Hearing Regarding Ben Bernanke's Nomination to Be Chairman of the Board of Goverrnors of the Federal Reserve
Tuesday, November 15, 2005; 7:00 PM
The transcript picks up after the lunch recess. To return to Part 1 of the transcript, click here.
(JOINED IN PROGRESS DUE TO HEARING ROOM AUDIO SYSTEM)
BERNANKE: ... it's one that improves economic growth or not and so on.
I think that generally the tax cuts, if they're well designed, do increase growth and therefore do partially offset the revenue loss.
But I think it's unusual for a tax cut to completely offset the revenue loss.
REED: Thank you, Dr. Bernanke.
One other area of concern, and that is although interest rates have not gone -- excuse me. We have had over the last several quarters increases by the Federal Reserve with respect to interest rates. But the long-term interest rates have hardly moved at all and that's, I think, an issue that is beginning to draw a lot of professional attention as to why that might be.
Although these long-term interest rates haven't gone up, the large federal budget deficits we've seen recently have substantially reduced our national savings. I think that's correct also.
And the decrease in national savings, I would assume, and I hope you do also, does harm our future prosperity and economy.
Is that accurate?
BERNANKE: It does increase the debt that we pass on to our children, that's correct.
REED: Now, just recently, I think Chairman Greenspan has talked about the potential for foreign lenders to become disenchanted. Won't interest rates have to rise substantially in our current posture if foreign lenders are not forthcoming? Is that almost axiomatic?
BERNANKE: I don't expect to see foreign lenders change their holdings very significantly.
The foreign holders are not doing us a favor. What they are doing is they're choosing a set of assets which they consider to be highly liquid, highly safe, from a country with a safe, strong legal system.
So it's for that reason that American assets make up the bulk of U.S. -- of international, sorry, international reserves. So I don't expect to see major changes in that.
Moreover, there's broad interest in holding U.S. assets, both by Americans, but also by foreign nonofficial sources as well. So I don't expect to see any such shift in demand for U.S. assets.
REED: Thank you, Dr. Bernanke.
SHELBY: Senator Stabenow?
STABENOW: Thank you, Mr. Chairman, and welcome back.
Dr. Bernanke, I wanted to talk a little bit more about this whole question of our U.S. assets, financial assets, and other assets being held by foreign investors.
We're told that about $9 trillion in all, if you look at financial assets, large portions of which are easily sold and highly susceptible to shifts in the market sentiment, interest rates, other variables, even a modest slowdown in the net new inflows from private and official foreign sources could have a negative impact on an economy where foreign investment is about 25 percent of our gross national product -- very alarming.
And I would argue that since a large portion of that is China and Japan, that that unduly impacts our ability to enforce trade laws, to address other issues with them.
Whether we want to acknowledge that or not, I have a hard time believing it doesn't have some impact there.
But it would appear to many of us that our trade deficits are leading us down an incredibly alarming path, as well as our budget deficits.
When you're looking back, do you see any instances where alternative monetary policy choices by the Fed could have moderated the build-up of these imbalances or had an impact on what's happening in terms of deficits?
BERNANKE: No, I don't think that the Federal Reserve -- whose mandate, after all, is domestic price stability and employment -- has much role in terms of the current account deficit.
The current account deficit is a very complex phenomenon. I believe it arises from, essentially, a global imbalance of saving and investment.
Countries outside the United States have a lot of savings that they want to put into international capital markets and insufficient investment to make use of those savings.
The United States has been the recipient of those savings. And that is, in some sense, a good thing because the U.S. is a very attractive destination for foreign capital flows. But it has also created this imbalance that we call the current account deficit.
I do believe the current account deficit needs to come down over a period of time. I think there are a number of elements needed to do that. Part of it would be to increase United States national savings through both private savings and public savings.
I would also be useful for our trading partners to do a number of things, including allowing their exchange rates to float more freely and be determined by the market and to rely less on exports as a source of demand for their economies.
So we need to rebalance the global international system. I believe that can be done over a period of time. But it won't happen overnight.
And I think the Federal Reserve's main objective should be to maintain domestic employment and price stability and to allow other factors to be predominant in curing the current account situation.
STABENOW: Let's talk for a moment -- you mentioned floating currency -- currency manipulation is of great concern to me and many of my colleagues.
We had a very strong vote -- I believe 67 members of the Senate, both parties, a year ago -- that sent a very strong message about how we want that to stop, particularly with China. China and Japan is also a concern, whether it be as aggressive or an open a process in Japan.
We have a process where the Treasury secretary comes in every six months, gives us a report. This past summer, he issued a semiannual report and was not able to bring himself to recognize that China's, in fact, manipulating the currency.
We all know it's happening.
STABENOW: Everybody in my state knows. Any business person knows that that's happening.
But once again we have in November now, this month, we will have access to another report, I fear, that will be the same as other reports, technically indicating that currency manipulation is not happening.
Do you believe the Federal Reserve has a role to play in ensuring that economies around the world allow market forces to determine the value of their currency?
BERNANKE: Senator, let me begin by saying that I think it's very much in China's own interest to allow their currency to float freely and be determined by the market. They're a very large country, they need to have independent monetary policy. It's difficult for them to continue sterilizing their interventionist the way they have been doing.
So I believe that they will come to the recognition, and I hope they do, that it's in their interest to allow their currency to be determined by market forces.
With respect to the Federal Reserve's role, the treasury usually takes the lead in matters of currency negotiation and the like, but the Federal Reserve in providing advice and assisting in whatever way possible, and I would certainly do that.
STABENOW: I would just comment that when you're talking about China's best interests, I would just note that we've lost over 1.5 million manufacturing jobs in America, which is where my focus us, our focus is on America, American businesses, American jobs. We've lost over 1.5 million jobs because of currency manipulation.
And while I appreciate that we can hope that someday China will get there, because it's in their interest, it's been long in our interest to have stopped this, along with counterfeiting and a number of other issues that have created an unlevel playing field for our businesses and our workers.
So I realize that is not directly under your purview, but I would hope that your knowledge and leadership would be used as we talk about the broad economic factors that allow us to create those good-paying jobs that we desperately need to keep and expand upon in this country. And certainly what we're doing to enforce -- or in this case not enforce trade laws -- has a tremendous impact on that, and certainly currency manipulation is one of those things.
Thank you very much, Mr. Chairman.
SHELBY: Senator Bayh?
BAYH: Doctor, welcome.
BERNANKE: Thank you.
BAYH: Welcome, Doctor. And I want to thank you for the visit you were kind enough to pay on me a week ago. I enjoyed our discussion.
As I told you at the time, I look forward to supporting your nomination and was impressed by your combination of both theoretical and practical concerns, which is the combination that I think we need in a Fed chairman.
BAYH: Doctor, let me begin by asking stylistic question, if I might. And I'd like to quote from an article in today's New York Times which concludes by saying, "As an academic economist and as a Fed governor, Mr. Bernanke prided himself on speaking clearly and sometimes even bluntly."
It then goes on to say that, perhaps to satisfy the concerns of members of Congress but also the bond market -- it said, to satisfy both constituents, he may have to sacrifice his plain speaking.
Is that true?
I, for one, am hoping you can continue to speak your mind in a language the American people can understand.
BERNANKE: I will try to speak clearly on all occasions, Senator.
BAYH: Good. I guess we'll have to be the judge of that as we go forward. But I hope you'll endeavor to do that. Clarity and transparency are, I think, normally better than the alternatives. And so, I hope you'll stick to your stylistic guns. Thank you.
Let me ask you about current account imbalances, if I might. And let me follow up on something that I think both Senator Reed and Stabenow were asking and also quote from today's New York Times.
It says, "Of the more than $30 trillion in foreign investment tracked by the Bank of International Settlements in the first three months of 2005, 42.5 percent were in dollars; 39.3 percent were in euros. The dollar's share was down four percentage points from around three years earlier while the euro's share was up by five percentage points."
The reason these statistics were cited by Chairman Greenspan was in furtherance of the notion that perhaps, in accordance with portfolio theory, some countries had reached the tipping point in terms of their level of dollar-denominated assets.
What's your take on that?
BERNANKE: Senator, it's an open question. There's still what's called -- what Chairman Greenspan calls the "home bias," the fact that most countries still own a smaller share of dollar denominated assets than the U.S. share in the world economy.
BERNANKE: And so it's a question of judgment about how much more dollar assets foreign investors will want to hold.
My sense is that there's still a broad appetite for dollar assets, both domestically and abroad. And as I indicated, I don't expect to see any major shifts in that appetite.
Clearly, we'll need to monitor the situation. We'll need to watch the behavior of interest rates, the dollar and other financial variables. But I see no indication of any major shift in these flows in the near term.
BAYH: Let me ask a question that I posed to you in our meeting in my office, and that is, the most likely course of events is that there may be an orderly readjustment of the imbalances that currently exist. But from time to time events happen that lead to disorderly movements. What should the appropriate policy response of our government be if there were to be a precipitous decline in our currency?
And what do we do about the conundrum where if you raise interest rates in the short run to defend our currency, it would have a stifling effect on the economy which then in the longer term could have a depressing effect on our currency? How do you strike the right balance there?
BERNANKE: Senator, answering the question, first but talking hypothetically -- I want to be sure everyone understands that.
BAYH: I understand.
And by the way -- forgive me for interrupting, but as a member of this body and admonishing you to speak bluntly and clearly, perhaps we should look in the mirror. I want to just put that on the record, too.
BERNANKE: Thank you, Senator.
The Federal Reserve has important responsibilities for maintaining financial stability. That involves ensuring ex ante, that banks, for example, are managing their portfolios safely, that the clearing and settlement systems are well-designed and secure, that there are good arrangements in place for dealing with some kind of financial crisis, no matter what its source might be, and that, ex post, should there be a problem, that there be plenty of liquidity provided to the banking system and that the Fed would make sure that whatever problems arise be brought to some venue where they can be unwound and discussed and assistance be given.
So broadly speaking, the Federal Reserve must deal with financial crises of all different kinds. There have been a variety of them.
BERNANKE: Should an untoward movement in dollars and interest rates cause financial stress, that would be the same sort of approaches that we would take that we've taken in other -- the Federal Reserve has taken in other circumstances -- would be applied in this case.
With respect to the macroeconomic implications, it would depend on the overall impact on the economy. Again, the Federal Reserve's responsibility is maximum employment and price stability. So the impact of the change in the dollar, interest rates, asset prices, however those things would occur, there'd have to be an evaluation about what the net change would have to be in order to make sure that the domestic economy is stabilized and is insulated from the impact of these changes.
BAYH: I've exceeded my time, but it would be a sticky problem, would it not?
BERNANKE: Surely it would be a sticky problem, and that's why it's good to have an experienced staff and lots of experience in the institution for dealing with these crises.
BAYH: I'm going to defer to my colleagues and stick around for a few moments.
But my concern in this regard is that if, in fact, other countries have reached the point at which they are not seeking to increase the percentage of dollar denominated assets, then perhaps that increases the risk of an exogenous event of some kind leading to a precipitous readjustment of the currency, thereby presenting you with this possible hypothetical.
BERNANKE: Senator, if I may, the demand for dollar assets is not simply by foreigners, but by Americans as well. And American household wealth, for example, is about $50 trillion.
There's an enormous demand for dollar denominated assets, and so I don't expect that that demand would drop precipitously.
BAYH: Let's hope.
Thank you, Mr. Chairman.
SHELBY: Thank you, Senator Bayh.
Dr. Bernanke, last week the Banking Committee, as you probably knew, heard from the banking regulators, including the Federal Reserve and several industry experts regarding the proposed Basel II capital standards.
While the regulators basically supported moving forward, some with a little caution in the wind, the outside experts -- a lot of them former regulators -- advised caution, raising concerns about lower capital ratios and failure to factor in all risks faced by banks.
SHELBY: What's your assessment of the Basel II proposal? I know you've been on the Fed as a member of the Fed. And if you're confirmed as chairman, which I hope you will shortly, what will the Federal Reserve do to address the unanswered questions -- and there are a lot of unanswered questions -- and concerns raised regarding Basel II?
BERNANKE: Chairman Shelby, Basel II or something like it appears necessary. The banking system has become financially extraordinarily sophisticated. Basel I is no longer sufficient as a means of determining adequate regulatory capital for the banking system.
The Federal Reserve, the other banking regulators, international counterparties have worked for a number of years trying to determine an appropriate system that would appropriately account for the complexity of the banking system. Basel II tries to embody the notion that the amount of regulatory capital should be based on modern risk- management techniques, which try to evaluate the risks associated with different kinds of investments.
It's true that there have been various concerns along the way, there have been disagreements along the way. My sense is that the banking regulators are proceeding in a very cautious and slow way. In particular, as you know, they have delayed the implementation following the QIS 4 results.
And, moreover, there's going to be a series of safeguards, including, for example, a slow transition, parallel run situation where both Basel I and Basel II capital stands will be calculated and (inaudible) based on the Basel I standards. There'll be a continual process of evaluation, of feedback, of comment.
There are various other safeguards as well, including Pillar II, which allows regulators to make additional assessments of capital depending on their evaluation.
And finally, I should just mention, among many other elements, both prompt corrective action and the leverage ratio, which are two other sort of belts-and-suspenders types of provisions, will remain in place to ensure that banks have sufficient capital.
So while I'm not involved personally directly in all the details at this point, I expect I will be if I'm confirmed. My sense is that they are being very cautious and moving very slowly to make sure that the regulatory capital is going to be sufficient to make the banking system safe and sound.
SHELBY: I want to touch on the Fed's role in crisis management. And I hope you will not be confronted with a crisis to manage, but I know you will be.
SHELBY: Over the past 20 years, the U.S. and world economies have benefited when the Federal Reserve took swift and appropriate action to respond to various financial disturbances.
Some now question whether the Federal Reserve will have a more difficult time in the event of a future crisis because of the large trade deficit and the large foreign official holdings of U.S. Treasury debt that we've been talking about.
Do you agree or disagree with the assessment that the Fed may not have the same flexibility as it had in the past?
And what measures, if any, would you as Fed chairman lead the Federal Reserve in taking to prepare for its role in crisis management, which will come, sooner or later?
BERNANKE: Chairman Shelby, it's certainly true that the economy has become much more open. The capital flows are much more important, that the current account is a much bigger issue.
And that, certainly, makes more complicated the Federal Reserve's objectives both of macro-objectives and financial crisis management.
Nevertheless, I don't believe that the ability of the Federal Reserve to respond, to meet its objectives, has been substantially compromised by this opening. It just makes the problem more complicated. It requires more expertise.
I think, in fact, that the financial system has benefited over the years from the meetings of a variety of financial crises, including 9/11, for example, which has led to hardening and providing additional back-up facilities and the like and other experiences that the Federal Reserve has had.
The depths, the liquidity, the flexibility of the financial markets has increased greatly. The strength of the clearing systems, the major financial centers, has been improved. So, certainly, I agree that we can never be complacent about financial crisis.
And I will certainly make every effort to be prepared for whatever may come my way. But I do believe that progress has been made in strengthening the system to be more resilient in the face of shocks.
SHELBY: Senator Sarbanes, do you have any questions?
SARBANES: Thank you very much, Mr. Chairman.
Dr. Bernanke, I have a number of questions I want to run through as quickly as I can. Before I do that, though, I do want to observe that -- well, let me start and then I'll come back to that.
On Basel II, which you just responded to the chairman about, it seems to me you're being much too sanguine. When they did the quantitative impact study, they found that more than half of the participating institutions would show a capital reduction of 25 percent or more, in some instances up to 50 percent, which, of course, raised a lot of red flags about the safety and soundness of the system and the adequate capital.
Do you think that prompt corrective action in the leverage capital requirements could be maintained if risk-based capital levels fell significantly below the leverage ratio?
BERNANKE: I guess the good news about QIS 4 is that it led the regulators to stop, take stock, to try to understand the results...
BAYH: Which only raises the question -- how did we get so far down this path and when they ran it through the models, it brought this absolutely showstopping result? How did that happen?
We keep holding these hearings. Chairman Shelby, to his credit, has really exercised a lot of oversight over this, repeatedly. Everyone says: Well, we're working it all out. It's going to be good.
And then all of a sudden, they do a quantitative run on the thing, and everyone says: Wow. How did we get to this posture? How did that happen?
BERNANKE: Senators, various issues have been identified that help explain the results. I don't have to go through all of them.
I'll give one example: Some of the results were based on relatively good times and didn't include some weak periods of the economy to give a higher loss rate.
But what it does emphasize -- and here, I agree with you, Senator, it's very important that this be done right and we need to learn from these exercises. If they were purely mechanical, they wouldn't be worth doing.
So we need to go slowly and cautiously and learn from these exercises and make sure that capital is adequate. And I agree with that 100 percent.
SARBANES: Well, I want to commend to you -- I won't pursue this question, because there are a number of others to ask. There was a panel after we heard from the regulators, including former FDIC chairman William Isaac and former FDIC chairman William Seidman, and Isaac says -- I mean, he said a number of things. But I quote him, he says, "Basel II will be used to reduce large bank capital ratios and either place small banks at a competitive disadvantage or force regulators to lower bank capital ratios. Neither option is acceptable public policy."
And Seidman -- and these are two, you know, experienced people -- said, "The original intent of Basel II was to more closely align minimum regulatory capital with actual risk, not to materially reduce overall capital levels within the banking system."
And I strongly commend the testimony of that second panel to you as you move ahead to examine this question.
Let me ask you about remittances. I know this is an issue you've been interested in. A recent study by the Inter-American Development Bank said Latin American immigrants will send over $50 billion in remittances to their family and friends and their countries of origin, the vast majority of which is from the United States.
We've been concerned about the state of the remittance market, especially that individuals are using methods of transmitting remittances that are outside the financial mainstream and therefore often subject to high fees which are -- and often to sort of hidden charges in the form of unfavorable exchange rates.
You studied this issue. You said typical nonbuying fees for remittances remain high on an absolute basis and consumers who deal with less scrupulous providers of remittance services may bear a significant financial cost.
I think we have an opportunity here to get immigrants into the financial mainstream using the leveraging issue -- I mean, the remittance issue in order to do that.
Would it be your intention to work on this issue as chairman of the Fed? And do you think there's a role the Fed can play in helping to achieve this goal of greater fairness for the immigrants who are doing the remittances and their inclusion in the financial system?
BERNANKE: Senator, yes I do. as my same speech as you're alluding to discussed, I think this is an excellent opportunity for mainstream financial institutions to bring immigrant communities into their organizations, to give them not only remittent services but other services: savings, borrowing, and the like.
And it's an opportunity that many of these organizations are already undertaking.
Federal Reserve is involved in this in numerous ways through banks of provision and regulation but also through, for example, the Fed ACH system which has been set up with Mexico to permit easier remittance payments, through financial education and also in managing the risks that are involved in these sorts of activities.
So I think that it is an important issue. It's very important, obviously, for the immigrants themselves and for the countries that are receiving the remittances. And I'll continue to be interested in that.
SARBANES: Well, Mr. Chairman, I see my time's up. I have a few more, but...
BENNETT: Thank you, Mr. Chairman, Senator Sarbanes.
I listened to this conversation about the current account and foreign ownership and I have a fundamental question.
Where else are they going to go?
BERNANKE: Senator, that was part of my response which is that American assets are very attractive assets and they will be an important part of any international portfolio and, of course, of Americans' portfolio as well.
BENNETT: Sure. I mean, I wouldn't want to invest a lot of my retirement money any place else but in the American economy. And this is a logical place; where else are they going to go?
I would like to pursue a little bit another question. We talked about inflation. We talked about price stability and price stability being the target and the old idea that, well, inflation and employment are tied together and you can't have high employment without overheating the economy, and so you have to make a choice.
BENNETT: And I think we've broken that link and decided you can have price stability and tight labor markets at the same time, because we've seen some of that before the recent recession.
What causes inflation? That becomes the fundamental question here. And there are some who would suggest that inflation is caused by too much growth, and the way to control inflation is to control growth.
But we've had low inflation and we've had growth in excess of 3 percent of GDP, sometimes up to 4 percent of GDP, without the sense of that the economy was overheating.
Could you just explain that in your best professorial manner to a graduate student here who wants to know how you're feeling about this whole question of whether or not inflation is caused by too much growth, and if not, by what?
BERNANKE: Senator, growth itself and growth capacity is ultimately determined by productivity, which, again, depends on issues like regulation, taxation, innovation, technology and the like, and also by employment growth, the number of workers available and the increase in their labor supply.
So those are the fundamental factors that determine growth. The amount of available growth varies over time according to economic conditions. It can be high. The United States has had good economic policies that have promoted growth in recent years, good technologies. And so in that sense strong growth does not create inflation.
If financial conditions are such, though, that aggregate demand, aggregate spending is greater than even the growth that underlying conditions can permit, then there can be increased pricing power, excess demand, and pricing pressures could increase. In that case, you can get some inflation.
I agree with your original statement, though, that in a long run sense the most important relationship is between low inflation and high growth. That is, when inflation is kept low and stable and expectations are kept low and stable, then the economy will be more stable and more growth will be possible.
So I think that's the most fundamental relationship between the two variables.
BENNETT: Well, I have always said wealth is created by two things. One is accumulated capital, and the other is risk taking. And that we need policies, both fiscal policy and monetary policy, that encourage both the accumulation of capital and then the willingness to take risks.
Now, I realize tax policy comes into that, because if you tax accumulated capital and thereby make it less attractive, or if you tax the rewards so that I take a risk but I'm not going to get that much of a reward out of it.
But taking those two, the role of accumulated capital and risk taking in creating growth, talk about the Fed's role with respect to that, because you don't control taxation.
BERNANKE: No, the Fed's role is to keep inflation low and stable. It makes markets work better. It reduces risks in the market, causes people to spend less time worrying about the value of money and more time about businesses and innovations and changes that'll make the economy better.
So that's, I think, the main contribution the Fed can make, is to ensure long-run price stability.
In the short run, the Fed can respond to various shocks to the economy and try and keep things on an even keel. But all that works best when inflation is kept low and stable.
BENNETT: Thank you, Mr. Chairman.
SHELBY: Senator Schumer? This will be your first round.
SCHUMER: Thank you, Mr. Chairman. And thank you for holding these hearings.
I want to thank you, Mr. Bernanke, for being here. Apologize I couldn't be here earlier. I was over on the House side.
And we've had some extensive discussions, and you've answered most of my questions very satisfactorily. A few I'd like to go over, even though we talked about them when we met.
China. Now, in May of this year you told this committee -- I'm quoting you -- "For large economies like China and the United States, it's preferable to have a market-determined flexible exchange rate. And China should move as expeditiously as possible toward loosening up its exchange rate. They are now ready to go to a more flexible rate regime, and I've urged them to do that."
That states your views correctly and without any modification.
BERNANKE: Yes, Senator.
SCHUMER: OK. Let me ask you a couple of questions about that: First, do you believe that our current account deficit is sustainable?
BERNANKE: I believe we need to bring it down over a period of time, yes.
Do you think that China and its particular inability or unwillingness to let the currency float is contributing to that current account deficit?
BERNANKE: It is a contribution, but there are many other factors as well, including the very high savings rates around the world and the export-led strategies of some other economies.
Do you believe the Chinese engage in mercantilist policies? You have said you did when we talked. Could you just elaborate a little bit?
BERNANKE: They have adopted a development strategy which other countries have also adopted which is focusing on export-led growth, that is that they are looking to export in order to help their economy grow. They see advantages in being able to sell to a global market, one that is more technologically sophisticated, and it has been proved a method that's helped them in their rapid growth...
SCHUMER: They try to maximize exports and minimize imports, would that be fair to say?
BERNANKE: I'm not sure about imports. In some cases, the imports are quite important. For example, China is a platform. And they bring in goods and services -- goods from other parts of Asia and reproduce them...
SCHUMER: But their goal is to increase their overall wealth. And that's what a mercantilist policy would be.
BERNANKE: They have focused on exports as a way of trying to increase their growth. Yes.
Now, second question is, China did promise to allow market forces to affect the value of the yuan, and yet the currency has moved as much in nearly four months as they said they'd allow it to move in a day. In other words, the total amount of movement.
Is it your view that China has kept its promise to allow the yuan to move with market forces?
BERNANKE: I think they need to do more to allow their exchange rate to become more flexible and more market...
SCHUMER: Obviously it wouldn't move so little if they weren't intervening, and it would be better if they didn't, or at least gradually moved away from it. I assume you assume that's correct.
Could you just talk a little bit about a reasonable timetable for China to allow its currency to float freely?
SCHUMER: Are they ready to do it immediately? That would be one extreme.
Should it take 10 years? That might be another extreme.
Could you talk a little bit about what you think is a reasonable timetable for them? And I'm not going to pin you down to two years, six months, but just talk to us a little about that.
BERNANKE: Senator, I think that they will go somewhat slowly. They want to make sure that their economy is ready for the flexible exchange rate. They're looking at the institutional factors involved in trading exchange rate and the like.
I'd be very reluctant to give a timetable.
I think that the Treasury...
SCHUMER: Are they moving too slowly now?
BERNANKE: I'd like to see them make further progress on this issue.
Thank you, Mr. Chairman.
SHELBY: Senator Bayh?
BAYH: Doctor, I'd just observe -- I'm a little concerned about a cavalier attitude with regard to -- not on your part, just in general about the current account imbalance and the sort of attitude of, oh, where else are they going to go? I can see the chancellor of the exchequer having made a comment like that in the 1930s, in the 1940s, and in fact, history evolved in a way that there was an alternative and that's where the global currency flows went.
It's also possible that other countries might choose to make decisions that we would view as being suboptimal in terms of the return on their investments for other reasons of state. For example, to pressure us on national security issues of some kind involving just to pick at random the issue of Taiwan, for example. There are occasionally nationalist issues that trump economic interests, and that is one of the reasons that I am somewhat concerned about just sort of saying, well, the current account deficit can run forever at -- what -- 6 percent now and maybe larger.
Eventually this has to unwind in some way or other, and it best be orderly rather than disorderly. So that was the nature of my questioning.
I'd like to shift and ask about the budget imbalances, the different imbalances that we're running.
I think in our conversation we both agreed that there was some level at which an internal momentum begins to take hold, when a deficit gets to a certain size and, you know, the interest payments begin to build, and the sort of snowball effect, for lack of a better term.
BAYH: And as I recall, we thought that was around 2 percent or thereabouts. Is that correct, in your opinion?
BERNANKE: Not precisely. A 2 percent deficit is about consistent with a stable ratio of debt-to-GDP. So maintaining a deficit at that level, while not optimal -- it would be better to get it lower -- at least doesn't have the property of raising the debt-to- GDP ratio.
There can be periods of higher deficits. I expect we will see one with the costs of Katrina, for example.
BAYH: Oh, indeed, we're already in one. I think our current deficit to GDP is about 2.7 percent, excluding Katrina.
BERNANKE: So as long as the deficit returns to a sustainable level over a period of time, then the debt-to-GDP ratio also will stabilize.
But I'm not disagreeing, in the sense that I think it's very important -- and here, my main concern is the long-run entitlement issues which I've already alluded to, which are going to put very heavy burdens on the FSC.
In order to prepare for those heavy burdens, I think we do need to begin to try to reduce the deficit, try to reduce spending, try to bring the budget closer to balance so that we'll be prepared to deal with those long-term entitlement...
BAYH: Here's the reason for my question: If we're already at 2.7, then we agree that we're above the rate at which the debt level to GDP begins to increase.
Therefore, any decision, be it spending or on the tax side, that increases the deficit only exacerbates that situation. I think, by definition, that's correct, isn't it?
BERNANKE: If you take as a baseline the mid-session review earlier this year...
BAYH: Remember my admonition from the Times about speaking bluntly.
BERNANKE: I will speak bluntly.
BAYH: I'm teasing.
BERNANKE: That baseline had a declining deficit-to-GDP ratio over the next few years. And then the question is whether or not that...
BAYH: Which timeline was that, Doctor?
BERNANKE: Over the next five years, the mid-session review shows the deficit as a share of GDP declining over time. However, there are important risks to that projection.
Obviously, since the summer, we've had Katrina, which will have a near-term impact.
BERNANKE: Another concern I would raise for you is the reliance for revenue on the alternative minimum tax, which the Congress is not willing to allow to actually take effect in that there have been patches each year.
So it's important for Congress to consider whether either to allow the alternative minimum tax to actually take affect or alternatively to undertake a tax reform or other measures that replace that revenue with some other form of revenue.
BAYH: Let me ask you one final question. I'm occasionally asked this, and it's always a little hard for me. But I find that a certain amount of reflection and introspection sometimes is -- I can learn more sometimes from things that maybe didn't go quite as I expected as much as I can from things that went as I expected.
Looking back in the different public policy pronouncements that you've made and situations you thought you'd analyzed correctly at the time, can you point to anything that just didn't turn out quite the way you expected and what you learned from that instance?
BERNANKE: In 2003, there was an episode where there was clearly a miscommunication between the Federal Reserve and the bond markets, and it caused a significant fluctuation in the bond markets. This was over the issue of whether or not there was some risk of deflation coming forward. And clearly there was a misunderstanding about that risk.
It impressed on me the importance of speaking clearly and communicating clearly and making sure that there's understanding on both sides about what the Fed is saying and what the Fed is intending to do.
BAYH: Thank you very much, Doctor. I wish you the best.
BERNANKE: Thank you.
SHELBY: I believe it's back to me, Dr. Bernanke.
In your previous tenure, Dr. Bernanke, when you were a member of the Board of Governors of the Federal Reserve, you spoke regarding, quote, "a global savings glut." Others have too.
Would you elaborate just for the record further on the potential causes of this behavior and whether our nation's economy has ever experienced similar circumstances? And should this situation persist, how would this affect the Federal Reserve's economic projections, if it would?
SHELBY: We realize there's capital in the world, which is money, I guess savings.
BERNANKE: The global savings glut idea attempts to point out that the current account deficit of the United States is not simply or entirely a product of U.S. economic policies. It is a global phenomenon created by global forces.
In particular, I argued in the speech that over the last 10 years or so the amount of savings being done around the world has exceeded desired investment in those same countries for various reasons, including the aging of some industrial economies, the oil revenues of crude producers, and most importantly, the fact that emerging market economies over the last 10 years have gone from being significant borrowers in international capital markets to large lenders, to having large current account surpluses.
As a result, there's been enormous amounts of capital dumped into international capital markets, which helps to account for the fact that global interest rates are at record lows or at least at very low levels.
The inflows of that capital into the United States, which is an attractive destination for this capital, and the resulting impact on asset price in the United States is, in my view, part of the reason why Americans have increased their consumption and reduced their savings, which has resulted in this current account deficit.
Now, as I've argued already today, I don't view the current account deficit as desirable. I think there's a number of reasons to try and end it. But in order to end it or at least to wind it down over a period of time, it's going to require action both within the United States and also within our trading partners.
On the part of the United States, we need to increase our own savings relative to investment. With respect to our trading partners, there needs to be, first, increased reliance on flexible exchange rates, as we've already discussed, and also more willingness on the part of our trading partners to rely on domestic spending, domestic government purchases or consumption, to drive their economies, as opposed purely to an export-led strategy.
SHELBY: Is it basically true that in a global economy where you have market forces working that capital would know no boundaries, it'd look for its best investment, would it not?
BERNANKE: That's correct. But at this point, some of the savings which is coming to the U.S. might well be served by going to, say, emerging market economies, which are, because they have perhaps inadequate infrastructures or insufficient transparency, are not receiving as much capital as in some sense would be ideal.
I think a more balanced global situation will be one where there's a closer balance between saving and investment, both in the United States and abroad.
SHELBY: Senator Sarbanes?
SARBANES: Just to follow up on the chairman's point quickly, isn't some of that capital coming from emerging market countries or developing economies?
BERNANKE: Yes, Senator, a great deal of it.
SARBANES: What's the rationale for that? Why should they be sending capital into the world's most advanced economy? At least what economics I learned, that was sort of the wrong way for the flows to be going in terms of building up worldwide prosperity.
BERNANKE: Senator, your basic point is right. Normally, you would expect to see capital flowing to emerging market economies, rather than out of emerging market economies.
The proximate cause of the switch, I would argue, was the financial crises of the late 1990s which occurred in a variety of emerging market economies in East Asia and Latin America and elsewhere, and led them to be much more cautious about accepting capital inflows and to focus more on building up their reserves, building up their current accounts, and looking more to an export- oriented strategy.
BERNANKE: So I think it's the effects of the financial crises which over a period of time I expect will wane. But that was the main impetus, I believe, for this shift in strategy on the part of the emerging market countries.
SARBANES: I take it you regard it as undesirable. I know in a speech you said, "In the longer term, however, the current pattern of international capital flow, should it persist, could prove counterproductive. Most important, for the developing world to be lending large sums on net to the mature industrial economies is quite undesirable as a long-run proposition." You agree with that statement, I presume.
BERNANKE: In the short run -- and I agree with Senator Bennett -- in the short run, given that these countries have high savings and they're unable to make full use of those savings domestically, it's understandable that they would send capital to the United States, which has very deep, liquid and strong capital markets.
Over a period of time, and not immediately but over a long period of time, a greater balance, which would involve more of these funds going into emerging markets, I think would be desirable.
SARBANES: You're on record as opposing the use of monetary policy to control asset bubbles, as I understand it, whether in the stock market or in the housing market. Instead, you've stated, "A far better approach is to use microlevel policies to reduce the incidence of bubbles, to protect the financial system against their effects."
The Wall Street Journal ran an article recently entitled, "Concerns Mount about Mortgage Risks," which reported, and I quote the Journal: "In the latest sign of how frothy the housing market has become, new data show the degree to which people are stretching to buy homes in a hot housing market. The data from the Mortgage Bankers Association show that adjustable rate and interest-only mortgages accounted for nearly two-thirds of mortgage originations in the second half of last year."
"Allen Fishbein, the director of housing and credit policy at the Consumer Federation of America called it a game of musical chairs.
SARBANES: "Somebody is going to have the chair pulled out from under them when they find prices have leveled out and then try to sell, only to find they can't sell for what they paid for it."
Are you concerned about the potential for a bubble in the housing market? And specifically, does the drastic increase in the use of risky financing schemes, including interest only and even negative amortization mortgages, concern you?
BERNANKE: Senator, as I understand it, the Federal Reserve is reviewing these practices with the idea of issuing guidance about so- called nontraditional mortgages.
I think it is important to make sure that mortgages of the nontraditional type, whether they're interest only, option ARMs or other similar types of mortgages, at first that they are consistent with safety and soundness on the part of the lenders and secondly, that consumers who are using these mortgages fully understand the implications of holding these mortgages should, for example, housing prices decline or interest rates rise.
I think it's very important to look at these instruments. And I believe that doing so would have on the margin some beneficial effects in reducing speculative activity in some local markets.
However, overall, I think the main reason to look at these instruments is to make sure that banks are protected and that the consumers are protected against the potential risks of these instruments.
SARBANES: Chairman Shelby in this committee, and I've joined with him on it, in expressing our concern that the federal banking agencies are not taking a sufficiently aggressive and sophisticated attitude toward examining institutions with respect to money laundering. There have been some very bad examples.
What will you do to evaluate and improve the strength of the Fed's consolidated supervisory activity in this area?
I'm getting into the dimension of your responsibilities that involve your regulatory function, which does not always draw, I think, the attention that it warrants or requires.
BERNANKE: Senator, the Bank Secrecy Act and the anti-money laundering rules are very important. Obviously, they bear on terrorist finance, they bear on money laundering by criminal organizations. And the Congress has passed a set of rules which require banks to be very careful to try to prevent such activities from occurring.
It's an important responsibility of the Federal Reserve to enforce those laws. I will certainly be interested in those activities.
As I understand it, the Federal Reserve's approach to enforcing so-called BSA/AML provisions is a risk-focused approach, which means that the Federal Reserve attempts to evaluate whether the banks or other financial institution's procedures and processes are sufficiently good to ensure compliance with the law rather than attempting to evaluate every individual transaction.
BERNANKE: I think that's a good approach. It's one that allows us, or allows the Federal Reserve, to evaluate the overall ability of the institution to meet the law without incurring the heavy costs and the heavy regulatory burden of checking each and every individual submission.
SARBANES: Well, I know I'm intruding on Senator Bennett's time -- if I could just close out this question?
I have this concern. In some instances, the money-laundering violations, which, of course, have an anti-terrorism financing important dimension to them as well, have been -- as they were found and corrective action taken by the Federal Reserve against them, were state banking systems.
But in other situations -- and a number of large banks are involved in that -- the violations had reached such a level of seriousness that they warranted criminal investigation by the Department of Justice, which, of course, raises a question: How do you explain situations in which senior officials of major financial institutions are found to have come sufficiently close to the line that criminal investigations of their conduct and of their institution are appropriate?
In other words, where were the gatekeepers or the watchmen, which are the banking regulatory agencies, where were they at an earlier stage in this process, instead of it having gone to the level or deteriorated to the level that criminal action by the Department of Justice was called for?
It seems to me that's a fairly clear call for the financial institution regulators to be more active in meeting their responsibilities.
BERNANKE: I agree with that, Senator.
SARBANES: OK. Thank you.
SHELBY: Senator Bennett?
BENNETT: Thank you, Mr. Chairman.
One last area I'd like to explore with you, Dr. Bernanke, is your attitude toward commodity prices as an indicator of inflation.
I remember, many years ago, the standard position was, well, when the stock market's going up, you buy stocks; when the stock market's going down, you buy gold. And it's just very simple. You take the cyclical nature of things. And your hedge against everything going to pot is gold. And then, once the bottom has been reached, you sell your gold and you start with stocks.
I don't know that anybody's that simplistic anymore, except maybe on the advertising pages of some magazines where the people are trying to sell gold.
But what about other commodities? I know an economist whom you know very well and whom I respect tremendously, Wayne Angell, who's always looking at a basket of commodities -- not necessarily gold by itself, but commodities, generally, foreign exchange rates, indicators of where we ought to be in policy.
BENNETT: You get an individual commodity, like natural gas, that is an anomaly because of the tremendous demand that has been created by natural gas, so maybe you take that out of the basket.
But just talk to us about your attitude toward commodities in general, some of these other basket issues -- gold, foreign exchange rates and so on -- in terms of what you see as their value as indicators of where the economy is really going.
BERNANKE: Senator, there's no perfect forecaster, no perfect indicator of inflation. Each of the variables you mentioned has an inflation component, so to speak, that reflects inflationary pressures. May reflect other things as well.
As you mentioned, natural gas or other energy commodities reflect supply-and-demand conditions arising from pressures in international markets, for example.
Exchange rates reflect inflation pressures. They may also reflect the balance of trade and other factors. So there's no single optimal indicator of inflation.
My personal strategy, therefore, is to be very eclectic and to look at a wide range of indicators. And among those is commodities, gold, exchange rates, the whole list. I think interest rates, real- side indicators, surveys, expectations, there's a whole list of variables which can be useful in forecasting inflation. And I think one has to be very open minded about using whatever information one has.
BENNETT: Let's talk about productivity in the same way. Bob Woodward's book about Chairman Greenspan indicates a situation where he challenged existing data points on productivity and ended up forcing the Fed to restructure the way they monitored it.
And he proved by saying -- and I've heard him say this, and I'm sure you have, too -- well, that violates the laws of arithmetic. By taking an equation and putting in various pieces of the equation, he said, the remaining piece, productivity, has to be higher than your measurement of productivity.
Obviously, an understanding of productivity fits into this whole discussion that we're having. Do you have any view as to the various measures of productivity and how it should be reported?
BERNANKE: Well, I draw two lessons from that late '90s experience that Bob Woodward was referring to. The first is that you don't just look at the conventional measures, you look at the data quite deeply and try to understand how the data are constructed and how they relate to each other, because there may be anomalies that'll be instructive. And that was the case in the late '90s.
The other is that published government data is not the only source of information. It's also important to talk to people in the marketplace, to talk to business people.
I think, in the case of Chairman Greenspan, he had indications from business people that they were making extraordinary gains in productivity based on new information and communications technologies.
BERNANKE: So by putting together those clues, I think one tries to make an inference about the general state of the economy, and productivity being one of the major variables to look at.
BENNETT: I have the sense that our failure to understand the impact of productivity in the information age is one of the reasons why we feel as confused as we do in some areas. We have industrial age mentality in the information age reality. And that can be a problem.
Just one last quick comment, and you don't need to answer this. This is just an admonition. One of my major focuses here in the Senate has to do with cybersecurity. And I have raised this with Chairman Greenspan in the past. If I were someone who wished this country ill, I would be more anxious to find a way to hack into the computer system and shut down the Fedwire, than I would to try to find a way to get a suitcase nuclear device into lower Manhattan, because the damage to the economy of shutting down the Fedwire would be greater than the damage by a nuclear explosion from a suitcase bomb virtually anywhere, whether it was lower Manhattan or Pennsylvania Avenue or whatever it might be.
I hope in your stewardship as the chairman of the Fed you pay attention to cyberterrorism and the vulnerability that we have to those who might break in, hack in.
BENNETT: The more time I spend on this, the more concerned I become. And I know that the financial community generally, with its various firewalls and ways of trying to hang on to the data is moving ahead. But every time I look at it, the next generation of attackers is substantially more sophisticated than the one that was there just 18 months ago. And our ability to provide security must always be working ahead on that.
So among the other things you have to do, don't neglect that particular morsel as it gets put on your plate.
BERNANKE: Thank you, Senator.
SHELBY: Senator Sarbanes?
SARBANES: I want to follow up Senator Bennett's point, but I want to not go quite as -- because he's dealing with people who are very calculatingly trying to do this thing. But this year several financial institutions, as well as private companies, government agencies, universities and other entities have reported breaches of Social Security numbers, credit and debit numbers, security codes, bank account information, other sensitive information.
In fact, The Washington Post had a story, they said, quote, "American corporations that eat your personal information for breakfast have suffered troubling data breaches over the past year or so, making the data on more than 50 million consumers vulnerable."
Now there's a coalition of 12 consumer groups that are concerned about privacy who have expressed very deep concerns about this.
As chairman of the Fed, would you work with the financial institutions that you regulate to reduce the likelihood of future data breaches? And further, would you be prepared to meet with these interested groups, this coalition of consumer groups concerned about financial privacy, to review with them and to discuss this important issue?
BERNANKE: Senator, I believe the banking regulators have already at least issued guidance or perhaps a regulation about data breaches that applies to financial institutions which is the group that they regulate.
BERNANKE: And I believe the Congress is considering similar legislation for other types of entities.
So I believe it's a very important issue. I think the Federal Reserve and the other banking regulators have already taken some steps in this direction, about providing rules, about how to protect data and how to react to data breaches.
To answer the second part of your question, I hope to meet broadly with a large number of people, including the groups that you referred to.
I think it's important for the Federal Reserve chairman not to confine himself to Wall Street analysts, but to speak to a wide range of people in the economy with different interests and different viewpoints. And I intend to do that.
SARBANES: Warren Buffett has warned us that derivatives are time bombs both for the parties that deal in them and the economic system. The Financial Times has said, so far, there has been no explosion, but the risks of this fast-growing market remain real.
How do you respond to these concerns?
BERNANKE: I'm more sanguine about derivatives than the position you just suggested. I think, generally speaking, they are very valuable. They provide methods by which risks can be shared, sliced and diced and given to those most willing to bear it.
They add, I believe, to the flexibility of the financial system in many different ways.
And, with respect to their safety, derivatives, for the most part, are traded among very sophisticated financial institutions and individuals who have considerable incentive to understand them and to use them properly.
The Federal Reserve's responsibility is to make sure that the institutions which it regulates have good systems and good procedures for ensuring that their derivatives portfolios are well-managed and don't create excessive risk in their institutions.
SARBANES: In a recent article in the New York Times, they stated, quote, "Seven years ago, Wall Street's top bankers were caught off guard by the near-collapse of the long-term capital management hedge fund. Since then, the number and influence of hedge funds have ballooned. The hedge fund explosion has prompted concerns that, if a big bet goes wrong, regulators and banks will again be caught up in a collapse."
My recollection is that the Federal Reserve Bank of New York was convening all-night, all-weekend meetings at the time of long-term capital management, putting enormous pressure on financial institutions to pick up on it in order to prevent the very collapse that's mentioned here.
How do you respond to this concern -- equally sanguine?
BERNANKE: Well, I think it's important not to be complacent. It's important for the Federal Reserve to be aware of what's going on in the market, particularly working through the banks, which are the counter-parties of a lot of hedge funds to understand their strategies and their positions.
Nevertheless, broadly speaking, my understanding is that the hedge fund industry has become more sophisticated, more diverse, less leveraged and more flexible in the years since LTCM.
BERNANKE: So, again, while it's very important to understand that industry and particularly to make sure that the banks are dealing in appropriate ways with hedge funds, my sense is that on net they are a positive force in the American financial system.
SARBANES: Do you think these issues contain a sufficient danger in them that it would warrant the Fed undertaking a special examination of these questions, if you were to become the chairman? Because if this went bad on your watch, I mean, there could be tremendous consequences, obviously.
BERNANKE: I think it's useful to have informal contacts to try to understand what's going on in the market, and we have various mechanisms -- the Federal Reserve has various mechanisms for learning about this market, in particular working through the various counter- parties that deal with hedge funds.
SARBANES: Well, I commend this area to you as one that ought to have some focus of your attention, otherwise it may well come back to haunt you.
BERNANKE: Thank you.
SARBANES: Could I ask you about HMDA and the Home Mortgage Disclosure Act? The data released in September showed that African- Americans and Hispanics pay more for home loans and face higher denial rates than similarly situated white Americans.
I understand the board's reviewed the HMDA data and flagged approximately 200 lenders for further scrutiny. And, in fact, Governor Olson at the Fed said any time a lender differentiates, the burden of proof shifts to the lender to demonstrate the pricing differentials are based on empirical analysis.
Would you agree with that? And how important do you think this issue is that's revealed by the HMDA data?
BERNANKE: Senator, the facts you point out are correct.
BERNANKE: They were revealed because the Federal Reserve asked for disclosures of pricing information as well as for quantity and denial information.
I think fair lending is extremely important. The Federal Reserve is going to follow up on these results. It's going to share the results, or has already shared the results with other bank regulators. And the intention is to find out why these discrepancies exist.
SARBANES: Mr. Chairman, I just want to close with a couple of observations.
SHELBY: You take your time.
SARBANES: We discussed this morning the inflation targeting. And I don't want to close out without referring back to it.
And I want to commend to you for your own thinking the danger that, if you had a numerical figure for inflation but not for unemployment, that there would be a shift in focus of policymaking and debate toward whether the Fed was achieving its inflation target and away from whether the Fed was achieving maximum employment through stabilizing output -- or, whether you intended that to happen or not, I think it's easy enough to assert that's not your intention, that you're keeping the dual mandate in mind and so forth.
But I think, in the real world of the dynamics and particularly in the way the media would cover such a question, the constant focus is going to be: Have you hit the numbers target on your inflation goal?
And that would, in effect, draw attention away from the sort of dual mandate and the emphasis we're placing on trying to balance the two.
I take some encouragement from your statement that, if confirmed, you'll take no precipitous steps in the direction of quantifying the definition of long-run price stability; that the matter requires further study at the Fed as well as extensive discussion and consultation.
I would propose further action only if a consensus can be developed and that taking such a step would further enhance the ability of the FOMC to satisfy its dual mandate of achieving both stable prices and maximum sustainable employment.
I don't think this is fully consistent with the Fed's current policy approach, which is an assertion you make in your statement.
And, obviously, there have been several members of the board who have resisted inflation-targeting for this very reason, amongst other reasons.
So you make that assertion but there are a number of very thoughtful people who disagree with it very strongly. Further, I refer back to earlier -- I don't think you can change the Fed's mandate except by statute from the Congress.
And I know you're laying out a rationale which you interpret it in such a way that it's encompassed within the mandate, but I think you have to be extremely careful.
And I particularly think, as I just said, that if you have a figure for inflation and not for unemployment, the public focus is going to be drawn to the inflation figure and that's going to become the overriding concern.
Finally, Mr. Chairman, I do welcome, in Dr. Bernanke's statement, his statement right at the outset, where he talks about this prospective new role and says, and I want to quote this because I think it's very important to underline it and, again, put it on the record.
SARBANES: "I would bear the critical responsibility of preserving the independent and nonpartisan status of the Federal Reserve, a status that in my view is essential to that institution's ability to function effectively and achieve its mandated objectives" -- in the plural, I might add.
"I assure this committee that if I am confirmed I will be strictly independent of all political influences and will be guided solely by the Federal Reserve's mandate from Congress and by the public interest." End of quote.
Thank you very much, Mr. Chairman.
SHELBY: Dr. Bernanke, we appreciate your appearance here today at your hearing, and especially what we had a bifurcated hearing with the votes in the Senate. We appreciate your candor and your ability.
I don't know of a Federal Reserve nominee chairman that has got as many publications under their belt as you do, and interesting. And I'm not going to tell you I've read all of them, but they are interesting to go with.
But we will try to move your nomination as soon as possible. I think it's a good nomination. I've said this from the beginning. And I will be consulting with Senator Sarbanes and see what we can do.
Thank you for your time today.
BERNANKE: Thank you.
SHELBY: Committee's adjourned.