive and one of sustained growth. Under your leadership, the Federal Reserve Board has done a good job monitoring the U.S. economy and managing monetary policy, as appropriate. Since this will be the last time you will be delivering the Fed's monetary policy report in your current term--and I hope you continue to serve--I want to take this opportunity to congratulate you on a job well done. I also want to thank you on behalf of the American people for your years of public service. We have all been the beneficiaries of your careful approach, and your service has set a high standard. Thank you for taking the time out of your busy schedule to be here, and I look forward to hearing your testimony. " CHRG-111shrg51395--117 PREPARED STATEMENT OF JOHN C. COFFEE, JR. Adolf A. Berle Professor of Law, Columbia University Law School March 10, 2009 Enhancing Investor Protection and the Regulation of Securities Markets ``When the music stops, in terms of liquidity, things will get complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing.'' ----Charles Prince, CEO of Citigroup Financial Times, July 2007 Chairman Dodd, Ranking Member Shelby, and Fellow Senators, I am pleased and honored to be invited to testify here today. We are rapidly approaching the first anniversary of the March 17, 2008, insolvency of Bear Stearns, the first of a series of epic financial collapses that have ushered in, at the least, a major recession. Let me take you back just one year ago when, on this date in 2008, the U.S. had five major investment banks that were independent of commercial banks and were thus primarily subject to the regulation of the Securities and Exchange Commission: Goldman Sachs, Merrill Lynch, Morgan Stanley, Lehman Brothers, and Bear Stearns. Today, one (Lehman) is insolvent; two (Merrill Lynch and Bear Stearns) were acquired on the brink of insolvency by commercial banks, with the Federal Reserve pushing the acquiring banks into hastily arranged ``shotgun'' marriages; and the remaining two (Goldman and Morgan Stanley) have converted into bank holding companies that are primarily regulated by the Federal Reserve. The only surviving investment banks not owned by larger commercial banks are relatively small boutiques (e.g., Lazard Freres). Given the total collapse of an entire class of institutions that were once envied globally for their entrepreneurial skill and creativity, the questions virtually ask themselves: Who failed? What went wrong? Although there are a host of candidates--the investment banks, themselves, mortgage loan originators, credit-rating agencies, the technology of asset-backed securitizations, unregulated trading in exotic new instruments (such as credit default swaps), etc.--this question is most pertinently asked of the SEC. Where did it err? In overview, 2008 witnessed two closely connected debacles: (1) the failure of a new financial technology (asset-backed securitizations), which grew exponentially until, after 2002, annual asset-backed securitizations exceeded the annual total volume of corporate bonds issued in the United States, \1\ and (2) the collapse of the major investment banks. In overview, it is clear that the collapse of the investment banks was precipitated by laxity in the asset-backed securitization market (for which the SEC arguably may bear some responsibility), but that this laxity began with the reckless behavior of many investment banks. Collectively, they raced like lemmings over the cliff by abandoning the usual principles of sound risk management both by (i) increasing their leverage dramatically after 2004, and (ii) abandoning diversification in pursuit of obsessive focus on high-profit securitizations. Although these firms were driven by intense competition and short-term oriented systems of executive compensation, their ability to race over the cliff depended on their ability to obtain regulatory exemptions from the SEC. Thus, as will be discussed, the SEC raced to deregulate. In 2005, it adopted Regulation AB (an acronym for ``Asset-Backed''), which simplified the registration of asset-backed securitizations without requiring significant due diligence or responsible verification of the essential facts. Even more importantly, in 2004, it introduced its Consolidated Supervised Entity Program (``CSE''), which allowed the major investment banks to determine their own capital adequacy and permissible leverage by designing their own credit risk models (to which the SEC deferred). Effectively, the SEC abandoned its long-standing ``net capital rule'' \2\ and deferred to a system of self-regulation for these firms, which largely permitted them to develop their own standards for capital adequacy.--------------------------------------------------------------------------- \1\ See John C. Coffee, Jr., Joel Seligman & Hillary Sale, SECURITIES REGULATION: Cases and Materials (10th ed. 2007) at 10. \2\ See Rule 15c3-1 (``Net Capital Requirements for Brokers and Dealers''), 17 CFR 240.15c3-1.--------------------------------------------------------------------------- For the future, it is less important to allocate culpability and blame than to determine what responsibilities the SEC can perform adequately. The recent evidence suggests that the SEC cannot easily or effectively handle the role of systemic risk regulator or even the more modest role of a prudential financial supervisor, and it may be more subject to capture on these issues than other agencies. This leads me to conclude (along with others) that the U.S. needs one systemic risk regulator who, among other tasks, would have responsibility for the capital adequacy and safety and soundness of all institutions that are too ``big to fail.'' \3\ The key advantage of a unified systemic risk regulator with jurisdiction over all large financial institutions is that it solves the critical problem of regulatory arbitrage. AIG, which has already cost U.S. taxpayers over $150 billion, presents the paradigm of this problem because it managed to issue billions in credit default swaps without becoming subject to regulation by any regulator at either the federal or state level.--------------------------------------------------------------------------- \3\ I have made this argument in greater detail in an article with Professor Hillary Sale, which will appear in the 75th Anniversary of the SEC volume of the Virginia Law Review. See Coffee and Sale, ``Redesigning the SEC: Does the Treasury Have a Better Idea?'' (available on the Social Science Research Network at http://ssrn.com/abstract=1309776).--------------------------------------------------------------------------- But one cannot stop with this simple prescription. The next question becomes what should be the relationship between such a systemic risk regulator and the SEC? Should the SEC simply be merged into it or subordinated to it? I will argue that it should not. Rather, the U.S. should instead follow a ``twin peaks'' structure (as the Treasury Department actually proposed in early 2008 before the current crisis crested) that assigns prudential supervision to one agency and consumer protection and transparency regulation to another. Around the globe, countries are today electing between a unified financial regulator (as typified by the Financial Services Authority (``FSA'') in the U.K.) and a ``twin peaks'' model (which both Australia and The Netherlands have followed). I will argue that the latter model is preferable because it deals better with serious conflict of interest problems and the differing cultures of securities and banking regulators. By culture, training, and professional orientation, banking regulators are focused on protecting bank solvency, and they historically have often regarded increased transparency as inimical to their interests, because full disclosure of a bank's problems might induce investors to withdraw deposits and credit. The result can sometimes be a conspiracy of silence between the regulator and the regulated to hide problems. In contrast, this is one area where the SEC's record is unblemished; it has always defended the principle that ``sunlight is the best disinfectant.'' Over the long-run, that is the sounder rule. If I am correct that a ``twin peaks'' model is superior, then Congress has to make clear the responsibilities of both agencies in any reform legislation in order to avoid predictable jurisdictional conflicts and to identify a procedure by which to mediate those disputes that are unavoidable.What Went Wrong? This section will begin with the problems in the mortgage loan market, then turn to the failure of credit-rating agencies, and finally examine the SEC's responsibility for the collapse of the major investment banks.The Great American Real Estate Bubble The earliest origins of the 2008 financial meltdown probably lie in deregulatory measures, taken by the U.S. Congress at the end of the 1990s, that placed some categories of derivatives and the parent companies of investment banks beyond effective regulation. \4\ Still, most accounts of the crisis start by describing the rapid inflation of a bubble in the U.S. housing market. Here, one must be careful. The term ``bubble'' can be a substitute for closer analysis and may carry a misleading connotation of inevitability. In truth, bubbles fall into two basic categories: those that are demand-driven and those that are supply-driven. The majority of bubbles fall into the former category, \5\ but the 2008 financial market meltdown was clearly a supply-driven bubble, \6\ fueled by the fact that mortgage loan originators came to realize that underwriters were willing to buy portfolios of mortgage loans for asset-backed securitizations without any serious investigation of the underlying collateral. With that recognition, loan originators' incentive to screen borrowers for creditworthiness dissipated, and a full blown ``moral hazard'' crisis was underway. \7\--------------------------------------------------------------------------- \4\ Interestingly, this same diagnosis was recently given by SEC Chairman Christopher Cox to this Committee. See Testimony of SEC Chairman Christopher Cox before the Committee on Banking, Housing and Urban Affairs, United States Senate, September 23, 2008. Perhaps defensively, Chairman Cox located the origins of the crisis in the failure of Congress to give the SEC jurisdiction over investment bank holding companies or over-the-counter derivatives (including credit default swaps), thereby creating a regulatory void. \5\ For example, the high-tech Internet bubble that burst in early 2000 was a demand-driven bubble. Investors simply overestimated the value of the Internet, and for a time initial public offerings of ``dot.com'' companies would trade at ridiculous and unsustainable multiples. But full disclosure was provided to investors and the SEC cannot be faulted in this bubble--unless one assigns it the very paternalistic responsibility of protecting investors from themselves. \6\ This is best evidenced by the work of two University of Chicago Business School professors discussed below. See Atif Mian and Amir Sufi, ``The Consequences of Mortgage Credit Expansion: Evidence from the 2007 Mortgage Default Crisis'', (http://ssrn.com/abstract=1072304) (May 2008). \7\ Interestingly, ``moral hazard'' problems also appear to have underlain the ``savings and loan'' crisis in the United States in the 1980s, which was the last great crisis involving financial institutions in the United States. For a survey of recent banking crises making this point, see Note, Anticipatory Regulation for the Management of Banking Crises, 38 Colum. J. L. & Soc. Probs. 251 (2005).--------------------------------------------------------------------------- The evidence is clear that, between 2001 and 2006, an extraordinary increase occurred in the supply of mortgage funds, with much of this increased supply being channeled into poorer communities in which previously there had been a high denial rate on mortgage loan applications. \8\ With an increased supply of mortgage credit, housing prices rose rapidly, as new buyers entered the market. But at the same time, a corresponding increase in mortgage debt relative to income levels in these same communities made these loans precarious. A study by University of Chicago Business School professors has found that two years after this period of increased mortgage availability began, a corresponding increase started in mortgage defaults--in exactly the same zip code areas where there had been a high previous rate of mortgage loan denials. \9\ This study determined that a one standard deviation in the supply of mortgages from 2001 to 2004 produced a one standard deviation increase thereafter in mortgage default rates. \10\--------------------------------------------------------------------------- \8\ See Mian and Sufi, supra note 6, at 11 to 13. \9\ Id. at 18-19. \10\ Id. at 19.--------------------------------------------------------------------------- Even more striking, however, was its finding that the rate of mortgage defaults was highest in those neighborhoods that had the highest rates of securitization. \11\ Not only did securitization correlate with a higher rate of default, but that rate of default was highest when the mortgages were sold by the loan originator to financial firms unaffiliated with the loan originator. \12\ Other researchers have reached a similar conclusion: conditional on its being actually securitized, a loan portfolio that was more likely to be securitized was found to default at a 20 percent higher rate than a similar risk profile loan portfolio that was less likely to be securitized. \13\ Why? The most plausible interpretation is that securitization adversely affected the incentives of lenders to screen their borrowers.--------------------------------------------------------------------------- \11\ Id. at 20-21. \12\ Id. \13\ See Benjamin J. Keys, Tanmoy K. Mukherjee, Amit Seru, and Vikrant Vig, ``Did Securitization Lead to Lax Screening? Evidence from Subprime Loans,'' (http://ssrn.com/abstract=1093137) (April, 2008). These authors conclude that securitization did result in ``lax screening.''--------------------------------------------------------------------------- Such a conclusion should not surprise. It simply reflects the classic ``moral hazard'' problem that arises once loan originators did not bear the cost of default by their borrowers. As early as March, 2008, The President's Working Group on Financial Markets issued a ``Policy Statement on Financial Market Developments'' that explained the financial crisis as the product of five ``principal underlying causes of the turmoil in financial markets'': a breakdown in underwriting standards for subprime mortgages; a significant erosion of market discipline by those involved in the securitization process, including originators, underwriters, credit rating agencies, and global investors, related in part to failures to provide or obtain adequate risk disclosures; flaws in credit rating agencies' assessment of subprime residential mortgages . . . and other complex structured credit products, . . . risk management weaknesses at some large U.S. and European financial institutions; and regulatory policies, including capital and disclosure requirements, that failed to mitigate risk management weaknesses. \14\--------------------------------------------------------------------------- \14\ The President's Working Group on Financial Markets, ``Policy Statement on Financial Market Developments,'' at 1 (March 2008). Correct as the President's Working Group was in noting the connection between the decline of discipline in the mortgage loan origination market and a similar laxity among underwriters in the capital markets, it did not focus on the direction of the causality. Did mortgage loan originators fool or defraud investment bankers? Or did investment bankers signal to loan originators that they would buy whatever the loan originators had to sell? The available evidence tends to support the latter hypothesis: namely, that irresponsible lending in the mortgage market was a direct response to the capital markets' increasingly insatiable demand for financial assets to securitize. If underwriters were willing to rush deeply flawed asset-backed securitizations to the market, mortgage loan originators had no rational reason to resist them. The rapid deterioration in underwriting standards for subprime mortgage loans is revealed at a glance in the following table: \15\--------------------------------------------------------------------------- \15\ See Allen Ferrell, Jennifer Bethel and Gang Hu, Legal and Economic Issues in Litigation Arising from the 2007-2008 Credit Crisis (Harvard Law & Economics Discussion Paper No. 612, Harvard Law School Program in Risk Regulation Research Paper No. 08-5) at Table 4. Underwriting Standards in Subprime Home-Purchase Loans, 2001-2006---------------------------------------------------------------------------------------------------------------- Debt Year Low/No-Doc Payments/ Loan/Value ARM Share Interest- Share Income Only Share----------------------------------------------------------------------------------------------------------------2001...................................... 28.5% 39.7% 84.0% 73.8% 0.0%2002...................................... 38.6% 40.1% 84.4% 80.0% 2.3%2003...................................... 42.8% 40.5% 86.1% 80.1% 8.6%2004...................................... 45.2% 41.2% 84.9% 89.4% 27.3%2005...................................... 50.7% 41.8% 83.2% 93.3% 37.8%2006...................................... 50.8% 42.4% 83.4% 91.3% 22.8%----------------------------------------------------------------------------------------------------------------Source: Freddie Mac, obtained from the International Monetary Fund. The investment banks could not have missed that low document loans (also called ``liar loans'') rose from 28.5 percent to 50.8 percent over the 5 year interval between 2001 and 2006 or that ``interest only'' loans (on which there was no amortization of principal) similarly grew from 6 percent to 22.8 percent over this same interval. Thus, the real mystery is not why loan originators made unsound loans, but why underwriters bought them. Here, it seems clear that both investment and commercial banks saw high profits in securitizations and believed they could quickly sell on a global basis any securitized portfolio of loans that carried an investment grade rating. In addition, investment banks may have had a special reason to focus on securitizations: structured finance offered a level playing field where they could compete with commercial banks, whereas, as discussed later, commercial banks had inherent advantages at underwriting corporate debt and were gradually squeezing the independent investment banks out of this field. \16\ Consistent with this interpretation, anecdotal evidence suggests that due diligence efforts within the underwriting community slackened in asset-backed securitizations after 2000. \17\ Others have suggested that the SEC contributed to this decline by softening its disclosure and due diligence standards for asset-backed securitizations, \18\ in particular by adopting in 2005 Regulation AB, which covers the issuance of asset backed securities. \19\ From this perspective, relaxed discipline in both the private and public sectors overlapped to produce a disaster.--------------------------------------------------------------------------- \16\ See text and notes infra at notes 56 to 61. \17\ Investment banks formerly had relied on ``due diligence'' firms that they employed to determine whether the loans within a loan portfolio were within standard parameters. These firms would investigate and inform the underwriter as to the percentage of the loans that were ``exception'' loans (i.e., loans outside the investment bank's normal guidelines). Subsequent to 2000, the percentage of ``exception loans'' in portfolios securitized by these banks often rose from the former level of 25 percent to as high as 80 percent. Also, the underwriters scaled back the intensity of the investigations that they would authorize the ``due diligence'' firm to conduct, reducing from 30 percent to as few as 5 percent the number of loans in a portfolio that it was to check. See Vikas Bajaj & Jenny Anderson, ``Inquiry Focuses on Withholding of Data on Loans,'' N.Y. Times, January 12, 2008, at p. A-1. \18\ See Richard Mendales, ``Collateralized Explosive Devices: Why Securities Regulation Failed to Prevent the CDO Meltdown And How To Fix It'' (Working Paper 2008) at 36 (forthcoming in 2009, U. Ill. L. Rev.). \19\ See Securities Act Release No. 8518 (``Asset-Backed Securities'') (January 7, 2005, 79 FR 1506). Regulation AB codified a series of ``no action'' letters and established disclosures standards for all asset-backed securitizations. See 17 C.F.R. 229.1100-1123 (2005). Although it did not represent a sharp deregulatory break with the past, Regulation AB did reduce the due diligence obligation of underwriters by eliminating any need to assure that assets included in a securitized pool were adequately documented. See Mendales, supra note 18.---------------------------------------------------------------------------Credit Rating Agencies as Gatekeepers It has escaped almost no one's attention that the credit rating agencies bear much responsibility for the 2008 financial crisis, with the consensus view being that they inflated their ratings in the case of structured finance offerings. Many reasons have been given for their poor performance: (1) rating agencies faced no competition (because there are really only three major rating agencies); (2) they were not disciplined by the threat of liability (because credit rating agencies in the U.S. appear never to have been held liable and almost never to have settled a case with any financial payment); (3) they were granted a ``regulatory license'' by the SEC, which has made an investment grade rating from a rating agency that was recognized by the SEC a virtual precondition to the purchase of debt securities by many institutional investors; (4) they are not required to verify information (as auditors and securities analysts are), but rather simply express views as to the creditworthiness of the debt securities based on the assumed facts provided to them by the issuer. \20\ These factors all imply that credit rating agencies had less incentive than other gatekeepers to protect their reputational capital from injury. After all, if they face little risk that new entrants could enter their market to compete with them or that they could be successfully sued, they had less need to invest in developing their reputational capital or taking other precautions. All that was necessary was that they avoid the type of major scandal, such as that which destroyed Arthur Andersen & Co., the accounting firm, that had made it impossible for a reputable company to associate with them.--------------------------------------------------------------------------- \20\ For these and other explanations, see Coffee, GATEKEEPERS: The Professions and Corporate Governance (Oxford University Press, 2006), and Frank Partnoy, ``How and Why Credit Rating Agencies Are Not Like Other Gatekeepers'' (http://ssrn.com/abstract=900257) (May 2006).--------------------------------------------------------------------------- Much commentary has suggested that the credit rating agencies were compromised by their own business model, which was an ``issuer pays'' model under which nearly 90 percent of their revenues came from the companies they rated. \21\ Obviously, an ``issuer pays'' model creates a conflict of interest and considerable pressure to satisfy the issuer who paid them. Still, neither such a conflicted business model nor the other factors listed above can explain the dramatic deterioration in the performance of the rating agencies over the last decade. Both Moody's and Standard & Poor were in business before World War I and performed at least acceptably until the later 1990s. To account for their more recent decline in performance, one must point to more recent developments and not factors that long were present. Two such factors, each recent and complementary with the other, do provide a persuasive explanation for this deterioration: (1) the rise of structured finance and the change in relationships that it produced between the rating agencies and their clients; and (2) the appearance of serious competition within the ratings industry that challenged the long stable duopoly of Moody's and Standard & Poor's and that appears to have resulted in ratings inflation.--------------------------------------------------------------------------- \21\ See Partnoy, supra note 20.--------------------------------------------------------------------------- First, the last decade witnessed a meteoric growth in the volume and scale of structured finance offerings. One impact of this growth was that it turned the rating agencies from marginal, basically break-even enterprises into immensely profitable enterprises that rode the crest of the breaking wave of a new financial technology. Securitizations simply could not be sold without ``investment grade'' credit ratings from one or more of the Big Three rating agencies. Structured finance became the rating agencies' leading source of revenue. Indeed by 2006, structured finance accounted for 54.2 percent of Moody's revenues from its ratings business and 43.5 percent of its overall revenues. \22\ In addition, rating structured finance products generated much higher fees than rating similar amounts of corporate bonds. \23\ For example, rating a $350 million mortgage pool could justify a fee of $200,000 to $250,000, while rating a municipal bond of similar size justified only a fee of $50,000. \24\--------------------------------------------------------------------------- \22\ See In re Moody's Corporation Securities Litigation, 2009 U.S. Dist. LEXIS 13894 (S.D.N.Y. February 23, 2009) at *6 (also noting that Moody's grossed $1.635 billion from its ratings business in 2006). \23\ See Gretchen Morgenson, ``Debt Watchdogs: Tamed or Caught Napping?'' New York Times, December 7, 2008, at p. 1, 40. \24\ Id.--------------------------------------------------------------------------- Beyond simply the higher profitability of rating securitized transactions, there was one additional difference about structured finance that particularly compromised the rating agencies as gatekeepers. In the case of corporate bonds, the rating agencies rated thousands of companies, no one of which controlled any significant volume of business. No corporate issuer, however large, accounted for any significant share of Moody's or S&P's revenues. But with the rise of structured finance, the market became more concentrated. As a result, the major investment banks acquired considerable power over the rating agencies, because each of them had ``clout,'' bringing highly lucrative deals to the agencies on a virtually monthly basis. As the following chart shows, the top six underwriters controlled over 50 percent of the mortgage-backed securities underwriting market in 2007, and the top eleven underwriters each had more than 5 percent of the market and in total controlled roughly 80 percent of this very lucrative market on whom the rating agencies relied for a majority of their ratings revenue: \25\--------------------------------------------------------------------------- \25\ See Ferrell, Bethel, and Hu, supra note 15, at Table 2. For anecdotal evidence that ratings were changed at the demand of the investment banks, see Morgenson, supra note 23. MBS Underwriters in 2007-------------------------------------------------------------------------------------------------------------------------------------------------------- Proceed Amount + Rank Book Runner Number of Market Overallotment Sold in U.S. Offerings Share ($mill)--------------------------------------------------------------------------------------------------------------------------------------------------------1....................................................... Lehman Brothers 120 10.80% $100,1092....................................................... Bear Stearns & Co., Inc. 128 9.90% 91,6963....................................................... Morgan Stanley 92 8.20% 75,6274....................................................... JPMorgan 95 7.90% 73,2145....................................................... Credit Suis109 7.50% 69,5036....................................................... Bank of America Securities LLC 101 6.80% 62,7767....................................................... Deutsche Bank AG 85 6.20% 57,3378....................................................... Royal Bank of Scotland Group 74 5.80% 53,3529....................................................... Merrill Lynch 81 5.20% 48,40710...................................................... Goldman Sachs & Co. 60 5.10% 47,69611...................................................... Citigroup 95 5.00% 46,75412...................................................... UBS 74 4.30% 39,832-------------------------------------------------------------------------------------------------------------------------------------------------------- If the rise of structured finance was the first factor that compromised the credit rating agencies, the second factor was at least as important and had an even clearer empirical impact. Until the late 1990s, Moody's and Standard & Poor's shared a duopoly over the rating of U.S. corporate debt. But, over the last decade, a third agency, Fitch Ratings, grew as the result of a series of mergers and increased its U.S. market share from 10 percent to approximately a third of the market. \26\ The rise of Fitch challenged the established duopoly. What was the result? A Harvard Business School study has found three significant impacts: (1) the ratings issued by the two dominant rating agencies shifted significantly in the direction of higher ratings; (2) the correlation between bond yields and ratings fell, suggesting that under competitive pressure ratings less reflected the market's own judgment; and (3) the negative stock market reaction to bond rating downgrades increased, suggesting that a downgrade now conveyed worse news because the rated offering was falling to an even lower quality threshold than before. \27\ Their conclusions are vividly illustrated by one graph they provide that shows the correlation between grade inflation and higher competition:--------------------------------------------------------------------------- \26\ Bo Becker and Todd Milburn, ``Reputation and Competition: Evidence from the Credit Rating Industry,'' Harvard Business School, Working Paper No. 09-051 (2008) (http://ssrn.com/abstract =1278150) at p. 4. \27\ Id. at 17. FOMC20071031meeting--204 202,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. I think the economy is slowing. Even the nonhousing part of the economy is slowing a bit. Housing prices are still obviously sliding down. We don’t really claim to know much about where they’re going to end up or where we are in that process, but it seems that they are falling and probably at an accelerating rate. Our modal forecast—“our” meaning from the submissions—is for an economy that slows further and runs below trend over several quarters. But if you just look at the size of the bars on the submissions, the size of that bar about downside risk to growth is very high, much higher than the bar about upside risk to inflation. There is a huge amount of uncertainty about what equilibrium is and where short-term interest rates should be over time. But I think it is fair to say that we are now at the high end of, if not slightly above, most of those estimates of where equilibrium is. Therefore, it seems to me sensible that most of our submissions had a downward slope to the path of the fed funds rate going forward over this period. The question then is not principally whether to move but when and what signal of a change or no change should come. I think it is a very close call, and everything that I say I say with a lot of unease and discomfort. If the choice is to stay firm but to signal more explicitly than we did in September that we’re likely to move further, that seems to me just a bad choice. I think it is likely to amplify many of the risks that you are all worried about and it probably would make people more tentative about coming in and doing what they’re going to do to let this thing work through the markets because they will be living with our acknowledgement of substantial downside risk without action and uncertainty about whether we’re going to move. I think you might argue that a decision not to move with an explicit asymmetry in the balance of risks to growth would lower the path going forward and add to that uncertainty in some sense. I do not think that the markets are so fragile now that they could not take an adverse surprise of this magnitude, even though it is a very, very large adverse surprise relative to recent history. I don’t think that’s a good argument for moving. I think the best argument is that we’re still in the midst of what is a very delicate and consequential asset-price adjustment in the U.S. economy with a fairly dense, thick, adverse tail on the potential implications about the evolution in housing. The Chairman spoke eloquently early in the year—I think it was early in the year, but maybe it was late last year—about the pattern of history and the acknowledgement that weakness tends to cumulate, and you don’t really have a lot of experience with sustained periods of below-trend growth without falling into a more substantial rise in unemployment rates. Those risks have to be substantially greater when you have an economy going through this kind of asset-price adjustment. I found these charts discouraging, not reassuring, in the sense that we’re anticipating a slowdown in the rate of growth of credit for the economy as a whole that’s comparable to ’01. I think the pressure on bank balance sheets is probably—it’s hard to make these statements with any certainty—greater than it was in ’01. At least a reasonable expectation is that it’s going to be bigger than it was in hindsight in ’01, and I think you have a much more substantial impairment to the functioning of what Kevin calls debt capital markets—the industry around the design of securitization and structured finance, et cetera, which has been so important to the way credit gets originated and moved. That disruption could take a long time to resolve, and I think that just has to amplify the density of the adverse tail and the growth outcome, certainly with more uncertainty at this time. I think that it is hard, but the better course of valor is to move today, and I like the language in alternative A. Let me just go quickly through the arguments against it that I find most compelling. The best argument against is the fear that many of us spoke about—that even though the inflation numbers have been reasonably reassuring and we haven’t seen substantial erosion in inflation expectations that we can measure, there is a bit of deterioration in the feel, in the psychology. We have to be very careful that we don’t add to that through our actions or people’s expectations about how we’re going to behave going forward. But we should take some comfort from the fact that the market is pricing in more than 100 basis points of easing over the next two years. You have to believe that a fair amount of that is already reflected in breakevens, reflected in what people are willing to pay for insurance against adverse inflation outcomes, and reflected in the dollar. It doesn’t mean that if we validate part of those expectations you won’t see erosion, but we should take some comfort from that. Just one more thing. We have been through three years of very substantial relative price shocks in energy prices, commodity prices, and some other things. Those hit an economy that was growing over the period above most estimates of potential, and we have had pretty good performance of underlying inflation and inflation expectations in that context. So even though we look forward and we see what’s happening in commodity prices, energy prices, and the dollar as posing some potential risk of upside pressure on input costs, that is hitting the economy in a very different state. The experience of those last couple of years should give us a fair amount of confidence in the judgments we bring as to how we think about inflation going forward. I think we have less uncertainty around an inflation forecast than we would have had two or three years ago and still substantial uncertainty around the growth forecast inevitably given what the economy is going through. The balances suggest that it is better to move today because of that. As I said, I’m comfortable with the language in alternative A. I would be comfortable with Governor Mishkin’s amendment to A—I think that helps a bit. I have a lot of sympathy for all the arguments against the first sentence in alternative A in any form, but on balance, I would say that we just don’t want to take the risk that, by omitting some statement like it, we cause people to price in a steeper slope to that path going forward. It is something that we should try to avoid, and the best way to achieve that is the language in A. Thank you." CHRG-111hhrg61852--38 Mr. Koo," I have argued that this is a very special type of recession that happens only after the bursting of a nationwide debt financed bubble as the asset prices collapsing, liabilities remaining, private sector balance sheets underwater. And in this type of recession, I believe the government will have to be in there spending to keep the GDP from falling so that people have income to repair their balance sheets. This action will have to be maintained until private sector balance sheets are repaired, and then you reverse course. Once the private sector is ready to borrow money, healthy again, then the government must reduce its deficit and at that time as quickly as possible. But we are still in the entrance part of this recession with all these people repairing their balance sheets. So I would hope that government will maintain fiscal stimulus, and that, of course, different types of fiscal stimulus--there are the tax cuts, and there is government spending. Tax cuts, I am afraid, are not very efficient. It is far better than nothing, but it is still inefficient in the sense that when people are trying to repair their balance sheets, and they get the tax cut, they use that to pay down debt, which means it doesn't add to the demand in the economy. So if the government spends the money directly, that will add more demand to the economy for the same amount of budget deficit. But if you cannot get people to agree on spending, then I will say at least keep the tax cuts from expiring because that is still better than nothing. Mrs. McCarthy of New York. Mr. Meltzer? " fcic_final_report_full--503 Most of what was going on here was under the radar, even for specialists in the housing finance field, but not everyone missed it. In a paper published in 2001, 94 financial analyst Josh Rosner recognized the deterioration in mortgage standards although he did not recognize how many loans were subject to this problem: Over the past decade Fannie Mae and Freddie Mac have reduced required down payments on loans that they purchase in the secondary market. Those requirements have declined from 10% to 5% to 3% and in the past few months Fannie Mae announced that it would follow Freddie Mac’s recent move into the 0% down payment mortgage market. Although they are buying low down payment loans, those loans must be insured with ‘private mortgage insurance’ (PMI). On homes with PMI, even the closing costs can now be borrowed through unsecured loans, gifts or subsidies. This means that not only can the buyer put zero dollars down to purchase a new house but also that the mortgage can finance the closing costs…. [I]t appears a large portion of the housing sector’s growth in the 1990’s came from the easing of the credit underwriting process ….The virtuous cycle of increasing homeownership due to greater leverage has the potential to become a vicious cycle of lower home prices due to an accelerating rate of foreclosures. 95 [emphasis supplied] The last increase in the AH goals occurred in 2004, when HUD raised the LMI goal to 52 percent for 2005, 53 percent for 2006, 55 percent for 2007 and 56 percent for 2008. Again, the percentage increases in the special affordable category outstripped the general LMI goal, putting added pressure on Fannie and Freddie to acquire additional risky NTMs. This category increased from 20 percent to 27 percent over the period. In the release that accompanied the increases, HUD declared: Millions of Americans with less than perfect credit or who cannot meet some of the tougher underwriting requirements of the prime market for reasons such as inadequate income documentation, limited downpayment or cash reserves, or the desire to take more cash out in a refinancing than conventional loans allow, rely on subprime lenders for access to mortgage financing. If the GSEs reach deeper into the subprime market , more borrowers will benefit from the advantages that greater stability and standardization create. 96 [emphasis supplied] Fannie did indeed reach deeper into the subprime market, confirming in a March 2003 presentation to HUD, “Higher goals force us deeper into FHA and subprime.” 97 According to HUD data, as a result of the AH goals Fannie Mae’s acquisitions of goal-qualifying loans (which were primarily subprime and Alt-A) increased (i) for very low income borrowers from 5.2 percent of their acquisitions in 1993 to 12.2 percent in 2007; (ii) for special affordable borrowers from 6.4 percent in 1993 to 15.2 percent in 2007; and (iii) for less than median income borrowers (which includes the other two categories) from 29.2 percent in 1993 to 41.5 percent in 2007. 98 94 Josh Rosner, “Housing in the New Millennium: A Home Without Equity is Just a Rental With Debt,” June, 2001, p.7, available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1162456. 95 96 97 98 Id., p.29. http://fdsys.gpo.gov/fdsys/pkg/FR-2004-11-02/pdf/04-24101.pdf , p.63601. Fannie Mae, “The HUD Housing Goals”, March 2003. HUD, Offi ce of Policy Development and Research, Profiles of GSE Mortgage Purchases, 1992-2000, 2001-2004, and 2005-2007. 499 FOMC20060920meeting--101 99,MR. STOCKTON.," The answer to that is “yes,” and I think there is some risk. One feature of our forecast is the fact that we are not projecting large declines nationwide in house prices. We are expecting a deceleration but not any outright declines. One could imagine that more of the adjustment could take place more quickly by a big drop in house prices that in some sense clears out that inventory through higher sales and maybe less production adjustment. On that side, you would probably get a quicker housing cycle than the one that we are projecting. However, it also brings with it some downside risk in that households would realize how much their net worth had fallen, which could have consequences for consumption both directly through the wealth effect and perhaps through sentiment. That correction could be quicker and maybe deeper, but then the rebound could be faster. That is a risk we have certainly contemplated. We were a little nervous about being too adventuresome on the house-price forecasting. We are not very good at forecasting asset values, we never understood how prices got as far out of alignment as we think they are, and we are not sure exactly what the process of correction is going to look like. So we have taken a middle stance between two models: one model that basically forecasts house prices off pure momentum and another one that takes seriously the analytical apparatus, which we showed you a year and a half ago at our special briefing on housing, that looks at the error-correction process of house prices to rents. The latter model actually does forecast outright declines nationwide in house prices by 2008. We are between a momentum model, which expects house prices to slow less than we are forecasting, and this error-correction model, which shows bigger declines." CHRG-111hhrg49968--9 Mr. Bernanke," Yes, sir, our expectation is that we will begin to see growth in the economy, so the end of the technical recession, later this year. Underlying that prediction is some stabilization in final demand, including consumer spending, as well as the importance of unwinding the inventory dynamic. Firms have been cutting back their production and, therefore, have lowered their stocks of unwanted inventories. As that process goes forward, they will be able to increase production as they no longer have to get rid of those extra inventories. So we expect to see some growth, not robust growth but some positive growth, later this year. Unfortunately, since the growth rate, in the beginning of the process will be lower than potential, we expect unemployment to continue to rise into next year and to come down only slowly. So we will have a weak labor market for some time. " FOMC20071031meeting--155 153,MR. KOHN.," Thank you, Mr. Chairman. I agree with President Hoenig that this is a difficult decision between staying where we are—and I would have downside risks to growth on that—or moving 25, but with more-balanced risks. I think it’s difficult—we are balancing a number of very difficult things here. On the one hand, the incoming data, as Dave has emphasized, have been, if anything, stronger than we anticipated on the real economy and include data for September and some hints for October in here. On the other hand, many members of the Committee, myself included, have a sense that the real interest rate is still a little to the high side of where it needs to be to promote full employment and stable prices over time. We expect the output gap to move over the next couple of quarters, as housing holds down growth relative to potential. We expect inflation to stay low and inflation expectations, if anything, perhaps to edge down as people realize that inflation is going to stay at 2 or below. I wonder whether the 50 basis points we did last time was enough to offset the tighter credit conditions that have developed and the market disruptions that are going to impede, particularly, the secondary markets for nonconforming mortgages for some time. This stuff isn’t going to go away soon, and it’s going to weigh on demand. Partly as a result of this sense, many of us think that the risks to growth are on the downside but are still worried about inflation expectations. The risks to growth on the downside are compounded, as the Chairman and Brian pointed out, by the sense that financial markets are still fragile and there is the tail risk of getting into the feedback spiral between concerns about the real economy and reactions in financial markets. Not the most likely outcome, but certainly a tail risk. As I tried to square several circles at the same time, I came down on alternative A: reducing 25 basis points but going to risks being roughly balanced. I see this as preemptive but not open ended. I think that combination of preempting some of the tail risk, getting a little ahead of the possibility, and buying this insurance is helpful. But going to roughly balanced risks takes out the open-ended sense that we’re on a path toward ever-lower interest rates. I see the incoming data for inflation as consistent with this. Inflation has been low even with today’s data. I think the core PCE has been low; the CPI is up a little but not much. I found the ECI data kind of interesting this morning. I have been a little concerned about labor costs creeping up, which you could see from some of the compensation data. But the ECI is a good, consistent measure over time. It is not totally comprehensive. Also, the fact that there is no increase in the growth rate of the ECI to me is pretty encouraging that underlying cost pressures are not building. By emphasizing our concerns about inflation—that the risks are roughly balanced—we are signaling that we are not buying into the full extent of the market expectations for our easing, and I think that is a good thing. The “roughly balanced” language will raise the hurdle a bit for ourselves to ease again in December if we have some weak data, but it won’t raise it so high that, if the data are really weak, we can’t react in a constructive way to change it. So putting all of this together and admitting that it is a close call, I think that alternative A—roughly balanced risks—minimizes the deviations from where we want to be, helps us send the signal about what we think might be coming and what our concerns are, and comes closest to furthering economic performance toward our objectives. I certainly agree with President Lacker that alacrity will be required. I think I actually called it “nimbleness” in the speech I gave—I want to quote myself again—and that will be very much in the forefront as we go forward next year, I agree. Thank you, Mr. Chairman." FOMC20070321meeting--56 54,MS. JOHNSON.," Constructing our outlook for the rest of the global economy this time entailed assessing the information in and implications of varying indicators of activity from different regions, the somewhat weaker prospects for U.S. output growth, and the backup in global oil prices. In addition, we struggled to understand the likely consequences of the episode of financial market volatility that emerged in global equity and credit markets at the end of February as well as the risks to our forecast that this episode might foreshadow. In the end, our baseline forecast for real GDP growth abroad is just slightly stronger over this year and about the same next year as in the January Greenbook. Our projection for foreign inflation has been revised up just a little in response to the higher level of our path for oil prices. The resulting contribution for U.S. real GDP growth this year from the external sector is about neutral and that for next year is a small negative; we now see exports, relative to the January forecast, as contributing slightly more positively to U.S. GDP growth over the forecast period and are projecting an arithmetic negative contribution from imports that is a bit smaller in magnitude, especially this year. The favorable news for activity abroad was mostly from the major foreign industrial countries. We were particularly surprised by Japanese real GDP growth in the fourth quarter, which in the latest data was an annual rate of 5.5 percent, 2 percentage points above our expectation in January. Household consumption showed some signs of strength—a development that has been lacking in Japanese economic activity for a long time. In addition, private investment spending increased at a double-digit rate. Available indicators for activity in January, such as machinery orders and household expenditures, support the view that solid expansion is continuing, and we have revised up our near-term forecast such that our projected growth rate for 2007 is ½ percentage point stronger. The economic expansion in the euro area continues to firm, and we were surprised by the fourth-quarter growth rate there, as well. The 3.6 percent annual rate of growth recorded for last quarter was 1 percentage point higher than we had expected in January. That strength was due particularly to investment and to export demand. We have revised up our outlook for growth over the forecast period about ¼ percentage point as a result. Within emerging Asia, real GDP continues to expand vigorously in China and in India, sustaining expansion in the region at an average annual rate of about 6 percent. We see average growth in Latin America this quarter as having been slowed by weakness in Mexico that is related to softness in U.S. manufacturing production. Mexican growth should rebound in line with the projected improvement in U.S. industrial production, resulting in average growth in the region of about 3½ percent over the forecast period. We have revised down slightly our forecasts for growth in Mexico and emerging Asia relative to the January outlook. On balance, we do not see the negative implications of the slightly weaker U.S. projection this time as outweighing the indications of robust domestic demand in Europe and Asia. Accordingly, our baseline forecast continues to be for vigorous growth on average abroad. A weaker U.S. outcome than projected is clearly a downside risk for the global economy, however. The rise in oil prices over the intermeeting period erased some of the inflation restraint that the low January level of global crude prices provided. We have added a couple of tenths to our inflation projection as a result, with most of the upward revision projected for the Asian emerging-market economies that are very dependent on imported crude oil. The heightened financial market volatility that appeared in late February was a global event, with stock prices in several major foreign countries declining 2 to 6 percent through the date of the Greenbook and then retracing somewhat over the past week. Credit spreads widened for risky credit abroad, including emerging- market sovereign risk spreads, and yields on long-term governments bonds moved down in the euro area, the United Kingdom, and Canada as investors shifted to higher quality securities. But in many instances, these moves just brought the particular price or yield back to its level toward the end of last year. Although the drop in Chinese stock prices on February 27 was seen on that day as a contributing factor, market developments on subsequent days support the view that much of the concern of global investors is directed toward the U.S. expansion and, in particular, the U.S. subprime mortgage market. We do not see the market correction to date as a source of significant restraint on spending abroad. In addition, the evident weakness in the U.S. housing sector has limited potential for spillover to economic activity abroad. Accordingly, we have strengthened a little our forecast for foreign real output growth and reduced the magnitude of the net subtraction from U.S. GDP growth implied by the projections for exports and imports. Clearly, global financial market participants are ready to react strongly to any news suggesting less-favorable outcomes on investments. This poses a negative risk to the global outlook as the financial market response to a negative shock may intensify the consequences of that shock for credit extension, spending, and ultimately global growth. On the upside, we have been surprised by the strength of domestic demand in some foreign industrial countries, and we could be underestimating its momentum. In addition, a more buoyant outcome for China is always a possibility. Last week we received data on the U.S. balance of payments for the fourth quarter, completing our picture for the year as whole. Although the annual total for the current account deficit rose in 2006, the balance for the fourth quarter narrowed quite a bit. That narrowing is due to a reduced trade deficit and a swing to positive in the figure for net investment income. A decrease in our nominal oil bill largely accounts for the improvement in the trade deficit, but the non-oil trade balance also narrowed somewhat. The smaller bill for imported oil in the fourth quarter resulted mainly from lower prices, although the quantity imported declined as well. The balance on the portfolio portion of U.S. net investment income was a sizable deficit that widened about $4 billion at an annual rate from the previous quarter. However, the positive balance on direct investment income jumped nearly $40 billion at an annual rate as receipts continued to be robust and payments fell sharply. The decline in payments was widespread across sectors and countries. The net result was a positive figure for total investment income of nearly $19 billion. Going forward, we expect that the current account deficit will resume widening from its reduced, fourth-quarter level and will reach about $950 billion, or 6½ percent of GDP, by the end of 2008. We project that a widening of the trade deficit will continue, with the oil and the non-oil components of the merchandise balance both becoming larger deficits. However, a positive change in the balance on services will partially offset the deterioration in the deficit on traded goods. The net investment income balance should account for a larger portion of the current account widening. The positive balance of direct investment income should drop back in the near term but then rise slowly to record a small, positive net change over the forecast period. However, the negative balance for portfolio income is expected to increase in magnitude significantly, as our net international investment position records yet greater net indebtedness. This increasing net indebtedness and wider current account deficit will continue as long as the trade deficit remains sizable. David and I will be happy to answer any questions." CHRG-110shrg50369--34 Mr. Bernanke," As house prices fall, people will become more reluctant to buy a house because they are afraid that the house price will keep falling, so they rent instead. And that puts pressure on rents and actually could drive up the rent. Senator Shelby. Good for the landlords and bad for the sellers. " FOMC20050503meeting--99 97,MR. GRAMLICH.," Thank you, Mr. Chairman. The short-run monetary choices are getting harder. While the world oil market is suffering a demand shock caused by rapid growth in China and elsewhere, it affects the economy as a supply shock, with simultaneous worsening of inflation and unemployment. Many of us lived through just the reverse of this in the late 1990s, with simultaneous improvement in inflation and unemployment. For us, turnabout is fair play. But while it may be fair play, the choices get harder. Does one look at the inflation numbers and tighten up or at the unemployment numbers and loosen up? The answer depends, I think, on whether the medium-term impact on inflation or unemployment is likely to be stronger and more pervasive. As the numbers came in over the past six weeks, initially I was on the hawkish side, worried that inflation would come loose from its moorings. In terms of Vincent’s Bluebook rhetorical chart [exhibit 6], I found myself over in column C somewhere looking for ways to tighten the statement to express more inflation concern. But as time went on, the dribs and drabs of steadily worsening data have shifted me over to where I am now, which is somewhere in column A, wanting to ease our rhetoric moderately. Given the enormous amount of accommodative policy that we have put in and May 3, 2005 62 of 116 meeting. And I guess I’ve been to too many meetings of this sort to suggest major changes in our rhetoric. [Laughter] But I would like to lobby for at least some elements of column A in the statement. The reasons for my change should be fairly apparent. As the Greenbook notes, the spending data have been consistently weak over the last six weeks. The first-quarter GDP report was below expectations in a way that is likely to last. Not only was GDP overestimated, but final sales were overestimated by even more. So the future forecast should be scaled down to reflect the lower final sales momentum and perhaps additionally because there might be something of an inventory overhang. In terms of spending components, there has always been a likelihood that consumption growth would slow as personal saving rates keep dropping to historic lows. And it was always likely that saving rates would revert to more normal, higher levels, slowing consumption growth. The wealth–income ratio was held up by house prices, and it, too, could revert to more normal levels, further slowing consumption growth. Consumer confidence has been dropping for a while now. On the whole, it is quite reasonable to project that consumption will grow less than income for the next few quarters, repressing income growth. Fiscal policy appears to be roughly neutral over the forecast horizon. I note that the Congress did pass a budget agreement that seems to contain at least moderate fiscal tightening. Whether this fiscal tightening will actually come to pass is still an open question, but we will probably not get much new demand impetus from the fiscal side or from the foreign side. Some parts of the world are growing well, but many of our trading partners are experiencing slowdowns of May 3, 2005 63 of 116 declines sharply, there may be enough dislocations around the world that export growth could still sputter. This means that over the medium term unusual importance attaches to capital investment. In the staff’s own words, in the data report we got, business fixed investment rose at a rate “well below” that in the fourth quarter; “spending on equipment and software decelerated and spending on nonresidential structures declined.” I might add that durable goods orders are down sharply. Housing starts are down, and the ISM [Institute for Supply Management] index of factory activity is down. The stock market is sluggish despite pretty decent earnings reports, and measures of small business confidence have plummeted. Even though this is a lot of data, I do think it’s too soon to tell if there’s a pattern here, but it wasn’t so long ago that we were worried about an investment pothole. Maybe we just got the timing of that a little wrong; with sluggish aggregate macro time series, that can easily happen, I think. Or there could be some other source of impending weakness in investment. It seems as if around this table about every eight months we get worried about a lack of corporate animal spirits. I don’t know what the answer is, but I do think that, if investment flags, there is no other obvious source of spending strength. Granted, as Gary says, the economy has shown a lot of resilience, but the spending still has to come from somewhere. As I said before, it is intrinsically difficult to conduct monetary policy when both objectives are turning the wrong way, but in the medium run I’m going to differ with many of you in at least raising the possibility that the weak spending data may trump the strong price data. Many of the price increases seem to be one-shot increases due to energy shocks and unlikely to pass through into continuing inflation. We talk about the core index, but the core index doesn’t purge all influence of May 3, 2005 64 of 116 important to keep our eye on wages, and wages have continued to be moderate, indicating that price pressures do seem to be contained for the longer run. And as many of us have noted over time, if aggregate demand does weaken, output gaps will fail to close and overall price pressures should wane. So what should we do about all of this? In the short run, I’ll go with the crowd. We have invested so much in advertising a climb in rates that we can’t back down now. For the medium run, however, I’m beginning to get worried on the negative side. At this meeting, I would like to shade our rhetoric toward the A column in the Bluebook. I guess the only other thing I could say is that I’d like to recommend that over the next six or eight weeks everybody study carefully the simulation that the staff labeled ""Sentiment slump with financial spillover."" [Laughter]" 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-111shrg57322--322 Mr. Birnbaum," Well, no. You asked me about housing. Senator Tester. OK. The housing market, what did you base that decline upon? " CHRG-111hhrg51698--165 Mr. Boccieri," Life is like that these days, I guess. Mr. Chairman, thank you for your leadership in having this Committee panel assembled here. Having a bit of an economics degree in college, it is amazing to me that it seems as if we are throwing the laws of supply and demand out the door. We are creating these artificial bubbles with these CDSs that drive price fluctuations up and down that have absolutely nothing to do, in my humble opinion, with supply and demand. When you have, for instance, oil prices spiking at $4 a gallon, even though there was more supply in the market a year ago than there was previous to that, there seems to be a push away from this notion that supply and demand should be running the market, rather than CDSs. I am a little bit concerned, and confused, about the argument that we are making here today for supporting this unregulated, unchecked, artificial price spike, if you will, of commodities and futures that are very important to American families. Having a stable market, a reliable market that underscores that when a consumer, a family goes to a gas station that they can have a reliable price there that they know was equitable and fairly traded, and that was marked by supply and demand and not by speculation, or manipulation like Mr. Damgard had suggested. I guess my question to the panel is this, that some of the panel have suggested that we take a broader look at manipulation, and that our concern about the test for manipulation is limited to conscious efforts versus those that are unconscious. Manipulation is a crime, and there are penalties associated with it. If the market participants are impacting markets unconsciously, but with the same impact as those who have attempted manipulation, shouldn't they be punished the same as those conscious manipulators? " FOMC20071211meeting--40 38,MR. SHEETS.," Our reading of the recent data suggests that economic activity abroad decelerated toward the end of the third quarter and has remained on a decelerating path thereafter. In the euro area, the United Kingdom, and Canada, this softening of activity appears to reflect—at least in part—increasing drag from the ongoing financial turmoil. Notably, in the euro area, business and consumer confidence have weakened some in recent months, PMIs for both the services and manufacturing sectors have declined, and recent readings on retail sales and industrial production have softened. In the United Kingdom, indicators of sentiment and retail sales also have slipped of late, and a slowdown in the housing sector is now under way—with declines in net mortgage lending, mortgage approvals, and major indexes of house prices. In response, the Bank of England late last week cut its key policy rate 25 basis points, to 5½ percent. The Bank of Canada also lowered its policy rate a notch last week, citing concerns about financial market turmoil. In assessing the impact of the financial turbulence, we continue to see little evidence that the emerging-market economies are being significantly affected. Over the past month or so, debt spreads for many of these economies have risen, and their equity markets have given back some ground, but these moves are relatively mild when viewed from a longer-term perspective. All told, foreign growth is projected to step down from an average rate of nearly 4½ percent during the first three quarters of this year to below 3 percent in the current quarter and early next year. In addition to headwinds from the financial turmoil, this slowing reflects policy actions in some countries (particularly China) to rein in above-trend growth, as well as the softer pace of activity in the United States. Thereafter, we see foreign growth rising back to a rate of 3¼ percent. This outlook is weaker over the next few quarters than in our October projection, in line with the lower U.S. forecast. In addition, given the renewed market turbulence, we now see the drag from financial developments as likely to be larger and more protracted than we had previously assumed. We continue to believe that these effects will be felt mainly in the advanced economies, but an important downside risk to our forecast is the possibility that the emerging-market economies may be more affected than we now expect. On Friday, we received revised Japanese GDP data for the third quarter. The latest estimate cuts growth in the quarter to 1.5 percent at an annual rate, down 1 percentage point from the initial reading. Notably, this growth can be attributed entirely to net exports, as domestic demand contracted for the second consecutive quarter. Residential investment plunged in the third quarter, as new building regulations temporarily weighed on spending. Our forecast calls for domestic demand to bounce back quickly, but downside risks are increasingly evident; for example, the profitability of small and medium-sized companies has recently deteriorated, labor market conditions seem to be softening, and wages continue to contract. The spot price of West Texas intermediate approached $100 per barrel in late November, but mounting concerns about the near-term outlook for global activity have since pushed the price back below $90 per barrel. At that level, spot WTI is down a few dollars per barrel since the last FOMC meeting. Continued concerns about the longer-term supply-demand balance, however, have kept the far-futures price at its late-November level, near $87 per barrel—up about $7 since the last FOMC meeting. Nonfuel commodity prices fell sharply in the third quarter and have continued on a downward trajectory. The prices of copper and nickel have plunged, driven by concerns that rising inventories may signal a softening of global demand for these commodities. The price of zinc has fallen as well. Notably, however, the prices of food commodities, including wheat, corn, and soybeans, have continued to rise. This run-up in food prices, coupled with high oil prices, has stoked inflation in a number of countries. For example, in the euro area, twelve-month headline inflation has jumped from 1.7 percent in August to 3 percent in November, led by food and energy prices, thus prompting the ECB to leave policy on hold at its meeting last week. Going forward, this rise in inflation may continue to limit the ECB’s willingness to ease policy, as fallout from the financial turmoil weighs on activity. In the United Kingdom, however, a recent rebound in inflation to slightly above the Bank of England’s 2 percent target—driven in part by rising food prices—did not deter last week’s policy move. Indeed, in cutting rates, the BoE noted that “higher energy and food prices are expected to keep inflation above the target in the short term.” In China, food price inflation is running at more than 15 percent and has pushed overall inflation to 6.9 percent in November. The pace of inflation has elicited a range of policy responses from the authorities, including a move over the weekend to further increase reserve requirements. Our forecast sees global food and oil prices soon leveling off in line with quotes from futures markets, and this would contribute to a welcome moderation of inflationary pressures in a number of countries. Since the last FOMC meeting, the dollar has strengthened on balance, rising 1 percent on average against the major currencies and ½ percent in broad nominal terms. Notwithstanding this reprieve from dollar depreciation, we continue to see the current account deficit—which still exceeds 5 percent of GDP—as a key factor that is likely to weigh on the exchange rate going forward. Thus our forecast incorporates some modest further real depreciation of the dollar. Notably, this depreciation comes entirely against our emerging-market trading partners, and we have slightly raised our projections for the pace at which the renminbi and several other emerging Asian currencies appreciate against the dollar. I conclude with a few words about the U.S. external sector. We expect that export growth, following its red-hot 19 percent performance in the third quarter, will moderate to a still-strong pace of around 7 percent in the current quarter and through the next two years, as exports are supported by past declines in the dollar and still- solid foreign activity. Import growth in the current quarter will be sustained at its moderate third-quarter rate by a seasonal rebound in oil imports, but import growth is expected to fall off during the first half of next year, in line with the softer pace of U.S. activity. Thereafter, imports are projected to gradually accelerate, as growth in the United States firms. All told, we see net exports making positive arithmetic contributions to growth of 0.1 percentage point in the fourth quarter of this year, 0.5 percentage point in 2008, and a little over 0.1 percentage point in 2009. That concludes our prepared remarks, and we are happy to take questions." FOMC20050630meeting--321 319,MR. FERGUSON.," I’ll continue to plow that ground just for one minute. I’m struck a bit by the fact that the stories on the run-up in commodity prices and oil prices are all about China and India. You have a forecast here where China’s growth falls off fairly dramatically. Growth in the rest of the world I would describe as maybe more of a downside risk. You point out the uncertainty in Europe and Japan and you’ve even marked down economic growth in the United States. Yet your commodity prices tend to be rather flat. All this run-up was associated with China, India, and global growth. You have global growth dampening, but we don’t seem to recover much in the way of these commodity prices—oil being one, but others in general. I’m obviously missing something. What is it?" 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." FOMC20050202meeting--147 145,MR. HOENIG.," Thank you, Mr. Chairman. For the economy, growth currently remains above trend and, as we all know, is likely to remain above trend several quarters forward. As a result, we are systematically approaching long-run potential GDP for the economy. I expect growth will be near 4 percent this year—above trend. There are obvious reasons for this: monetary policy remains accommodative, consumer spending on goods and housing is strong, and business equipment spending is strong. While fourth-quarter growth was below expectations, final sales to domestic purchasers were at a robust 4.3 percent pace. And I think the labor market continues to improve. Evidence from our District is very much in line with this outlook. Most retailers we contacted said that holiday sales were moderately higher than a year ago, and many said that sales were above their plan. In addition, many ski resorts in our region reported sharp increases in hotel occupancy and a near-record volume of ski visits, many from foreigners. Job growth picked up in December. Hiring announcements since the last FOMC meeting exceeded layoff announcements by a margin of two to one, and a substantial fraction of small and midsized manufacturers said that they plan to increase employment in the coming months. District manufacturing continues to expand at a brisk pace; production, new orders, and employment all rose in December, and firms remained upbeat about future activity. Capital spending plans for 2005 are reported strong. We all know where the price indexes are right now but, looking to the future, I would expect to see further increases in core inflation. With the federal funds rate below the lower bound of most estimates for the neutral rate, I remain alert to the greater or increasing risk of inflation. In addition, there are several other reasons to think that this upside risk may be rising. First of all, as others have said here today, we are hearing more about the return to pricing power. Further, a greater pass- through of higher commodity prices seems to be occurring. The possibility of continued dollar depreciation is strong, as is a greater pass-through of higher import prices. And slowing productivity February 1-2, 2005 101 of 177 Evidence from the District supports these observations. For example, the fraction of businesses reporting labor shortages was 53 percent in January, up significantly from last quarter and last year. As a result, wage pressures in the District have also increased. About 26 percent of the employers contacted in January said that they had to boost wages more than normal as compared to 17 percent last quarter and 11 percent a year ago. In addition, our manufacturing survey showed evidence of greater pricing power. For example, among respondents reporting higher input prices, the share who also reported higher output prices has risen markedly, from 40 percent in the fourth quarter of 2003 to 60 percent in the fourth quarter of 2004, the same as before the recession. Similarly, among those who expect to pay higher input prices going forward, those who also expect to charge higher output prices has risen markedly from 41 to 51 percent. In summary, the outlook for the nation and our region is certainly good. Growth is robust, and we are hearing increasingly that there is a lot of money looking for opportunity. I would submit that the risk of higher inflation, therefore, is now large enough that we should at least be thinking about raising rates more aggressively toward neutral than we have in the past. Thank you." FOMC20051213meeting--61 59,MR. LACKER.," Okay. If I could just follow up for a second: In the late ’90s, your forecast of productivity growth seemed to display a cyclicality—almost a responsiveness to recent productivity growth—that in hindsight took it up above where productivity growth came in and then down below it. Are you worried about the sensitivity of your forecast to recent data?" FOMC20060808meeting--146 144,MS. BIES.," I would prefer to leave housing in because housing resources aren’t readily substitutable for other parts of the economy. If we leave resource utilization in, we’re sort of acknowledging that, although housing is soft, there are still resource pressures in other parts of the economy. I think the picture is better balanced that way." 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”). CHRG-110shrg50409--9 Chairman Dodd," Well, thank you very much, Mr. Chairman. And let me just briefly say I appreciate the efforts of the Fed regarding both credit cards and the things dealing with predatory lending practices. We welcome those rules, and we welcome the suggestions in the credit card areas, and a future point here, we will maybe have more discussion about that. But I wanted to at least reflect my appreciation of what the Fed has done regarding those matters, and we appreciate it very much. I am going to put this clock on at 5 minutes so we can give everyone a chance to raise any questions they have on the monetary policy issues. Some of the questions may overlap, and at the conclusion of that, Secretary Paulson and Chairman Cox will be here to have a broader discussion about the proposals being made by Treasury over the weekend. Let me, if I can, jump to the economic projections for 2009, the concerns about economic growth that you have raised in your statement here this morning. Given the fact that we have, as you point out, acknowledged the risk to your forecast for economic growth are skewed to the downside, to use your words, and given the fact that the stimulus package is about to--the effects of it are going to run out by the end of the year. The housing crisis continues, obviously, as we all know painfully. Gasoline prices, as you point out, are at record levels, costing consumers tremendously. The issues involving the weakness in the labor market are significant, 94,000 jobs lost every month for the last 6 months on a consistent basis. Inflation, as you point out, while it may abate in the coming years, it certainly is going to be with us for some time. What suggestions do you have for us in all of this? And I realize you may want to reserve some final judgment on the effects of the stimulus package and will not know the full effects of that until maybe toward the end of the year. But as we look down the road as policy setters here in the Congress looking at ideas, including a possibly a second stimulus package, one of the suggestions we made to increase productivity is to invest more heavily in infrastructure, the infrastructure needs of the country. I wonder if you might just share with us your views as to what ideas, as a menu of ideas, without necessarily embracing one or the other, but what you would be planning to do rather than just sort of waiting out the year and a new administration coming in, we will be leaving here, adjourning in late September, early October, maybe coming back, maybe not until after inauguration of the President late in January, it seems to me this would be an opportune time for us to be considering very seriously policy considerations that would provide for greater economic growth and opportunity than what we are presently looking at. " CHRG-110hhrg44901--195 The Chairman," The gentleman from Colorado, I ask him to yield me 1 minute, if I can, because the gentleman from New Jersey's history is deeply flawed. The Affordable Housing Fund, which people are opposed to for philosophical reasons, for the slowing down of the GSEs, makes no historical sense. In the previous Congress, controlled by the Republicans, there was no Affordable Housing Fund attached to GSE reform, and the Senate didn't act on it. Any kind of historical experiment, you look for control. In fact, under the Republican Congress, GSE reform passed the House, it went to the Senate, and they didn't act on it. By the way, the Senate bill, which the Senate Republicans put forward, did have an Affordable Housing Fund. They were prepared to accept it, and the bill didn't go forward. In fact, it is now under a Democratic Congress we are on the verge of passing legislation that the Republic Congress wouldn't pass. But to blame the Affordable Housing Fund ignores the history that in a previous Congress the House passed the bill, sent it to the Senate with an appropriate set of regulations, and the Senate didn't act on it under Republican rule, and it was not in any way, shape, or form the problem of the Affordable Housing Fund. I thank the gentlemen from California. " CHRG-110hhrg46591--295 Mr. Bartlett," Congressman, it is very clear that it was housing that led us into the recession, and so I think the housing is going to be required to lead us out of the recession. " FOMC20070918meeting--136 134,MR. PLOSSER.," Thank you, Mr. Chairman. As many of you might imagine, I’ve struggled mightily with this particular decision. My outlook for the economy has changed sufficiently for me to support a cut in the fed funds rate at this meeting. My reasoning may be a little different from that of some of you; nonetheless it leads to the same outcome. My view is in many ways similar to that of President Evans—that economic growth has slowed, and it is likely to be somewhat slower into 2008. Thus my view that the equilibrium real rate has declined and its forecast has declined somewhat leads to my view that the funds rate needs to follow that real rate down. Also, given the current behavior of inflation, I am more comfortable moving toward what I would consider to be a more neutral rate. If we do cut the funds rate today, however, I believe that how we communicate that is far more important than anything that we may do in a long time. This is particularly true since we have not been particularly clear about our inflation goals. As I mentioned in my earlier comments, I’d be much more comfortable with this if we had a numerical target, which would help anchor expectations. I think we need to convey the idea that our policy, as many have said, is based on our forecast for growth and inflation and that it is forward looking. That forecast has changed, and we have lowered interest rates consistent with that revision. With that change in policy, we need to have a balance-of-risks statement that is much more balanced in its assessment; moreover, we need to convey to the market that we expect to see some weak data in future months but that those data to a large degree are already built into our forecast. The weaker-than-expected data in the coming months will not necessarily result in a new forecast. For example, I won’t be revising my forecast just because the September employment report comes in weak. It’s only when we accumulate sufficient evidence that the economy is veering from our new projected path that we would want to revise our forecast and perhaps our policy, although I do want to remind everyone that revisions can go both ways. We might be revising our growth forecast up if the evidence suggests that we’ve been too pessimistic about housing or about bank credit availability or, as Dave Stockton mentioned, about consumer sentiment. Similarly, we might find that we’ve been too optimistic about inflation if inflation expectations rise. I think it is crucial that we try to convey these ideas to the public, if not in the statement then at least in the minutes and our speeches going forward. Let me note that our decision to produce our forecasts on a more frequent basis will be a major step forward in actually trying to convey this type of information. I think it would be a mistake, as President Hoenig suggests, to set up expectations with our language that the rate cut today is necessarily or even likely the start of a series of rate cuts. This expectation could even undermine our action to the extent that it causes consumers and businesses to postpone spending until they think we’re done and could give the impression that, with each new piece of weak data, we’ll be lowering the funds rate further even though we have already incorporated that into our forecast. This reasoning leads me to think that, if we’re going to cut rates today, I would prefer to do 50 basis points, provided—and it’s a big proviso—that we work hard in our statement to convey the idea that the action we are taking is based on something like balanced risks. We have brought the rate to a level that we think is consistent with our new forecast and consistent with our goals of inflation and output growth. In fact, we may even be on hold for a while after this if things pan out according to what the Greenbook suggests. I think a 25 basis point cut would risk setting up expectations for further cuts, which perhaps would be read as taking the same strategy to lower rates as we took to raise them. I want to avoid that. I do realize there’s some risk that a more aggressive action could actually reignite inflation expectations. Vice Chairman Geithner made three good points about what the risks of a more aggressive action are: expectations of inflation, fear in the marketplace that we see something they don’t and that the economy is actually worse than they’re predicting, and the potential for fueling those people who think we are bailing people out and thereby creating moral hazard. Those are risks. I don’t deny that. But I think they are manageable, particularly if we mitigate them through our statement by saying that we now think risks are balanced and conveying the forward-looking impressions that I have given. This brings me to language. Of the three alternatives in the Bluebook, obviously in terms of rate cuts, alternative B is probably where I’d start, although I’m more inclined to have a more balanced approach to risk in paragraph 4. In fact, something more like paragraph 4 in alternative D would suit me better, but perhaps a simpler way would be to rewrite paragraph 4 as follows. This is just a suggestion—it’s a little shorter: “With this action, the Committee judges that the downside risks to economic growth are now roughly balanced by the upside risks to inflation. The Committee will continue to monitor incoming economic information relative to the outlook and act as needed to foster price stability and sustainable economic growth.” That is a little shorter and conveys the kind of balance that I think is important. In some versions of the statement, we have had a little too much of a temptation to promote the idea that we can fine-tune the economy, and I think that’s a dangerous and slippery slope. With regard to the rationale, I’m happy with paragraph 3 on inflation. Indeed, I noticed that there was no capacity utilization in that statement, which pleases me no end. [Laughter] You know, we have to take small victories when we can. I would like to see some changes to paragraph 2. In particular, I’d like us to say a little less about the disruptions in the financial markets. I think this has the potential to confuse people—that our move is being taken as a desire to bail out bad actors—and that could feed into moral hazard. We are moving because our outlook for the broader economy is weakening. The tightening of credit conditions may have the potential to affect the real economy, and that’s why we are acting preemptively. So I would again try to simplify paragraph 2, and I suggest the following language: “Economic growth was moderate during the first half of the year; but labor market strength has moderated, and the housing correction appears to have intensified and may be exacerbated by the tightening of credit conditions. Today’s action is intended to help forestall some of the potential adverse effects of those events on the broader economy and to promote moderate growth over time.” Finally, as I said earlier, I believe it will be very important to communicate, in the minutes and perhaps our speeches going forward, that our forecast incorporates weak data in the near term and, although we may individually have different views as to what that near term might look like, that forecast has been incorporated in our funds rate assessment and we intend to alter our bias or our policy only if our forecast changes appreciably in the months to come. Thank you, Mr. Chairman." 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? " FOMC20080130meeting--251 249,MR. MISHKIN.," Also an issue that the Chairman raised yesterday was that the housing market is a big component of our downside risk. The market's concerns about future declines in housing prices are causing a very sharp decrease in demand for housing. That could turn around very quickly as well. Even now we should be thinking about these issues, and Governor Kohn's use of the word ""nimble""--I like ""flexibility,"" but I think ""nimble"" is probably a better word--is really I think key here. It is somewhat of a departure from normal--exactly what the Chairman said. This episode is different from past episodes. So we do need to start thinking about this, and the staff will need to think about exactly these issues. " CHRG-111shrg57319--481 Mr. Killinger," Again, that product or that feature has been around for many years. I think what we are all dealing with is the housing crisis, or the housing boom grew and as competition grew, the use of limited documentation and no documentation kind of loans certainly expanded. And as we were commenting earlier, as we became more concerned that the housing market had increased in risk, I think that is one of the elements we all started to take a look at. So in our case, we started to cut back on our originations. We eliminated some of the product offerings. We tightened underwriting. As I heard from David Schneider earlier this morning, at one point, we also decided that limited documentation loans were not appropriate. Senator Kaufman. And what size mortgages were stated income loans used for at WaMu? " CHRG-111shrg57322--277 Mr. Tourre," Senator, I would echo some of my colleagues' comments. First, I take full responsibility for my actions. Second, I am saddened and humbled by what happened, in the market in 2007 and 2008, in the overall financial crisis. But I believe my conduct was proper. And, again, to the extent excess credit contributed to the asset price bubble which ultimately magnified the crisis, Goldman Sachs was involved in some of these products that potentially could have excessive credit extension, but, again, I firmly believe that my conduct was correct. Senator Pryor. I think that is one of the problems here, Mr. Chairman. I think as part of your oversight here, I think the American people are hoping that you help us all figure out what went wrong and how we can fix it, but also I think that there is a lot of concern with the general public--and I know I am speaking for Arkansas here--that people around the country feel like Wall Street has contributed, in fact, has largely caused--I am not talking about one individual or one company, but Wall Street has contributed to and caused a lot of the economic crisis that we have been going through, and hopefully most of that is behind us now. But, my sense is that people feel like you are betting with other people's money and other people's future because, for example, in the real estate area, someone gets a mortgage and that gets sold and it gets chopped up and bounced around; and, instead of Wall Street, it looks more like Las Vegas. But they look at that, and all of a sudden they are losing control of their financial security. And I feel like, the fact that all of you have said basically throughout the course of this hearing really there is not a real clear ethical standard, there are not real bright lines on what you can and cannot do, and you wear different hats, and it is complicated; and, the fact, as Senator McCaskill said, you are market makers, but you are also playing in that market. And whether that is truly a conflict of interest or not, whether you truly have a fiduciary responsibility or not, I just think that we need to spend some time as the Senate and the Subcommittee and various committees in the Senate thinking through that. And, anyway, some of the things that we have heard today are very troubling, and I do sense that you are not taking full responsibility for your actions at Goldman's and also Goldman's actions and also the industry's actions that helped contribute to this financial meltdown. So, with that, Mr. Chairman, thank you. Senator Levin. Thank you, Senator Pryor. Senator Ensign. Senator Ensign. Thank you, Mr. Chairman. This is an incredibly important hearing, and I appreciate you holding this. I want to make a couple of comments before I get into your questions. First of all, Senator Pryor, I think most people in Las Vegas would take offense at having Wall Street compared to Las Vegas, because in Las Vegas actually people know that the odds are against them. They play anyway. On Wall Street, they manipulate the odds while you are playing the game, and I would say that it is actually--it is much more dishonest because it is almost like somebody was playing a slot machine and the guys on Wall Street were in there kind of tweaking the odds while you were playing it, and in their favor the vast majority of the time. Senator Pryor. That is a fair point. And also in Las Vegas people are betting their own money, and that is not always the case with---- Senator Ensign. That is very good. A couple other comments. First of all, I think that Wall Street definitely had a role in the financial crisis, but I also think we have a responsibility here on our end between the Community Reinvestment Act, Fannie and Freddie, out of control that we let them get, that is certainly--because without the real estate market doing what it was doing, I mean, that is where these bets were occurring, and everybody got the false idea that the whole real estate value was going to continue to go up and up and up, where bubbles never continue to go up. We know that. And, unfortunately, a lot of smart people on Wall Street got fooled by that. The point that I want to make also is that you all have mentioned that you are market makers, and I think part of this hearing is to find out whether you were actually market manipulators instead of just market makers. And I think that is a key part of it, and that is where I am going to take some of my questioning. I want to start with talking about the role of the credit rating agencies. Did you personally or do you know of Goldman Sachs employees who actually spoke to the credit rating agencies and tried to influence how some of these tranches were rated? Go down the line, just yes or no. " FOMC20061025meeting--163 161,MR. KOHN., Instead of “economic growth appears to have slowed further in the third quarter” it would just be “economic growth has slowed over the course of the year.” CHRG-110shrg50369--55 Mr. Bernanke," Senator, one thing that is certainly true is that a lot of the big house price declines are taking place in high-priced areas like California and Florida, Nevada, Arizona, where prices went up a lot before, and now they are coming back down. Senator Bennett. That is the price range that it is hitting in Utah as well. Thank you, Mr. Chairman. " CHRG-111hhrg74855--220 Mr. Gensler," From the statistics right from the PHM market, about 74 percent of their transactions are with the large financial houses, the houses you are talking about. " FOMC20050630meeting--60 58,MR. GRAMLICH.," So if we see house prices going up, we’re in effect cutting the funds rate while the house prices are going up?" CHRG-110shrg38109--42 Chairman Bernanke," Price stability consistent with strong employment as well. Senator Shelby. Productivity. The President's economic report noted that between 2000 and 2005, productivity growth in the United States accelerated to about 3 percent, Mr. Chairman, the fastest growth of any G-7 country, which includes Canada, France, Germany, Italy, Japan, and the United Kingdom. Most other major industrialized countries suffered a slowdown in productivity growth. What factors do you believe explain the difference in productivity growth given that the other G-7 countries also have access to the same technological improvements and broad capital markets the United States has? And could you expand on these differences in productivity, what productivity implies for our standard of living and our long-term growth? " FOMC20080805meeting--71 69,MR. EVANS.," Thank you, Mr. Chairman. Regarding a comment that Bill Dudley made about housing prices, for financial institutions, it's going to matter a lot whether we're looking at a decline from 15 percent to 20 percent or from 15 percent to 30 percent. Housing inventories, unsold homes, are very high, and I guess I'm wondering again--we have gone over this a few times--what factors are likely to get housing advancing if it's not a sharp decline in housing prices? I'm having a hard time understanding why the expectation would not be for a relatively sharp decline. I'm translating the Greenbook/OFHEO numbers to Bill's numbers, and I'm not sure, but it seems to me that financial institutions ought to be thinking that a significant adjustment must still be in train if we're not expecting demand to pick up all of a sudden. The mortgage origination challenges are there. Or is this disequilibrium just going to sit there for an extended period of time? " CHRG-110hhrg38392--98 Mr. Sires," Thank you, Mr. Chairman. Thank you, Mr. Bernanke, for being here with us today. I just want to follow up on the housing issue. I represent a district that is across from New York, the northern part, the Jersey City area, which has seen a boom of housing over the last few years. With that, the prices really went up high. A lot of people had to resort to subprime lending to get housing, and it created a lot of jobs, a lot of good-paying construction jobs. I do not know whether this is regional, but I have seen the prices of the houses not really going down when we are losing a lot of those jobs that were created. I would just like to know the impact on these construction jobs. I know that approximately 10 percent of the jobs created in this country are through construction. What effect is this going to have on the economy? Do you see it as regional? Because I know they are going to--I have friends in Florida, and they are going through the same process, the same things where good-paying jobs are being lost. Do you see this trend changing? I know mortgages are getting tighter. Subprime is very difficult to get. Home equity loans to create these jobs are impossible in some cases. Do you see this trend changing anytime soon? " FOMC20080805meeting--138 136,MR. MISHKIN.," Well, I get one more chance in the policy round. That is the one I am going to really go for. I am sure that people are waiting for it. [Laughter] My modal forecast has not changed appreciably. Clearly, I am very concerned about the headwinds as a result of the difficulty in recapitalizing financial institutions, which Governor Warsh talked a lot about. As a result, I think that we are going to have subpotential growth for quite a period of time. However, the bigger concern is that I see downside risks as having risen substantially. So let me first talk about the things that are the less worrisome downside risks. I think there are increased downside risks just on the real side of the economy. In particular, the consumer has been very resilient, but I am not as sure that that will be true in the future. We just saw terrible auto sales. It could be just one month, and it could bounce back up. But it could be a precursor to much bigger problems, which would not be completely surprising given some of the other things going on with housing prices and credit restrictions. That is one downside risk. The second is that European growth may have shifted down, and so the kind of problems that we are experiencing here perhaps are being experienced there, particularly in terms of lower housing prices in some parts of the euro zone. That could mean less demand for our exports, and it would be another negative for economic activity. The third is that we have actually seen a backup in mortgage rates, and that can have a direct effect on housing demand. It is pretty grim when you look at what is going on in terms of housing starts, but it could get worse. It can't go below zero, but it could get worse. So if that were all there was, I would say that there may be a little increase in downside risk, but it wouldn't frighten me. But I really am very worried about the potential downside risks in the financial sector. I have to disagree very strenuously with the view that, because you have been in a ""financial stress"" situation for a period of time, there is no potential for systemic risk. In fact, I would argue that the opposite can be the case. Just as a reminder, remember that in the Great Depression, when--I can't use the expression because it would be in the transcripts, but you know what I'm thinking--something hit the fan, [laughter] it actually occurred close to a year after the initial negative shock. In this particular environment, we have to think about where we started. We were very lucky that this financial disruption occurred when bank balance sheets actually were in very good shape initially. You know, thank our lucky stars that it happened at that point. We are now a year into this. Bank balance sheets do not look very good, for all the reasons that we have been discussing. In fact, they look pretty grim. We have had some failures, and we are concerned about other failures. So we have a very different environment. In that situation, if a shoe drops--and we have had big shoes dropping; we had Bear Stearns, we had the GSEs, and we had smaller cases like IndyMac--and if financial systems are in a very weakened state, really bad things could happen. I think that there really is a serious danger here. In particular, we could have a dynamic through a decline in demand for housing because of the backup in mortgage rates or other reasons lowering housing prices and that spilling over into the financial system in terms of raising credit spreads, which then lowers demand, and we could get a nasty, vicious spiral. It is exactly one of these adverse feedback loops that we are all concerned about. So this is not off the table, and it very much worries me. I will talk about the implications of that for policy later. On the inflation front, although I definitely see upside risks, I think they may have diminished just a smidgen. There is a question about how large those upside risks are. In terms of my thinking about what drives the inflation process, it is expectations about future output gaps and expectations about inflation over a long period, not a short-term period. I see absolutely no evidence that, in the last couple of months, we have had deterioration in long-term inflation expectations. If anything, they have gotten a little better since March. If you look at the numbers--and Bill had it in his picture--basically there was some ratcheting up when the crisis first hit. I would argue a lot of that had to do with inflation risk, because there really was increasing inflation risk. There has been a slight movement up--maybe a tenth, maybe you could say two-tenths--in expectations when you look at forecasters. I am very skeptical of consumer surveys because, exactly what behavioral economics tells us, there is framing. If headline inflation is high, short-term inflation expectations go up, which should happen, but long-term inflation expectations also go up. When headline goes down, then they will come down. There was a nice little article from the San Francisco Fed in one of those little letter deals on exactly this issue, which came up with exactly this conclusion. I recommend that you read it; and the good news is that it takes only four minutes to read because the articles are meant to be very short. So I really do not see that there has been deterioration, and--I think that this is very important--it is why I stressed the issue of the analytic framework for thinking about the inflation process and what monetary policy can do. We can't control relative prices, but we can do something about long-run inflation expectations and expectations about future output gaps. So I haven't seen a problem lately that there has been deterioration in long-run expectations. What about output gaps? Well, if anything, they look as though they are expected to widen maybe a smidgen, not that much. We don't have any indication to expect that we will be overshooting in terms of having output greater than potential. Again, that should not be raising inflation. It should, if anything, maybe lower it a bit. Finally, of course, oil prices are lower. I don't think that means that they will stay low because the volatility is huge; but at least the fear that they are going to keep on going up and up and up--so it would not be a one-shot change but would be put into long-run inflation--has, I think, diminished somewhat. So where do I stand in terms of the upside risk? There still is upside risk because having high headline inflation does have the potential to spill over into inflation expectations. All of us have that concern. But I want to emphasize very strongly that it has not happened yet; I think that is very important. I also think it is very important to monitor this. One concern that members of the Committee have is that we wouldn't react fast enough because we have sometimes been inertial in the past. That is a serious concern. But I think there is a strong argument that, when you have very big downside risks to economic activity, you want to deal with inflation expectations when they actually indicate that there is some problem. And I just do not see that at this juncture. Thank you very much. " 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. " fcic_final_report_full--506 Table 6. 101 Higher Risk Loans Produced Higher Delinquency Rates at Fannie Mae Goals by Vintage Loan Count Serious Delinquency Rate 2004 & Prior EA/MCM & Housing Goals 115,686 17.59% 2005 EA/MCM & Housing Goals 56,822 22.35% 2006 EA/MCM & Housing Goals 110,539 25.19% 2007 EA/MCM & Housing Goals 224, 513 29.70% Just how desperate Fannie and Freddie were to meet their AH goals is revealed by Fannie’s behavior in 2004. As reported in the American Banker on May 13, 2005, “A House Financial Services Committee report shared with lawmakers Thursday accused Fannie Mae and Freddie Mac of engaging over several years in a series of dubious transactions to meet their affordable-housing goals…The report cited several large transactions entered into by Fannie under which sellers were allowed to repurchase loans without recourse. For example, it said that in September 2003, Fannie bought the option to buy up to $12 billion of multifamily mortgage loans from Washington Mutual, Inc., for a fee of $2 million, the report said. Under the agreement, the GSE permitted WaMu to repurchase the loans…’ This was the largest multifamily transaction ever undertaken by Fannie Mae and was critical for Fannie Mae to reach the affordable-housing goals, the report said.” 102 A clearer statement of what happened here is contained in WaMu’s 10-K for 2003. Freddie had engaged in a similar but larger transaction with WaMu in 2003, reported as follows in WaMu’s 10-K dated December 31, 2003: Other noninterest income increased in 2003 compared with 2002 partially due to fees paid to the Company [WaMu] by the Federal Home Loan Mortgage Corporation (“FHLMC” or Freddie Mac”). The Company received $100 million in nonrefundable fees to induce the Company to swap approximately $6 billion of multi-family loans for 100% of the beneficial interest in those loans in the form of mortgage-backed securities issued by Freddie Mac. Since the Company has the unilateral right to collapse the securities after one year, the Company has effectively retained control over the loans. Accordingly, the assets continue to be accounted for and reported as loans. This transaction was undertaken by Freddie Mac in order to facilitate fulfilling its 2003 affordable housing goals as set by the Department of Housing and Urban Development. Fannie and Freddie were both paying holders of mortgages to temporarily transfer to them possession of goal-qualifying loans that the GSEs could use to satisfy the AH goals for the year 2003. After the end of the year, the seller had an 101 102 Fannie Mae, “GSE Credit Losses,” presentation to House Financial Services Committee, April 16, 2010. Rob Blackwell, “Two GSEs Cut Corners to Hit Goals, Report Says,” American Banker , May 13, 2005, p.1. absolute right to reacquire these loans. There can be little doubt, then, that as early as 2003, Fannie and Freddie were under so much pressure to find the subprime or other loans that they needed to meet their affordable housing obligations that they were willing to pay substantial sums to window-dress their reports to HUD. 3. The Affordable Housing Goals were the Sole Reason That the GSEs’ Acquired So Many NTMs CHRG-111shrg57319--132 Mr. Cathcart," But I would like to pick up on something that Mr. Vanasek said concerning FICO scores. There were two things that happened with respect to FICO scores. There was definitely an overdependence on them, but under the surface, the bank had changed the way it originated. Banks changed the way they were originating loans, which I think is what Mr. Vanasek already said. But the second change was the customer behavior also changed and we had a phenomenon which we had never seen before, which was that a buyer who bought a house that ended up being so-called underwater, where the house was worth less than the mortgage, actually stopped making payments. We first saw this in 2006, and what resulted is when you looked at the delinquency rates for a population of borrowers, you found that the high FICO score borrowers were delinquent at exactly the same rate as the low FICO score borrowers, which in theory was impossible. So it had the whole industry scratching its head. That phenomenon appeared about Q4 of 2006. In retrospect, what became clear was that in the past, borrowers would have first let their credit cards go and the very last asset that they allowed to go delinquent was their home. This time around, it literally went in reverse, where it was deteriorating housing prices that caused the mortgage to go delinquent and the credit cards were preserved. And we actually saw that phenomenon in our credit card portfolio, where we found that people who didn't own houses had performance that did not deteriorate in the earlier stages of the cycle, whereas people who owned homes deteriorated. And that was completely counterintuitive. So these sorts of changes, when you throw them into an environment where there is an overdependence on FICO, results in really basically steering with the lights out. Senator Kaufman. Mr. Melby, do you have any comments on that, FICO scores? " fcic_final_report_full--175 Ed Parker, the head of mortgage fraud investigation at Ameriquest, the largest subprime lender in , , and , told the FCIC that fraudulent loans were very common at the company. “No one was watching. The volume was up and now you see the fallout behind the loan origination process,” he told the FCIC.  David Gussmann, the former vice president of Enterprise Management Capital Markets at Fannie Mae, told the Commission that in one package of  securitized loans his an- alysts found one purchaser who had bought  properties, falsely identifying himself each time as the owner of only one property, while another had bought five proper- ties.  Fannie Mae’s detection of fraud increased steadily during the housing bubble and accelerated in late , according to William Brewster, the current director of the company’s mortgage fraud program. He said that, seeing evidence of fraud, Fan- nie demanded that lenders such as Bank of America, Countrywide, Citigroup, and JP Morgan Chase repurchase about  million in mortgages in  and  mil- lion in .  “Lax or practically non-existent government oversight created what criminologists have labeled ‘crime-facilitative environments,’ where crime could thrive,” said Henry N. Pontell, a professor of criminology at the University of Califor- nia, Irvine, in testimony to the Commission.  The responsibility to investigate and prosecute mortgage fraud violations falls to local, state and federal law enforcement officials. On the federal level, the Federal Bu- reau of Investigation investigates and refers cases for prosecution to U.S. Attorneys, who are part of the Department of Justice. Cases may also involve other agencies, in- cluding the U.S. Postal Inspection Service, the Department of Housing and Urban Development, and the Internal Revenue Service. The FBI, which has the broadest ju- risdiction of any federal law enforcement agency, was aware of the extent of the fraudulent mortgage problem.  FBI Assistant Director Chris Swecker began noticing a rise in mortgage fraud while he was the special agent in charge of the Charlotte, North Carolina, office from  to . In , that office investigated First Bene- ficial Mortgage for selling fraudulent loans to Fannie Mae, leading to the successful criminal prosecution of the company’s owner, James Edward McLean Jr., and others. First Beneficial repurchased the mortgages after Fannie discovered evidence of fraud, but then—without any interference from Fannie—resold them to Ginnie Mae.  For not alerting Ginnie, Fannie paid . million of restitution to the government. McLean came to the attention of the FBI after buying a luxury yacht for , in cash.  Soon after Swecker was promoted to assistant FBI director for investigations in , he turned a spotlight on mortgage fraud. “The potential impact of mortgage fraud is clear,” Swecker told a congressional committee in . “If fraudulent prac- tices 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.”  In that testimony, Swecker pointed out the inadequacies of data regarding fraud and recommended that Congress mandate a reporting system and other remedies and require all lenders to participate, whether federally regulated or not. For exam- ple, suspicious activity reports, also known as SARs, are reports filed by FDIC-in- sured banks and their affiliates to the Financial Crimes Enforcement Network (FinCEN), a bureau within the Treasury Department that administers money-laun- dering laws and works closely with law enforcement to combat financial crimes. SARs are filed by financial institutions when they suspect criminal activity in a finan- cial transaction. But many mortgage originators, such as Ameriquest, New Century, and Option One, were outside FinCEN’s jurisdiction—and thus the loans they gener- ated, which were then placed into securitized pools by larger lenders or investment banks, were not subject to FinCEN review. William Black testified to the Commis- sion that an estimated  of nonprime mortgage loans were made by noninsured lenders not required to file SARs. And as for those institutions required to do so, he believed he saw evidence of underreporting in that, he said, only about  of feder- ally insured mortgage lenders filed even a single criminal referral for alleged mort- gage fraud in the first half of .  FOMC20060131meeting--77 75,MR. STOCKTON.," That sounds like a reasonable sensitivity. As you know, we have presented this effect in the past. It’s a little larger than the effects that we get when we run our model, which would be measured more around ¼ percentage point to ½ percentage point. Now, you may recall that last June John Williams presented some simulations of various housing-price scenarios. Our relatively small effects come from just simulating a lower path for the price of housing, and as you know, our model has a relatively low marginal propensity to consume out of housing wealth, one that is similar to that out of overall household wealth. It’s not difficult to imagine upping those effects. If one wants to assume that, instead of the three and a half cents on the dollar effect that we have incorporated in our model, the marginal propensity to consume was around five to seven cents on the dollar, those effects would obviously be increased. The second potential channel that our straightforward model simulations don’t account for is that a lower path for housing prices could be accompanied by some hit to consumer sentiment. There would be an outsized effect on consumer spending if households really became more pessimistic given the downturn in what is an asset with a high profile in their portfolios. And the third possibility that John explored in his simulations was related to one of the alternative simulations we show this time around: If weakening in house prices and housing activity occurred when the term premium was widening back out, you would then have the effects not only directly on the housing-sector side, which could be amplified, but also on other forms of interest sensitive spending. So I think there are some pretty wide confidence intervals. The numbers that you cited are bigger than our standard simulation, but seem reasonable and in the ballpark if one wants to make a few adjustments in some of the assumptions that we made. As I contemplate our outlook and the things that I worry about the most on the domestic side of the economy, I’d say the housing sector is clearly one of the biggest risks that you’re currently confronting." CHRG-111hhrg55814--151 Mr. Royce," Right, I understand your argument on that. Part of the problem here are the unintended consequences. And unless we set very clear parameters on this authority, we run the risk of the market really interpreting the worst here. Let me give you an example, and this has to do with moral hazard. It was often stated by several individuals, including members of this committee, that the government would not bail out Fannie Mae and Freddie Mac when they ran into trouble. But because there was a level of ambiguity, the market perceived these institutions as government-backed. At times, we asserted they were not, but the market perceived that they were, which, by the way, turned out to be the case. Economists pointed this out at the time. With respect to the chairman's comments, it's true that several members often raise the example of Fannie and Freddie. We do this not simply because the GSEs were at the center of the mortgage market meltdown--and I feel they were. When you put a mandate from Congress that one half of your portfolio has to be either Alt-A or subprime, when you manage to bully the system into a way where you have zero downpayment loans and so forth, and when it ends up being 85 percent of the losses of these institutions, I think you can see how some of us would believe that played a large role in the market turning into a bubble. I think that many in the Fed believed it did too. And I think, going back to what happened over on the Senate side, the fact that Senate Democrats blocked the real reforms that passed the Senate Banking Committee, on a party-line vote, and I think the fact that Fannie's and Freddie's political pull prevented real reforms during the years--because I certainly saw them up here, lobbying against the reforms that would be necessary to deleverage these institutions until it was too late--I think we can see out of that how we ended up with moral hazard in the system. And creating more GSEs would compound that problem. " FOMC20060920meeting--152 150,MR. MISHKIN.," Many of you know I have an upbeat personality—some might actually say loud—but certainly upbeat. The way I look at the forecast and the situation with the economy is quite positive in the sense that what we’re seeing, really, is a return to normalcy and a more balanced economy. The excesses in the housing sector seem to be unwinding in an acceptable way, so I think it is quite reasonable in terms of the Greenbook forecast to think that the spillover here is not going to be a big problem because we’re actually moving resources from a sector that had too much going into it, into sectors that need to have more resources at the present time. So in that sense, I’m actually quite positive. The other thing that I am quite comfortable with in the Greenbook forecast—though, clearly, there’s uncertainty—is that we’re going to see a decelerating core inflation rate. Furthermore, when we look at inflation expectations, they seem to be very well contained and seem also to have responded well to the pause at the last meeting. However, I should say that, although we’ve seen that inflation expectations are well anchored, there’s a question about whether they’re anchored at quite the right level. They seem to be anchored somewhere around 2½ percent on the CPI, and that is probably with a differential between the CPI and the PCE of about ½ percentage point, or 50 basis points. It still seems to be somewhat on the high side in terms of what many people on the Committee have expressed is their comfort zone. So I think that is a concern. There is a significant probability that things may not turn out so rosy on the output front—we should have a concern that things could go somewhat wrong in terms of the housing sector. If that happened, we might see much lower output growth. There is a reasonable probability of recession. It’s mentioned in the Greenbook. I think your numbers are quite reasonable. So in that context, we could actually have lower output, a wider output gap, and some actual deceleration of inflation. I agreed very much with the conclusion that you came to because it’s reasonable to think that the long-run inflation we’re moving to is around 2 percent unless we get one of the scenarios with a lot more softness. That the deceleration is not going to go much below the Greenbook forecast of around 2 percent by 2008 does cause me a bit of concern. I’m not sure that I would describe the risks as unbalanced. For me, in terms of a forecast, probably I would be comfortable saying they’re balanced. However, I think inflation is too high in the forecast and, in that context, does require much more vigilance. Of course, that will be reflected in the discussion later today. Thank you." FinancialCrisisInquiry--52 MACK: Well, clearly, given what we’ve been through and the pain that homeowners are going through, and the people losing their homes, we have been very direct in our mortgage area to make sure—and I think I gave you a statistic that we’re about 44 percent, with all of our mortgages that we hold—have renegotiated the payments. So in that aspect, the answer is yes. But when you look at some of the automobile companies who we have loans to, you know, those loans are—are made based on how much risk we’re taking. We know those automobile companies or other industrial companies need loans, but we also have a fiduciary responsibility to make sure that we have done our due diligence and it’s not the same social push as we do in home loans and our mortgage facilities. GRAHAM: In terms of evaluating—and maybe I’ll turn this question to Mr. Moynihan—as among potential sources of—of investment for growth, how do you then relate those judgments as to the compensation of the executives and other personnel responsible for making those decisions? For instance, there’s—there’s concern that maybe an excessive amount of—of capital was placed in the housing market to the detriment of other areas of the economy. Is that a factor that is considered in your performance evaluation? MOYNIHAN: I think the—a specific factor I’d say no. No, sir. But in terms of generally how we build our financial plans and how we think about how we grow our business, we make allocations of capital, and then one of the goals of a executive or a person working is to make that financial plan, and that—so it indirectly factors in. But specifically we don’t relate someone’s individual performance into a broader social question of how to allocate capital in the financial system. FOMC20050630meeting--150 148,MR. GALLIN.," If rates flatten out; that’s because we would not be getting a kick any more from lower rates. House prices can go up and housing remains affordable if rates are lower. But if they flatten out and stay flat, one might think that it’s going to be hard for house-price gains to keep humming along the way they’ve been going. That’s going to start to eat into affordability." CHRG-111hhrg53240--68 Chairman Watt," All right, my time has run out, unfortunately, and I am well over the 3 minutes that I said I was going to try to hold people to. The gentleman from Texas is recognized for 3 minutes. Dr. Paul. Thank you, Mr. Chairman. I want to follow up on my question about whether or not current Federal Reserve policy is fair to the consumer. I argue there is a real challenge to the consumer in two points. One, the consumer is always losing purchasing power, and only the Federal Reserve can undo the purchasing power of a dollar. And also the low interest rates which are artificial, because the Fed is involved in interest rates and it really hurts the innocent consumer. As a matter of fact, the people who are more frugal, the people who borrow against mortgages, they don't care that much. But the frugal people who are doing what a lot of people think they should do, they get penalized. And I know the answer so often that comes back is--I always get the quotes back of what the CPI is doing, and there is really no inflation so don't worry about it. Inflation is a monetary issue and we just doubled the money supply in a short period of time. And I would also argue that prices are going up significantly in certain areas. One thing characteristic about inflation, all prices don't go up uniformly. If they did and wages went up uniformly, inflation would be no problem. But we have educational costs, they go up disproportionately. Just think about how military equipment goes up and how the military industrial complex gets served with this system. And then also the people who participate in the financial bubbles, and if they are able to get out they benefit tremendously. But also today in medicine, today we are facing this medicine crisis. Not that the care isn't there. We can get good care, but it costs too much. That is an inflationary problem as much as anything else, because those places where government gets involved, like these three things I mentioned, that is where the money goes and that is where the prices get pushed up. You don't get better service, because you don't get better education or medical care, you get higher prices. So what is your defense of this position that the Fed isn't a very good protector of the consumer because it undermines the value of a dollar? We have lost 96 percent of the value of our dollar since the Fed has been in existence, and also this low interest rate issue that I bring up. Ms. Duke. We are conducting monetary policy to achieve our dual mandate, which is low inflation and steady prices and economic growth. And the inflation rate right now, the core consumer inflation is about 1.8 percent. Dr. Paul. According to government statistics, but not according to the consumers. Private sources say that the consumer price index is much higher than what the government reports. So it is in the interest of the government and the Federal Reserve to say that there is no erosion. But whether or not it is today or next year, we know the history. But what justification is it? Doesn't this seem to be unfair? If you had a CD in the bank, or your parents had a CD in the bank and they were making 1 percent instead of 5 percent, is that fair or unfair? Ms. Duke. The interest rates are set and are managed, again, to meet our mandate. And right now rates are particularly low in order to support economic activity, particularly funds' availability to borrowers. Dr. Paul. I think the consumer loses on that deal. Thank you. " 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-111hhrg55811--293 Mr. Bachus," The White House requested you testify, which is fine. I didn't know if you had--have you looked at the White House proposal as opposed to the chairman's draft? " CHRG-109shrg30354--51 Chairman Bernanke," I absolutely agree with your point, Senator. In fact, in my testimony before the Joint Economic Committee, I argued that at some point, a point which I did not specify, the Fed would have to get off this 25 basis point per meeting escalator and adopt a more flexible approach, possibly varying its pace of tightening, possibly taking a pause. That has been the practice in the past. That is the practice of the European Central Bank and the Bank of Japan today. They do not move at every meeting. They move based on the state of the economy and based on the pace at which they wish to tighten. So I did make that point. I think it is still relevant. But of course, we always look at this meeting by meeting, and we will be evaluating all options when we come to meet in August. Senator Sarbanes. This development in the housing market that I showed earlier, and the drop in the new housing starts, that is a 22 percent drop in a matter of months. Now the National Association of Home Builders, which obviously would be quite concerned about something of this sort, has written to Members of the Committee about this. And I understand that some forecasters say that this could result in a 1.5 percent drop in GDP. Now we have relied on the strong housing market to keep the economy up in recent times, and now this seems to indicate a deterioration in that position. Furthermore, in your statement when you talk about higher core inflation, you reference increase in residential rents, as well as the imputed rent on owner-occupied homes. Now the Association of Home Builders makes, it seems to me, a rather valid point in communicating with us about this measure, saying that the weakness in new housing increases the demand for rental housing. Therefore, the price of rental housing goes up and the imputed value of the owner's equivalent rent--which they are not actually paying, it is a statistical measure--that goes up. And therefore, the core inflation goes up. Then the reaction to the core inflation going up is to raise the interest rates in order to check what is perceived as an inflation problem. The raise in the interest rates intensifies this trend in the decline in new housing, available housing, greater demand for rental housing, a greater imputed value into the core inflation measure. And you have this vicious circle contributed to by the raised interest rates. That seems to me to have some validity, that observation. What is your reaction to that? " FinancialCrisisReport--227 Numerous documents show that OTS and the FDIC were, in fact, aware that WaMu was issuing high risk loans that led to poor quality securitizations: 2005 OTS email describing poor quality Long Beach mortgage backed securities: “Performance data for 2003 and 2004 vintages appear to approximate industry average while issues [of securities] prior to 2003 have horrible performance. ... [Long Beach] finished in the top 12 worst annualized [net credit losses] in 1997 and 1999 thru 2003. … At 2/05, [Long Beach] was #1 with a 12% delinquency rate. Industry was around 8.25%.” 863 2005 FDIC analysis of WaMu high risk loans: “Management acknowledges the risks posed by current market conditions and recognizes that a potential decline in housing prices is a distinct possibility. Management believes, however that the impact on [WaMu] would be manageable, since the riskiest segments of production are sold to investors, and that these investors will bear the brunt of a bursting housing bubble.” 864 2005 OTS email discussing allowing lower standards for loans held for sale: “[L]oans held for sale could be underwritten to secondary market standards …. I believe we would still find that secondary market requirements are more lax than our policy on underwriting to fully indexed rates. … [I]f you allow them [WaMu] the exception for loans held for sale … they probably do not have a ton of loans that fall far outside our policy guidance.” 865 2006 OTS email discussing Long Beach loans that had to be repurchased from buyers: “The primary reasons for the problem were … [g]eneral lower quality 2005 production due to economy and lowered standards …. The $4.749 billion in loans on [Long Beach] books at 12/31/05 are largely comprised of the same 2005 vintage production that was sold in the whole loan sales and are now subject to the increased repurchases. … Management is balancing the probability that these loans will perform worse than expected and priced for, versus the increased income they generate … in considering whether to [sell] some or all of the portfolio.” 866 862 “Securitizations of Washington Mutual and Long Beach Subprime Home Loans,” chart prepared by the Subcommittee, Hearing Exhibit 4/13-1c; 10/17/2006 “Option ARM” draft presentation to the WaMu Board of Directors, JPM_WM02549027, chart at 2, Hearing Exhibit 4/13-38. 863 4/14/2005 email from OTS examiner to colleagues, OTSWME05-0120000806, Hearing Exhibit 4/13-8a. 864 Undated draft memorandum from WaMu examination team to the FDIC Section Chief for Large Banks, FDIC- EM_00251205-10, Hearing Exhibit 4/16-51a (likely mid-2005). 865 9/16/2005 email from OTS Examiner-in-Charge at WaMu, OTSWMS05-002 0000535, Hearing Exhibit 4/16-6. 866 1/20/2006 email from Darrel Dochow to Michael Finn and others, OTSWMS06-007 0001020. 2008 OTS email after WaMu’s failure: “We were satisfied that the loans were originated for sale. SEC and FED [were] asleep at the switch with the securitization and repackaging of the cash flows, irrespective of who they were selling to.” 867 2005 WaMu audit of Loan Sales and Securitization planned no further audit for three years. In March 2007, OTS informally suggested that more frequent audits would be appropriate given the high volume and high risk nature of WaMu’s securitization activity and “data integrity issues surrounding the creation of securitization trusts, resulting in loan repurchases from those trusts.” 868 OTS was two years too late, however; the secondary market for subprime securities collapsed four months later. FOMC20070131meeting--94 92,MS. MINEHAN.," I’m interested in the risks you see around the GDP growth rate in your forecast. I note a couple of things. First, some of the growth rate depends upon consumers getting the message that they really ought to be saving for the future instead of spending as they have been. I wonder why they’d do that this year if they didn’t do it last year. Second, I notice that, if you compare the Greenbook GDP forecast with the central tendency of the members of the Committee, growth is a good deal slower—0.3 or 0.4 slower, which in this realm is a lot. I’m interested in how you see the upside risk to this, particularly given that, even with your slower growth rate, you get to zero output gap relatively quickly." FOMC20060920meeting--133 131,MR. GUYNN.," Thank you, Mr. Chairman. Since this is my last meeting, I want to say formally what an honor it has been to serve under your leadership, at least for a short while, and under Chairman Greenspan’s leadership before that. And to my colleagues around the table and around the room, I want to say what an extraordinary experience it has been to work with you not only on policymaking but also on the other System business for so many years. There is a lot that I will miss, and your friendship is at the top of the list. I will be mercifully short with my comments this morning. At our last meeting, I indicated that the data from around our District had finally begun to reflect the anecdotal reports of slowing that we’ve been getting for some months. The most recent data underscore that trend, but with some crosscurrents that suggest that some sectors continue to be reasonably solid. With a total of forty-four directors in the six offices in our Atlanta District, we have an unusually large complement of regular month-to-month contacts who can often signal a significant shift in sentiment about what may lie ahead. Sometime ago we began to ask our directors each month to give us not only their views on specific economic issues but also their overall sense of the economic outlook. Very simply, we asked them to indicate whether they think six months out that growth will be stronger, about the same, or weaker. Over the past six months we have watched the aggregation of those views deteriorate to the point that, in our tabulation last week, the only directors who expected things six months out to be better were from New Orleans, where economic conditions can only get better. Some of the uneasiness about the outlook in our region clearly reflects the sharp housing adjustment that we’ve seen, particularly in our once-hot coastal markets. That painful adjustment continues, with folks in the industry saying that they think the bottom may be as much as a year away. I talked just yesterday afternoon, before I left to come to Washington, with the CEO of one of the large national homebuilders headquartered in Atlanta. Mr. Chairman, I think he was in the group that came to see you and others just a few weeks ago. He emphasized that the adjustment that’s going on is broader and more significant than the data suggest. He said that sales cancellation rates, even in cities like Atlanta, now exceed 50 percent, whereas they had been running about 30 percent. He underscored something that we have talked about before, and it has been mentioned again this morning, that the fall in the real selling price is often masked by incentives and give-backs that have become very widespread. He said the only exception to the adjustment in housing that he could see was in the major Texas markets. The stories out of New Orleans continue to be depressing, with business leaders now saying it may be a decade, rather than a few years, before the housing crisis there can be substantially resolved. There are simply not enough habitable housing units to accommodate the workers, especially low-skilled hospitality industry workers who are needed by businesses that are trying desperately to reopen and to get back on their feet. As a consequence, more and more jobs are being moved out to other cities, and many of them are not expected to return. As I mentioned at the outset, there are also more-encouraging crosscurrents in our region. Manufacturing activity still looks reasonably solid; transportation and tourism do as well. We had some good employment gains in all our states last month, after some disappointing data the month before. We continue to get reports of shortages of skilled labor in a number of trades, including the construction industry. Despite continuing input price pressures, which others have talked about, we’re told that the ability to pass along those costs in final goods and services is still very limited for many businesses. As far as the national economy is concerned, it’s my view that we’re about where we expected to be at this point, with no huge surprises since our last meeting. Evidence of slowing is now more apparent, but many crosscurrents also exist at the national level. Corporate profits are high, investment spending still seems to be reasonably strong, and consumer spending remains supportive of growth. While many sectors continue to perform reasonably well, as my regional remarks suggest, considerable uncertainty does exist about housing, both in terms of how steep the slowdown will be and what the slowdown might mean for consumer spending. Although energy prices have clearly fallen back, inflation, as everyone has said, remains above our preferred range. We’ve had some encouraging monthly inflation data since our last meeting, but the hoped-for moderation in prices that we expected to see is still mostly a forecast. Still, I take some encouragement from the fact that the forecast for lower inflation readings over the period ahead is not only reflected in the Greenbook but also in the modeling work my own staff has done and in the projections of outside forecasters. Additionally, modest inflation expectations seem to be holding. And markets are not expecting us to deviate from our current policy stance, at least for the short run. Finally, Mr. Chairman, I want to say to you and others that I’m counting on all of you to protect the buying power of my hard-earned retirement savings. [Laughter] I’m going to have lots more time as a retiree to be a Fed watcher and a letter writer, and I promise to be in touch if you don’t do a good job. [Laughter] Thank you very much." 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." fcic_final_report_full--323 On August , OFHEO’s Lockhart notified Fannie that increasing the portfolio cap would be “premature” but the regulator would keep the request under “active consideration.” Lockhart wrote that he would not authorize changes, because Fannie could still guarantee mortgages even if it couldn’t buy them and because Fannie re- mained a “significant supervisory concern.” In addition, Lockhart noted that Fannie could not prudently address the problems in the subprime and Alt-A mortgage mar- ket, and the company’s charter did not permit it to address problems in the market for jumbo loans (mortgages larger than the GSEs’ loan limit).  Although there had been progress in dealing with the accounting and internal control deficiencies, he ob- served, much work remained. Fannie still had not filed financial statements for  or , “a particularly troubling issue in unsettled markets.”  As Lockhart testified to the FCIC, “It became clear by August  that the tur- moil was too big for the Enterprises [the GSEs] to solve in a safe and sound manner.” He was worried that fewer controls would mean more losses. “They were fulfilling their mission,” Lockhart told the FCIC, “but they had no power to do more in a safe and sound manner. If their mission is to provide stability and lessen market turmoil, there was nothing in their capital structure” that would allow them to do so.  Lockhart had worried about the financial stability of the two GSEs and about OFHEO’s ability to regulate the behemoths from the day he became director in May , and he advocated for more regulatory powers for his largely toothless agency. Lockhart pushed for the power to increase capital requirements and to limit growth, and he sought authority over mission goals set by the Department of Housing and Urban Development, as well as litigation authority independent of the Department of Justice. His shopping list also included the authority to put Fannie and Freddie into receivership, a power held by bank regulators over banks, and to liquidate the GSEs if necessary. As it stood, OFHEO had the authority to place the GSEs in conservator- ship—in effect, to force a government takeover—but because it lacked funding to op- erate the GSEs as conservator, that authority was impracticable. The GSEs would deteriorate even further before Lockhart secured the powers he sought.  “THE ONLY GAME IN TOWN ” But Fannie and Freddie were “the only game in town” once the housing market dried up in the summer of , Paulson told the FCIC. And by the spring of , “[the GSEs,] more than anyone, were the engine we needed to get through the problem.”  Few doubted Fannie and Freddie were needed to support the struggling housing market. The question was how to do so safely.  Purchasing and guaranteeing risky mortgage-backed securities helped make money available for borrowers, but it could also result in further losses for the two huge companies later on. “There’s a real trade- off,” Lockhart said in late —a trade-off made all the more difficult by the state of the GSEs’ balance sheets.  The value of risky loans and securities was swamping their reported capital. By the end of , guaranteed and portfolio mortgages with FICO scores less than  exceeded reported capital at Fannie Mae by more than seven to one; Alt-A loans and securities, by more than six to one. Loans for which borrowers did not provide full documentation amounted to more than ten times re- ported capital.  FOMC20080625meeting--58 56,MR. BULLARD.," But then you're switching into the low-growth period, and then we take the correlations for low-growth periods, which I guess are maybe not as severe as in recession periods. " FOMC20070321meeting--64 62,MR. STOCKTON.," It’s a combination of two bets that are probably both risky. One is that in fact productivity will continue and that what we’ve seen more recently is a little more pronounced cyclical sag in productivity growth and not a sign that underlying structural productivity is weaker than we’re estimating. The second bet is that, on the supply side, the growth in the labor force will be relatively weak. Therefore, we will not need to have as much employment growth—" CHRG-110shrg50409--32 Mr. Bernanke," But as I said earlier, I think the housing sector, together to some extent with oil, is at the heart of the current uncertainty, the current situation. I think were it to happen that there would become a general view that the housing situation had stabilized, you would see actually a very strong bounce-back in the economy and the financial markets, and it is the uncertainty about when that happens that remains a problem. Again, it is the Congress' prerogative to decide what to do about the GSEs and other housing-related legislation. But as I tried to indicate before, I think the best thing that we can do to remove this uncertainty and to speed the recovery is to make sure that the housing market and the mortgage finance markets are functioning as well as possible. Senator Bennett. Yes, but very specifically, taking away the word ``deal''--and I agree with you that even though that is the word we have seen in the press, that is probably not the right word. But the structure that you have agreed to in terms of some kind of a back-up for the GSEs, should they get in trouble, do you have the feeling that the announcement of the terms of that structure should remove some of the uncertainty with respect to their future? " CHRG-111hhrg58044--85 Mr. Watt," Are you prepared to assert to me that if I have a low credit score, that is likely to cause me to have a fire at my house? " FOMC20060808meeting--127 125,CHAIRMAN BERNANKE.," Thank you very much. First of all, I’d like to thank everyone for a really helpful and thoughtful discussion. It was very useful. Let me just make a few comments. First, we do need to be careful to think about what the optimal policy looks like. It doesn’t take the form that we keep raising rates until we’re happy with the inflation rate. Instead, what we need to look for is the rate that, if maintained, will ultimately give us a good trajectory in the economy. I would submit that we don’t really know where that is yet. President Lacker made some very interesting arguments about the real rate of interest in the late ’90s. Those are good arguments, but I would reply to him, first, that we’ve seen very low real rates in the past decade, a global savings glut and all of that, and, second, we have at the moment an IS shock of very significant and unknown size—the housing market, which is declining very sharply. So I agree that we may well want to go up from where we are. I think that’s, in fact, a more likely outcome. But we really can’t be sure at this point where we ultimately want to stop, and we need to be a bit cautious and try to learn about exactly where that level is going to be. For those reasons, I’m not comfortable with alternatives A or C because they basically say that we’re done, either at 5.25 or 5.50, and so the choices then are between alternative B and alternative D. I’m concerned with alternative D because, besides raising the rate to 5.50, it signals further increases. After seventeen consecutive moves, we would be tightening into a housing decline. We don’t have that much confidence that we need to be so strong at this point. Signaling a strong concern about inflation but being more cautious in groping for the optimal level of the interest rate is probably a wiser course. I remind you that the Fed has not been terribly successful with soft landings. We have a chance to get one. All else being equal, I think it would be good if we could achieve that. So I’d recommend alternative B. I’ll come back to the language in just a moment. I characterize this as a hawkish pause. I think it has several advantages: The first is to gather information. With respect to some of the points President Poole raised, I think the key information we want to look at is, first, activity; we want to look at employment, housing, and consumption, in particular, which will give us some indications about growth going forward. But we also want to look at inflation data and inflation expectations data. Inflation expectations, specifically, are mentioned in the statement, and an untethering of inflation expectations would be, on its own, grounds for us to respond. The risk of our falling behind the curve by pausing is relatively small. Again, I think that we’re not more than a couple of moves away from the optimal level. Therefore, if we miss a meeting or two and then move again in November or December, we will still be able to reach this optimal level within a reasonable period of time. Moreover, we have a degree of freedom on the other end, so to speak. If the markets expect us to begin to cut, we can always maintain the rate at the level for a longer period than expected to get some further restriction. So on the substance I think there are grounds, after seventeen moves and with the housing market in an indeterminate situation, to pause and to get more information. I’d like to say a word about the tactics as well. President Minehan was correct that my introduction of the idea of a pause was not particularly well received. But we have now, at least reading the commentary, explained the difference between a pause and a stop. It’s useful for us to get the flexibility that will allow us not necessarily to move at every meeting but to move as the data require. A demonstration of that flexibility has some value in terms of creating some more optionality for us in the future. Also, we have been talking about data dependence. By creating this flexibility, we’ll be able to increase the relationship between what we do and what the data say, and I think that’s already working. For example, I would note the wide dispersion of views among the dealers about where we’re eventually going to stop. That dispersion of views comes from differences about where they think the economy and inflation are going. It is very encouraging to me that they are now not looking to us for forward guidance but rather looking at the state of the economy and trying to judge where the Fed will have to go to achieve its objectives. So recognizing the concerns that have been raised and taking them very seriously, I think that our best option, of perhaps not very many great options, is a hawkish pause, which I associate with alternative B. With respect to the language, I think it is an improvement to take at least the first sentence of section 3 in alternative C, which includes high resource utilization, and use it in place of the first sentence of section 3 in alternative B. I have two questions for the group. One, do we want to reintroduce or go back to our old language of including productivity gains? If so, that would require the second sentence of alternative A, section 3. If not, we just use the whole section 3 of alternative C. That’s question one. Two, President Poole has expressed concern about the housing reference. We could simply say “reflecting the lagged effects” and leave out the housing part. I would take suggestions on that. I would note that we have used this housing phrase in the past few meetings, and so it would be a change. President Lacker." FOMC20080130meeting--113 111,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. Nellie, I have two questions for you. One is on exhibit 9, where you forecast in the middle right panel the rate of increase in defaults on subprime ARMs. If you compare that with your reset rate estimate and your house-price assumption or the house-price assumption in the market, I wonder whether that looks a little optimistic. Can you just say a little more about why, under the baseline scenario, given what has happened to house prices already and what is ahead, you wouldn't think that would be substantially greater? " 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-111shrg57322--546 Mr. Birnbaum," Sorry. Which information? Senator Coburn. The information of the fact that the housing market, the prices in the housing market, as you testified earlier, as an indicator, that you were seeing softness in that market, you were seeing a decelerating increase in prices, then you saw a flat price, then you saw a deceleration of price. " CHRG-111shrg57320--304 Mr. Doerr," Well, we were becoming concerned with what would happen were there to be a dramatic downturn in the mortgage industry and with housing in general, or what effect that sort of downturn would have on the mortgage industry. Senator Levin. Loans were risky, were they? They had multiple risk factors layered on top of each other. Borrowers in low documentation loans were subject to higher default risk. Is that not true? Payment shock increased default risk. Geographic concentrations were vulnerable to high housing rate increases. Were they all true? " FOMC20070131meeting--199 197,MR. PLOSSER.," Thank you, Mr. Chairman. I’ll start off by saying that today I favor maintaining the federal funds rate at 5¼ percent. As we discussed yesterday and we learned this morning, the picture that seems to be emerging from the latest economic information is one of reasonably strong underlying growth, which has been temporarily weakened by housing and autos. Given that temporary weakness, I think it would be premature to raise rates today; but I am not confident that core inflation will continue to decelerate in the coming quarters, and that could risk our credibility. The level of inflation continues to be higher than I’d like to see, and in my forecast we may not see a return to price stability unless monetary conditions are tightened further. Although I don’t think today is the day to do it, I do want us to consider tightening if we see growth accelerating back to trend more quickly than in the Greenbook. I say this not because I think that growth will put upward pressure on inflation but because the associated equilibrium real rates that are implied by that higher growth, which we are beginning to see in the marketplace, will eventually force our hand. As I mentioned in my remarks on the economy at the past two meetings, I have been of the mind that a somewhat slower economy, combined with a constant funds rate, might be sufficient to ensure a decline in core inflation. As the economy strengthens, that scenario becomes a little less likely. If the economy continues to strengthen, a failure to act not only puts our price stability goal at risk but also risks our credibility with the public. Thus it would be ill-advised to suggest in our statement that we are finished acting for a while, and therefore I would not favor the language that Bill Poole circulated last week. My preference is for the language describing the rationale given in alternative C in table 1 of the Bluebook. The rationale in alternative C, including both sections 2 and 3, is really not more hawkish than the language of alternative B, yet it’s more concise and comes closer to my views on the current state of the economy. Indeed, since under alternative B, section 3, or alternative C, section 3, we would be making sizable changes in the language from our last statement, I also think that it’s appropriate at this time to purge the language about the high level of resource utilization having the potential to sustain inflation pressures or lower oil prices to mitigate core inflation. All the recent work on the forecasting of medium-term and longer-term inflation that I have seen says that these Phillips-type models don’t help us forecast core inflation very well. The FRB/US model of the Greenbook looks as though it has very flat tradeoffs, certainly in the near term anyway; so I think it would be useful to change our language at this point. I have not been a fan of that language, but in the past I was persuaded that we should leave it so as to avoid unnecessary changes that might confuse the public. But since we are considering changes at this time, I would favor going with alternative C, which gets rid of this language. I’m happy to continue with the risk assessment that we had last time, eliminating the word “nonetheless,” although frankly I would not greatly resist actually going with the assessment of risk in alternative C. Thank you, Mr. Chairman." CHRG-109hhrg28024--44 Mrs. Maloney," And finally, this large debt, deficit, and trade deficit--what is the implication for growth for our economy, and isn't this structure bad for economic growth in the long term? " CHRG-111hhrg55809--265 Mr. Bernanke," I would be fooling myself and you if I said I knew with any certainty. But most forecasters, including the Fed, are currently looking at growth in 2010, but not growth so rapid as to substantially lower the unemployment rates. " FOMC20071031meeting--159 157,MR. LOCKHART.," Well, I’m gaining ground this morning. [Laughter] Having said that, I prefer that we reduce the federal funds rate target 25 basis points. My thought process is that the softening of economic activity, at least in some sectors, and the lower estimates suggest that the neutral rate of interest may be falling. The downside risks to economic growth and the evidence of lingering liquidity issues are to me good arguments for taking steps that insure against an inadvertently restrictive policy stance. With regard to the policy statement, I am going to continue to use the inexperience excuse as long as I can, even though we have some newer members. But just a few remarks. The language in the rationale section of alternative A most closely reflects my assessment of the situation, but I am not entirely comfortable with any of the options for the assessment of risk. The real economic outlook faces uncertainties on the downside that are difficult to characterize. Because of that, I am skeptical that we can credibly claim near-term downside growth risks to be roughly in balance with upside inflation risks, as is done in alternatives A and C. That said, I worry that the wording in alternative B would be interpreted as a rather significant loss of confidence in the economy and a signal that another rate reduction is probable in the near term. At this point, I’d prefer not to send a signal that another rate cut is most likely in December. Since our last meeting, expectations were centered on no change in the fed funds target today until a string of weak housing and earnings reports moved the probabilities strongly in the direction of a rate reduction. Thus, judging from the evolution of market expectations since our September meeting, the assessment of risk language in our last statement was sufficient to convince financial market participants that our decision on the funds rate is being driven by incoming data. As I said, I think the assessment of risk statement should try to recognize the uncertainties inherent in our growth forecasts—and those uncertainties are greater than those associated with our inflation forecast—but without tilting expectations in favor of a future rate cut. As I said in my remarks yesterday, it is quite possible that we will enter another period in which headline inflation numbers exceed the trend suggested by core measures. If that is even a short-lived problem, my opinion is that—and this is based on the Bluebook version—we would be well served to note that fact by adopting the language in alternative C, section 3. However, I do note that the new language, as presented this morning, in alternative A, section 3, is quite helpful because it largely incorporates the language in alternative C. Thank you, Mr. Chairman." CHRG-110shrg50418--85 Chairman Dodd," So some acknowledgement of the fact that while certainly that was going on in the housing sector, we all acknowledge that, we had 75 hearings on the housing. But in a sense, GMAC is providing that credit at those low rates and so forth at the time. " FOMC20080805meeting--73 71,MR. EVANS.," The staff has been way out front in projecting the housing decline, and that has been very helpful. Is there any dissonance between what Bill said and your pretty substantial expectation of housing-price declines? " CHRG-111shrg57322--316 Mr. Birnbaum," I did not say that, though. That is how you put it. Senator Tester. OK. So did you not think the housing market was in decline? Senator Tester. Do you think the housing is in decline right now? " CHRG-110hhrg46591--241 Mr. Watt," Thank you. Thank you to all of the witnesses for their testimony. I believe Mrs. McCarthy is the first to be recognized in this round. Mrs. McCarthy of New York. Thank you, Mr. Chairman. Again, thank you for your testimony. You know, when this all started, the first thing that came to my head was Enron. One of the things I was thinking about with Enron was, where is the moral guide in our financial system nowadays? I happen to think that an awful lot of innocent people are community bankers, are independent bankers, are credit union guys. They did not make any of these loans, yet they are still out there trying to help inside the community. I know there was a story going back a while ago that one of the larger financial institutions on Wall Street had been told by their risk management guy that they were overloaded and that they should stop buying an awful lot of these pieces of commercial paper out there. He was fired. He did go to another large company that actually took his advice, and that was one of the larger companies that came out of this risk free. We cannot legislate morality. Whether it was banking, or whether it was Wall Street, they have lost their way. Reputation on Wall Street was the most important thing, and that is what their customers counted on. We cannot do that. That has to come from within the system. I guess what I need to know is, what are the lessons that we can learn from other countries? They got involved. They bought our paper. Everybody wanted to be part of that bubble. Have they done anything that we have done differently where we could look to them to see if there are some sort of regulations? They always complained about our having too many regulations. Now they are saying that we should actually be more regulated. So is there a balance in there? That is going to be the biggest problem, as far as this committee goes, in trying to find a balance. I do not think there is anybody here who really wants to overregulate. We want the system to run smoothly. I would look forward to hearing any of your comments on that. " CHRG-110shrg50414--73 Mr. Bernanke," Yes. Senator Shelby. Could you just in a few minutes describe several of the proposals that you considered, telling us in detail in specific terms why those proposals were deemed inadequate by both the Treasury and the Fed? " Secretary Paulson," OK. I will go first. We have, as you know, Senator, been talking with Congress and talking among ourselves for some time about what is going on in the housing area. And we have worked very hard together to approach the foreclosure issue. And so there is a lot of work that was done in dealing with foreclosures, No. 1. No. 2, as you yourself have said, you saw some case-by-case approaches, and, you know, I would argue that every one of those was absolutely essential and was necessary. And as we looked at this situation, we said the root cause of this is housing. The root cause is housing and the housing correction, and until we get at that, we are not going to solve it. And as we looked at how we get at that, there are some that said we should just go and stick capital in the banks--put preferred stocks, stick capital in the banks. And that is what you do when you have failures. That is what happened in Japan. That is what happened in other spots. We have dealt with some failures, and we have dealt with them where there is capital. But we said the right way to do this is not going around and using guarantees or injecting capital--and there have been various proposals to do that--but to use market mechanisms. And, again, I think that some of the questions here and some of the frustration here I share, you know, on compensation and so on. And when you deal with ad hoc situations, when you deal with an institution that is failing or about to fail, and you have to buy mortgages or securities well above value, or you need to put capital in, then you take tough compensation measures. But as we looked at it and thought about this--and we consulted together about this, you know, for a long time--and said ultimately--and we hope we do not get there. We hope that this decline can be arrested. But we both had said that until the biggest part of the correction in housing prices is over, there is no way to really have a stable financial system. So we decided that this market mechanism and going out very broadly--this is broadly to financial institutions all over, and working on the asset prices and helping develop value that the market can build around. Senator Shelby. Do you agree with that, Chairman Bernanke? " FOMC20051213meeting--23 21,MR. MADIGAN.," I might add, President Poole, that we do make estimates of the growth rate of the domestic component as well as the growth rate of the foreign component. According to our estimates, the deceleration over the past several years has occurred in both components. But we estimate that growth for the domestic component would be about flat or slightly negative for this year for the first time in many years—maybe ever—whereas the foreign component, according to our estimates, has slowed from growth rates of around 9 percent earlier around the turn of the decade to a little less than 6 percent recently. Of course, these estimates have to be taken with a big grain of salt December 13, 2005 9 of 100" FOMC20051101meeting--93 91,MR. POOLE.," I’d like to renew a plea that I’ve made a couple of times over the years. I think everybody in this room believes that a vigorously competitive international sector is good for growth and, therefore, I bristle when you talk about that in terms of a drag on growth and a negative contribution to GDP. You’re talking about an arithmetic way of adding up the GDP account. But what’s happening is that vigorous growth in demand is being partially met from abroad, and that’s not necessarily bad for growth. So I bristle when I hear it put this way because some of this ends up filtering into our public discourse. And even though we may understand that we’re talking about the arithmetic statement of the GDP account, it seems misleading. So I want to mention that." fcic_final_report_full--55 In , Congress provided tax relief and HUD relaxed Fannie’s capital require- ments to help the company avert failure. These efforts were consistent with lawmak- ers’ repeated proclamations that a vibrant market for home mortgages served the best interests of the country, but the moves also reinforced the impression that the government would never abandon Fannie and Freddie. Fannie and Freddie would soon buy and either hold or securitize mortgages worth hundreds of billions, then trillions , of dollars. Among the investors were U.S. banks, thrifts, investment funds, and pension funds, as well as central banks and investment funds around the world. Fannie and Freddie had become too big to fail. While the government continued to favor Fannie and Freddie, they toughened regulation of the thrifts following the savings and loan crisis. Thrifts had previously dominated the mortgage business as large holders of mortgages. In the Financial In- stitutions Reform, Recovery, and Enforcement Act of  (FIRREA), Congress imposed tougher, bank-style capital requirements and regulations on thrifts. By con- trast, in the Federal Housing Enterprises Financial Safety and Soundness Act of , Congress created a supervisor for the GSEs, the Office of Federal Housing Enterprise Oversight (OFHEO), without legal powers comparable to those of bank and thrift supervisors in enforcement, capital requirements, funding, and receivership. Crack- ing down on thrifts while not on the GSEs was no accident. The GSEs had shown their immense political power during the drafting of the  law.  “OFHEO was structurally weak and almost designed to fail,” said Armando Falcon Jr., a former di- rector of the agency, to the FCIC.  All this added up to a generous federal subsidy. One  study put the value of that subsidy at  billion or more and estimated that more than half of these bene- fits accrued to shareholders, not to homebuyers.  Given these circumstances, regulatory arbitrage worked as it always does: the markets shifted to the lowest-cost, least-regulated havens. After Congress imposed stricter capital requirements on thrifts, it became increasingly profitable for them to securitize with or sell loans to Fannie and Freddie rather than hold on to the loans. The stampede was on. Fannie’s and Freddie’s debt obligations and outstanding mort- gage-backed securities grew from  billion in  to . trillion in  and . trillion in .  The legislation that transformed Fannie in  also authorized HUD to prescribe affordable housing goals for Fannie: to “require that a reasonable portion of the cor- poration’s mortgage purchases be related to the national goal of providing adequate housing for low and moderate income families, but with reasonable economic return to the corporation.”  In , HUD tried to implement the law and, after a barrage of criticism from the GSEs and the mortgage and real estate industries, issued a weak regulation encouraging affordable housing.  In the  Federal Housing Enterprises Financial Safety and Soundness Act, Congress extended HUD’s authority to set af- fordable housing goals for Fannie and Freddie. Congress also changed the language to say that in the pursuit of affordable housing, “a reasonable economic return . . . may be less than the return earned on other activities.” The law required HUD to consider “the need to maintain the sound financial condition of the enterprises.” The act now ordered HUD to set goals for Fannie and Freddie to buy loans for low- and moderate- income housing, special affordable housing, and housing in central cities, rural areas, and other underserved areas. Congress instructed HUD to periodically set a goal for each category as a percentage of the GSEs’ mortgage purchases. 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-111hhrg56241--161 The Chairman," The gentleman from New Jersey and the gentleman from Texas derided it as very ineffective and weak, and it failed in the Senate. I voted for the bill in the House and in the committee. When it got to the House Floor and the Republican leadership put in an amendment restricting affordable housing, unrelated to the structural organization of Fannie and Freddie, I then voted against that. But I voted for the bill until they put that amendment in. I thank the gentleman and he will get an additional minute for yielding. " CHRG-111hhrg55811--295 Mr. Bachus," The White House proposal, there has been a lot of testimony from these witnesses that the White House proposal as it was offered would have actually made things a lot worse, I think is maybe a characterization I would use from some of the witnesses, not all. Do you agree? " FOMC20060510meeting--141 139,MR. FISHER.," Well, I think Bill Poole has summarized a lot of what I would have said. I forecasted that in the memo that was sent around. I would advocate tightening 50 basis points. I would dispute only one comment of President Poole’s. Getting ahead of the markets is less important than getting ahead of the economy. I do take note of your FOMC surprise chart. The question really is, If we undertake an action, will it lead to a market reaction that might affect the economy negatively? It’s not so much that we have a market surprise. We’re going to have market surprises at any time, and I can walk you through, after thirty years of operating a hedge fund, a four-year cycle of market surprises. A market surprise is going to hit us at some point, but the question is, Is it a trip wire? There is a risk that the trip wire would be the housing market. We’ve discussed that to a great degree, although you, Mr. Chairman, I think gave us some good data on the offset. I think it’s important for us to get ahead of what I view—not just because of the anecdotal evidence we have but also because of the work done by our staff—as a significant expansion in capital expenditures with growth shifting to very strong business investment, excess liquidity that is going to fuel that investment, and as we all discussed, significant indications that inflation is stronger than we would like to see it. We see that analytically, as I said earlier, with the way we calculate inflation in Dallas, but also from the anecdotal evidence. Having said that, I think the wording that is now in alternative B is more attractive. I know there are some who would like to provide what I call a full frontal view of what we look like and what we discussed. But as I like to say, Mr. Chairman, in romancing the market sometimes a little modesty might be more effective in achieving the ultimate goal. I think we’ve achieved that to an extent. I do not like the language that we see growth as likely to moderate because I don’t have confidence in that statement and I’m not sure it’s necessary. I’d prefer the wording that President Poole sent around in terms of its brevity. However, in the interest of perhaps more exposure, or a more-revealing presentation, I would like to add one word, which is the word “global” before “resource utilization.” [Laughter] Thank you very much." CHRG-110shrg50415--70 Mr. Ludwig," Senator, I agree with much of what the Chairman said, that is, Chairman Levitt. But there is clearly a problem here with mark-to-market accounting that has to be fixed, and the best way I could describe the problem is that if any of us had to sell our house in 24 hours and in this market we said, OK, I have got to sell my house in 24 hours, whatever it costs, somebody might offer you 10 percent of what your house is worth. To say that that house, your own house, which you may have paid $200,000 for, is now worth $10,000 because you had only 24 hours to sell it in a very bad market is not, in common-sense terms, the true value of that house. Mark-to-market accounting by its term presupposes there is a functioning market. And the problem we have had over this really once-in-a-hundred-year cycle is that there has not been a market. So there clearly has to be honesty and transparency in our accounting principles, but what we cannot do is what you cannot do when there is no market. One method that has been suggested in these kinds of circumstances that can be used is to cash-flow. If the loan is cashflowing, if you are getting payments on time, it is clearly not worth zero. It is worth more than that. So this is an area, I think, that deserves some considerable study. We, of course, do not want to just throw the baby out with the bath water. But mark-to-market accounting when there is no market has not served wholly well. Senator Menendez. I understand that, and I---- " FOMC20060131meeting--60 58,MR. STOCKTON.,"2 As we see it, the recent configuration of data suggests that, to the extent that there was any noticeable weakness in the fourth quarter, it was short-lived, and we are Thank you, Mr. Chairman. A few years back, I noted that my briefings could largely be characterized as a collection of confessions and excuses. This morning I would like to add a new element to that list: denial. As you know, the BEA’s advance estimate for the growth in real GDP in the fourth quarter—shown in the top left panel of your first exhibit—came in last Friday at an annual rate of 1.1 percent, about half the pace that we had projected. But at this point, we don’t believe that this estimate should be taken as a signal that the economy has fundamentally weakened. To be sure, after a first round of sorting through the details of that report, we haven’t found a smoking gun that gives us any strong reason to override the BEA’s estimate. But we have assumed that there will be a bounceback in some areas that were surprisingly weak last quarter, most notably motor vehicle output and federal spending. 2 The materials used by Messrs. Stockton, Struckmeyer, and Sheets are appended to this transcript (appendix 2). heading into the first quarter on a reasonably solid trajectory. As seen in the top right panel, after spiking up this autumn, initial claims quickly returned to pre-hurricane levels and have dropped even further in recent weeks, giving no suggestion of any softening in the labor market. Industrial production (line 1 of the middle left panel) actually peaked in the fourth quarter, driven by a sharp acceleration in manufacturing output (line 2). Moreover, as shown to the right, recent manufacturing surveys are supportive of our forecast of moderate gains in production as we move into the new year. Consumer spending and capital outlays have also remained solid. Setting aside the effects of the large swings in motor vehicle purchases that occurred in the second half of last year, consumer spending, shown in the bottom left panel, has been on a steady uptrend. And yesterday’s reading on real PCE excluding motor vehicles in December suggests that the first quarter started on a strong note. Shipments of nondefense capital goods (plotted as the red line in the bottom right panel) were released last week after the Greenbook was published, and they were stronger than we had projected. Moreover, new orders (the black line) have remained above shipments, suggesting that equipment spending should be buoyant in coming months. The top left panel of your next exhibit lays out our longer-term outlook for real GDP. As seen by the blue bars, the growth of real GDP is projected to step up this year to 3.9 percent before falling back to 3 percent in 2007. That pattern is influenced importantly by our assumed hurricane effects, and as shown by the red bars, aside from those effects we are expecting a gradual deceleration in activity over the next two years. Our inflation projection is shown to the right. Overall PCE prices are expected to decelerate over the next two years as consumer energy prices slow sharply. We continue to expect a small bump-up in core inflation this year as higher prices for energy, nonfuel imports, and commodity prices are passed through into the prices of final goods and services. But we expect core inflation to edge back down in 2007 as these influences abate. Although this story is pretty much the same as the one in December, we did have, in addition to last Friday’s GDP excitement, a few other developments to deal with over the intermeeting period. As shown in the middle left panel, crude oil prices rose further in recent weeks and are now projected to average $6.50 per barrel higher than in the December Greenbook. As Nathan will be discussing shortly, we also revised up a bit our projection for foreign activity, lowered our projection for the dollar, and—as shown in the middle right panel—raised our forecast for nonfuel import prices. With oil and imports providing a little more upward pressure on costs, we nudged up our forecast for core PCE prices this year and, along with it, our fed funds assumption over the next year—plotted as the black line in the bottom left. We made no substantive changes to our fiscal policy assumptions. As shown in the bottom right panel, fiscal policy provides some impetus to activity this year, related largely to hurricane spending and the implementation of the prescription drug benefit, but is expected to be a nearly neutral influence next year. The principal source of slowing in aggregate activity in our forecast continues to be the housing sector, the subject of exhibit 3. The accumulating data have made us more confident, though far from certain, that we are reaching an inflection point in the housing boom. The bigger question now is whether we will experience the gradual cooling that we are projecting or a more pronounced downturn. I’ll be interested to hear your reports this morning. As for the recent data, sales of existing homes (the red line in the top left panel) have dropped sharply in recent months and by more than we had expected. New home sales (the black line) have also moved off their peaks of last summer but are more consistent with our expectation of a gradual softening. That expectation receives some further support from the more-timely mortgage bankers’ purchase index—plotted to the right. Purchase applications also are off their highs but are not indicating any sharp retrenchment through January. With respect to house prices, the recent data and anecdotes also have pointed to some weakening. As a result, our forecast of a sharp deceleration in home prices— shown in the middle left panel—seems less of a stretch than it did a while back. As shown to the right, the bottom line is that, after contributing importantly to the growth of real GDP over the past four years, residential investment is expected to decelerate sharply this year and to turn down a bit in 2007. As we have noted before, our house- price forecast also has implications for consumer spending. Slower growth of house prices is the chief factor causing the wealth-to-income ratio (the black line in the bottom left panel) to drift down over the projection period. That downdrift, along with the lagged reaction to higher interest rates, results in a gradual rise in the personal saving rate over the next two years. As shown to the right, although spending growth falls short of that of income, overall PCE receives considerable support from the strong gains in disposable income that result from the projected flattening of energy prices, ongoing employment gains, and a step-up in the pace of hourly compensation. Business investment is the subject of exhibit 4. Spending on equipment and software, plotted as the black line in the top left panel, slows gradually over the projection period, largely because the accelerator effects that propelled the earlier recovery in capital outlays begin to wane. Nevertheless, with the cost of capital remaining moderate and corporate balance sheets strong, we are forecasting solid increases in real E&S spending this year and next. Our projection for total nonresidential structures, shown in the panel to the right, reflects some divergent patterns in the components. We expect outlays for drilling and mining (line 2) to increase sharply further this year in response to the run-up that has occurred in the prices for crude oil and natural gas. Although those prices are expected to level off, the lagged effects of the earlier gains should result in some further, albeit diminished, increase in drilling activity in 2007. Excluding drilling and mining (line 3) we are projecting a modest recovery in nonresidential construction activity in response to ongoing gains in employment and gradually declining vacancy rates in the office and industrial sectors. One of the reasons that we are reasonably optimistic about the investment outlook is that the total return to capital—plotted in the middle left panel—remains quite favorable. And although we expect that return to recede a bit as labor costs pick up, it would still remain elevated by historical standards over the forecast period. The remainder of the exhibit is something of a going-away present to the Chairman. While he always seemed to have a grip on where productivity was headed in the future, we always seemed to be struggling to explain what had happened in the past. Most recently, those struggles have centered on understanding the continuing strong gains in productivity in the first half of this decade. One important element of our story has been that the investment boom of the late 1990s was at least partly responsible for sowing the seeds of the further acceleration in multifactor productivity that we have experienced this decade. That capital equipment embodied rapidly improving technologies and allowed firms to sometimes radically restructure business processes. More broadly, as adjustment costs associated with absorbing those investments waned, the productivity advantages showed through more clearly. The bottom panel provides some modest support for the proposition that some of the improved performance of multifactor productivity of the first half of the decade can be traced to the earlier investment boom. That panel employs a new data set based on research spearheaded by my colleagues Carol Corrado, Paul Lengermann, and Larry Slifman that calculates multifactor productivity for detailed industries. Along the x-axis, we measure for each of 60 industries the average rate of growth in investment over the 1995-to-2000 period relative to that industry’s historical norm. On the y-axis, we plot the acceleration in MFP experienced by each industry from the 1995-to-2000 period to the 2000-to-2004 period. As seen by the red regression line, those industries for which the growth of equipment and software was unusually high in the late 1990s were more likely than others to experience a subsequent acceleration in multifactor productivity in the first part of this decade. Obviously, this is not a structural relationship and is meant to be impressionistic. But the recovery in equipment spending over the past few years leaves us optimistic that multifactor productivity can continue to grow at a rapid clip, though perhaps not quite at the pace registered over the first half of the decade. Sandy will now continue our presentation." CHRG-111hhrg53238--45 Mr. Zywicki," Thank you, and let me make clear that even though this hearing estopped banking industry perspectives, I appear only as myself. My affiliation with the banking industry is as a consumer. I am going to address the Consumer Financial Protection Agency today, and I think there are three fatal problems with the CFPA that I think are irremediable and really can't be overcome or approved. The first is that it is based on misguided paternalism. The second is that because it misdiagnoses the underlying problems, it will create unintended consequences that will probably exacerbate rather than improve the situation we have seen in the past few years. And, third, it creates a new apparatus of bureaucratic planning that is simply unfeasible and, at a minimum, unworkable. First, it is based on an idea of misguided paternalism. The causes of the foreclosure crisis, if we focus on that particular issue, really have very little to do with consumer protection. What the causes of foreclosure crises erode from were a set of misaligned incentives that consumers rationally responded to. When consumers rationally respond to incentives, that is not a consumer protection problem. Take an example. Say there is a fellow in California who got a no-doc nothing-down loan. California has an antideficiency law that means that if you walk away from your house, the bank is limited in taking back the house and they can't sue you for any deficiency. Say the guy was going to buy the house, live in it for a couple of years, and then flip it for a profit. Instead, the house goes down in value. He crunches the numbers and says well, it is worth it for me to walk away from the house and give it back to the bank. The bank can't sue me for any deficiency. There is no consumer protection issue in that hypothetical. There is a very, very, very serious safety and soundness issue. That was a very foolish loan by the bank, and it really created a lot of problems for safety and soundness. But that is not a consumer protection issue. And if we consider it a consumer protection issue, rather than consumers rationally responding to incentives, we are going to have problems. Similarly, the other factor that caused a lot of foreclosures was adjustable rate mortgages. Adjustable rate mortgages are not inherently dangerous. There have been many times in the past, over the past 30 years, where adjustable rate mortgages have been 50 or 60 or 70 percent of the new mortgages that were written. Adjustable rate mortgages are a problem when the Federal Reserve engages in the kind of crazy monetary policy it engaged in from 2001 to 2004. When the Federal Reserve engages in crazy monetary policy, that is not a consumer protection issue. And I don't think there is anything in the CFPA that will make the Federal Reserve engage in better monetary policy in the future. So that basing it on the misguided idea that the crisis was spawned by hapless consumers being victimized by ruthless lenders is not going to be a basis for good policy. Second, that leads to a second problem which is a problem of unintended consequences. Consider two issues identified in the Obama Administration's White Paper, prepayment penalties and mortgage brokers and yield spread premiums. Prepayment penalties are an especially good example. They talk about how they are going to get rid of prepayment penalties in subprime mortgages. Well, what we know about prepayment penalties from all the empirical evidence is that there is no empirical evidence that prepayment penalties increase foreclosures. Why is that? Because consumers pay a premium in order to have the right to prepay their mortgage, because that shifts the risk of interest rate fluctuations to the bank. Consumers pay about 20 to 50 basis points more for a mortgage that has a right to prepay, and that is even higher for subprime borrowers for reasons we can talk about. The effect is that by allowing borrowers to pay less for a mortgage, they are less likely to get into financial trouble and less likely to end up in foreclosure. So getting rid of prepayment penalties would increase the price of mortgages and have no discernible impact on foreclosures. In fact, it could end up having the unintended consequence of worsening things. Why? Because the United States is virtually unique in the Western world in having the right generally to prepay your mortgage, which is basically to refinance when your interest rates go down. What a lot of Americans did was when equity ramped up in their house, they exercised that right to prepay and refinance their mortgage and sucked out all the equity in their house. As a result, when their house went down in value, they decided to walk away from the house. In Europe, they have had very big property value decreases as well, but Europe has not had a foreclosure crisis. And one reason is because in Europe nobody can prepay their mortgage. You have a 10- or 15-year mortgage with a balloon payment and an adjustable rate mortgage and no right to prepay. No right to prepay means you can't suck out the mortgage when your house goes up in value. When you can't suck out the mortgage, then you have a better equity if the house goes down in value. So that banning prepayment penalties would likely have the impact of increasing foreclosures by giving more people an opportunity to suck out equity in their homes going forward. With respect to mortgage brokers, the evidence is clear that competition is what matters. If we reduce the number of mortgage brokers, people are going to pay more for mortgages. Finally, let me say the third point, which is the problem of bureaucrat central planning. The CFPA essentially requires an impossibility. It requires identifying certain terms and mortgages as being unsafe. What we know is there are no individual terms and mortgages that are unsafe. Terms in combination may be unsafe. Terms designed with State antideficiency laws may be unsafe. But the idea you can identify certain terms as unsafe is just folly and will stifle innovation and create other problems. Thank you. [The prepared statement of Professor Zywicki can be found on page 211 of the appendix.] " CHRG-111hhrg56767--36 HOUSING FINANCE AGENCY " FOMC20061212meeting--120 118,MR. KOHN.," I think there’s another offsetting thing that you can see in this chart, and that is trend productivity growth. If you look at the red band, you can see that it rose quite a bit in the late 1990s, when trend productivity growth rose. Now we’re below the late ’90s with approximately the same trend productivity growth but apparently much less investment demand relative to saving. I think the Chairman’s point offsets the productivity." CHRG-110shrg50409--28 Mr. Bernanke," Well, as your point about the first quarter makes clear, even after the fact, it is sometimes hard to know exactly how much growth there was. Yes, our forecast calls for growth in the second half, but relatively weak. Part of what seems to have happened is that perhaps the fiscal stimulus or other factors--some of the growth that we anticipated--has been pulled forward into the second quarter, which looks to be doing somewhat better, frankly, than we anticipated. So our forecast---- Senator Bennett. You mean pulled forward into the first quarter? " 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" FOMC20080625meeting--86 84,MR. EVANS.," Thank you, Mr. Chairman. Most of my contacts continued to report sluggish domestic demand, and they are not currently seeing any improvement in activity. In addition, their comments often focused on the substantially higher costs that they are facing for a wide range of nonlabor inputs. With regard to business activity, much of what we heard about the District and the national economy was a rehashing of preexisting developments. At our last meeting, we felt that there was substantial risk of a further softening in second-quarter growth, so the absence of new news is a positive development. With regard to specific sectors, exporters I have talked with continue to thrive, and steel producers are doing quite well. But any business associated with housing markets is very weak, and the motor vehicle outlook continues to worsen. All Detroit Three CEOs are expecting light vehicle sales to be less than 15 million units in 2008. The Seventh District has experienced substantial flooding in recent weeks, particularly in Iowa. We have been in contact with state officials and numerous businesses. The corn and soybean crops have experienced significant losses, though the range of estimates is wide. Higher estimates for lost corn output in Iowa are about 10 percent. That substantial loss would represent a national crop loss of just about 2 percent. In addition, although there have been transportation disruptions, especially on the Mississippi, our contacts expect these to be short-lived. So overall, our sense is that the economic damage seems to be relatively contained, especially in comparison with the floods in 1993, which hit a much wider geographic area and affected activity for a longer period of time. Turning to the national picture, the incoming data regarding growth generally have been positive. Indeed, the string of upward quarterly forecast revisions continues. In particular, I have been impressed by how much second-quarter GDP growth forecasts have moved up. This is not to say that we are out of the woods. Clearly, the continued difficulties in the housing and credit markets as well as the unrelenting increases in energy prices pose important downside risks to activity. Our Chicago Fed national activity index continues to be in territory I would characterize as a recession--the three-month moving average is minus 1.08 this past month. Still, the risk of the adverse feedback loop that concerned us so much clearly seems less likely today. Importantly, the financial situation seems better. Though conditions are still far from normal, institutions have had time to cope with bad portfolios, much as President Bullard mentioned. They have made significant progress in raising capital and have increased provisions against losses. I think our lending facilities have helped financial institutions gain time to facilitate the adjustment process. It seems well beyond our abilities, however, to engineer a return to ""normal financial conditions,"" given the extent of financial losses and overbuilding in housing. With regard to our economic projections, we expect growth this quarter to be similar to the Greenbook; but unlike the Greenbook, we are looking for the momentum to carry forward to a better second half of the year. Beyond this year, we think growth will run near potential. This is based on a fed funds rate path close to that in the futures markets. We are assuming a fed funds rate of 2� percent by the fourth quarter and 3� percent by the end of 2009. Turning to inflation, a number of factors present a concern for inflation expectations and our ability to bring inflation down. As I mentioned, my contacts spent a good deal of time talking about materials cost pressures, and many around the table have talked about those as well. Many manufacturers were citing large increases in energy and most commodity prices, and everyone was passing along some portion of these cost increases. I have one anecdote on this: In retail, Crate&Barrel reported on recent buyers' trips to Asia, saying that prices for items purchased there would be 15 to 20 percent higher for next year. Finally, wage pressures have been subdued thus far. Still, econometric analysis by my staff reminded me that wage inflation tends to follow price inflation not the other way around. So by the time we see wage pressures, either we are not behind the curve now, or it is ""Katie, bar the door!"" It is probably one or the other. [Laughter] Indeed, I am concerned that large and persistent changes in costs and in relative prices of high-profile items, such as energy, could change the inflationary mindset of businesses and households. The resulting increase in inflation expectations would pose a difficult challenge for monetary policy. Maybe it will end up being okay; maybe surveys will be right. But it is a big risk, and that risk is a bit large for my comfort. Looking ahead, we all see the substantial upside risk to price stability posed by the passthrough of higher costs and any possible increase in inflation expectations. While I hope I am wrong, I feel that we may need to accept a somewhat longer period of resource slack than we would like in order to address these risks and put inflation more firmly on a downward trajectory. Under our projection for GDP growth, the economy does not close the modest resource gaps we project will be in place at the end of 2008 until beyond the forecast horizon. Along with a flattening in energy and other commodity prices, such gaps should be sufficient to contain inflation expectations and bring overall PCE inflation near 2 percent in 2009 and 2010. That is our expectation. But my base case does not have inflation moving below 2 percent until after 2010, and that is even with more aggressive policy tightening than the Greenbook path. Now, turning to the long-term projections, I think that our forecasts for 2010--or at least the way that I think about it--do suffer from some difficulties. We would like to mention in the write-up that, at the end of the period, the range is between 1� percent and 2 percent, and we can infer policymakers' preferences from that. That is one interpretation. Given the inflationary pressures, that is harder and harder for many people to come up with. I think in some cases it requires a monetary policy response that is beyond what most people would expect that we could actually do. So I don't try to force my inflation forecast into my preferred range if it is too hard. Based upon monetary policy, it is more medium term. So I do tend to favor a longer period. I am somewhat indifferent between the first and the second options. I don't really see a lot of difference, but something that has a five-year forecast I think is useful. Whether or not it has the fourth year and whether or not it is core PCE or total are less important issues. One argument for this is an interesting body of research, which I have been exposed to only at conferences--and Jim probably knows it better than most--on learning and whether individuals in the economy can learn these rules without a variety of information. Some of the better papers that I have seen on that remind us that you need more pieces of information than just what the target is, whether it be 1� percent or 2 percent. You need some type of contour when people are learning with simplistic learning rules, like least squares learning. So I think a bit more contour on the forecast would be helpful. In my mind, that pushes you toward the five years of forecasting as opposed to a steady state or a five-to-ten-year forecast. I think that's an important element. On the trial run, I think we could do it sooner than that, but I know a lot of staff resources are involved. So I favor sooner rather than later. Thank you. " CHRG-110shrg38109--133 Chairman Bernanke," No, not necessarily. Foreign markets have strengthened considerably in terms of their quality. Clearly, the world is experiencing a lot of growth and so there are a lot of opportunities out there. By investing broadly, an investor diversifies his or her portfolio and reduces the overall risk that they face. Senator Tester. How about from an economic growth standpoint here in this country? I think from an investor standpoint, I hear you. But what about an economic growth standpoint here? Is it a negative factor, positive factor, or no impact? " FOMC20060629meeting--17 15,MR. SLIFMAN.,"2 Thank you, Mr. Chairman. Many of the spending indicators that we’ve received over the past few weeks have been coming in to the weak side of our expectations. As you can see by comparing the red and blue striped bars in the top left panel of exhibit 1, in the Greenbook we responded to the weaker numbers by revising down our projection for second-quarter growth of real GDP to a 2 percent annual rate, about 1¾ percentage points less than in the May Greenbook. We interpreted some of the unexpected softness as reflecting weaker underlying demand, and we let that part feed through beyond the current quarter as well. But as I’ll discuss shortly, the softness of the spending data wasn’t the only factor leading us to temper our forecast for the out quarters. A key component of the downward revision to the current quarter has been a slower-than-anticipated pace of consumer spending—the panel to the right. Based largely on the available data for retail sales, motor vehicles, and the CPI, we estimate that real PCE in the second quarter rose at an annual rate of only 2.2 percent. The slowing reflects a step-down in purchases of light motor vehicles as well as essentially flat real outlays for goods other than motor vehicles in the first two months of the quarter. The other big surprise in the recent data is the sharper-than-expected drop-off in housing activity, as illustrated in the middle left panel. Despite the May uptick in 2 The materials used by Messrs. Slifman, Wilcox, and Kamin are appended to this transcript (appendix 2). housing starts, the levels of both starts and permits are well below where we thought they would be at the time of the last Greenbook. In contrast to the household sector, the business sector indicators generally have been favorable. For example, orders and shipments for nondefense capital goods, plotted to the right, continue to point to strengthening demand. In addition, business spending for new structures, not shown, appears to have posted another sizable gain this quarter. The scant data available for June do not suggest that the slowdown in spending earlier in the quarter has been cumulating. As shown in the bottom left, initial claims for unemployment insurance, after retracing the rise that was associated with the effects of the temporary government shutdown in Puerto Rico, have remained in a range consistent with further moderate employment increases. Meanwhile, as shown to the right, the Empire State and Philadelphia business surveys, which were less favorable in April and May, were considerably more positive this month. Thus, while many of the indicators of activity have lately been to the downside of our expectations, the news has not been entirely negative. All told, we still see economic growth as being in a transition—to a pace somewhat below that of potential. This can be seen in exhibit 2, which presents the longer-run outlook. We now think that real GDP, as shown by the striped blue bars in the top left panel, will increase at a 2¾ percent rate in the second half of this year and through 2007. As I mentioned earlier, several developments besides the incoming spending indicators influenced our thinking about the economic outlook. First, revised data from the BEA now put the 2005:Q4 change in wage and salary disbursements, plotted by the black line in the top right panel, considerably below the figure published at the time of the last Greenbook, the red dashed line. The reduction in labor income suggests less consumption going forward. Regarding our assumption for monetary policy, the funds rate is assumed to be increased to 5¼ percent at this meeting and to remain there through the end of 2007. As shown in the middle right panel, the Wilshire 5000 stock market index is about 7 percent below the level we had assumed in the May Greenbook. We assume that equity prices will rise at a 6½ percent annual rate going forward—a pace that roughly maintains risk-adjusted parity with the returns on Treasury securities. The latest reading on house prices from the OFHEO index, illustrated in the bottom left panel, was in line with our expectations. We continue to expect an appreciable deceleration in house prices over the projection period. Finally, after several Greenbooks in which we revised up our forecast of crude oil prices, this round we revised down our forecast. When we prepared the Greenbook, the spot price of WTI was just under $70 per barrel, about $5 less than at the time of the May Greenbook. And with futures prices also lower, we reduced the path of crude oil prices throughout the projection period. Exhibit 3 presents some details of the outlook for business fixed investment. As illustrated in the top left panel, total real outlays for equipment and software, excluding the volatile transportation equipment component, are projected to increase 7½ percent over the four quarters of 2006 and to grow nearly as fast in 2007. You can see from the red portion that the bulk of the support comes from spending for high-tech equipment. Much of the recent strength in the high-tech sector has reflected a spurt in capital spending for communications equipment by telecom service providers, whereas demand for servers and PCs, the top right panel, has faltered. However, our forecast calls for real outlays for computing equipment to pick up later this year and to be sustained in 2007. Industry analysts cite several upcoming technological developments that should boost demand for new servers and PCs. These are summarized in the middle left panel. With regard to servers, several manufacturers plan to offer new generations of servers this autumn that offer significantly faster computing power and, just as important, lower electricity consumption. In addition to ongoing demand for large-scale servers from financial services companies, demand for clusters of small-scale servers—so-called server farms—by Internet content providers, for example, also appears to be robust. With regard to PCs, Intel will be introducing a fundamentally new chip design in the second half of this year that reportedly will increase performance and significantly reduce power consumption. With the new generation of chips on the horizon, prices on old chips have been plummeting. We project that demand for PCs should step up later this year, spurred by the combination of the new generation of chips for high-end users and falling prices on old chips for middle- and low-end users. The table to the right presents our forecast for real spending on nonresidential structures. As shown in line 2, outlays for drilling and mining have been growing briskly. Reflecting the sharp increases in prices of oil and natural gas over the past few years, the number of drilling rigs in operation, the bottom left panel, has been climbing steadily, with much of the increase for the natural gas component. We see the growth of activity slowing somewhat next year as the prices of natural gas and crude oil begin to flatten. Outside drilling and mining, investment in new buildings has strengthened recently, as vacancy rates (illustrated for office buildings by the black line in the bottom right panel) have been trending down and rents received by building owners (the red line) have been climbing. That said, we think the current rate of investment growth is unsustainable, given our projection of decelerating employment and business sales, and consequently the growth rate of construction spending slows in our forecast. Turning now to the household sector, the subject of exhibit 4, we expect real PCE, the red bars in the top left panel, to increase at a rate of about 3 percent in the second half of this year and to stay close to that pace in 2007. The forecast reflects two important crosscurrents. On the one hand, real income growth, the blue bars, is projected to be robust reflecting, in part, a waning drag from higher energy prices. On the other hand, the wealth-to-income ratio, plotted by the black line in the top right panel, falls in our forecast as house prices decelerate. With slower gains in wealth and rising interest rates, we expect that spending will be restrained relative to income and, accordingly, the saving rate will rise. The remainder of the exhibit examines the housing market. Looking through the monthly volatility, you can see that sales of new homes and existing homes, the middle left panel, are well off their peaks, whereas backlogs of unsold homes, the panel to the right, have increased significantly. In putting together the forecast, we factored in the recent data on starts, sales, and inventories, which led us to mark down the profile of activity throughout the forecast period. All told, as shown in the bottom left panel, we expect that real residential investment spending will drop 5¼ percent this year and fall another 1¾ percent next year. Widespread anecdotal reports suggest that the drop in demand is being driven partly by a withdrawal from the market by investors and purchasers of second homes. Data on mortgage originations by investors and those purchasing second homes, which begin on a monthly basis in mid-2003 and are available only through March, are plotted to the right. The first thing to note is that these groups are a relatively small part of the overall market. Moreover, although the data are quite noisy, neither group, at least through March, was leaving the housing market in droves. Nevertheless, the recent spate of reports and a jump in the rate of contract cancellations for new homes, which homebuilders attribute largely to a retreat by investors, pose a downside risk to the housing outlook. Another risk to the forecast is the possibility of a pronounced deterioration in the financial conditions of some vulnerable households, which could cause them to retrench significantly on spending. As shown in exhibit 5 in the top left panel, the financial obligations ratio for homeowners has risen sharply over the past year or so. It reached a record high in the second half of last year, and we estimate that it rose further in the first quarter of this year. (As an aside, the rate for renters has actually been falling since mid-2001, though that could be changing.) Some analysts have expressed concern about the high level of the financial obligations ratio—especially in light of the potential for further increases in obligations related to variable-payment mortgages, which represent more than one-fifth of all outstanding first-lien mortgages. Nowadays, variable-payment mortgages typically carry a fixed interest rate for a few years before converting to floating-rate, and most aren’t scheduled for a payment change for some time. The top right table presents some evidence. As you can see in the last column, the bulk of variable-rate mortgages—both ARMs and interest-only—that have yet to reprice won’t begin to reprice until after 2007. Moreover, the end of the interest-only term for nearly all I-O mortgages that are awaiting the end of the I-O term is well in the future—line 3 of the table. Given these patterns, scheduled mortgage payment changes should have only a limited effect on the aggregate mortgage burden—adding just a few tenths to the homeowners’ financial obligations ratio this year and next. As a result, we have not seen—and don’t expect—a broad deterioration in mortgage credit quality. For example, as shown in the middle left panel, delinquency rates for prime borrowers, who account for 85 percent of the mortgage market, have been relatively flat for some time—as illustrated by the black line. That said, there are some indications of stress among subprime borrowers. This group presumably is at greater potential risk for financial stress generally: Note the higher levels of their delinquency rates, the red line, compared with the prime market. In particular, we are seeing a deterioration among subprime borrowers with variable-rate mortgages—the red line in the panel to the right. This type of loan is far more prevalent in the subprime market, representing about two-thirds of all subprime mortgages. The fixed-rate period for subprime variable-rate loans is considerably shorter than that for prime loans—typically one or two years versus five to seven years—so more subprime borrowers with variable-rate mortgages are likely to see their monthly payments rise over the projection period. And the increases for those subprime borrowers experiencing resets could be striking: We estimate increases of something like 25 to 30 percent of their original payment. More generally, households that are likely to be more financially vulnerable appear to have become decidedly more pessimistic. The bottom left panel plots the Michigan consumer sentiment index stratified by income. Consumer sentiment for both upper- and lower-income groups plunged last autumn. Currently, both groups appear more concerned than they had been before mid-2005, but the lower third appears especially nervous. Our baseline projection for the household sector incorporates these developments. Nevertheless, the greater stress evident among the most financially vulnerable segment of the household sector presents a downside risk to the forecast. David will now continue our presentation." CHRG-110shrg46629--17 Chairman Bernanke," Thank you. Chairman Dodd, Ranking Member Shelby, and Members of the Committee, I am pleased to present the Federal Reserve's Monetary Policy Report to the Congress. As you know, this occasion marks the 30th year of semiannual testimony on the economy and monetary policy by the Federal Reserve. And in establishing these hearings, the Congress proved prescient in anticipating the worldwide trend toward greater transparency and accountability of central banks in the making of monetary policy. Over the years, these testimonies and the associated reports have proved an invaluable vehicle for the Federal Reserve's communication with the public about monetary policy even as they have served to enhance the Federal Reserve's accountability for achieving that dual objectives of maximum employment and price stability set forth by the Congress. I take this opportunity to reiterate the Federal Reserve's strong support of the dual mandate. In pursuing maximum employment and price stability, monetary policy makes its greatest possible contribution to the general economic welfare. Let me now review the current economic situation and the outlook beginning with developments in the real economy and the situation regarding inflation before turning to monetary policy. I will conclude with comments on issues related to lending to households and to consumer protection, topics not normally addressed in monetary policy testimony but, in light of recent developments, deserving of our attention today. After having run at an above trend rate earlier in the current economic recovery, U.S. economic growth has proceeded during the past year at a pace more consistent with sustainable expansion. Despite the downshift in growth, the demand for labor has remained solid, with more than 850,000 jobs having been added to payrolls thus far in 2007 and the unemployment rate having remained at 4.5 percent. The combination of moderate gains in output and solid advances in employment implies that recent increases in labor productivity have been modest by the standards of the past decade. The cooling of productivity growth in recent quarters is likely the result of cyclical or other temporary factors but the underlying pace of productivity gains may also have slowed somewhat. To a considerable degree, the slower pace of economic growth in recent quarters reflects the ongoing adjustment in the housing sector. Over the past year, home sales and construction have slowed substantially and house prices have decelerated. Although a leveling off of home sales in the second half of 2006 suggested some tentative stabilization of housing demand, sales have softened further this year, leading the number of unsold new homes in builders' inventories to rise further relative to the pace of new home sales. Accordingly, construction of new homes has sunk further, with starts of new single-family houses thus far this year running 10 percent below the pace of the second half of last year. The pace of home sales seems likely to remain sluggish for a time partly as a result of some tightening in lending standards and the recent increase in mortgage interest rates. Sales should ultimately be supported by growth in income and employment as well as by mortgage rates that--despite the recent increase--remain fairly low relative to historical norms. However, even if demand stabilizes as we expect, the pace of construction will probably fall somewhat further as builders work down stocks of unsold new homes. Thus, declines in residential construction will likely continue to weigh on economic growth over coming quarters, although the magnitude of the drag on growth should diminish over time. Real consumption expenditures appear to have slowed last quarter, following two quarters of rapid expansion. Consumption outlays are likely to continue growing at a moderate pace aided by a strong labor market. Employment should continue to expand, though possibly at a somewhat slower pace than in recent years, as a result of the recent moderation in the growth of output and ongoing demographic shifts that are expected to lead to a gradual decline in labor force participation. Real compensation appears to have risen over the past year and, barring further sharp increases in consumer energy costs, it should rise further as labor demand remains strong and productivity increases. In the business sector, investment in equipment and software showed a modest gain in the first quarter. A similar outcome is likely for the second quarter as weakness in the volatile transportation equipment category appears to have been offset by solid gains in other categories. Investment in nonresidential structures, after slowing sharply late last year, seems to have grown fairly vigorously in the first half of 2007. Like consumption spending, business fixed investment overall seems poised to rise at a moderate pace bolstered by gains in sales and generally favorable financial conditions. Late last year and early this year motor vehicle manufacturers and firms in several other industries found themselves with elevated inventories, which led them to reduce production to better align inventories with sales. Excess inventories now appear to have been substantially eliminated and should not prove a further restraint on growth. The global economy continues to be strong. Supported by solid economic growth abroad U.S. exports should expand further in coming quarters. Nonetheless our trade deficit, which was about 5.25 percent of nominal gross domestic product in the first quarter is likely to remain high. For the most part, financial markets have remained supportive of economic growth. However, conditions in the subprime mortgage sector have deteriorated significantly, reflecting mounting delinquency rates on adjustable-rate loans. In recent weeks, we have also seen increased concerns among investors about credit risk on some other types of financial instruments. Credit spreads on lower quality corporate debt have widened somewhat, and terms for some leveraged business loans have tightened. Even after their recent rise, however, credit spreads remain near the low end of their historical ranges and financing activity in the bond and business loan markets has remained fairly brisk. Overall, the U.S. economy appears likely to expand at a moderate pace over the second half of 2007, with growth then strengthening a bit in 2008 to a rate close to the economy's underlying trend. Such an assessment was made around the time of the June meeting of the Federal Open Market Committee by the members of the Board of Governors and the Presidents of the Reserve Banks, all of whom participate in deliberations on monetary policy. The central tendency of the growth forecasts, which are conditioned on the assumption of appropriate monetary policy, is for real GDP to expand roughly 2.25 to 2.5 percent this year and 2.5 to 2.75 percent in 2008. The forecasted performance for this year is about one-quarter percentage point below that projected in February, the difference being largely the result of weaker than expected residential construction activity this year. The unemployment rate is anticipated to edge up to between 4.5 and 4.75 percent over the balance of this year and about 4.75 percent in 2008, a trajectory about the same as the one expected in February. I turn now to the inflation situation. Sizable increases in food and energy prices have boosted overall inflation and eroded real incomes in recent months, both unwelcome developments. As measured by changes in the price index for personal consumption expenditures, PCE inflation, inflation ran at an annual rate of 4.4 percent over the first 5 months of this year, a rate that if maintained would clearly be inconsistent with the objective of price stability. Because monetary policy works with a lag, however, policymakers must focus on the economic outlook. Food and energy prices tend be quite volatile so that, looking forward, core inflation, which excludes food and energy prices, may be a better gauge than overall inflation of underlying inflation trends. Core inflation has moderated slightly over the past few months with core PCE inflation coming in at an annual rate of about 2 percent so far this year. Although the most recent readings on core inflation have been favorable, month-to-month movements in inflation are subject to considerable noise and some of the recent improvement could also be the result of transitory influences. However, with long-term inflation expectations contained, futures prices suggesting that investors expect energy and other commodity prices to flatten out, and pressures in both labor and product markets likely to ease modestly, core inflation should edge a bit lower on net over the remainder of this year and next year. The central tendency of FOMC participants forecast for core PCE inflation--2 to 2.25 percent for all of 2007 and 1.75 to 2 percent in 2008--is unchanged from February. If energy prices level off as currently anticipated, overall inflation should slow to a pace close to that of core inflation in coming quarters. At each of its four meeting so far this year, the FOMC maintained its target for the Federal funds rate at 5.25 percent, judging that the existing stance of policy was likely to be consistent with growth running near trend and inflation staying on a moderating path. As always, in determining the appropriate stance of policy, we will be alert to the possibility that the economy is not evolving in the way we currently judge to be the most likely. One risk to the outlook is that the ongoing housing correction might prove larger than anticipated, with possible spillovers onto consumer spending. Alternatively consumer spending, which has advanced relatively vigorously on balance in recent quarters, might expand more quickly than expected. In that case, economic growth could rebound to a pace above its trend. With the level of resource utilization already elevated, the resulting pressures in labor and product markets could lead to increased inflation over time. Yet another risk is that energy and commodity prices could continue to rise sharply, leading to further increases in headline inflation and, if those costs pass through to the prices of nonenergy goods and services, to higher core inflation as well. Moreover, if inflation were to move higher for an extended period and increase became embedded in longer-term inflation expectations, the reestablishment of price stability would become more difficult and costly to achieve. With the level of resource utilization relatively high and with a sustained moderation in inflation pressures yet to be convincingly demonstrated, the FOMC has consistently stated that upside risks to inflation are its predominant policy concern. In addition to its dual mandate to promote maximum employment and price stability, the Federal Reserve has an important responsibility to help protect consumers in financial services transactions. For nearly 40 years, the Federal Reserve has been active in implementing, interpreting, and enforcing consumer protection laws. I would like to discuss with you this morning some of our recent initiatives and actions, particularly those related to subprime mortgage lending. Promoting access to credit and to homeownership are important objectives and responsible subprime mortgage can help to advance both goals. In designing regulations, policymakers should seek to preserve those benefits. That said, the recent rapid expansion of the subprime market was clearly accompanied by deterioration in underwriting standards, and in some cases by abusive lending practices and outright fraud. In addition, some households took on mortgage obligations they could not meet, perhaps in some cases because they did not fully understand the terms. Financial losses have subsequently induced lenders to tighten their underwriting standards. Nevertheless, rising delinquencies and foreclosures are creating personal, economic, and social distress for many homeowners and communities, problems that will likely get worse before they get better. The Federal Reserve is responding to these difficulties at both the national and the local levels. In coordination with the other Federal supervisory agencies we are encouraging the financial industry to work with borrowers to arrange prudent loan modifications to avoid unnecessary foreclosures. Federal Reserve Banks around the country are cooperating with community and industry groups that work directly with borrowers having trouble meeting their mortgage obligations. We continue to work with organizations that provide counseling about mortgage product to current and potential homeowners. We are also meeting with market participants--including lenders, investors, servicers, and community groups--to discuss their concerns and to gain information about market development. We are conducting a top to bottom review of possible actions we might take to help prevent recurrence of these problems. First, we are committed to providing more effective disclosures to help consumers defend against improper lending. Three years ago, the Board began a comprehensive review of Regulation Z, which implements the Truth in Lending Act, or TILA. The initial focus of our review was on disclosures related to credit cards and other revolving credit accounts. After conducting extensive consumer testing, we issued a proposal in May that would require credit card issuers to provide clearer and easier to understand disclosures to consumers. In particular, the new disclosures would highlight applicable rates and fees, particularly penalties that might be imposed. The proposed rules would also require card issuers to provide 45 days advance notice of a rate increase or any other change in account terms so that consumers will not be surprised by unexpected charges and will have time to explore alternatives. We are now engaged in a similar review of the TILA rules for mortgage loans. We began this review last year by holding four public hearings across the country, during which we gathered information on the adequacy of disclosures for mortgages, particularly for nontraditional, traditional, and adjustable rate products. As we did with credit card lending, we will conduct extensive consumer testing of proposed disclosures. Because the process of designing and testing disclosures involves many trial runs, especially given today's diverse and sometimes complex credit products, it may take some time to complete our review and propose new disclosures. However, some other actions can be implemented more quickly. By the end of the year, we will propose changes to TILA rules to address concerns about mortgage loan advertisements and solicitations they may be incomplete or misleading and to require lenders to provide mortgage disclosures more quickly so that consumers can get the information they need when it is most useful to them. We already have improved a disclosure that creditors must provide to every applicant for an adjustable rate mortgage product to explain that better the features and risks of these products such as ``payment shock'' and rising loan balances. We are certainly aware, however, that disclosure alone may not be sufficient to protect consumers. Accordingly, we plan to exercise our authority under the Home Ownership and Equity Protection Act, HOEPA, to address specific practices that are unfair or deceptive. We held a public hearing on June 14 to discuss industry practices including those pertaining to prepayment penalties, the use of escrow accounts for taxes and insurance, stated income and low documentation lending, and the evaluation of a borrower's ability to repay. The discussion and ideas we heard were extremely useful and we look forward to receiving additional public comments in coming weeks. Based on the information we are gathering, I expect the Board will propose additional rules under HOEPA later this year. In coordination with the other Federal supervisory agencies, last year we issued principles-based guidance for nontraditional mortgages, and in June of this year we issued supervisory guidance on subprime lending. These statements emphasized the fundamental consumer protection principles of sound underwriting and effective disclosures. In addition, we reviewed our policies related to the examination of nonbank subsidiaries of bank and financial holding companies for compliance with consumer protection laws and guidance. As a result of that review and following discussions of the Office of Thrift Supervision, the Federal Trade Commission, and State regulators as represented by the Conference of State Bank Supervisors and the American Association of Residential Mortgage Regulators, we are launching a cooperative pilot aimed at expanding consumer protection compliance reviews at selected nondepository lenders with significant subprime mortgage operations. The reviews will begin in the fourth quarter of this year and will include independent state-licensed mortgage lenders, nondepository mortgage lending subsidies of bank and thrift holding companies, and mortgage brokers doing business with or serving as agents of these entities. The agencies will collaborate in determining the lessons learned and in seeking ways to better cooperate in ensuring effective and consistent examination of and improved enforcement for nondepository mortgage lenders. Working together to address jurisdictional issues and to improve information sharing among agencies, we will seek to prevent abusive and fraudulent lending while ensuring that consumers retain access to beneficial credit. I believe that the actions I have described today will help address the current problems. The Federal Reserve looks forward to working with Congress on these important issues. Thank you. " FOMC20070918meeting--99 97,MR. PLOSSER.," Thank you, Mr. Chairman. On balance, the data and the anecdotal evidence in our District say that the economy continues to expand and advance moderately, but the pace may have slowed somewhat since June. Readings of our Business Outlook Survey of regional manufacturing have been very volatile this summer. You may recall that in June, our activity index rose to 18, which was its highest value since April 2005. The index fell to 9 in July and to 0 in August. The September survey, conducted during the first two weeks of September, remains confidential and will not be announced to the public until this Thursday at noon—so these are really new data. In fact, we finalized it only yesterday. It indicates some recovery in general activity, new orders, and shipments. The general activity index rose from 0 to 10.9. New orders and shipments indexes also improved. Another piece of good news from the manufacturers’ capital spending plans is that they remain positive, with the index at a level typically seen during expansions. Plans to increase capital spending were common among nearly all the major manufacturing sectors covered by our survey. Consistent with this, our respondents generally see improvements in their business activity coming over the next six months. In September we asked a special question about whether the recent changes in the construction and financial sectors had any adverse effects on their business or their business plans. About two-thirds of the respondents said there was no impact on their orders or shipments. About 11 percent reported a substantial decline. Most of these firms were housing-related industries. One was in auto parts, and one was in apparel. Similarly, three-quarters of the respondents had no change in their capital spending plans, and only about 9 percent expected to cut back substantially on their capital spending relative to plan over the rest of the year. My reading of this is that the manufacturing sector in the region is holding up pretty well. In contrast, residential construction activity in the region continues to deteriorate, and we are expecting to see declines in house prices. Earlier these declines were seen only at the Jersey Shore, but now they seem to have spread a little more widely in the District. Interestingly enough, homebuilders reported reducing prices to stimulate sales but with relatively little success. Several contacts told us that they were more concerned about the negative effects on buyer psychology of recent financial market developments than they were about the availability of mortgage financing. That our region has been largely less dependent on subprime lending than some other areas may be part of the reason for that. Nevertheless, none of our contacts in the real estate industry were willing to forecast when the demand for housing was going to pick up. Nonresidential construction has also softened somewhat in our region, as indicated by the value of contracts, but that’s a very volatile number. These data tend to be revised up; but the decline still is quite pronounced, and it bears watching. At the same time, vacancy rates remain very low in the Philadelphia area, and so the demand seems to be there, but the contracts are down for the moment. Employment growth over the three-state region ending in July remains below trend in New Jersey and Delaware and kind of flat in Pennsylvania. Some firms continue to support what has already been said—difficulty in finding qualified workers. One of our board members runs a temporary employment agency that goes through tens of thousands of people every month. She said that there has been an uptick in walk-in traffic of people applying for employment, particularly skilled workers, but in fact, there has been no falloff whatsoever in the demand from firms looking for these people. So she has seen no decline in demand for these workers, but she has seen a little uptick in the supply coming through their office. Our three-state unemployment rate remains relatively low and below that of the nation. Nonetheless, July unemployment rates in our three states were a little higher than we saw earlier in this year. The inflation picture for the District has changed little since our last meeting. Wage increases have been moderate. Several firms report large increases in benefit costs but not an acceleration of those benefit costs. The prices of industrial goods are increasing, but retail price increases haven’t been as widespread as they were earlier. In summary, our region’s inflation has not accelerated. It hasn’t decelerated either. Economic activity in the Third District continues to expand, but its pace has perhaps slowed somewhat. Our business contacts generally expect activity to remain slow but on an upward trend and are more uncertain about the outlook than they were, but their plans seem to be in place. One board member spent a great deal of time talking to a number of CEOs and CFOs about capital spending plans, and it was funny. He said that they said, well, everybody thought there was going to be a capital spending program reduction. They weren’t planning a reduction, but they knew somebody else who was. It was very hard to find the person who was actually doing it, but everybody thought that someone else was doing it. So it was a little anecdotal. The national economy looks more vulnerable to me than it did six weeks ago, but it would be a mistake—and I think Dave Stockton did an excellent job of reminding us—to count out the resiliency of the U.S. economy at this early stage. I think there can be a tendency in the midst of financial disruptions, uncertainty, and volatility to overestimate the amount of spillover that they will exert on the broader economy. For example, the rate cuts after the stock market crash in 1987 were reversed fairly quickly. Unfortunately, we have very little hard data as yet to help us gauge the potential size or persistence of the impact on real activity of the August turmoil, and early signs may be fraught with noise and overreaction to headlines. So I think we have to be very careful. Of course, it is possible that disruptions will further restrain the already weak housing market by reducing the supply of mortgage credit. Nonconforming mortgage rates, even to prime borrowers, remain elevated, but conforming rates to prime borrowers are actually lower right now. Reduced lending in the alt-A and subprime market is not a surprise. It has been difficult to obtain those loans since the early part of this year, and I think that is not a big change. The biggest surprise, at least for me, is that the impact on the obtainability of mortgages to homebuyers of the recent disruptions has been in the area of nonconforming jumbo mortgages. Yet the availability of these mortgages and their rates are likely to settle back down more quickly to normal levels since most of the people borrowing at the jumbo rates tend to be closer to prime borrowers than to subprime. However, as banks take some action to bring some of these risky assets back onto their balance sheets, we may look forward to further restraints on credit because they don’t want to push their capital ratios any harder than they have, and so that may have a diminishing effect. But putting aside any financial market effects, signs of stabilization in the housing markets that we saw early this year just have not been sustained, as we all know. Home prices have decelerated and have been falling in certain localities, and that’s likely to continue. Incoming data suggest that the downturn in housing may be both more prolonged and somewhat deeper than certainly I had earlier anticipated. The question has been whether this decrease in housing wealth would spill over into consumer spending, regardless of the source of the decrease in housing wealth. The argument has been that the strength in the labor markets and the stock market gains would continue, and continued personal income growth would buoy the consumer and mitigate those declines. I remind everybody that, even though the market is down heavily in August, it is still up roughly 5 percent for the year. So it wouldn’t be a tank unless something further happened. August nonfarm payroll surprisingly fell by 4,000 jobs in August, as we know. I wouldn’t be too surprised to see this number revised up. Loss of government jobs concentrated in local education took a very big hit, and this might be overstating the seasonal adjustment factors that are going into this in the timing of the starts of the school year. Still, there was weaker private payroll growth. There’s no question about that, and the revisions done in June and July were down substantially. Thus, nonfarm payroll gains have averaged about 44,000 over the past three months, whereas private payrolls have been a little more than 70,000 for the past three months, and that’s weaker than we’ve seen during the rest of the year. There’s no question about that. On the positive side, business spending remains fairly solid, but our hard data are somewhat stale and may be a little sketchy. Although not in the data yet, there’s some risk of temporary weaknesses in business fixed investment going forward simply because of the increased uncertainty inherent in financial market disruptions. So far most of the firms we’ve talked to, as I said earlier, say that their capital spending plans remain in place, and only a few nonmanufacturing firms have mentioned not canceling but just delaying them until the market has settled down. Risk premiums have increased from abnormally low levels, which is probably beneficial. This has raised the cost of capital for some firms; but for most firms, financing for capital spending remains available. Many banks say that they have lending available and that they will lend to good customers. There’s not a problem. Indeed, most capital expenditures by businesses, in fact, are internally financed, and so the turmoil in the credit markets may not have as much spillover on capital spending as we might otherwise expect. So unless there’s a sharp decline in business sentiment, which could occur if the financial market turbulence worsens, I don’t expect to see that much of a pullback in business investment spending, except possibly in the very, very near term. On balance, I believe that within the forecast period we can see a return to trend growth, which I still estimate at about 2¾ percent, somewhat higher than the Greenbook. I still think that’s the most likely outcome, but I now expect that return to be delayed by a couple of quarters given housing, and it won’t be under way until certainly late in 2008. I admit there’s still considerable uncertainty surrounding that forecast, and I certainly see that there’s a possibility of particularly bad outcomes, some of which the Greenbook scenarios have laid out. I also expect that some of the indicators we receive over the next few months are likely to be weak, but not necessarily weaker than many of us have already built into our new forecasts. Indeed, because of the financial markets disruptions, the August data won’t be particularly helpful or useful in reading the trends in the economy. I think it’s going to be crucially important for us to convey to the public that we are forward looking, that we expect to see somewhat weaker data coming in, but that they may not necessitate a further change either in our forecast or in our policy. Only when we accumulate sufficient new information that causes our forecast to deviate from our already lowered projections do we want to revise our forecast and perhaps our policy. I think this is a point that we need to make very clearly to the public, if not in our statement, which we should try, then in the minutes and in our speeches as we go out. I think it would be detrimental to our cause and to good policy if the public expected us to react to each piece of incoming data. On the inflation side, I see that recent readings on core inflation have moderated. Headline inflation remains quite elevated. I don’t think that we can afford to be sanguine. I continue to see underlying inflation pressures, as has already been articulated. Long-range inflation expectations have been stable, but I’m concerned as we go forward with potential rate cuts. I’m concerned about their remaining stable, particularly when we may be lowering rates without being clear about what our inflation goals are. Indeed, I think the current situation clearly shows the benefit of having an explicit inflation goal. By anchoring those expectations, an explicit goal would mean less of a tradeoff between our two goals and so might make this policy decision easier and even perhaps more effective. Thus, while my forecast has built in some near-term policy easing partly to offset the anticipation of tighter credit conditions, I believe that we might find ourselves in a position sometime during ’08 in response to rising inflation of having to raise the fed funds rate back up. We need to be particularly careful now with our communications regarding any policy action we take, but I’ll save that discussion for the policy go-round. Thank you, Mr. Chairman." CHRG-111hhrg52397--22 Mr. Sherman," Thank you. One of the arguments always made against regulation is, ``Let the buyer beware.'' The credit agencies were here saying, ``Don't regulate us, just don't rely on our rating.'' Now, we are told well, the counterparties should protect themselves. The fact is at best, these derivatives are insurance. At worst, they are a bet at the casino. Either way, we do not let you sell fire insurance on my house without setting up reserves. And that insurance policy on my house is basically for the benefit of my bank, you do not want to know how little equity I have in the house. Yet, you can go to a bank and say we will protect you not from Brad's house burning down, but from the house declining in value, and Sherman defaulting on the loan, and it is not insurance, it is customized. Or you can sell that as a casino bet and go to somebody who does not hold my mortgage and sell them an insurance policy against me not paying my mortgage. Either way, there ought to be reserves. Anything else means you can sell an unlimited quantity and ultimately we are told, ``Well, this is just a private market decision.'' Tell that to the taxpayers who have bailed out AIG. And if this business goes overseas, there will always be an unregulated casino where you go and you put your money down on number 24 and you win and the bank does not pay off. Fine, let that casino be offshore. Let some other government have to bail out the next AIG. Let us not be told that the present system is fine so long as the taxpayers write the check. I yield back. " FOMC20050202meeting--149 147,MR. BERNANKE.," Thank you, Mr. Chairman. The economic recovery seems well entrenched, and domestic final demand continued strong, foreshadowing healthy growth in 2005. I don’t see inflation risks as having changed materially in recent months. In particular, labor costs have been remarkably subdued. However, with the recovery no longer fragile, continued withdrawal of monetary accommodation at a measured pace remains the appropriate policy, in my view. Some have cited a possible slowdown in labor productivity growth as an upside risk for inflation on the grounds that slower productivity growth implies a more rapid rise in unit labor costs. While lower productivity does, of course, lead to higher unit labor costs, all else equal, the links between productivity growth and inflation, as well as the implications for policy, are actually quite February 1-2, 2005 102 of 177 First, it’s important to note that an assumption of slower productivity growth is already incorporated into the Greenbook forecast. The staff projects output per hour in the nonfarm business sector to rise at about a 1.7 percent annual rate in 2005, less than recent experience and about a percentage point below the profession’s consensus estimate of the long-run trend. The projected slowdown reflects both cyclical factors and the assumption that there will be some giveback of the extraordinary recent gains. As productivity growth has surprised repeatedly on the upside for almost a decade now, I think the risks for the Greenbook productivity projections should be viewed as well balanced, at worst. The staff projects that the deceleration in the cyclical component of output per hour should have little effect on inflation but will instead lower profit margins. And even though the expected slowdown in structural productivity growth will put upward pressure on prices, the staff expects the impact on inflation of that productivity slowdown to be offset by other factors like declining energy prices and a stabilization of the dollar. To summarize, the Greenbook’s baseline forecast shows that some slowing of productivity growth, at least, is not inconsistent with continued stable inflation. The interesting question is: What will happen if productivity growth in 2005 comes in even lower than the 1.7 percent projected by the staff? If firms view the resulting increase in the rate of growth of unit labor costs as more or less permanent, then historical experience suggests that these costs will be passed on to consumers fairly quickly, thereby boosting inflation in the short run. However, it does not follow that policy should therefore be tightened more aggressively. The appropriate response depends also on the reaction of aggregate demand to this change in productivity growth. If a slowing in productivity growth occurs that is both perceived as permanent and is also largely unexpected by households and firms, then stock prices should fall and households should mark down their estimates of permanent income. The resulting decline in aggregate demand will tend to offset the inflationary impacts of the productivity slowdown. Also, because firms will expect February 1-2, 2005 103 of 177 illustrated in chart 6 of the Bluebook, the optimal policy response to a permanent slowdown in productivity growth may well involve a slower pace of tightening rather than a faster one, despite a possible short-run bump in inflation. This scenario is just a mirror image of the post-1995 experience in which a perceived increase in secular productivity growth sparked a stock market boom and rapid growth in spending, and hence was not disinflationary, despite the fact that unit labor costs declined. What if productivity growth slows substantially but aggregate demand does not respond? In that instance, unfortunately, we might be called upon to make a judgment about whether the slowdown is likely to prove temporary or permanent. If it is temporary, then neither inflation nor policy should respond very much. If the slowdown is judged to be permanent, however, the failure of aggregate demand to adjust would suggest that households and firms anticipated the slowdown, while the staff was too optimistic. In this case, the slowdown in productivity should indeed be met with a tightening of policy in the short run. However, the funds rate should be lower in the long run, reflecting the fact that the neutral fed funds rate will also be lower. This scenario is the mirror image of the 2002-2003 period in which productivity gains created disinflationary pressures that did require aggressive easing in the short run. To summarize, slower productivity growth does not necessarily require a tighter policy. First, some slowing is already anticipated and incorporated into the Greenbook forecast. Second, if a significant slowing occurs, the key issue is the extent to which aggregate demand responds to the slowdown. A sufficiently large decline in aggregate demand might well reverse the presumption that tighter policy is needed when unit labor costs rise. Thank you." CHRG-110shrg50417--131 Chairman Dodd," But that does not explain the difference why--I mean, I have got a vacation house and I have got my primary residence. Now, one house I can cram down and work out a mortgage on because the bankruptcy courts would allow me to do that. But on my primary residence, I cannot. Just to pick an example out of thin air, just say I had eight homes, and so seven of them I can protect in a bankruptcy proceeding. But the poor guy with one house cannot. How do you explain that to people? What is the justification? Ms. Finucane. I think you are asking us something about bankruptcy law as opposed to what you began with, which is the issue around do we think that is a good solution to the foreclosure issue. And we can speak to the foreclosure issue, not bankruptcy law. " Chairman Dodd," OK. Mr. Palm, same question. " FOMC20050322meeting--84 82,MS. MINEHAN.," This is probably going on a little long, but I’ll ask one quick question. I see that you have gone from a negative contribution to growth in the first quarter from equipment spending to a positive one. But in terms of the growth rate for the first quarter, you end up with a projection that’s on the order of 10 percentage points under the growth rates predicted elsewhere in the Blue Chip and the Wall Street forecasts, and so forth. I know you’ve probably done some hand-wringing about that. Any thoughts?" FOMC20050630meeting--174 172,MR. POOLE.," Okay. It’s a significant part of total new construction. And I know in the community where I live—I thought this was real estate hype when we bought our house—we were told that we had bought the land and got the house for free. But that’s just about the case, because the houses in my area—a subdivision built in the 1960s—are being torn down, and houses with 3,000 square feet are being replaced by houses with 6,000 to 8,000 square feet on nice one-acre lots. So the land value is significant. On this question about what is really happening to land values in urban areas, I don’t know whether the data are available to answer that. I suppose a detailed look at real estate records and tax records, if you had enough resources to do it, would enable you to look at properties where the houses are being torn down and replaced with new homes. And that would probably give you a pretty good measure of the underlying value of the land in those areas. In any event, when real rates of interest come down, one would expect to see increases in the value of the land relative to the structure. So one would expect, I think, to see more teardowns. I gather that, though it’s not a brand-new phenomenon, the scale of it is probably much increased in recent years from 10 or 20 years ago. At any rate, I offer those observations because, if we are in a world that is going to have much lower real rates of interest for some time to come, one would expect to see the price-to-rent ratio go up. Maybe this line in the chart has another 40 percent to go to get to equilibrium! June 29-30, 2005 59 of 234" CHRG-110shrg38109--5 STATEMENT OF SENATOR ROBERT P. CASEY Senator Casey. Mr. Chairman, thank you very much for gathering us here. Chairman Bernanke, thank you for your time here today and for your service. I do not have a long statement, but I just wanted to highlight a couple of things I know that you have touched on before and that I am sure we will speak to today, some of the long-term fiscal challenges that you outlined here in your previous testimony, I guess a week or so ago, with regard to Medicare, Social Security, and other demands that are being placed on the Federal budget into the future. I appreciate the fact that you are thinking about and focusing on that and building that into the planning that you do. I think also the people that I represent in Pennsylvania are concerned about those costs. They are concerned about the deficit, which I guess last year was $248 billion. This year, the projection is for something less than that. But they are also concerned about the impact, as Chairman Dodd outlined, of the costs in their own lives, in their real lives, and you know the cost of health care and college tuition and housing and so many other areas. I hope that one of the things we have a chance to discuss today is the impact that those costs have, the impact not just on that family, the horrific impact it can sometimes have on their budgets, but also the impact that that has on overall long-term economic growth and stability. So, I look forward to discussing that today with you, and we appreciate the time you are spending with us, and we appreciate the report. " fcic_final_report_full--9 And the leverage was often hidden—in derivatives positions, in off-balance-sheet entities, and through “window dressing” of financial reports available to the investing public. The kings of leverage were Fannie Mae and Freddie Mac, the two behemoth gov- ernment-sponsored enterprises (GSEs). For example, by the end of , Fannie’s and Freddie’s combined leverage ratio, including loans they owned and guaranteed, stood at  to . But financial firms were not alone in the borrowing spree: from  to , na- tional mortgage debt almost doubled, and the amount of mortgage debt per house- hold rose more than  from , to ,, even while wages were essentially stagnant. When the housing downturn hit, heavily indebted financial firms and families alike were walloped. The heavy debt taken on by some financial institutions was exacerbated by the risky assets they were acquiring with that debt. As the mortgage and real estate mar- kets churned out riskier and riskier loans and securities, many financial institutions loaded up on them. By the end of , Lehman had amassed  billion in com- mercial and residential real estate holdings and securities, which was almost twice what it held just two years before, and more than four times its total equity. And again, the risk wasn’t being taken on just by the big financial firms, but by families, too. Nearly one in  mortgage borrowers in  and  took out “option ARM” loans, which meant they could choose to make payments so low that their mortgage balances rose every month. Within the financial system, the dangers of this debt were magnified because transparency was not required or desired. Massive, short-term borrowing, combined with obligations unseen by others in the market, heightened the chances the system could rapidly unravel. In the early part of the th century, we erected a series of pro- tections—the Federal Reserve as a lender of last resort, federal deposit insurance, am- ple regulations—to provide a bulwark against the panics that had regularly plagued America’s banking system in the th century. Yet, over the past -plus years, we permitted the growth of a shadow banking system—opaque and laden with short- term debt—that rivaled the size of the traditional banking system. Key components of the market—for example, the multitrillion-dollar repo lending market, off-bal- ance-sheet entities, and the use of over-the-counter derivatives—were hidden from view, without the protections we had constructed to prevent financial meltdowns. We had a st-century financial system with th-century safeguards. When the housing and mortgage markets cratered, the lack of transparency, the extraordinary debt loads, the short-term loans, and the risky assets all came home to roost. What resulted was panic. We had reaped what we had sown. • We conclude the government was ill prepared for the crisis, and its inconsistent response added to the uncertainty and panic in the financial markets. As part of our charge, it was appropriate to review government actions taken in response to the developing crisis, not just those policies or actions that preceded it, to determine if any of those responses contributed to or exacerbated the crisis. CHRG-111shrg57321--167 Mr. McDaniel," I think there were a number of reasons. Among the principal or the most proximate reasons would be that we went from a period where there was a long period of home price appreciation. There was low interest rates and low credit spreads so that there was a lot of credit availability. We had the introduction of--when we had the introduction of a softening in the housing market, the loose credit that had been available tightened very rapidly and that curtailed refinancing opportunities for many borrowers who were anticipating that they were going to be able to refinance their mortgages. Senator Kaufman. OK. Ms. Corbet. Ms. Corbet. I would concur with all of that statement. Indeed, it was predicting what the likely outcome would be, not only in terms of the housing market, but also unemployment, borrower behavior, also credit correlations. All of those in terms of the forecast were certainly not as great as the outcome that actually transpired. Senator Kaufman. So essentially it was the housing market. I mean, it was the housing market, all the things that were happening---- Ms. Corbet. It was the confluence, many factors---- Senator Kaufman [continuing]. The meltdown of all the things. Ms. Corbet. Yes. Senator Kaufman. Mr. McDaniel, is that---- " FOMC20060629meeting--87 85,MS. PIANALTO.," Thank you, Mr. Chairman. Much like the Greenbook, the reports that I hear from my directors and business contacts are consistent with an economy that is expanding, but at a slower pace than earlier this year. Activity related to residential real estate has softened, and I continue to hear from my business contacts that they are concerned that consumer spending will retrench in response to the softer housing market and higher energy prices. But I do not get much indication that this concern is having a substantial effect on their business plans. Capital spending plans in particular seem little changed from the beginning of this year. As for inflation, rising costs are widely reported by my business contacts, but most of these pressures are still related to energy and material prices. I continue to hear that productivity-adjusted wage pressures remain in check. Among producers of intermediate goods, the number of firms that report the ability to pass through costs seems to be increasing, but as of now, I am not hearing a lot in the way of substantial price increases at the retail level. Despite what I am hearing from my business contacts, the data tell a different story, and they have affected my thinking since our last meeting. The core inflation numbers have been drifting up, whether calculated by excluding food and energy or by the trimmed mean and median CPI measures that we monitor in Cleveland. Since December the majority of items in the CPI weighted by their expenditure shares have risen at annual rates in excess of 3 percent. It is still possible, of course, that the pattern of these price increases that have been showing up lately is just an outsized but transitory pass-through of energy and commodity prices or the realignment of rents to the exceptional residential housing market that we have seen in the past few years. But this explanation is becoming increasingly difficult for me to defend. At our May meeting I expressed concerns that risks were weighted against both our objectives, and the Greenbook baseline now reflects those concerns: weaker economic growth and higher inflation. At this time, I do not see any signs that the real economy is going to be weaker than projected in the Greenbook baseline, but unfortunately I do not expect an inflation outlook that is much better than the Greenbook baseline either. That is my report, Mr. Chairman. 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. " FOMC20070628meeting--142 140,CHAIRMAN BERNANKE.," All in all, there still seems to be general agreement that the risks to inflation remain to the upside and remain the predominant concern. Is that a reasonable summary? Are there any comments? Let me present just a few essentially random thoughts at this point. First of all, from my perspective, the biggest puzzle about what’s happening is the behavior of the labor market, which is continuing. We’ve had slow growth. Unemployment is at least not falling anymore, but it remains stable at a fairly low level. My scenario for the soft landing plus some moderation of inflation involves some cooling of the labor market from here. I still think it will happen, but admittedly, there is only the slightest suggestion so far that it is happening. In particular, we have not yet seen the decline of construction employment, which I have continually referred to and continue to expect. There have been a number of discussions about why we haven’t seen that response yet. Some have noted the possibility that a lot of the workers are undocumented and, therefore, are not being counted by the usual measures. However, they seem to have been counted when the market was expanding. So it is a little puzzling why suddenly they are not being counted. Thus I still think there will be some moderate softening in the labor market over the next year. If that does not happen, then we will be at some risk of higher upside growth than we anticipate and higher inflation pressures than we anticipate. So for me that is a central thing to look at. I think in talking about this, it is important to note how uncertain we are about what the natural rate of unemployment is and that entire concept. Judging from the FOMC’s 2009 projections, most of us think that the natural rate may be a bit below 5 percent, and I would note that the unemployment rate was in the mid to low 4s for four years in the late 1990s and has been in that range now for about two and one-half years. So it is not entirely evident where the natural rate is, and it does make some difference obviously. Again, I expect to see some moderation in the labor markets, and I believe that is critical to our scenario. Like everyone else, I think the housing situation continues to involve downside risks. I would reiterate what President Poole said—that this is an asset market; that therefore price changes are inherently, at least to some extent, unpredictable; that a lot is going to depend on confidence, which is going to depend on results, which is going to depend on confidence; and therefore, that we need to be very careful, just the same as with inflation, about declaring victory too soon on the housing front. In particular, there is an interaction between the mortgage market and financial markets. There has been discussion of that already today, but there is the potential for some trigger to lead to what would amount to an effective tightening in financial markets, which would affect not only housing but also potentially, for example, corporate credits. Although that remains just a risk, I think it’s one we need to keep in mind. I agree with the general view around the table that, except for housing, the economy looks to be healthy. Capital spending is not going gangbusters, but it does seem to have come back to some modest trend. I also agree with what a number of people said about the strength of the world economy. We shouldn’t get too carried away with the export sector. What we’re hoping for here is that net exports will not be a net drag on growth. [Laughter] Nevertheless, that is an improvement over the past, and the strong world economy should on net be helpful to our economy. Like everyone else, I’m encouraged about the incoming inflation data. I agree that some of these good numbers may be partially transitory. However, when you analyze this, there has been a decided step-down in the past three or four months in the shelter component. I would make two observations. One is that, excluding shelter, core PCE inflation is now at the lowest number since the end of 2003; if the shelter numbers of the past three months were to persist, then that would automatically arithmetically give us some additional progress on inflation. Now, that may not happen. Clearly we have month-to- month variations, as we have mentioned many times; but I think some slack could combine with some more moderation in rents. On the inflation expectations issue, I thought David Wilcox’s graphs were very instructive. I do very much believe that inflation expectations influence actual inflation and that the anchoring of inflation expectations is very important. But I don’t think they’re anchored at 2.000; I think that they’re anchored at a general range somewhere around 2 percent. What David’s graph showed was that the level of expectations that we observe seems also to be consistent with 1.8 or 1.7. So I don’t think that’s an absolute barrier, though I concede that expectations play an important role. Two, I would also just comment about the statistical issue. I was among a number of people who talked about the statistical significance of the change in inflation that we have seen and noted that these month-to-month changes are subject to a lot of variable shocks. But let me just say that I think it’s probably worth noting that, in the classical statistical significance tests and everything we’re doing here, we’re Bayesian decisionmakers, and we’re trying to make a decision based on our best estimate of where we are at a given moment. Even if we concluded that inflation’s decline is not statistically significant in a classical sense, we still ought to act as if there has been some decline in inflation. As a thought experiment, I would ask what we would be saying now if we had gone up 0.6 percentage point from where we were in May. I think that would have led to a somewhat different tone around the table. So while acknowledging the statistical variability and the transitory nature, I think that there has been some improvement and that it is showing through into our thinking about the economy. One last thought—a number of people have mentioned the distinction between core and total inflation. I agree that our communication on this issue really needs some work. I was just in Chicago, and several people, including directors and employees, asked me, “Don’t you guys drive? Don’t you eat?” [Laughter] Clearly, we understand why we do this, but I think we need to improve our communication on that particular front. That’s a little segue into what we’ll be talking about tomorrow. So if you will bear with me—I know it is six o’clock, but I’d like to ask Vincent just to give us a brief introduction to the monetary policy discussion we’ll be having tomorrow. That will save us some time tomorrow and give us a chance to think overnight about the subject." FOMC20080625meeting--43 41,MR. SLIFMAN.," We expect foreclosures to rise--and to rise appreciably. One thing we have done in thinking about house prices is, in effect, to build in some extra house-price depreciation, above and beyond what our price�rent model would want to say, to reflect the kinds of factors that you are talking about--the foreclosures, what that means then for the vacancy rate, and what that does to house prices, particularly in certain parts of the country. I see President Yellen nodding her head because California, for sure, is one place where that could clearly be an important factor. " CHRG-111hhrg53245--47 The Chairman," But you say here, ``The Systemic Risk Council could be authorized to establish an acceptable limit of bank growth and impose appropriate limits on growth that are not consistent with the limits.'' By that, do you mean capital requirements? There's no actual limit? " CHRG-110hhrg46591--140 Mr. Ackerman," What if there was no past? Ms. Rivlin. Well, no, there was a past. Subprime mortgages didn't start in 2006. There was a history. Ned Gramlich has set this out rather nicely in his book. But the problem was as long as prices were going up, housing prices, there were relatively small defaults on subprime. So using that history--and there was a history--was misleading. As soon as we got to the top of the housing market, all the rules changed. " 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? " FOMC20070807meeting--42 40,MR. WILCOX.," Thank you, Mr. Chairman. In putting together the Greenbook forecast for this meeting, we adjusted our outlook in five ways in response to the developments that Bill Dudley has just described. First and foremost in terms of its implications for real activity, we took on board the implications of the decline in the value of equities since the June Greenbook. Second, we adjusted our home-price forecast down a notch, both in response to slightly disappointing indicators of home- price appreciation during the second quarter and in recognition of the bleaker conditions in housing markets more generally, including the developments in the subprime mortgage market. In all, we took the level of home prices down 1½ percent by the end of 2008, with about one-third of that amount representing our response to the incoming indicators and two-thirds reflecting the other considerations. In combination and allowing for some relatively minor offsets, the reduction in equity values and home prices took about $1 trillion off the balance sheet of the household sector and weakened our outlook for consumer spending through the usual wealth- effect channels. Third, we further adjusted our forecast of real PCE to allow for a direct effect of interest-rate resets. We estimate that 4.7 million variable-rate subprime loans are scheduled to undergo interest-rate resets over the next year and a half. If all these resets were to take full effect, they would result in extra interest payments cumulating to about $12 billion between now and the end of 2008. For several reasons, however, we think that $12 billion figure represents a loose upper bound on the likely effect of resets on consumption spending. For example, even in today’s relatively more hostile financial environment, some households will succeed in refinancing into a prime mortgage with a lower rate; others will sell their property and become renters rather than bear the additional debt service payments; and some who remain in their homes with no refinancing will have the financial wherewithal to shield their spending from a dollar-for-dollar reduction in response to the increase in debt service payments. In light of these considerations, we took consumer spending down by half the amount of the reset-induced payments. Fourth, we adjusted down our forecast for new-home sales to allow for the unusual restraint that the tightening in mortgage-borrowing conditions since the last Greenbook will likely impose on the demand for new homes. The adjustment we made this time followed similar downward revisions in March and June; together, these three revisions were calibrated to unwind the boost to mortgage originations that we think was provided by nonprime lending in 2005 and 2006. Overall, we took the trajectory of new-home sales down 6 percent this round—half in response to the mortgage developments and half in response to the disappointing pace of sales data for June. Having cut the pace of sales, we then also took down the rate of new construction in the forecast to keep inventories of unsold new homes from bulging too much further. Finally, we trimmed our forecast for investment in equipment and software a bit on the theory that the increase in spreads that investment-grade and especially non- investment-grade firms now are facing might reflect greater uncertainty in the business climate and that they might respond to that uncertainty by being a little more reluctant to invest. To be sure, the econometric evidence supporting this hypothesis is not rock solid, but it did strike us as suggestive enough to warrant a modest adjustment. All told, these responses to the more hostile financial climate took about ¼ percentage point off our forecast for the growth of real GDP over the second half of this year and next, with about half of that amount reflecting the changes working through the traditional wealth channel and the remainder representing the combined influence of the three less traditional adjustments. Could the implications of the financial situation for the real economy be even worse than we have built into the baseline? You bet. I almost invariably resist the temptation to declare that uncertainty about the real economy is greater than usual, but the current situation strikes me as the exception that proves the rule. In the “Alternative Scenarios” section of the Greenbook, we sketched three situations in which economic activity would be markedly weaker than in the baseline. In the first, residential investment drops 10 percent relative to baseline by the middle of next year, and home prices drop a total of 20 percent in nominal terms over the next year and a half—unprecedented in modern times but not outside the realm of possibility, as it would merely return the valuation of the housing stock to the level predicted by one of the house-price models that we track. The second scenario adds a deterioration in consumer sentiment, giving the meltdown in the housing sector an additional vehicle for spilling over into consumer spending more generally. In both of these scenarios, financial conditions deteriorate relative to baseline but only to the extent judged “normal” by the model in light of the weaker overall economy. The third scenario adds a further and more virulent deterioration in financial conditions, with a 10 percent decline in equity values and a 100 basis point widening in the spread on investment-grade securities. In the third scenario, we nearly—though not quite—succeed in generating a recession despite a substantial easing of monetary policy. On the other hand, could it be better? A key objective in putting together this forecast has been to ensure that risk lies on both sides of the baseline forecast. For example, yesterday’s market rebound is a reminder that stranger things have happened than for calm to break out in financial markets. One cannot rule out that, six months or a year from now, we will look back on this episode much as we look back on the flare-up in February of this year or as we look back on the stock-market break in 1987, with a sense of surprise that the financial event did not leave a greater imprint on the real economy. Even if the financial markets do not heal themselves quickly, consumers may prove more willing to postpone the increase in the saving rate that we have assumed in the baseline; businesses may aim to build the investment share of GDP back much closer to the levels that it attained in the late 1990s; and home sales may recover more quickly than we have assumed. A second challenge that we faced in putting the forecast together—more routine than the task of factoring in the implications of financial-market developments—was to take account of the annual revision to the national income and product accounts. As you know, the BEA revised down the growth of real GDP ⅓ percentage point, on average, in 2004, 2005, and 2006. Conveniently, this time around, the BEA made only very small adjustments to their estimates of PCE inflation. Because the NIPA revision gave us no new reason to revise our previous assessment of the pressures in product markets, we took our estimate of potential output down in line with actual GDP, thereby maintaining the gap between the two at its previous level as of the end of 2006. In line with our custom in years past, we carried the revision to the growth of potential through into the forecast period. As a result, we now have potential output increasing 2¼ percent in both 2007 and 2008. A virtue of the approach that we have taken in revising the supply side of the projection is that it leaves most of the variables you care about undisturbed. Thanks to the BEA, inflation is essentially unrevised. Because we moved potential down in line with actual, the GDP gap and the unemployment rate trajectories are also essentially unrevised. And with real interest rates and the GDP gap about the same as before, r* is also roughly unrevised. In short, if you make your policy decisions based on expected inflation and expected resource utilization, your policy choices after the revision should be about the same now as they were before the revision, provided that you see the prospects for resource utilization as roughly the same now as they were before the revision. The one variable that is different, of course, in the projection as well as in history, is the growth rate of real GDP. But a conventional analysis would view the revision to that variable as something you simply have to accept—not something you can do anything about. In a statement that will strike you as reminiscent of “other than that, Mrs. Lincoln…,” I would summarize the nonfinancial news that we received during the intermeeting period as having been remarkably consistent with our June projection. On the downside, the most notable development, to be sure, was in home sales, both new and existing, confirming the recent step-down in housing demand. Pending home sales—our most reliable near-term indicator of existing-home sales— rebounded in June, but to a level that is still well below its average in the first quarter. Even so, were it not for the substantial disruption on the lending side, the portrait of the housing sector that we would be reporting to you today would be substantially the same as the one we presented in June. Elsewhere, the data on orders and shipments of nondefense capital goods in June were a little softer than we had expected. The slowdown in light-vehicle sales in July to 15.2 million units at an annual rate raises a warning flag, but we are inclined at this point to interpret that result as a temporary pause rather than a harbinger of much weaker spending ahead. All that said, last Friday’s employment report once again showed a little more momentum in hiring than we had expected, and initial claims for unemployment insurance in the two weeks since the July survey week have remained low, giving no sign of any material deterioration in labor-market conditions. The increase in the unemployment rate to 4.6 percent in July was not a surprise given the moderate pace of growth, on average, thus far this year. Moreover, the indicators that we have in hand put manufacturing IP on track to post a solid increase in July. All told, the real economy seems to have entered the period of intense financial-market turbulence with, if anything, a little more momentum than we would have projected at the time of the June meeting. On the inflation front, the picture looks very much the same as it did at the time of the June Greenbook. We still see the bulk of the improvement in core PCE inflation during the second quarter as likely to prove transitory. In a nod to the relatively favorable recent monthly readings, we trimmed our forecast for the second half of this year by 0.1 percentage point despite a number of factors that could put slightly greater upward pressure on inflation, including the slower pace of structural productivity growth, the higher level of commodity prices, and the uptick of a tenth in the Michigan measure of long-term inflation expectations. Next year, as energy prices turn down slightly, inflation expectations remain well contained, and pressures on resource utilization ease slightly, we continue to have core inflation edging down to a rate of 2 percent; and we have top-line inflation dipping slightly below the core rate to 1.8 percent for the year as a whole, before coming back up in line with the core over the next two years. Karen will now continue our presentation." FOMC20071211meeting--121 119,MR. MADIGAN.,"2 Thank you, Mr. Chairman. I will be referring to the draft announcement language in table 1, which is unchanged from the version distributed in the Bluebook and which is included in the package labeled “Material for FOMC Briefing on Monetary Policy Alternatives.” As shown in section 4 of the left-hand column, following the October meeting the Committee issued a statement that concluded that the upside risks to inflation roughly balanced the downside risks to growth, suggesting that the Committee saw reasonably good odds that, after 75 basis points of easing, the stance of policy would foster sustainable economic growth and price stability over time. As many of you have noted, however, events over the intermeeting period have undermined this view. The staff and the markets have interpreted incoming information as pointing to a distinctly weaker outlook for the economy. As Dave discussed, the staff has lowered its forecast for aggregate demand in light of deteriorating conditions in financial markets, incoming data on spending and output that were weaker than expected, and the higher path for energy prices suggested by futures markets. That weaker forecast for aggregate demand was reflected in a 70 basis point decline in the Greenbook-consistent measure of the equilibrium real federal funds rate, which placed it about 40 basis points below the current real federal funds rate. These developments have prompted the staff to tilt down its assumed trajectory for monetary policy, with a 25 basis point easing at this meeting and another ¼ point move in 2009. The assumed easing is not quite fast enough to offset the adverse shock to aggregate demand, and a small degree of economic slack consequently emerges over the next year or so that was not present in the October Greenbook. That slack can be seen as purposeful, as the staff has also interpreted incoming information as implying a modest adverse shock to aggregate supply: Recent inflation data and higher energy prices point to higher total and core inflation in the third and fourth quarters and, in the staff forecast, over the next few quarters as well. Given the restraint on inflation resulting from the projected emergence of modest slack, the staff judges that its assumed path for monetary policy will leave total inflation and core inflation, respectively, at the same 1.7 percent and 1.9 percent annual rates in 2009 that were projected in the October Greenbook. Should the Committee find the staff forecast persuasive as a modal forecast, view that outcome as satisfactory, and see the risks around that projection, while perhaps larger than previously, as not sharply skewed in either direction, it might be inclined to ease policy by the quarter point assumed in the staff forecast and adopt a statement along the lines shown as alternative B in table 1. Like the staff, members might see the incoming evidence as suggesting that the outlook for real activity has weakened and perhaps that the downside risks to growth have increased. The deterioration in financial markets, in particular, might be a source not only of a downward revision to your outlook but also of a greater sense of uncertainty about prospects for aggregate demand. The financial system is dealing with significant 2 Materials used by Mr. Madigan are appended to this transcript (appendix 2). credit losses and resulting capital erosion and constrictions on balance sheet capacity. The eventual effect of those problems on the availability of credit to households and firms is unknown. In particular, the potential interactions of financial stress with real economic developments, especially those in the housing sector, are difficult to assess. In view of these considerations, as shown in section 2 the suggested rationale language for alternative B would state that economic growth is slowing; would cite softening in recent spending data; and would indicate that financial strains have increased in recent weeks. While the Committee may see significant downside risks to spending, it might also remain worried about the potential for an increase in inflation pressures and might view inflation risks as having risen a bit over the past six weeks. The recent inflation picture looks slightly less benign than it did earlier. Moreover, the increase in oil futures prices suggests that energy prices could continue to boost overall and core inflation. Members may also view downward pressure on the dollar as likely to persist. The language shown in section 3 would continue to cite the same concerns about inflation that the Committee has recognized in recent statements. In circumstances of increased risks to growth and continued substantial inflation risks, the Committee might, as back in September, prefer not to express an overall assessment of the balance of risks. As shown in section 4, the Committee could say that “recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation.” However, if the Committee’s predilection is that further easing will probably be necessary but it still wishes to underscore its concern about inflation, you could insert a sentence after the first sentence in section 4 saying that “on balance, the Committee sees downside risks to growth as having increased, but it must also remain attentive to the upside pressures on inflation.” Most dealers expect you to couple a ¼ point easing today with an assessment that the risks are skewed to the downside. But even the version without an explicit risk assessment probably would be read as consistent with further policy easing going forward, particularly since you eased in October following a statement in September that was comparable to the one shown in section 4. It might be worth noting that many market participants expect the Federal Reserve to augment its monetary policy action today with some announcement regarding the discount window—for example, a reduction in the primary credit spread. As the Chairman noted earlier today, the absence of such a reference in today’s announcement could prompt some investor disappointment; but given your monetary policy action under alternative B, the effect on market interest rates seems likely to be limited, and presumably, any effect today will be reversed tomorrow. If the Committee is already persuaded that the economic outlook has weakened more sharply than in the Greenbook or if it has become significantly more concerned about the downside risks to growth, it might prefer the 50 basis point easing of alternative A. The Committee might see the larger move at this time as warranted particularly by risk-management considerations. The Greenbook presented two alternative scenarios—a “greater housing correction” and a “credit crunch”—that illustrate downside risks and suggest that the Committee may need to ease markedly further over coming quarters. In the case of the credit crunch scenario, for example, the estimated version of the Taylor rule calls for a funds rate that troughs at 2.6 percent, well below the low point currently built into market interest rates. As shown in the second column, the language suggested for alternative A explicitly cites both a weaker outlook and greater downside risks in explaining the relatively large policy move. As in alternative B, the language on inflation would be nearly unchanged from that employed in October. But in section 4 of alternative A, the Committee would indicate a judgment that—following the further reduction in interest rates—the upside risks to inflation roughly balance the downside risks to growth. Or the risk language shown in red in section 4 of alternative B could instead be employed under alternative A; this might be appropriate if the Committee felt that the same elevated risks that motivated it to ease 50 basis points also suggested that it was difficult to weigh the remaining risks after the action. In either case, short- and intermediate-term market interest rates would likely decline noticeably under alternative A. In contemplating the pros and cons of alternative A, one consideration might be whether the Committee views this combination of sharp easing and the associated language, particularly the version coupled with an inconclusive risk assessment, as likely to lead market participants to worry about what information the Committee might have that would lead it to take such a substantial step, and so undermine investor confidence. If, in contrast, the Committee saw the downside risks to growth as somewhat greater but was not yet convinced that the outlook had deteriorated substantially and remained concerned about inflation prospects, it might consider implementation of alternative C. As indicated in the right-hand column, under this alternative the Committee would maintain the stance of policy at this meeting but conclude that the downside risks to growth now are the predominant concern. With overall inflation on the high side and upward pressures stemming from energy prices and dollar depreciation, members might be concerned that policy easing could go too far. The stance of policy has already been eased 75 basis points despite only limited evidence to date that economic weakness is spreading to a significant degree beyond the housing sector. Indeed, as some of you suggested, the incoming indicators of slowing growth over the intermeeting period may be broadly in line with what you expected in October. If so, the Committee may feel that its monetary policy actions to date—and, at the margin, the establishment of the TAF as well as swap lines with foreign central banks—probably will provide sufficient insurance that financial problems will remain contained and will not greatly restrict the availability of credit to households and businesses. Thus members may believe that further easing is not and probably will not be necessary. Indeed, members may find worrisome the prescription of the optimal control simulation in the Bluebook that a slight degree of policy firming would be appropriate over coming quarters if the Committee were pursuing a 1½ percent long-run objective for inflation. Even with such unease about inflation prospects, though, the Committee may be sufficiently concerned about the current threat to growth to judge that, on balance, the risks are tilted to the downside with an unchanged stance of policy. I will conclude by responding belatedly to a question that President Evans posed at the last meeting. He asked what the experience has been with including an indication of downside risks in the policy statement. In particular, would markets likely see such a risk assessment as signaling a likelihood of an imminent policy easing? Answering the question on the basis of the historical record is not entirely straightforward, partly because the Committee’s practices have evolved over time; as President Evans noted, it has been only since 1999 that the Committee has released a risk assessment or some other form of a tilt along with its announcement. Despite some qualifications, the basic answer seems to be, not surprisingly, that the risk assessments have been predictive of future Committee action. The experience from December 2000 through January 2002 makes this point clearly. During that period, at fourteen meetings in a row the Committee indicated that “the risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future.” In eleven of those fourteen instances, that indication was followed by a policy easing at the next meeting. Later, toward the end of 2002, one of two indications of downside risk was followed by an easing, and in June 2003, a different balance of risks—one concerned with disinflation—was followed by an easing. All in all, it seems reasonable to judge in current circumstances that maintaining the stance of policy while assessing that the risks are tilted to the downside, as under alternative C, would lead market participants to continue to put high odds on future policy easing. But the absence of policy action at this meeting despite nearly unanimous expectations of policy easing would mean that the expectation of a downtilt in rates would begin from a notably higher level and might be less steep, prompting a significant upward shift in short- and intermediate-term interest rates. That concludes my prepared remarks." FOMC20070918meeting--83 81,MR. FISHER.," I won’t ask a silly question like the one I asked before. I just have two quick questions, one for Dave, and the other for Karen. When we look at the labor situation, from an analytical standpoint, it seems to me that there is cognitive dissonance between that and what we are hearing anecdotally. What I’m hearing anecdotally—and I will talk a bit about that in a minute, but I’d like your viewpoint—are still complaints about labor shortages, from bank tellers to chemical workers to hotel maids, et cetera, et cetera, et cetera. You see it in the Beige Book. You hear it from the CEOs with whom I’ve talked. You see it District by District. How do you square these two corners, Dave? That’s my question for you. Then, for Karen, my question is this: You talked about the non-industrial country growth. I would submit, by the way, that those are the industrial countries now in terms of how they are fueling their growth; what we call “industrial” countries are service-driven economies. Setting that aside, you talked about the impact on growth, and you mentioned oil in particular. I would like to get your views on the potential inflationary impact from the kind of demand growth that we are seeing and the growth that you are projecting elsewhere in the world." CHRG-111hhrg51591--3 Mr. Garrett," Thank you, Mr. Chairman. And I look forward to an interesting discussion today on the appropriate role of the Federal Government to regulate insurance going forward, particularly in the context of proposals for risk regulators and resolutionary authority for these large non-bank financial institutions. You know, as I have outlined in my previous hearings, I have concerns with some of these proposals and the unintended consequences if they are to be implemented. As for a systemic risk regulator, we have been told throughout history that more regulation will solve our problems. You know, the Federal Reserve itself was created to ensure that these asset bubbles and panics would never happen again. It was back in 1914 that the then-Comptroller of the Currency had high expectations when speaking about the law that created the Fed. He said, ``Under the operation of this law, such financial and commercial crises or panics that the company experienced in 1873 and 1893 and 1907 seem to be mathematically impossible.'' Clearly, he was mistaken, and he has had a lot of company since then. A certain level of regulation is appropriate, but many of the reforms being talked about now will reduce market discipline and increase moral hazard. With the resolution authority being proposed by Secretary Geithner and others, for instance, I have real doubts that this can be implemented without institutionalizing an entire segment of too-big-to-fail companies. So I have concerns in general about systemic risk regulation and resolution authority, but they seem particularly inappropriate for the insurance industry. Insurance companies, especially those dealing primarily with retail customers, are different in nature from banks, for example. They are not nearly as interconnected with the rest of the financial services sector and the economy as a whole. Additionally, we already have the State guarantee funds to deal with insolvent insurance companies. And quite frankly, these funds have historically worked very well. Bond insurance, as you mentioned, of course is a bit of an outlier here, and the committee, I think, will address some of the unique challenges facing that sector on a different track. Also of concern in this current environment, and with the makeup of the present Administration and the congressional leadership are proposals calling for significant regulatory changes. To supporters of these proposals, I would say: Be very careful what you wish for. And when you think about it, it is not too far of a stretch to see a tri-layered or even a quadruple-layered regulatory structure for insurance when all the dust settles. You could have State regulation, Federal regulation, systemic risk regulation, and resolution authority regulation on top of that. So while the topic of Federal versus State regulation of insurance fosters intense debate, I believe we all can agree that a multi-layered regulatory structure for the insurance industry would not provide the best model for a competitive and a robust marketplace. Finally, in one other piece of the regulatory puzzle, I have been working with Congressman Dennis Moore, and we have been directly involved in the Nonadmitted and Reinsurance Reform Act. As you may know, this is a piece of legislation that passed the House overwhelmingly in the past two Congresses. What it would do is update and streamline State regulation in the nonadmitted or surplus lines and reinsurance market. So the surplus lines bill is an area of insurance regulatory reform where there is broad consensus. I look forward to working with my colleagues on the other side of the aisle to make sure that we get that piece of legislation done during this term in Congress. And with that, I yield back. " CHRG-110hhrg41184--73 Mr. Bernanke," There are a lot of factors involved. Mr. Price of Georgia. The stimulus package that Congress recently passed, many of us were concerned about it being temporary and having questionable effect, truly to stimulate the market, the economy, in the long-run. And if we think about the housing situation currently, I think there are two basic options available. One is to try to stimulate housing purchase through some tax policy. And the other is to increase the liability of the taxpayer for becoming the natures mortgage banker. Do you have a sense about which road we ought to head down? " FOMC20050503meeting--75 73,MR. LACKER.," On balance, after hitting a soft patch in March, economic activity in the Fifth District appears to have bounced back somewhat in April. The improvement was centered in manufacturing and retailing, where modest growth replaced flat activity in March. Services firms, meanwhile, continued to report the moderate growth we’ve seen over the last several months. District manufacturers suggest that demand generally remained solid, and many indicate that they’ve successfully passed through higher energy and materials costs. Our shipments and new orders indexes both moved up for April. Most of our manufacturing contacts say that they do not plan to reduce capital spending in coming months and that they remain reasonably optimistic about future prospects. The exception to this picture is, as usual, in the textile, apparel, and furniture industries that compete directly with Chinese producers. They continue to complain of a lack of pricing power, and their capital spending is generally limited to maintaining rather than expanding May 3, 2005 29 of 116 weakens. The wage gains are being reported in higher-skilled industries, however, while it is elsewhere in the sector that workers are being shed. The recent bounce in retail sales in the Fifth District appears to be centered in big-ticket items. In our April survey, big-ticket sales posted their strongest reading since July 2003. Sharp upticks were registered in retail employment and wages as well. Housing activity remains solid in our District. Home sales are strong in most areas and quite robust in some, including my own neighborhood where I received six offers in one day on my house! On the inflation front, our April survey suggests that price pressures remain contained, though the rate of increase in prices paid by manufacturers edged higher. We continue to hear concerns about having to pay higher energy prices, and a few producers also complain that higher energy costs are dampening consumer demand. Turning to the national picture, the data we’ve received since March have been disappointing on both the real side and inflation. The slowing in the real side has been broad-based, and although it has been relatively mild overall, the deceleration in capital spending is particularly disappointing given the expectation that business investment would generally drive this expansion. On inflation, core PCE inflation continues to move up. The latest report shows it at a 2.9 percent annual rate over the last three months, considerably above the 1.7 percent rate over the twelve months to March. If this situation were to persist, it would present a classic dilemma for monetary policy: weakening real growth and rising inflation. At this point, however, there are good reasons to think that it will not. First, the economic fundamentals underlying this recovery appear sound. Prospects for growth in real household income look good, and, although capital spending may not soon replicate last year’s strong pace, investment May 3, 2005 30 of 116 should be temporary. The Fifth District reports of a rebound in April that I mentioned earlier are consistent with this view as well. Second, weak real data did not change the Board staff’s estimate of potential output. Instead, the Greenbook forecast has a more protracted narrowing of the output gap, with a significantly wider gap still near 1 percent to the end of 2006. It seems reasonable to believe that this wider output gap will help push core PCE [personal consumption expenditures] inflation back below 2 percent, and this view gets some support from the gratifying fact that TIPS [Treasury inflation-protected securities] inflation compensation has declined a bit since March, both for the first five years out and the five years after that. Moreover, market participants expect inflation to remain that well contained even with about ¼ percentage point less of expected tightening by the end of 2006 than had been foreseen as of March. That raises the likelihood that actual and expected inflation can be contained without the aggressive type of funds tightening that has been needed to do so in the past. One might think that with eight weeks to go until the next meeting and with the possibility of the soft patch expiring soon and removing the dampening effect on out-year inflation expectations, we run the risk of being overtaken by events and rising inflation pressures. I tend to think, however, that market participants understand our preferences well enough that the yield curve will react sensitively to the data should inflation risks pick up. We should be sure that our communications don’t inhibit that process." FOMC20060131meeting--106 104,MR. STERN.," Thank you, Mr. Chairman. Let me start with one anecdote about housing activity in the District. I don’t know how representative this is nationwide, obviously, but there are signs of slowing in both housing construction and, more dramatically, in sales recently. And this winter in the Twin Cities, several hundred unionized construction workers are not working. Last year 100 percent were. But they’re all expected to be back at work in the spring, and that suggests to me—and this is more a question than a conclusion—that the ultimate correction in housing may occur later and be more severe than I was earlier expecting. As far as the national economy is concerned, like others, I am inclined to discount the fourth quarter. I find the Greenbook story about the outlook reasonably convincing. I personally think that we will see pretty good growth in both ’06 and ’07. I tend to rely, as you know, on the underlying fundamentals and the resilience of the economy, and those things seem to me to be sound and in place. And so I think the overall outlook is pretty good. I do think that there was a disconnect in the fourth quarter between the supply or output side and the demand side. If you look at the numbers for employment and hours, you would have certainly come up with a stronger forecast. Now, you may plug in a negative productivity number. That’s one way of reconciling it. Maybe the November and December employment data will get revised down. I guess that’s another way of reconciling it. Perhaps some of the aggregate demand components will ultimately be revised up a bit. But there does seem to be a disconnect there, nothing that I find all that troubling, but something I think worth bearing in mind if we want to think about the fourth quarter. I think the key to the outlook and to policy going forward, though, is inflation. And I went and looked at what has happened to the core PCE over the past eight or nine years. And the range of increases in core PCE inflation over that period was about 1¼ to 2¼ percent, and I think the average over the past eight or nine years was something like 1¾ percent. I don’t cite those numbers just to prove that I can look them up. I cite them because I would characterize that whole period as a period of low inflation, maybe something resembling price stability. And if I ask myself, “Is inflation likely to break out on the high side of that range in the relatively near term?” my answer to that is “no.” And I think most bond market participants, at least the way they are pricing things, would also answer that question with a “no.” Part of that is, of course, that we have been moving policy, and it seems to me that policy, measured by the real federal funds rate, is now certainly in the ballpark where it needs to be. I anticipate that we’ll move again today, as I think we should, in part to validate market expectations. Is policy perfectly positioned within the ballpark? Well, I don’t know the answer to that, but I do think it is well positioned within the ballpark, and I think we need to bear that in mind as we go forward." CHRG-110hhrg38392--11 Mr. Bernanke," I will do my opening statement. Thank you. Chairman Frank, Ranking Member Bachus, and members of the committee, I am pleased to present the Federal Reserve's Monetary Policy Report to the Congress. As you know, this occasion marks the 30th year of semiannual testimony on the economy and monetary policy for the Federal Reserve. In establishing these hearings--Mr. Hawkins and Mr. Humphrey were mentioned--the Congress proved prescient in anticipating the worldwide trend toward greater transparency and accountability of central banks in making monetary policy. Over the years, these testimonies and the associated reports have proved an invaluable vehicle for the Federal Reserve's communication with the public about monetary policy, even as they have served to enhance the Federal Reserve's accountability for achieving the dual objectives of maximum employment and price stability set forth by the Congress. I take this opportunity to reiterate the Federal Reserve's strong support of the dual mandate. In pursuing maximum employment and price stability, monetary policy makes its greatest possible contribution to the general economic welfare. Let me now review the current economic situation and the outlook beginning with developments in the real economy and the situation regarding inflation before turning to monetary policy. I will conclude with comments on issues related to lending to households and consumer protection, topics not normally addressed in monetary policy testimony, but in light of recent developments deserving of our attention today. After having run at an above-trend rate earlier in the current economic recovery, U.S. economic growth has proceeded during the past year at a pace more consistent with sustainable expansion. Despite the downshift in growth, the demand for labor has remained solid with more than 850,000 jobs being added to payrolls thus far in 2007 and the unemployment rate having remained at 4\1/2\ percent. The combination of moderate gains in output and solid advances in employment implies that recent increases in labor productivity have been modest by the standards of the last decade. The cooling of productivity growth in recent quarters is likely the result of cyclical or other temporary factors, but the underlying pace of productivity gains may also have slowed somewhat. To a considerable degree, the slower pace of economic growth in recent quarters reflects the ongoing adjustment in the housing sector. Over the past year, home sales in construction have slowed substantially and house prices have decelerated. Although a leveling off of home sales in the second half of 2006 suggested some tentative stabilization of housing demand, sales have softened further this year, leading the number of unsold new homes in builders' inventories to rise further relative to the pace of new home sales. Accordingly, construction of new homes has sunk further, with starts of new single family houses thus far this year running 10 percent below the pace in the second half of last year. The pace of home sales seems likely to remain sluggish for a time, partly as a result of some tightening and lending standards and the recent increase in mortgage interest rates. Sales should ultimately be supported by growth in income and employment, as well as by mortgage rates that--despite the recent increase--remain fairly low relative to historical norms. However, even if demand stabilizes as we expect, the pace of construction will probably fall somewhat further as builders work down the stocks of unsold new homes. Thus, declines in residential construction will likely continue to weigh on economic growth over coming quarters, although the magnitude of the drag on growth should diminish over time. Real consumption expenditures appear to have slowed last quarter following two quarters of rapid expansion. Consumption outlays are likely to continue growing at a moderate pace, aided by a strong labor market. Employment should continue to expand, though possibly at a somewhat slower pace than in recent years as a result of the recent moderation in the growth of output and ongoing demographic shifts that are expected to lead to a gradual decline in labor force participation. Real compensation appears to have risen over the past year, and barring further sharp increases in consumer energy costs, it should rise further as labor demand remains strong and productivity increases. In the business sector, investment in equipment and software showed a modest gain in the first quarter. A similar outcome is likely for the second quarter, as weakness in the volatile transportation equipment category appears to have been offset by solid gains in other categories. Investment in nonresidential structures, after slowing sharply late last year, seems to have grown fairly vigorously in the first half of 2007. Like consumption spending, business fixed investment overall seems poised to rise at a moderate pace, bolstered by gains in sales and generally favorable financial conditions. Late last year and early this year, motor vehicle manufacturers and firms in several other industries found themselves with elevated inventories, which led them to reduce production to better align inventories with sales. Excess inventories now appear to have been substantially eliminated and should not prove a further restraint on growth. The global economy continues to be strong. Supported by solid economic growth abroad, U.S. exports should expand further in coming quarters. Nonetheless our trade deficit, which was about 5\1/4\ percent of nominal gross domestic product in the first quarter, is likely to remain high. For the most part, financial markets have remained supportive of economic growth. However, conditions in the subprime mortgage sector have deteriorated significantly reflecting mounting delinquency rates on adjustment rate loans. In recent weeks, we have also seen increased concerns among investors about credit risk on some other types of financial instruments. Credit spreads on lower quality corporate debt have widened somewhat and terms for some leveraged business loans have tightened. Even after their recent rise, however, credit spreads remain near the low end of their historical ranges and financing activity in the bond and business loan markets has remained fairly brisk. Overall, the U.S. economy appears likely to expand at a moderate pace over the second half of 2007 with growth then strengthening a bit in 2008 to a rate close to the economy's underlying trend. Such an assessment was made around the time of the June meeting of the Federal Market Committee by the members of the Board of Governors and the presidents of the Reserve Banks, all of whom participate in deliberations on monetary policy. The central tendency of the growth forecast, which are conditioned on the assumption of appropriate monetary policy, is for real GDP to expand roughly 2\1/4\ to 2\1/2\ percent this year and 2\1/2\ to 2\3/4\ percent in 2008. The forecasted performance for this year is about \1/4\ percentage point below that projected in February, the difference being largely a result of weaker than expected residential construction activity this year. The unemployment rate is anticipated to edge up between 4\1/2\ and 4\3/4\ percent over the balance of this year and about 4\3/4\ percent in 2008, a trajectory about the same as the one expected in February. I turn now to the inflation situation. Sizable increases in food and energy prices have boosted overall inflation and eroded real incomes in recent months, both unwelcome developments. As measured by changes in the price index for personal consumption expenditures (PCE inflation), inflation ran at an annual rate of 4.4 percent over the first 5 months of this year, a rate that, if maintained, would clearly be inconsistent with the objective of price stability. Because monetary policy works with a lag, however, policymakers must focus on the economic outlook. Food and energy prices tend to be quite volatile, so that, looking forward, core inflation (which excludes food and energy prices) may be a better gauge than overall inflation of underlying inflation trends. Core inflation has moderated slightly over the past few months, with core PCE inflation coming in at an annual rate of about 2 percent so far this year. Although the most recent readings on core inflation have been favorable, month-to-month movements in inflation are subject to considerable noise, and some of the recent improvement could also be the result of transitory influences. However, with long-term inflation expectations contained, futures prices suggesting that investors expect energy and other commodity prices to flatten out, and pressures in both labor and product markets likely to ease modestly, core inflation should edge a bit lower, on net, over the remainder of this year and next year. The central tendency of FOMC participants' forecast for core PCE inflation--2 to 2\1/4\ percent for 2007 and 1\3/4\ to 2 percent in 2008--is unchanged from February. If energy prices level off as currently anticipated, overall inflation should slow to a pace close to that of core inflation in coming quarters. At each of its four meetings so far this year, the FOMC has maintained its target for the Federal funds rate at 5\1/4\ percent, judging that the existing stance of policy was likely to be consistent with growth running near trend and inflation staying on a moderating path. As always, in determining the appropriate stance of policy, we will be alert to the possibility that the economy is not evolving in the way we currently judge to be the most likely. One risk to the outlook is that the ongoing housing correction might prove larger than anticipated with possible spillovers onto consumer spending. Alternatively, consumer spending, which has advanced relatively vigorously, on balance, in recent quarters, might expand more quickly than expected; in that case, economic growth could rebound to a pace above its trend. With the level of resource utilization already elevated, the resulting pressures in labor and product markets could lead to increased inflation over time. Yet another risk is that energy and commodity prices could continue to rise sharply leading to further increases in headline inflation, and if those costs pass through to the prices of nonenergy goods and services, to higher core inflation as well. Moreover, if inflation were to move higher for an extended period and the increase became embedded in longer-term inflation expectations, the reestablishment of price stability would become more difficult and costly to achieve. With the level of resource utilization relatively high and with the sustained moderation in inflation pressures yet to be convincingly demonstrated, the FOMC has consistently stated that upside risks to inflation are its predominant policy concern. In addition to its dual mandate to promote maximum employment and price stability, the Federal Reserve has an important responsibility to help protect consumers in financial services transactions. For nearly 40 years, the Federal Reserve has been active in implementing, interpreting, and enforcing consumer protection laws. I would like to discuss with you this morning some of our recent initiatives and actions, particularly those related to subprime mortgage lending. Promoting access to credit and to home ownership are important objectives, and responsible subprime mortgage lending can help to advance both goals. In designing regulations, policymakers should seek to preserve those benefits. That said, the recent rapid expansion of the subprime market was clearly accompanied by deterioration in underwriting standards, and in some cases, by abusive lending practices and outright fraud. In addition, some households took on mortgage obligations they could not meet, perhaps in some cases because they did not fully understand the terms. Financial losses have subsequently induced lenders to tighten their underwriting standards. Nevertheless, rising delinquencies in foreclosures are creating personal, economic, and social distress for many homeowners and communities, problems that likely will get worse before they get better. The Federal Reserve is responding to these difficulties at both the national and the local levels. In coordination with other Federal supervisory agencies, we are encouraging the financial industry to work with borrowers to arrange prudent loan modifications to avoid unnecessary foreclosures. Federal Reserve banks around the country are cooperating with community and industry groups that work directly with borrowers who are having trouble meeting their mortgage obligations. We continue to work with organizations that provide counseling about mortgage products to current and potential homeowners. We are also meeting with market participants--including lenders, investors, servicers, and community groups--to discuss their concerns and to gain information about market developments. We are conducting a top-to-bottom review of possible actions we might take to help prevent recurrence of these problems. First, we are committed to providing more effective disclosures to help consumers defend against improper lending. Three years ago, the Board began a comprehensive review of Regulation Z, which implements the Truth in Lending Act (TILA). The initial focus of our review was on disclosures related to credit cards and other revolving credit accounts. After conducting extensive consumer testing, we issued a proposal in May that would require credit card issuers to provide clearer and easier-to-understand disclosures to customers. In particular, the new disclosures would highlight applicable rates and fees, particularly penalties that might be imposed. The proposed rules would also require card issuers to provide 45 days' advance notice of a rate increase or any other change in account terms so that consumers will not be surprised by unexpected charges and will have time to explore alternatives. We are now engaged in a similar review of the TILA rules for mortgage loans. We began this review last year by holding four public hearings across the country during which we gathered information on the adequacy of disclosures for mortgages, particularly for nontraditional and adjustable rate products. As we did with credit card lending, we will conduct extensive consumer testing of proposed disclosures. Because the process of designing and testing disclosures involves many trial runs, especially given today's diverse and sometimes complex credit products, it may take some time to complete our review and propose new disclosures. However, some other actions can be implemented more quickly. By the end of this year, we will propose changes to TILA rules to address concerns about mortgage loan advertisements and solicitations that may be incomplete or misleading and to require lenders to provide mortgage disclosures more quickly so that consumers can get the information they need when it is most useful to them. We already have improved a disclosure that creditors must provide to every applicant for an adjustable rate mortgage to explain better the features and risks of these products, such as ``payment shock'' and rising loan balances. We are certainly aware, however, that disclosure alone may not be sufficient to protect consumers. Accordingly, we plan to exercise our authority under the Home Ownership and Equity Protection Act (HOEPA) to address specific practices that are unfair or deceptive. We held a public hearing on June 14th to discuss industry practices, including those pertaining to prepayment penalties, the use of escrow accounts for taxes and insurance, stated income and low documentation lending, and the evaluation of a borrower's ability to repay. The discussion and ideas we heard were extremely useful, and we look forward to receiving additional public comments in coming weeks. Based on the information we are gathering, I expect that the Board will propose additional rules under HOEPA later this year. In coordination with the other Federal supervisory agencies, last year we issued principles-based guidance on nontraditional mortgages, and in June of this year, we issued supervisory guidance on subprime lending. These statements emphasize the fundamental consumer protection principles of sound underwriting and effective disclosures. In addition, we reviewed our policies related to the examination of nonbank subsidiaries of bank and financial holding companies for compliance with consumer protection laws and guidance. As a result of that review, and following discussions with the Office of Thrift Supervision, the Federal Trade Commission, and State regulators, as represented by the Conference of State Bank Supervisors and the American Association of Residential Mortgage Regulators, we are launching a cooperative pilot project aimed at expanding consumer protection compliance reviews at selected nondepository lenders with significant subprime mortgage operation. These reviews will begin in the fourth quarter of this year and will include independent State-licensed mortgage lenders, nondepository mortgage lending subsidiaries of bank and thrift holding companies, and mortgage brokers doing business with or serving as agents of these entities. The agencies will collaborate in determining the lessons learned and in seeking ways to better cooperate in ensuring effective and consistent examinations and improved enforcement for nondepository mortgage lenders. Working together to address jurisdictional issues and to improve information sharing among agencies, we will seek to prevent abusive and fraudulent lending while ensuring that consumers retain access to beneficial credit. I believe that the actions I have described today will help address the current problems. The Federal Reserve looks forward to working with the Congress on these important issues. Thank you, Mr. Chairman. [The prepared statement of Chairman Bernanke can be found on page 65 of the appendix.] " CHRG-110shrg50414--68 Mr. Bernanke," Well, foreclosures are not all of it, but it is an important part. The housing market is very central to this whole issue, and I support and I have supported efforts to avoid preventable foreclosures. I have spoken about this on a number of occasions, and I think it would be helpful to the economy. I would note that steps have been taken. The GSE conservatorship, for example, has already lowered interest rates and has helped to stabilize the mortgage market, which will be supportive of house prices and, therefore, reducing foreclosures. The Federal Reserve is on the board of the Hope for Homeowners bill that was just passed by this Congress that involves $300 billion of purchases of mortgages to be refinanced into the FHA. I am sure much more could be done. I will support further action. I would note two things. First, as a minor point, one of the things that this program being discussed could do would be to purchase second liens, which have proved to be a very significant barrier to the resolution of foreclosures. But, more importantly, the housing market is not going to recover if the economy is declining, if jobs are being lost, if credit is not available. And so I do think you cannot separate these as two completely separate issues. You need to have financial stability and financial markets working properly for the economy and the housing market to have a chance to recover. " FOMC20061025meeting--13 11,MS. JOHNSON.," Once again I find myself reporting to you that movements in global oil prices are among the developments during the intermeeting period that were factors in our deliberations about the external sector. Global crude oil spot and futures prices fell further following our September projection but by differing amounts over the maturity spectrum. When we finalized the current baseline forecast, spot prices and very near term futures prices had moved down more than $4 per barrel; futures contracts that mature at the end of 2007 had recorded price declines of about $2; those maturing at the end of 2008 had price declines of about 50 cents. Indeed, for contracts maturing beyond 2009, prices actually rose such that the far-dated contract for December 2012 had moved up about $1 per barrel in price. We adjusted our projection for U.S. oil import prices by amounts similar to these changes in futures prices. The differential movement in prices implies that, even though prices have moved down all along the path through the forecast period, this path now slopes up more steeply than it previously did. So our outlook is for oil prices to rise rather sharply over the forecast period, although from a lower starting point than in the September Greenbook. The reasons for the additional decline in prices during September and October include the return of production to near previous rates at Prudhoe Bay, the absence of any sign of late-season hurricanes in the Gulf of Mexico, and awareness of current high inventory levels. These inventories are by their very nature transitory; hence, market participants seem to believe that some of the current abundant supply will diminish over time, leaving limited spare production capacity and chronic risks to production in Nigeria, Iran, Iraq, and elsewhere. Late last week, OPEC announced production cuts of 1.2 million barrels per day as of November 1. Although the size of actual cuts by individual OPEC suppliers remains to be seen, we judge that significant cuts, albeit not as large as those announced, are needed for prospective demand to be consistent with prices in the futures curve. Those prices remain elevated—around the levels expected at the start of this year. We again asked ourselves how the substantial drop in oil prices since their August peak matters for the U.S. economy. As Dave mentioned, some of the near-term variance in U.S. real GDP growth reflects the path of real imports, including oil imports. The nominal trade deficit is clearly narrowed as a consequence of lower oil prices. We expect that the average oil bill in the fourth quarter will show an improvement from the third quarter of $60 billion at an annual rate. The net trade balance on nominal goods and services will improve by just about the same amount as other trade components experience small, offsetting changes. As oil prices rise going forward, the nominal value of oil imports should move back up; but for 2007 as a whole, we expect that the total figure will be about the same as the total for this year, followed by a moderate increase in 2008. With respect to our forecast for exports, we again expect that real exports of goods and services will expand at an annual rate of about 4½ percent through early 2008 and then will accelerate slightly, to about 5 percent, over the second half of 2008. We see this pace of export growth as reflecting moderately strong growth of trade in both services and merchandise. These components in turn reflect solid average growth of around 3¼ percent in foreign real GDP. The projected acceleration in real exports in 2008 reflects a boost from relative prices as U.S. export price inflation moderates. This projected pace of export growth is somewhat below that observed in recent years, particularly in the first half of this year. To some extent, the double-digit growth of U.S. real exports early this year reflected rapid real GDP growth abroad at that time. But our models cannot explain all the strong growth, and a sizable positive residual has emerged in our model. During the first quarter, exceptionally rapid growth of real GDP was widespread abroad as most industrial countries and many emerging-market economies in both Asia and Latin America recorded particularly robust real expansion. The rapid growth moved many foreign economies closer to potential and was not sustainable over the long run. We read recent indicators of activity abroad as generally confirming our expectation that slowing from those very rapid rates would occur through the year. According to the data, among the industrial countries, Canada and Japan have GDP already decelerating in the second quarter. In contrast, the pace of expansion strengthened in the euro area; but with further tightening of monetary policy and an increase in the value-added tax in Germany to take effect at the start of next year, our outlook calls for a slowdown in growth there as well. For the emerging-market economies, the most important news is Chinese third-quarter real GDP growth, announced just after the Greenbook was distributed. Based on the data and our best estimate of a seasonally adjusted series for the level of Chinese GDP, real growth in China was at an annual rate of about 5½ percent in the third quarter from the second quarter, following two quarters of growth above 12 percent. These data are only approximate as they are inferred from the annual growth rates published by the Chinese authorities. However, it does seem clear that the measures implemented by Chinese officials to cool the economy have had some effect. We are projecting that growth going forward will return to rates between 8 and 8½ percent. Of course, the band of uncertainty around this forecast is significant. We judge growth at that pace to be consistent with Chinese potential and acceptable to Chinese officials. This picture of real output growth abroad is a benign soft landing. We are projecting slowing that does not overshoot in many foreign economies, including importantly the euro area, Japan, and China. We believe that domestic demand growth in Canada, Japan, the euro area, and Mexico will continue to sustain their domestic expansions and growth in the global economy and will underlie ongoing moderate strength in U.S. exports. With respect to the current quarter, trade data for August surprised us with the strength of exports and led us to revise up by more than 2½ percentage points our estimate of the annual rate of growth of real exports in the third quarter. The surprise was widespread across categories of merchandise trade other than computers and semiconductors and included strong exports to most of our trading partners, with the important exceptions of Canada and Mexico. With no special stories or specific components of interest, we have projected that real export growth will revert to its historical relationship with foreign output and relative prices. However, the positive surprise in August reminds us that there is upside risk to our forecast for real exports as well as downside risk should foreign growth slow more than expected. Real merchandise imports in August came in above our expectation as well. We have accommodated that surprise in part by reducing real imports projected for the fourth quarter, particularly real oil imports. All in all, our baseline forecast for the combined contribution of imports and exports to U.S. GDP growth over the forecast period is for a small negative effect during the second half of this year that becomes slightly more negative through the second half of 2008, reaching about 0.4 percentage point as strengthening U.S. real GDP growth boosts import growth above that for exports. David and I will be happy to answer any questions." CHRG-110shrg46629--144 PREPARED STATEMENT OF BEN S. BERNANKE Chairman, Board of Governors of the Federal Reserve System July 19, 2007 Chairman Dodd, Ranking Member Shelby, and Members of the Committee, I am pleased to present the Federal Reserve's Monetary Policy Report to the Congress. As you know, this occasion marks the 30th year of semiannual testimony on the economy and monetary policy by the Federal Reserve. In establishing these hearings, the Congress proved prescient in anticipating the worldwide trend toward greater transparency and accountability of central banks in the making of monetary policy. Over the years, these testimonies and the associated reports have proved an invaluable vehicle for the Federal Reserve's communication with the public about monetary policy, even as they have served to enhance the Federal Reserve's accountability for achieving the dual objectives of maximum employment and price stability set for it by the Congress. I take this opportunity to reiterate the Federal Reserve's strong support of the dual mandate; in pursuing maximum employment and price stability, monetary policy makes its greatest possible contribution to the general economic welfare. Let me now review the current economic situation and the outlook, beginning with developments in the real economy and the situation regarding inflation before turning to monetary policy. I will conclude with comments on issues related to lending to households and consumer protection--topics not normally addressed in monetary policy testimony but, in light of recent developments, deserving of our attention today. After having run at an above-trend rate earlier in the current economic recovery, U.S. economic growth has proceeded during the past year at a pace more consistent with sustainable expansion. Despite the downshift in growth, the demand for labor has remained solid, with more than 850,000 jobs having been added to payrolls thus far in 2007 and the unemployment rate having remained at 4\1/2\ percent. The combination of moderate gains in output and solid advances in employment implies that recent increases in labor productivity have been modest by the standards of the past decade. The cooling of productivity growth in recent quarters is likely the result of cyclical or other temporary factors, but the underlying pace of productivity gains may also have slowed somewhat. To a considerable degree, the slower pace of economic growth in recent quarters reflects the ongoing adjustment in the housing sector. Over the past year, home sales and construction have slowed substantially and house prices have decelerated. Although a leveling-off of home sales in the second half of 2006 suggested some tentative stabilization of housing demand, sales have softened further this year, leading the number of unsold new homes in builders' inventories to rise further relative to the pace of new home sales. Accordingly, construction of new homes has sunk further, with starts of new single-family houses thus far this year running 10 percent below the pace in the second half of last year. The pace of home sales seems likely to remain sluggish for a time, partly as a result of some tightening in lending standards and the recent increase in mortgage interest rates. Sales should ultimately be supported by growth in income and employment as well as by mortgage rates that--despite the recent increase--remain fairly low relative to historical norms. However, even if demand stabilizes as we expect, the pace of construction will probably fall somewhat further as builders work down stocks of unsold new homes. Thus, declines in residential construction will likely continue to weigh on economic growth over coming quarters, although the magnitude of the drag on growth should diminish over time. Real consumption expenditures appear to have slowed last quarter, following two quarters of rapid expansion. Consumption outlays are likely to continue growing at a moderate pace, aided by a strong labor market. Employment should continue to expand, though possibly at a somewhat slower pace than in recent years as a result of the recent moderation in the growth of output and ongoing demographic shifts that are expected to lead to a gradual decline in labor force participation. Real compensation appears to have risen over the past year, and barring further sharp increases in consumer energy costs, it should rise further as labor demand remains strong and productivity increases. In the business sector, investment in equipment and software showed a modest gain in the first quarter. A similar outcome is likely for the second quarter, as weakness in the volatile transportation equipment category appears to have been offset by solid gains in other categories. Investment in nonresidential structures, after slowing sharply late last year, seems to have grown fairly vigorously in the first half of 2007. Like consumption spending, business fixed investment overall seems poised to rise at a moderate pace, bolstered by gains in sales and generally favorable financial conditions. Late last year and early this year, motor vehicle manufacturers and firms in several other industries found themselves with elevated inventories, which led them to reduce production to better align inventories with sales. Excess inventories now appear to have been substantially eliminated and should not prove a further restraint on growth. The global economy continues to be strong. Supported by solid economic growth abroad, U.S. exports should expand further in coming quarters. Nonetheless, our trade deficit--which was about 5\1/4\ percent of nominal gross domestic product (GDP) in the first quarter--is likely to remain high. For the most part, financial markets have remained supportive of economic growth. However, conditions in the subprime mortgage sector have deteriorated significantly, reflecting mounting delinquency rates on adjustable-rate loans. In recent weeks, we have also seen increased concerns among investors about credit risk on some other types of financial instruments. Credit spreads on lower-quality corporate debt have widened somewhat, and terms for some leveraged business loans have tightened. Even after their recent rise, however, credit spreads remain near the low end of their historical ranges, and financing activity in the bond and business loan markets has remained fairly brisk. Overall, the U.S. economy appears likely to expand at a moderate pace over the second half of 2007, with growth then strengthening a bit in 2008 to a rate close to the economy's underlying trend. Such an assessment was made around the time of the June meeting of the Federal Open Market Committee (FOMC) by the members of the Board of Governors and the presidents of the Reserve Banks, all of whom participate in deliberations on monetary policy. The central tendency of the growth forecasts, which are conditioned on the assumption of appropriate monetary policy, is for real GDP to expand roughly 2\1/4\ to 2\1/2\ percent this year and 2\1/2\ to 2\3/4\ percent in 2008. The forecasted performance for this year is about \1/4\ percentage point below that projected in February, the difference being largely the result of weaker-than-expected residential construction activity this year. The unemployment rate is anticipated to edge up to between 4\1/2\ and 4\3/4\ percent over the balance of this year and about 4\3/4\ percent in 2008, a trajectory about the same as the one expected in February. I turn now to the inflation situation. Sizable increases in food and energy prices have boosted overall inflation and eroded real incomes in recent months--both unwelcome developments. As measured by changes in the price index for personal consumption expenditures (PCE inflation), inflation ran at an annual rate of 4.4 percent over the first 5 months of this year, a rate that, if maintained, would clearly be inconsistent with the objective of price stability.\1\ Because monetary policy works with a lag, however, policymakers must focus on the economic outlook. Food and energy prices tend to be quite volatile, so that, looking forward, core inflation (which excludes food and energy prices) may be a better gauge than overall inflation of underlying inflation trends. Core inflation has moderated slightly over the past few months, with core PCE inflation coming in at an annual rate of about 2 percent so far this year.--------------------------------------------------------------------------- \1\ Despite the recent surge, total PCE inflation is 2.3 percent over the past 12 months.--------------------------------------------------------------------------- Although the most recent readings on core inflation have been favorable, month-to-month movements in inflation are subject to considerable noise, and some of the recent improvement could also be the result of transitory influences. However, with long-term inflation expectations contained, futures prices suggesting that investors expect energy and other commodity prices to flatten out, and pressures in both labor and product markets likely to ease modestly, core inflation should edge a bit lower, on net, over the remainder of this year and next year. The central tendency of FOMC participants' forecasts for core PCE inflation--2 to 2\1/4\ percent for 2007 and 1\3/4\ to 2 percent in 2008--is unchanged from February. If energy prices level off as currently anticipated, overall inflation should slow to a pace close to that of core inflation in coming quarters. At each of its four meetings so far this year, the FOMC maintained its target for the Federal funds rate at 5\1/4\ percent, judging that the existing stance of policy was likely to be consistent with growth running near trend and inflation staying on a moderating path. As always, in determining the appropriate stance of policy, we will be alert to the possibility that the economy is not evolving in the way we currently judge to be the most likely. One risk to the outlook is that the ongoing housing correction might prove larger than anticipated, with possible spillovers onto consumer spending. Alternatively, consumer spending, which has advanced relatively vigorously, on balance, in recent quarters, might expand more quickly than expected; in that case, economic growth could rebound to a pace above its trend. With the level of resource utilization already elevated, the resulting pressures in labor and product markets could lead to increased inflation over time. Yet another risk is that energy and commodity prices could continue to rise sharply, leading to further increases in headline inflation and, if those costs passed through to the prices of nonenergy goods and services, to higher core inflation as well. Moreover, if inflation were to move higher for an extended period and that increase became embedded in longer-term inflation expectations, the reestablishment of price stability would become more difficult and costly to achieve. With the level of resource utilization relatively high and with a sustained moderation in inflation pressures yet to be convincingly demonstrated, the FOMC has consistently stated that upside risks to inflation are its predominant policy concern. In addition to its dual mandate to promote maximum employment and price stability, the Federal Reserve has an important responsibility to help protect consumers in financial services transactions. For nearly 40 years, the Federal Reserve has been active in implementing, interpreting, and enforcing consumer protection laws. I would like to discuss with you this morning some of our recent initiatives and actions, particularly those related to subprime mortgage lending. Promoting access to credit and to homeownership are important objectives, and responsible subprime mortgage lending can help advance both goals. In designing regulations, policymakers should seek to preserve those benefits. That said, the recent rapid expansion of the subprime market was clearly accompanied by deterioration in underwriting standards and, in some cases, by abusive lending practices and outright fraud. In addition, some households took on mortgage obligations they could not meet, perhaps in some cases because they did not fully understand the terms. Financial losses have subsequently induced lenders to tighten their underwriting standards. Nevertheless, rising delinquencies and foreclosures are creating personal, economic, and social distress for many homeowners and communities--problems that likely will get worse before they get better. The Federal Reserve is responding to these difficulties at both the national and the local levels. In coordination with the other Federal supervisory agencies, we are encouraging the financial industry to work with borrowers to arrange prudent loan modifications to avoid unnecessary foreclosures. Federal Reserve Banks around the country are cooperating with community and industry groups that work directly with borrowers having trouble meeting their mortgage obligations. We continue to work with organizations that provide counseling about mortgage products to current and potential homeowners. We are also meeting with market participants--including lenders, investors, servicers, and community groups--to discuss their concerns and to gain information about market developments. We are conducting a top-to-bottom review of possible actions we might take to help prevent recurrence of these problems. First, we are committed to providing more-effective disclosures to help consumers defend against improper lending. Three years ago, the Board began a comprehensive review of Regulation Z, which implements the Truth in Lending Act (TILA). The initial focus of our review was on disclosures related to credit cards and other revolving credit accounts. After conducting extensive consumer testing, we issued a proposal in May that would require credit card issuers to provide clearer and easier-to-understand disclosures to customers. In particular, the new disclosures would highlight applicable rates and fees, particularly penalties that might be imposed. The proposed rules would also require card issuers to provide 45 days' advance notice of a rate increase or any other change in account terms so that consumers will not be surprised by unexpected charges and will have time to explore alternatives. We are now engaged in a similar review of the TILA rules for mortgage loans. We began this review last year by holding four public hearings across the country, during which we gathered information on the adequacy of disclosures for mortgages, particularly for nontraditional and adjustable-rate products. As we did with credit card lending, we will conduct extensive consumer testing of proposed disclosures. Because the process of designing and testing disclosures involves many trial runs, especially given today's diverse and sometimes complex credit products, it may take some time to complete our review and propose new disclosures. However, some other actions can be implemented more quickly. By the end of the year, we will propose changes to TILA rules to address concerns about mortgage loan advertisements and solicitations that may be incomplete or misleading and to require lenders to provide mortgage disclosures more quickly so that consumers can get the information they need when it is most useful to them. We already have improved a disclosure that creditors must provide to every applicant for an adjustable-rate mortgage product to explain better the features and risks of these products, such as ``payment shock'' and rising loan balances. We are certainly aware, however, that disclosure alone may not be sufficient to protect consumers. Accordingly, we plan to exercise our authority under the Home Ownership and Equity Protection Act (HOEPA) to address specific practices that are unfair or deceptive. We held a public hearing on June 14 to discuss industry practices, including those pertaining to prepayment penalties, the use of escrow accounts for taxes and insurance, stated-income and low-documentation lending, and the evaluation of a borrower's ability to repay. The discussion and ideas we heard were extremely useful, and we look forward to receiving additional public comments in coming weeks. Based on the information we are gathering, I expect that the Board will propose additional rules under HOEPA later this year. In coordination with the other Federal supervisory agencies, last year we issued principles-based guidance on nontraditional mortgages, and in June of this year we issued supervisory guidance on subprime lending. These statements emphasize the fundamental consumer protection principles of sound underwriting and effective disclosures. In addition, we reviewed our policies related to the examination of nonbank subsidiaries of bank and financial holding companies for compliance with consumer protection laws and guidance. As a result of that review and following discussions with the Office of Thrift Supervision, the Federal Trade Commission, and State regulators, as represented by the Conference of State Bank Supervisors and the American Association of Residential Mortgage Regulators, we are launching a cooperative pilot project aimed at expanding consumer protection compliance reviews at selected nondepository lenders with significant subprime mortgage operations. The reviews will begin in the fourth quarter of this year and will include independent State-licensed mortgage lenders, nondepository mortgage lending subsidiaries of bank and thrift holding companies, and mortgage brokers doing business with or serving as agents of these entities. 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 nondepository mortgage lenders. Working together to address jurisdictional issues and to improve information-sharing among agencies, we will seek to prevent abusive and fraudulent lending while ensuring that consumers retain access to beneficial credit. I believe that the actions I have described today will help address the current problems. The Federal Reserve looks forward to working with the Congress on these important issues." CHRG-111hhrg56847--207 Mr. Bernanke," Well, the main thing we are doing, of course, is that we have purchased a large amount of mortgage-backed securities guaranteed by the government-sponsored enterprises. And right now, the 30-year mortgage rate is about 4.8 percent, so that is clearly going to make it accessible. Affordability right now in terms of house prices and interest rates is about the best it has been for a very long time. You are right that the large amount of vacant and foreclosed properties is a major drag, particularly in some areas of the country. And I agree with Ms. Kaptur on this issue that we need to work with the Treasury and with the banks to do what we can to get these resolved as quickly as possible, whether it is through renegotiation of the mortgage, whether it is through a short sale or however it is done to get people situated and allow those houses to be turned over in the marketplace. So we are working to try to manage that situation. But that is clearly a big overhang for the housing market. " CHRG-111shrg51290--45 Mr. Bartlett," Senator, our group concluded about 2 years ago, and I am joined here with the President of the Housing Policy Council that led this, we concluded about 2 years ago that the focus should be on the ability to repay, that a mortgage should have the ability to repay. There are a lot of ingredients to that, of which teaser rates and prepayments is part of it, but that should be the focus. It should be the ability to repay for the life of the loan. We adopted it ourselves for our companies, which is about 80 percent of the mortgage market, but then equally important, we then recommended it to the Fed, which they adopted it in perhaps a slightly less fulsome form than we did, but the same thing. Ms. McCoy. The problem with focusing just on the prepayment penalty is that assumes the consumer has the ability to refinance during the introductory period, and we have seen that that may not be true for a couple of reasons. First of all, their credit scores may be sinking. And second, house prices may fall. Now, we are in a very unusual situation now, but in the 1990s, I lived in Cleveland, where housing price appreciation was pretty fragile. It was going up in other parts of the country, but you were never quite sure if you could sell your house for what you bought it at. Senator Merkley. Thank you. I think that is a very good point, and if I could just restate and make sure that we are on the save wavelength here, that even without a prepayment penalty, you may be locked into a loan, if it has a short teaser rate followed by high interest, but you may be locked in because the value of your house falls and you no longer have the equity to be able to refinance in a prime loan. Ms. McCoy. Correct. Senator Merkley. Thank you very much, Mr. Chairman. " CHRG-110shrg50414--55 FEDERAL HOUSING FINANCE AGENCY " 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." FOMC20061212meeting--133 131,MS. MINEHAN.," You could take out “than anticipated,” and if you’re looking at A, you could take out “more” because I think it says exactly what you want to do. It puts a little more emphasis on growth and on problems affecting growth, but it doesn’t raise issues about who anticipated what and when." 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." FOMC20080430meeting--160 158,MR. STOCKTON.," Yes, 1980�82 is in there. Again, the composition of where these residuals are is obviously heavily tilted in this case to housing, some of which is already behind us. So it isn't quite as though all of this weakness is prospective. Some of this weakness we have already had, and so there are very big negative residuals now on housing relative to where you would otherwise have been. " 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. " FOMC20050630meeting--114 112,MR. GALLIN.," I’ll leave the monetary policy aspect to my colleagues. But let me make a couple of points about land use restriction. Certainly, land use restrictions, environmental restrictions, and those types of things have played a role in the rapid rise in house prices. That certainly is a factor. I mentioned in my briefing that I like to compare house prices to rent—and this is one of the reasons—as opposed to comparing them to incomes. If increased regulation boosts house prices, people are just going to have to pay more out of their income for housing because of the regulations put in place. But land use restrictions should affect rents as well. So, it should drive up the cost of buying a home, and it should also drive up the cost of renting a home. It can be a significant factor, but it should be in both of those elements. And this is somewhat of an aside, but I find it interesting. I talk to a lot of builders as part of my day-to-day work here, and I’ve asked them about this very issue. They say definitely that land use restriction is a big concern for them. But I also went back and looked at newspaper articles written in ’86, ’87, ’88, and ’89, and it’s truly remarkable how the view back then was that housing prices could never fall because, as people were saying left and right, there was no more buildable land left due to environmental regulations and land use restrictions. They were saying that right up to 1989 when house prices leveled out in nominal terms. I’m not saying these things aren’t real— the builders say they are real—but they’re certainly not new though they may be new in their effects. But just to get back to the point, I think they should be captured in the price and the rent data." fcic_final_report_full--27 There were government reports, too. The Department of Housing and Urban De- velopment and the Treasury Department issued a joint report on predatory lending in June  that made a number of recommendations for reducing the risks to bor- rowers.  In December , the Federal Reserve Board used the HOEPA law to amend some regulations; among the changes were new rules aimed at limiting high- interest lending and preventing multiple refinancings over a short period of time, if they were not in the borrower’s best interest.  As it would turn out, those rules cov- ered only  of subprime loans. FDIC Chairman Sheila C. Bair, then an assistant treasury secretary in the administration of President George W. Bush, characterized the action to the FCIC as addressing only a “narrow range of predatory lending is- sues.”  In , Gramlich noted again the “increasing reports of abusive, unethical and in some cases, illegal, lending practices.”  Bair told the Commission that this was when “really poorly underwritten loans, the payment shock loans” were beginning to proliferate, placing “pressure” on tradi- tional banks to follow suit.  She said that she and Gramlich considered seeking rules to rein in the growth of these kinds of loans, but Gramlich told her that he thought the Fed, despite its broad powers in this area, would not support the effort. Instead, they sought voluntary rules for lenders, but that effort fell by the wayside as well.  In an environment of minimal government restrictions, the number of nontradi- tional loans surged and lending standards declined. The companies issuing these loans made profits that attracted envious eyes. New lenders entered the field. In- vestors clamored for mortgage-related securities and borrowers wanted mortgages. The volume of subprime and nontraditional lending rose sharply. In , the top  nonprime lenders originated  billion in loans. Their volume rose to  billion in , and then  billion in .  California, with its high housing costs, was a particular hotbed for this kind of lending. In , nearly  billion, or  of all nontraditional loans nationwide, were made in that state; California’s share rose to  by , with these kinds of loans growing to  billion or by  in California in just two years.  In those years, “subprime and option ARM loans saturated California communities,” Kevin Stein, the associate director of the California Reinvestment Coalition, testified to the Commission. “We estimated at that time that the average subprime borrower in Cali- fornia was paying over  more per month on their mortgage payment as a result of having received the subprime loan.”  Gail Burks, president and CEO of Nevada Fair Housing, Inc., a Las Vegas–based housing clinic, told the Commission she and other groups took their concerns di- rectly to Greenspan at this time, describing to him in person what she called the “metamorphosis” in the lending industry. She told him that besides predatory lend- ing practices such as flipping loans or misinforming seniors about reverse mortgages, she also witnessed examples of growing sloppiness in paperwork: not crediting pay- ments appropriately or miscalculating accounts.  Lisa Madigan, the attorney general in Illinois, also spotted the emergence of a troubling trend. She joined state attorneys general from Minnesota, California, Washington, Arizona, Florida, New York, and Massachusetts in pursuing allegations about First Alliance Mortgage Company, a California-based mortgage lender. Con- sumers complained that they had been deceived into taking out loans with hefty fees. The company was then packaging the loans and selling them as securities to Lehman Brothers, Madigan said. The case was settled in , and borrowers received  million. First Alliance went out of business. But other firms stepped into the void.  State officials from around the country joined together again in  to investi- gate another fast-growing lender, California-based Ameriquest. It became the na- tion’s largest subprime lender, originating  billion in subprime loans in —mostly refinances that let borrowers take cash out of their homes, but with hefty fees that ate away at their equity.  Madigan testified to the FCIC, “Our multi- state investigation of Ameriquest revealed that the company engaged in the kinds of fraudulent practices that other predatory lenders subsequently emulated on a wide scale: inflating home appraisals; increasing the interest rates on borrowers’ loans or switching their loans from fixed to adjustable interest rates at closing; and promising borrowers that they could refinance their costly loans into loans with better terms in just a few months or a year, even when borrowers had no equity to absorb another refinance.”  CHRG-110shrg50369--53 Mr. Bernanke," Well, we do have some data on investor-owned properties, and that has been increasing quite a bit. And my recollection is that among the mortgages that are having problems, something on the order of 20 percent of them are investor-owned; therefore, it is not a family that is being in risk of losing their home. So that is a significant consideration, and I think that in those cases investors who make a bad investment should bear the consequences. Senator Bennett. That is my own attitude as well. But we are having conversations about stimulus packages around here, and it had not occurred to me, until I had this information from people in the housing market, that if we could stimulate people to buy the lower-priced houses, and those are the people who need the shelter, anyway, and there is not a surplus of inventory there, that that would have a very salutary effect both in terms of taking care of people's needs and on the economy, because home builders would start to build again, they just would not be building in that portion of the housing market where there is an oversupply. But you do not have any specific data as to where the price points are in the inventory overhang? " FOMC20071211meeting--49 47,MR. STOCKTON.," In response to your first question about whether there is independent information in that estimate of the equilibrium funds rate for the Greenbook-consistent measure, the answer is that there is no independent information. It’s just a transformation of the revision in the GDP outlook into interest rate space. Now, obviously, we provide a few other measures in that table, some based on a large-scale econometric model and some on smaller-scale models. Those have come down, too. So I don’t think our forecast is doing something different from, well, what those other models suggest. In response to your second question, our forecast of housing activity going forward is not driven by the foreclosures. The foreclosure forecast that we have is driven importantly by the house-price developments, and there we have marked down our house-price forecast. We would expect some increase in foreclosures, and obviously that would have some feedback on overall lending and conditions of bank balance sheets. In general, since the October forecast, we have built in more broadly about ¼ percentage point to the level of GDP in additional restraint on spending coming from the increased overall financial turmoil—not just in the housing markets, but we’ve taken down a little our forecast of consumption and our forecast of business fixed investment too. Basically, looking at the past correlation between measures of overall financial stress and the residuals of our spending equations, there’s considerable correlation there. That is, our standard models, as I noted in the past, have very rudimentary financial transmission mechanisms in them—mostly a few interest rates, a few asset prices, housing, equity, and the exchange rate. In the past, periods when we’ve seen significant increase in financial stress have also been associated with significant shortfalls in spending, and we’ve tried as best we can to build that in. Most of that effect overall is in housing—over half of it—but some of it we think will spill over elsewhere. Those bank balance sheets are going to be impaired. We think there will be some restraint on lending going forward. But, boy, it’s a lot of guess work! On the housing side, I do think we can go through more-careful calculations of the implications of the shutdown of the nonprime market and the current impairment in the jumbo markets, but beyond that, I’d say we’re very loosely calibrating it." FOMC20071031meeting--103 101,MR. MADIGAN.,"4 Thank you, Mr. Chairman. I will be referring to the package labeled “Material for FOMC Briefing on Monetary Policy Alternatives.” That package includes two versions of table 1: The first is the version that was discussed in the Bluebook, and the second is a revised version dated October 31. The revised table presents basically the same policy alternatives as the Bluebook version but with some changes in the rationale and risk assessment sections. To review, alternatives B and C contemplate leaving the stance of policy unchanged today, but they differ importantly in their assessments of risk: Alternative C characterizes the downside risks to growth as roughly offsetting the upside risks to inflation, whereas alternative B indicates that the downside risks to growth are the Committee’s greater policy concern. Alternative A, in contrast, eases the stance of monetary policy 25 basis points and indicates that the Committee assesses the risks to growth and inflation as roughly in balance. In discussing these alternatives, I will basically be working from right to left across the two versions of the table. As Dave Stockton discussed yesterday in response to a question from Vice Chairman Geithner, the Greenbook projection is a modal forecast. Without consideration of risks, the Greenbook analysis would seem to support the Committee’s selection of alternative C. In that forecast, which is conditioned on the federal funds rate remaining at 4¾ percent, economic growth slows in the near term, and below-trend growth over the next few quarters closes the small positive output gap that the staff sees as currently prevailing. Maintaining the present stance of monetary policy leads to a gradual strengthening of the expansion over 2008 and 2009 and by enough to leave the economy producing at its capacity. Core inflation stays under 2 percent, while total inflation runs a bit lower, reflecting declining energy prices. Judging by your projections, most of you would find such a trajectory for inflation satisfactory, at least for the next couple of years if not over the longer term. Your projection submissions, however, as well as your comments yesterday, suggest that many of you see less vigor in aggregate demand than the Greenbook does as well as appreciable downside risks—an outlook that might argue against alternative C. The Greenbook provided several alternative simulations involving greater weakness in housing and larger fallout from financial stress that illustrate some prominent risks to spending; they suggested that the path of the federal funds rate might need to run ¾ percentage point or more below baseline should such weakness in aggregate demand eventuate. The choice of alternative B could be consistent with a modal expectation along the lines of the Greenbook coupled with appreciable concerns about downside risks and a judgment that you need to await additional information before deciding whether to ease policy further. As noted in alternative B, section 2, of either version, the statement would in effect explain the decision to stand pat, first, by recognizing that economic growth last quarter was solid and perhaps conveying the implicit suggestion that the economy was likely to continue to expand at an acceptable pace, even if growth were to slow temporarily; second, by noting that strains in financial markets have eased somewhat on balance; and third, by indicating that the domestic 4 The materials used by Mr. Madigan are appended to this transcript (appendix 4). economy apart from housing has proven resilient and that the global economy remains strong. At the same time, the statement would indicate that the Committee is concerned about downside risks to growth, explicitly citing the potential effect of tightening credit conditions. Regarding inflation, the language would be identical to that used in September. The statement would conclude by indicating that, on balance, the Committee saw the downside risks to growth as the greater policy concern. As Bill Dudley noted, the market was all but certain as of yesterday that you will ease policy today 25 basis points. Today, in response to the economic data released earlier, intermediate and longer-term interest rates have risen somewhat; however, futures quotes still suggest that investors now see high odds that you will ease policy today. Thus, the announcement of an unchanged stance of policy would come as a considerable surprise to markets. To be sure, the assessment under alternative B that the downside risks are the greater policy concern and its implication that further easing might well be forthcoming before long would soften the blow. But a selloff in bond and equity markets would no doubt ensue. Moreover, financial asset prices could remain volatile for a time, as investors attempted to recalibrate their expectations of the probable path of monetary policy going forward. Concern about such market reactions clearly would not persuade you to ease policy at this meeting if you judged that an unchanged stance of policy would likely be more consistent with maximum employment and stable prices, and hitching monetary policy to market expectations would make for extremely poor economic outcomes. But especially in circumstances of persisting financial strains, concern about unnecessarily adding to those strains might incline you a bit more toward easing, as in alternative A, if you were already strongly leaning that way today based on your view of economic and financial fundamentals. As I noted yesterday, your economic projections suggest that most of you believe that the stance of policy should be eased within the next six to twelve months, and many of you indicated that some easing was appropriate imminently. You may see several reasons for preferring to move earlier rather than later. In particular, you may think that a timely reduction in interest rates could be valuable now in buoying household, business, and investor confidence. Yesterday the Chairman noted the possibility of a vicious cycle involving a deteriorating macroeconomic outlook and tightening credit conditions. By bolstering confidence in the outlook, easing policy as expected could help reduce concerns about deteriorating economic fundamentals and declining asset values. Beyond reducing the risks of nonlinear responses, easing policy as expected by market participants would support growth of aggregate demand over time through the usual channels. Of course, you may also be worried about a possible increase in inflation. Such concerns may reflect a variety of factors—the further sharp increase in oil prices of recent weeks, the depreciation of the dollar, accelerating unit labor costs, and perhaps the relatively high level of resource utilization. But given the recent good inflation performance, you may feel that downside risks to growth are the more immediate danger and believe that further easing today to address those risks is warranted. You may also believe that, should the easing eventually appear to have been unnecessary, you could act as quickly to remove stimulus as you did to put it in place. If you were inclined toward easing policy another 25 basis points at this meeting, you would need to confront the question of the appropriate statement language. In both versions of alternative A, the first two sentences of section 2 are similar to those proposed for alternative B. But rather than emphasizing remaining downside risks, the statement would then repeat most of the “help forestall” language used in September. The language proposed for the inflation paragraph in both versions is identical to the corresponding paragraph suggested for alternative B; again, the language shown in the October 31 version suggests a bit more concern about inflation risks than the September language. Finally, both versions of alternative A would characterize the upside risks to inflation as roughly balancing the downside risks to growth. This indication might well lead market participants to reduce the nearly two-thirds odds that they currently place on another quarter-point easing in December and might trim the extent of the overall easing of policy anticipated over the next year or so. Thus, implementation of alternative A also could prompt some further backup in market interest rates. In closing, let me remind the Committee that the September trial run highlighted the potential for inconsistencies between the results of the projections survey and the Committee’s statement. Your latest forecast submissions indicated that, while a minority of you sees the risks to inflation as skewed to the upside, a slight majority perceives the risks to total inflation as broadly balanced, and a more-sizable majority judges that the risks to core inflation are in balance. These results could be seen as incongruent with the draft statements for some of the alternatives. For example, alternative A references upside risks to inflation. Several considerations might explain this apparent inconsistency. For example, your responses on skews in the projections survey may capture only the subjective probabilities that you attach to various outcomes, while you may see the statement language as capturing not only the odds but also the economic costs associated with those outcomes. Or perhaps the upside risks to inflation referenced in the statement should be interpreted as reflecting the views of all members not just of the majority who saw inflation risks as balanced, thus encompassing the views of those in the minority who see upside inflation risks. Finally, I am worried about the possibility that some of you may have provided your numerical projections under the assumption of appropriate monetary policy but may not have applied that assumption as well to your individual risk assessments. In your upcoming remarks, you may wish to address whether there is any tension between your own views of the distribution of risks and the risk assessments in the draft statements. Thank you." FOMC20070807meeting--43 41,MS. JOHNSON.," The financial market turmoil over the intermeeting period has not been confined to U.S. markets. In today’s financially globalized world, events in one asset market frequently have consequences in other markets and other countries; both the level and the volatility of asset prices abroad have moved with U.S. asset market developments. Equity prices are generally down, although not in China. Yields on long-term sovereign fixed-income securities are also generally down. CDS spreads, corporate bond spreads, EMBI+ spreads, and similar measures are generally up. With so much action happening in global financial markets, you might have expected some major revisions to our outlook for foreign real growth and inflation. Yet with the exception of revisions to some second-quarter numbers because of surprises from incoming data, the baseline forecast this time is little changed from that in June. Two reasons for the lack of significant macroeconomic consequences in the rest of the global economy from these financial events seem particularly noteworthy. One is that there is no sector abroad in any of the major regions that corresponds to the U.S. housing sector and its direct ties to credit problems related to subprime mortgages. The second reason is that we do not observe any telltale signs, such as overexpansion by one or more industries or fragile household balance sheets, that would suggest that some repricing of risky assets and perhaps some restraint in credit creation would trigger significant changes in real economic behavior of firms or households. The global economy expanded strongly in the first half of this year with the underlying strength broadly distributed across regions and sectors. As a result, it is in robust condition and is likely able to withstand the adjustment proceeding in financial markets without substantial risk to continued real expansion or creation of inflationary pressures. Of course, we cannot be certain that continued or more- intense disorderly conditions in financial markets will not trigger a negative macroeconomic reaction, nor do we know for sure that problems are not already present but are not yet visible to us. So we see the events of the past several weeks as giving rise to an abundance of downside risk to our forecast of real activity rather than to changes in the baseline. Despite a basically unchanged outlook for the rest of the global economy, two elements of the international forecast merit some further discussion: global oil market developments over the intermeeting period and the staff’s judgment that U.S. real imports of goods and services will expand at a rate about 1 percentage point lower than we projected in June. On July 31, the spot price for WTI rose above $78 per barrel and attracted attention for having reached a new peak value. Although that price subsequently moved back down somewhat, the spot WTI price was about $7 per barrel higher on the day we finalized the Greenbook forecast than it was on the comparable day in June. In part, the upward shift in the spot WTI price reflected an unwinding of most of the unusual discount for WTI relative to Brent and other grades of oil that persisted from mid-March until recently as a result of large inventories of WTI at certain locations. By comparison, the spot price for Brent crude oil rose nearly $4 per barrel over the same interval. The upward pressure on spot prices appeared to arise from the supply side, with production restraint by OPEC a factor. However, although prices moved up noticeably at the front of the curve, futures prices for oil dated later this year and early next year moved up much less; and futures prices for crude oil in late 2008 and beyond actually moved down. As a consequence, the oil futures curve returned to what is called “backwardation,” meaning that the spot price is above futures prices, which tend to flatten out at more- distant dates. Putting all this together, our forecast for the U.S. oil import price is more than $4 per barrel higher for the very near term than it was in June, but it is little changed over 2008. So the impact of higher oil prices on our trade deficit is limited. Whereas some upward push to consumer prices abroad might result from the recent increases in crude oil prices, our expectation, based on futures markets, that they will prove transitory means that few sustained pressures on inflation should result. Our forecast for the growth of total U.S. imports of goods and services has been revised down about 1 percentage point for the second half of this year and nearly that much for next. The resulting annual growth rates of 2¾ percent in the near term and 3 percent next year are about 3 percentage points below the growth we are projecting for real exports of goods and services. Although in the near term slightly weaker projected imports for oil and natural gas are part of the story, further out weaker growth in imported core goods and services largely account for the revision. For these two categories, the downward revision reflects the changes in this forecast to the projected level of the dollar and to the path for U.S. real GDP. We have made some small adjustments to our outlook for the constituent currencies in our broad dollar index that by chance are offsetting, leaving the staff forecast for the rate of depreciation of our real broad dollar index going forward about the same as in June. However, the depreciation of the dollar that has already occurred since your June meeting resulted in a downward shift in the current-quarter starting value for our forecast path of about 1¼ percent. That real depreciation works to restrain imports of core goods and of services somewhat, especially in the near term. Parenthetically, it also has a stimulative effect on our exports of core goods and services. The lower path for U.S. GDP growth going forward is the primary explanation of our downward revision to projected import growth. With U.S. GDP now expected to grow at an annual rate of 2 percent, rather than 2½ percent, imports of both core goods and services decelerate more than in proportion, as our best estimate of the income elasticities for each of these categories is above 1. Of course, the baseline path for U.S. real GDP takes into account the lower imports and the simultaneous nature of the determination of GDP and its components. But the information contained in the annual revision to past U.S. GDP growth and the prospect of lower potential GDP going forward was “news” to our import model and led us to make the downward revisions I have just described. With growth of real exports of goods and services revised up only slightly, their positive contribution to real GDP growth is just a bit more positive. In contrast, the negative contribution from real imports is now significantly smaller in absolute value. As a result, the overall arithmetic contribution from real net exports to real GDP growth over the forecast period is positive at an annual rate of about ¼ percentage point. Such an outcome would mean that real net exports have contributed or will contribute positively to real GDP growth in each of 2006, 2007, and 2008. From the perspective of real GDP, a positive contribution from real net exports is one very reasonable criterion for external adjustment, should it be sustained. Brian will now continue our presentation." FOMC20080130meeting--102 100,MR. MADIGAN.," I think they say that the Committee is expecting relatively slow growth in the period immediately ahead but that the economy avoids a recession. There is some recovery over the subsequent years. It is not extraordinarily brisk. It is a fairly gradual recovery in terms of growth. The unemployment rate moves up a little, as you would expect with a period of growth below trend, but does not get extraordinarily high; and inflation, after coming under some upward pressure of late, gradually edges back down to levels below 2 percent. I am not sure that I am saying anything terribly enlightening here. Of course, one point that I should emphasize is that the full summary of economic projections, we hope, gives more texture than I was just able to give to the Committee's views about the modal outcome and to the Committee's concerns about the risks to both growth and inflation. " CHRG-110hhrg46591--294 Mr. Green," Thank you. I appreciate that, Mr. Chairman. You are a much better lawyer. Let us just visit briefly--I think, Mr. Bartlett, you mentioned earlier that the next stimulus package should contain something with a reference to housing. What did you have in mind for housing? " FOMC20050630meeting--146 144,MR. GALLIN.," If you look at the housing affordability picture—basically relating house prices and interest rates and income—it has been moving around in a fairly stable and favorable area for the last, say, 8 to 10 years." CHRG-109shrg30354--14 STATEMENT OF SENATOR ELIZABETH DOLE Senator Dole. Thank you, Chairman Shelby. Mr. Chairman, I join my colleagues in extending a very warm welcome to you this morning. We have seen very strong growth in our economy over the last few years even as our Nation as has faced some extremely challenging times. I expect the positive economic trends will continue in the coming months and years. Still, we have hard work ahead indeed to ensure that all levels and sectors of the economy benefit from this prosperity. In just the past year, the economy has created nearly 2 million new jobs and the national unemployment rate remains lower, as we have said so often, than the average of the 1970's, the 1980's and 1990's. While we are seeing a cooling of the housing sector, the other pistons of our economic engine are firing. There have been recent reports that wages are going up, which I hope signals that wages are beginning to catch up with the very dramatic increases in productivity. Also, consumer confidence has continued to rise. The first-quarter GDP results of this year were revised upward to an impressive 5.6 percent, as we have heard already this morning. This has resulted in higher than expected tax revenues and a decline in the deficit. In fact in the first 9 months of fiscal year 2006, we have seen one of the highest growth in tax revenues in 25 years, second only to last year. These are indeed indicators of a robust and expanding economy. Still, I share the concerns of the American people that energy prices continue to increase. There is no question these costs are putting a real strain on families and businesses. Folks also are concerned about the availability and affordability of health care. In order to address this broader problem, I believe we must empower families to make health care decisions based on their specific needs and allow them greater choice over how their health care dollars are spent. We must also work to improve transparency, portability, and efficiency to better meet consumers' needs. In addition, as our overall economy is thriving, we must be mindful that there are areas in some of our States like North Carolina where the economic picture is not quite as bright, where factories and businesses have closed and people are out of jobs. In North Carolina, we have experienced a transition from our tradition tobacco and manufacturing industries of textiles and furniture to new high-growth industries like biotechnology and pharmaceuticals. These new jobs, as we all know, require a well-educated and highly trained workforce. To this end, we must make education and job training a priority and focus our efforts on closing the gap between skilled and unskilled workers. Unfortunately, this gap has only widened since my days as Secretary of Labor. As our economy moves forward, the opportunities for lower-skilled workers are simply diminishing. It is imperative that we educate our less-skilled workers so that they can take advantage of the new jobs that are being created. I continue to have confidence that the very forces that stimulate economic growth, tax relief to spur investment, free but fair trade, ever-improving global communications, higher education and training for workforce, and of course, hard work, these will ensure that we stay on course toward greater opportunity for North Carolina and for the Nation. Mr. Chairman, thank you for being here today. I look forward to hearing from you and working closely with you on these and other important issues. Thank you. " CHRG-111hhrg55809--49 Mr. Bernanke," I think, in the near future, we need to have a plan for Fannie and Freddie. I didn't include it because I was focused essentially on the Treasury's proposal and on the systemic risk aspects. But you are absolutely right; I think the GSEs need to be discussed in the near term. Not just for systemic risk reasons, but because we have a lot of uncertainty about housing and what is going to happen to the housing structure, housing finance system. So I hope that in the very near future, and I believe that is the intention, I hope in the very near future, we will have some proposals on that. " 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. " CHRG-110hhrg34673--134 Mr. Bernanke," So you are arguing that the Housing Fund would raise the cost of mortgages because we are putting a tax on the GSE's? " CHRG-109shrg30354--61 Chairman Bernanke," That is one part. But in addition, we are seeing, we are hoping at least that these energy price increases will not continue at the same pace as they have been going on in the past. And that would remove a source of inflation pressure, as well. Senator Reed. If the economy moderates, what will that do to already, from my perspective, inadequate job growth? Would you anticipate job growth to also moderate? " fcic_final_report_full--122 The risk in these loans was growing. From  to , the average loan-to- value ratio rose about , the combined loan-to-value ratio rose about , and debt- to-income ratios had risen from  to : borrowers were pledging more of their income to their mortgage payments. Moreover,  of these two originators’ option ARMs had low documentation in .  The percentage of these loans made to in- vestors and speculators—that is, borrowers with no plans to use the home as their primary residence—also rose. These changes worried the lenders even as they continued to make the loans. In September  and August , Mozilo emailed to senior management that these loans could bring “financial and reputational catastrophe.”  Countrywide should not market them to investors, he insisted. “Pay option loans being used by investors is a pure commercial spec[ulation] loan and not the traditional home loan that we have successfully managed throughout our history,” Mozilo wrote to Carlos Garcia, CEO of Countrywide Bank. Speculative investors “should go to Chase or Wells not us. It is also important for you and your team to understand from my point of view that there is nothing intrinsically wrong with pay options loans themselves, the problem is the quality of borrowers who are being offered the product and the abuse by third party originators. . . . [I]f you are unable to find sufficient product then slow down the growth of the Bank for the time being.”  However, Countrywide’s growth did not slow. Nor did the volume of option ARMs retained on its balance sheet, increasing from  billion in  to  billion in  and peaking in  at  billion.  Finding these loans very profitable, through , WaMu also retained option ARMs—more than  billion with the bulk from California, followed by Florida.  But in the end, these loans would cause significant losses during the crisis. Mentioning Countrywide and WaMu as tough, “in our face” competitors, John Stumpf, the CEO, chairman, and president of Wells Fargo, recalled Wells’s decision not to write option ARMs, even as it originated many other high-risk mortgages. These were “hard decisions to make at the time,” he said, noting “we did lose revenue, and we did lose volume.”  Across the market, the volume of option ARMs had risen nearly fourfold from  to , from approximately  billion to  billion. By then, WaMu and Countrywide had plenty of evidence that more borrowers were making only the minimum payments and that their mortgages were negatively amortizing—which meant their equity was being eaten away. The percentage of Countrywide’s option ARMs that were negatively amortizing grew from just  in  to  in  and then to more than  by .  At WaMu, it was  in ,  in , and  in .  Declines in house prices added to borrowers’ problems: any equity remain- ing after the negative amortization would simply be eroded. Increasingly, borrowers would owe more on their mortgages than their homes were worth on the market, giv- ing them an incentive to walk away from both home and mortgage. Kevin Stein, from the California Reinvestment Coalition, testified to the FCIC that option ARMs were sold inappropriately: “Nowhere was this dynamic more clearly on display than in the summer of  when the Federal Reserve convened FOMC20070807meeting--180 178,CHAIRMAN BERNANKE.," “Have increased, credit conditions have become tighter.” And the housing." CHRG-111shrg57923--28 Mr. Horne," I appreciate it. Well, I think the words come to my mind, and it is probably words you have been hearing often over the past few months in particular, and those are the words ``moral dilemma.'' And I think this is what it is all about, and, again, my esteemed panelists here have brought up the concept of what I think is a moral dilemma. You know, if you are inside of an agency whose job is both to support the financial markets in terms of being directly involved in assisting them in growing and expanding and at the same time regulate them, there is a moral dilemma. If you are inside of an institution whose goal is to make as much profit as possible and at the same time you want to stick within regulatory bounds, you have a moral dilemma. So the issue that we have--and I can only speak for my company--is our goal is if we do not get the data right, we are dead in the water because people will stop buying our data. So our moral dilemma is getting the facts correct, and there is no dilemma. We either get it right or we get it wrong. And if we get it wrong, we are not in business very long. So part of the issue that I have is that I do believe that there is a need for an independent agency inside of the Government to deal with these issues without having to face the moral dilemma. I believe that there are issues that have to be faced by Congress, and it is going to take a little while for that to gel and come together. In the meanwhile, I do not think you can go and continue moving forward with the state of the economy as it is and the current what I call systemic bubbles that are occurring all across the country to continue to occur without having the information necessary to at least in the short term provide information above where you currently are today. And you are in very many cases at a point of stone chisels and knives, I might say, from a data standpoint, turning it into information in comparison to where the commercial market is and the commercial sector is in terms of managing their own information, although I have to say many of these companies, as was mentioned earlier, that I know of personally--because I worked with them in building some of these systems or trying to build some of these systems--are now all of a sudden spending hundreds of million dollars revamping their own internal risk management and analytic systems, including probably all of the top 20 banking and investment firm organizations, have incredible plans moving forward for building their own infrastructures, which in the long run the Government actions relative to what should be done in terms of capturing this data will probably improve their capabilities and, therefore, improve the trade of information and exchange between the two parties. But, again, I think you have a long-run situation where you need to get away from the moral dilemma. I think you have a short-run situation which is you have got to get the information in the hands of the people who can do something about it sooner rather than later, because there are other bubbles on the horizon that could pop, and unless you know that they are happening, unless you understand them, unless you address them, and unless you spend less money than just throwing it at the whole market, you spend it at the appropriate places, you are going to have greater pushback from the taxpayer in terms of being able to have the tools in your possession to be able to do the things that you want to do. Senator Reed. Thank you. Senator Corker. Senator Corker. Thank you, Mr. Chairman, and I thank each of you for outstanding testimony. There is something very appealing about the presentation which is--and we thank you for spending so much time in our personal office talking about it. I know Senator Reed feels the same way, I am sure. And then there is a piece of it that is almost kind of an eerie feeling. On the other hand, it is sort of the chaos of the market system and the companies you are talking about, Mr. Horne, investing that money to figure out ways of getting a tenth--just a little tenth of a point off, and they are taking advantage of anomalies that exist to make money, and I mean that in a positive way, OK? And then, on the other hand, we are talking about Professor Liechty creating models, if you will. You talk a little bit about NOAA, and NOAA is an interesting analogy except that NOAA is sort of talking about what is going to happen with the weather, and there is nothing you can do about it. I mean, it is just going to happen. On the other hand, you are talking about setting up models to keep anomalies or huge systemic risk occurrences from happening, and I guess how do you, when you are designing these models, keep yourself from sort of interfering from this chaos that can be positive or actually sort of creating self-fulfilling prophecies in some ways by virtue of the modeling that you set up? " FOMC20050920meeting--100 98,MR. KOHN.," Thank you, Mr. Chairman. Like President Geithner and many others of you, I do view this as one of those rare situations in which we can truly say the outlook is more uncertain than usual. [Laughter] But that should not deter us from proceeding with our “measured pace” of rate increases. The pre-Katrina data themselves suggested some potentially interesting questions about the outlook, which could have implications for policy going forward. I was especially struck by the weakness in capital spending, despite high and rising profits and strength in other aspects of the so-called fundamentals. It’s possible that business caution has increased again, perhaps out of concern about the effects of the rapid run-up in energy prices on demand since last spring. But at the same time, house prices on the OFHEO index continued to rise at a very rapid pace through the second quarter, supporting household spending and further increases in resource utilization. The expansion was continuing but had become even more unbalanced—more reliant on declining household saving rates induced by rising house prices. Core inflation was coming in lower than expected again. But the potential for future price increases, absent a further tightening of policy, was suggested by upside surprises on one measure of labor costs, rising resource utilization, and the threat that increases in energy costs could feed through to underlying September 20, 2005 76 of 117 I agree with the staff’s assessment that the most likely outcome from Katrina is that the economy will not be materially deflected from the path it was on. After the initial disruptions, fiscal stimulus, rising house prices, and still favorable financial conditions, along with the economy’s natural resilience, should overcome any drag from higher energy prices and should keep activity increasing at a good clip in an economy that is already producing at a high level of resource utilization. Under these circumstances, inflation pressures will not abate. And judging from the tendency for the output gap to continue to shrink this year, we’ll probably need at least a couple of rounds of rate increases to keep the economy near its potential and to prevent inflation from trending higher. Katrina has greatly added to uncertainty, and not just about the extent of the near-term disruption or the effects on energy markets. The more difficult uncertainties relate to how people may react to what has happened, how the government will decide to respond, and how businesses and households will react to these governmental actions and to whatever the path of energy prices turns out to be. How these uncertainties are resolved will affect the economy’s medium-term prospects. But at this point, that added uncertainty doesn’t look particularly asymmetrical in its implications for the path of policy. The risks are still two-sided. Growth could be stronger than anticipated, for example, owing to greater government spending and new tax incentives, with implications for inflation. But on the other side, the rise in energy prices may have less of a persistent effect on core inflation than the staff has predicted. The feed-through of energy prices to core inflation has declined appreciably over time, September 20, 2005 77 of 117 August may have it right that higher energy prices will have more of a negative influence on demand than a positive effect on long-term inflation. The skews in the probabilities for the most likely outcomes were highlighted by the Michigan survey on Friday, pointing to extra weight on the possibility of weaker growth from increasing energy prices that affect consumer psychology and spending but also pointing to potentially higher inflation if expectations do become unanchored. And these skews themselves have offsetting implications for policy. Moreover, uncertainty isn’t going to be reduced by pausing or slowing the pace of tightening. This uncertainty isn’t about the response of the economy to past or future monetary policy actions. Raising the funds rate, as expected, isn’t likely to undermine sentiment or spending. Indeed, pausing, slowing down, or being more ambiguous about our expectations for policy going forward could confuse the public about our view of the situation. In sum, this is a situation in which we should make our best guesses as to the likely outcome, however bad those guesses may be, and act on them, continuing the “measured pace” of tightening for now. Thank you." CHRG-109hhrg23738--159 Mr. Hensarling," Well, and I certainly agree with you that sunsetting would be a very important part of the mix in the legislation. In the time I have remaining, allow me to switch subjects, back to an earlier subject of the recent GSE legislation. Part of that legislation includes an Affordable Housing Fund, which I believe you are acquainted with, has Fannie and Freddie using 5 percent of their after-tax profits to fund this particular fund, on top of approximately 82 other government housing programs, all ostensibly aimed at affordable housing. Given the duopoly nature of Fannie and Freddie, do you believe they have sufficient market power to essentially impose that cost upon the market, so that at the end of the day, perhaps, we are taking money out of one affordable housing dynamic and simply turning around and turning it over to another? Do they have sufficient power to impose that cost on the ultimate consumer? " CHRG-111shrg57319--600 Mr. Rotella," I would, Senator. I would also say that there were incredible incentives in the environment to leverage during this period. I also believe that there was a general belief that housing would not decline and institutions became excessively reliant on models that turned out to be wrong. So that drove a lot of Wall Street firms to look for yield, and as we have heard during the day, the GSEs had a dominant stranglehold on conforming product, and because the yields were so low on that product, there were other parts of the market that Wall Street and others looked to essentially chase yield. Senator Levin. I think Mr. Cathcart testified that Option ARM home sales depend on housing price appreciation for repayment through refinancing and are viable in a healthy market where housing prices are constantly on the rise. But when housing prices depreciate, Option ARMs become problem assets. Would you agree with that, Mr. Rotella? " CHRG-110hhrg41184--177 Mr. Shays," Let me just ask you, in regards to, you've already talked about the spread, the Fed rate, and banks which are private institutions setting mortgages higher--we had a hearing yesterday that was rather depressing and made me want to buy gold--and the bottom line was: We increased the supply of housing exceeding demand, which really accelerated our just trying to have people buy homes, who shouldn't have. And the question is: Does this incredible excess supply of housing negate what you're trying to do in lowering interest rates? " FOMC20080916meeting--149 147,MS. CUMMING.," Thank you, Mr. Chairman. In our forecast, we do show a downgrade in real activity in the near term since the August meeting. Downside risks to the economy we see as still very considerable, and I would probably say that they really have increased quite a bit. I'll say a few more words about that. I'll also talk about the inflation front. We have long thought that inflation in the medium term will moderate, and we've been taking some comfort from recent developments that have been cited already. On the weaker economic outlook, we see the intensification of adverse growth coming from many things mentioned already: the unemployment rate increase and the likelihood that consumer spending is going to be negative. I would put great stress also on indications that world demand is slowing abruptly, as Nathan mentioned. I think that all three of these things are occurring in an environment in which we have massive correction, adjustment, structural change in autos, housing, and financial intermediation. That adjustment is really interconnected--one has effects on the others. As part of this--particularly in the financial sector, I would say--in our senior loan officer survey we've seen indications that, even as rates in, say, the mortgage markets start to ease a bit, nonprice terms may still be tightening. President Pianalto talked about other areas in which borrowers are facing much tougher terms. As financial institutions feel their capital is constrained--and there's plenty of evidence that balance sheets are constrained across much of the financial sector--those kinds of nonprice rationing measures probably will become more evident. Second, as we discussed earlier, we've seen that credit losses, which thus far have been largely confined to the financial sector and increasingly their shareholders, run some risk of spilling over to other kinds of investors, who to date really have not felt that impact, such as money market fund investors, as mentioned earlier. In addition, the three big corrections that we have seen in autos, housing, and financial intermediation are not limited to the United States. In particular, as you know, several G-10 countries are facing very difficult situations in their housing markets, not much different from us; and the financial intermediation adjustment is truly a global correction. On the inflation side, as I mentioned, we have acknowledged that we've seen elevated rates of inflation. But the recent developments--as we've seen in inflation expectations discussed earlier, in energy and other commodity prices, the unit labor cost developments that President Yellen discussed, and the year-over-year changes in import prices--are all pointing in the direction of some moderation of inflation and moderation of inflation expectations. In particular, we have looked at inflation expectations as measured by financial markets and feel that the decline that we see in those expectations cannot be explained simply by the drop in energy prices and technical factors but look larger than that. We would attribute that to indications, again, that global demand is slowing. Coming into this meeting today, we favor alternative B. I would associate myself with the comments of President Stern and President Evans, that if we were, in fact, going to make a move today, it would be better to make a large move of 50 basis points. Thank you, Mr. Chairman. " CHRG-110shrg46629--9 STATEMENT OF SENATOR JACK REED Senator Reed. I will not exercise such statesmanlike restraint. Thank you, Mr. Chairman. And thank you, Chairman Bernanke, for joining us today to discuss the state of monetary policy and its reflection on our economy. At the past eight meetings of the FOMC, the Fed has held the Federal Fund rates steady at 5.25 percent. However, significant turmoil in the housing market particularly related to subprime mortgages, a growing trade deficit, and a negative household savings rate continue to pose tremendous challenges to setting monetary policy. I know, Mr. Chairman, you have personally expressed concern about core inflation being higher than is desirable in the long run. But the risk of raising interest rates too high is that a weakening housing sector and rising oil prices may be taking their toll on consumers and businesses alike and slowing down the economy too much already. I look forward to your insights about the kind of policies that are likely to be effective in addressing the challenges we face in this economy and offering real opportunities for growth that provide widespread benefits to the American people. On a systemic level, the weakening housing sector and turmoil in the subprime mortgage market have placed pressure on both investors and borrowers. Bear Stearns has recently announced that two of its hedge funds are now worth nearly nothing after some of its investments in subprime mortgages went bad. Last week both Moody's and Standard & Poor's significantly downgraded ratings on hundreds of subprime related bonds. The ABX Index, which tracks the performance of various classes of subprime related bonds hit new lows yesterday. In the past few months portions of the index that tracked especially risky mortgage bonds with junk grade ratings have been falling. And this is now spread into the portion of the index that track bonds with ratings of AAA or AA. According to Merrill Lynch's latest fund manager survey which polled 186 fund managers controlling $618 billion in assets, 72 percent of managers said that credit or default risk was the biggest threat to financial market stability. I would appreciate hearing your thoughts on some of these events, particularly as they may pertain to the financial accelerator effect you spoke of in Georgia last month and the efforts of the Federal Reserve to monitor some of these risks. Finally, the Federal Reserve has the authority and responsibility to prohibit unfair and deception lending practices. As such, Mr. Chairman, I was pleased to hear that the Fed will likely propose additional rules under the Home Ownership and Equity Protection Act, HOEPA, to provide consumers with better protections through bans on some mortgage purchases. Additionally, I understand that the Fed will join other regulators in a pilot project to monitor the practices of nondepository subprime mortgage firms. I am interested in your perspective on what additional actions the Federal Reserve will be taking to meet the regulatory portion of its mandate. I look forward to your testimony, Mr. Chairman. Thank you. " FOMC20071031meeting--208 206,MR. MISHKIN.," It was to add a phrase before the downside risks to growth to say, “The Committee judges that the upside risks to inflation roughly balance the somewhat reduced downside risks to growth.” It would give a flavor that, in fact, our actions have reduced the downside risk." FOMC20050202meeting--137 135,MR. GUYNN.," Thank you, Mr. Chairman. As was the case at the time of our last meeting, I think we should be pleased with the way things are unfolding. Output continues to expand at a good February 1-2, 2005 94 of 177 spending, we’re getting sufficient job creation to at least gradually push unemployment lower, and inflation remains at a low level. What we’re seeing in our Southeast region certainly confirms and helps to explain the favorable picture we see at the national level. Most of the key sectors of our regional economy, including consumer spending, housing, manufacturing, retail, tourism, and auto sales, remain positive. We found it encouraging that a large share of investment spending by businesses was reported to be attributable to the anticipation of increased sales. Other planned investment spending is being attributed to a desire to upgrade technology and to continue to improve competitiveness and cost efficiency. Consumer spending in our region continues to be strong. Tourism has been especially positive. Florida theme parks are once again full to capacity, hotel bookings are up, and hotel room tax collections are 8 percent ahead of year-ago levels. Housing growth in our region has eased a bit, though it still remains at a high level. The good pace of overall activity has contributed to new regional job creation. While having slowed somewhat in December, job creation has been sufficient to move ahead of the peak experienced just before the onset of the recession. Our District added some 264,000 jobs last year, an increase of 1.4 percent. Florida led the District, creating 172,000 new jobs. Since the end of the recession, Florida has accounted for 27 percent of the net new jobs created in the entire country. The District unemployment rate, at 4.9 percent as of the end of December, remains below that of the nation. Finally, I continue to be watchful for imbalances and their implications for inflation. At our last board meeting, our directors provided additional reports of continued sharp run-ups in housing prices in selected areas, especially in some Florida real estate markets. One director who manages a large trucking firm noted that equipment shortages in trucking are leading to frequent price increases. She reported that fuel surcharges are also being readily passed on and that rationing of February 1-2, 2005 95 of 177 commented that railroads are beginning to decline to renew some contracts to ship certain bulk chemicals, which are less profitable than containers and piggyback loads. As for policy, nothing in the data from either our region or at the national level suggests to me that we need to change the path that current policy is on in terms of either speeding up or slowing down the pace with which we’re removing the substantial accommodation that remains. Markets are expecting further moves. And our models are suggesting that even with several more increases in our fed funds target rate, the real economy should expand between 3½ to almost 4 percent next year. That modeling work suggests that unemployment should continue to edge down and that the CPI should average between 2½ and 3 percent. Of course, the risks to these forecasts that people have already talked about are not insignificant. But I’m comfortable with the path we’re on, at least for now. Thank you, Mr. Chairman." FOMC20070628meeting--124 122,MR. POOLE.," Thank you, Mr. Chairman. Let me talk first about some of the anecdotal reports. A contact with a large software company suggested that the IT industry is doing fine. Labor is very tight because technical people are in such scarce supply. This company is expanding development facilities in China and India. They are not allowed to import the labor they need, and so they will send the operations abroad. My contacts with transportation industry people get the same information that Richard Fisher is emphasizing. Movement of goods is just really, really flat. The over-the-road trucking industry is actually taking down capacity, selling off the older, less efficient trucks. In the express business, UPS is taking down capacity. FedEx is more optimistic, probably taking market share. A contact with the fast food industry says that their business volume is down. The whole industry is down. Sales revenues are up a bit, but it is because of price increases. The casual dining industry is down even more. There is sort of a disconnect here between the overall view of the economy, I think, and the anecdotal reports that come from the movement of goods. Of course, the most cyclical part of the economy is always the goods part. The services part is much more stable. Perhaps what is going on here is simply what is also in the Greenbook’s second-quarter numbers, because the goods part of the economy—consumption—is pretty flat. I think consumption is only—I forget the exact number—1.6 or something. That is an annual rate. You have to divide that by 4 to tell you what is actually going on in the quarter itself. Of course, the housing industry continues to decline. So maybe these anecdotal reports really are consistent with what is going on and what is in the Greenbook picture. The Greenbook picture makes a lot of sense to me. Let me talk a little more about housing. The staff presentation had a point that I want to underscore—that the housing downturn is unlike any other that we have had. I think the chart went back to 1972, but you could go back before that. If you look at the housing downturns and the recessions of the 1950s, they were all related to a very standard cyclical pattern. Interest rates would rise, housing—starts, permits, construction—would start to turn down well before the cycle peak, and then housing would start to recover after the cycle peak as interest rates came down. The current situation is completely different from that standard pattern. Here we had a housing boom driven by a period of very low interest rates. The period really got started when we were holding the fed funds rate at 1 percent. Then you had a lot of these financial innovations and subprime mortgages that added a sector to the market that hadn’t traditionally been there. Interest rates came up, housing prices are flattening out, and my concern is that there is a lot more to go. This is an asset market that does not work anything like securities markets. It is completely different from the stock market and the bond market. Housing starts and permits peaked in the early part of last year, and the adjustment really got under way. But if you think about how much of the adjustment is complete—well, there is not much sign that much is complete because the inventory of unsold new houses is close to its peak. There is no convincing evidence that it is really starting to come down. We have seen some bankruptcies of builders, but not very many. A lot of banks—I know from our contacts—are putting pressure on their builders to sell out their houses and pay off the loans. The same thing is true of “the ground,” as the real estate people like to put it. Builders are stopping their development of new land for housing developments because they don’t have the financing to support it anymore. The banks are starting to turn off the credit spigot because these companies are getting pretty close to the edge. They have laid off a large number of workers, but they have to sell out their inventory. Still, the number of months’ supply that they are sitting on is abnormally high; it really hasn’t come down. We also know that prices in this market respond with a very substantial lag to the underlying determinants of prices. So prices of existing homes are only gradually adjusting, and I think there is probably more of that to go. We know that there will be a lot more resets of these adjustable-rate mortgages. The projections are that a lot more defaults than we have yet seen will occur in that area. So I think that we have a long adjustment to go here. Whether that will spread into the rest of the economy, I don’t know. I share the Greenbook estimate that probably there won’t be major fallout, but it seems to me that the risk there is significant. I just wanted to underscore that point because I think this risk is by far the biggest that we face at this time. Thank you." CHRG-109shrg26643--130 PREPARED STATEMENT OF BEN S. BERNANKE Chairman, Board of Governors of the Federal Reserve System February 16, 2006 Mr. Chairman and Members of the Committee, I am pleased to be here today to present the Federal Reserve's Monetary Policy Report to the Congress. I look forward to working closely with the Members of this Committee on issues of monetary policy as well as on matters regarding the other responsibilities with which the Congress has charged the Federal Reserve System. The U.S. economy performed impressively in 2005. Real gross domestic product (GDP) increased a bit more than 3 percent, building on the sustained expansion that gained traction in the middle of 2003. Payroll employment rose 2 million in 2005, and the unemployment rate fell below 5 percent. Productivity continued to advance briskly. The economy achieved these gains despite some significant obstacles. Energy prices rose substantially yet again, in response to increasing global demand, hurricane-related disruptions to production, and concerns about the adequacy and reliability of supply. The Gulf Coast region suffered through severe hurricanes that inflicted a terrible loss of life; destroyed homes, personal property, businesses, and infrastructure on a massive scale; and displaced more than a million people. The storms also damaged facilities and disrupted production in many industries, with substantial effects on the energy and petrochemical sectors and on the region's ports. Full recovery in the affected areas is likely to be slow. The hurricanes left an imprint on aggregate economic activity as well, seen, in part, in the marked deceleration of real GDP in the fourth quarter. However, the most recent evidence--including indicators of production, the flow of new orders to businesses, weekly data on initial claims for unemployment insurance, and the payroll employment and retail sales figures for January--suggests the economic expansion remains on track. Inflation pressures increased in 2005. Steeply rising energy prices pushed up overall inflation, raised business costs, and squeezed household budgets. Nevertheless, the increase in prices for personal consumption expenditures excluding food and energy, at just below 2 percent, remained moderate, and longer-term inflation expectations appear to have been contained. With the economy expanding at a solid pace, resource utilization rising, cost pressures increasing, and short-term interest rates still relatively low, the Federal Open Market Committee (FOMC) over the course of 2005 continued the process of removing monetary policy accommodation, raising the Federal funds rate 2 percentage points in eight increments of 25 basis points each. At its meeting on January 31 of this year, the FOMC raised the Federal funds rate another \1/4\ percentage point, bringing its level to 4\1/2\ percent. At that meeting, monetary policymakers also discussed the economic outlook for the next 2 years. The central tendency of the forecasts of Members of the Board of Governors and the presidents of Federal Reserve Banks is for real GDP to increase about 3\1/2\ percent in 2006 and 3 percent to 3\1/2\ percent in 2007. The civilian unemployment rate is expected to finish both 2006 and 2007 at a level between 4\3/4\ percent and 5 percent. Inflation, as measured by the price index for personal consumption expenditures excluding food and energy, is predicted to be about 2 percent this year and 1\3/4\ percent to 2 percent next year. While considerable uncertainty surrounds any economic forecast extending nearly 2 years, I am comfortable with these projections. In the announcement following the January 31 meeting, the Federal Reserve pointed to risks that could add to inflation pressures. Among those risks is the possibility that, to an extent greater than we now anticipate, higher energy prices may pass through into the prices of nonenergy goods and services or have a persistent effect on inflation expectations. Another factor bearing on the inflation outlook is that the economy now appears to be operating at a relatively high level of resource utilization. Gauging the economy's sustainable potential is difficult, and the Federal Reserve will keep a close eye on all the relevant evidence and be flexible in making those judgments. Nevertheless, the risk exists that, with aggregate demand exhibiting considerable momentum, output could overshoot its sustainable path, leading ultimately--in the absence of countervailing monetary policy action--to further upward pressure on inflation. In these circumstances, the FOMC judged some further firming of monetary policy may be necessary, an assessment with which I concur. Not all of the risks to the economy concern inflation. For example, a number of indicators point to a slowing in the housing market. Some cooling of the housing market is to be expected and would not be inconsistent with continued solid growth of overall economic activity. However, given the substantial gains in house prices and the high levels of home construction activity over the past several years, prices and construction could decelerate more rapidly than currently seems likely. Slower growth in home equity, in turn, might lead households to boost their saving and trim their spending relative to current income by more than is now anticipated. The possibility of significant further increases in energy prices represents an additional risk to the economy; besides affecting inflation, such increases might also hurt consumer confidence and thereby reduce spending on nonenergy goods and services. Although the outlook contains significant uncertainties, it is clear that substantial progress has been made in removing monetary policy accommodation. As a consequence, in coming quarters the FOMC will have to make ongoing, provisional judgments about the risks to both inflation and growth, and monetary policy actions will be increasingly dependent on incoming data. In assessing the prospects for the economy, some appreciation of recent circumstances is essential, so let me now review key developments of 2005 and discuss their implications for the outlook. The household sector was a mainstay of the economic expansion again last year, and household spending is likely to remain an important source of growth in aggregate demand in 2006. The growth in household spending last year was supported by rising employment and moderate increases in wages. Expenditures were buoyed as well by significant gains in household wealth that reflected further increases in home values and in broad equity prices. However, sharply rising bills for gasoline and heating reduced the amount of income available for spending on other consumer goods and services. Residential investment also expanded considerably in 2005, supported by a strong real estate market. However, as I have already noted, some signs of slowing in the housing market have appeared in recent months: Home sales have softened, the inventory of unsold homes has risen, and indicators of homebuilder and homebuyer sentiment have turned down. Anecdotal information suggests that homes typically are on the market somewhat longer than they were a year or so ago, and the frequency of contract offers above asking prices reportedly has diminished. Financial market conditions seem to be consistent with some moderation in housing activity. Interest rates on 30-year, fixed-rate mortgages, which were around 5\3/4\ percent over much of 2005, rose noticeably in the final months of the year to their current level of around 6\1/4\ percent. Rates on adjustable-rate mortgages have climbed more considerably. Still, despite the recent increases, mortgage rates remain relatively low. Low mortgage rates, together with expanding payrolls and incomes and the need to rebuild after the hurricanes, should continue to support the housing market. Thus, at this point, a leveling out or a modest softening of housing activity seems more likely than a sharp contraction, although significant uncertainty attends the outlook for home prices and construction. In any case, the Federal Reserve will continue to monitor this sector closely. Overall, the financial health of households appears reasonably good. Largely reflecting the growth in home mortgages, total household debt continued to expand rapidly in 2005. But the value of household assets also continued to climb strongly, driven by gains in home prices and equity shares. To some extent, sizable increases in household wealth, as well as low interest rates, have contributed in recent years to the low level of personal saving. Saving last year was probably further depressed by the rise in households' energy bills. Over the next few years, saving relative to income is likely to rise somewhat from its recent low level. In the business sector, profits continued to rise last year at a solid pace, boosted in part by continuing advances in productivity. Strong corporate balance sheets combined with expanding sales and favorable conditions in financial markets fostered a solid increase in spending on equipment and software last year. Investment in high-tech equipment rebounded, its increase spurred by further declines in the prices of high-tech goods. Expenditures for communications equipment, which had fallen off earlier this decade, showed particular strength for the year as a whole. In contrast, nonresidential construction activity remained soft. Although the financial condition of the business sector is generally quite strong, several areas of structural weakness are evident, notably in the automobile and airline industries. Despite these problems, however, favorable conditions in the business sector as a whole should encourage continued expansion of capital investment. For the most part, the financial situation of State and local governments has improved noticeably over the past couple of years. Rising personal and business incomes have buoyed tax revenues, affording some scope for increases in State and local government expenditures. At the Federal level, the budget deficit narrowed appreciably in fiscal year 2005. Outlays rose rapidly, but receipts climbed even more sharply as the economy expanded. However, defense expenditures, hurricane relief, and increasing entitlement costs seem likely to worsen the deficit in fiscal year 2006. Outside the United States, economic activity strengthened last year, and at present global growth seems to be on a good track. The economies of our North American neighbors, Canada, and Mexico, appear to be expanding at a solid pace. Especially significant have been signs that Japan could be emerging from its protracted slump and its battle with deflation. In the euro area, expansion has been somewhat modest by global standards, but recent indicators suggest that growth could be strengthening there as well. Economies in emerging Asia generally continue to expand strongly. In particular, growth in China remained vigorous in 2005. Expanding foreign economic activity helped drive a vigorous advance in U.S. exports in 2005, while the growth of real imports slowed. Nonetheless, the nominal U.S. trade deficit increased further last year, exacerbated in part by a jump in the value of imported petroleum products that almost wholly reflected the sharply rising price of crude oil. Surging energy prices also were the dominant factor influencing U.S. inflation last year. For the second year in a row, overall consumer prices, as measured by the chain-type index for personal consumption expenditures, rose about 3 percent. Prices of consumer energy products jumped more than 20 percent, with large increases in prices of natural gas, gasoline, and fuel oil. Food prices, however, rose only modestly. And core consumer prices (that is, excluding food and energy) increased a moderate 1.9 percent. The relatively benign performance of core inflation despite the steep increases in energy prices can be attributed to several factors. Over the past few decades, the U.S. economy has become significantly less energy intensive. Also, rapid advances in productivity as well as increases in nominal wages and salaries that, on balance, have been moderate have restrained unit labor costs in recent years. Another key factor in keeping core inflation low has been confidence on the part of the public and investors in the prospects for price stability. Maintaining expectations of low and stable inflation is an essential element in the Federal Reserve's effort to promote price stability. And, thus far, the news has been good: Survey measures of longer-term inflation expectations have responded only a little to the larger fluctuations in energy prices that we have experienced, and for the most part, they were low and stable last year. Inflation compensation for the period 5 to 10 years ahead, derived from spreads between nominal and inflation-indexed Treasury securities, has remained well-anchored. Restrained inflation expectations have also been an important reason that long-term interest rates have remained relatively low. At roughly 4\1/2\ percent at year-end, yields on ten-year nominal Treasury issues increased only slightly on balance over 2005 even as short-term rates rose 2 percentage points. As previous reports and testimonies from the Federal Reserve indicated, a decomposition of long-term nominal yields into spot and forward rates suggests that it is primarily the far-forward components that account for the low level of long rates. The premiums that investors demand as compensation for the risk of unforeseen changes in real interest rates and inflation appear to have declined significantly over the past decade or so. Given the more stable macroeconomic climate in the United States and in the global economy since the mid-1980's, some decline in risk premiums is not surprising. In addition, though, investors seem to expect real interest rates to remain relatively low. Such a view is consistent with a hypothesis I offered last year--that, in recent years, an excess of desired global saving over the quantity of global investment opportunities that pay historically normal returns has forced down the real interest rate prevailing in global capital markets. Inflation prospects are important, not just because price stability is in itself desirable and part of the Federal Reserve's mandate from the Congress, but also because price stability is essential for strong and stable growth of output and employment. Stable prices promote long-term economic growth by allowing households and firms to make economic decisions and undertake productive activities with fewer concerns about large or unanticipated changes in the price level and their attendant financial consequences. Experience shows that low and stable inflation and inflation expectations are also associated with greater short-term stability in output and employment, perhaps in part because they give the central bank greater latitude to counter transitory disturbances to the economy. Similarly, the attainment of the statutory goal of moderate long-term interest rates requires price stability, because only then are the inflation premiums that investors demand for holding long-term instruments kept to a minimum. In sum, achieving price stability is not only important in itself; but it is also central to attaining the Federal Reserve's other mandated objectives of maximum sustainable employment and moderate long-term interest rates. As always, however, translating the Federal Reserve's general economic objectives into operational decisions about the stance of monetary policy poses many challenges. Over the past few decades, policymakers have learned that no single economic or financial indicator, or even a small set of such indicators, can provide reliable guidance for the setting of monetary policy. Rather, the Federal Reserve, together with all modern central banks, has found that the successful conduct of monetary policy requires painstaking examination of a broad range of economic and financial data, careful consideration of the implications of those data for the likely path of the economy and inflation, and prudent judgment regarding the effects of alternative courses of policy action on prospects for achieving our macroeconomic objectives. In that process, economic models can provide valuable guidance to policymakers, and over the years substantial progress has been made in developing formal models and forecasting techniques. But any model is by necessity a simplification of the real world, and sufficient data are seldom available to measure even the basic relationships with precision. Monetary policymakers must therefore strike a difficult balance--conducting rigorous analysis informed by sound economic theory and empirical methods while keeping an open mind about the many factors, including myriad global influences, at play in a dynamic modern economy like that of the United States. Amid significant uncertainty, we must formulate a view of the most likely course of the economy under a given policy approach while giving due weight to the potential risks and associated costs to the economy should those judgments turn out to be wrong. During the nearly 3 years that I previously spent as a Member of the Board of Governors and of the Federal Open Market Committee, the approach to policy that I have just outlined was standard operating procedure under the highly successful leadership of Chairman Greenspan. As I indicated to the Congress during my confirmation hearing, my intention is to maintain continuity with this and the other practices of the Federal Reserve in the Greenspan era. I believe that, with this approach, the Federal Reserve will continue to contribute to the sound performance of the U.S. economy in the years to come. FOMC20060920meeting--136 134,MR. KOHN., Growth recession. CHRG-110shrg50416--22 ASSISTANT SECRETARY, DEPARTMENT OF HOUSING AND URBAN CHRG-109hhrg28024--84 Mr. Bernanke," I think, Congressman, that we have an opportunity now to address the important concerns about GSEs and their potential effects on financial stability. I understand the good intentions underlying the House bill, but I feel that it does not solve the problem. And, therefore, if we were to go with that bill, we would be missing perhaps the last opportunity we're going to have in many years to really address these problems. In particular, the House bill does not go as far as the Senate bill or as bank regulatory bills do in giving the GSE regulator power over capital and setting capital. Secondly, it is not precise in terms of when receivership would be invoked, leaving uncertainty in the market about exactly when that would happen and creating an impression of Government backing for the GSEs. And thirdly, and I think most important, the point that Chairman Greenspan made extensively in his numerous testimonies on the subject, the portfolios of the GSEs are much larger than can be justified in terms of their fundamental housing mission. And these large portfolios represent a risk to financial stability. And if the taxpayer were to be called upon, also to the FISC. The House bill does address portfolios, but it doesn't provide, in my opinion, sufficiently strong guidance to the regulator to mandate that the portfolios be limited to an amount needed to serve the true housing mission of those organizations. " FOMC20080805meeting--102 100,MR. LOCKHART.," Thank you, Mr. Chairman. The contours and basic outcomes of Atlanta's forecast are similar to the baseline of the Greenbook forecast. So I want to focus my remarks this morning on the underlying assumptions in both forecasts--assumptions that I view as pivotal and if we miscalculate could result in a longer-term policy error. It seems that at every meeting there's great uncertainty around the outlook, and this juncture is no different. I perceive considerable uncertainty and debatable assumptions in the base-case scenario. As I see it, the key assumptions broadly are that housing stabilizes, perhaps as indicated by housing prices, in the second half of '09. Inflation pressures intensify in the near term but then abate because of economic slack and lower commodity prices and, as discussed, core import prices. Recent declines in oil prices stick, and prices remain more or less flat. Certainly since the Greenbook was published, we note the fluctuations just in the past few days that were referred to earlier, and I also can't dismiss geopolitical risks and the potential of a severe shock. Finally, financial market stress will persist for some months but diminish next year. These assumptions, using the respectable term ""assumptions,"" have the feeling to me of ""bets,"" not so respectable a term. The policy assumption integral to both the Greenbook and the Atlanta forecasts could be added to this, and that is that rate rises starting in 2009 won't choke off improving growth and will be enough to blunt remaining inflation pressures. So I'll devote my comments to input from regional and other contacts that either serve to confirm or cast doubt on these assumptions. We oriented this cycle's questions to our Atlanta and Branch directors to, first, evidence of wage pressures and pass-through of higher costs. In interpreting the feedback, we noted some confusion between a business's management of its labor costs versus general wage pressures. We heard that businesses are working to keep their total wage bills in check by raising wages for key talent but letting less critical employees go or cutting their work hours as an offset. The reduction in hours is attributed to some combination of weaker product demand and increased average productivity. Rising unemployment appears to be keeping wage demands in check. There are exceptions, such as the oil field services industry, for which qualified staff are in short supply, and certain skilled industrial and business trades in which local bottlenecks exist. In businesses enjoying strong export demand, some employers are utilizing bonuses rather than commitment to permanent wage increases. So our regional contacts did not indicate the development of broad-based underlying pressures on labor costs reflecting wage demands. As for inflation pass-through, our contacts reported widespread and growing efforts to pass through higher input costs. Pass-through efforts appear to be the rule rather than the exception. As one Branch director put it, people are passing through costs like crazy using high energy costs as cover. The reports of my supervision staff regarding banking conditions indicate a continuing decline in asset quality and a very nervous interbank funding market. Foreclosed properties, both single-family and condo, are making up the majority of house sales and slowing the absorption of the oversupply of new homes. Some contacts are very concerned about the prospect of a second wave of foreclosures as option ARM mortgage borrowers, mostly concentrated in large states like Florida and California--these are borrowers who are currently paying less than the accrued interest--run up against maximum loan-to-value ceilings. New, higher GSE standards are resulting in fewer borrowers being qualified, putting downward pressure on house prices and bringing more foreclosures. Virtually all comparables for Florida residential valuation are based on forced sales and foreclosures, we are told. Beyond the deterioration in real estate portfolios, banks are reporting growing problems in credits to food distributors, restaurants, trucking, and other petroleum fuel or input-intensive industries. Based on my calls with financial market contacts, it seems that--no surprise--much of the attention in financial markets has shifted from private fixed-income markets to Fannie and Freddie. Fixed-income markets for private securities appeared to have improved relative to their lows since the current financial turmoil began. Although significant concerns remain, it appears that leveraged-loan deals are getting done. Volume is down, spreads are up, and the deals are very conservative, but deals are getting done. That said, one of the patterns in my calls over the past year has been that, every time one concern abates, another seems to jump up and take its place. Although the recent legislation appears to have alleviated concerns about the Fannie and Freddie senior debt, my contacts indicate that there is widespread uncertainty about what will happen to junior securities if the Treasury injects funds. Furthermore, more than once I heard the view that foreign holders of GSE debt are concerned that their positions are not as safe as they believed. One contact mentioned that the 18-month term of the guarantee is reportedly affecting some holders' maturity choices. In response to my question about the relative weakness of European banks, one contact suggested that they have booked much of their troubled assets in the ""hold to maturity"" account, suggesting slower recognition of losses and difficulties ahead. We confirmed with one large regional bank CFO significant deterioration of HELOCs in their portfolio and, by implication, broadly among regional banks. The option ARM problem, by contrast, is perceived to be possibly the next shoe to drop but, as I said earlier, not uniformly distributed across the country. Finally, we heard the view that markets perceive banks as facing protracted difficulty raising capital. To conclude, the downside risks to growth have not diminished in my opinion. On the flip side, I agree that the upside risks to inflation are obviously a serious concern. In particular, I put a fair amount of weight on the possibility that inflation will not moderate sufficiently without a more substantial tightening of monetary policy than that projected in the Greenbook baseline. My intermeeting internal and external discussions make it difficult for me to dismiss some of the alternative scenarios in the Greenbook, specifically the ""severe financial stress"" scenario, the ""typical recession"" scenario, and the ""inflationary spiral"" scenario; and in a high-uncertainty environment, I don't view any of these scenarios as exclusive of another. That said, I see the risks to both the inflation and the growth objectives as very roughly in balance at this time. Thank you, Mr. Chairman. " fcic_final_report_full--197 Mudd testified that by , when the housing market was in turmoil, Fannie Mae could no longer balance its obligations to shareholders with its affordable hous- ing goals and other mission-related demands: “There may have been no way to sat- isfy  of the myriad demands for Fannie Mae to support all manner of projects [or] housing goals which were set above the origination levels in the marketplace.”  As the combined size of the GSEs rose steadily from . trillion in  to . tril- lion in ,  the number of mortgage borrowers that the GSEs needed to serve in order to fulfill the affordable housing goals also rose. By , Fannie and Freddie were stretching to meet the higher goals, according to a number of GSE executives, OFHEO officials, and market observers. Yet all but two of the dozens of current and former Fannie Mae employees and regulators interviewed on the subject told the FCIC that reaching the goals was not the primary driver of the GSEs’ purchases of riskier mortgages and of subprime and Alt-A non-GSE mortgage–backed securities. Executives from Fannie, including Mudd, pointed to a “mix” of reasons for the purchases, such as reversing the declines in market share, responding to originators’ demands, and responding to shareholder demands to increase market share and profits, in addition to fulfilling the mission of meeting affordable housing goals and providing liquidity to the market. For example, Levin told the FCIC that while Fannie, to meet its housing goals, did purchase some subprime mortgages and mortgage-backed securities it would other- wise have passed up, Fannie was driven to “meet the market” and to reverse declining market share. On the other hand, he said that most Alt-A loans were high-income- oriented and would not have counted toward the goals, so those were purchased solely to increase profits.  Similarly, Lund told the FCIC that the desire for market share was the main driver behind Fannie’s strategy in . Housing goals had been a factor, but not the primary one.  And Dallavecchia likewise told the FCIC that Fan- nie increased its purchases of Alt-A loans to regain relevance in the market and meet customer needs.  Hempstead, Fannie’s principal contact with Countrywide, told the FCIC that while housing goals were one reason for Fannie’s strategy, the main reason Fannie en- tered the riskier mortgage market was that those were the types of loans being origi- nated in the primary market.  If Fannie wanted to continue purchasing large quantities of loans, the company would need to buy riskier loans. Kenneth Bacon, Fannie’s executive vice president of multifamily lending, said much the same thing, and added that shareholders also wanted to see market share and returns rise.  For- mer Fannie chairman Stephen Ashley told the FCIC that the change in strategy in  and  was owed to a “mix of reasons,” including the desire to regain market share and the need to respond to pressures from originators as well as to pressures from real estate industry advocates to be more engaged in the marketplace.  fcic_final_report_full--217 And Merrill continued to push its CDO business despite signals that the market was weakening. As late as the spring of , when AIG stopped insuring even the very safest, super-senior CDO tranches for Merrill and others, it did not reconsider its strategy. Cut off from AIG, which had already insured . billion of its CDO bonds  —Merrill was AIG’s third-largest counterparty, after Goldman and Société Générale—Merrill switched to the monoline insurance companies for protection. In the summer of , Merrill management noticed that Citigroup, its biggest com- petitor in underwriting CDOs, was taking more super-senior tranches of CDOs onto its own balance sheet at razor-thin margins, and thus in effect subsidizing returns for investors in the BBB-rated and equity tranches. In response, Merrill continued to ramp up its CDO warehouses and inventory; and in an effort to compete and get deals done, it increasingly took on super-senior positions without insurance from AIG or the monolines.  This would not be the end of Merrill’s all-in wager on the mortgage and CDO businesses. Even though it did grab the first-place trophy in the mortgage-related CDO business in , it had come late to the “vertical integration” mortgage model that Lehman Brothers and Bear Stearns had pioneered, which required having a stake in every step of the mortgage business—originating mortgages, bundling these loans into securities, bundling these securities into other securities, and selling all of them on Wall Street. In September , months after the housing bubble had started to deflate and delinquencies had begun to rise, Merrill announced it would acquire a subprime lender, First Franklin Financial Corp., from National City Corp. for . billion. As a finance reporter later noted, this move “puzzled analysts because the market for subprime loans was souring in a hurry.”  And Merrill already had a  million ownership position in Ownit Mortgage Solutions Inc., for which it provided a warehouse line of credit; it also provided a line of credit to Mortgage Lenders Net- work.  Both of those companies would cease operations soon after the First Franklin purchase.  Nor did Merrill cut back in September , when one of its own analysts issued a report warning that this subprime exposure could lead to a sudden cut in earnings, because demand for these mortgages assets could dry up quickly.  That assessment was not in line with the corporate strategy, and Merrill did nothing. Finally, at the end of , Kim instructed his people to reduce credit risk across the board.  As it would turn out, they were too late. The pipeline was too large. REGULATORS: “ARE UNDUE CONCENTRATIONS OF RISK DEVELOPING? ” As had happened when they faced the question of guidance on nontraditional mort- gages, in dealing with the rapidly changing structured finance market the regulators failed to take timely action. They missed a crucial opportunity. On January , , one year after the collapse of Enron, the U.S. Senate Permanent Subcommittee on In- vestigations called on the Fed, OCC, and SEC “to immediately initiate a one-time, joint review of banks and securities firms participating in complex structured finance products with U.S. public companies to identify those structured finance products, transactions, or practices which facilitate a U.S. company’s use of deceptive account- ing in its financial statements or reports.” The subcommittee recommended the agen- cies issue joint guidance on “acceptable and unacceptable structured finance products, transactions and practices” by June .  Four years later, the banking agencies and the SEC issued their “Interagency Statement on Sound Practices Con- cerning Elevated Risk Complex Structured Finance Activities,” a document that was all of nine pages long.  FOMC20050809meeting--139 137,MR. LACKER.," Thank you, Mr. Chairman. Incoming economic data since our last meeting have been consistent with a reasonably paced recovery and well-contained inflation. Payroll employment has been solid. It has even accelerated a bit lately, indicating steady improvement in overall labor market conditions. The ISM [Institute for Supply Management], industrial production, retail sales, and durable goods orders all came in stronger than anticipated, and the GDP report exceeded what was expected in the June Greenbook. The recent strength in business investment bodes well, I think, for the ability of that sector to take the baton from the housing market should it wane. For now, though, households seem confident enough in future income prospects to continue to expand spending, particularly on durable goods and housing. Thus, the outlook for the remainder of the year is brighter now, August 9, 2005 41 of 110 Our information on the Fifth District’s economy is broadly consistent with the national outlook. Retail sales picked up markedly in July, as shopper traffic and big-ticket indicators both rose significantly. Employment growth in the sector seemed to moderate last month, however, unlike the national figure. In the service sector outside of retail, revenue growth picked up and employment continued to expand at a steady pace. Manufacturing shipments rose modestly in July, but new orders declined. Excluding the ailing textile industry, things look much better but still registered a bit of a slowdown in July. Employment in manufacturing continues to decline. Our surveys indicate that price pressures remain well contained in our District in both the manufacturing and service sectors. And the housing market in our District remains quite robust. In response to the stronger real outlook, the yield curve has shifted up significantly. The 10-year Treasury yield has risen over 40 basis points since just before the June meeting, and the 5-year yield rose 47 basis points as of a couple of days ago. Market participants are now expecting substantially more tightening this year and next year—an assessment with which the Greenbook concurs. The federal funds rate is now expected to reach 4¼ percent by mid-2006, an upward revision of about 50 basis points since our last meeting. In comparison, inflation expectations have been remarkably stable. Inflation compensation, as measured from the TIPS [Treasury inflation-protected securities] curve, has increased only 5 basis points at the 10-year horizon since the June meeting and has actually fallen at the 5-year horizon—and this despite the fact that oil prices have risen substantially on net. It’s quite striking that the stronger real outlook over the intermeeting period has led to August 9, 2005 42 of 110 expectations are obviously a good thing, although they are stabilized right now at the upper end of my comfort zone and I’d be happier if they were ½ point lower. What’s really impressive, though, is the public’s belief that we will move the funds rate by whatever amount necessary to prevent stronger real prospects from showing through to future inflation. Our past behavior and communications evidently have given people a fair amount of confidence that we will allow short-term real rates to fluctuate as needed in response to changing fundamentals. This, Mr. Chairman, was the idea behind the question I asked you earlier. The issue is whether the economy might be able to withstand fluctuations in capacity utilization or the output gap, or however we measure it, without necessarily having these real relative price changes that are naturally going to occur in that circumstance pass through to overall inflation. This implies, however, a fairly flexible outlook for policy rates, even if market measures of expected inflation do not move around very much. I think one of the most important challenges we are going to face over the next year or so will be to preserve and enhance this confidence the public has in the responsiveness of policy to evolving economic fundamentals. Thank you." fcic_final_report_full--191 The Office of Thrift Supervision had also regulated Lehman since  through its jurisdiction over Lehman’s thrift subsidiary. Although “the SEC was regarded as the primary regulator,” the OTS examiner told the FCIC, “we in no way just assumed that [the SEC] would do the right thing, so we regulated and supervised the holding company.”  Still, not until July —just a few months before Lehman failed— would the OTS issue a report warning that Lehman had made an “outsized bet” on commercial real estate—larger than that by its peer firms, despite Lehman’s smaller size; that Lehman was “materially overexposed” to the commercial real estate sector; and that Lehman had “major failings in its risk management process.”  FANNIE MAE AND FREDDIE MAC: “TWO STARK CHOICES” In , while Countrywide, Citigroup, Lehman, and many others in the mortgage and CDO businesses were going into overdrive, executives at the two behemoth GSEs, Fannie and Freddie, worried they were being left behind. One sign of the times: Fannie’s biggest source of mortgages, Countrywide, expanded—that is, loos- ened—its underwriting criteria, and Fannie would not buy the new mortgages, Countrywide President and COO Sambol told the FCIC.  Typical of the market as a whole, Countrywide sold  of its loans to Fannie in  but only  in  and  in .  “The risk in the environment has accelerated dramatically,” Thomas Lund, Fan- nie’s head of single-family lending, told fellow senior officers at a strategic planning meeting on June , . In a bulleted list, he ticked off changes in the market: the “proliferation of higher risk alternative mortgage products, growing concern about housing bubbles, growing concerns about borrowers taking on increased risks and higher debt, [and] aggressive risk layering.”  “We face two stark choices: stay the course [or] meet the market where the market is,” Lund said. If Fannie Mae stayed the course, it would maintain its credit discipline, protect the quality of its book, preserve capital, and intensify the company’s public voice on concerns. However, it would also face lower volumes and revenues, contin- ued declines in market share, lower earnings, and a weakening of key customer rela- tionships.  It was simply a matter of relevance, former CEO Dan Mudd told the FCIC: “If you’re not relevant, you’re unprofitable, and you’re not serving the mission. And there was danger to profitability. I’m speaking more long term than in any given quarter or any given year. So this was a real strategic rethinking.”  Lund saw significant obstacles to meeting the market. He noted Fannie’s lack of capability and infrastructure to structure the types of riskier mortgage-backed secu- rities offered by Wall Street, its unfamiliarity with the new credit risks, worries that the price of the mortgages wouldn’t be worth the risk, and regulatory concerns sur- rounding certain products.  At this and other meetings, Lund recommended study- ing whether the current market changes were cyclical or more permanent, but he also recommended that Fannie “dedicate significant resources to develop capabilities to compete in any mortgage environment.”  Citibank executives also made a presenta- tion to Fannie’s board in July , warning that Fannie was increasingly at risk of being marginalized, and that “stay the course” was not an option. Citibank proposed that Fannie expand its guarantee business to cover nontraditional products such as Alt-A and subprime mortgages.  Of course, as the second-largest seller of mort- gages to Fannie, Citibank would benefit from such a move. Over the next two years, Citibank would increase its sales to Fannie by more than a quarter, to  billion in the  fiscal year, while more than tripling its sales of interest-only mortgages, to  billion.  CHRG-109hhrg28024--206 Mr. Bernanke," The economy as a whole has recovered very strongly from the slow period earlier this decade, and I think that's very positive. We have strong GDP growth. We have low inflation. We have strong productivity growth. Compare our economy to many other industrial economies. We see that we've had a very good run. " FOMC20060510meeting--114 112,MR. STERN.," Thank you, Mr. Chairman. The District economy continues to perform well, and the ongoing expansion is broadly based. Given that summary, let me just comment on three particular areas, beginning with a few things of interest that came out of a breakfast we had a couple of weeks ago with the leaders of the Twin Cities financial community. First, hiring costs reportedly are rising significantly in order to attract college graduates and those with advanced degrees. This has implications for salaries more broadly because of internal compression and retention issues—perhaps not a surprise given the duration of the expansion and the gains in employment over the past several years. Second, and this is largely by way of confirming things that have been in the press lately, distinctions between the activities of commercial banks and much more specialized firms like hedge funds, venture capitalists, and private equity firms are diminishing, as the last group is invading the banks’ turf, especially in providing credit of one form or another to business. This was also a theme at a financial institutions dinner I attended a few weeks earlier. These competitive pressures may help to explain the results from the latest survey of senior loan officers indicating further easing of standards and terms for C&I (commercial and industrial) loans. The third area I want to comment on is housing. Data through April show that activity in the District in terms of starts and permits is running so far this year at about the same pace that it ran last year. However, according to a variety of anecdotal reports, speculative building is slowing dramatically if not stopping altogether, and the high end of the housing market, interestingly enough, is doing better, perhaps far better, than the lower tiers. There are reports of price softening in the middle part of the market. Given the volume of projects that are currently under way in the District, I would judge that the inventory of unsold homes, especially of condominiums, will continue to rise, and the pace of price increase will moderate further, if not turn negative in some markets. As to the national economy, growth appears to me to be healthy and is likely to be well sustained as best I can determine. Still, I think that there are a few straws in the wind that suggest that some deceleration is in the offing, including the evolution of housing activity and the diminution of the positive wealth effect, at least from that source. I do not want to exaggerate that effect at this moment. It is based largely on what we are seeing in the most recent data, but the anecdotes, at least that I am getting, are consistent with that. Also, while it seems pretty clear that the economy has weathered the run-up in energy prices well, we should not lose sight of its negative implications for real incomes and ultimately for spending. As for inflation, here it seems to me that uncertainty about the outlook has increased, as the core numbers have come in a touch above what I had earlier anticipated. Also, inflation expectations appear to have deteriorated. Still, in my experience, it is not a good idea to overemphasize high-frequency observations, and as a consequence of that, I am not ready yet to raise my inflation forecast." 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." FOMC20050202meeting--133 131,MR. SANTOMERO.," Thank you, Mr. Chairman. Economic activity in the Third District continues to expand at a moderate pace, but there is some variation across the three states of our District. Leading indicators are signaling continued solid growth in New Jersey and Delaware but more modest growth in Pennsylvania. Payroll employment in our states grew at a 1¼ percent pace in the fourth quarter of last year, down from an unsustainably strong pace earlier in the year. Pennsylvania continues to have the slowest job growth and the highest unemployment rate among February 1-2, 2005 89 of 177 Our business outlook survey indicated a considerably slower pace of expansion in regional manufacturing in January. The general activities, new orders, and shipment indexes all fell to their lowest levels in 18 months. This is something to watch. The deterioration is not just localized in Philadelphia. I note that New York’s manufacturing survey also weakened in January. At the same time, it’s important to remember that these are just one-month readings, and other indicators in the January survey are less negative. For example, current and future employment indexes in our survey are near their highest levels in the current expansion. Turning to future capital spending in the District, we participated, as did the other Districts, in the Board staff’s survey. Our results are quite similar to the results for the nation as reported in Larry Slifman’s memo. On a related topic, all of these results—in addition to the comments from firms in our District over the past several months—suggest that the expiration of the partial- expensing provisions had a smaller impact on firms than is assumed in the baseline Greenbook forecast. Turning to our economic intelligence on other sectors, there appears to be little change. Consumers continue to spend at a moderate pace. Holiday sales in the region generally met expectations for a good, if not spectacular, showing. As was true in the nation, sales of luxury items showed the strongest performance, with year-over-year current dollar gains greater than 10 percent. Most of the other retailers reported year-over-year increases of around 3 percent. As I reported last month, nonresidential construction in our region remains soft. The office vacancy rate in the Philadelphia metropolitan region has remained at about 16.5 percent since the end of 2003, although we are seeing some net absorption over the past year. The construction of two new office towers will increase available space significantly, by about 5 percent. Meanwhile, residential construction has remained healthy, but it is down from its peak. House appreciation continues, especially on the New Jersey shore, where prices were up over 20 percent in the past year. In summary, the economic expansion continues at a moderate pace in the Third District, and February 1-2, 2005 90 of 177 My outlook for the nation is similar to that of the Greenbook, with real growth averaging about 3¾ percent over the next two years. Like the Greenbook, we expect consumer spending to expand at about that pace as well. This consumption forecast reflects our view that the current personal saving rate, despite its low level, is not likely to lead to a reduction in household spending. As we all know and as was mentioned here today, the personal saving rate averaged 1 percent last year. That compares to an average since 1959 of over 7 percent. There has been some concern expressed that consumers will hold back on their spending as we withdraw monetary stimulus, but a Philadelphia staff analysis casts considerable doubt on this outcome. That study points out several factors that warrant our attention. First, measured personal saving excludes some investments, such as investment in human capital and capital gains, therefore underestimating the true saving rate. Second, our real-time data series show that personal saving rates have been revised upward systematically, tending to wipe out low measured saving rates in the past. Since 1965, the mean revision has been about 2½ percentage points. Third, the permanent income hypothesis suggests that a low saving rate may signal expectations of faster future growth in labor income. Moreover, there is no significant empirical evidence that a low saving rate forecasts slower consumption growth. While our forecasts are similar to the Greenbook’s with respect to consumer spending and total GDP, there are some key differences. As I’ve already mentioned, we expect less of an effect from the expiring tax incentives on business investment. So we see stronger growth there, and our pattern of growth is smoother than in the baseline forecast in the Greenbook. We also anticipate a large depreciation in the dollar for reasons we talked about today; that discussion was helpful to me in understanding the Greenbook forecast. Thus, real net exports do not make much of a negative or positive contribution to growth over the next year in our forecast. Our larger depreciation of the dollar, coupled with less slack than in the Greenbook baseline, leaves us to project a slow rise in core PCE inflation over the forecast horizon to 1¾ percent for 2005 and 2 percent for 2006. This February 1-2, 2005 91 of 177 and our forecast are predicated on maintaining our strategy of gradually removing policy accommodation to bring policy back to a more neutral stance. Nothing in the current conditions or in the economic outlook suggests that it’s time to revise that strategy. We are at a point in the cycle where I think it is particularly important that we remain vigilant and forward-looking with respect to inflation. The recent acceleration in core CPI inflation means that it is no longer in the lower part of the acceptable range, in my view. This acceleration has not been large, and it has not yet shown up in the core PCE inflation. Nonetheless, both oil prices and the dollar pose an upside inflation risk. Thus, it seems prudent for us to remain vigilant and to continue on our upward path for the funds rate." CHRG-109hhrg31539--46 Mr. Bernanke," Well, as you indicated, the downcurrent in the housing market so far appears to be orderly. The level of activity is still relatively high on an historical basis, but we recognize the risk you are pointing to. We are watching it very carefully. I would just note that there are other aspects of the economy which are to some extent taking up the slack, so to speak, created by a slowing housing market, including investment in nonresidential construction and exports, among others. So we are looking at the overall economy. We are looking at housing. Clearly that is a very important sector we are watching very carefully. Ms. Pryce. We are very concerned in Ohio, and I appreciate your attention. Thank you. I yield back. " FOMC20050630meeting--198 196,MR. PEACH.," Well, I think in part it may go back to one of the issues discussed earlier about the rate at which replacement is taking place. Now, I haven’t done this in the most scientific way, but if you just take periodic estimates of the stock of housing, whether from the Census or from the American Housing Survey, and try to line up changes in the stock with new production, it appears that we’re in a period when a lot of destruction of old housing is taking place. As you mentioned, the average estimate on tear-downs is 300,000, but I’ve seen estimates as high as 700,000 units." CHRG-111shrg55117--32 Mr. Bernanke," Yes, sir. You are absolutely right. Inventory liquidation is not complete yet, but it is substantially advanced, and that will be a support to production both here and perhaps even more so abroad, which will create a stronger global economy, which will be helpful indirectly. We expect a recovery, and there is still a great deal of uncertainty, but we expect a recovery to start off relatively slow, and in part it is because of the consumer who is facing a damaged balance sheet, still has high debt on the balance sheet. Wealth has been reduced by housing and equity price declines. So we do not expect the consumer to come roaring back by any means, particularly with the labor market in the condition that it is in. So the American consumer is not going to be the source of a global boom by any means. On that very topic we are continuing to encourage our trading partners in Asia and elsewhere to understand--and I believe that they do--that they need to substitute their own domestic spending, their own domestic demand, for American consumers as the engine of growth in their economies. And we are seeing, for example, in China, with their large fiscal package there and their attempts to strengthen their infrastructure spending, we are seeing some motion in that direction. So our anticipation is for a recovery that will start slowly, begin to pick up speed over time, but it depends very much on to the extent consumers can get comfortable with their financial situations going forward, and also to the evolution of the labor market. Senator Bennett. Thank you. " FOMC20080625meeting--129 127,MS. YELLEN.," Thank you, Mr. Chairman. I favor alternative B with the proposed wording. Given the forecast and the risks around it, our next move on the funds rate is likely to be up, and the question is when. Assuming that the data on growth and inflation come in roughly as I and the Greenbook expect, I would envision beginning to remove policy accommodation toward the end of this year, similar to the assumption in the Greenbook. As I mentioned, I'm not very confident that the outlook for growth and employment has improved as much as the Greenbook assumes. I'm concerned that households and firms are in a python squeeze of an intensifying credit crunch and a continuing decline in housing wealth as well as pressures from surging food and energy prices. I think the economy has shown resilience so far, and that's reassuring, but I don't think it's assured for the future. The aggressive policy actions that we have put in place since January are actually working to cushion the blow, and that's part of the reason that we haven't seen a greater unraveling so far. I mentioned yesterday that, with respect to inflation, the behavior of both core inflation and wages thus far makes me optimistic that headline inflation will come down if commodity prices finally level off. But I think there's no doubt that the risks with respect to inflation are not symmetrical at this point, and they have definitely increased. I still see inflation expectations as reasonably well anchored, but there's no doubt that a wage�price spiral could develop, and dealing with it would be a very difficult and very painful problem for the Committee. So while I feel that we are essentially credible now, I wouldn't want to take absolutely for granted that this is something that we can count on going forward. At this point, the federal funds rate remains well below the recommendations of most versions of the Taylor rule. I have viewed this as appropriate, not largely as insurance against downside risk but simply in refection of the unusually severe pressures from collapsing wealth and tight credit and financial constraints. But it does seem to me to be appropriate going forward to at least take out some insurance against the development of a wage�price spiral mentality, and that could take the form of gradually removing that discrepancy from what, for example, a Taylor rule recommends. But before we begin to do that, it does seem to me that we should wait to get a somewhat clearer picture of where the real side is going. " CHRG-109shrg30354--12 STATEMENT OF SENATOR ROBERT MENENDEZ Senator Menendez. Thank you, Mr. Chairman. Welcome, Chairman Bernanke. Let me say, recently we learned that the anticipated deficit for the fiscal year 2006 is down from what had been projected and for that we should all be happy. However, we are still talking about a deficit of $296 billion. And though that is better than the original estimated deficit of $423 billion, which some considered was an inflated estimate in the first instance, it is a far cry from the $600 billion budget surplus for 2006 that was predicted by the White House back in 2001. Now that discussion certainly belies the $10 trillion to $12 trillion debt that the Congressional Budget Office tells us we are headed to by 2011. So while some in this country believe that are our economy is chugging along quite well because our gross domestic product continues to grow, there seems to be an increasing gap between the average citizen and those at the top of our economic ladder. The disparity between the haves and have-nots seems to be widening at an alarming rate. When I am back in New Jersey, I hear more and more from New Jerseyians that they are working harder and longer just to try to keep their heads above water, whether it is because of higher costs for college, soaring health care costs, increasing energy prices, gas prices, stagnant and flat wages, or pensions being underfunded and in some cases totally abandoned, there is a huge disconnect between growth in our GDP and the situation that the average American finds themselves and their families in. So the question is, who is this economy working for? I look forward to your testimony today and to hearing your thoughts on some of those items I have just mentioned and other challenges we face as a Nation, such as the cooling off of the housing market and what that may mean, rising energy prices, consequences of deficit and debt, record trade deficits, real wages remaining flat, negative household and national savings, a variety of global influences and how these factors affect the dynamic of the modern global economy that we have. Those are the challenges I hear from average New Jerseyians and Americans that they are currently facing and that you have before you. So as we wish you well in the stewardship of the economy, we look forward to hearing your testimony and hopefully reflecting upon some of those items. If not, I will pursue it in my questions. Thank you, Mr. Chairman. " FOMC20060808meeting--106 104,MR. POOLE.," Thank you, Mr. Chairman. As others are, I am very torn about this decision. I come out for holding the funds rate constant, and here is the problem that I have with our situation. Part of it is the language that we used in the past. If you look at the first exhibit that we were given, you see that the fed funds rate responded to the second-quarter GDP report and the employment report. We have told the market that we are going to be data dependent, and we have told the market that resource utilization matters to us. It seems to me that the lesson from that is, first, we should come through with what we told the market we were going to do and, second, we should get some of those things out of the statement because we need to put a lot more emphasis on the inflation risk that we face going forward. I am particularly unhappy, quite frankly, with leaving the reference to housing in there. Housing is likely to continue to have some weak numbers, and it seems to me that we don’t want the market to believe that policy is really being driven by one sector of the economy. I offered some language for section 2. I think that is a statement about the past—“has moderated from its quite strong pace.” If you just look at the second-quarter GDP report, there was moderation pretty much across the board. That was the language I suggested. I think we ought not to be referring to housing explicitly. We should try to move toward a bare bones statement and not create expectations in the market that we are going to be responding. Of course, between now and our next meeting we may get some more measures that people would interpret as reflecting resource utilization. One of the things that is peculiar about having that in the statement at this point is that the staff is not forecasting any significant gap in resource utilization that would put downward pressure on inflation. So how can we be referring to resource utilization as our primary reason for thinking that inflation is going to moderate? It seems to me that there is some internal inconsistency there. The problem that I have with alternative B, as it is now worded, is this: If we believe that we will want to increase the target funds rate at our next meeting—which I think is the interpretation of that last section—then we should do it today. We shouldn’t signal it for the future. Given that expectations seem to be well contained, I think that we have a chance to use our language to get out from under some of the expectations we have created and that we should come through on the expectations we have already created. You see that clearly in the way the market set the fed funds rate in response to the incoming data. We’ve said we were going to be data dependent, and I think we’d better come through and be data dependent. I want to say one other thing about housing. I think that housing may be telling us that it is really a good measure of consumer confidence. Housing obviously involves people looking forward and deciding what commitments they’re willing to make. I would interpret housing as being a combination measure of people’s attitudes toward the future, the security of their income flows, and the commitments they’re willing to make—to include obviously not only the households themselves but also the lenders that are responsible for making mortgage decisions. So I would downplay housing as a direct component of GDP. Thank you." FOMC20080625meeting--55 53,MR. SLIFMAN.," It's hard for me to think of it in these probabilistic terms. I would say that we still think that the economy is going to have these negative effects that are associated with periods of low growth. Now, whether that is precisely a recession or simply just a low-growth period, it's hard for me to distinguish. " CHRG-111shrg57319--509 Mr. Rotella," Senator, Chairman Levin repeated a couple of colorful comments I made in some emails about my views of the business. As I said in my opening statement, this business was on an explosive growth path when I joined. It was on an explosive growth path with a very weak infrastructure. Senator Kaufman. Exactly. " CHRG-109hhrg31539--219 Mr. Bernanke," The higher prices have reduced our growth. We have estimates that GDP has been reduced between \1/2\ percent and 1 percent from growth in the last few years, but I think it is important going forward that we look to other sources of energy and trying to diversify our portfolio of energy sources and trying to increase our conservation, and doing all that, we will, I think, ultimately overcome this problem. " 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-111hhrg53240--16 Chairman Watt," I think that is another question that I have, but my time has run out and I don't want to abuse it. I actually think this may be a panel that we do a second round of questions, so as not to put the other members at a disadvantage. Let me proceed with recognizing the ranking member for 5 minutes for his questions. Dr. Paul. Thank you, Mr. Chairman. And welcome, Governor Duke, to our hearing. I find it rather fascinating that we are talking about where the regulations will go, whether it is going to be in the Fed or a new agency. From my viewpoint, I am not sure it makes a whole lot of difference. I think it is the principle of regulation, whether it will work or not. But it is rather ironic that a lot of people are talking about putting them in the Fed with the amount of failure of the Federal Reserve and the amount of noncompliance or at least, an observation by the Congress, its inability to audit makes it sort of ironic that we might give the Federal Reserve even more power. I am concerned about the history of regulation. We don't have a real good record that regulations prevent problems. We have had the SEC around for a long time, and the SEC didn't prevent Enron and so many other bankruptcies and big problems. Then, of course, when we had that failure, we had Sarbanes-Oxley and that hasn't prevented much either. We had a lot of housing regulations. It didn't prevent the housing bubble. It goes on and on. A lot of people think, if you are not a strong endorser of all these regulations, therefore, you think it runs free and there is no regulation. But the regulations come differently; it comes through the marketplace. If you do badly, and you don't serve the consumer, you go bankrupt. But when you prop-up policies that are bad, ultimately the consumer is hurt by these regulations because the market doesn't hold them in check, and I see that as a bigger problem. The question is, though, do you think that with additional regulations, more rules and--it might not hurt the consumer in the sense that it is going to be difficult to come up with a new package for the consumer. People might just say, ``To heck with gift cards and other things; I am not going to mess with this.'' And then there is a cost; there is a cost always, and it is always borne by the consumer. Any time you have a regulation, you say, I am going to regulate the businessman, that is a fallacy. All regulations are a tax, and they are a tax that is passed on to consumers. Could you address that, on how you can regulate without putting a tax on the consumer? Ms. Duke. I think all consumer regulation--and I frankly do think there needs to be some, that it needs to be informed by a deep understanding--an understanding of the market, an understanding of financial institutions, an understanding of the way financial markets operate and the way transactions operate--in order to avoid adding excessive costs; and that such regulations have to be done with an eye toward the availability of financial services. So it is a balance between the quality and the quantity of financial services. Dr. Paul. Right now, there is a big grass-roots effort by consumers, who are saying that the Congress has not fulfilled its responsibility in knowing exactly what the Federal Reserve does--what kind of agreements they make with international banks, other governments, international financial organizations, what kinds of conversations they have had with companies like Goldman Sachs. And because of this consumer concern, they have asked for more oversight of the Federal Reserve, and there are now 277 Members of Congress who think that should be the case. Why do you think it would hurt consumers for us to know more about what the Federal Reserve is doing, which may well be hurting the consumer if we knew more about it? How can this information be harmful? Ms. Duke. Congressman, we are making quite a bit of information available now. We have a weekly report of our balance sheet. We have a monthly report which is submitted to Congress. We have a great deal of information on our Web site. And we also are subject to quite a bit of GAO oversight. The one place, the one exception to that oversight, is in monetary policy; and what research has shown with monetary policy is that the independence of monetary policy is important for expectations of-- Dr. Paul. May I interrupt, because this bill would have nothing to do with monetary policy. They might find out what has been done, but it wouldn't interfere at all with monetary policy. And I would beg to disagree. There is more than one issue. It is not monetary policy. If you look at the code, it exempts about five categories; one is, all relationships and transactions with foreign governments, foreign central banks, international financial institutions, private corporations. So those are exempt, too, and I think those are pretty important. In a way, if the Federal Reserve can have an agreement with another government, that is like a treaty. And surely it isn't exactly what the founders intended when they wrote the Constitution. I see my time has expired. " CHRG-111hhrg53241--10 The Chairman," We will now begin with the panel, and we will begin with a man with whose work I am very familiar and of which I am very admiring, Joseph Flatley from the Mass Housing Investment Corporation. Let me say at the outset, any additional material that anyone on the panel or on the committee wants to submit for the record will be accepted, if there is no objection, and I hear none. So the record is open for any submissions. Mr. Flatley? STATEMENT OF JOSEPH L. FLATLEY, PRESIDENT AND CHIEF EXECUTIVE OFFICER, MASSACHUSETTS HOUSING INVESTMENT CORPORATION, ON BEHALF OF THE NATIONAL ASSOCIATION OF AFFORDABLE HOUSING LENDERS (NAAHL) " CHRG-111hhrg48868--672 Mr. Royce," The issue to us is of course the fact that Senator Snowe was concerned about this very provision, and so when the stimulus bill came before the Senate, she attached to that an amendment aimed at restricting bonuses over $100,000 to any company that received Federal bailout money. And that measure drafted by Olympia Snowe in the Senate and by Ron Wyden applied these restrictions retroactively to those bonuses received or promised in 2008 and onward. And, of course, the issue was at some point that provision was stripped out during the closed-door conference negotiation involving the House and Senate leaders and involving the White House. And a measure reportedly originally reported by ``ABC News,'' that it was Senator Chris Dodd who put that provision in it, but at any rate, a provision that the Democratic leadership on both the House and Senate side were aware of replaced the provision voted out of the Senate by 100 members of the Senate. And so, instead, we had a final bill come back to the House with a new provision in it, a provision that explicitly exempted bonuses agreed to prior to the passage of the stimulus bill. So, you know, for us on the House side, you can see the surprise. Republicans all voted against that bill, but in that bill, then, we find a provision that nobody voted on in the Senate or House on the Floor, but instead is put in during a closed conference and expressly prohibits us from attempting to prevent the use of taxpayer money for bailouts of firms for payment of bonuses to firms which the taxpayers have themselves bailed out, and, so, hence our concern over the line of communication. So, if there's any company communication or lobbyist retained by the company that did have any communication on this, the request from this committee is for that to be produced. And, again, thank you very much, Mr. Chairman. " FOMC20061212meeting--175 173,MR. PLOSSER.," Thank you, Mr. Chairman. I, too, favor maintaining the federal funds rate at its current level at this point. As many people have said, the incoming data have been voluminous but not very informative. However, inflation continues to be higher than I’d like to see it and is forecast to remain so for longer than I’d like to see, thus putting our credibility at risk. I am more optimistic than the Greenbook about the possibility for a quicker rebound to potential. But even if you take the staff’s Greenbook forecast, with growth expected to be below trend for at least several more quarters before returning to trend, I’m comfortable with maintaining the current federal funds rate and the implicit firming that doing so would imply as the economy slows down. Although I don’t think we should raise the fed funds rate today, I do want to put on the table and reemphasize, as several people have, that we need to acknowledge that if real growth rebounds quicker toward trend than is currently forecast, whether in the fourth quarter of this year or the first quarter of next year, then we must be in a position to raise the fed funds rate at that time. I happen to put more probability on that being the case than perhaps some do. A failure to do that or to signal that we will do that would put considerable upward pressure on the inflation outlook and on the public’s perception of our commitment to price stability. Of course, if we begin to see much larger spillovers from housing corrections or from other sectors, which I don’t think we will, we may want to allow the nominal funds rate to decline as the equilibrium market rates decline—again, not to exploit a Phillips curve type of tradeoff but to drive the real rate down at the appropriate time. But that would also be signaling that we are content with the current level of inflation, and I don’t think we are at this point. So I don’t think that’s really in the cards. Given the outlook, I see not much to be gained and much to be lost from lowering the fed funds rate, as many people have indicated. In regard to the language, I lean toward alternative B, but I must confess I’m still a novice at the nuance of some of this language stuff, and I go back and forth. I am sympathetic to the view expressed by President Minehan and to Bill Poole’s comments about the words “than anticipated,” but I am concerned about section 2, and I have some mixed emotions about it. It seems to me that the way section 2 is currently being construed is a bit asymmetric. President Yellen was making this point. We talk about the weakness that we’ve seen, and then we make a comment that says, “But we expect growth to be moderate.” That seems to me to be an asymmetric treatment of what we’ve really been talking about. If we’re going to be explicit about where we’ve seen weakness, then we also ought to be explicit about why we still see growth as being moderate because otherwise you see only one side of the coin. Whether we talk about strength in the labor markets or strength in consumer spending, it seems to me that we need to balance the statement; otherwise the section doesn’t make a lot of sense to me. Now, as I think through that, I become more and more attracted to President Hoenig’s view that maybe the less we say the better because saying more requires more explanation. In general, I have somewhat mixed feelings about the language issue. I tend to think that we ought to change the language of the statement more often rather than less often because putting in a new word is always excruciatingly painful and understanding the nuances of what we’re trying to convey to the market is very difficult. One alternative is to be much more eclectic about what we say and either use the minutes to explain it further or not. I don’t know that I would necessarily advocate doing that, but I think that we need to think about using the language in the statement in ways that perhaps don’t lock us into things in the way the language currently does. That’s my observation. Thank you, Mr. Chairman." CHRG-111shrg56376--159 Chairman Dodd," Good idea. Good suggestion. Senator Corker. Senator Corker. Thank you, Mr. Chairman, and I thank each of you for your testimony. I know Gene and Marty we have talked with--a great deal about this and certainly appreciate the two of you coming in. I am going to ask some questions that do not necessarily reflect my point of view but just to probe. I am open on all of these issues and am still, like many Members on this Committee, trying to figure out what is the best route or have you all propose something, and maybe a hybrid of that is best, who knows? But hopefully we will get to that--I know we will--before we regulate. You mentioned the issue of having an alphabet soup of people coming to talk to us, and it is not unlike having witnesses come before our Committee with differing points of views in many ways. I have to tell you, I have enjoyed that. Each of the regulators, sometimes gleefully, sometimes not, points out the deficiencies of the other regulator. And I have to tell you, there is some merit in that. Just for what it is worth, you know, to have a captive regulator, much like we have with the GSEs, which would be the case with all banks, to me, could be very problematic. I think having feet on the ground sometimes gives you a sense--I know in my business it was very important to be in various States where we were building. As Senators, we go back home to our States to not be Washingtonized, and there is just some benefit of having feet on the ground, as the FDIC has argued and as the Fed has argued. And then the OCC to me is the most procyclical--which what we are talking about is a super OCC. Let us face it. They are the most procyclical organization that we have. They move quickly in a direction that creates bubbles, and now they are out throughout the country. Anybody that has got a commercial real estate loan or anything like it is being criticized, and so they are creating, I think strongly creating a self-fulfilling prophecy. So I would love to hear your comments about the RUBs being helpful in some cases and the competition being helpful, but also what would be in this to keep the OCC--super OCC, if you will--from being so procyclical as they are now. " CHRG-111hhrg52400--5 Mr. Sherman," In this hearing is the question, what is insurance? Derivatives are, at best, insurance. At worst, they are a casino bet. AIG sold fire and life insurance through its regulated subsidiaries, and those subsidiaries are pretty much okay. It sold portfolio insurance through unregulated subsidiaries, convincing the world that it wasn't insurance, and they took down the company, if not the world economy. The fire insurance policy on my house protects my lender in case my house burns down. But if my lender wants protection from the much greater risk that the value of my house goes down, or the value of my mortgage goes down, they also buy insurance. They call it a derivative, and it's completely unregulated. We need to make sure that credit default swaps and similar derivatives are classified as insurance, and are subject to reserves. I yield back. " 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-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. FOMC20070807meeting--87 85,MR. LOCKHART.," Thank you, Mr. Chairman. My basic view of appropriate policy is little changed from the previous meeting. None of the intermeeting developments yet compel me to change my view that our focus should remain on reducing inflation and inflation expectations. The outlook for GDP growth remains acceptable, especially in view of the recent downward revisions in the data and the associated lowering of estimates of growth potential. Our baseline outlook is consistent with that of recent months, but the new concern is obviously the financial markets that clearly are skittish about spillovers from the subprime market and about contagion in credit markets spreading beyond structured products. Evidence within the Sixth District is consistent with this basically stable and positive outlook. Florida is seeing some notable spillovers from their problems in real estate, but some of these problems are idiosyncratic to the state—for example, the widespread inability to get wind and storm insurance. The rest of the District has not seen serious spillover into the broader economy. Just like the Greenbook, we view the fundamentals of the economy to be stable. Although the residential real estate market may take some time to stabilize, the problem seems generally contained. Our model suggests slightly stronger growth than the baseline Greenbook throughout the forecast period. Our trend growth rate has not been reduced quite as much as the Greenbook’s, and our inflation forecast is not as favorable. At this juncture, we are not ready to give much weight to some of the more extreme alternate Greenbook scenarios. We certainly recognize more uncertainty and volatility than at the last meeting, but we’re still expecting results essentially in line with the baseline Greenbook forecast. In the past few days, I have had substantive conversations with some well-positioned credit market observers, including managers of large investment portfolios, suggesting that the skittishness of financial markets is not likely to abate until later this fall. They have suggested that the choppiness in financial markets will be the rule in the near term and, very important, that the threshold for what constitutes a shock is now much lower than usual. I believe that the correct policy posture is to let the markets work through the changes in risk appetite and pricing that are under way, but the market observations of one of my more strident conversational counterparts— and that is not Jim Cramer [laughter]—are worth sharing. This party sees problems in the subprime structured debt market spreading to the CLO leveraged-loan market and, in a knock-on effect, to repo and commercial paper markets as well as to investment-grade corporate credit. This party points to nonprice rationing, commercial paper rollover risk, and general CDO contagion caused by the damaged credibility of rating agencies and contraction of collateral values. This party argues that treating the widening of credit spreads as normalization ignores substantial subsurface potential dislocations as evidenced by the collapse of American Home Mortgage Corporation. All that said, another counterpart noted a large pool of money now on the sidelines that is ready to provide financing for reasonable deals if prices fall low enough. Importantly, a large portion of this money comes from reliable long-term sources of investment, pension funds and insurance companies. Notwithstanding some descriptive rhetoric, this is not the credit crunch of the late 1980s, when the traditional financial intermediaries were strained for capital. The traditional investors are still out there with substantial liquidity, and they are just temporarily on the sidelines for understandable reasons and, barring further shocks, should return to the markets in force later this fall. The dislocations in the financial markets call for a posture of vigilant monitoring of developments but nothing more for now. Regarding the balance of risks, it is early to materially adjust the weighting of GDP downside versus inflation upside risks. But I have heightened concern, as many of you do, about the continuing housing sector weakness combined with some potential of credit market turbulence in time affecting business investment and consumer confidence and thereby the real economy. Thank you, Mr. Chairman." CHRG-111shrg57321--168 Mr. McDaniel," That was it. Senator Kaufman. Mr. McDaniel, as you said in your testimony, and as you mentioned here earlier, as early as 2003, you were talking about the housing market. You were saying that the housing market--on page 18 of your testimony. So you knew as early as 2003 this was going to be a problem. This just didn't come on you in 2006 and 2007 like I think sometimes it is characterized by certain people, as kind of like a natural disaster. It was like a volcano or a hurricane. This housing thing happened, and you have just got to understand when things like that happen. We had years and years and this never happened before. Therefore--I mean, this is a constant theme we are hearing in these hearings. But as early as 2003, you knew the housing market was a problem and you lay out what your concerns are. So you are now at 2006 and 2007, and I understand you have tightened your standards, but when it is all over, an incredible number of these thousands--they said something like 10,000 RMBSes from 2002 to 2007, the majority of AAA ratings are now rated as junk. How does that happen? " CHRG-110shrg38109--84 Chairman Bernanke," It is similar--small and large businesses are similar in magnitude, and so in that respect, you are correct, yes. Senator Allard. You are saying that the small business sector would grow--you think it is 50-50, then, between economic growth from large business and economic growth from small business? " fcic_final_report_full--225 CDOs; pushing ratings out the door with insufficient review; failing to adequately disclose its rating process for mortgage-backed securities and CDOs; and allowing conflicts of interest to affect rating decisions.  So matters stood in , when the machine that had been humming so smoothly and so lucratively slipped a gear, and then another, and another—and then seized up entirely. COMMISSION CONCLUSIONS ON CHAPTER 10 The Commission concludes that the credit rating agencies abysmally failed in their central mission to provide quality ratings on securities for the benefit of in- vestors. They did not heed many warning signs indicating significant problems in the housing and mortgage sector. Moody’s, the Commission’s case study in this area, continued issuing ratings on mortgage-related securities, using its outdated analytical models, rather than making the necessary adjustments. The business model under which firms issuing securities paid for their ratings seriously under- mined the quality and integrity of those ratings; the rating agencies placed market share and profit considerations above the quality and integrity of their ratings. Despite the leveling off and subsequent decline of the housing market begin- ning in , securitization of collateralized debt obligations (CDOs), CDOs squared, and synthetic CDOs continued unabated, greatly expanding the expo- sure to losses when the housing market collapsed and exacerbating the impact of the collapse on the financial system and the economy. During this period, speculators fueled the market for synthetic CDOs to bet on the future of the housing market. CDO managers of these synthetic products had potential conflicts in trying to serve the interests of customers who were bet- ting mortgage borrowers would continue to make their payments and of cus- tomers who were betting the housing market would collapse. There were also potential conflicts for underwriters of mortgage-related secu- rities to the extent they shorted the products for their own accounts outside of their roles as market makers. CHRG-111shrg57319--103 Mr. Vanasek," And some subprime mortgage loans purchased from others, namely Ameriquest, were retained on the balance sheet. They tended to be higher quality subprime loans and they were monitored very closely. I held quarterly business reviews with every business unit reviewing their delinquencies and growth and changes in policies and so forth in an effort to maintain control of the growth. Senator Coburn. So basically, you were buying higher-quality subprime loans from competitors than what you were selling into the market? " fcic_final_report_full--229 Mortgage D elinq u en c ies b y R egion Arizona, California, Florida, and Nevada—the “sand states”—had the most problem loans. IN PERCENT, BY REGION 16% 12 8 4 0 13.6% Sa n d states 8.7% U . S . tota l 7.0% Non - sand states 1998 2000 2002 2004 2006 2008 2010 N OTE: Se ri o u s de li nq u en ci es i n clu de m o r tgages 90 da y s o r m o r e p ast d u e and those i n f o r e cl os ur e . S O U RCE: Mo r tgage Banke r s Asso ci at i on Nat i ona l De li nq u en cy S urv e y Figure . Serious delinquency also varied by type of loan (see figure .). Subprime ad- justable-rate mortgages began to show increases in serious delinquency in early , even as house prices were peaking; the rate rose rapidly to  in . By late , the delinquency rate for subprime ARMs was . Prime ARMs did not weaken un- til , at about the same time as subprime fixed-rate mortgages. Prime fixed-rate mortgages, which have historically been the least risky, showed a slow increase in se- rious delinquency that coincided with the increasing severity of the recession and of unemployment in . The FCIC undertook an extensive examination of the relative performance of mortgages purchased or guaranteed by the GSEs, those securitized in the private market, and those insured by the Federal Housing Administration or Veterans Ad- ministration (see figure .). The analysis was conducted using roughly  million mortgages outstanding at the end of each year from  through .  The data contained mortgages in four groups—loans that were sold into private label securiti- zations labeled subprime by issuers (labeled SUB), loans sold into private label Alt-A securitizations (ALT), loans either purchased or guaranteed by the GSEs (GSE), and loans guaranteed by the Federal Housing Administration or Veterans Administration (FHA).  The GSE group, in addition to the more traditional conforming GSE loans, CHRG-111hhrg48674--232 Mr. Bernanke," We are looking for long-term growth. " FOMC20050630meeting--159 157,MR. GALLIN., It’s going to make housing significantly— CHRG-109shrg24852--26 Chairman Shelby," It brought liquidity to the housing market. " FOMC20050630meeting--196 194,MS. JOHNSON.," Well, for one thing, the U.K.’s 1990 cycle was amplified by regulatory changes that preceded it, which led to mortgage lending that was excessive and not well supervised. It was a kind of blind-leading-the-blind situation: The regulator changed the rules and the financial institutions moved into the market and practices and norms changed. A great deal of lending took place. The supervisors were learning as much as the lenders were and—well, let me put it this way—it didn’t go well. In the past, there has certainly been a correspondence between household consumption and housing wealth in the U.K. So when they suffered the big drop in the 1990 rundown of housing prices, they also had a big change in household consumption out of disposable income, and so forth, June 29-30, 2005 67 of 234 Now, a couple of the characteristics of the U.K. market have always led us to think that it’s not a telling example. One is the prevalence of variable-rate mortgages, which causes the process of tightening monetary policy to contain the macroeconomy to have a bit of extra leverage over the discretionary income of households—to an extent that is not the case with fixed-rate mortgages Obviously, there’s a counterpart effect on the earnings of mortgage lenders, and so forth, in the U.S. economy that you need to take account of to fully understand that. But there is that characteristic. And there is the fact that house prices actually fell in the U.K., so they had big negative equity problems, which complicated the process of how to unwind the interaction of household behavior and financial intermediary behavior. To the extent people walked away from the houses, the financial intermediaries were getting collateral that perhaps no longer equaled the value of the loan. On the other hand, some households didn’t walk away; they just remained in a negative equity position for some time. And that had a long, dampening effect on their spending patterns. So there were complex reactions involved. But this time around, at least based on my conversations with U.K. officials, they think they’ve improved a lot of those things. So in that sense, there is something to be learned. Financial institutions now know better how to maintain their balance sheets and how to do this lending. The households know better, too; they’ve learned a bit. U.K. officials think they’ve seen a lessening to some degree of this tight link between housing wealth and consumption so that they’re not both on the run-up and then, when it stops, extrapolating what the consequences would be. On the other hand, I have to admit that I occasionally read my little machine while I sit here, and in the last hour it carried three statements from a member of the Bank of England’s Monetary Policy Committee who must have been making a speech. And all three statements the media chose June 29-30, 2005 68 of 234 [Laughter] And all of the statements were slightly two-handed, along the lines of: Monetary policy should not be driven by housing prices, but we must look at them closely. [Laughter] I think there are lessons to be learned; I’m not saying there aren’t. But certainly the 1990s episode had some characteristics that were far more extreme and that would never happen here because of institutional differences. And the present episode, which has remedied some of those earlier problems, I think is not such a bad deal. They’ve slowed the increase in housing prices. They aren’t having negative equity. They don’t have financial institutions that look like they’re going to become or technically are insolvent. I think in that sense they moved to improve their infrastructure, so to speak. They talk about the issue a lot but I think they feel the situation is okay at this time." CHRG-110hhrg41184--180 Mr. Bernanke," It is very difficult to know and we have been wrong before. But given how much construction has come down already, I imagine that by later this year, housing will stop being such a big drag directly on GDP. Prices may decline into next year, but we don't really know. The useful thing to appreciate, I guess, is that as house prices fall, they are self-correcting in a way because part of the reason that prices peaked and began to come down was that housing had become unaffordable. The median family couldn't afford a median home. As prices come down and incomes go up, you get more affordability and therefore more people come into the market. " FOMC20080916meeting--89 87,MR. STOCKTON.," Thank you, Mr. Chairman. In response to your request for some economy in our remarks this morning, I'm going to set aside my prepared remarks and just hit some of the highlights here. We did receive a great deal of macroeconomic data since we closed the Greenbook last Wednesday. We didn't seem to get any of it right, but it all netted out to just about nothing. [Laughter] Retail sales came in considerably weaker than we had anticipated, enough by themselves to have knocked about � percentage point off third-quarter GDP growth. But some of that was offset in higher retail inventories, and the rest was offset by a stronger-than-expected merchandise trade report for July. It all left us still feeling very comfortable with our forecast because it looks to us as though economic growth is going to drop below 1 percent on average in the second half of the year. In terms of the things that really have stood out over the intermeeting period, at least to my mind, one has been the weakness in consumption. As I indicated, the retail sales report was weak; and now with that report in hand, we'd probably mark down our current-quarter consumption forecast to a decline of 1� percent at an annual rate. What I think is really remarkable about that is that this weakness is occurring even though we still think spending is probably receiving some boost from the rebates. So excluding that effect, we'd be looking at something even weaker. Now, as you know, we've been head-faked a number of times by the retail sales data, which are subject to some pretty substantial revisions. So I wouldn't necessarily take that report at face value. But the drop we've seen in motor vehicle purchases pretty much mirrors in size and timing the kind of falloff that we've seen in overall consumption spending. So it looks like a very weak picture for consumption. The other notable development over the intermeeting period has been the weakness in the labor markets--now not principally in the payroll employment figures. Private payroll employment has been falling pretty sharply but not any faster than we would have thought. But the rise in the unemployment rate is remarkable. Now, some of the 0.4 percentage point increase in the unemployment rate last month could be statistical noise. It wouldn't be entirely surprising to see it fall back some. But the more than 1 percentage point rise that we've had since April is not going to be statistical noise. Some of that increase probably reflects a bigger response to the emergency unemployment compensation program than we previously thought, and we've upped our estimates for that to a little less than 0.3 percentage point on the level of the unemployment rate. But even putting that aside, we have experienced a more significant rise in the unemployment rate, and I think that's consistent with other things that we're seeing in terms of the labor market data. We've seen another appreciable jump in initial claims. Announced job cuts are up. Job openings are down. Survey hiring plans have softened. Now, this sharp rise in the unemployment rate is a bit difficult to square with a GDP figure that looks as though it was running above 3 percent in the second quarter and even 2 percent if you want to average the first and second quarters together. There are occasionally large errors in Okun's law, as I think I've noted in the past. It seems as though Okun's law gets obeyed about as frequently as the 55 mile an hour speed limit on I-95. [Laughter] But still, one of the things that we should probably be considering is that perhaps the economy has not been as strong as suggested by the real GDP figures. Real gross domestic income, which is output measured on the income side of the accounts, has risen about 2 percentage points less than GDP over the past year. And if we look at industrial production and compare that with the components of GDP that are, in essence, goods production, there's about a 1 percentage point discrepancy there, with industrial production suggesting weaker figures than GDP. We see no reason to discount the rise in the unemployment rate as suggesting that we're entering the second half with more labor market slack than we had previously thought. Furthermore, on net, we've revised down our projected growth in GDP over the next two years--admittedly just a bit--and that was in response to two pretty strong crosscurrents. One was the significantly lower oil prices that we have in this forecast. We do think they're going to provide some support to underlying disposable income and spending. But the positive effect of that on our forecast going forward was more than offset by a significant marking down in our forecast for net exports--which Nathan will be discussing--in response to an appreciation of the dollar and a further downward revision to our outlook for foreign activity. On net, that left us with a little lower growth rate and carrying forward a noticeably higher unemployment rate over the forecast period. Now, those were pretty small adjustments. I don't think we've seen a significant change in the basic outlook, and certainly the story behind our forecast is very similar to the one that we had last time, which is that we're still expecting a very gradual pickup in GDP growth over the next year and a little more rapid pickup in 2010. The three things that are absolutely central to producing that outcome are our projection that we're going to get a stabilization in housing in 2009--and early in 2009; that there will be some diminishment of the drag on growth from the financial turbulence; and that oil prices flatten out. Of those three, to my mind, the component that probably is most central and most important would be seeing some stabilization in the housing market, not only because this has been a big drag on growth and will also have consequences for household wealth but also because if there's going to be some clarity and reassurance to financial market participants, it seems as though some end to the housing debacle has to be in sight. We think we are seeing a few glimmers of hope there--however, we thought that on occasion in the past and have been proven wrong. But sales of existing homes have been flat since the turn of the year. Sales of new homes have been flat for several months now. We've had a drop in mortgage interest rates that followed the takeover of Fannie and Freddie. Starts have fallen so much now that, in fact, builders are making significant progress in working down the inventory of unsold new homes and even months' supply has tipped down of late. So we think that some things are looking a little better for us there. As a consequence, we're expecting to see some bottoming-out near the end of this year or the beginning of next year--but not a sharp recovery. Overall residential investment actually is still a negative for 2009 but less of a negative than it has been this year. As you know from the Greenbook, our estimates suggest that the financial restraints on overall activity--actually on the level of GDP--will increase between 2008 and 2009, but their effects on the growth rate of GDP are diminishing somewhat. Finally, with regard to oil prices, by our assessment the rise in crude oil prices since the beginning of 2006 is probably knocking about � percentage point off growth in 2008; and with a flattening out of oil prices, we expect that to be more of a neutral factor over the next two years. That's providing some impetus. A lot of what's going on in our forecast is bad things not worsening any more quickly next year than they did this year, rather than things actually getting better. I guess it's a sad comment that we're relying on second derivatives turning positive to be the main force generating some upward impetus to economic growth. But we are projecting a gradual pickup. Now, on the inflation side, this morning's CPI report for August actually came in a little better than we were expecting. The CPI in August fell 0.1 percent. We had been expecting an increase of 0.1 percent. That surprise was all in the energy component, but we at least did see some moderation in the retail food price side that we were looking for, and the change in core CPI fell back to 0.2 percent after a string of 0.3 percent increases. I don't think these data will do much to change our basic forecast, which is for total PCE prices to be up somewhere in the neighborhood of a 5 percent rate in the third quarter, and core prices up 3 percent. Still, if one looks back at the last few CPIs and PCEs, things have come in a little higher on the core side. The projected 3 percent increase is up about � percentage point from where we were in our August forecast, and our interpretation of this is that we're probably seeing more upward impetus and passthrough from the higher energy prices, other commodity prices, and imports than we had previously expected. That certainly squares with what we're hearing from our business contacts. It also squares with what we saw last week in the PPI, which was another very sharp increase in prices of intermediate materials. At least going forward, for the first time since this process got under way, we are seeing more than just a futures price forecast flattening out. Some easing in the prices of both oil and other commodities and the appreciation of the dollar are giving us at least a little more confidence that some of these cost pressures are going to abate going forward and that we will get the disinflation that we have been forecasting. We continue to see reasonably encouraging signs on inflation expectations. The medium-term and long-term inflation expectations in the preliminary Michigan report last week dropped 0.3 percentage point, to 2.9 percent. TIPS haven't really done very much, and hourly labor compensation continues to come in below our expectations. So based on our assessment, once these cost pressures work their way through the system--and we still think that the process will take place over the second half--we think that we'll get some receding of core inflation from the 2.4 percent that we're projecting for this year to 2.1 percent next year and 1.9 percent in 2010. Just a couple of final remarks on current events. Hurricanes Gustav and Ike obviously created an enormous amount of devastation for a whole lot of people, but they don't really appear to us to have significant macroeconomic consequences. There will be some temporary disruption to oil and gas extraction and refining, but it looks as though the basic infrastructure has largely been spared. I'll be interested to hear President Fisher's report. Retail gasoline prices have jumped in the last few days, but wholesale prices for delivery in October are actually lower than they were before the storms were on the horizon. I think that suggests that this is not going to be a major negative event. Undoubtedly, industrial production is going to fall like a stone in September, reflecting these two hurricanes as well as the Boeing strike, but we're expecting that to bounce right back again. I don't really have anything useful to say about the economic consequences of the financial developments of the past few days. I must say I'm not feeling very well about it at the present, but I'm not sure whether that reflects rational economic analysis or the fact that I've had too many meals out of the vending machines downstairs in the last few days. [Laughter] But in any event, we're obviously going to need to wait a bit to see how the dust settles here, but I think the sign would be obviously in a bad direction. I'll turn over the floor to Nathan. " CHRG-111hhrg74090--199 Mr. Cox," Chairman Rush, I think ultimately the industry will make two arguments about he concurrent authority and the problems with it. The first is, it is too much enforcement, but as Ms. Hillebrand said, and as someone who spent years making priority lists, your list is way longer than you will ever get to and the problem with this bubble bursting was not too much enforcement. The second problem which is more subtle or real is an inconsistency in enforcement policy, and Ms. Barkow appropriately says that this rulemaking authority, if it is clear, if the rules are clear enough, certainly will solve the problem, and I would further say that the CFPA is given the sufficient authority to make sure the is happening in a uniform way. But there is a second response to the inconsistency, which is unlike rulemaking where I agree you want a unified rulemaker, when it comes to enforcement, this is where regulatory competition actually works because you are competing to be a better enforcer as opposed to competing for a race to the bottom so that people will charter with you, which was a serious problem in creating this situation. And when you compete to do better, you are aware that if you don't do it and somebody else enforces your rule in a situation that you might get embarrassed, Madoff, SEC, you know, that when you have competitive enforcement you have a market that essentially forces public entities to be aware of that. That actually works, and when it comes to UDAP authority, I just want to say, it is so important. The state attorneys general, and I am patting myself on the back here because I was part of a small group who did this. We were the only ones out there screaming about and bringing these cases. The FTC was saying it is great because they were going after different actors but did one case where we got half a billion dollars back to people with subprime mortgages followed by another case where there was $300 million and I thought that was too little and I had left by then. I mean, this was a problem that if you were on the ground you saw it. I mean, it was visceral. These people were utterly out of control. The State AGs were able to enforce it because they had a different enforcement agenda. They were sitting at a different place. Regulatory competition works in terms of an open enforcement model. " fcic_final_report_full--585 East 2005,” September 20, 2005, pp. 5–7. 9. Alan Greenspan, “The Economic Outlook,” testimony before the Joint Economic Committee, 109th Cong., 1st sess., June 9, 2005. 10. Christopher Mayer, written testimony for the FCIC, Forum to Explore the Causes of the Financial Crisis, day 2, session 5: Mortgage Lending Practices and Securitization, February 27, 2010, pp. 5–6. 11. Antonio Fatás, Prakash Kannan, Pau Rabanal, and Alasdair Scott, “Lessons for Monetary Policy from Asset Price Fluctuations Leaving the Board,” International Monetary Fund, World Economic Out- look (Fall 2009), chapter 3. 12. James MacGee, “Why Didn’t Canada’s Housing Market Go Bust?” Federal Reserve Bank of Cleve- land. Economic Comment (December 2, 2009). 13. Morris A. Davis, Andreas Lehnert, and Robert F. Martin, “The Rent-Price Ratio for the Aggregate Stock of Owner-Occupied Housing,” Federal Reserve Board Working Paper, May 2005, p. 2. 14. Price data from CoreLogic CSBA Home Price Index, Single-Family Combined. Rent data is Bu- reau of Labor Statistics, metro-level Consumer Price Index (CPI-U), Owners’ Equivalent Rent for Pri- mary Residence; all index figures are adjusted so that Jan. 1997=1. Methods follow from Federal Reserve Bank of San Francisco Economic Letter, “House Prices and Fundamental Value,” Number 2004–27, Oc- tober 1, 2004. 15. National Association of Realtors Housing Affordability Index, accessed from Bloomberg as com- posite Index (HOMECOMP). The index began in 1986. 16. The index also assumes that the qualifying ratio of 25%, so that the monthly principal & interest payment could not exceed 25% of the median family monthly income. More about the methodology can be found at National Association of Realtors, Methodology for the Housing Affordability Index. 17. Ben Bernanke, letter to FCIC Chairman Phil Angelides, December 21, 2010, p. 2. 18. Kristopher S. Gerardi, Christopher L. Foote, and Paul S. Willen, “Reasonable People Did Disagree: Optimism and Pessimism about the U.S. Housing Market Before the Crash,” Federal Reserve Bank of Boston Public Policy Discussion Paper No. 10-5, August 12, 2010. 19. Donald L. Kohn, “Monetary Policy and Asset Prices , ” speech delivered at “Monetary Policy: A Journey from Theory to Practice,” a European Central Bank Colloquium held in honor of Otmar Issing, Frankfurt, Germany, March 16, 2006. 20. Richard A. Brown, “Rising Risks in Housing Markets,” memorandum to the National Risk Com- mittee of the Federal Deposit Insurance Corporation, March 21, 2005, pp. 1–2. 21. Board of Governors, memorandum from Josh Gallin and Andreas Lehnert to Vice Chairman [Roger] Ferguson, “Talking Points on House Prices,” May 5, 2005, p. 3. 22. Missal, p. 40. 23. William Black, testimony before the FCIC, Hearing on the Impact of the Financial Crisis—Miami, Florida, session 1: Overview of Mortgage Fraud, September 21, 2010, transcript, p. 78; and email from William Black to FCIC, December 12, 2010. 24. Reply of Attorney General Lisa Madigan (Illinois) to the FCIC, April 27, 2010, p. 7. 25. Chris Swecker, Assistant Director Criminal Investigative Division Federal Bureau of Investigation, statement before the House Financial Services Subcommittee on Housing and Community Opportunity, 108th Cong., 2nd sess., October 7, 2004. 26. Florida Department of Law Enforcement, “Mortgage Fraud Assessment,” November 2005. 27. Wilfredo Ferrer, testimony before the FCIC, Hearing on the Impact of the Financial Crisis— Miami, Florida, session 3: The Regulation, Oversight, and Prosecution of Mortgage Fraud in Miami, Sep- tember 21, 2010, transcript, pp. 186–87. 28. Ann Fulmer, supplemental written testimony for the FCIC, Hearing on the Impact of the Finan- cial Crisis—Miami, Florida, session 1: Overview of Mortgage Fraud, September 21, 2010, p. 2; Fulmer, testimony, transcript, pp. 80–81. 29. Ed Parker, interview by FCIC, May 26, 2010. 30. David Gussmann, interview by FCIC, March 30, 2010. 31. William H. Brewster, interview by FCIC, October 29, 2010. 32. Henry Pontell, written testimony for the FCIC, Hearing on the Impact of the Financial Crisis— FOMC20061212meeting--65 63,MR. MOSKOW.," Thank you, Mr. Chairman. Business activity in the Seventh District appears to be expanding at a slightly slower pace than the last time we met. But most of my contacts were still positive about the outlook, and when we put together our forecast for the national economy, we did not make any large changes to the projections of either growth or inflation. We see output recovering as we move into ’07 and core PCE staying near its current rate through the forecast period. As Janet discussed, we’ve talked about the bimodal nature of the national economy. Housing is weak, and the auto sector is struggling, but the rest of the economy is performing well. We see these sectoral differences, particularly with regard to autos, in our District economy. Michigan’s unemployment rate is about 7 percent, and it was the only state to show a year-over- year decline in the OFHEO house price measure. In contrast, Illinois and Wisconsin have a more diversified manufacturing base, and they’re doing well. Furthermore, we continue to hear reports of growth in demand for manufactured goods outside of autos and residential construction. One example of this is Caterpillar. They expect revenues from highway construction and mining equipment to remain strong with some easing in the U.S. market being offset by increased demand from abroad. Manufacturers of machine tools continue to report solid orders. Of course, such reports contrast sharply with our conversations with the Big Three automobile makers. General Motors indicates that they expect ’07 to be another challenging year. Incentives are one issue. GM thinks that their own incentives are now about the right level, including the Classic, [laughter] whereas others are still high. Another issue is that the UAW contract will be coming up for renewal next year in September, and the negotiations are expected to be difficult. Turning to labor markets more generally, Kelly and Manpower said that the overall nationwide placements of temporary workers were unchanged year over year, but placements of light industrial production workers continue to increase, and conversions from temporary to permanent remain strong. Moreover, their clients, while cautious, generally do not expect any prolonged period of weakness. These temp firms said that wage pressures were steady to down a bit, but a major national specialty retailer indicated that he was having difficulty hiring holiday workers and permanent workers and that he was planning for an increase of 10 to 12 percent in wages for entry-level full-time hires. Retailers also told us that they believed strong labor markets were supporting spending, and they were looking forward to good results for the holiday season. With regard to inflation, even though energy prices have moved off their peaks, there were few signs of rollbacks in fuel surcharges. Indeed, we even heard of further cost pass-throughs from petroleum-based inputs. However, we did not get the sense that general cost pressures were intensifying. Finally, we held our annual economic outlook symposium ten days ago in the midst of the first major snowstorm of the year. The three dozen hardy forecasters predicted real GDP growth of 2.8 percent in ’07 and the employment rate to drift up to 4.9 percent by the second half of the year. They also forecast that total CPI would increase 2½ percent and that sales of light vehicles would be 16.4 million units. Turning to the national outlook, the data have come in somewhat softer than I expected at our last meeting. Our uncertainty about the outlook has increased somewhat, but I still think that there are significant forces supporting activity and that the economy will return to a better growth path as we move into next year. To be sure, residential construction is quite weak, auto sales are softer, and the businesses supplying these industries are experiencing some sizable reductions in demand. However, I do not get the sense of a secondary spillover to other sectors of the economy. Importantly, the labor market has remained robust, supporting household spending—as we’ve talked about. Business confidence appears to be holding up fairly well. Indeed, I’m impressed by the lack of pessimism among my contacts, even those who are experiencing flattening sales or sluggish sales. Finally, real interest rates are low across the maturity spectrum, and risk spreads remain narrow. Given the liquidity in the system, it’s still hard to see current financial conditions as being that restrictive. In the end, we did not make any large changes to the overall contours of our GDP forecast. We still see the economy growing moderately below potential in ’07 and increasing at a pace moderately above potential in 2008. Now, we condition our baseline forecast on market expectations for interest rates. Accordingly, this outlook is boosted by the expected decline in the funds rate that’s in the market. If, like the Greenbook, we had assumed a flat federal funds rate path, we would project a recovery only to potential in ’08. Turning to inflation, the recent data have not clarified the trends. The six-month change in the core PCE price index is down, but the three-month numbers have moved up. In Chicago, we like to use indicator models, like the ones that Stock and Watson developed, as a way to assess the implications of incoming data for future inflation. These are time series models, and they forecast inflation based on more than 80 economic indicators linked to inflationary pressures. The projections of these models have changed little since our last meeting. Our forecasts continue to show inflation running too high for my taste. Even our most optimistic models, which are estimated using data only since 1984, have core PCE inflation flat at 2.4 percent through 2008. In sum, I am still concerned that inflation will be too high for too long; and even though the downside risks to growth have increased, I continue to see inflation as the predominant risk." FOMC20060131meeting--61 59,MR. STRUCKMEYER.," Your next two exhibits detail the supply-side assumptions of the staff forecast, starting with the projection of structural labor productivity. In our analysis, structural labor productivity growth is defined as the increment to labor productivity that can be sustained over time. It is a medium- to long-run concept that attempts to eliminate the bulk of the cyclical influences on productivity growth. As shown on the top right, structural labor productivity growth can, in turn, be decomposed into the contributions from capital deepening, labor quality, and structural multifactor productivity growth. As indicated in the middle left panel, the recovery that has occurred in the level of business capital spending over the past four years translates into a pickup in the growth of capital services, although not to the pace that prevailed during the boom years of 1995 to 2000. The contribution of capital deepening to structural productivity growth—that is, the product of the growth in capital services per hour and the capital share of output—picks up gradually over the next two years. Note in the middle right panel that the bulk of this contribution comes from investments in information technology—as has been the case for all of this decade. In contrast, the pace of growth in structural multifactor productivity—shown in the bottom left—has greatly exceeded the pace over the 1995 to 2000 period. This is just the manifestation at the aggregate level of the driving forces shown in Dave’s scatter plot. However, we have allowed for slightly slower growth in 2006 and 2007 than in the preceding years as the marginal gains from additional organizational improvements and embodied technical change begin to wane. In addition, as noted in the right, we’ve seen some leveling-off in expenditures on research and development lately, which may well manifest itself in a somewhat slower pace of technological change in the years ahead. Your next exhibit presents our estimates of potential output growth. As shown on line 1, we expect potential real GDP to expand at a 3¼ percent pace over the next two years. As you can see on line 2, total potential hours worked—or trend labor input— is expected to slow somewhat. Although population growth is expected to be well maintained, the trends in both labor force participation and the average workweek are offsetting factors. As we’ve noted before, the downtrend in the labor force participation rate (shown in the middle left) mainly reflects the changing demographic composition of the workforce. The estimated trend in the workweek (in the middle right panel) shifted down in 2001—reflecting the introduction of NAICS in the payroll survey—and is expected to fall at about the same pace in 2006 and 2007 as it has since 2001. The implications of these supply-side assumptions for the labor market are shown in the bottom two panels. Although nonfarm payrolls are expected to increase briskly in the near term, we expect gains to slow progressively over the next two years, reflecting the moderation in the pace of economic growth and the slower growth in the potential labor force that I just described. Indeed, we expect trend payroll growth to average only 100,000 per month over the next two years. As shown on the bottom right, the unemployment rate holds fairly steady this year and next. Given the pace of economic growth last year, our model of Okun’s law was surprised by the extent of the decline in the unemployment rate—the gap between the red and black lines. We are expecting this error to be worked off over the course of this year, and in 2007 the unemployment rate moves in sync with the Okun’s law simulation. Your next exhibit presents the outlook for the growth in labor compensation. In the January Greenbook, we projected hourly compensation, as measured by both the ECI and P&C compensation per hour, to accelerate over the next two years. We think that continued strong growth in structural labor productivity will elevate wage demands, while labor market slack will be a relatively neutral influence on compensation growth. Inflation expectations to date have remained anchored, but we have allowed for some pass-through into wages of the higher price inflation in 2004 and 2005. This morning’s reading on the ECI showed that hourly compensation in private industry increased 3 percent in the 12 months ending in December—the same as the judgmental projection in the January Greenbook. However, as you can see in the bottom left, our econometric equation for the ECI has overpredicted the actual growth in compensation since the middle of 2004, possibly suggesting that our estimated NAIRU of 5 percent is too high. In looking at the range of econometric wage and price models that we follow, the evidence on a change in the NAIRU is mixed. We have noted a tendency for some models to overpredict inflation lately. But as shown in the bottom right, the random nature (and the smaller absolute size) of the errors from one of our better reduced-form price equations does not yet suggest the need to lower our estimate of the NAIRU. I will return to the implications of this assumption later in my remarks. Your next exhibit presents the outlook for inflation. Recent readings on headline inflation (shown in the top left) have remained at the high end of the elevated range that has prevailed since 2004. Those readings reflect mainly the direct effects of higher energy prices, which have increased at an average pace of 20 percent per year over the past two years. In contrast, we have seen some moderation in the pace of core consumer price inflation, with the twelve-month change in both the core PCE and the core CPI indexes slowing to about 2 percent. Looking ahead, we have had to cope with somewhat greater pressures on inflation in this Greenbook. These pressures stem mainly from the upward revisions to our projections of crude oil prices and core nonfuel import prices that Dave discussed. As a result of these changes, the moderation in PCE energy prices is somewhat less than in past Greenbooks, and we anticipate greater spillovers on the prices of other industrial materials (shown in the middle right). On net, we expect core PCE prices (line 4 in the bottom left panel) to increase 2¼ percent this year before decelerating to 1¾ percent in 2007 as the influence of these cost shocks recedes. The bottom right panel shows two alternative simulations that address key risks to the inflation outlook. The adverse shocks simulation assumes that the economy is hit with additional increases in the prices of oil, non-oil imports, and industrial materials that match those that prevailed in 2004. Under the assumption that the funds rate remains on its baseline path, core PCE inflation moves up to about 2½ percent in 2006 and 2007 (the red line). In contrast, as I noted earlier, our estimate of the NAIRU may be too high, and a second simulation examines the implications of a 4¼ percent NAIRU—essentially one standard deviation below our current estimate. Under this assumption, core PCE price inflation falls to 1½ percent by the end of next year. Even though these two simulations embody some fairly large differences in assumptions from the Greenbook baseline, both simulations remain well inside a 70 percent confidence interval about our forecast. Nathan will now continue with our presentation." FOMC20080805meeting--76 74,MR. DUDLEY.," I think what makes it complicated, though, is that there's a nonlinearity. If the housing-price declines do turn out to be on the higher side, it then puts more stress on the financial system and on credit availability, which then leads to a weaker economy, which then puts more stress on the housing sector. So small differences in the path get amplified. " CHRG-111hhrg55811--296 Mr. Johnson," No I don't. Well, let me say I do and I don't. If forced to choose between the current discussion draft and the White House proposal, I would still prefer the White House proposal, but I can understand why the gentlemen on this panel with me who are describing primarily the impact on them rather than the overall impact on the market system-- " 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. " CHRG-110shrg50369--142 PREPARED STATEMENT OF SENATOR ELIZABETH DOLE Thank you, Chairman Dodd and Ranking Member Shelby for holding this very important hearing today. Chairman Bernanke, I join my colleagues in extending you a warm welcome. Since last August, our financial markets have experienced tremendous uncertainty. Credit and capital markets around the world have struggled to comprehend the ramifications of the U.S. subprime lending and housing crisis. Fortunately, the Federal Reserve has been quick to act, lowering the federal funds rate from 5.25 percent to 3 percent. Congress also is working to help boost our economy. Several recent reports have highlighted ongoing economic challenges. Such as last week, the Wall Street Journal said that the ``leading economic indicators'' fell for the fourth straight month. Since its July 2007 high, the index has fallen by 2 percent, which is the largest 6-month drop since 2001. Additionally, for the week ending on February 16, the 4-week average of initial unemployment claims rose by 10,750 to 360,500, pointing to a softening of the labor market. Furthermore, by the third quarter of 2007, household debt rose to $13.6 trillion from $7.2 trillion in 2001, a 10-percent annual increase. Over this same time period, mortgage borrowing more than doubled. As a result, one out of every seven dollars of disposable income earned by Americans goes towards paying down debt. Fears loom of higher inflation and more ``pain at the pump.'' The price of a barrel of oil has hovered around the $90 mark and recently closed above $100 per barrel. If these higher gas prices and inflationary pressures continue, coupled with the well-known weakness in across our housing sector, I--like many folks I hear from--am very concerned that future economic growth could be hindered. No question, the health of our economy is influenced by many complex issues and expected and unexpected events. That said, I would like to highlight a few areas where I am focused to help spur growth and job creation. I strongly support Trade Adjustment Assistance, which helps ensure that displaced workers have the ability to train for new careers. In recent years, my home state of North Carolina has undergone a difficult economic transition, as our state continues to evolve from a manufacturing and agriculture-based economy to a more services-oriented economy. In North Carolina and across the country, there is a need to address the growing gap between skilled and unskilled workers. Senator Cantwell and I have introduced legislation that would allow more workers to receive TAA benefits, including training, job search and relocation allowances, income support and other reemployment services. Additionally, with respect to current regulation of financial institutions, it has come to my attention that some smaller banks are overburdened by compliance with Sections 404 and 302 of the Sarbanes-Oxley corporate accountability law. Mr. Chairman, these financial institutions are already highly-regulated, and it has become increasingly apparent that these regulations, while well-intended, only increase their costs of doing business. I hope this committee will soon consider legislation that would provide true regulatory relief for all financial institutions. Chairman Bernanke, thank you again for being here today. I look forward to hearing from you--and working with you--on these and other important issues. FOMC20080130meeting--184 182,MR. FISHER.," First, Mr. Chairman, I want to say a good word about President Poole. I have sat next to him since I got here. I would give him hyperbolic praise if he hadn't handed me the IT Oversight Committee; otherwise, I think he is a wonderful human being. [Laughter] Much of what I was going to say has been said. I think President Plosser, President Lacker, and others have summarized what I would have said about my own District. We continue to grow, but at a decelerated pace, and our current forecast is for employment growth of 2 percent for our District for 2008. That is relatively healthy, and I really am not going to take more time on that subject. I am delighted to hear all this anecdotal evidence. We were talking, Governor Mishkin and I, about Woody Allen earlier. If I remember correctly, he had a wonderful quip--that he cheated on his metaphysics exam by looking into another boy's soul. [Laughter] Basically, what we are doing at this time of transition is almost cheating on the data by looking at the anecdotal evidence. My broader CEO soundings indicate pretty much the same as what we are seeing in our District and what others have mentioned--shipping, rail, express delivery, manufacturing, and other activities are much slower. Retail sales are soft. As President Poole and others pointed out, truckers are suffering. Receivables are being stretched out. Delinquencies are rising. I could bore you with specifics company by company, as I am tempted to do, but I will not unless you wish me to. The point is that, while there are tales of woe, none of the 30 CEOs to whom I talked, outside of housing, see the economy trending into negative territory. They see slower growth. Some of them see much slower growth. None of them at this juncture--the cover of Newsweek notwithstanding, a great contra-indicator, which by the way shows ""the road to recession"" on the issue that is about to come out--see us going into recession. I will just give you two indicators there. If you look at MasterCard and dig into their data, their December retail sales ex-auto, ex-gas, were up 5 percent and in January to date were up 4 percent. President Poole mentioned UPS, and President Lockhart has the incoming CEO of UPS on his board. Year over year to January, they are up 2 percent. So it is anemic. It is not negative. The expectation is not to be negative. My CEO soundings indicate pretty much what we have forecast as a group--much slower growth, not necessarily a recession. Where the difference comes, Mr. Chairman, is on the inflation front. Others have spoken eloquently about inflation. I just want to make a couple of comments here. It is uncanny in the charts that we show in exhibit 5, for example, that we have food PCE prices and energy PCE prices peaking almost as we speak. That may be true in the spot markets. That is not the way it works in reality. AT&T has 100,000 trucks. Southwest Airlines has I don't know how many airplanes. They contract and hedge out forward their energy costs, and the kick-in of any turndown does not occur immediately but rather is stretched out over a time period. I would ask our staff, as we go forward, to try to get a better feeling for that. We are certainly struggling with that in Dallas. As far as food prices are concerned, which again I remind you are twice the weight of energy prices in the headline PCE and the CPI, I heard some very disturbing news. Frito-Lay, for example, which when we last met I reported was going to increase prices 3 percent, has inched them up another 3 percent, to 6 percent, and that is their planning for the year. This is the first time in memory, according to my contacts, that grocery prices are rising faster than restaurant food. Yet it is not simply food where we are seeing this kind of pressure, and I want to come back to the lag effect that occurs. This morning the CEO of Burlington Northern told me that the so-called rail adjustment factor, which captures fuel, labor, supply, and other costs from the previous quarter and is contractually input into contracts for the coming quarter, rose at the highest rate in history--11 percent. That means that even if you are shipping lumber, even if you are shipping whatever goes into housing, by contract--of course, that can be negotiated, I am sure--for the coming quarter the price rise from the shippers, the railers, will be 11 percent. Finally, going back to food and other items bought by consumers--when you drill down deep into Wal-Mart, which has 127 million customers, and you talk about the specifics of their sales, their expansion is not coming from unit sales, it is coming from price inflation. A senior official there tells me that they are budgeting a 2 to 3 percent increase for nonfood items for '08, 6 to 7 percent for food items. It is the first time in his fifteen-year history at the company that they are going to use their price leadership strategy on the plus side of the inflation ledger. So I do worry about inflation expectations, Mr. Chairman. I will summarize with the statement that was in today's New York Times by the CEO of Tyson Foods, who said, ""Because of the unanticipated high corn and soybean meal costs, we have no choice but to raise prices substantially."" That is my major concern besides the additional weakness we are seeing in the economy. Thank you, Mr. Chairman. " 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. " FOMC20061025meeting--99 97,MR. POOLE.," Mr. Chairman, I was going to make a suggestion. I don’t know whether there is general assent to this. It seems to me it would be helpful, before our December meeting, to have a better read on the vulnerability of the housing firms to bankruptcy. I can imagine a lot of defaults there, causing us some concern or a lot of public concern. Presumably, with all our banking and housing contacts, we ought to be able to get a better read. All I know is the very informal kind of feedback that I received over recent weeks, and a lot of people brought up that all these builders have only six months or so and some of them are going to go under. So a suggestion is that, as part of the Beige Book process, we try to get a better read on that situation." FOMC20061025meeting--160 158,MR. KOHN.," Thank you, Mr. Chairman. I support keeping rates unchanged and alternative B. I think that rate, at least for now, seems consistent with growth of the economy just a tad below the growth of its potential and a gradual decline in inflation. Incoming data will tell us if we’re wrong on that, but right now that looks like our best bet to accomplish the objectives I think the Committee ought to be accomplishing. I agree that the pace and the extent of disinflation are great uncertainties here. President Poole has made a valuable contribution here about the loss function relative to the policy path. A failure to reverse the earlier increase in inflation is the main risk to good economic performance that we face. Therefore, we need to see a downward path of inflation. I think our minutes and our speeches have made it pretty clear that that’s what the Committee means by inflation risks remaining. I think the public understands that. President Poole has made a valuable distinction between the loss function and the economic outlook and what that implies for interest rates, but I don’t agree with his conclusion. After all, the Greenbook forecast has essentially a flat federal funds rate and a very, very gradual decline in inflation barely along the path that most Committee members could tolerate. If our loss function is asymmetrical relative to that, it’s more likely that interest rates would have to rise than to fall relative to the Greenbook path. Moreover, many members of the Committee seem to have a stronger path for output, and maybe even inflation going forward, than is embedded in the Greenbook. So the wording about additional firming that may be needed, the asymmetrical wording of a risk assessment, is the appropriate representation of how this Committee is looking at the potential future path of interest rates given both the loss function and the Committee’s outlook for growth and inflation. I do have some comments on the language. In section 2, I like the addition of the forward-looking language and, unlike President Fisher, the use of “moderate.” It seems to me that the word “moderate” is fairly ambiguous, but it does suggest that we don’t expect a great deal of weakness going forward or a great deal of strength. I think that’s about where the Committee is—growth close to, maybe a bit below, the growth of potential, and the word “moderate” conveys the sense that the Committee wasn’t looking for something really weak or something really strong going forward. So I think that was a valuable addition. Like you, President Fisher, I did wonder about the specific reference to the third quarter and how that would play out. Governor Kroszner actually brought this to my attention on Friday. The advantage of the reference to the third quarter is that, by our acknowledging a weak third quarter, the markets might not react as strongly to a print that begins with the number 1 as they would if we didn’t acknowledge that. There are also a couple of disadvantages. The third quarter could come in much closer to 2½ percent. There are a lot of assumptions built into that number. We could be wrong. But even more important, from my perspective, an awful lot of the weakness in the third quarter is in net exports and inventory change. The underlying feel to the third quarter and final demand aren’t really all that different from the second quarter. So emphasizing the weakness in the third quarter in our language may not give a good sense of what we think the underlying situation was. Alternative language might be a more general sentence saying that “economic growth has slowed over the course of the year, partly reflecting a cooling of the housing market.” That more general sentence about “over the course of the year” probably reflects better where the Committee is. I could live with the third-quarter language that’s in there now, but I would have a slight preference for the other one. In section 3, I actually have a slight preference for the wording under alternative A. I’ve always been a little uncomfortable with relating the outlook for inflation to the level of energy prices. The last major increase in energy prices was last spring, and I think they’ve been kind of level since April or May and actually have come down. Some of the commentary after our last announcement pointed out the contradiction in which we have energy prices both pushing up inflation and pulling it down in the future. So my slight preference, again, would be for the wording of alternative A, which says that the high level of resource utilization has the potential to sustain pressures. It doesn’t reference the high level of prices of energy and other commodities. In section 4, the risk assessment, looking at the language that Vincent put on the table yesterday, I think the first sentence of that does a better job of enunciating what the Committee has been thinking about—that the reduction of inflation is what we’re looking at. But I’m hesitant to change the risk assessment language. I think that people do understand what we mean by our risk assessment language now. I am concerned that changing it would provoke a reaction, and I’m not confident that I know what the reaction would be. So my preference, again, is to stick with the current risk assessment language that’s in alternative B. Thank you, Mr. Chairman." CHRG-110hhrg38392--107 The Chairman," The gentleman from Texas. Dr. Paul. Thank you, Mr. Chairman. I find it rather ironic that the Federal Reserve has complete control over the money supply, yet it is the Treasury that is supposed to protect the value of the dollar. It seems like you have a little bit of responsibility for the value of the dollar as well. I have a question about the GDP. In the first quarter, our GDP did not do so well; it was less than 1 percent. Our population growth averages about 1.5 percent. So, if we have total wealth divided by the population, we actually have negative growth. Could this not be a part of the explanation as to why some people feel there is inequality and that they are not doing as well in the economy? Wouldn't this explain some of the concerns that we have? " 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." FOMC20060328meeting--40 38,MR. LACKER.," Dave, I was struck by the alternative scenario in which productivity growth is slower because, even with the Taylor rule in place, it makes inflation rise rather than nominal compensation growth fall. So I was just wondering, does that result convey a lack of credibility in the estimated Taylor rule, or what do you think is going on there?" FOMC20060920meeting--66 64,MR. FISHER.," Well, again, it’s just something I’m interested in. It’s not unimportant, but I have a more important question. Karen, I noticed last week that the International Monetary Fund forecasts global economic growth, non-U.S. growth, of around 5 percent. Our number is 3¼ percent. What is the difference between us? If we’re underestimating, what would be the policy implications?" FOMC20061025meeting--59 57,MR. FISHER.," Mr. Chairman, at our last meeting I engaged in a little Texas brag. I mentioned that the employment growth rate in our District was twice that of the national average. Then I read in the pre-briefing for the Board last night the penultimate sentence, which had a wonderful three-word phrase—“Humility is required.” So let me report that economic growth in our District has slowed somewhat, and I want to put the “somewhat” in perspective. We redid the numbers of our first-quarter real GDP growth. Growth of the state real gross product for the first quarter was 9 percent for the Eleventh District. So it’s not a great wonder that it is slowing—it is slowing down from too torrid a pace. But our housing sector is still sweet—perhaps the only spot left in the country—particularly in the Houston area. We actually are building a new auto plant, President Moskow, a Toyota plant in San Antonio, which is getting an inordinate amount of attention. The exports from our state are growing at a monthly rate annualized at 45 percent, and Texas is now the largest exporting state in the nation. So from the standpoint of economic growth, even as I am trying to be humble, the District is doing exceedingly well. The only consistently sour note that we hear is what you have heard around this table—and just now from First Vice President Barron—that we have continued reports of shortages of skilled and unskilled labor, from chemical engineers to school teachers to bank tellers and even to hotel housekeeping staff. So we have a significant problem in terms of labor shortages—skilled, semi- skilled, and now, increasingly, unskilled. To put some numbers on this, we have a contact who has surveyed fifty plants on the Gulf Coast for the price of welders. In eight months, the price for a welder has gone from $19 an hour to $25 an hour. You have to pay them a bonus of $100 when they show up, and you have to pay them a completion bonus as well. The bottom line is that in the Eleventh District we’re behaving as though we were a full-employment economy. In the rest of my comments, I’d like to emphasize not my District but our views on the U.S. and the global economies, particularly the U.S. economy. I want to go back to your concluding remarks, Mr. Chairman, at the last meeting, when you reminded us that, if we believe we need to have output below potential to help address inflation pressures, it’s a delicate operation, and we may have a very narrow channel to navigate as we go forward—just to keep with your naval analogy of a few seconds ago. This summer I sailed the Corinth Canal, which is so narrow that at times you feel you can reach out and touch both sides. Even though I was on vacation, I was actually thinking of one side as the shoals of slow economic growth—almost recessionary growth, which seems to be what the Greenbook is forecasting at least for the third quarter, and the risk that seems to be out there—and of the other side as the shoals of inflation. From the 27 or 28 CEOs and CFOs to whom I spoke in preparing for this meeting, as I always do, I do hear reports of a slowdown. I talked to two of the Big Five housebuilders this time. They are cutting back significantly. Let me give you some numbers. For example, Centex owns 109,000 lots outright and has 54,000 lots under hard option and 80,000 lots under soft option, as they call it. They’ve canceled 25 percent of their hard options. That is $85 million worth of properties. Hovnanian is walking away from $100 million worth of hard option properties. The effort there is to cut back so that what was a two-month leading supply has now become a three- month leading supply. You can see how the dynamics are beginning to work. They’re moving on price, but they are also trying to shut down their inventory and are taking very quick action. That is a depressing factor. One of the truck dealers I talked with, Rush Enterprises, has about $2.7 billion a year in sales. I believe they are the largest in the country; they are nationwide. They are reporting that Christmas retail activity seems to be backing up; in other words, it is slower than it was in previous years. This is an operator with 41 years of experience. They are also building their inventory, particularly in the coastal areas, with the heavy trucks that are going to be used for home construction. The book-to-bill ratio for Texas Instruments has fallen below 1; it is the lowest since 2000. And if you read the newspapers, you will see that the airlines are offering very deep discounts and for longer periods than before. So there seems to be a slowdown in activity. With that said, when you talk to the rails, there is a diminution of growth, perhaps 1 percent third quarter over second quarter, and if you talk to UPS, as I reported last time, you’re still seeing some rather robust reports of economic growth of 2 to 3 percent. I think the best way to summarize the economy is, as President Moskow said earlier, that although there are weak signs, the economy is still robust. The chairman and CEO of Cadbury-Schweppes said, “I keep looking and listening, but I’m just not seeing what everybody tells me is going to happen.” Again, as I reported last time, the CEO of EDS, who is an experienced businessman, said, “It’s a funny period. Everybody is prepared to be bearish, but it’s simply not materializing.” So, David, from an economic standpoint, both from the anecdotal evidence and our own economic modeling, we don’t quite accept the Greenbook’s forecast of the kind of slowdown that you’re expecting for the third quarter or for the second half. There are positive benefits, and the benefits are, of course, with price pressure abatement. My favorite anecdotal example, by the way, comes from globalization at work, Karen. Interestingly, the CEO of Fluor, who is one of my contacts, reports that when they bid for the Bay Bridge construction, their bid on U.S. steel prices was rejected as being too expensive. They went back and bid based on what they could buy steel from China for, and the bid was accepted. Canadian steel now sells for 25 percent less than U.S. steel, and Chinese steel is being dumped into this market at a price 40 percent lower than Canadian steel. From the standpoint of raw materials and energy, you have seen price pressure abatement. But from businessperson after businessperson, we still hear the same reports, Mr. Chairman, that we hear in our District and that you’ve heard around this table, which is of significant price pressures stemming from labor. As I mentioned earlier, it is not just skilled labor; it is now semi-skilled labor such as truck drivers and welders. Increasingly shortages are being reported, throughout our District and the rest of the country. So I would summarize by agreeing with President Moskow in that we in the Eleventh District find the Greenbook’s projection of economic growth to be too pessimistic. Although price pressures have abated somewhat, we know by our measure—the trimmed-mean PCE, off of which we key our view of the economy—that the three-month rate is still running at 2.9 percent and the twelve-month rate is running at 2.7 percent. I would argue as we navigate this narrow channel, Mr. Chairman, whether it’s the channel you describe or the Corinth Canal, that I would be more careful of the inflationary shoals than of the risk of excessive slowdown of growth. Thank you." fcic_final_report_full--472 Much of the Commission majority’s report, which criticizes firms, regulators, corporate executives, risk managers and ratings agency analysts for failure to perceive the losses that lay ahead, is sheer hindsight. It appears that information about the composition of the mortgage market was simply not known when the bubble began to deflate. The Commission never attempted a serious study of what was known about the composition of the mortgage market in 2007, apparently satisfied simply to blame market participants for failing to understand the risks that lay before them, without trying to understand what information was actually available. The mortgage market is studied constantly by thousands of analysts, academics, regulators, traders and investors. How could all these people have missed something as important as the actual number of NTMs outstanding? Most market participants appear to have assumed in the bubble years that Fannie and Freddie continued to adhere to the same conservative underwriting policies they had previously pursued. Until Fannie and Freddie were required to meet HUD’s AH goals, they rarely acquired subprime or other low quality mortgages. Indeed, the very definition of a traditional prime mortgage was a loan that Fannie and Freddie would buy. Lesser loans were rejected, and were ultimately insured by FHA or made by a relatively small group of subprime originators and investors. Although anyone who followed HUD’s AH regulations, and thought through their implications, would have realized that Fannie and Freddie must have been shifting their buying activities to low quality loans, few people had incentives to uncover the new buying pattern. Investors believed that there was no significant risk in MBS backed by Fannie and Freddie, since they were thought (correctly, as it turns out) to be implicitly backed by the federal government. In addition, the GSEs were exempted by law from having to file information with the Securities and Exchange Commission (SEC)--they agreed to file voluntarily in 2002--leaving them free from disclosure obligations and questions from analysts about the quality of their mortgages. When Fannie voluntarily began filing reports with the SEC in 2003, it disclosed 35 Fannie Mae, 2010 Second Quarter Credit Supplement, http://www.fanniemae.com/ir/pdf/sec/2010/ q2credit_summary.pdf. 36 “Moody’s Projects Losses of Almost Half of Original Balance from 2007 Subprime Mortgage Securities,” http://seekingalpha.com/article/182556-moodys-projects-losses-of-almost-half-of-original- balance-from-2007-subprime-mortgage-securities. 467 that 16 percent of its credit obligations on mortgages had FICO scores of less than 660—the common definition of a subprime loan. There are occasionally questions about whether a FICO score of 660 is the appropriate dividing line between prime and subprime loans. The federal bank regulators use 660 as the dividing line, 37 and in the credit supplement it published for the first time with its 2008 10-K, Fannie included loans with FICO scores below 660 to disclose its exposure to loans that were other than prime. As of December 31, 2008, borrowers with a FICO of less than 660 had a serious delinquency rate about four times that for borrowers with a FICO equal to or greater than 660 (6.74% compared to 1.72%). 38 Fannie did not point out in its filing that a FICO score of less than 660 was considered a subprime loan. Although at the end of 2005 Fannie was exposed to $311 billion in subprime loans it reported in its 2005 10-K (not filed with the SEC until May 2, 2007) that: “The percentage of our single-family mortgage credit book of business consisting of subprime mortgage loans or structured Fannie Mae MBS backed by subprime mortgage loans was not material as of December 31, 2005.”[emphasis supplied] 39 Fannie was able to make this statement because it defined subprime loans as loans it purchased from subprime lenders. Thus, in its 2007 10-K report, Fannie stated: “Subprime mortgage loans are typically originated by lenders specializing in these loans or by subprime divisions of large lenders, using processes unique to subprime loans. In reporting our subprime exposure, we have classified mortgage loans as subprime if the mortgage loans are originated by one of these specialty lenders or a subprime division of a large lender .” 40 [emphasis supplied] The credit scores on these loans, and the riskiness associated with these credit scores, were not deemed relevant. Accordingly, as late as its 2007 10-K report, Fannie was able to make the following statements, even though it is likely that at that point it held or guaranteed enough subprime loans to drive the company into insolvency if a substantial number of these loans were to default: FOMC20080916meeting--114 112,MR. LOCKHART.," Thank you, Mr. Chairman. I finalized the thinking that went into my prepared remarks late last week, which seemed like a good idea at the time. But I should follow the philosophy of Charlie Brown, who I think said, ""Never do today what you can put off until tomorrow."" [Laughter] Obviously, we can't ignore the events of the weekend and yesterday's financial markets. So late yesterday I reviewed the views that I shaped last week and tried to ground them in an assessment of whether the outlook for the real economy has changed materially, whether the balance of risks has been altered, and whether, in my opinion, we must reintroduce a risk-management approach and consider taking out more insurance. With that as prologue, let me make just a couple of comments on regional soundings from the last couple of weeks. Anecdotal reports from the Sixth District support the view that the economy is quite weak but not deteriorating markedly. The CFO of a large retailer of housing-related goods said that they think they see a bottom forming. I am also starting to hear some reports that housing markets feel as though they are beginning to stabilize; but, really, it is a little too early to say that a bottom has formed in any of our housing markets. My overall sense from District contacts and our surveys is of an economy that is quite weak, with no clear trend evident. Turning to the national outlook, like most forecasts, my view on the likely path for the economy has not changed materially since our August meeting. I see nothing in the data and hear nothing from District reports that alters my views that the second half will be very weak. I expect this weak period to be followed by a slow recovery gathering in 2009, but the foundation of a recovery starting around year-end or early 2009 may be far from solid. The contraction of credit availability that is confirmed by both surveys and anecdotal evidence could deepen as financial institutions face tight liquidity and difficulty recapitalizing. A protracted credit crunch would likely operate as a substantial drag on the economy. Consistent with the Greenbook, I expect some near-term improvement in headline inflation, as we saw this morning, some near-term deterioration of core inflation measures, and inflation moving in the right direction later this year and into next year. That said, one director said that he and his particular industry had seen no moderation of price increases up to this date. I am comforted somewhat that the upward drift in some inflation expectation measures appears to have been reversed. In addition, my staff has been monitoring revisions to inflation forecasts of professional forecasters, which also seem to suggest that concerns about accelerating inflation have abated somewhat. Regarding the balance of risks in the economy, I am concerned that the downside risks to growth may be gathering force, as evidenced by the weakening personal consumption and retail sales data, the weakening economies of export partners, and the delicate state of the financial markets. At the same time, I perceive that there is significant risk that the current disinflationary environment may fail to bring core inflation down to anything resembling acceptable levels for the longer term. Adding up all of this, I perceive a very rough balance of risks that could break either way in coming months. My view of the appropriate policy path is consistent with the Greenbook--that the fed funds rate target will remain stable at or close to the current level for several months going into 2009. My preference is to hold the fed funds rate at the current level of 2 percent. Among the reasons is that a � percentage point drop, as suggested by alternative A, is really not clearly called for by a changed outlook for the real economy. Inflation risks are still in play, and I think we should give credit markets more time to digest events and sort out rate relationships. As regards the statement, my preference is alternative B. However, I am concerned that the reference to the recent financial turbulence is not quite strong enough, so I took a shot at rephrasing just the beginning of the rationale section to read as such: ""Economic growth appears to have slowed recently, and labor markets have weakened further. In addition, strains in financial markets have increased significantly""--basically taking the slightly stronger expression in the alternative A rationale and putting it in alternative B. So my position, Mr. Chairman, is to hold at this meeting. Thank you very much. " fcic_final_report_full--56 In , President Bill Clinton announced an initiative to boost homeownership from . to . of families by , and one component raised the affordable housing goals at the GSEs. Between  and , almost . million households entered the ranks of homeowners, nearly twice as many as in the previous two years. “But we have to do a lot better,” Clinton said. “This is the new way home for the American middle class. We have got to raise incomes in this country. We have got to increase security for people who are doing the right thing, and we have got to make people believe that they can have some permanence and stability in their lives even as they deal with all the changing forces that are out there in this global economy.”  The push to expand homeownership continued under President George W. Bush, who, for example, introduced a “Zero Down Payment Initiative” that under certain cir- cumstances could remove the  down payment rule for first-time home buyers with FHA-insured mortgages.  In describing the GSEs’ affordable housing loans, Andrew Cuomo, secretary of Housing and Urban Development from  to  and now governor of New York, told the FCIC, “Affordability means many things. There were moderate income loans. These were teachers, these were firefighters, these were municipal employees, these were people with jobs who paid mortgages. These were not subprime, preda- tory loans at all.”  Fannie and Freddie were now crucial to the housing market, but their dual mis- sions—promoting mortgage lending while maximizing returns to shareholders— were problematic. Former Fannie CEO Daniel Mudd told the FCIC that “the GSE structure required the companies to maintain a fine balance between financial goals and what we call the mission goals . . . the root cause of the GSEs’ troubles lies with their business model.”  Former Freddie CEO Richard Syron concurred: “I don’t think it’s a good business model.”  Fannie and Freddie accumulated political clout because they depended on federal subsidies and an implicit government guarantee, and because they had to deal with regulators, affordable housing goals, and capital standards imposed by Congress and HUD. From  to , the two reported spending more than  million on lob- bying, and their employees and political action committees contributed  million to federal election campaigns.  The “Fannie and Freddie political machine resisted any meaningful regulation using highly improper tactics,” Falcon, who regulated them from  to , testified. “OFHEO was constantly subjected to malicious political attacks and efforts of intimidation.”  James Lockhart, the director of OFHEO and its successor, the Federal Housing Finance Agency, from  through , testified that he argued for reform from the moment he became director and that the companies were “allowed to be . . . so politically strong that for many years they resisted the very legislation that might have saved them.”  Former HUD secre- tary Mel Martinez described to the FCIC “the whole army of lobbyists that continu- ally paraded in a bipartisan fashion through my offices. . . . It’s pretty amazing the number of people that were in their employ.”  FinancialCrisisReport--72 Mr. Killinger’s annual “Strategic Direction” memoranda to the Board in 2005, 2006, and 2007, also contradict his testimony that the strategy of expanding high risk lending was put on hold. On the first page of his 2005 memorandum, Mr. Killinger wrote: “We continue to see excellent long-term growth opportunities for our key business lines of retail banking, mortgage banking, multi-family lending and sub-prime residential lending.” 184 Rather than hold back on WaMu’s stated strategy of risk expansion, Mr. Killinger told the Board that WaMu should accelerate it: “In order to reduce the impact of interest rate changes on our business, we have accelerated development of Alt-A, government and sub-prime loan products, as well as hybrid ARMs and other prime products, specifically for delivery through retail, wholesale and correspondent channels.” 185 The 2005 strategic direction memorandum also targeted Long Beach for expansion: “Long Beach is expected to originate $30 billion of loans this year, growing to $36 billion in 2006. To facilitate this growth, we plan to increase account managers by 100. We expect Long Beach to have 5% of the sub-prime market in 2005, growing to [a] 6% share in 2006.” 186 Despite warning against unsustainable housing prices in March 2005, Mr. Killinger’s 2006 “Strategic Direction” memorandum to the Board put even more emphasis on growth than the 2005 memorandum. After reviewing the financial targets set in the five-year plan adopted in 2004, Mr. Killinger wrote: “To achieve these targets, we developed aggressive business plans around the themes of growth, productivity, innovation, risk management and people development.” 187 His memorandum expressed no hesitation or qualification as to whether the high risk home lending strategy was still operative in 2006. The memorandum stated: “Finally, our Home Loan Group should complete its repositioning within the next twelve months and it should then be in position to grow its market share of Option ARM, home equity, sub prime and Alt. A loans. We should be able to increase our share of these categories to over 10%.” 188 Contrary to Mr. Killinger’s hearing testimony, the 2006 memorandum indicates an expansion of WaMu’s high risk home lending, rather than any curtailment: “We are refining our home loans business model to significantly curtail low margin Government and conventional fixed rate originations and servicing, and to significantly 184 6/1/2005 Washington Mutual memorandum from Kerry Killinger to the Board of Directors, “Strategic Direction,” JPMC/WM - 0636-49 at 36, Hearing Exhibit 4/13-6c. 185 Id. at 644. 186 Id. at 646. 187 6/6/2006 Washington Mutual memorandum from Kerry Killinger to the Board of Directors, “Strategic Direction,” JPM_00808312-324 at 314, Hearing Exhibit 4/13-6d. 188 Id. at 315 [emphasis in original removed]. increase our origination and servicing of high margin home equity, Alt. A, sub prime and option ARMs. Action steps include merging Longbeach sub prime and the prime business under common management, merging correspondent activities into our correspondent channel, getting out of Government lending, curtailing conventional fixed rate production, expanding distribution of targeted high margin products through all distribution channels and potentially selling MSRs [Mortgage Servicing Rights] of low margin products. We expect these actions to result in significantly higher profitability and lower volatility over time.” 189 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. " FOMC20070131meeting--62 60,CHAIRMAN BERNANKE., You also have to assume that the Fed accommodates with increased nominal GDP growth as well. CHRG-109shrg30354--86 Chairman Bernanke," No, not perfectly, but if things go as generally expected. I think there is a lot we could do to make those forecasts more informative and that might be one direction to go in the future. But I understand that is an ambiguous phrase. Senator Sununu. You also say in your testimony that ``It bears emphasizing that, because productivity growth seems likely to remain strong.'' So you were assuming that productivity growth will remain strong. On what are you basing that assumption? " CHRG-111shrg56376--178 Mr. Ludwig," I do not think you need to do that. I think the issue of the Federal thrift charter is an issue that is fundamentally steeped in the housing policy of the United States. That is, do we want to foster housing as a special goal. That decision need not be made if you have a single consolidated institutional supervisor. Senator Reed. Thank you, gentlemen. " CHRG-110hhrg41184--178 Mr. Bernanke," Well, the housing market is correcting for that reason, and house prices are declining. But at some point the market will stabilize, and demand will come back into the market. Construction, which is already down more than half, will begin to stabilize, and then subsequently prices will begin to stabilize. That's what we're looking forward to. " CHRG-110hhrg44903--61 Mr. Scott," Another part of my question is yesterday, we made a very bold and I think a very, very, very good and substantial move with our housing package. And given the fact that now we have addressed our housing package, let me ask you, do you believe that a second round of stimulus package is necessary? Would you support a second round of stimulus in the face of what people are saying and economists, that we still expect sustained economic weakness to last, many say, for the next 2 or 3 years? So my point is, given the housing package, given the earlier stimulus, do you foresee down the road a necessity to move with a second stimulus package? And what do you think the first stimulus package has done? " CHRG-111shrg57319--5 MUTUAL BANK " Mr. Vanasek," OK. Mr. Chairman, Senator Coburn, and distinguished Members of the Committee, thank you for the opportunity to discuss the mortgage and financial crisis from the perspective of a Chief Credit Officer in the sixth-largest bank in this country.--------------------------------------------------------------------------- \1\ The prepared statement of Mr. Vanasek appears in the Appendix on page 134.--------------------------------------------------------------------------- I was the Chief Credit Officer and later the Chief Risk Officer of Washington Mutual during the period of September 1999 to December 2005, when I retired. Prior to serving in this capacity, I had worked for several large banking companies in senior credit-oriented roles, including PNC, First Interstate Bank, Norwest/Wells Fargo. Altogether, I have 38 years of experience in credit-oriented positions and have been fortunate enough to have well-established histories and constructive relationships with all of the major banking regulators. The failure of Washington Mutual occurred in September 2008, nearly 3 years after my retirement, so much of what I will tell you today is historical information about the company's strengths and weaknesses during the years of my direct involvement. Washington Mutual was a reflection of the mortgage industry characterized by very fast growth, rapidly expanding product lines, and deteriorating credit underwriting. This was a hyper-competitive environment in which mistakes were made by loan originators, lending institutions, regulatory agencies, rating agencies, investment banks that packaged and sold mortgage-backed securities, and the institutions that purchased these excessively complex instruments. It was both the result of individual failures and systemic failures fueled by self interest, failure to adhere to lending policies, very low interest rates, untested product innovations, weak regulatory oversight, astonishing rating agency lapses, weak oversight by boards of directors, a cavalier environment on Wall Street, and very poorly structured incentive compensation systems that paid for growth rather than quality. One must also seriously question the wisdom of the elimination of Glass-Steagall and its impact on the securitization market. Washington Mutual was a company that had grown with exceptional speed due to acquisitions primarily in California during the industry crisis of the early 1990s. By 2000, it was a company in search of identity. At one point, the CEO wanted the company to expand the commercial lending area in an effort to earn a higher price earnings ratio on the stock, only to abandon the strategy 3 years later. The focus then shifted to rapidly expanding the branch network by opening as many as 250 locations within 12 months in cities where the company had no previous retail banking experience. Ultimately, this proved to be an unsuccessful strategy due in part to the effort to grow too quickly. The focus then shifted away from the diversification to becoming the so-called low-cost producer in the mortgage industry. This effort was likewise unsuccessful, in large measure due to an expensive undertaking to write a completely new mortgage loan origination and accounting software system that ultimately failed and had to be written off. By mid-2005, the focus had shifted again to becoming more of a higher-risk subprime lender at exactly the wrong time in the housing market cycle. This effort was characterized by statements advocating that the company become either via acquisition or internal growth a dominant subprime lender. In addition to subprime, the company was a large lender of adjustable-rate mortgages, having had 20 years' experience with the product. As in the case of subprime, the product had only been available to a narrow segment of customers. Adjustable-rate mortgages were sold to an ever-wider group of borrowers. Product features were also expanded. Historically, plain vanilla mortgage lending had been a relatively safe business. During the period 1999 to 2003, Washington Mutual mortgage losses were substantially less than one-tenth of one percent, far less than losses of commercial banks. But rapidly increasing housing prices masked the risks of a changing product mix and deteriorating underwriting, in part because borrowers who found themselves in trouble could almost always sell their homes for more than the mortgage amount, at least until 2006 or 2007. There is no one factor that contributed to the debacle. Each change in product features and underwriting was incremental and defended as necessary to meet competition. But these changes were taking place within the context of a rapidly increasing housing price environment and were, therefore, untested in a less favorable economic climate. 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. The appetite of Wall Street and investors worldwide created huge demand for high-yielding subprime mortgages that resulted in a major expansion of what was historically a relatively small segment of the business led by Household Finance. The Community Reinvestment Act also contributed by demanding loans--that banks make loans to low-income families, further expanding subprime lending. One obvious question is whether or not these risks were apparent to anyone in the industry or among the various regulatory or rating agencies. There is ample evidence in the record to substantiate the fact that it was clear that the high-risk profile of the entire industry, to include Washington Mutual, was recognized by some but ignored by many. Suffice it to say, meeting growth objectives to satisfy the quarterly expectations of Wall Street and investors led to mistakes in judgment by the banks and the mortgage lending company executives. A more difficult question is why boards of directors, regulatory agencies, and rating agencies were seemingly complacent. Another question may be my personal role and whether I made significant effort to alter the course of lending at Washington Mutual. In many ways and on many occasions, I attempted to limit what was happening. Just a few examples may suffice. I stood in front of thousands of senior Washington Mutual managers and executives in an annual management retreat in 2004 and countered the senior executive ahead of me on the program who was rallying the troops with the company's advertising line, ``The power of yes.'' The implication of that statement was that Washington Mutual would find some way to make a loan. The tag line symbolized the management attitude about mortgage lending more clearly than anything I can tell you. Because I believed this sent the wrong message to the loan originators, I felt compelled to counter the prior speaker by saying to the thousands present that the power of yes absolutely needed to be balanced by the wisdom of no. This was highly unusual for a member of the management team to do, especially in such a forum. In fact, it was so far out of the norm for meetings of this type that many considered my statement exceedingly risky from a career perspective. I made repeated efforts to cap the percentage of high-risk and subprime loans in the portfolio. Similarly, I put a moratorium on non-owner-occupied loans when the percentage of these assets grew excessively due to speculation in the housing market. I attempted to limit the number of stated income loans, loans made without verification of income. But without solid executive management support, it was questionable how effective any of these efforts proved to be. There have been questions about policy and adherence to policy. This was a continual problem at Washington Mutual, where line managers, particularly in the mortgage area, not only authorized but encouraged policy exceptions. There had likewise been issues regarding fraud. Because of the compensation systems rewarding volume versus quality and the independent structure of the originators, I am confident at times borrowers were coached to fill out applications with overstated incomes or net worth to meet the minimum underwriting requirements. Catching this kind of fraud was difficult at best and required the support of line management. Not surprisingly, loan originators constantly threatened to quit and to go to Countrywide or elsewhere if the loan applications were not approved. As the market deteriorated, in 2004, I went to the Chairman and CEO with a proposal and a very strong personal appeal to publish a full-page ad in the Wall Street Journal disavowing many of the then-current industry underwriting practices, such as 100 percent loan-to-value subprime loans, and thereby adopt what I termed responsible lending practices. I acknowledged that in so doing the company would give up a degree of market share and lose some of the originators to the competition, but I believed that Washington Mutual needed to take an industry-leading position against deteriorating underwriting standards and products that were not in the best interests of the industry, the bank, or the consumers. There was, unfortunately, never any further discussion or response to the recommendation. Another way I attempted to counteract the increasing risk was to increase the allowance for loan and lease loss to cover the potential losses. Regrettably, there has been a longstanding unresolved conflict between the SEC and the accounting industry on one side and the banks and the bank regulators regarding reserving methodology. The SEC and accounting profession believed that more transparency in bank earnings is essential to investors and that the way to achieve transparency is to keep reserves at levels reflecting only very recent loss experience. But banking is a cyclical business, which the banks and the bank regulators recognize. It is their belief and certainly my personal belief that building reserves in good times and using those reserves in bad times is the entire purpose of the loan loss reserves. What is more, the investors, the FDIC, and the industry are far better protected reserves that are intended to be sufficient to sustain the institution through the cycle rather than draining reserves at the point where losses are at their lowest point. At one point, I was forced by external auditors to reduce the loan loss reserve of $1.8 billion by $500 million or risk losing our audit certification. As the credit cycle unfolded, those reserves were sorely needed by the institution. In my opinion, the Basel Accord on bank capital requirements repeats the same mistake of using short-term history rather than through-the-cycle information to establish required capital levels, and as such has been a complete and utter failure. The conventional wisdom repeated endlessly in the mortgage industry and at Washington Mutual was that while there had been regional recessions and price declines, there had never been a true national housing price decline. I believe that is debatable. But it was widely believed, and partially on this premise, the industry and Washington Mutual marched forward with more and more subprime high loan-to-value and option payment products, each one adding incrementally to the risk profile. Thank you for your time and attention. I will be happy to address your questions. Senator Levin. Thanks, Mr. Vanasek. Mr. Cathcart. TESTIMONY OF RONALD J. CATHCART,\1\ FORMER CHIEF ENTERPRISE RISK OFFICER (2006-2008), WASHINGTON MUTUAL BANK " CHRG-111shrg57923--10 Mr. Tarullo," So our focus--so here is what happened, what I found so interesting during the crisis itself. During the crisis itself, private analysts, who are operating on the basis of less than full information, of course, and regulators both found themselves focused on common equity. Now, some of the market guys called it tangible common equity, but basically, it was common equity. And I think that what all of us, if we didn't already believe it, and some of us did, but if we didn't already believe it, what all of us concluded from this exercise was that common equity needed to be an even more important component of the equity of financial firms going forward. The stress tests, the SCAP, were conducted with the assumption that--or under a set of standards that looked to the common equity levels as well as the traditional tier one levels, and I think, Senator, that regulators around the world whom we talk to in the Financial Stability Board, market analysts, and the financial institutions themselves have all converged around the proposition that common equity really and truly is far and away the most important--not the only, but the most important component of regulatory capital. Why? Because if it is adequate, it allows the firm to continue as an ongoing institution. There are some forms of equity, tier two--excuse me, capital--tier two capital, which will be available to protect the Deposit Insurance Fund or senior creditors, but not to keep the firm going on an ongoing basis. And since I don't think any of us relish the thought of another go-around of major challenges to major financial institutions, I think we are all focused on finding the best way to maintain higher levels of common equity--when I say all of us, I don't just mean regulators. I think that is a market imperative, as well. Senator Reed. Thank you. We had a sidebar which we don't need to continue about Basel II. I think we do have to spend some time thinking hard about the rules of capital going forward. But just two quick comments about the issue at hand. I don't want to trivialize this, but essentially, this center would be on patrol for bubbles in the economy, things that could cause, you know, not in one forum but throughout the economy, real problems. Is that too simple, or is that---- " FOMC20080109confcall--40 38,MR. HOENIG.," Thank you, Mr. Chairman. I recognize that the risks on the economy are elevated. I have recognized it for some time. My concern is that the risks are elevated as dangerously, if you will, for inflation as for the slowdown. We have at this point a situation in which we have revised up our inflation numbers and yet that is after we have cut 100 basis points, which we have not seen the full effect of. Those rate cuts are in process now, and they are not going to address the housing issue, given its circumstances, and they are going to work slowly through the rest of the economy as we move forward. We have revised up in our estimates the fourth-quarter real GDP numbers, and I think that is important to note even though I know our risks overall are elevated for growth, given some of the data coming in. Job growth came in disappointingly. It did so also in September, and it was revised up significantly after that. I don't know if the numbers will be revised up, but I would like to go cautiously, recognizing that they have been revised up in the past. I think there are tail risks. There is an important risk of the economy slowing, perhaps going into recession. I think that there is an elevated risk of the inflation numbers continuing to creep up as they have over the past several months. If these inflation numbers continue to rise as we decrease interest rates, there is a very serious cost that will have a very significant detrimental effect on the economy in the long run, which we need to keep sight of. My concern--as others have expressed, but it is a very serious concern on my part--is that we say we can reverse the policy position or raise interest rates later. But it is extremely difficult, and understandably so, because the earlier actions will still be having an effect while the economy shows a slowing. When it starts to pick up, we won't be sure, just as now, whether we really are going to accelerate and whether the economy is going to pick up. So we delay in reversing those actions, understandably so. So that is why I want to be very cautious about coming down with our interest rates because we will be very cautious going up with our interest rates on the other side of that. I am very pleased that you have not put an actual proposal on an action today. I would be very uncomfortable with that. I think we need to have a full discussion with more information before we commit to any kind of interest rate moves at our month-end meeting. I understand the risk, but I think it requires a lot of analysis as we look both at inflation and what that may mean to us if it's rising and at the real danger of a recession. Thank you. " CHRG-111shrg62643--136 Mr. Bernanke," Yes. Senator Menendez. We had negative growth. " FOMC20070509meeting--134 132,MS. MINEHAN.," Gosh, as usual the state of play here has gotten confused—for me, anyway. First of all, the thing I am least confused about is the policy recommendation. I do not think we should do anything at this time. I think we should stay the course at 5¼. I am very much in favor of alternative B. Second, I want to comment about what Vince said about the reaction to our statement the last time, in large part because I found that the people who talked to me about it over the past several weeks felt that our statement communication was somehow murkier than usual, if that is possible. Personally, I felt that we were very clear in that statement—we saw that there was more two-sided risk—and ultimately the market has come around to that belief. I guess I have come to the view that it is not a bad thing that the market reacted a bit more strongly. We probably should have anticipated that, and I think I even commented about it at the last meeting—that when you make a change to open a two-way possibility for policy a little more explicitly, it will have a bigger impact on the overall market. Third, with regard to the discussion about the language in alternative B, I was of the opinion that in terms of growth we have a certain set of risks coming from the housing market and rising energy and gasoline prices, which to some extent was offset by continued strength in employment, the financial market adding to household wealth, the growth around the rest of the world, some brighter picture from business investment spending, and so forth. So I look at the growth part of this as a bit more balanced and somewhat less uncertain than last time but at the inflation part as being more uncertain. So I was attracted both to President Stern’s recommendation and even to a recommendation that would replace section 3 of alternative B with section 3 of alternative C. But I think about the Chairman’s most recent comments about how strongly the market might react to that, what it might say about what has been a nuanced discussion here about inflation. We all expect inflation—we in Boston somewhat less than the rest of you—to moderate over the next year or year and a half to something that is within what some people have called their comfort zone. I am a little worried that we might send a message of more concern than we might have intended from replacing that language, although I agree with President Stern. I think the language of alternative C, particularly with regard to uncertainty, is somewhat more reflective of what we talked around the table than the existing language of section 3. Finally, I may be kidding myself here, but I have been taking the language in section 3 as saying not so much that we’re committed to a comfort zone of between 1 and 2, although I take President Poole’s comments on this seriously, but rather that the dynamics of inflation had the risk that inflation would accelerate rather than decelerate and that is what we were concerned about. Again, that is my personal reading on this because that is the context in which I think about concerns about inflation at this time. I would agree with President Poole that there is a way in which you can read this that is gradually pushing us into giving a target and a target range, and that may be where everybody wants to go here. I do not know, but I think there is a little risk around a specific number, as I have said many times. I would agree with Governor Kohn and his comments about wondering whether we really want to push inflation just for the sheer sake of pushing it to below 2 or, rather, waiting for the ability to move opportunistically at some point." FOMC20081216meeting--152 150,MR. LACKER., And housing always goes down in a recession. FOMC20050630meeting--41 39,CHAIRMAN GREENSPAN., Have you adjusted that for the modernization per housing unit? FOMC20050322meeting--107 105,MS. MINEHAN.," Thank you, Mr. Chairman. Economic activity seems definitely on the upswing in New England. As we discussed conditions with our Beige Book contacts, met with our small business advisory group, and talked in some depth with local temporary-help agencies and software developers—as we did our usual round of contacts—the themes of solid growth and increasing confidence were repeated with some frequency. Manufacturers, especially those that have some defense business, report very good sales, and, at least in the case of one large manufacturer, an inability to keep up with demand. Labor markets have strengthened as well, and benchmark revisions to employment data indicate that 2004 was a better period for job growth in New England than previously thought. Temporary help agencies report good demand for labor, and help-wanted is stronger, as judged by both traditional measures and the indexed data on the region that are available from Monster.com. Housing remains strong, though we don’t see much sign of speculation and there is some softness at the upper end of the price range. Retail business is reported to be good, and both business and consumer confidence has increased. Contacts in the regional economy appear to be moving from a focus on concerns about March 22, 2005 45 of 116 of small businesses in the period since our February meeting, and they almost uniformly report rising costs of raw materials and labor that are starting to impact their prices. In a growing number of cases, these firms have been able to make price increases stick, even to big buyers like Wal-Mart, though, largely, the price increases have been in the form of surcharges. Skilled workers are becoming difficult to find. Businesses report that they’re in a hiring mode and have to pay up to get the people they need. Some companies have begun to hire in advance of need, simply to have a pool of available workers. Capital spending plans seem quite solid, and now there is a mixture of firms spending not only to further increase productivity but also to expand to handle increased business. Two areas of concern emerged beyond those related to rising costs. The first involves tourism in northern New England. Evidently, while this was a snowy year in the southern part of our region, the northern areas have suffered from both too little snow and the timing of storms, which created weekend travel problems. The second is a continued sluggishness in commercial real estate markets. Given the number of large mergers affecting the region, both in the financial services industry and elsewhere, and the reduction of headquarters staff that has resulted, commercial vacancy rates remain high and rents low—especially in downtown and suburban Boston. I should say the rents are relatively low, since Boston rents tend to be high anyway. This has not, however, seemed to put much of a crimp in the market for purchasing commercial buildings, which continues to be quite strong. Turning to the national scene, I’ve been struck by the strength of the incoming economic data, as has everyone else. We in Boston have adjusted our forecast upward, especially in the near March 22, 2005 46 of 116 Greenbook over the forecast horizon, though our calculations suggest some greater economic capacity and less downward pressure on the unemployment rate. However, there is not a lot to argue about here, given the continuing upside surprises in overall economic growth and in price pressures. Indeed, it seems clear to me that the underlying rationale we have used in moving policy slowly and gradually to a less accommodative place is becoming questionable. Unlike last year when growth seemed fragile and uncertain, economic growth now seems solid and resilient and in less need of policy accommodation. Overall credit and financial conditions are supportive, if not encouraging, to spending and growth. Business investment is not taking a breather with the ending of the tax incentive, and consumers aren’t either, except in their post-holiday purchases of autos. Surely it is possible to see downside risks from a rise in the saving rate, from an untoward increase in oil prices that impacts demand, or from an impact arising out of the external deficit. But I think it’s even easier to imagine upside inflation surprises as rising energy, raw material, import, and labor costs get embedded into economic activity. In that regard, I found the Greenbook alternatives focused on a spending boom and on a boom with rising inflation expectations very interesting. I should also note that while my admiration for the FRB/US model is enormous, I think it’s difficult for any model to correctly anticipate the full interplay of economic factors once the unexpected happens. The baseline, I think, is still pretty much a good, solid forecast. Continued solid productivity growth will keep nascent cost pressures and inflation expectations under control. However, the risks that this will not happen seem to me to have grown and to have become a bit more one-sided. That is, I think we need to be more focused on the risks that rising cost pressures will get out of hand. March 22, 2005 47 of 116 case could be made for moving faster rather than slower toward that so-called neutral place. Taking larger steps now would have the benefit of affecting market attitudes toward risk in a positive way, largely because it is not what markets expect us to do. That option has some attraction to me. But it could be too much of a surprise and indicate too much concern about future prospects than perhaps is necessary. However, we could take advantage of this point in time by preparing the markets for greater policy flexibility. That is, we could change the language of the announcement by following the Chairman’s example in taking out the reference to a measured pace. In my view, anyway, that would have two benefits. It would continue the process of removing policy accommodation, and it would focus markets better on the uncertainties of the future." fcic_final_report_full--30 In Bakersfield, California, where home starts doubled and home values grew even faster between  and , the real estate appraiser Gary Crabtree initially felt pride that his birthplace,  miles north of Los Angeles, “had finally been dis- covered” by other Californians. The city, a farming and oil industry center in the San Joaquin Valley, was drawing national attention for the pace of its development. Wide-open farm fields were plowed under and divided into thousands of building lots. Home prices jumped  in Bakersfield in ,  in ,  in , and  more in . Crabtree, an appraiser for  years, started in  and  to think that things were not making sense. People were paying inflated prices for their homes, and they didn’t seem to have enough income to pay for what they had bought. Within a few years, when he passed some of these same houses, he saw that they were vacant. “For sale” signs appeared on the front lawns. And when he passed again, the yards were untended and the grass was turning brown. Next, the houses went into foreclosure, and that’s when he noticed that the empty houses were being vandalized, which pulled down values for the new suburban subdivisions. The Cleveland phenomenon had come to Bakersfield, a place far from the Rust Belt. Crabtree watched as foreclosures spread like an infectious disease through the community. Houses fell into disrepair and neighborhoods disintegrated. Crabtree began studying the market. In , he ended up identifying what he be- lieved were  fraudulent transactions in Bakersfield; some, for instance, were al- lowing insiders to siphon cash from each property transfer. The transactions involved many of the nation’s largest lenders. One house, for example, was listed for sale for ,, and was recorded as selling for , with  financing, though the real estate agent told Crabtree that it actually sold for ,. Crabtree realized that the gap between the sales price and loan amount allowed these insiders to pocket ,. The terms of the loan required the buyer to occupy the house, but it was never occupied. The house went into foreclosure and was sold in a distress sale for ,.  Crabtree began calling lenders to tell them what he had found; but to his shock, they did not seem to care. He finally reached one quality assurance officer at Fremont 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." fcic_final_report_full--484 Thus, about 27 percent of Bear’s readily available sources of funding consisted of PMBS that became unusable for repo financing when the PMBS market disappeared. The loss of this source of liquidity put the firm in serious jeopardy; rumors swept the market about Bear’s condition, and clients began withdrawing funds. Bear’s offi cers told the Commission that the firm was profitable in its first 2008 quarter—the quarter in which it failed; ironically they also told the Commission’s staff that they had moved Bear’s short term funding from commercial paper to MBS because they believed that collateral-backed funding would be more stable. In the week beginning March 10, 2008, according to the FCIC staff report, Bear had over $18 billion in cash reserves, but by March 13 the liquidity pool had fallen to $2 billion. 51 It was clear that Bear—solvent and profitable or not—could not survive a run that was fueled by fear and uncertainty about its liquidity and the possibility of its insolvency. Parenthetically, it should be noted that the Commission’s staff focused on Bear because the Commission’s majority apparently believed that the business model of investment banks, which relied on relatively high leverage and repo or other short term financing, was inherently unstable. The need to rescue Bear was thought to be evidence of this fact. Clearly, the five independent investment banks—Bear, Lehman Brothers, Merrill Lynch, Morgan Stanley and Goldman Sachs—were badly damaged in the financial crisis. Only two of them remain independent firms, and those two are now regulated as bank holding companies by the Federal Reserve. Nevertheless, it is not clear that the investment banks fared any worse than the much more heavily regulated commercial banks—or Fannie and Freddie which were also regulated more stringently than the investment banks but not as stringently as banks. The investment banks did not pass the test created by the mortgage meltdown and the subsequent financial crisis, but neither did a large number of insured banks— IndyMac, Washington Mutual (WaMu) and Wachovia, to name the largest—that were much more heavily regulated and, in addition, offered insured deposits and had access to the Fed’s discount window if they needed emergency funds to deal with runs. The view of the Commission majority, that investment banks—as part of the so-called “shadow banking system”—were special contributors to the financial crisis, seems misplaced for this reason. They are better classified not as contributors to the financial crisis but as victims of the panic that ensued after the housing bubble and the PMBS market collapsed. Bear went down because the delinquencies and failures of an unprecedentedly large number of NTMs caused the collapse of the PMBS market; this destroyed the 50 51 FCIC, “Investigative Findings on Bear Stearns (Preliminary Draft),” April 29, 2010, p.16. Id., p.45. 479 usefulness of AAA-rated PMBS as assets that Bear and others relied on for both capital and liquidity, and thus raised questions about the firm’s ability to meet its obligations. Investment banks like Bear Stearns were not commercial banks; instead of using short term deposits to hold long term assets—the hallmark of a bank— their business model relied on short-term funding to carry the short term assets of a trading business. Contrary to the views of the Commission majority, there is nothing inherently wrong with that business model, but it could not survive an unprecedented financial panic as severe as that which followed the collapse in value of an asset class as large and as liquid as AAA-rated subprime PMBS. CHRG-111hhrg54867--275 Secretary Geithner," Congressman, we do not have the ability to prevent all foreclosures. It is just not a realistic objective for us. But we are making a lot of progress and bringing more stability to the housing market and making sure that people are allowed to take advantage of a loan-modification program that reduces their monthly payments to a more affordable level. And we expect, within the next several weeks, to be in a position where half a million households are benefitting from modifications that substantially reduce their monthly payments. You are already seeing, of course, interest rates of mortgages at historic lows. Housing is more affordable today. There is a little bit more stability in housing values now. And people are able to refinance their mortgages even if they are underwater. And those things are helping together. But you are right to emphasize the fact that there are still a lot of people in this country who are facing the risk of foreclosure. And we are going to reduce that risk, but it is still with us. It is one of the reasons why we don't want to leave people any illusion that we are through the worst of this crisis and it is time now to dial back and wind down those programs. " CHRG-109shrg24852--52 Chairman Greenspan," We have had such experiences in the past, and quite correctly, there have been regional problems associated with unwinding of frothy local housing markets. One thing that obviously is an issue with respect to the overall economy of these metropolitan areas, is that unlike earlier history, we have developed a mortgage instrument to a point, and the ability to extract equity from homes to such an extent, that now a surprisingly large proportion of consumer expenditures and home modernization outlays are financed by home equity extraction. That is clearly a consequence of one, house turnover, largely because, of course, the seller of the home extinguishes a mortgage which is less than the mortgage of the buyer of the home, which is essentially a reduction or extraction of equity from that home of that exact difference. Then of course there are cash-outs, which have increased over the years, associated with refinancing, and then finally, a significant amount of extraction of unrealized capital gains essentially from home equity loans. These are large enough to be an issue in the overall consumption expenditures of a local community, and in the event that you begin to get a retrenchment in house turnover, which would presumably be associated with unwinding of a frothy market, you would probably also have impacts on consumer expenditures in that particular area. There are obviously national implications of this as well. We would expect as the housing boom eventually simmers down, as we have long expected it would but find no evidence that it is about to, that it would begin to have some impact on consumption expenditures, and if not for the fact that we perceive capital investment picking up the slack, it would give us some pause as to economic consequences of the adjustment process. Senator Allard. Mr. Chairman, you kind of moved into my second question where people were extracting this equity out of their home. If the value of these homes should begin drop or something, that could create some problems for our national economy, or would it not? " FOMC20081216meeting--106 104,MR. AHMED.," I will be referring to the exhibits that follow the blue International Outlook cover page. Financial markets in foreign economies remain stressed but have not suffered further pronounced deterioration since the October FOMC meeting. As shown at the top of your first exhibit, government bond yields in major industrial economies have dropped, likely reflecting further expected monetary policy easing, lower inflation expectations, and a firming of the belief that economic recoveries are not around the corner. Equity markets, shown in the middle left, have changed only moderately, on net, since your last meeting, compared with large declines in previous months. The emerging-market aggregate CDS spread, shown in the middle, has been volatile but remains elevated. As shown to the right, gross private capital inflows to emerging markets through debt and syndicated loans have continued to trend downward. The exchange value of the dollar against the major foreign currencies (the black line in the bottom left panel) has moved down a little since the last FOMC meeting. Some bilateral exchange rate movements were substantial, however, with the dollar appreciating markedly against the pound and depreciating against the yen. As shown to the right, the dollar has appreciated somewhat against the currencies of our other important trading partners, driven by movements in the Mexican peso and the Brazilian real. Earlier this month, the dollar registered one of its biggest daily increases against the Chinese renminbi in recent years, although this shows up only as a tiny blip in the chart. We believe that Chinese authorities will allow the renminbi to depreciate somewhat in the coming months; NDF (nondeliverable forward) contracts also imply an expected depreciation of the renminbi against the dollar over the next year or so. Incoming evidence on economic activity abroad continues to be grim. As shown in line 1 of the table in exhibit 2, we now estimate that foreign economic growth was below 1 percent in the third quarter. Although growth in Canada (line 7) and Mexico (line 12) surprised on the upside, readings elsewhere were generally weaker than expected, with real GDP contracting in the United Kingdom, the euro area, and Japan (lines 4 through 6). As shown by the red bars in the middle left panel, net exports made significant negative contributions to growth in these three economies. Domestic demand (the blue bars) was also soft. Growth in emerging Asia (line 9) was barely positive in the third quarter, reflecting subdued growth in China (line 10) and substantial contractions in most of the newly industrialized economies (shown in the middle right). With data from the current quarter pointing to greater weakness than we expected and a substantially more pessimistic U.S. outlook, we have further slashed our forecast for total foreign growth to minus 1� percent in the current quarter and minus 1� percent in the next, before a recovery to a positive but still relatively weak average pace of about 1 percent through the remainder of next year. The widespread nature of the economic slowdown in large part seems to reflect trade linkages. As depicted at the bottom, in recent years U.S. economic growth (the black line) and the growth of total real exports of our major trading partners (the green line) have been significantly related. Although foreign exports are affected by many factors in addition to U.S. GDP, the relationship shown and the gloomy outlook for U.S. economic activity through next year paint a bleak near-term picture for foreign exports. Your next exhibit focuses on the advanced foreign economies in more detail. Data from Europe point to a sharp slowing in the current quarter. The timeliest indicators are PMIs (purchasing managers' indexes), which, as shown in the top left panel, have plummeted in recent months in both the United Kingdom and the euro area, reaching levels well below those observed during the 2001 downturn. As depicted to the right, in Japan, exports (the black line) and industrial production (the blue line) have contracted during the current quarter, and conditions in the labor market have deteriorated further, as manifested by the decline in the ratio of job openings to applicants (the red line). Indicators from the current quarter in Canada, shown in the middle left, point to weakness in real exports and a continued drop in housing starts. Authorities in advanced foreign economies are attempting to shore up aggregate demand through fiscal stimulus. As listed in the middle right panel, many countries have announced stimulus packages, including Germany, France, and the United Kingdom. We estimate that the actual stimulative content of the packages announced so far is likely to be small but expect that additional measures will be introduced next year. The total fiscal stimulus that we are assuming should boost growth in the advanced foreign economies by � to � percentage point at an annual rate from mid-2009 through 2010. The possibility of bigger fiscal initiatives is an upside risk to our outlook for foreign growth. Many of the foreign central banks have become more aggressive in easing monetary policy, as can be seen at the bottom left. Since the last FOMC meeting, the Bank of England and the ECB have slashed policy rates by a total of 250 basis points and 125 basis points, respectively, and the Bank of Canada and the Bank of Japan have lowered rates by smaller amounts. More rate cuts are expected in all of these economies, which could bring rates in Japan back down to the zero lower bound. As shown on the bottom right, inflation in the advanced foreign economies is now expected to recede at a faster rate than previously projected, reflecting sharp declines in commodity prices as well as diminished resource utilization. Turning to emerging-market economies, as shown in the top left panel of exhibit 4, the recent behavior of Chinese industrial production, total exports, and imports from Asia is now reminiscent of developments during the year 2001. The plunge in imports from Asia casts doubt on the notion that China has become an independent engine of growth in the region. As depicted to the right, Korean exports and aggregate industrial production in Korea, Singapore, and Taiwan are plummeting. In Mexico, third-quarter output was bolstered by expansion in the agricultural sector, but as shown in the middle left, exports have moved down sharply, and consumer confidence has dropped below 2001-02 levels. In Brazil, too, shown on the right, there has been some softening in exports (the black line), which had been supported by high commodity prices, although industrial production (the blue line) has held up a bit better. With prospects for exports in the doldrums, policy stimulus has become all the more important to the outlook for emerging-market economies. As noted in the bottom left, monetary easing has continued, with interest rate cuts in many emerging Asian economies, including China and Korea. China, Malaysia, and Brazil have also lowered bank reserve requirements. In addition, fiscal stimulus packages have been announced in a number of economies, most notably China. China's 16 percent of GDP spending package considerably overstates the ultimate effects on growth as it includes some previously announced projects, its implementation may take longer than announced, and the federal government is slated to pay for only 30 percent. Discounting the headline number, we estimate that the Chinese package could boost growth 1 to 1� percentage points per year. Other countries, such as Korea and Mexico, have introduced smaller but still sizable packages, which we expect will give some impetus to growth. In sum, our near-term forecast calls for total foreign growth to be the weakest since 1982, and as sketched out in our alternative simulation in the Greenbook, there would appear to be downside risks even to this forecast. Your final exhibit focuses on the U.S. trade outlook. Weak global demand has contributed to falling prices for food and metals, which have led a sharp decline in nonfuel commodity prices (the blue line in the top left panel). Oil prices (the black line) also have continued to move down rapidly, but futures prices project some recovery ahead. The fall in commodity prices has exerted downward pressure on U.S. trade prices (shown in the top middle panel); both core import prices and core export prices dropped markedly in October and November, which for import prices were the largest monthly declines in the fourteen-year history of the index. A sense of the extent of weakness in global demand can also be seen in shipping rates (shown to the right), which have taken a nosedive. As in the 2001 recession, U.S. real exports and imports of goods (shown in the middle left) are now trending down. Imports (the red line) have been moving down all year. The falloff in exports (the black line) is a more recent development and, in part, reflects hurricane-related disruptions and the strike at Boeing. As shown in the table, growth of both real exports of goods and services (line 1) and real imports (line 3) was noticeably weaker in the third quarter than we had previously estimated. For the current quarter, we see both real exports and real imports contracting sharply, reflecting the slowdown in global demand. Looking ahead, our projections for a stronger broad real dollar (shown in the middle right) along with our weaker outlook for foreign growth have led us to revise down sharply our forecasts for exports, especially in 2009. In the near term, our projections for imports have also been marked down considerably. As shown in line 5, the contribution of net exports to U.S. growth is expected to swing slightly negative in the current quarter, following large positive contributions earlier this year. The current quarter's contribution is considerably weaker than projected in both the October and the December Greenbooks, as last week's export data surprised us on the downside. Next quarter, with a substantially greater step-down in imports than in exports, we expect the contribution of net exports to U.S. growth to jump back up, before returning to negative territory for the remainder of the forecast period. That concludes our presentation. " FOMC20051101meeting--73 71,MS. JOHNSON.," The staff forecast for real GDP growth and inflation abroad is little changed this time from the forecast in the September Greenbook. This is the case despite additional hurricanes, volatile energy prices, and a notable rise in long-term interest rates in several foreign industrial countries during the intermeeting period. The futures path for WTI [West Texas intermediate] crude oil prices retraced somewhat in October. Accordingly, we have incorporated into this forecast global oil prices through 2007 that are about $2 per barrel lower than in the previous forecast. Nevertheless, the outlook for global crude oil prices remains elevated at about $60 per barrel for WTI and is more than $8 above the level six months ago. Clearly, factors related to crude oil supply have contributed at times to upward pressure on global crude oil prices. In addition to disruptions as a result of the hurricanes, there are market concerns about the change in leadership in Saudi Arabia, politics in Iran, Venezuela, and Russia, and reduced production as a result of violence in Iraq. However, the trend increase since 2003 in not only spot prices but also in far futures prices occurred despite expansion of global oil production, evidence that underlying global demand for crude oil is also importantly responsible for the price pressures. This persistent, strong, underlying demand for energy reflects fundamental robustness in global economic activity—perhaps more than has been generally recognized. As a consequence, we have observed during this year further moves up in energy prices and in prices for nonfuel primary commodities along with average real growth abroad that has remained moderately strong, although a bit below the rapid pace of 2004. As in September, we are calling for real GDP abroad on average to expand at about 3 percent in the current quarter, following growth at that pace in the third quarter, and to accelerate a bit in 2006 and 2007. This favorable picture incorporates a return to steady expansion in Japan and solid, albeit slightly moderating, growth in the emerging Asian region. In addition, real growth in Mexico should recover from a disappointing outcome during the first half of this year. November 1, 2005 18 of 114 mixed, but in Germany industrial orders have come in strong and the October Ifo measure of business climate jumped to a five-year peak. Among the emerging- market economies, Chinese industrial production accelerated through September, and retail sales growth remained above 12 percent. Korean real GDP growth rose to 7.5 percent in the third quarter, and Brazil continues to enjoy very strong export sales. The mix of sustained global growth and upward shifts in commodity prices, particularly crude oil prices, naturally heightens concerns about higher consumer price inflation. Headline inflation rates abroad have moved up significantly with the rise in crude oil prices. Our outlook, however, is for these prices to decelerate over the forecast period given our projection (and that of the futures markets) that crude oil prices will be about flat next year and edge down in 2007 and given that the effects of previous increases in crude prices on inflation will wane and then end. Such an outcome depends upon an absence of significant second-round effects of oil prices on domestic prices and wages abroad. To date, core inflation in the major foreign countries confirms this is the case. The combination of continued growth and contained inflation pressures sounds optimistic. Rest assured, we have found numerous risks about which to worry. The elevated energy prices could sap consumer demand more than we expect, undermining the pace of real growth. In the face of higher costs, business spending on new capital could falter, particularly in emerging Asia where few countries have petroleum production sectors. Wage demands could react to the increase in headline inflation and threaten to ignite a set of second- and third- round effects. We do not see evidence of these developments at this time, but it is too soon to conclude that the danger of such actions has passed. A second feature of the international forecast that merits a few minutes is the approximately neutral contribution of real net exports to U.S. real GDP growth in the third quarter, following a positive contribution in the second quarter. The third-quarter NIPA [national income and product accounts] data released last Friday imply a slightly smaller, less positive, contribution than we had incorporated in the Greenbook baseline forecast or in the September forecast. However, in the current quarter, compared with the September forecast, we are assuming a greater rebound in exports and have reduced our assessment of the extent to which the external sector will provide a drag on GDP growth. Accordingly, we expect that on a four-quarter change basis, the external sector will record a slightly positive contribution to U.S. real GDP growth for the year— the first annual positive contribution since 1995. However, we are not ready to declare that external adjustment has arrived, and we expect a return to a small drag on U.S. growth from the external sector in the current quarter and on balance over the forecast period. November 1, 2005 19 of 114 imports. But recently we have experienced weakness in other components of real imports. During this intermeeting period, imports again surprised us on the downside, with August data for nominal imports much weaker than expected. This negative surprise included both goods and services, and within goods, it was particularly the case for imports of consumer goods and industrial supplies. For the near-term forecast we have included some effects as a result of the hurricanes and the disruption to general trade they caused. As a result, there is some implicit payback in the forecast for real imports in the fourth quarter. Nevertheless, compared with the September Greenbook, we have lowered the growth of real imports in 2006 and 2007 in response to the somewhat softer outlook for U.S. activity and to a higher path for import prices. Growth of third-quarter real exports was also revised down, although not by enough to offset weaker imports. Hurricane effects also figure in our estimate for third-quarter exports. More significant has been the recent strike at Boeing. We judge that the strike had a more pronounced impact on September=s exports than we previously thought, leading us to weaken real exports for last quarter. But the rapid conclusion of that strike also led us to strengthen real exports for the current quarter. For 2006 and 2007, we expect export growth will average a bit above 5 percent per year, consistent with our outlook for steady real output growth abroad. In sum, actual trade data through August, our estimates of how the turbulent weather of recent months has affected exports and imports, and our projections of global primary commodity prices, particularly crude oil, combine to imply unusual quarter-to-quarter fluctuations in growth of real exports and real imports. Some of these developments have surprised us since the September Greenbook. Going forward, however, we expect that the transitory weather effects will fade by early 2006. We look for real exports and imports to expand at similar rates on balance in 2006 and 2007. With imports substantially greater than exports, this outcome implies a negative contribution from the external sector of about ⅓ percentage point each year. David and I will be happy to take your questions." CHRG-109hhrg31539--55 Mr. Bernanke," Our concern, Congresswoman, is to achieve a sustainable growth path. We don't want to get into a situation where we get into a boom and bust. We don't want to get into inflation, because inflation also detracts from the buying power of workers and the consumers. So we are looking to try and achieve a sustainable growth path. We are aware of the risks to that, and we are going to do our utmost to achieve that. " CHRG-111hhrg52397--261 Mr. Duffy," I will just say that I think that they had a huge bet that the housing market would never go down. I do not think they ever believed that that asset would go down, and they could leverage it as many times over as they want. And they were undercapitalized to write all these contracts. And when the market turned, you talk about an illiquid market, the housing market might be the most illiquid market in the world, so there is no one to take over the exposures. " CHRG-111shrg50814--19 Chairman Dodd," Yes. Let me, if I can in the minute or so left here, I noted in my opening comments that housing and autos have historically led us out of recessions in many ways. I don't know if you agree or not, but it is ironic that housing, and to a lesser degree autos, have led us into this recession. Who is going to lead us out of this recession? What sector of the economy? " CHRG-111hhrg49968--139 Mr. Bernanke," You are on the hook for it. And I believe that one of the things that this body will want to look at is reform of Fannie and Freddie and figure out how the government's intervention in the housing market ought to be conducted. I think many people are convinced that the way Fannie and Freddie were set up before was not entirely satisfactory, and we need to have some rethinking about what role the government should play in the housing market. " CHRG-111hhrg54872--293 Mr. Manzullo," I agree with that. I guess the issue is the powers have already been out there to stop the subprime meltdown. But it is interesting that some of the people who complain now that those powers were not used, were the first in line to say, we have to have housing for everybody. Housing became a right, and then an entitlement, and then the meltdown started on it. Thank you. " Mr. Green," [presiding] Mr. Driehaus of Ohio is recognized for 5 minutes. " FOMC20050630meeting--70 68,MR. GALLIN.," Let me note just one last thing. The pictures are going to look the same as those Dick showed, whether we look at house prices relative to income or to rent. So, even if the rent series might have this problem or that problem—and it does have problems—house prices have grown quite dramatically using the adjusted data that I used relative to incomes as well." CHRG-109hhrg22160--12 Mr. Greenspan," Well, Mr. Chairman, I think the first thing that we have to focus upon is this extraordinary shift that is about to occur, starting in 2008, in which roughly 30 million people are going to leave the labor force over the next 25 years and enter into retirement. This creates a very significant slowing in the rate of economic growth. When the rate of growth of the working-age population relative to the total goes down--and even with productivity increasing at a reasonably good clip the rate of growth in GDP per capita must slow down. This is going to cause a confrontation in the marketplace between the desire on the part of retirees to maintain essentially what we call their replacement rate--namely, that a standard of living relative to the standard of living they enjoyed just prior to retirement will be maintained. If that is done, it will put significant pressure on the working-age-population economic growth, and so we have to find a way to get a larger pie to solve both sides of this. The advantage of having individual accounts is over a fairly broad spectrum, but the one that I think is most important actually relates to the issue which your Ranking Member mentioned before. These accounts, properly constructed and managed, will create, as you also point out, a sense of increased wealth on the part of the middle-and lower-income classes of this society, who have had to struggle with very little capital. And while they do have a claim against Social Security system in the future, as best as I can judge, they don't feel as though it is personal wealth they way they would with personal accounts. And I think that is a quite important issue with respect to this. The major issue of personal accounts is essentially economic, in the sense that, confronted with the very large baby boom retirement and the economic difficulties associated with it, the structure of essentially a pay-as-you-go system, which is what our Social Security system is, which worked exceptionally well for almost 50, 60 years, that system is not well suited to a period in which you do not any longer have significant overall population growth, and therefore a very high ratio of workers to retirees. And it is no longer the case, as existed in the earlier years, that life expectancy after age 65 was significant. We have been fortunate in that, for a number of reasons, our longevity has increased measurably. But it does suggest that if we are going to create the type of standard of living that we need in the future for everybody, we are going to need to build the capital stock, plant and equipment, because that is the only way we are going to significantly increase the rate of productivity growth which will be necessary to supply the real goods and services that the individuals who are retired at that point and the individuals who are activity working would sense their right in this economy. And if we are going to do that, we have to have a significant increase in national savings, because even though it doesn't exactly tie one to one because there are other ways in which productivity rises, the central core of productivity increase is capital investment. And to have capital investment you need to have savings. Now, we in the United States have had a very low national or domestic savings rate and have been borrowing a good part of it from abroad to finance our existing capital investment. We are obviously not going to be able to do that indefinitely, which puts even more pressure on building up our domestic savings. And what this means is that whatever type of structure we have for retirement, it has to be fully funded. The OASI has $1.5 trillion in the trust fund at this stage. The required full funding is over $10 trillion. In short, we do not have the mechanisms built into our procedures for retirement and retirement income and pensions which are creating a degree of savings necessary to create the capital assets which are a precondition to get a rate of growth in productivity, given the slow growth in the labor force which we project going forward in order to create enough GDP for everybody. So my major concern is that the current model, which served us so well for so many decades, is not the type of model we would certainly construct from scratch, and we have to move in a different direction. And one of the reasons that I think we have to move toward a private individual account system is they, by their nature, tend to be significantly fully funded, even if they are defined contribution plans, because individuals know what they need for the future and they tend to put monies away adequately to create the incomes they will need in retirement. So I think this is an extraordinarily important problem that exists. And I won't even go on to mention the fact that the Medicare shortfall, so far as the issue of where full funding lies, is several multiples in addition to what we confront in Social Security. " FOMC20080916meeting--120 118,MS. YELLEN.," Thank you, Mr. Chairman. During the past several weeks, my head office and Branch directors have become decidedly more pessimistic about the economic outlook. My own assessment of incoming data coincides with theirs. My contacts also report that their businesses are still raising prices in response to past increases in commodity and import prices that boosted their costs. I expect as a consequence that core inflation will remain uncomfortably high for a while longer, but the marked decline in commodity prices since June reinforces my conviction that there is light at the end of this inflation tunnel. With respect to growth, our forecast is similar to the Greenbook's, with a little more weakness in the second half of this year and a little more strength in 2009. I think the risks to this forecast are decidedly skewed to the downside. I agree with the Greenbook's assessment that the strength we saw in the upwardly revised real GDP growth in the second quarter will not hold up. Despite the tax rebates, real personal consumption expenditures declined in both June and July, and retail sales were down in August. My contacts report that cutbacks in spending are widespread, especially for discretionary items. For example, East Bay plastic surgeons and dentists note that patients are deferring elective procedures. [Laughter] Reservations are no longer necessary at many high-end restaurants. And the Silicon Valley Country Club, with a $250,000 entrance fee and seven-to-eight-year waiting list, has seen the number of would-be new members shrink to a mere thirteen. [Laughter] Exports were a huge source of strength in the second quarter, but I am concerned that we cannot count on very large contributions to growth from exports going forward, now that the dollar has begun to rise and economic growth abroad has slowed, even turning negative in some important trade partners. Indeed, the growing weakness of the global outlook appears to be an important explanation for the reversion in commodity prices, and this adds a dimension of gloom to what would otherwise be a decided plus for both inflation and demand. Recent data also suggest that labor markets are weakening across the board--a development that will cast a pall on household income and spending. The interaction of higher unemployment with the housing and financial markets raises the potential for even worse news--namely, an intensification of the adverse feedback loop we have long worried about and are now experiencing. Indeed, delinquencies have risen substantially across the spectrum of consumer loans, and credit availability continues to decline. One ray of hope is that the changes at Fannie and Freddie have caused a notable drop in mortgage rates. Another is that the decline in home prices has become somewhat less steep, and we have seen an outright improvement in home inventories relative to sales. But my contacts are very pessimistic about the prospects for nonresidential construction. They note that construction is continuing on projects in the pipeline with committed funding, but new projects are all but impossible to finance. Turning to inflation, I have long anticipated and still expect that inflation will fall to more-reasonable levels in 2009. However, developments since our August meeting diminish the upside risks to this projection. The drop in oil and other commodity prices, along with the appreciation of the dollar, should work to moderate the current inflation bulge and diminish the potential for a wage�price spiral to develop. Import inflation has already begun to ease. Furthermore, we have seen a remarkable decline in inflation compensation for the next five years in the TIPS market. I would not rely heavily on this decline to support my view, but I do have to say that the decline is a lot more reassuring than the alternative. I was also encouraged by the 30 basis point drop in long-term inflation expectations in the most recent Michigan survey. I anticipate that the recent jump in the unemployment rate will place some additional downward pressure on growth in labor compensation, which has been quite low, and in core inflation. Although the jump in the unemployment rate probably partly reflects the extension of unemployment insurance coverage, a back-of-the-envelope calculation suggests that the upper bound on this effect is just a few tenths of a percent. I would agree with the Greenbook estimates. We have also examined the possibility that the increase in unemployment reflects a rise in the NAIRU due to sectoral employment shifts out of construction and finance and into other industries. Ned Phelps has argued that the sectoral shift story implies a sizable dispersion of employment growth across industries and states. But we looked at these data and found no significant increase, so I don't find this Phelps argument particularly convincing. Considering all of these factors, I expect both headline and core PCE price inflation to fall to about 2 percent for 2009 as a whole, and I see the risks to this projection as roughly balanced. With respect to policy, I would be inclined to keep the funds rate target at 2 percent today. For now, it seems to me that the additional liquidity measures that have been put in place are an appropriate response to the turmoil. I am fine with the wording of alternative B and would support President Lockhart's suggestion for change. That would seem fine to me, too. In view of the intensified financial stress and the potential for more turmoil, obviously I think we will need to be flexible in setting policy going forward, and I am very concerned about downside risks to the real economy and think that inflation risk is diminished. " FinancialCrisisReport--62 In 2004, WaMu set the stage for its High Risk Lending Strategy by formally adopting aggressive financial targets for the upcoming five-year time period. The new earnings targets created pressure for the bank to shift from its more conservative practices toward practices that carried more risk. Mr. Killinger described those targets in a June 2004 “Strategic Direction” memorandum to WaMu’s Board of Directors: “Our primary financial targets for the next five years will be to achieve an average ROE [Return on Equity] of at least 18%, and average EPS [Earnings Per Share] growth of at least 13%.” 148 In his memorandum to the Board, Mr. Killinger predicted continuing growth opportunities for the bank: “In a consolidating industry, it is appropriate to continually assess if shareholder value creation is best achieved by selling for a short-term change of control premium or to continue to build long-term value as an independent company. We believe remaining an independent company is appropriate at this time because of substantial growth opportunities we see ahead. We are especially encouraged with growth prospects for our consumer banking group. We would also note that our stock is currently trading at a price which we believe is substantially below the intrinsic value of our unique franchise. This makes it even more important to stay focused on building long-term shareholder value, diligently protecting our shareholders from inadequate unsolicited takeover proposals and maintaining our long held position of remaining an independent company.” 149 Mr. Killinger identified residential nonprime and adjustable rate mortgage loans as one of the primary bank businesses driving balance sheet growth. 150 Mr. Killinger also stated in the memorandum: “Wholesale and correspondent will be nationwide and retooled to deliver higher margin products.” 151 (2) Approval of Strategy After 2002, Washington Mutual stopped acquiring lenders specializing in residential mortgages, 152 and embarked upon a new strategy to push the company’s growth, focused on increasing its issuance and purchase of higher risk home loans. OTS took note of this strategy in WaMu’s 2004 Report on Examination: 148 6/1/2004 Washington Mutual memorandum from Kerry Killinger to the Board of Directors, “Strategic Direction,” JPM_WM05385579 at 581. 149 Id. at 582. 150 Id. 151 Id. at 585. 152 The only new lender that Washington Mutual acquired after 2004 was Commercial Capital Bancorp in 2006. “Management provided us with a copy of the framework for WMI’s 5-year (2005-2009) strategic plan [which] contemplates asset growth of at least 10% a year, with assets increasing to near $500 billion by 2009.” 153 CHRG-110hhrg46596--529 Mrs. Maloney," In line with the gentleman's question, would you comment on the proposal that Treasury is considering of 30-year long-term loans at 4.5 percent interest rate for first-time home buyers to shore up the housing market, housing values as a response to the concerns that the gentleman raised? Ms. Warren. Congresswoman, I just want to make this point about it. This looks like a very promising idea. But we cannot keep taking slices of approaches here. This, for example, will do nothing to help people who are losing their homes in foreclosure. And so you cannot refinance a house that is now at 130 percent of loan-to-value ratio. You just can't do it. And so-- " FinancialCrisisInquiry--153 It only makes sense that as income moves up, housing prices should be able to move up in a perfectly parallel fashion—you make a little bit more money, you can afford a little bit more house. Those lines were parallel for the good part of 40 years. And what happened in 2001, when Dr. Greenspan traded the dot.com bust for the housing boom, he lowered rates down to 1 percent. He made money free, and encouraged all of the lending possible to try to restart the economy after the dot.com bust. I simply think he did a bad job. Other people think he did a great job. But I think that he enabled this housing market. So when you started seeing rates—rates started—they started raising rates in 2004? When rates started to be—started an increasing path, you saw prime mortgage origination in 2004 drop 50 percent. That just makes sense. Everybody refinanced their homes that could. Everyone got reset and settled, but subprime origination in 2004 doubled. And then it doubled again in ‘05, as prime originations fell off a cliff because rates were moving up. So what happened is Wall Street had these machines built to manufacture mortgages. We wanted affordable housing, so they could lower rates with exotic mortgages. And what you saw from 2001 on is you saw those two parallel lines, home price—median home price and median income—diverge. And not only did they diverge by—for those of you that are statisticians, it was an eight standard deviation divergence. OK? That doesn’t happen very often. I know we talk about once-in-a- lifetime calamities every 10 years, that one just hasn’t happened. THOMPSON: The Fed would have certainly seen that. Why, in your opinion was there no action taken there? BASS: You know, I mean, why—why do politicians not want to take the punch bowl away when things are going well is kind of what you’re asking me. It’s just a difficult decision. And, politically—even appointments at the Fed, right? Everyone’s on somewhat of a re- election cycle. If you make that difficult decision when things are good, you’re the bad guy. You’d rather be the guy that helps clean it up once it breaks. So you get into more of a—an ideological question when you ask. CHRG-110hhrg38392--91 Mr. Bernanke," I think that there is an adjustment correction going on. The housing market expanded to very high levels of production. Despite the fact that we are off 30 percent in terms of construction this year from the peak, we are at levels that were reached in the late 1990's, for example, so the housing market is still producing more than 1 million homes a year. So I think we have to watch very carefully what is happening. We need to make sure our mortgage markets are functioning well and so on. But I think this is a process that is going to have to work its way out, and it has been working its way out, and we will be watching it as it does. " CHRG-110hhrg34673--133 Mr. Garrett," Thank you, Mr. Chairman, and thank you, Mr. Chairman, for your testimony today. I appreciate your spending the time with us. I would like to go back and begin my questioning with a topic that is of great importance to me, and we have already touched on it, at least with one series of questioning, and that is dealing with GSE reform. On the one hand, I am pleased to see that the Administration is taking what I would say is a slightly tougher tone, if you will, on pushing for a brighter line test between what is appropriate and what is inappropriate between the primary and the secondary markets and what the GSE's are involved in. That is on the positive side. On the negative side, from my position, I have seen something of a softening with the Treasury stance with regard to portfolio limitations, which I believe should be a true concern to us. I know that there are ongoing negotiations, if you will, between the Treasury and our esteemed and gracious chairman behind us to try to reach a compromise on this issue, and as part of the negotiations there is consideration of what has been dubbed the MTI, the mortgage tax increase, better known as the ``Housing Fund,'' and I would be curious to have your take on an aspect of that. I raised a similar question to you when you were here before the committee a year ago and new on board, but I know since that time you have had an opportunity to get into the weeds a little bit more on this topic. You have already testified here and before other committees with regard to the importance of the housing market in general to our boom in the economy that we have had and the slight slowness of the housing market and what impact that could have on the overall economy. My first question to you is: What additional impact could we see if we did have a tax, if you will, on that marketplace by having a fee or an assessment on the GSE's for this new Housing Fund, or the MTI? " FOMC20060629meeting--107 105,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. I guess I’d say the center of gravity of this discussion is a little stronger than the Greenbook, and I think that’s pretty much where we are, too. We expect real GDP growth to follow a path pretty close to potential in the balance of ’06 and in ’07, and we expect core PCE inflation to moderate gradually to around 2 percent in ’07. This forecast assumes a monetary policy path close to that of the Greenbook, somewhat under the market’s forecast. Since May, in our view, the balance of risks has shifted a bit toward the less-favorable mix of somewhat more downside risk to real growth and somewhat more upside risk to inflation. Relative to the Greenbook, however, this implies that we have a stronger trajectory for demand growth and a slightly lower path for inflation. On the growth side, I guess I’d say we see a pretty healthy adjustment process under way with a change in the composition of growth. We don’t see the incoming data, the anecdotes, and the recent developments in financial markets as supporting the view that real growth is likely to stay significantly below potential over the full forecast period. We had already anticipated the slowdown in residential investment that has now materialized; therefore, we didn’t see that as a basis for revising down our forecast. We believe the changes in household wealth in general have less effect on consumption than the Board staff believes, and as a result we expect a more modest deceleration in growth. We expect stronger employment growth, too, and we have a stronger view of the rate of growth in private investment going forward. The world economy still looks pretty robust to us. So overall, in our view, this supports a forecast for the economy to be growing at a rate a bit above 3 percent over the next year and a half. But the risks to this forecast of growth seem a little less balanced than they did in May. We see less chance that the expansion is going to reaccelerate to a pace significantly above potential, and we see a bit more chance for a weaker outcome. The principal source of downside risk to us remains the possibility that households are going to reduce consumption growth significantly because they feel less rich, less secure, less comfortable borrowing, and less certain about the future. On the inflation outlook, we have moved up our expected trajectory for core PCE price inflation, but we still expect this measure to moderate, as I said, to around 2 percent by the end of ’07. This forecast is pretty favorable. It rests on the familiar fundamental forces of energy prices, if they follow the futures curve, becoming a source of moderation to price pressure going forward. Strong productivity growth keeps unit labor costs from accelerating sharply. Profit margins adjust to absorb any increase in unit labor costs that might come if labor’s share starts to move back toward its historical average. Growth of aggregate demand moderates to potential— it probably has already moderated to potential—which attenuates the risk of further upside pressure on resource utilization going forward. Most important, long-term inflation expectations have come down a bit. They remain in the range of the past few years, and they have proven responsive to changes in policy expectations in a more reassuring way than we saw very recently. As in May, however, we believe the risks to this forecast are still somewhat to the upside because of the following: Headline inflation and near-term inflation expectations have been running substantially above core for some time. Virtually all the ways we try to capture underlying inflation have been running above core. The recent rise in core may imply more momentum in inflation dynamics. You might say that long-term inflation expectations are a little higher than we want over time, and they may have been too responsive to changes in the incoming data. The medium-term trajectory for the dollar seems likely to be down. Profit margins, for reasons we don’t fully understand, have been very high and have been rising, and maybe that tells us something about inflation psychology that we don’t see in the long-term breakevens and TIPS. The long-term forecasts of inflation that the staff presentations give us show a lot of persistence of inflation. Inflation falls very, very slowly over time; and if that path is right, it could cause some further damage to inflation psychology. If you just step back and look at how much our expectations and the markets’ expectations about the terminal rate, the funds rate at which we’d stop tightening, have changed over the past two years, it’s really remarkable. The expectations eighteen months ago were about 200 basis points below where we are now. That change may imply that we will learn in retrospect that we were too loose for too long, and therefore we’ll have to do more than we thought to counteract that effect on inflation. That’s a possibility, not a prediction. So as I said in the beginning, in some sense the balance of risks has shifted in a way that complicates the monetary policy choice for us, and the shift leaves us with less confidence about the appropriate path for policy going forward. On balance, monetary policy appears to be getting some traction in the United States, and the expansion still looks to be in good shape. Inflation risks seem a bit tilted to the upside, and monetary policy needs to continue to be directed at ensuring significant moderation in the trajectory of inflation over the next few years. Thank you." 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." FinancialCrisisInquiry--143 Reserve here in D.C. It’s—it’s not a large data point. However, their answer at the time was—and—and this was—this was also the thought that was—that was homogeneous throughout Wall Street’s analysts—was home prices always track income growth and jobs growth. And they showed me income growth on one chart and jobs growth on another, and said, “We don’t see what you’re talking about because incomes are still growing and jobs are still growing.” And I said, well, you obviously don’t realize where the dog is and where the tail is, and what’s moving what. But again, it was my opinion which, you know, they intended—or they—disregarded. GRAHAM: Thank you. CHAIRMAN ANGELIDES: Mr. Holtz-Eakin? HOLTZ-EAKIN: Thank you, Mr. Chairman. Thank you, everyone, for coming today. Mr. Bass, you got my attention with leverage at 68 to one at Citi. Can you walk through those numbers for me again? BASS: Sure. HOLTZ-EAKIN: I just want to make sure I understand sort of the full range of your argument, which sounds to me as if, first, there’s the officially measured leverage, then a leverage measure which recognizes the off balance sheet, uncapitalized derivative positions—things like that. I’m trying to figure out where—where do the numbers... BASS: 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-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. " fcic_final_report_full--325 Two days later, Fannie CEO Mudd reported losses in the fourth quarter of , acknowledging that Fannie was “working through the toughest housing and mort- gage markets in a generation.”  The company had issued . billion of preferred stock, had completed all  requirements of the consent agreement with OFHEO, and was discussing with OFHEO the possibility of reducing the  capital surplus requirement. The next day, Freddie also reported losses and said the company had raised  billion of preferred stock. As both companies had filed current financial statements by this time, fulfilling a condition of lifting the restrictions imposed by the consent agreements, Lockhart an- nounced that OFHEO would remove the portfolio caps on March , . He also said OFHEO would consider gradually lowering the  capital surplus require- ment, because both companies had made progress in satisfying their consent agree- ments and had recently raised capital through preferred stock offerings. Mudd told the FCIC that he sought relief from the capital surplus requirement because he did not want to face further regulatory discipline if Fannie fell short of required capital levels.  On February , , the day after OFHEO lifted the growth limits, a New York Fed analyst noted to Treasury that the  capital surcharge was a constraint that prevented the GSEs from providing additional liquidity to the secondary mortgage market.  Calls to ease the surcharge also came from the marketplace. Mike Farrell, the CEO of Annaly Capital Management, warned Treasury Undersecretary Robert Steel that a crisis loomed in the credit markets that only the GSEs could solve. “We be- lieve that we are nearing a tipping point; . . . lack of transparency on pricing for vir- tually every asset class” and “a dearth of buyers” foreshadowed worse news, Farrell wrote. Removing the capital surcharge and passing legislation to overhaul the GSEs would make it possible for them to provide more stability, he said. Farrell recog- nized that the GSEs might believe their return on capital would be insufficient, but contended that “they will have to get past that and focus on fulfilling their charters,” because “the big picture is that right now whatever is best for the economy and the financial security of America trumps the ROI [return on investment] for Fannie and Freddie shareholders.”  Days before Bear Stearns collapsed, Steel reported to Mudd that he had “encour- aging” conversations with Senator Richard Shelby, the ranking member of the Senate Committee on Banking, Housing, and Urban Affairs, and Representative Frank, chairman of the House Financial Services Committee, about the possibility of GSE reform legislation and capital relief for the GSEs. He intended to speak with Senate Banking Committee Chairman Christopher Dodd. Confident that the government desperately needed the GSEs to back up the mortgage market, Mudd proposed an “easier trade.” If regulators would eliminate the surcharge, Fannie Mae would agree to raise new capital.  In a March  email to Fannie chief business officer Levin, Mudd suggested that the  capital surplus requirement might be reduced without any trade: “It’s a time game . . . whether they need us more . . . or if we hit the capital wall first. Be cool.”  FOMC20080318meeting--51 49,MR. ROSENGREN.," Thank you, Mr. Chairman. Since our last meeting, the economic data have continued to indicate a very weak economy and that, in all likelihood, we have entered a recession. Like the Greenbook, my outlook is particularly influenced by indications of significantly weaker labor markets and a housing market that is as yet showing no signs of reaching bottom. Private payroll employment fell 101,000 in February, and the sum of the downward revisions in December and January was about the same magnitude. Not only have we had three months of declining private payroll employment, but also the decline has been widespread across most industries. The Blue Chip economic forecast, the Greenbook forecast, and our own forecast have the unemployment rate peaking somewhere between 5� and 6 percent. While most analysts are in the process of downgrading their forecasts from skirting to actually having a mild recession, the risk of a more severe downturn is uncomfortably high. A major determinant of the severity of a downturn will be the housing market. Because recent developments in the housing market are so different from most postwar history, I remain very concerned that the effects of substantial declines in housing prices will be difficult to capture in statistical models based on historical data. The Case-Shiller index indicates that housing prices fell approximately 10 percent in 2007, and a decline of similar magnitude this year would mean that many homes purchased in the past several years are in a negative equity position. Elevated foreclosures and large inventories of unsold properties are providing abundant opportunities to purchase homes at heavily discounted prices financed at low interest rates by historical standards. But widespread concerns that prices will continue to fall have resulted in many prospective buyers deferring purchase decisions. To date, the housing market has been quite weak, despite relatively low unemployment rates. But if our forecasts are right, job losses this year are likely to exert a significant further drag on housing prices as rising unemployment rates force additional home sales or foreclosures. Falling housing prices are likely to have a collateral impact on consumption. Perhaps reflecting this risk, the credit default swap rates on retailers have been rising, and we are increasingly hearing of retailers that are closing stores or postponing expansions. Retailers, like consumers, are aware that high oil prices, increasing job losses, and losses of wealth in the stock and housing markets are not likely to be conducive to robust consumption. Exacerbating the negative economic news is the continued deterioration in financial markets. Credit spreads have widened significantly over the past six weeks, with many spreads more than 50 basis points higher than at the last meeting. Hedge fund and money managers that I talk to are acutely aware of the counterparty risk and are very carefully managing their collateral. Most firms with excess collateral are in the process of managing that position down. The deleveraging that is going on has reduced the willingness of banks and other financial intermediaries to finance their positions. In addition, as concerns with liquidity rise, we are once again seeing renewed pressure on the asset-backed commercial paper market. The rise in credit default swaps for companies like Washington Mutual and Lehman Brothers indicates increased concerns for the solvency of other large financial institutions with large exposures to mortgages. The potential for a further episode of financial market dysfunction and for runs on additional financial firms is significant. My primary concern at this time is that we could suffer a severe recession. Falling collateral values and impaired financial institutions can significantly exacerbate economic downturns. Some indicators of inflation are higher than we want, but during previous recessions, commodity prices and inflation rates fell. Given my forecast for the economic outlook, I expect substantial excess capacity to significantly reduce inflationary pressures going forward, and I see little evidence that higher commodity prices are causing upward pressures on wages and salaries. " FOMC20070131meeting--65 63,MR. FISHER.," Just to follow up on your point and go to exhibit 12, about foreign GDP growth rates, which Joe talked about. In terms of any pressures on unit labor costs that you see developing, I didn’t quite catch your statement, or I may have misinterpreted it, but basically I thought I heard that these growth rates are not likely to lead the inflationary pressures." FOMC20061025meeting--170 168,VICE CHAIRMAN GEITHNER.," If we consider the merits of Don’s change, or the Kroszner-Kohn change, to that second section, does it convey the sense of growth? If you look through the recent slowdown, growth strengthens relative to the pace in the second and third quarters. Does “moderate” imply some modest strengthening relative to the pace of the second and third quarters?" CHRG-110shrg50369--39 Mr. Bernanke," The measure of shelter costs is related to rents drawn from various sources. Senator Shelby. One more question, Mr. Chairman. What do you judge to be the threat of slow growth continuing with inflation remaining above the Federal Reserve's comfort level? What would you say to that? In other words, what do you judge to be the threat of the slow growth continuing with inflation remaining above your comfort level? " CHRG-110shrg50414--202 Secretary Paulson," I would say the reason we want flexibility to, if we need to, buy some other classes of assets would be that if the banks--if capital starts to--as capital flows more freely, it will help the housing, because the fact that the financial system is gummed up and there is illiquidity hurts it and it may be that to deal with---- Senator Bunning. Student loans and then credit card debt are messing up the housing? " CHRG-109hhrg28024--148 Mr. Garrett," Getting to the questions on the GSEs, just a couple more points, I appreciate your comments as to the importance of them. I'm just curious, in your mind, whether you think that Fannie and Freddie are really the soundest and the best way that we have to assist homeowners in financing, or is there something else that Congress can do, as we always like to say, to level the proverbial playing field, to provide methods for S&Ls and banks and other financial institutions to get into the market on the same level field as Fannie and Freddie are right now to address the issues that have been already raised as far as increasing the housing market and to provide liquidity. Is there something else we could be doing aside from Fannie and Freddie? " Mr. Bernanke," I'd have to hear your specific suggestions. As I indicated before, Fannie and Freddie did a very important service to us, to the economy, to the country, by creating the secondary mortgage markets. They are no longer the only participants. Obviously, there are now large financial institutions which are also involved in creating and servicing these markets. I think what they do is very valuable. I have no desire to-- " Mr. Garrett," I'll follow up with some of the other models that are out there. I would appreciate your comments as to whether Congress can explore some of these other avenues as well to either supplement or eventually go down the road to a different direction. Another thing that the House did, it passed this committee, and the House passed the GSE reform legislation. As you know, one of the aspects was what I will call the five percent tax or five percent diversion, always with the laudable goal of trying to provide revenue to those most in need in the housing market. The question on the other side of that equation comes, and this involves your concerns and mine as well, with regard to portfolio size and limitations. I think we are on the same page. I was fighting for that when your predecessor was here, to try to put those stronger limitations in place. What is your comment on what the House has done in that area by diverting revenue from the normal revenue stream? Does this put an additional burden on the GSEs to basically go in the other direction that we would want them to into, and that is to increase the portfolio to make up for the lost income? " Mr. Bernanke," I'm afraid, Congressman, that is out of my purview. It's really up to Congress to decide how they want to manage these kinds of funds. My main concerns are about financial stability and, therefore, about the fact that we have such a large portfolio which has to be hedged in a complicated dynamic fashion. " FOMC20050630meeting--210 208,MR. GALLIN.," That is my opinion on the matter. If you put a new home into place on a plot of land and follow that over time, the value of the structure might rise, reflecting an improvement to the house, or it might deteriorate. But as for the land, once the house is built, it falls into existing house land. That’s what it is from then on. And if the value of that package of land and structure is going up and you think the value of the structure is not, it’s coming in through the land. If you flip to the very last page of the handout, page 33, the lower panel shows levels of the June 29-30, 2005 71 of 234 and an estimate of construction costs. That basically reflects the cost of a bundle of construction materials over time—a certain amount of lumber, a certain amount of—" CHRG-110hhrg34673--120 Mr. Bernanke," Those are very high tax rates, and they would have adverse effects on growth. " FOMC20080130meeting--144 142,MR. PLOSSER., But is the mechanism through a wealth effect on consumption growth? FOMC20081029meeting--197 195,MR. FISHER., So it's possible that we might have marginally higher rates of growth than-- FOMC20051213meeting--51 49,MS. MINEHAN., To keep pace with the growth in the labor force. CHRG-111shrg57321--182 Mr. McDaniel," The growth in the debt markets. Senator Kaufman. Right. " CHRG-111hhrg55809--269 Mr. Bernanke," That is right, by the end of 2010, if growth is about 3 percent. "