{"id":1776,"date":"2009-12-17T21:52:21","date_gmt":"2009-12-18T01:52:21","guid":{"rendered":"https:\/\/freedom24.org\/rationalpost\/?p=1776"},"modified":"2009-12-22T00:29:06","modified_gmt":"2009-12-22T04:29:06","slug":"bunning-%e2%99%a5-bernanke","status":"publish","type":"post","link":"https:\/\/freedom24.org\/rationalpost\/bunning-%e2%99%a5-bernanke\/","title":{"rendered":"bunning \u00e2\u2122\u00a5 bernanke"},"content":{"rendered":"

\"bernanke\"<\/a>For all its flaws, one of the great strengths of the American political system is the degree to which competing perspectives fight to the death in Washington’s marketplace of ideas. A perfect example is the recent exchange between Senate Banking Committee member (and Baseball Hall of Famer)\u00c2\u00a0Jim Bunning<\/a> and his monetary nemesis Fed Chairman Bernanke<\/a> on the eve of a controversial re-nomination…
\n<\/em><\/p>\n

Bunning Statement On The Re-Nomination Of Ben Bernanke To Be Chairman Of The Federal Reserve<\/strong>
\nSenate Banking Committee<\/a> on\u00c2\u00a0Thursday, December 3, 2009<\/p>\n

Four years ago when you came before the Senate for confirmation to be Chairman of the Federal Reserve, I was the only Senator to vote against you. In fact, I was the only Senator to even raise serious concerns about you. I opposed you because I knew you would continue the legacy of Alan Greenspan, and I was right. But I did not know how right I would be and could not begin to imagine how wrong you would be in the following four years.<\/p>\n

The Greenspan legacy on monetary policy was breaking from the Taylor Rule to provide easy money, and thus inflate bubbles. Not only did you continue that policy when you took control of the Fed, but you supported every Greenspan rate decision when you were on the Fed earlier this decade. Sometimes you even wanted to go further and provide even more easy money than Chairman Greenspan. As recently as a letter you sent me two weeks ago, you still refuse to admit Fed actions played any role in inflating the housing bubble despite overwhelming evidence and the consensus of economists to the contrary. And in your efforts to keep filling the punch bowl, you cranked up the printing press to buy mortgage securities, Treasury securities, commercial paper, and other assets from Wall Street. Those purchases, by the way, led to some nice profits for the Wall Street banks and dealers who sold them to you, and the G.S.E. purchases seem to be illegal since the Federal Reserve Act only allows the purchase of securities backed by the government.<\/p>\n

On consumer protection, the Greenspan policy was don\u00e2\u20ac\u2122t do it. You went along with his policy before you were Chairman, and continued it after you were promoted. The most glaring example is it took you two years to finally regulate subprime mortgages after Chairman Greenspan did nothing for 12 years. Even then, you only acted after pressure from Congress and after it was clear subprime mortgages were at the heart of the economic meltdown. On other consumer protection issues you only acted as the time approached for your re-nomination to be Fed Chairman.<\/p>\n

Alan Greenspan refused to look for bubbles or try to do anything other than create them. Likewise, it is clear from your statements over the last four years that you failed to spot the housing bubble despite many warnings.<\/p>\n

Chairman Greenspan\u00e2\u20ac\u2122s attitude toward regulating banks was much like his attitude toward consumer protection. Instead of close supervision of the biggest and most dangerous banks, he ignored the growing balance sheets and increasing risk. You did no better. In fact, under your watch every one of the major banks failed or would have failed if you did not bail them out.<\/p>\n

On derivatives, Chairman Greenspan and other Clinton Administration officials attacked Brooksley Born when she dared to raise concerns about the growing risks. They succeeded in changing the law to prevent her or anyone else from effectively regulating derivatives. After taking over the Fed, you did not see any need for more substantial regulation of derivatives until it was clear that we were headed to a financial meltdown thanks in part to those products.<\/p>\n

The Greenspan policy on transparency was talk a lot, use plenty of numbers, but say nothing. Things were so bad one TV network even tried to guess his thoughts by looking at the briefcase he carried to work. You promised Congress more transparency when you came to the job, and you promised us more transparency when you came begging for TARP. To be fair, you have published some more information than before, but those efforts are inadequate and you still refuse to provide details on the Fed\u00e2\u20ac\u2122s bailouts last year and on all the toxic waste you have bought.<\/p>\n

And Chairman Greenspan sold the Fed\u00e2\u20ac\u2122s independence to Wall Street through the so-called \u00e2\u20ac\u0153Greenspan Put\u00e2\u20ac\u009d. Whenever Wall Street needed a boost, Alan was there. But you went far beyond that when you bowed to the political pressures of the Bush and Obama administrations and turned the Fed into an arm of the Treasury. Under your watch, the Bernanke Put became a bailout for all large financial institutions, including many foreign banks. And you put the printing presses into overdrive to fund the government\u00e2\u20ac\u2122s spending and hand out cheap money to your masters on Wall Street, which they use to rake in record profits while ordinary Americans and small businesses can\u00e2\u20ac\u2122t even get loans for their everyday needs.<\/p>\n

Now, I want to read you a quote: \u00e2\u20ac\u0153I believe that the tools available to the banking agencies, including the ability to require adequate capital and an effective bank receivership process are sufficient to allow the agencies to minimize the systemic risks associated with large banks. Moreover, the agencies have made clear that no bank is too-big-too-fail, so that bank management, shareholders, and un-insured debt holders understand that they will not escape the consequences of excessive risk-taking. In short, although vigilance is necessary, I believe the systemic risk inherent in the banking system is well-managed and well-controlled.\u00e2\u20ac\u009d<\/p>\n

That should sound familiar, since it was part of your response to a question I asked about the systemic risk of large financial institutions at your last confirmation hearing. I\u00e2\u20ac\u2122m going to ask that the full question and answer be included in today\u00e2\u20ac\u2122s hearing record.<\/p>\n

Now, if that statement was true and you had acted according to it, I might be supporting your nomination today. But since then, you have decided that just about every large bank, investment bank, insurance company, and even some industrial companies are too big to fail. Rather than making management, shareholders, and debt holders feel the consequences of their risk-taking, you bailed them out. In short, you are the definition of moral hazard.<\/p>\n

Instead of taking that money and lending to consumers and cleaning up their balance sheets, the banks started to pocket record profits and pay out billions of dollars in bonuses. Because you bowed to pressure from the banks and refused to resolve them or force them to clean up their balance sheets and clean out the management, you have created zombie banks that are only enriching their traders and executives. You are repeating the mistakes of Japan in the 1990s on a much larger scale, while sowing the seeds for the next bubble. In the same letter where you refused to admit any responsibility for inflating the housing bubble, you also admitted that you do not have an exit strategy for all the money you have printed and securities you have bought. That sounds to me like you intend to keep propping up the banks for as long as they want.<\/p>\n

Even if all that were not true, the A.I.G. bailout alone is reason enough to send you back to Princeton. First you told us A.I.G. and its creditors had to be bailed out because they posed a systemic risk, largely because of the credit default swaps portfolio. Those credit default swaps, by the way, are over the counter derivatives that the Fed did not want regulated. Well, according to the TARP Inspector General, it turns out the Fed was not concerned about the financial condition of the credit default swaps partners when you decided to pay them off at par. In fact, the Inspector General makes it clear that no serious efforts were made to get the partners to take haircuts, and one bank\u00e2\u20ac\u2122s offer to take a haircut was declined. I can only think of two possible reasons you would not make then-New York Fed President Geithner try to save the taxpayers some money by seriously negotiating or at least take up U.B.S. on their offer of a haircut. Sadly, those two reasons are incompetence or a desire to secretly funnel more money to a few select firms, most notably Goldman Sachs, Merrill Lynch, and a handful of large European banks. I also cannot understand why you did not seek European government contributions to this bailout of their banking system.<\/p>\n

From monetary policy to regulation, consumer protection, transparency, and independence, your time as Fed Chairman has been a failure. You stated time and again during the housing bubble that there was no bubble. After the bubble burst, you repeatedly claimed the fallout would be small. And you clearly did not spot the systemic risks that you claim the Fed was supposed to be looking out for. Where I come from we punish failure, not reward it. That is certainly the way it was when I played baseball, and the way it is all across America. Judging by the current Treasury Secretary, some may think Washington does reward failure, but that should not be the case. I will do everything I can to stop your nomination and drag out the process as long as possible. We must put an end to your and the Fed\u00e2\u20ac\u2122s failures, and there is no better time than now.<\/p>\n

Not to be outdone, see below for Bernanke’s comprehensive (if somewhat unsatisfying) <\/em>response<\/a> to the Senator’s inquisition…<\/em><\/p>\n

Questions for The Honorable Ben Bernanke, Chairman, Board of Governors of the Federal\u00c2\u00a0Reserve System, from Senator Bunning<\/strong>:<\/p>\n

1. Please provide:
\na. Unreleased transcripts of all F.O.M.C. meetings you participated in as a Governor or\u00c2\u00a0Chairman.
\nb. Unreleased transcripts of all Board of Governors meetings you participated in as a\u00c2\u00a0Governor or Chairman.
\nc. Transcripts and minutes of meetings of the board of the Federal Reserve Bank of\u00c2\u00a0New York during your tenure as Chairman of the Board of Governors.
\nd. Details, including any unreleased administrative notices, on any exemptions granted\u00c2\u00a0or denied to Federal Reserve Act sections 23(a) and 23(b) during your tenure as\u00c2\u00a0Chairman.
\ne. Details of all discount window transactions during your tenure as Chairman,\u00c2\u00a0including the date, amount, identity of the borrower, details of any collateral posted,\u00c2\u00a0explanation of the valuation of any collateral posted, any analysis of the health of the\u00c2\u00a0borrower at the time of the transaction, and any legal opinions regarding the\u00c2\u00a0transaction.
\nf. Details of all transactions at facilities created under section 13(3) of the Federal\u00c2\u00a0Reserve Act during your tenure as Chairman, including the date, amount, identity of\u00c2\u00a0the borrower, details of any collateral posted, explanation of the valuation of any\u00c2\u00a0collateral posted, any analysis of the health of the borrower at the time of the\u00c2\u00a0transaction, and any legal opinions regarding the transaction.
\ng. Copies of any swap or other agreements with foreign central banks, legal opinions\u00c2\u00a0related to those agreements, and any analysis of the agreements or the need for the\u00c2\u00a0agreements.
\nh. Any economic analysis or policy materials regarding the need for or effectiveness of\u00c2\u00a0any Federal Reserve facilities created under Federal Reserve Act section 13(3).
\ni. Any economic analysis or policy materials regarding the need for or effectiveness of\u00c2\u00a0unconventional monetary policy facilities or actions taken during your tenure as\u00c2\u00a0Chairman.
\nj. Any transcripts, minutes, details, legal opinions, economic analysis, phone call logs,\u00c2\u00a0policy materials, or any other relevant information from the F.O.M.C., the Board of\u00c2\u00a0Governors, the Federal Reserve Bank of New York, or other relevant body not\u00c2\u00a0provided under the above requests regarding the use of Federal Reserve Act section\u00c2\u00a013(3) or actions and decisions regarding AIG, Bank of America, Citigroup, Bear\u00c2\u00a0Stearns, Lehman Brothers, General Motors, Chrysler, CIT, or GMAC.<\/p>\n

Without addressing every specific item, I believe that the release of much of the information
\nrequested would inhibit the policymaking process or reduce the effectiveness of policy and thus
\nwould not be in the public interest.<\/p>\n

Making public the information you request regarding policy deliberations (including meeting
\ntranscripts and related documents) could stifle the Federal Reserve\u00e2\u20ac\u2122s policy discussions, limiting
\nthe ability of participants to engage in the candid and free exchange of views about alternative<\/p>\n

– 2 –<\/p>\n

approaches that is necessary for effective policy. Although transcripts are not released for five
\nyears (and I believe that we are the only major central bank that does make transcripts public),
\nwe provide extensive information about our deliberations, including through Committee
\nstatements, minutes, quarterly economic projections, testimonies, speeches, the semi-annual
\nMonetary Policy Report to the Congress, and other vehicles.<\/p>\n

The detailed information you have requested regarding participation in Federal Reserve\u00e2\u20ac\u2122s broad-
\nbased lending programs would significantly undermine the usefulness of such programs. The
\ncritical purpose of these programs is to provide institutions that have temporary liquidity needs
\nwith a means to meet those needs by coming to the Federal Reserve. Releasing the names of
\ninstitutions that borrow would stigmatize such borrowing, making firms less willing to come to
\nthe Federal Reserve and so make it more difficult for the Federal Reserve to respond to financial
\nmarket strains. Moreover the Federal Reserve has been highly responsible in its use of these
\nprograms. For example, our discount window loans are fully collateralized, and we have never
\nlost a penny on such operations. Likewise, the loans made under section 13(3) have been fully
\nsecured. We provide extensive information regarding the number of institutions to which we are
\nlending under each of our credit programs, and the type of collateral we have accepted, on our
\nwebsite, as well as information on exemptions granted under sections 23A and 23B of the
\nFederal Reserve Act.<\/p>\n

Finally, the release of staff analyses could have adverse effects on Federal Reserve policy. In
\norder for the Federal Reserve staff to be able to provide its best policy analysis and advice to
\npolicymakers, it is necessary for some staff analysis to be kept confidential for a period of time.
\nRelease of such information could expose Federal Reserve staff to political pressure. Such
\npressure could lead the staff to omit more sensitive material from its policy analyses and more
\ngenerally might cause the staff to skew its analyses and judgments. That outcome could have
\nserious adverse effects on Federal Reserve policy decisions, to the detriment of the performance
\nof our economy.<\/p>\n

The Federal Reserve is very transparent. On a weekly, monthly, quarterly, semi-annual and
\nannual basis, the Federal Reserve provides to the public in-depth and detailed information
\nregarding its operations, activities and policy decisions. These materials include:<\/p>\n

\u00e2\u20ac\u00a2 Weekly Balance Sheets – H.4.1 Release (See December 10, 2009 Release, attached as Ex.
\n1, tab A) (also available on our public website:
\nhttp:\/\/www.federalreserve.gov\/monetarypolicy\/bst_fedsbalancesheet.htm);<\/p>\n

\u00e2\u20ac\u00a2 Monthly Transparency Reports (See November 2009 Report, attached as Ex. 1, tab B)(also
\navailable on our public website:
\nhttp:\/\/www.federalreserve.gov\/monetarypolicy\/files\/monthlyclbsreport200911.pdf);<\/p>\n

\u00e2\u20ac\u00a2 Policy statements released immediately following each FOMC Meeting (See November 4,
\n2009 Release, attached as Ex. 1, tab C) (also available on our public website:
\nhttp:\/\/www.federalreserve.gov\/newsevents\/press\/monetary\/20091104a.htm);<\/p>\n

– 3 –<\/p>\n

\u00e2\u20ac\u00a2 Minutes of each FOMC Meeting (See November 3-4, 2009 Minutes, attached as Ex. 1, tab
\nD) (also available on our public website:
\nhttp:\/\/www.federalreserve.gov\/monetarypolicy\/files\/fomcminutes20091104.pdf);<\/p>\n

\u00e2\u20ac\u00a2 Semiannual Monetary Policy Report & Testimony (See July 2009 Report, attached as Ex.
\n1, tab E)(also available on our public website:
\nhttp:\/\/www.federalreserve.gov\/monetarypolicy\/files\/20090721_mprfullreport.pdf);<\/p>\n

\u00e2\u20ac\u00a2 Annual audit of the Federal Reserve\u00e2\u20ac\u2122s financial statement provided by independent
\naccounting firm (See Audit, published in Annual Report and attached separately as Ex. 1,
\ntab F) (also available on our public website:
\nhttp:\/\/www.federalreserve.gov\/boarddocs\/rptcongress\/annual08\/pdf\/audits.pdf); and<\/p>\n

\u00e2\u20ac\u00a2 Voluminous information on policy actions available on our public website:
\nhttp:\/\/www.federalreserve.gov\/monetarypolicy\/bst.htm.<\/p>\n

In addition, the Federal Reserve has submitted one statement for the record and testified before
\nCongress 43 times this calendar year, including:<\/p>\n

\u00e2\u20ac\u00a2 Twelve appearances by the Chairman;<\/p>\n

\u00e2\u20ac\u00a2 Three appearances by the Vice Chairman;<\/p>\n

\u00e2\u20ac\u00a2 Nine appearances by the Governors;<\/p>\n

\u00e2\u20ac\u00a2 Twelve appearances by the Staff of the Board of Governors; and<\/p>\n

\u00e2\u20ac\u00a2 Six appearances by the Presidents, Vice Presidents and Staff of the Reserve Banks.<\/p>\n

Further, the Federal Reserve has already been audited numerous times in 2009, including:<\/p>\n

\u00e2\u20ac\u00a2 The Annual Audit (as mentioned); and<\/p>\n

\u00e2\u20ac\u00a2 GAO Audits of non-monetary policy, which total 33 to date – 24 completed and 9 in
\nprocess (reports of the audits are available on GAO\u00e2\u20ac\u2122s website:
\nhttp:\/\/www.gao.gov\/docsearch\/repandtest.html).<\/p>\n

2. Treasury published the names of banks that received TARP funds without causing a
\npanic. Why would disclosing the names of companies that borrow at the discount window
\nor other Fed facilities be different, especially if only released after a time delay?<\/p>\n

It is essential that participants in our liquidity programs remain confident that their usage of these
\nprograms will be held in confidence. If borrowers instead fear that market participants and
\nothers may learn about their usage of these programs, then they will be less inclined to borrow,
\nreducing the effectiveness of the programs for countering pressures in financial markets. This is
\nnot just a theoretical possibility. When the strains in financial markets erupted in August 2007,<\/p>\n

– 4 –<\/p>\n

banks were quite reluctant to utilize the primary credit program out of concern that their
\nborrowing would be discovered by market participants and interpreted as a sign of financial
\nweakness. Indeed, that stigma significantly reduced the effectiveness of the primary credit
\nprogram, and prompted the Federal Reserve to establish the Term Auction Facility and other
\nprograms to more directly address liquidity pressures.<\/p>\n

3. What was the involvement of the Board of Governors in each transaction by the New
\nYork Fed under Federal Reserve Act section 13(3)? Did the Board materially alter the
\nterms of any such transaction? Did the Board approve each transaction before the New
\nYork Fed began negotiations? Please provide other relevant information and
\ndocumentation.<\/p>\n

As required by section 13(3) of the Federal Reserve Act, the Board of Governors considered and
\napproved, by an affirmative vote of not less than the required number of members, each credit
\nfacility established under the authority of that provision, after making the required determination
\nthat unusual and exigent circumstances existed. Prior to Board of Governors approval of these
\nfacilities, Board of Governors and New York Federal Reserve Bank staff worked together to
\nstructure the proposal that was presented to the Board of Governors for approval. As authorized
\nby section 13(3), the Board of Governors imposed specific limits and conditions on these credit
\nfacilities as appropriate to the particular facility. Detailed information concerning each of the
\ncredit facilities authorized by the Board under section 13(3) is available on the Board\u00e2\u20ac\u2122s public
\nwebsite.<\/p>\n

4. Did anyone, including the White House or Treasury, request commitments from you
\nsurrounding your re-nomination? Did you make any commitments regarding your re-
\nnomination?<\/p>\n

No one has requested any commitments from me in connection with my re-nomination, nor have
\nI made any commitments other than what I said in my statement before the Senate Banking
\nCommittee that, if re-appointed, I will work to the utmost of my abilities in the pursuit of the
\nmonetary policy objectives established by Congress to promote price stability and maximum
\nemployment.<\/p>\n

5. We saw the crowding out of the private mortgage market caused by Freddie and
\nFannie\u00e2\u20ac\u2122s overwhelming control of mortgages during 2002 to 2006 period. Do you think
\nthere is a danger to allowing an extended public-controlled mortgage market? And what
\nsteps is the Fed taking to reestablish a private mortgage market?<\/p>\n

The U.S. mortgage market has had extensive government involvement for many decades,
\nincluding Fannie Mae, Freddie Mac, the Federal Housing Administration, Ginnie Mae, and the
\nFederal Home Loan Banks. That involvement has had important benefits, including the
\ndevelopment of the mortgage securitization market. However, as the placing of Fannie Mae and
\nFreddie Mac into conservatorship shows, the under-capitalization of the GSEs together with the
\nimplicit government guarantee has also imposed heavy costs on the taxpayer. The Congress will
\nneed to address the appropriate role of the GSEs in the future of the mortgage market.<\/p>\n

– 5 –<\/p>\n

The Federal Reserve\u00e2\u20ac\u2122s agency debt and mortgage-backed securities purchase programs stabilized
\nthe functioning of private secondary mortgage markets during the height of the financial turmoil.
\nThese actions also provided significant benefits to primary mortgage markets.<\/p>\n

6. Time and energy in macroeconomic analysis is spent attempting to measure business
\nand consumer confidence. Confidence measures are part of macroeconomic forecasting
\nand directly impact monetary policy decisions. Likewise, certain market movements
\nreflect investor confidence or lack of confidence. Gold is at an all-time high because
\ninvestors have lost confidence in policymakers’ handling of fiat currencies. How is the Fed
\nincorporating this market information into its analytical framework? Does the lack of
\nconfidence in fiat currencies have the potential to impact monetary policy?<\/p>\n

Gold is used for many purposes, including as a reserve asset, as an investment, and for use in
\nelectronics, automobiles, and jewelry. Thus, fluctuations in the price of gold can reflect changes
\nin demand associated with any of these uses, as well as changes in supply. In monitoring the
\nprice of gold, the Federal Reserve must attempt to interpret which of these factors is responsible
\nfor its fluctuations at any point in time. One of the ways we do this is by consulting other
\nindicators of market sentiment. A number of measures of expected future inflation in the United
\nStates, including measures taken from inflation-protected bonds and surveys of consumers and
\nprofessional forecasters, have been well contained. Accordingly, increases in the price of gold
\ndo not appear to reflect increases in the expected future of U.S. inflation.<\/p>\n

7. Paul Krugman recently wrote about the problem policymakers will face in the future
\nbecause of the publi\u00e2\u20ac\u2122’s lack of trust. The public backlash regarding what it sees as
\nunwarranted bailouts of banks is well-known. What is the Fed doing to restore public
\nconfidence and what are the potential negative implications of this lack of trust on the
\nFed’s ability to conduct monetary policy?<\/p>\n

The public\u00e2\u20ac\u2122s frustration with the support provided banks and certain other financial institutions is
\nunderstandable. Unfortunately, withholding the support would have resulted in a substantially
\nmore severe economic recession with significantly greater job losses. My colleagues and I on
\nthe Federal Reserve Board are taking every opportunity, including through speeches and
\nCongressional testimony, to explain to the public the reasons for the Federal Reserve\u00e2\u20ac\u2122s actions.
\nMoreover, we fully support the efforts under way–in particular, strengthening supervision of
\nsystemically critical institutions and developing a regime to prevent the disorderly failure of
\nsystemically important nonbank financial institutions while imposing losses on the shareholders
\nand creditors of such firms–to reduce the odds that similar support will be needed in the future.<\/p>\n

Most critical for the Federal Reserve\u00e2\u20ac\u2122s ability to conduct monetary policy is the public\u00e2\u20ac\u2122s
\nconfidence in our commitment to achieving our dual mandate of maximum employment and
\nprice stability. The public\u00e2\u20ac\u2122s confidence in our commitment should be bolstered by the Federal
\nReserve\u00e2\u20ac\u2122s swift and forceful monetary policy response to the financial crisis and resulting
\nrecession and by our careful development of tools that will facilitate the firming of monetary
\npolicy at the appropriate time even with a large Federal Reserve balance sheet.<\/p>\n

– 6 –<\/p>\n

8. What are the limits on the ability of the Fed to engage in quantitative easing?<\/p>\n

A central bank engages in quantitative easing when it purchases large quantities of securities,
\npaying for them with newly created bank reserve deposits, to increase the supply of bank
\nreserves well beyond the level necessary to drive very short-term interbank interest rates to zero.
\nThe Federal Reserve\u00e2\u20ac\u2122s large-scale asset purchases have been intended primarily to improve
\nconditions in private credit markets, such as mortgage markets; the increase in the quantity of
\nreserves is largely a byproduct of these actions. In any case, while large-scale asset purchases
\ncan help support financial market functioning and the availability of credit, and thus economic
\nrecovery, excessive expansion of bank reserves could result in rising inflation pressures.
\nCongress has given the Federal Reserve a dual mandate to promote maximum employment and
\nstable prices. That mandate appropriately gives the Federal Reserve flexibility to engage in
\nquantitative easing to combat high unemployment and avoid deflation while requiring that it
\navoid quantitative easing that would be so large or prolonged that it could cause persistent
\ninflation pressures.<\/p>\n

9. In 2002-2005 period, we learned that there is a cost to keeping interest rates too low for
\ntoo long. And, we learned it is much more difficult to tighten policy\/raise interest rates
\nafter a period of low rates for a long time. Now, you have taken rates to unprecedented low
\nlevels and have also intervened in the mortgage market to produce historic low mortgage
\nrates. If the US economy bounces back more strongly than currently anticipated, isn\u00e2\u20ac\u2122t the
\nFed going to have a very tough time raising interest rates without once again impacting
\nasset prices, especially the housing market?<\/p>\n

Federal Reserve policymakers consistently have said, in the statements that the Federal Open
\nMarket Committee releases immediately after each of its meetings and in their speeches, that the
\nFederal Reserve will evaluate its target for the federal funds rate and its securities purchases in
\nlight of the evolving economic outlook and conditions in financial markets. In that regard, we
\nannounced that we plan to end our purchases of mortgage-backed securities at the end of the first
\nquarter of 2010; we also announced–and have implemented–a gradual reduction in the pace of
\nour purchases of such securities. More recently, we made clear that the low target for the federal
\nfunds rate is conditional on low rates of resource utilization, subdued inflation trends, and stable
\ninflation expectations. As the economy continues to recover, it will eventually become
\nappropriate to raise our target for the federal funds rate and perhaps take other steps to reduce
\nmonetary policy accommodation. Our continuing communication about monetary policy should
\nensure that market participants and others are not greatly surprised by our actions and thus help
\navoid sharp adjustments in asset prices.<\/p>\n

10. What is the Fed\u00e2\u20ac\u2122s current thinking about using asset price levels in monetary policy
\nanalysis? Does the Fed need to anticipate asset bubbles? How can the Fed incorporate
\nasset prices into their analysis?<\/p>\n

Asset prices play an important role in the analysis that underpins the conduct of monetary policy
\nby the Federal Reserve. We carefully monitor a wide range of asset prices (as well as other
\naspects of financial market conditions) and assess their implications for the goal variables that
\nthe Congress has given us, namely inflation and employment. There is a widely held consensus<\/p>\n

– 7 –<\/p>\n

that central banks should counteract the effects of asset prices on the ultimate goal variables in
\nthis manner.<\/p>\n

What is less clear is whether the Federal Reserve should attempt to use monetary policy to \u00e2\u20ac\u0153lean
\nagainst\u00e2\u20ac\u009d bubbles in asset prices by tightening monetary policy more than would be indicated by
\nthe medium-term outlook for real activity and inflation alone. To be sure, the experience of the
\npast two years provides a vivid illustration of the economic devastation that can be wrought by
\nan asset price bubble first building up and then bursting. However, three important challenges
\nwould have to be surmounted before tighter monetary policy could be deemed an effective
\nresponse to bubbles: First, we would have to be confident in our ability to detect bubbles at an
\nearly stage in their development, given substantial lags in the effects of monetary policy on real
\nactivity and inflation, and the general need for policy to ease in response to the economic
\nweakness that follows a bubble\u00e2\u20ac\u2122s collapse. Second, we would have to be confident that the steps
\nwe took to restrain a bubble in one sector would not cause so much harm in other sectors as to
\nleave the economy worse off, on net, than if we had not acted. Finally, we would have to be
\nconfident that an adjustment in the stance of monetary policy would be effective in restraining
\nthe bubble itself. It is not clear that these conditions can all be met. And even if they could, we
\nwould still have to determine that some alternative to tighter monetary policy would not be a
\nbetter way of responding to the problem.<\/p>\n

At this stage, it seems to me that the exercise of regulatory and supervisory policy is likely to be
\na more effective approach to addressing issues posed by possible bubbles. Regulators have an
\nongoing responsibility to ensure the safety and soundness of the institutions under their care; and
\nthis responsibility implies a need to monitor closely the actions of the firm that might cause it to
\nbe exposed to risks of all types, including those actions that might contribute to the development
\nof a bubble as well as the possible effects on the firm of the bursting of an asset price bubble. On
\nbalance, therefore, I see a comprehensive and aggressive macroprudential regulatory framework
\nas likely to be the more promising means of preventing and restraining asset-price bubbles.<\/p>\n

All that said, we are giving the issue fresh consideration and attempting to incorporate into our
\nanalysis the lessons of the last two years in this regard.<\/p>\n

11. The Fed appears to have coordinated some of its actions in the past year or so with
\nother policymakers globally. Does the Fed have an obligation to disclose any of these
\nagreements or coordinated efforts? When the Fed engages in agreements with foreign
\npolicymakers, it has the potential to abrogate its authority. What procedures are in place
\nto make sure this doesn\u00e2\u20ac\u2122t happen? What checks and balances are in place?<\/p>\n

In the past year or so, the Federal Reserve has implemented and disclosed policy actions that
\nhave been coordinated with actions taken by policymakers from other countries. These actions
\ninclude both the use of central bank liquidity swaps, which have been in place since December
\n2007, and a reduction in the target for the federal funds rate in October 2008, which occurred in
\nconjunction with similar rate actions by other central banks. The Federal Reserve announced
\nthese actions in press releases and maintains detailed information with respect to them on our
\nweb site.<\/p>\n

– 8 –<\/p>\n

The authority for these operations is well established. Policy rate operations clearly fall within
\nthe purview of the monetary policy authority of the Federal Reserve, and the Federal Reserve
\nAct and longstanding historical precedent support the authority of the Federal Reserve to engage
\nin swap operations with foreign central banks. We are committed to being as transparent as
\npossible about our policies and operations without undermining our ability to effectively fulfill
\nour monetary policy and other responsibilities. The Federal Reserve regularly reports to the
\nCongress and provides both the Congress and the public with a full range of detailed information
\nconcerning its policy actions, operations, and financial accounts, including arrangements with
\nforeign central banks such as the liquidity swaps. The Chairman of the Federal Reserve Board
\ntestifies and provides a report to the Congress semiannually on the state of the economy and on
\nthe Federal Reserve\u00e2\u20ac\u2122s actions to carry out the monetary policy objectives that the Congress has
\nestablished, and Federal Reserve officials frequently testify before the Congress on all aspects of
\nthe Federal Reserve\u00e2\u20ac\u2122s responsibilities and operations, including economic and financial
\nconditions and monetary policy.<\/p>\n

12. China is playing a larger and larger role in the growth trajectory of the global economy.
\nAnd, China is one of the largest U.S. creditors. Yet, the macroeconomic data from China is
\nnotoriously untrustworthy. How is the Fed conducting its analysis of the Chinese
\nmacroeconomic outlook without access to good data?<\/p>\n

While macroeconomic data from China vary in quality, their reliability appears to be improving,
\nand they now provide a reasonable picture of what is going on. In addition to data from China,
\none can also examine Chinese international trade by looking at the statistics produced by its
\nmajor trading partners, including the United States. At the Federal Reserve, we monitor a wide
\nrange of Chinese and international data in analyzing Chinese economic and policy developments.
\nWe also closely follow studies on China performed by independent experts, and keep regular
\ncontact with these experts, Chinese academics and authorities, and other U.S. agencies. Through
\nall these means, we are able to put together a satisfactory assessment of the performance of the
\nChinese economy, allowing us to make an informed projection of the country\u00e2\u20ac\u2122s economic
\noutlook and its implications for the U.S. economy.<\/p>\n

13. There are a number of macro trends at work that do not seem sustainable — 1) the
\nsubstantial accumulation of foreign exchange reserves by surplus\/creditor nations, 2) the
\nescalation of public debt levels in many of the developed market economies, and 3) excess
\nand deficient savings ratios. These trends do not seem likely to reverse on their own.
\nRather, they require tough decisions and compromise on the part of governments around
\nthe world. What is the role of the Fed in this rebalancing process?<\/p>\n

To achieve more balanced and sustainable economic growth and to reduce the risks of financial
\ninstability, economies throughout the world must act to contain and reduce global imbalances. In
\ncurrent account surplus countries, including most Asian economies, authorities must act to
\nnarrow the gap between saving and investment and to raise domestic demand, especially
\nconsumption. As a country with a current account deficit, the United States must increase its
\nnational saving rate by encouraging private saving and, more importantly, by establishing a
\nsustainable fiscal trajectory, anchored by a clear commitment to substantially reduce federal<\/p>\n

– 9 –<\/p>\n

deficits over time. By the same token, other countries experiencing large increases in public debt
\nmust implement credible fiscal consolidation policies.<\/p>\n

Monetary policy, by itself, is not well suited to address external imbalances. Rather, the goal of
\nthe Federal Reserve, as given to us by Congress, is to pursue maximum employment and stable
\nprices, not to achieve a particular level of the trade balance. Our role is to ensure the strongest
\npossible macroeconomic environment, by pursuing the two legs of our mandate, and to work
\nwith fiscal and other policymakers to create conditions that will foster a sustainable external
\nposition. Toward this end, the Federal Reserve participates actively in the G-20 and other
\ninternational organizations in a cooperative effort to devise strategies for dealing with these
\nissues.<\/p>\n

14. Please explain the legality of each version of the AIG bailout\/loans. How were each of
\nthe loans to AIG collateralized?<\/p>\n

Each of the facilities established by the Federal Reserve was authorized and established under
\nsection 13(3) of the Federal Reserve Act (12 U.S.C. \u00c2\u00a7 343). Section 13(3) permits the Board, in
\nunusual and exigent circumstances, to authorize a Federal Reserve Bank to provide a loan to any
\nindividual, partnership, or corporation if, among other things, the loan is secured to the
\nsatisfaction of the Reserve Bank and the Reserve Bank obtains evidence that the individual,
\npartnership or corporation is unable to secure credit accommodations from other banking
\ninstitutions.<\/p>\n

As described in more detail in the Board\u00e2\u20ac\u2122s Monthly Report on Credit and Liquidity Programs
\nand the Balance Sheet and the reports filed by the Board under section 129 of the Emergency
\nEconomic Stabilization Act of 2008, the–<\/p>\n

\u00ef\u201a\u00b7 Revolving Credit Facility with AIG is secured by the pledge of assets of AIG and its
\nprimary non-regulated subsidiaries, including AIG\u00e2\u20ac\u2122s ownership interest in its regulated
\nU.S. and foreign subsidiaries;
\n\u00ef\u201a\u00b7 The loan to Maiden Lane II LLC (ML-II) is secured by all of the residential mortgage-
\nbacked securities and other assets of ML-II, as well as by a $1 billion subordinate position
\nin ML-II held by certain of AIG\u00e2\u20ac\u2122s U.S. insurance subsidiaries;1 and
\n\u00ef\u201a\u00b7 The loan to Maiden Lane III LLC (ML-III) is secured by all of the multi-sector
\ncollateralized debt obligations and other assets of ML-III, as well as a $5 billion
\nsubordinated position in ML-III held by an AIG affiliate.<\/p>\n

15. The most recent changes to the AIG bailout give the New York Fed equity in AIG
\nsubsidiaries in exchange for loan forgiveness. Under what section of the Federal Reserve
\nAct are those equity stakes permissible? Please provide any legal opinions on the subject.<\/p>\n

The Federal Reserve Bank of New York received the preferred equity in the two special purpose
\nvehicles established to hold the equity of two insurance subsidiaries of AIG in satisfaction of a<\/p>\n

1
\nUpon establishment of the ML-II facility, the securities borrowing facility that the Federal Reserve had established
\nfor AIG in October 2008 was terminated. Advances under this securities borrowing facility were fully collateralized
\nby investment grade debt obligations.<\/p>\n

– 10 –<\/p>\n

portion of AIG\u00e2\u20ac\u2122s borrowings under the revolving credit facility established under section 13(3)
\nof the Federal Reserve Act. As a result of the receipt of these preferred interests, AIG\u00e2\u20ac\u2122s
\nborrowings under the revolving credit facility were reduced by $25 billion, and the maximum
\namount available under the facility was reduced from $60 billion to $35 billion. The amount of
\npreferred equity received by the Federal Reserve was based on valuations prepared by an
\nindependent valuation firm. The revolving credit facility continues to be fully secured by nearly
\nall of the remaining assets at AIG. We continue to believe, based on these valuations and
\ncollateral positions, that the Federal Reserve will be fully repaid.<\/p>\n

16. The most recent changes to the AIG bailout give the New York Fed equity in AIG
\nsubsidiaries in exchange for loan forgiveness. Does that indicate that the original \u00e2\u20ac\u0153loans\u00e2\u20ac\u009d
\nwere not really collateralized loans at all, rather they were equity stakes?<\/p>\n

No. The revolving credit facility established for AIG in September 2008 was and is fully
\nsecured by assets of AIG and its primary non-regulated subsidiaries, including AIG\u00e2\u20ac\u2122s ownership
\ninterest in its regulated U.S. and foreign subsidiaries.<\/p>\n

The facility is fully secured by the assets of AIG, including the shares of substantially all of
\nAIG\u00e2\u20ac\u2122s subsidiaries. The loan was extended with the expectation that AIG would repay the loan
\nwith the proceeds from the sale of its operations and subsidiaries. AIG has developed and is
\npursuing a global restructuring and divestiture plan that is designed to achieve this objective and
\na number of significant sales already have occurred. The credit agreement stipulates that the net
\nproceeds from all sales of subsidiaries of AIG must first be used to pay down the credit extended
\nby the Federal Reserve.<\/p>\n

17. When the first nine large banks received the initial 125 billion TARP dollars, Secretary
\nPaulson and you said those nine banks were healthy. Do you now agree with the TARP
\nInspector General\u00e2\u20ac\u2122s finding that Citigroup and Bank of America should not have been
\nconsidered healthy by you and Secretary Paulson?<\/p>\n

On October 14, 2008, the Federal Reserve joined in a press release with Treasury and the FDIC
\nto announce a number of steps to address the financial crisis, including announcing the
\nimplementation of the Capital Purchase Program (\u00e2\u20ac\u0153CPP\u00e2\u20ac\u009d). The first nine banks to receive CPP
\nfunds were selected because of their importance to the financial system at large. In fact, the
\nSIGTARP report notes that approximately 75 percent of all assets held by U.S.-owned banks
\nwere held by these nine institutions. In addition, these first nine institutions were considered to
\nbe viable, though some were financially stronger than others. The press release referred to these
\nnine systemically important institutions as \u00e2\u20ac\u0153healthy\u00e2\u20ac\u009d to indicate that these institutions were
\nviable and were not receiving government funds because they were in imminent danger of
\nfailure.<\/p>\n

18. In 2008, you came to Congress and warned of a catastrophic financial collapse if we did
\nnot authorize TARP. One major problem you predicted was that companies would not be
\nable to sell commercial paper. However, the Fed has the authority to buy that same
\ncommercial paper and in fact, you created a lending facility to buy commercial paper the<\/p>\n

– 11 –<\/p>\n

week after TARP was approved. Did the Fed already have plans to implement this facility
\nbefore you and Secretary Paulson came to Congress requesting TARP?<\/p>\n

The commercial paper market was severely disrupted by the financial crisis, in particular after
\nLehman Brothers failed on September 15, 2008, and a large money fund broke the buck the
\nfollowing day. The Federal Reserve created three facilities in response to the dislocation in
\nmoney markets, each of which was designed to finance purchases of commercial paper. The
\nAsset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) was
\nannounced on September 19, 2008. The Commercial Paper Funding Facility (CPFF) was
\nannounced on October 7, 2008. And the Money Market Investor Funding Facility (MMIFF) was
\nannounced on October 21, 2008. Your question refers to the CPFF, which was announced the
\nweek after the TARP was approved. All of these facilities helped address strains in money
\nmarkets, but they did not replace the commercial paper market completely, and the ability of
\nfirms to sell commercial paper was severely impaired.<\/p>\n

On September 18, 2008, Secretary Paulson and I met with Congressional leadership to discuss
\nthe financial situation and explain our view that the global financial system was on the verge of a
\ncollapse. We expressed concern about a number of areas of the economy and financial markets,
\nincluding as one example the potential collapse of the commercial paper market. At that time,
\nthe Federal Reserve was working towards developing the AMLF. The Federal Reserve began to
\nthink about constructing the CPFF after observing the effects of the failure of Lehman Brothers
\non the commercial paper market. The limitations on the Federal Reserve\u00e2\u20ac\u2122s ability to address the
\nnumerous problems that were rapidly emerging in financial markets in the fall of 2008 spurred
\nthe decision by then-Secretary Paulson and me to approach the Congress. As we explained to
\nCongress, the tools available to the agencies at the time were insufficient to address the serious
\nstresses facing the financial markets, and action by Congress was necessary to stem the crisis.<\/p>\n

19. When you came to Congress last September requesting Congress to pass TARP, did
\nyou have any inclination that those funds would be used for something else besides buying
\ntoxic assets?<\/p>\n

Last September, the financial and economic situation was evolving very rapidly. In particular,
\nthe situation–which was already very grave when Secretary Paulson and I began our intensive
\nconsultations with the Congress–had deteriorated sharply further by the time when the
\nlegislation authorizing the TARP was enacted. What was clear from the outset of those intensive
\nconsultations was that the financial system was in substantial danger of seizing up in a way that
\nhad not occurred since at least the Great Depression, and that would have led to an even worse
\neconomic collapse than the one that we have actually experienced. What was not clear, however,
\nwas the strategy that would be most effective in arresting that process of seizing up. Initially, the
\nstrategy that, indeed, received the most attention envisioned using the resources anticipated to be
\nprovided under the TARP to purchase so-called toxic assets off the balance sheets of private
\nfinancial institutions, in order to improve the transparency of those balance sheets and to create
\nthe capacity for the private institutions to engage in new lending. Even until Lehman Brothers
\nfell, the issues plaguing the financial system were closely linked to mortgages, and indeed so too
\nwere the options being considered most seriously. Only after the aftershocks of Lehman\u00e2\u20ac\u2122s
\nfailure sapped confidence in the broader set of financial institutions, and interbank markets<\/p>\n

– 12 –<\/p>\n

seized up, did it become clear to Treasury that providing large amounts of capital to viable banks
\nwould be a superior response to the profound and rapid deterioration that had become the
\nimmediate concern, in substantial part because capital injections could be implemented much
\nmore quickly than asset purchases. These capital injections provided a means to reinforce
\nconfidence in the banking system and its ability to absorb potential losses while retaining an
\nability to lend to creditworthy borrowers. The Federal Reserve supported the Treasury\u00e2\u20ac\u2122s
\ndecision to adopt the capital-purchase strategy.<\/p>\n

20. In your discussions with Ken Lewis about Bank of America\u00e2\u20ac\u2122s acquisition of Merrill
\nLynch, did you mention the consequences he could face regarding his employment if Bank
\nof America did not go through with this deal?<\/p>\n

As I indicated in my June 2009 testimony before the House Committee on Oversight and
\nGovernment Reform, in my discussions with senior management of Bank of America about the
\nMerrill Lynch acquisition, I did not tell Ken Lewis, the CEO of Bank of America, or the other
\nmanagers of the institution that the Federal Reserve would take action against the board of
\ndirectors or management of the company if they decided not to complete the acquisition by
\ninvoking a Material Adverse Change (MAC) clause in the acquisition agreement. It was my
\nview, as well as the view of others, that the invocation of the MAC clause in this case involved
\nsignificant risk for Bank of America, as well as for Merrill Lynch and the financial system as a
\nwhole, and it was this concern I communicated to Mr. Lewis and his colleagues. The decision to
\ngo forward with the acquisition rightly remained in the hands of Bank of America\u00e2\u20ac\u2122s board of
\ndirectors and management.<\/p>\n

A recent report by the Special Inspector General for the Troubled Asset Relief Program with
\nregard to government financial assistance provided to Bank of America and other major banks
\nconfirmed, after review of relevant documents, that there was no indication that I expressed to
\nMr. Lewis any views about removing the management of Bank of America should the Merrill
\nLynch acquisition not occur.<\/p>\n

21. Why was the SEC not notified of the Bank of America\/Merrill Lynch deal?<\/p>\n

The SEC was fully aware of the deal by Bank of America Corporation (BAC) to acquire Merrill
\nLynch. Chairman Cox was present in New York when BAC announced the deal in September
\n2008. The SEC staff discussed details of the Merrill Lynch acquisition with BAC. The SEC was
\nnot a party to the arrangement by the Treasury, Federal Reserve, and FDIC to provide a ring
\nfence for certain assets of BAC in mid-January 2009 and therefore had no role in negotiating the
\narrangement, though it was informed of the arrangement.<\/p>\n

22. When was the first time you became aware of AIG\u00e2\u20ac\u2122s potential vulnerability? Did
\nanyone raise any kind of red flag to you about AIG exploiting regulatory loopholes?<\/p>\n

The Federal Reserve did not have, and does not have, supervisory authority for AIG and
\ntherefore did not have access to nonpublic information about AIG or its financial condition
\nbefore being contacted by AIG officials in early September 2008, concerning the company\u00e2\u20ac\u2122s
\npotential need for emergency liquidity assistance from the Federal Reserve.<\/p>\n

– 13 –<\/p>\n

23. According to the TARP Inspector General, the Fed Board approved the New York
\nFed\u00e2\u20ac\u2122s decision to pay par on A.I.G.\u00e2\u20ac\u2122s credit default swaps. What was your role in that
\ndecision, and why was it approved?<\/p>\n

I participated in and supported the Board\u00e2\u20ac\u2122s action to authorize lending to Maiden Lane III for the
\npurpose of purchasing the CDOs in order to remove an enormous obstacle to AIG\u00e2\u20ac\u2122s future
\nfinancial stability. I was not directly involved in the negotiations with the counterparties. These
\nnegotiations were handled primarily by the staff of FRBNY on behalf of the Federal Reserve.<\/p>\n

With respect to the general issue of negotiating concessions, the FRBNY attempted to secure
\nconcessions but, for a variety of reasons, was unsuccessful. One critical factor that worked
\nagainst successfully obtaining concessions was the counterparties\u00e2\u20ac\u2122 realization that the U.S.
\ngovernment had determined that AIG was systemically important and accordingly would act to
\nprevent AIG from undergoing a disorderly failure. In those circumstances, the government and
\nthe company had little or no leverage to extract concessions from any counterparties, including
\nthe counterparties on multi-sector CDOs, on their claims. Furthermore, it would not have been
\nappropriate for the Federal Reserve to use its supervisory authority on behalf of AIG (an option
\nthe report raises) to obtain concessions from some domestic counterparties in purely commercial
\ntransactions in which some of the foreign counterparties would not grant, or were legally barred
\nfrom granting, concessions. To do so would have been a misuse of the Federal Reserve\u00e2\u20ac\u2122s
\nsupervisory authority to further a private purpose in a commercial transaction and would have
\nprovided an advantage to foreign counterparties over domestic counterparties. We believe the
\nFederal Reserve acted appropriately in conducting the negotiations, and that the negotiating
\nstrategy, including the decision to treat all counterparties equally, was not flawed or
\nunreasonably limited.<\/p>\n

It is important to note that Maiden Lane III acquired the CDOs at market price at the time of the
\ntransaction. Under the contracts, the issuer of the CDO is obligated to pay Maiden Lane III at
\npar, which is an amount in excess of the purchase price. Based on valuations from our advisors,
\nwe continue to believe the Federal Reserve\u00e2\u20ac\u2122s loan to Maiden Lane III will be fully repaid.<\/p>\n

24. Did Fed regulators of Citi approve the $8 billion loan Citi made to Dubai in December
\nof last year, which was well after the firm received billions of taxpayer dollars? Do you
\nexpect we will get that money back?<\/p>\n

With the exception of mergers and acquisitions, the Federal Reserve does not pre-approve
\nindividual transactions of the financial institutions we supervise. Whether Citi is able to recover
\nthis or any other loan it extends is a function of the standards it applied when it underwrote the
\nloan. Nevertheless, the U.S. government\u00e2\u20ac\u2122s recovery of the TARP funds provided to Citi would
\nnot hinge on Citi\u00e2\u20ac\u2122s ability to collect on one individual debt, but rather on Citi\u00e2\u20ac\u2122s ability to manage
\nits credit and other risk exposures, which is where the Fed\u00e2\u20ac\u2122s supervision has and will continue to
\nfocus. We are currently in discussion with Citi as well as other recipients of TARP funds to
\ndetermine the appropriateness of TARP repayment.<\/p>\n

– 14 –<\/p>\n

25. In response to a question posed by Chairman Dodd, you stated you can give instances
\nwhere the Fed\u00e2\u20ac\u2122s supervisory authority aided monetary policy. Please do so with as much
\ndetail as possible.<\/p>\n

As a result of its supervisory activities, the Federal Reserve has substantial information and
\nexpertise regarding the functioning of banking institutions and the markets in which they operate.
\nThe benefits of this information and expertise for monetary policy have been particularly evident
\nsince the outbreak of the financial crisis. Over this period, supervisory expertise and information
\nhave helped the Federal Reserve to better understand the emerging pressures on financial firms
\nand markets and to use monetary policy and other tools to respond to those pressures. This
\nunderstanding contributed to more timely and decisive monetary policy actions. Supervisory
\ninformation has also aided monetary policy in a number of historical episodes, such as the period
\nof \u00e2\u20ac\u0153financial headwinds\u00e2\u20ac\u009d following the 1990-91 recession, when banking problems held back the
\neconomic recovery.<\/p>\n

Even more important than the assistance that supervisory authority provides monetary policy, in
\nmy view, is the complementarity between supervisory authority and the Federal Reserve\u00e2\u20ac\u2122s ability
\nto promote financial stability. Our success in helping to stabilize the banking system in late 2008
\nand early 2009 depended heavily on the expertise and information gained from our supervisory
\nrole. In addition, supervisory expertise in structured finance contributed importantly to the
\ndesign of the Commercial Paper Funding Facility, the Money Market Investor Funding Facility,
\nand the Term Asset-Backed Securities Loan Facility, all of which have helped to stabilize
\nbroader financial markets. Historically, our ability to respond effectively to the financial
\ndisruptions associated with the September 11, 2001, terrorist attacks, to the 1987 stock market
\ncrash, as well as a number of other episodes, was greatly improved by our supervisory expertise,
\ninformation, and authorities. At the same time, the Federal Reserve\u00e2\u20ac\u2122s unique expertise
\ndeveloped in the course of making monetary policy can be of great value in supervising complex
\nfinancial firms.<\/p>\n

26. In response to a question posed by Chairman Dodd, you stated \u00e2\u20ac\u0153we do not see at this
\npoint any extreme mis-valuations of assets in the United States.\u00e2\u20ac\u009d Does that mean you
\nbelieve the price of gold is not artificially inflated or out of line with fundamentals? If so,
\nwhat does the rise in the gold price signify to you?<\/p>\n

Gold is used for many purposes. It is an input into the production of electronics, automobiles,
\nand jewelry; it is held as reserve asset by governments; and it represents an investment for
\nprivate individuals. With fluctuations in the price of gold reflecting changes in demand
\nassociated with any of these uses, as well as changes in supply, it is extremely difficult to gauge
\nwhether or not price changes are consistent with fundamentals. The most recent increases in the
\nprice of gold likely reflect diverse influences, including investor concerns about the many
\nuncertainties facing the global economy; however, it is also the case that the rise in gold prices
\nhas not been much out of line with the increases in other commodities. According to the
\nCommodity Research Bureau, after fluctuating in a broad range for the previous 1-1\/2 years, the
\nprice of gold has risen 22 percent since early July, while the CRB\u00e2\u20ac\u2122s index of overall commodity
\nprices has risen 17 percent. These increases appear to reflect the recovery of the global
\neconomy, and it is not clear they have been out of line with fundamentals.<\/p>\n

– 15 –<\/p>\n

27. In response to a question posed by Senator Johnson, you indicated your concern about
\nthe GAO possibly gaining access to \u00e2\u20ac\u0153all the policy materials prepared by staff.\u00e2\u20ac\u009d What is
\nyour concern about Congress and the public having the same understanding of the issues
\nsurrounding monetary policy decisions as you and the rest of the Fed have?<\/p>\n

I think it desirable and beneficial for Congress and the public to have the same understanding of
\nissues surrounding monetary policy decisions that I and my colleagues on the FOMC have. To
\nthat end, we explain our policy decisions in frequent testimony and reports to Congress as well
\nas in press releases, minutes, and speeches. In addition, the Federal Reserve makes a great deal
\nof policy-related data and research material, including materials prepared by Federal Reserve
\nstaff, readily available to the Congress and the public. But, in order for the Federal Reserve staff
\nto be able to provide its best policy analysis and advice to monetary policymakers, it is necessary
\nfor some staff analysis to be kept confidential for a period of time. If instead this material were
\nturned over to the GAO, that could ultimately lead to political pressure being applied directly to
\nthe Federal Reserve\u00e2\u20ac\u2122s staff. Such pressure could lead the staff to omit more sensitive material
\nfrom its policy analyses and more generally might cause the staff to skew its analyses and
\njudgments. That outcome could have serious adverse effects on monetary policy decisions, to
\nthe detriment of the performance of our economy. Also, investors and the general public would
\nlikely perceive a requirement to turn confidential staff analyses over to the GAO as undermining
\nthe independence of monetary policy, potentially leading to some unanchoring of inflation
\nexpectations and thus reducing the Federal Reserve\u00e2\u20ac\u2122s ability to conduct monetary policy
\neffectively.<\/p>\n

28. In response to a question posed by Senator Corker, you stated \u00e2\u20ac\u0153On the mortgage-
\nbacked securities, we have a longstanding authorization to do that. I do not think there is
\nany legal issue.\u00e2\u20ac\u009d Please provide the Fed\u00e2\u20ac\u2122s legal analysis on the authority to purchase such
\nsecurities, particularly those issued by Fannie Mae and Freddie Mac, which are not full-
\nfaith-and-credit obligations of the United States.<\/p>\n

Section 14(b)(2) of the Federal Reserve Act (12 U.S.C. 355) authorizes the Federal Reserve
\nBanks, under the direction of the FOMC, to \u00e2\u20ac\u0153buy and sell in the open market any obligation
\nwhich is a direct obligation of, or fully guaranteed as to principal and interest by, any agency of
\nthe United States.\u00e2\u20ac\u009d The Board\u00e2\u20ac\u2122s Regulation A (12 CFR 201) has long defined the Federal
\nNational Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation
\n(Freddie Mac), and the Government National Mortgage Association (Ginnie Mae) as agencies of
\nthe United States for purposes of this paragraph. All mortgage-backed securities (MBS)
\nacquired by the Federal Reserve in its open market operations are fully guaranteed as to principal
\nand interest by Fannie Mae, Freddie Mac, and Ginnie Mae.<\/p>\n

29. In response to question posed by Senator Johanns regarding an exit strategy, you said
\n\u00e2\u20ac\u0153The next step at some point, when the economy is strong enough and ready, will be to
\nbegin to tighten policy, which means raising interest rates. We can do that by raising the
\ninterest rate we pay on excess reserves. Congress gave us the power to pay interest on
\nreserves that banks hold with the Fed. By raising that interest rate, we will be able to raise
\ninterest rates throughout the money markets.\u00e2\u20ac\u009d<\/p>\n

– 16 –<\/p>\n

In response to a written question I posed to you at the July 22 monetary policy hearing,
\nyou said the Fed at that time had no plans to switch to using the new interest on reserves
\npower as the means of setting the policy rate. However, in your response to Sen. Johanns
\nyou sound inclined to use the reserve interest rate as the policy rate. Is that correct, and if
\nso, what has changed in the last few months?<\/p>\n

In my written response to the question you posed on July 22, I indicated that the Federal Reserve
\ncurrently expects to continue to set a target (or a target range) for the federal funds rate as part of
\nits procedure for conducting monetary policy. We are already using the authority that the
\nCongress provided to pay interest on reserve balances, and we anticipate continuing to use that
\nauthority in the future. For example, when the time is appropriate to begin to firm the stance of
\nmonetary policy, the Federal Reserve could increase its target for the federal funds rate. As I
\nindicated in my response to Senator Johanns, the Federal Reserve could affect the increase in the
\nfederal funds rate partly by increasing the interest rate that it pays on reserves. The Federal
\nReserve also has a number of additional tools for managing the supply of bank reserves and the
\nfederal funds rate, and these tools could be used in conjunction with the payment of higher rates
\nof interest on reserves.<\/p>\n

30. In response to a question posed by Sen. Gregg, you stated \u00e2\u20ac\u0153it would be worthwhile to
\nconsider, for example, whether regulators might prohibit certain activities. If a financial
\ninstitution cannot demonstrate that it can safely manage the risks of a particular type of
\nactivity, for example, then it could be scaled back or otherwise addressed by the regulator.\u00e2\u20ac\u009d
\nDo you have examples of such activities in mind? Are there some activities that we should
\nprohibit banks or other financial institutions from engaging in outright?<\/p>\n

Congress traditionally has sought to limit the ability of insured depository institutions to engage,
\ndirectly or through a subsidiary, in potentially risky activities. Therefore, banking supervisors
\nhave emphasized safety and soundness, banking organizations\u00e2\u20ac\u2122 management of risks associated
\nwith their activities, and the adequacy of their capital to support those risks. In that regard, the
\nFederal Reserve has the authority to take a series of actions to ensure that bank holding
\ncompanies and state member banks operate in a safe and sound manner.<\/p>\n

As evidenced by the recent subprime lending crisis, even traditional banking activities such as
\nlending may pose significant risks if not safely managed. These activities do not lend themselves
\nto general prohibitions, but rather to institution-specific consideration. The Federal Reserve
\nconsiders whether a banking organization can effectively manage the risk of its regular or
\nproposed activities through its ongoing supervisory process as well as its analysis of proposals to
\nengage in new activities. Going forward, the Federal Reserve will continue to consider actions
\nunder our authority to restrict any activities that present safety and soundness concerns. Such
\nactions that we might take include, but are not limited to:<\/p>\n

\u00ef\u201a\u00b7 Imposing higher capital requirements to address weaknesses in asset quality, credit
\nadministration, risk management, or other elevated levels of risk associated with an
\nactivity;
\n\u00ef\u201a\u00b7 Requiring a banking organization to make more detailed and comprehensive public
\ndisclosures regarding a particular activity;<\/p>\n

– 17 –<\/p>\n

\u00ef\u201a\u00b7 Exercising our enforcement authority to limit the overall nature or performance of an
\nactivity, such as by imposing concentrations limits; and
\n\u00ef\u201a\u00b7 Issuing cease and desist orders to correct unsafe or unsound practices.<\/p>\n

31. In response to a question posed by Sen. Corker, you mentioned you could provide more
\ndetail about problems at the Fed and the actions you are taking to correct them. What
\nspecific shortcomings have you identified and what specific steps have you taken to address
\nthem?<\/p>\n

The financial crisis was the product of fundamental weaknesses in both private market discipline
\nand government supervision and regulation of financial institutions. Substantial risk
\nmanagement weaknesses led to financial firms not recognizing the nature and magnitude of the
\nrisks to which they were exposed. Neither market discipline nor government regulation
\nprevented financial institutions from becoming excessively leveraged or otherwise taking on
\nexcessive risks. Within the United States, every federal regulator with primary responsibility for
\nprudential supervision and regulation of large financial institutions saw firms for which it was
\nresponsible approach failure.<\/p>\n

At the Federal Reserve, we have extensively reviewed our performance and moved to strengthen
\nour oversight of banks. We have led internationally coordinated efforts to tighten regulations to
\nhelp constrain excessive risk taking and enhance the ability of banks to withstand financial stress
\nthrough improved capital and liquidity standards. We are building on the success of the
\nSupervisory Capital Assessment Program (the \u00e2\u20ac\u0153stress tests\u00e2\u20ac\u009d) to reorient our approach to large,
\ninterconnected banking organizations to incorporate a more \u00e2\u20ac\u0153macroprudential\u00e2\u20ac\u009d approach to
\nsupervision. As such, we are expanding our use of simultaneous and comparative cross-firm
\nexaminations, and drawing on a range of disciplines–economists, market experts, accountants
\nand lawyers — from across the Federal Reserve System. We are also complementing our
\ntraditional on-site examinations with enhanced off-site surveillance programs, under which
\nmulti-disciplinary teams will combine supervisory information, firm-specific data analysis, and
\nmarket-based indicators to identify emerging issues.<\/p>\n

32. What was your role in including in the TARP proposal the ability to purchase \u00e2\u20ac\u0153any
\nother financial instrument\u00e2\u20ac\u009d? Was inclusion of such a provision your suggestion?<\/p>\n

Apart from stating the need for it, I was not involved in the negotiations between the
\nAdministration and the Congress on the terms of the TARP. However, the flexibility afforded
\nthe TARP to purchase financial instruments as needed to promote financial stability proved
\ncrucial in allowing a rapid response to the quickly deteriorating financial conditions in October
\n2008.<\/p>\n

33. What was your role in the decision to make capital investments rather than toxic asset
\npurchases with TARP funds?<\/p>\n

It became apparent in October 2008 that the plan to purchase toxic assets was likely to take some
\nmonths to implement and would not be available in time to arrest the escalating global crisis.
\nFollowing the approach used in a number of other industrial countries, the Treasury made capital<\/p>\n

– 18 –<\/p>\n

available instead to help stabilize the banking system. The Treasury consulted closely with the
\nFederal Reserve on this decision.<\/p>\n

34. As a general matter I do not think the Fed Chairman should comment on tax or fiscal
\npolicy, so please respond to this from the perspective of bank supervision and not fiscal
\npolicy. Are there any provisions of the tax code that unwisely distort financial institutions\u00e2\u20ac\u2122
\nbehavior that Congress should consider as part of financial regulatory reform? For
\nexample, the tax code allows deductions for the interest paid on debt, which may cause
\nfirms to favor debt over equity. Do you have concerns about that provision? Are there
\nother provisions that influence companies\u00e2\u20ac\u2122 behavior that concern you?<\/p>\n

The taxation of businesses and households is a fundamental part of fiscal policy. I have avoided
\ntaking a position on explicit tax policies and budget issues during my tenure as Chairman of the
\nFederal Reserve Board. I believe that these are decisions that must be made by the Congress, the
\nAdministration, and the American people. Instead I have attempted to articulate the principles
\nthat I believe most economists would agree are important for the long-term performance of the
\neconomy and for helping fiscal policy to contribute as much as possible to that performance. In
\nthat regard, tax revenues should be sufficient to adequately cover government spending over the
\nlonger-term in order to avoid the economic costs and risks associated with persistently large
\nfederal deficits. But the choices that are made regarding both the size and structure of the federal
\ntax system will affect a wide range of economic incentives that will be part of determining the
\nfuture economic performance of our nation.<\/p>\n

In assessing the lessons of the recent financial crisis, it is difficult to find evidence that the tax
\ntreatment of financial institutions played a role in the problems that developed. In particular, the
\ntax structure faced by these institutions did not change prior to the onset of these problems and
\ndid not appear to be associated with the buildup of leverage and risk taking that occurred. The
\nmore important remedial steps must be taken in the regulatory sphere, and I have outlined a
\ncomprehensive program aimed at ensuring that a crisis of this kind does not recur.<\/p>\n

35. Do you think a cap on bank liabilities is appropriate? For example, do you think
\nlimiting a bank\u00e2\u20ac\u2122s liabilities to 2% of GDP is a good idea?<\/p>\n

In the policy debate about how best to control the systemic risk posed by very large firms,
\nrestriction on size is one of the solutions being discussed. However, a cap on a bank\u00e2\u20ac\u2122s liabilities
\nlinked to a measure such as GDP may not be appropriate. In pursuing a size restriction,
\npolicymakers would need to carefully analyze the metric that was used as the basis for the
\nrestriction to ensure that limits on lines of business reflect the risks the activities present. Broad-
\nbased caps applied without such analysis potentially could limit the banking system\u00e2\u20ac\u2122s ability to
\nsupport economic activity.<\/p>\n

36. AIG still has obligations to post collateral on swaps still in force. Will the Fed post
\ncollateral if the deteriorating credit conditions at AIG or general credit market issues
\nrequire it?<\/p>\n

– 19 –<\/p>\n

No. The Federal Reserve can only lend to borrowers on a secured basis; the Federal Reserve
\ncannot post its own assets as collateral for a third party. AIG is obligated to continue to post
\ncollateral as required under the terms of its derivatives contracts with its counterparties. AIG
\nmay borrow from the revolving credit facility with the Federal Reserve to meets its obligations
\nas they come due, including to meet collateral calls on its derivative contracts. AIG itself is
\nobligated to repay all advances under the revolving credit facility, which is fully secured by
\nassets of AIG, including the shares of substantially all of AIG\u00e2\u20ac\u2122s subsidiaries.<\/p>\n

37. If TARP and other bailout actions were necessary because the largest financial firms
\nwere too big to fail, why have the largest few institutions actually been allowed to grow
\nbigger than they were before the bailouts? Does it concern you that those few institutions
\nwrite approximately half the mortgages, issue approximately two-thirds of the credit cards,
\nand control approximately 40% of deposits in this country?<\/p>\n

I am concerned about the potential costs to the financial system and the economy of institutions
\nthat are perceived as too big to fail. To address these costs, I have detailed an agenda for a
\nfinancial regulatory system that ensures systemically important institutions are subject to
\neffective consolidated supervision, that a more macroprudential outlook is incorporated into the
\nregulatory and supervisory framework, and that a new resolution process is created that would
\nallow the government to wind down such institutions in an orderly manner. In addition, high
\nconcentrations might raise antitrust concerns that consumers would be harmed from lack of
\ncompetition in certain financial products. For this reason, antitrust enforcement by bank
\nregulators and the Department of Justice would preclude mergers that are considered likely to
\nhave significant adverse effects on competition.<\/p>\n

38. On May 5, 2009, in front of the Joint Economic Committee, you said the following
\nabout the unemployment rate: “Currently, we don\u00e2\u20ac\u2122t think it will get to 10 percent. Our
\ncurrent number is somewhere in the 9s” . In November it hit 10.2%, and many economists
\npredict it will go even higher. This is happening despite enormous fiscal and monetary
\nstimulus that you previously said would help create jobs. What happened after your JEC
\ntestimony in May that caused your prediction to miss the mark?<\/p>\n

At the time of my testimony before the JEC, the central tendency of the projections made by
\nFOMC participants was for real GDP to fall between 1.3 and 2.0 percent over the four quarters
\nof 2009 and for the unemployment rate to average between 9.2 and 9.6 percent in the fourth
\nquarter. As it turned out, we were too pessimistic about the overall decline in real GDP this year
\nand too optimistic about the extent of the rise in the unemployment rate. Although we indicated
\nin the minutes from the April FOMC meeting that we saw the risks to the unemployment rate as
\ntilted to the upside, we underestimated the extent to which employers were able to continue to
\nreduce their work forces even after they began to increase production again. These additional
\njob reductions have contributed to surprisingly large gains in productivity in recent quarters and
\nto the unexpectedly steep rise in the unemployment rate.<\/p>\n

39. In his questioning at your hearing, Sen. DeMint mentioned several of your predictions
\nabout the economy that proved inaccurate. For example:<\/p>\n

– 20 –<\/p>\n

March 28, 2007: \u00e2\u20ac\u0153The impact on the broader economy and financial markets of the
\nproblems in the subprime markets seems likely to be contained.\u00e2\u20ac\u009d<\/p>\n

May 17, 2007: \u00e2\u20ac\u0153We do not expect significant spillovers from the subprime market to the
\nrest of the economy or to the financial system.\u00e2\u20ac\u009d<\/p>\n

Feb. 28, 2008, on the potential for bank failures: \u00e2\u20ac\u0153Among the largest banks, the capital
\nratios remain good and I don\u00e2\u20ac\u2122t expect any serious problems of that sort among the large,
\ninternationally active banks that make up a very substantial part of our banking system.\u00e2\u20ac\u009d<\/p>\n

June 9, 2008: \u00e2\u20ac\u0153The risk that the economy has entered a substantial downturn appears
\nto have diminished over the past month or so.\u00e2\u20ac\u009d<\/p>\n

July 16, 2008: Fannie Mae and Freddie Mac are \u00e2\u20ac\u0153adequately capitalized\u00e2\u20ac\u009d and \u00e2\u20ac\u0153in no
\ndanger of failing.\u00e2\u20ac\u009d<\/p>\n

I do not bring these up to criticize you for making mistakes. Rather, it is important to
\nexamine the reason for mistakes to learn from them and do better in the future. Have you
\nor the Fed examined why those predictions were wrong? Have you or the Fed changed
\nanything such as your models, forecasts, or data sets as a result? What has the Fed done to
\nrevamp its analytical framework to better anticipate potential macroeconomic problems?<\/p>\n

The principal cause of the financial crisis and economic slowdown was the collapse of the global
\ncredit boom and the ensuing problems at financial institutions. Financial institutions suffered
\ndirectly from losses on loans and securities on their balance sheets, but also from exposures to
\noff-balance sheet conduits and to other financial institutions that financed their holdings of
\nsecurities in the wholesale money markets. The tight network of relationships between regulated
\nfinancial firms with these other institutions and conduits, and the severity of the feedback effects
\nbetween the financial sector and the real economy were not fully understood by regulators or
\ninvestors, either here or abroad. Our failure to anticipate the full severity of the crisis,
\nparticularly its intensification in the fall of 2008, was the primary reason for the forecasting
\nerrors cited by Senator DeMint.<\/p>\n

We also are expanding our use of forward-looking aggregate macroeconomic scenario analysis
\nin supervisory practices to enhance our understanding of the consequences of changes in the
\neconomy for individual firms and the broader financial system. In addition, we are conducting
\nresearch to augment our macroeconomic forecasting tools to incorporate more refined channels
\nby which information on possible financial market stresses would feed back to the
\nmacroeconomy.<\/p>\n

40. Derivatives such as credit-default swaps played an important role in the financial
\ncrisis, and they are central to the financial reforms currently being contemplated. During
\nthe Senate Banking Committee\u00e2\u20ac\u2122s hearing in November 2005 to confirm you as Alan
\nGreenspan\u00e2\u20ac\u2122s successor, you had the following exchange with Senator Paul Sarbanes:<\/p>\n

– 21 –<\/p>\n

SARBANES: Warren Buffett has warned us that derivatives are time bombs, both for
\nthe parties that deal in them and the economic system. The Financial Times has said so far,
\nthere has been no explosion, but the risks of this fast growing market remain real. How do
\nyou respond to these concerns?<\/p>\n

BERNANKE: I am more sanguine about derivatives than the position you have just
\nsuggested. I think, generally speaking, they are very valuable. They provide methods by
\nwhich risks can be shared, sliced, and diced, and given to those most willing to bear them.
\nThey add, I believe, to the flexibility of the financial system in many different ways. With
\nrespect to their safety, derivatives, for the most part, are traded among very sophisticated
\nfinancial institutions and individuals who have considerable incentive to understand them
\nand to use them properly. The Federal Reserve\u00e2\u20ac\u2122s responsibility is to make sure that the
\ninstitutions it regulates have good systems and good procedures for ensuring that their
\nderivatives portfolios are well managed and do not create excessive risk in their
\ninstitutions.<\/p>\n

Do you still agree with that statement? If not, why do you think you were wrong?<\/p>\n

I continue to believe that OTC derivative instruments are valuable tools for the management of
\nrisk and that they are an important part of our financial markets. Events of the last two years
\nhave demonstrated, however, that there were significant weaknesses in the risk management
\nsystems and procedures for these derivatives at some market participants and that supervisors did
\nnot fully appreciate the interconnections among regulated dealers and their unregulated
\ncounterparties that magnified these weaknesses. Supervisors have recognized that financial
\ninstitutions must make changes in their risk-management practices for OTC derivatives by
\nimproving internal processes and controls and by ensuring that adequate credit risk-management
\ndisciplines are in place for complex products, regardless of the form they take. Efforts are under
\nway to improve collateralization practices to limit counterparty credit risk exposures and to
\nstrengthen the capital regime. Regulators both in the United States and abroad also are speeding
\nthe development of central counterparties (CCPs) that offer clearing services for some OTC
\nderivative contracts. These CCPs offer financial institutions another tool for managing the
\ncounterparty credit risk that arises from OTC derivatives.<\/p>\n

41. An important factor in the financial crisis (and a large part of the ultimate cost to
\ntaxpayers) was the implicit government guarantee of the GSEs. In part because of
\ndecisions you made, there is now an explicit government guarantee of every large firm on
\nWall Street. Has moral hazard increased or decreased over the past year?<\/p>\n

The actions by Treasury, the Federal Deposit Insurance Corporation, and the Federal Reserve
\nwere taken to stabilize financial markets during a time of unprecedented turmoil. These actions
\nmitigated the effect of financial market turmoil on the U.S. economy more generally. Moral
\nhazard has been, and continues to be, a significant concern with respect to large financial
\ninstitutions. The Secretary of the Treasury has proposed significant reforms that include
\nenhanced supervision of systemically important financial firms, a focus on macro-prudential
\nsupervision and new resolution authority over systemically important financial firms. These
\nreforms would mitigate moral hazard and I strongly support them.<\/p>\n

– 22 –<\/p>\n

42. Via the FDIC, the American public now explicitly guarantees the bonds of Wall Street
\nfirms where bonuses are surging and individual employees can be paid millions of dollars a
\nyear. What is your opinion on the morality of this guarantee?<\/p>\n

The Federal Deposit Insurance Corporation\u00e2\u20ac\u2122s Temporary Liquidity Guarantee Program (TGLP)
\nis one of many necessary actions taken to stabilize financial markets during a time of
\nunprecedented financial stress. These actions helped support the flow of credit and mitigated the
\nmost severe potential effects of the turmoil on the economy. Many households and businesses
\nbenefited from these guarantees. These and similar actions were taken with the sole objective of
\nbetter achieving the mandate given to us by the Congress, namely (for the FDIC) to mitigate
\nserious systemic risks and (for the Federal Reserve) to promote financial stability, price stability
\nand maximum employment. Hence, they were justified–indeed necessary and appropriate under
\nour Congressional mandate.<\/p>\n

43. The importance you place on the output gap is well known. You have often cited
\n\u00e2\u20ac\u0153excess slack\u00e2\u20ac\u009d in the economy to justify loose monetary policy, arguing that a large output
\ngap lowers the risk of inflation. But economists such as Allan Meltzer have noted that there
\nare “lots of examples of countries with underutilized resources and high inflation. Brazil in
\nthe 1970s and 1980s.” Moreover, in a new paper dated December 2009 and titled “Has the
\nRecent Real Estate Bubble Biased the Output Gap?”, researchers at the Federal Reserve
\nBank of St. Louis state \u00e2\u20ac\u0153Because this (predicted) output gap is so large, several analysts
\nhave concluded that monetary policy can remain very accommodative without fear of
\ninflationary repercussions. We argue instead that standard output gap measures may be
\nseverely biased by the bubble in real estate prices that, according to many, started around
\n2002 and burst in 2007.\u00e2\u20ac\u009d They conclude with a warning: “We offer a word of caution to
\npolicymakers: Policies based on point estimates of the output gap may not rest on solid
\nground.” Please comment on 1) Allan Meltzer’s point and 2) the St. Louis Fed’s research
\npaper. Why do you continue to put such a high priority on the output gap?<\/p>\n

I do find the evidence compelling that resource slack, as measured by an output or
\nunemployment gap, is one factor that influences inflation. But it is not the only such factor, and
\nAllan Meltzer is correct that there have been examples of underutilized resources coinciding with
\nhigh or rising inflation. This was the case in the United States in the 1970s, for example, when
\nlarge increases in the price of imported oil both raised inflation and held down production.
\nFurthermore, estimates of the output gap are inherently uncertain, and I agree that it is important
\nto keep that uncertainty in mind when we make decisions about monetary policy. Some
\nestimates, such as the one you cite from researchers at the St. Louis Fed, suggest that the output
\ngap is not large at present. However, the bulk of the evidence indicates that resource slack is
\nnow substantial, as evidenced by an unemployment rate of 10 percent and a rate of
\nmanufacturing capacity utilization of only 68 percent–lower than seen at the trough of every
\npostwar recession prior to the current one. Thus, I continue to expect slack resources, together
\nwith the stability of inflation expectations, to contribute to the maintenance of low inflation in
\nthe period ahead.<\/p>\n

– 23 –<\/p>\n

44. In a scenario in which unemployment remains uncomfortably high, but the dollar
\ncontinues to fall and commodities including oil and gold continue to rise, what would the
\nFed do? At what point do market signals take priority over hard-to-measure statistics like
\nthe output gap?<\/p>\n

The output gap is only one of many economic signals, including a broad array of economic data
\nand market indicators, that the FOMC consults in setting policy. It is difficult to predict what
\nactions the FOMC would take in some future situation. Certainly it would be mindful of its dual
\nmandate to foster price stability and maximum sustainable employment. If declines in the dollar
\nand increases in commodity prices were creating upward pressures on consumer prices and
\ncausing expectations of future inflation to rise, those developments would be taken extremely
\nseriously by the Committee, and would have to be balanced against the high rate of
\nunemployment that you posit in your hypothetical. But the clear lesson from the experience of
\nthe 1970s and from that of other countries is the high cost that a nation pays in terms of
\nmacroeconomic performance when it loses sight of the importance of maintaining a credible plan
\nfor the achievement of price stability and maximum sustainable employment in the medium and
\nlonger terms.<\/p>\n

45. The Fed has a dual mandate: maximum employment and price stability. But
\nunemployment is at its highest level in decades. And in early and mid-2008, with oil at $150
\na barrel and prices of basic staples skyrocketing, opinion polls showed that inflation was
\nthe public’s highest concern, even more so than jobs or the housing market. Why has the
\nFed failed so badly in its mandate? Is employment an appropriate objective for monetary
\npolicy? Should the Fed have a single mandate of price stability?<\/p>\n

The Federal Reserve\u00e2\u20ac\u2122s performance should be judged in terms of the extent to which its policies
\nhave fostered satisfactory outcomes for economic activity and inflation given the unanticipated
\nshocks that have occurred. For example, while U.S. consumer price inflation was temporarily
\nelevated by shocks to the prices of energy and other commodities during early and mid-2008 and
\nthen dropped sharply after the intensification of the global financial crisis, the Federal Reserve\u00e2\u20ac\u2122s
\npolicies have been successful in keeping the longer-term inflation expectations of households
\nand businesses firmly anchored throughout this period. Moreover, while the financial crisis led
\nto a severe economic contraction and a steep rise in unemployment, the Federal Reserve\u00e2\u20ac\u2122s
\nextraordinary policy measures have been crucial in averting a global financial collapse that
\nwould have been associated with far higher rates of unemployment.<\/p>\n

I support the Federal Reserve\u00e2\u20ac\u2122s dual mandate of maximum employment and price stability.
\nThese congressionally mandated goals are appropriate and generally complementary, because
\nprice stability helps moderate the short-term variability of employment and contributes to the
\neconomy\u00e2\u20ac\u2122s employment prospects over the longer run. Under some circumstances, however,
\nthere may indeed be a temporary tradeoff between the elements of the dual mandate. For
\nexample, an adverse supply shock might cause inflation to be temporarily elevated at the same
\ntime that employment falls below its maximum sustainable level. In such a situation, a central
\nbank that focused exclusively on bringing inflation down as quickly as possible might well
\nexacerbate the economic weakness, whereas a monetary policy strategy consistent with the<\/p>\n

– 24 –<\/p>\n

Federal Reserve\u00e2\u20ac\u2122s dual mandate would aim to foster a return to price stability at a lower cost in
\nterms of lost employment.<\/p>\n

46. In February 2009, Janet Yellen, president of the San Francisco Fed, said that the Fed
\nneeded to fight back against the argument that its liquidity efforts would eventually lead to
\nhigher inflation and higher interest rates, calling the notion “ludicrous”. Since then, the
\ndollar has fallen precipitously, oil has almost doubled in price, and gold has surged to all-
\ntime highs. Do you share your colleague’s view on inflation?<\/p>\n

The dollar serves as an international reserve currency; hence, short-term fluctuations in the
\nforeign exchange value of the dollar are often linked to global developments rather than to U.S.
\nmonetary policy or inflation. Indeed, the intensification of the global economic and financial
\ncrisis in the second half of 2008 was associated with a substantial rise in the foreign exchange
\nvalue of the dollar as investors increased their holdings of relatively safe dollar-denominated
\nassets. As financial markets have recovered this year and the world economy has stabilized, that
\nappreciation has gradually unwound and the foreign exchange value of the dollar has essentially
\nreturned to its level prior to the events of the fall of 2008. The prices of energy and other
\ncommodities are also closely linked to global economic developments; for example, the spot
\nprice for West Texas intermediate crude oil dropped sharply from around $130 per barrel in July
\n2008 to around $40 per barrel at the turn of the year, but it has subsequently rebounded to about
\n$75 per barrel as the global economic outlook has improved. The Commodity Research
\nBureau\u00e2\u20ac\u2122s index of overall commodity prices indicates that the rise in the price of gold over the
\npast few months is in line with the increased prices of other commodities over the same period.<\/p>\n

I do not believe that the Federal Reserve\u00e2\u20ac\u2122s credit and liquidity programs will lead to higher
\ninflation. Longer-term inflation expectations appear stable, and as I have emphasized in the past,
\nthe Federal Reserve has the tools it needs to withdraw the current substantial degree of monetary
\npolicy stimulus when it is appropriate to do so. The Federal Reserve will adjust the stance of
\npolicy as needed to fulfill its dual mandate of fostering price stability and maximum
\nemployment.<\/p>\n

47. What does the surge in gold mean to you? At what price level would it begin to worry
\nyou, if it doesn’t already? Does gold have any impact on the Fed’s policy deliberations?<\/p>\n

As mentioned in response to questions #6 and #26, gold is used for many purposes. Movements
\nin the price of gold are determined by changes in the demand for gold for its various uses and
\nchanges in supply conditions. Therefore, assessing why gold prices have recently risen and
\nwhether the increase is consistent with fundamentals is very difficult. Accordingly, it is also
\ndifficult to specify a particular level of the price of gold which, if exceeded, would indicate
\nparticularly worrisome developments. As also mentioned earlier, the Federal Reserve looks at a
\nwide array of indicators of market sentiment and inflation expectations. Among those indicators
\nis the price of gold, but for the reasons just noted, its movements are often harder to interpret
\nthan those of some of the other indicators. Nonetheless, we will continue to monitor the price of
\ngold going forward.<\/p>\n

– 25 –<\/p>\n

48. Why does the Fed insist on waiting five years before it releases transcripts of FOMC
\nmeetings to the public?<\/p>\n

The effectiveness of monetary policy deliberations is facilitated by the policy of maintaining the
\nconfidentiality of FOMC meeting transcripts for five years, so that participants can have a candid
\nand free exchange of views about alternative policy approaches. It is noteworthy that the five-
\nyear interval prior to publication of FOMC meeting transcripts is much shorter than required
\nunder the Federal Records Act, which directs such records to be transmitted to the National
\nArchives and made public after a 30-year period. Moreover, from an international perspective,
\nthe Federal Reserve is virtually unique with regard to this aspect of its transparency; no other
\nmajor central bank publishes transcripts of its monetary policy meetings.<\/p>\n

49. Has the Fed ever had an internal debate about how monetary policy contributes to
\ngeopolitical tensions via the rising oil prices caused by a falling dollar?<\/p>\n

Monetary policy may exert some effect on oil prices through a number of channels, including:
\nthe cost of carrying inventories and of investing in productive capacity, the pace of economic
\ngrowth, and the exchange rate. However, the effects of changes in interest rates and exchange
\nrates on oil prices appear to be relatively small. Accordingly, my sense is that variations in
\nmonetary policy have played only a limited role in the wide swings in oil prices observed in
\nrecent years.<\/p>\n

50. Before the financial crisis there was a widespread sense, especially on Wall Street
\ntrading desks, that the stock market was strangely resilient. This encouraged excessive
\nrisk-taking in various types of assets. Do you have direct or indirect knowledge of the
\nFederal Reserve or any government entity or proxy ever intervening to support the stock
\nmarket (or any individual stock) via futures or in any other way? If yes, who decides the
\ntiming of such intervention and with what criteria? How is it funded? Which Wall Street
\nfirm handles the orders, and who sees them before they are executed?<\/p>\n

The Federal Reserve has not intervened to provide support to the stock market or individual
\nstocks by trading in futures or any other financial instrument. I have no knowledge of any other
\nU.S. government entity providing such support.<\/p>\n

51. You have repeatedly stated your concern that an audit of the Fed will undermine the
\nindependence of the Fed in monetary policy. What do you fear influence from Congress
\nwill lead to, tighter or looser policy?<\/p>\n

Broadening the scope of the GAO to include a review of monetary policy functions would
\nundermine the safeguards that Congress put in place in 1978 to promote monetary policy
\nindependence and insulate the Federal Reserve from short-run political pressures. As a result,
\nhouseholds, businesses, and investors might well conclude that the Federal Reserve would not be
\nin a position to combat inflation pressures as effectively as in the past. This loss of confidence
\ncould lead to higher inflation expectations, hence boosting interest rates and raising the cost of
\ncredit for households and businesses. Moreover, inflation expectations would be more likely to
\nrise in response to monetary policy accommodation undertaken to address high unemployment<\/p>\n

– 26 –<\/p>\n

and weak economic activity. This potentially greater sensitivity of inflation expectations to
\naccommodative monetary policy could limit the Federal Reserve\u00e2\u20ac\u2122s ability to combat high
\nunemployment and economic weakness without an undesirable boost in inflation.<\/p>\n

52. Do you believe our banking system is facing a future like Japan\u00e2\u20ac\u2122s system faced in the
\n1990s, with zombie banks as an obstacle to economic prosperity? Why or why not?<\/p>\n

I do not believe that the U.S. banking system is facing a future akin to that of Japanese banks in
\nthe 1990s. Japanese authorities took a long time to take the steps that were necessary to deal
\nwith zombie banks and ensure a sound banking system, because they first had to construct a
\nstrong system of bank supervision and regulation. It wasn\u00e2\u20ac\u2122t until the late 1990s that new laws
\nwere passed to deal with bank insolvencies and the Financial Supervisory Agency, which later
\nbecame the Financial Services Agency (FSA), was established. And it was not until 2002 that
\nthe FSA conducted its first round of examinations of major banks aimed at ensuring that they
\nwere adequately identifying and provisioning against non-performing loans.<\/p>\n

In contrast, U.S. authorities, including the Federal Reserve, have been able to quite rapidly take
\nstrong steps to address bank weakness. First, the Commercial Bank Examination Manual and the
\nBank Holding Company Supervision Manual have long contained guidance for bank and bank
\nholding company (BHC) examiners on evaluating the adequacy of loan loss reserves, and
\nexaminers continue to follow this guidance. In addition, earlier this year, the Federal Reserve
\nand other federal bank supervisors completed a comprehensive forward-looking capital
\nassessment exercise–the Supervisory Capital Assessment Program (SCAP)–on the largest 19
\nU.S. BHCs. This exercise went further than a regular BHC examination (which produces a
\nsnapshot of current BHC health), because it involved estimating losses that might arise over a
\nperiod of two years under more-adverse-than-expected economic assumptions, and because it
\nensured consistency across institutions.<\/p>\n

53. Do you believe the Fed\u00e2\u20ac\u2122s policies are enabling banks to put off recognizing their losses?<\/p>\n

The Federal Reserve\u00e2\u20ac\u2122s policies are not enabling banks to defer recognizing incurred loan losses
\nor overstating income. We require institutions to prepare regulatory reports in accordance with
\ngenerally accepted accounting principles (GAAP). Currently, GAAP requires estimated incurred
\nloan losses to be recognized in the financial statements. We have issued numerous reminders in
\nthe form of supervisory guidance that reiterate the need for institutions to take appropriate loan
\nlosses. Most recently, we issued guidance on commercial real estate lending that encouraged
\ninstitutions to work with borrowers while reiterating the importance of recognizing loan losses
\non restructured loans as appropriate. By no means have we been suggesting any type of
\nforbearance on loan loss recognition. However, we believe that the accounting loan loss model
\nneeds to be modified to improve recognition of credit losses.<\/p>\n

54. What was your rationale for letting Lehman fail?<\/p>\n

Concerted government attempts to find a buyer for Lehman Brothers or to develop an industry
\nsolution proved unsuccessful. Moreover, providers of both secured and unsecured credit to the
\ncompany were rapidly pulling away from the company and the company needed funding well<\/p>\n

– 27 –<\/p>\n

above the amount that could be provided on a secured basis. As you know, the Federal Reserve
\ncannot make an unsecured loan. Because the ability to provide capital to the institution had not
\nyet been authorized under the Emergency Economic Stabilization Act, the firm\u00e2\u20ac\u2122s failure was,
\nunfortunately, unavoidable. The Lehman situation is a clear example of why the government
\nneeds the ability to wind down a large, interconnected firm in an orderly way that both mitigates
\nthe costs on society as whole and imposes losses on the shareholders and creditors of the failing
\nfirm.<\/p>\n

55. Reportedly, the Fed is requiring banks to report their derivatives positions to the Fed.
\nDoes the Fed have the expertise and analytical capacity to understand and act on that
\ninformation?<\/p>\n

Yes. The Federal Reserve has staff members with both financial economics and financial
\nanalysis expertise. These staff members contribute both to the analysis of financial data at the
\nmacro or market level and to the understanding of models used by individual institutions in their
\nderivatives activities.<\/p>\n

56. Given that some economic conditions have worsened beyond what was assumed in the
\n\u00e2\u20ac\u0153stress tests\u00e2\u20ac\u009d earlier this year, do you still believe the stress tests to be useful or accurate
\nrepresentations of the institutions examined?<\/p>\n

I believe that the stress tests are still a useful representation of the risks of the examined
\ninstitutions in a more stressful environment than expected. It is true that since the scenarios for
\nthe stress tests were specified, the unemployment rate has risen sharply and will be above the
\nrate that was assumed for 2009 in the more adverse scenario. However, the latest private
\nforecasts indicate that the unemployment rate next year will be noticeably below the rate
\nassumed in the more adverse scenario, and the rebound in real GDP next year will be larger than
\nwas assumed. Further, incoming data on house prices have been considerably better than
\nexpected, which should reduce losses, and a significant part of the estimated losses in the stress
\ntests at the examined institutions were related to the substantially lower house prices assumed in
\nthe more adverse scenario.<\/p>\n

57. In your recent Washington Post op-ed, you recognized that the Fed \u00e2\u20ac\u0153did not do all that
\nit could have\u00e2\u20ac\u009d under your leadership to prevent the financial crisis, why should the public
\nhave any confidence that the next time the Fed will do all it can?<\/p>\n

The regulatory framework that was in place at the onset of the crisis had not kept pace with
\ndramatic changes in the structure and activities of the financial sector. Specifically, U.S. and
\nglobal regulations did not adequately address the possibility of significant losses in the trading
\nbook, securitizations, and some other capital market activities that had become a significant
\nfeature of the financial system. The Federal Reserve has already taken steps, working with
\ndomestic supervisors and the Basel Committee on Bank Supervision, to increase capital
\nrequirements for trading activities and securitization exposures. The Federal Reserve is moving
\ntoward agreement with international counterparts on measures to improve the quality of capital,
\nwith a particular emphasis on the importance of common equity. We are also discussing options
\nunder which systemically important firms could supplement their capital base in times of stress<\/p>\n

– 28 –<\/p>\n

through instruments that, for example, would trigger conversion into common equity when
\neconomic conditions or a firm\u00e2\u20ac\u2122s individual condition had weakened substantially. In addition,
\nwe are implementing strengthened guidance on liquidity risk management to better capture the
\ncomplex financing characteristics of large, wholesale funded institutions, and are weighing
\nproposals for quantitatively based requirements. It is important to couple these enhancements
\nwith legislative action to redress gaps in the regulatory framework by, for example, extending the
\nperimeter of regulation to ensure that firms like AIG and Lehman Brothers are subject to robust
\nconsolidated supervision.<\/p>\n

58. Are you concerned that the debt to GDP ratio in this country is more than 350%? Do
\nyou believe a high debt to GDP ratio is reason for tightening Fed policy? Why or why not?<\/p>\n

The current ratio of public and private debt to GDP, including not only the debt of the
\nnonfinancial sector but also the debt of the financial sector, is about 350 percent. (Many analysts
\nprefer to focus on the debt of the nonfinancial sectors because, they argue, the debt of the
\nfinancial sector involves some double-counting–for example, when a finance company funds the
\nloans it provides to nonfinancial companies by issuing bonds. The ratio of total nonfinancial
\ndebt to GDP is about 240 percent.) Private debt has been declining as households and firms have
\nbeen reducing spending and paying down pre-existing obligations. For example, households,
\nwho are trying to repair their balance sheets, reduced their outstanding debt by 1.3 percent (not at
\nan annual rate) during the first three quarters of this year.<\/p>\n

In contrast, public debt is growing rapidly. Putting fiscal policy on a sustainable trajectory is
\nessential for promoting long-run economic growth and stability. Currently, the ratio of federal
\ndebt to GDP is increasing significantly, and those increases cannot continue indefinitely. The
\nincreases owe partly to cyclical and other temporary factors, but they also reflect a structural
\nfederal budget deficit. Stabilizing the debt to GDP ratio at a moderate level will require policy
\nactions by the Congress to bring federal revenues and outlays into closer alignment in coming
\nyears.
\nThe ratio of government debt to GDP does not have a direct bearing on the appropriate stance of
\nmonetary policy. Rather, the stance of monetary policy is appropriately set in light of the
\noutlook for real activity and inflation and the relationship of that outlook to the Federal
\nReserve\u00e2\u20ac\u2122s statutory objectives of maximum employment and price stability. Of course,
\ngovernment indebtedness may exert an indirect influence on monetary policy through its
\npotential implications for the level of interest rates consistent with full employment and low
\ninflation. But in that respect, fiscal policy is just one of the many factors that influence interest
\nrates and the economic outlook.<\/p>\n

59. The FDIC is seeing significant losses on the mortgages of failed banks. Why shouldn\u00e2\u20ac\u2122t
\nwe assume the Fed will see similar losses on the mortgages on the Fed\u00e2\u20ac\u2122s balance sheet?
\nHow is the Fed valuing those assets?<\/p>\n

In conducting open market operations to support the availability of mortgage financing to
\nhouseholds, the Federal Reserve has purchased only mortgage-backed securities (MBS) that are
\nfully guaranteed as to principal and interest by Fannie Mae, Freddie Mac, and Ginnie Mae;
\naccordingly, the Federal Reserve has no exposure to credit losses on the mortgages that underlie<\/p>\n

– 29 –<\/p>\n

these MBS. Each week, the Federal Reserve publishes, in its H.4.1 statistical release, the current
\nvalue of these securities, measured as the remaining principal balance on the underlying
\nmortgages. The Federal Reserve also reports, in the Monthly Report on Credit and Liquidity
\nPrograms and the Balance Sheet, the end-of-month fair market value of these MBS. The fair
\nmarket value is determined using market values obtained from an independent pricing vendor.<\/p>\n

The Federal Reserve also holds mortgage loans, MBS, and collateralized debt obligations that
\nare backed by mortgage-related assets through Maiden Lane LLC, Maiden Lane II LLC, and
\nMaiden Lane III LLC. At the end of each quarter, the assets of these entities are revalued and
\nthe fair value of the assets is reported in the H.4.1 statistical release and in the Monthly Report
\non Credit and Liquidity Programs and the Balance Sheet. As explained in the Appendix to the
\nMonthly Report, because of the mix of assets held by these entities, the terms on which the
\nFederal Reserve acquired these assets, the equity or subordinated debt positions in these entities
\nheld by others, and the longer term nature of these facilities (which allows the assets to be held to
\nmaturity or sold as markets stabilize and asset values recover), the Board does not anticipate that
\nthe Federal Reserve or taxpayers will incur any net loss on the Federal Reserve\u00e2\u20ac\u2122s loans to these
\nentities.<\/p>\n

60. I am concerned about the falling value of the dollar. China has disclosed that it has
\ntaken as much as a $350 billion loss on its dollar holdings since March, and believes it may
\ntake another $220 billion should the dollar fall a further 10%. Under what scenario do you
\nsee China continuing to buy our debt when your actions, along with Treasury’s, wipe out
\nhalf a trillion dollars of value in the assets purchased from us?<\/p>\n

Since March, the value of China\u00e2\u20ac\u2122s dollar holdings as measured in its own currency has not been
\naffected by fluctuations in the U.S. dollar against other currencies, because operations by
\nChinese authorities in their foreign exchange markets have kept the value of the renminbi
\nessentially unchanged against the U.S. dollar over this period. The cited losses of $350 billion
\nmay represent the gains China would have recorded had all of its foreign holdings been in
\ncurrencies other than the dollar, but this is a hypothetical measure of foregone value rather than a
\nrealized loss, and, in any event, would just offset gains recorded as the dollar rose between the
\nsummer of 2008 and March 2009.<\/p>\n

Absent a policy shift in China that entails a discontinuation of official operations to resist upward
\npressure on the country\u00e2\u20ac\u2122s currency, China will continue to accumulate external assets and thus
\nlikely will continue to invest in U.S. assets. In fact, China has continued to purchase U.S.
\nTreasuries in recent months. More generally, U.S. balance of payments data show that purchases
\nof Treasury securities this year by all foreign official entities have been sizable, even during
\ntimes when the dollar moved lower. Foreign countries, including China, find Treasury securities
\nattractive because the market for U.S. government securities is one of the deepest and most
\nliquid markets in the world and because the U.S. dollar is widely accepted as the premier reserve
\ncurrency.<\/p>\n

61. Some observers see a new asset bubble forming in the stock market. Does it concern
\nyou that under some measures the current price to earnings ratio on the S&P 500 is<\/p>\n

– 30 –<\/p>\n

considerably higher than the ratio when Alan Greenspan gave his “irrational exuberance”
\nspeech?<\/p>\n

While assessing the fundamental values of financial assets is inherently very difficult, there is
\nnot much evidence to suggest that the stock market is currently in a bubble. Broad stock-price
\nindexes have increased markedly since their troughs early this year. However, share prices have
\nyet to retrace all their losses since September 2008, and are substantially below their peaks in
\n2007. Even more to the point, measures of risk premiums on broad stock-price indexes, despite
\nhaving narrowed substantially relative to their record highs in late 2008, are still very wide by
\nhistorical standards, suggesting that investors are not overly sanguine about the risks of investing
\nin the stock market. Consistent with that view, implied volatilities on broad stock-price indexes
\nhave hovered at elevated levels in recent months, even as the economy has begun to recover. All
\nthat said, stock values ultimately depend on the evolution of company earnings, which in turn
\ndepend on the path of the economy. Because economic forecasts are inherently very uncertain,
\nthe appropriate valuations of stocks are also uncertain.<\/p>\n

62. According to the transcript of the June 24-25 FOMC meeting you said \u00e2\u20ac\u0153Ambiguity has
\nits uses but mostly in noncooperative games like poker. Monetary policy is a cooperative
\ngame. The whole point is to get financial markets on our side and for them to do some of
\nour work for us. In an environment of low inflation and low interest rates, we need to seek
\never greater clarity of communication to the markets and to the public.\u00e2\u20ac\u009d If you still believe
\nthat, why are you concerned about opening more information about monetary policy to the
\npublic eye through an audit or other means of increasing transparency?<\/p>\n

I believe that transparency is critical to the effective conduct of monetary policy. Indeed, over
\nthe past several years, the Federal Reserve has taken significant steps to enhance the clarity of its
\ncommunications to the public and the Congress. In the autumn of 2007, the FOMC began
\npublishing the economic projections of Committee participants four times per year rather than
\nsemiannually. In early 2009, the FOMC extended the horizon of these forecasts to include
\nlonger-run projections, which provide information about participants\u00e2\u20ac\u2122 estimates of the longer-run
\nsustainable rates of economic growth and unemployment and about their assessments of the
\nlonger-run average inflation rate that best fulfills the Federal Reserve\u00e2\u20ac\u2122s dual mandate. Last June,
\nthe Federal Reserve began publishing a monthly report entitled \u00e2\u20ac\u0153Credit and Liquidity Programs
\nand the Balance Sheet\u00e2\u20ac\u009d that presents detailed information about the Federal Reserve\u00e2\u20ac\u2122s programs
\nto foster market liquidity and financial stability.<\/p>\n

Moreover, the Congress–through the Government Accountability Office–can and does audit all
\naspects of the Federal Reserve\u00e2\u20ac\u2122s operations except for deliberations on monetary policy and
\nrelated issues. The Congress specifically exempted those deliberations to protect monetary
\npolicy from short-term political pressures. The repeal of this exemption could lead households,
\nbusinesses, and investors to conclude that the Federal Reserve would not be in a position to
\ncombat inflation pressures as effectively as in the past. As a result, inflation expectations would
\nlikely move higher, boosting interest rates and raising the cost of credit for households and
\nbusinesses.<\/p>\n

– 31 –<\/p>\n

63. Did you or anyone else at the Fed realize the extent to which bailing out AIG would
\nbenefit European banks?<\/p>\n

At the time the decisions were made to provide financial assistance to AIG and subsequently to
\nrestructure that assistance, we knew that the company was a very large, diversified financial
\nservices company that had extensive interconnections with the financial markets in this country
\nand globally. As I indicated in my testimony earlier this year before the House Financial
\nServices Committee, the range of parties that had potential exposure to AIG was sweeping:
\nmillions of policyholders of its insurance subsidiaries in the United States and elsewhere, state
\nand local governments, workers whose 401(k) plans had purchased insurance from AIG, banks
\nand investment banks that had loans or lines of credit to the company, and money market funds
\nand others that held AIG\u00e2\u20ac\u2122s outstanding commercial paper. Those with AIG exposure consisted
\nof individuals and businesses, financial institutions and commercial enterprises, private and
\ngovernmental entities, and domestic and foreign parties.<\/p>\n

64. Did the effect of a failure of AIG on European banks in any way contribute to the
\ndecision to rescue AIG? If so, why did you not request European governments provide
\nfinancial assistance as well?<\/p>\n

As noted in the answer to question 63, the decisions to provide financial assistance to AIG and
\nsubsequently to restructure that assistance were based on a wide range of factors, including the
\npotential exposure of a broad spectrum of financial market participants to the company. During
\nthe recent financial markets crisis, the Federal Reserve has coordinated with foreign central
\nbanks and bank regulators in implementing measures to stabilize the banking system globally.
\nSeveral European governments provided financial assistance to banks within their jurisdictions
\nas part of these efforts.<\/p>\n

65. Why were the monoline insurers allowed to fail while AIG was rescued, when they had
\nsignificant derivatives exposure just like AIG?<\/p>\n

AIG\u00e2\u20ac\u2122s near-failure occurred at an extraordinary time. Global financial markets were under
\nunprecedented strains. Major financial firms were under intense stress and three very large
\nfirms–Fannie Mae, Freddie Mac, and Lehman Brothers–had recently failed or been placed into
\nconservatorship. The Federal Reserve and the Treasury judged that, given the severe market and
\neconomic stresses prevailing at that time, the failure of AIG would have posed an unacceptable
\nrisk for the global financial system and our economy. A disorderly failure on the part of AIG
\nwould have directly affected insurance policyholders in the United States and worldwide, state
\nand local government entities that had lent to AIG, 401(k) plans that had purchased insurance
\nfrom AIG, financial institutions with large exposures to AIG, and money market mutual funds
\nand others that had invested in AIG\u00e2\u20ac\u2122s commercial paper. More broadly, AIG\u00e2\u20ac\u2122s failure would
\nhave further damaged already fragile market confidence and could have precipitated a broad-
\nbased run on financial institutions around the world.<\/p>\n

In contrast to AIG, the monoline insurers came under substantial pressure in an earlier period
\nwhen market and economic strains were much less pronounced, and the effects of the failure of<\/p>\n

– 32 –<\/p>\n

monolines were judged as being less likely to have serious adverse effects on the financial
\nsystem and the economy.<\/p>\n

66. In November 2009, the AIG bailout was revised to give the New York Fed ownership of
\nseveral AIG subsidiaries in exchange for a reduced balance owed on loans by the New York
\nFed. What was the valuation used by the Fed for these subsidiaries, and how was that
\nvaluation determined? Did the Fed or AIG try to sell the subsidiaries to private entities?
\nIf so, what was the result, and if not, why not? What is the Fed\u00e2\u20ac\u2122s plan to dispose of the
\nequity stakes?<\/p>\n

The revolving credit facility is fully secured by all the unencumbered assets of AIG, including
\nthe shares of substantially all of AIG\u00e2\u20ac\u2122s subsidiaries. The loan was extended with the expectation
\nthat AIG would repay the credits with the proceeds from the sale of its operations and
\nsubsidiaries. The credit agreement stipulates that the net proceeds from all sales of subsidiaries
\nof AIG must first be offered to pay down the credit extended by the Federal Reserve. AIG has
\ndeveloped a plan to divest its non-core business in order to repay U.S. government support.<\/p>\n

Most recently, AIG has begun the process of selling two of its insurance subsidiaries with
\nsignificant business overseas, American International Assurance Co. (AIA) and American Life
\nInsurance Company (ALICO). The step taken last week by the Federal Reserve to accept shares
\nin two newly created companies that hold the common stock of AIA and ALICO, respectively, in
\nsatisfaction of a portion of the credit extended by the Federal Reserve facilitates the sale of these
\ntwo companies and the repayment of the Federal Reserve. The value of the Federal Reserve\u00e2\u20ac\u2122s
\npreferred interests represents a percentage of the market value of AIA and ALICO, based on
\nvaluations provided by independent advisers. AIA has announced plans for an initial public
\noffering in 2010 and ALICO has announced that it has positioned itself for an initial public
\noffering or a sale to a third party. AIG also continues to pursue the sale of other subsidiaries, the
\nnet proceeds of which would be applied to repay the AIG loan.<\/p>\n

67. Have you recommended any candidates to fill the empty seats on the Board of
\nGovernors? If so, who?<\/p>\n

No. The selection of Board members of the Federal Reserve is the responsibility of the President
\nof the United States. Every President takes this responsibility seriously and I am therefore
\nconfident he is committed to filling the vacant seats with well-qualified individuals.<\/p>\n

68. Andrew Haldane, head of financial stability at the Bank of England, argues that the
\nrelationship between the banking system and the government (in the UK and the US)
\ncreates a \u00e2\u20ac\u0153doom loop\u00e2\u20ac\u009d in which there are repeated boom-bust-bailout cycles that tend to
\nget cost the taxpayer more and pose greater threat to the macroeconomy over time. What
\ncan be done to break this loop?<\/p>\n

The \u00e2\u20ac\u0153doom loop\u00e2\u20ac\u009d that Andrew Haldane describes is a consequence of the problem of moral
\nhazard in which the existence of explicit government backstops (such as deposit insurance or
\nliquidity facilities) or of presumed government support leads firms to take on more risk or rely
\non less robust funding than they would otherwise. The new financial regulatory structure that I<\/p>\n

– 33 –<\/p>\n

and others have proposed to counteract moral hazard would address this problem. In particular,
\na stronger financial regulatory structure would include: a consolidated supervisory framework
\nfor all financial institutions that may pose significant risk to the financial system; consideration
\nin this framework of the risks that an entity may pose, either through its own actions or through
\ninteractions with other firms or markets, to the broader financial system; a systemic risk
\noversight council to identify, and coordinate responses to, emerging risks to financial stability;
\nand a new special resolution process that would allow the government to wind down in an
\norderly way a failing systemically important nonbank financial institution (the disorderly failure
\nof which would otherwise threaten the entire financial system), while also imposing losses on the
\nfirm\u00e2\u20ac\u2122s shareholders and creditors. The imposition of losses would reduce the costs to taxpayers
\nshould a failure occur.<\/p>\n

69. Mervyn King, governor of the Bank of England, argued in his recent Edinburgh speech
\nthat re-regulating the financial system will not effectively reduce its risks. And history
\nsuggests that Big Finance always gets ahead of even the most able regulators. Governor
\nKing insists instead that the largest banks should be broken up, so they are no longer \u00e2\u20ac\u0153too
\nbig to fail.\u00e2\u20ac\u009d Paul Volcker and Alan Greenspan, in recent statements, have supported the
\nsame broad approach. Can you explain why you differ from Mervyn King, Paul Volcker,
\nand Alan Greenspan on this policy prescription?<\/p>\n

I agree that no financial institution should be too big to fail. The policy of the Federal Reserve is
\nthat systemically important institutions should be regulated in a way that recognizes the full
\npanoply of risks that they present to the financial system and to the economy more broadly.
\nSuch risks include but may not be limited to credit, liquidity, operational, and systemic risks. A
\ndifficulty of the prior regulatory framework is that sufficient charges and requirements were not
\nimposed on such institutions, leaving them with an inappropriate incentive to become large and
\ncomplex for the sake of possibly becoming recognized as too big to fail. The regulatory
\napproach we are currently working to develop and implement seeks to correct this important
\nshortcoming by imposing a comprehensive and robust set of safeguards, capital charges, and
\nother measures that are designed to reflect the full range of risks posed by large, complex
\norganizations. While significant challenges to developing and implementing such an approach
\nexist, an appropriately calibrated system along these lines should help reduce the potential for
\nany firm to be too big to fail. An important complement to stronger regulation and supervision,
\nhowever, is the development of an effective resolution regime that would allow the government
\nto wind down in an orderly way a troubled financial firm even in cases where a disorderly failure
\nwould pose a threat to the financial system and the economy.<\/p>\n

70. In the time between the bailout of Bear Stearns and the failure of Lehman, should you
\nor the Treasury have more clearly communicated that firms should not expect government
\nassistance? Why do you think Lehman, AIG, and others continued to act like there would
\nbe such assistance? Are there any lessons we should learn from that period that are
\napplicable to efforts to reform our financial regulation?<\/p>\n

Between the time of the near failure of Bear Stearns and the collapse of Lehman, a number of
\ntroubled financial institutions did in fact fail or were acquired by other financial institutions in
\nprivate transactions. Moreover, in the aftermath of JPMorgan Chase\u00e2\u20ac\u2122s acquisition of Bear<\/p>\n

Stearns, many financial firms took steps to strengthen their financial positions, including writing
\ndown troubled assets, raising capital, and reducing leverage. However, these steps were not
\nsufficient in many cases to allow the firms to survive the worsening of the financial crisis in the
\nfall of 2008. Our decisions at that time, like those we took at each stage of the crisis, depended
\ncritically on the details of the circumstances then prevailing. As I have outlined elsewhere, a
\nconcerted effort was made to find a private-sector solution to the problems at Lehman. Had a
\nviable buyer emerged, the Federal Reserve would have strongly supported the sale, but in the
\nevent, no such buyer was forthcoming. Moreover, providers of both secured and unsecured
\ncredit to the company were rapidly pulling away from the company and the company needed
\nfunding well above the amount that could be provided on a secured basis. Before the enactment
\nof the legislation authorizing the TARP, the government lacked the ability to inject capital to
\nprevent the disorderly collapse of a failing systemically important non-banking institution. In
\nlight of these circumstances, failure was the only possible outcome for Lehman. Two critical
\nlessons should be gleaned from the Lehman experience. First, Congress must ensure that all
\nsystemically important firms are subject to robust consolidated supervision. Second, going
\nforward, there is an acute need for the Congress to enact a resolution regime that would allow the
\ngovernment to wind down a failing systemically important nonbank financial institution in an
\norderly way, and to impose losses as appropriate on shareholders and creditors.<\/p>\n","protected":false},"excerpt":{"rendered":"

For all its flaws, one of the great strengths of the American political system is the degree to which competing perspectives fight to the death in Washington’s marketplace of ideas. 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