Bernanke Testifies Before Senate Banking, Housing and Urban Affairs Committee
Hearing on Semiannual Monetary Policy Report
Wednesday, February 14, 2007
SEN. CHRISTOPHER J. DODD, D-CONN. CHAIRMAN
SEN. TIM JOHNSON, D-S.D.
SEN. JACK REED, D-R.I.
SEN. CHARLES E. SCHUMER, D-N.Y.
SEN. EVAN BAYH, D-IND.
SEN. THOMAS R. CARPER, D-DEL.
SEN. ROBERT MENENDEZ, D-N.J.
SEN. DANIEL K. AKAKA, D-HAWAII
SEN. BOB CASEY, D-PA.
SEN. SHERROD BROWN, D-OHIO
SEN. JON TESTER, D-MONT.
SEN. RICHARD C. SHELBY, R-ALA. RANKING MEMBER
SEN. ROBERT F. BENNETT, R-UTAH
SEN. WAYNE ALLARD, R-COLO.
SEN. MICHAEL B. ENZI, R-WYO.
SEN. CHUCK HAGEL, R-NEB.
SEN. JIM BUNNING, R-KY.
SEN. MICHAEL D. CRAPO, R-IDAHO
SEN. JOHN E. SUNUNU, R-N.H.
SEN. ELIZABETH DOLE, R-N.C.
SEN. MEL MARTINEZ, R-FLA.
FEDERAL RESERVE SYSTEM BOARD OF GOVERNORS
CHAIRMAN BEN BERNANKE
DODD: The committee will come to order.
Let me thank all of our colleagues and others who have made it in this morning to participate in this hearing in our first true winter morning this year.
Mr. Chairman, we thank you for being with us as well, and appreciate your testimony before the committee.
Let me open the -- I will do is open up with a brief opening statement. I'll turn to my colleague, Senator Shelby, and then any of my other colleagues who would like to make some brief opening remarks.
Their full statements, I'll guarantee, will be included in the record, as will yours and any supporting documentation, Mr. Chairman, you'd like to be a part of the record this morning.
And we'll try and move along so we can get to the question-and- answer period with you as quickly as possible.
This morning, the committee is pleased to welcome Federal Reserve Chairman Bernanke to deliver the Feds semi-annual monetary policy report.
I want to congratulate you, Mr. Chairman, for completing your first year as chairman. Following in the footsteps of a very successful chairman can be difficult and is something that I can certainly relate to, sitting in this chair and sitting next to my friend from Alabama.
But I believe that you have done a very good job in gaining the respect and confidence of the markets and your colleagues on the Federal Reserve Board.
The Feds monetary policy, most notably its decision to stop rising interest rates in June, has played a very important role in some recent positive economic developments.
During 2006, the economy grew at a sustainable rate and unemployment was kept to under 5 percent. While this is not quite as strong as it was in the late 1990s, when growth was higher and unemployment fell below 4 percent with much higher labor force participation, this economic news is welcome.
Long-term interest rates have remained at modest levels despite a large federal budget deficit, historic current account deficit, and the cumulative effect of the Feds two-year cycle of raising interest rates that ended in June.
While these developments are, as I said, positive, there are other facts that in my view raise some very important questions about our nation's long-term ability to provide economic security, opportunity and prosperity to the people of this country.
As I travel around these days and talk to many people from a variety of walks of life, I'm confronted with people who are concerned about the future: whether or not we'll have the kind of stability and long-term growth necessary for our success.
DODD: What I'm hearing from people is that they are concerned about many of the same things. Health care costs are rising at a rate that is unsustainable for businesses and employees. Over the past six years, health care costs have increased by 30 percent.
More than 46 million Americans have no health insurance at all today, as we all know. That's an increase of 6 million people over the past six years.
The price of gasoline, home heating oil and other forms of energy has skyrocketed over the past years. This past summer, gasoline cost over $3 per gallon in many parts of the country. And while it's much lower today, it is still twice as high as it was five years ago.
Families are concerned as well. They cannot afford to send their kids to college. My colleague from New York Senator Schumer has spent a lot of time on this issue. College tuition has risen by more than twice the rate of inflation over the past 20 years. Room, board and tuition at many private universities now cost well over $50,000 a year.
As these costs rise, working Americans are experiencing more and more uncertainty about their future. People are wondering whether their home is losing value, as they see houses in their neighborhood sell for less today than they did a year ago.
And millions of Americans are in exotic and subprime mortgages, while the potential for sharp increases in monthly payments -- right around the corner, these increases in monthly payments. Several credible reports say that we are facing a tidal wave of defaults and foreclosures, which could strip these families of their major, if not their only, source of wealth and long-term economic security.
Despite some recent gains in household incomes, the real median family income -- what a family right in the middle of the middle class earns in a year -- is lower today than it was six years ago. People are working longer and harder, but many are not bringing home enough money to keep pace with what they need.
And for those who lose their jobs, the prospect of falling out of the middle class is greater today. Americans are more than twice as likely to experience a precipitous drop in income as Americans of a generation ago, according to a recent research study by Jacob Hacker (ph) at Yale University.
As we worry about some Americans falling out of the middle class, we must also be concerned about those working hard to climb into the middle class. Over 10 million Americans today do not have access to mainstream financial institutions, such as a bank or a credit union or a thrift. For these entrepreneurs and workers, affordable credit and capital services are scarce, if not impossible, to find.
And as a result, millions of our fellow citizens lack the financial tools that they need to build more secure and prosperous futures for themselves and their families.
Finally, Mr. Chairman, our nation finds itself with trade policies that are unsustainable as well, in my view.
We learned this week that last year we ran a record trade deficit of $763 billion. Our nation's current account deficit will approach 7 percent of our GDP. We are relying on over $2.4 billion a day from foreign investors, who are increasingly foreign governments, to finance our economic growth because of the lack of savings here at home.
The administration has an official trade policy that is, in key respects, out of touch, I think, with reality. For instance, it is widely believed that China manipulates its currency. We had a very good hearing, as you may know, with Hank Paulson before this committee a week or so ago on the exchange rate issue. Yet the administration refuses to officially recognize that fact.
When Chairman Bernanke was in China as part of the strategic economic dialogue, he gave a speech that pointed out, and I quote, "the effective subsidy that an undervalued currency provides for Chinese firms that focus on exporting," end quote.
But this subsidy is not the sole cause of either our record international trade deficit or our loss of over $3 million manufacturing jobs, including about 1 million of those jobs in critical national defense-related industries. The distortion of Chinese currency manipulation is having, I think, a very significant negative impact on American manufacturing jobs.
As policymakers, I think we need to ask ourselves a very fundamental question: Are we satisfied with America's place in the world at the beginning of this new century? I don't think that any one of us can look at all the facts and reach any conclusion other than that we can do a lot better than I think we are. And for the sake of the people we serve and generations coming after them, I think all of us would agree we've got to do better.
There are steps we can and should take, in my view, to build a stronger foundation for a more secure and prosperous future. Today's hearing provides the committee with an opportunity to discuss some of these steps.
We can start by keeping interest rates at modest levels. And again, I congratulate the Fed on doing that since last June.
Certainly monetary policy is obviously an important component of our economic future. The Fed's dual mandate is to promote full employment and price stability. This is a vital and difficult mission. And we look forward to hearing from the chairman about the steps the Fed has taken since its last report to fulfill that statutory mandate.
In addition, we need our federal financial regulatory agencies to be vigilant in ensuring not only the safety and soundness of our financial institutions but, indeed, that those institutions are serving, not thwarting, the aspirations of Americans to build a more secure and prosperous life for themselves and those families.
DODD: So I look forward to discussing the aspect of the Fed's mission, as well as with you, today, Mr. Chairman.
And I would turn to my colleague from Alabama for any opening comments he may have, and then to my colleagues here as well for any brief statements they want to make as we start this hearing.
SHELBY: Thank you, Chairman Dodd.
Chairman Bernanke, we're pleased to have you before the committee again to deliver the Federal Reserve's semiannual monetary policy report.
This hearing, as you know, provides an important mechanism for sharing accountability over the Fed's policies and operations.
Chairman Bernanke, you have recently completed one year at the helm of the Federal Reserve System. When President Bush nominated you for this position, I noted at the hearing that you would have big shoes to fill following the footsteps of the distinguished Chairman Greenspan. I also noted my belief that the president made a superb choice in asking you to take on this responsibility.
The Federal Reserve's conduct of monetary policy thus far under your leadership has given me further reason to applaud your service.
Chairman Bernanke, as 2006 began, there was much debate as to whether the Federal Reserve would prove successful in engineering a soft landing after many successive increases in the Fed fund's target rate.
Certainly the economic data in recent weeks tells us that the debate is maybe all but over. Analysts and other Fed watchers are now giving you high praise for the manner in which you've handled your responsibilities, and I join them.
Real gross domestic product, GDP, increased at an annual rate of 3.5 percent in the fourth quarter of 2006. For all of 2006, GDP grew 3.4 percent, compared with 3.2 percent increase in '05. Both numbers topped the 20-year average of 3.1 percent.
Along with the strong growth, we've seen positive news on the job front. The Labor Department reported that the economy created, Mr. Chairman, more than 2.2 million jobs last year; 400,000 more than previously estimated. We continue to enjoy a low unemployment rate, both historically and relative to other industrialized nations.
At its most recent meeting on January 31, the Federal Open Markets Committee kept the federal funds target rate at 5.25 percent, the fifth consecutive meeting with no change.
Fed watchers noted that the latest FOMC statements seem more upbeat on growth prospects and keeping inflation in check.
My colleagues and I, Mr. Chairman, will no doubt spend time this morning trying to figure out how long the FOMC intends to leave short- term rates unchanged. And I'm certain that today's hearing will also include some discussions of the potential risks in the economy, such as the housing market slowdown, among others.
Mr. Chairman, while it's our responsibility to continue to examine the horizons of such risk, we must also note the strong performance of this economy. I hope that we'll also take time today to discuss the various strengths and how to maintain and build upon them.
Chairman Bernanke, again, we welcome you back to the committee. And we like the job you're doing.
DODD: Senator Schumer was next on our list, but Senator Casey -- and this early-bird rule applies here, so Senator Casey...
CASEY: Mr. Chairman, thank you very much for gathering us here.
CASEY: Chairman Bernanke, thank you for your time here today and for your service.
I don't have a long statement, but I just wanted to highlight a couple of things I know that you've touched on before and I'm sure will speak to today.
Some of the long-term fiscal challenges that you outlined here in your previous testimony, I guess a week or so ago, with regard to Medicare and Social Security and other demands that are being placed on the federal budget into the future; and I appreciate the fact that you're thinking about it and focusing on that and building that into your -- the planning that you do.
And I think, also, the people that I represent in Pennsylvania are concerned about those costs. They're concerned about the deficit, which I guess last year was $248 billion; this year the projection is for something less than that.
But they're also concerned about the impact, as Chairman Dodd outlined, of the cost in their own lives. And they realize -- and you know this -- the cost of health care and college tuition and housing and so many other areas that I hope that one of the things we have a chance to discuss today is the impact that those costs have, the impact not just on that family, the horrific impact it can sometimes have on their budgets, but also the impact that that has on overall long-term economic growth and stability.
So I look forward to discussing that today with you. And we appreciate the time you're spending with us and appreciate the report.
DODD: Senator Bunning?
BUNNING: Thank you, Mr. Chairman.
Chairman Bernanke, thank you for being here today.
To repeat what I told you at the Budget Committee hearing a few weeks ago, the Federal Open Markets Committee did the right thing by stopping the increases in the Fed fund rates after the June '06 Fed meeting. By holding rates constant, you have done the right thing ever since. After the latest increases, stock markets took off and the cost of credit leveled off.
If the Fed had chosen to continue hiking rates, mortgages and other forms of credit would have become less and less affordable to the average American.
Over the last two years, the cost of credit, such as mortgage -- student loans and credit cards -- have all increased. I'm not sure how much more tightening consumers could have handled before serious harm was done to the economy.
Higher interest rates accelerated the housing decline. We will not know the full extent of the damage for months, if not longer. If the Fed had not stopped when it did, we would have been in even more danger.
You have been at the helm of the Fed for a year now. My initial fears were that you would be a carbon copy of your predecessor, yet you have done some things I have never seen your predecessor do: embrace open and full debate.
BUNNING: There is an old saying that there is a reason we have two ears and one mouth: It is often more important to listen than to talk.
During your brief tenure at the Fed, you have made a serious effort to improve on how the Fed listens.
But you know I'm not going to let you off that easy, even though today is Valentine's Day.
The people of my state and I have real concerns about the dangers that lie ahead for our economy. As this committee discussed with Secretary Paulson last month, our constituents are nervous when they see more and more manufacturing jobs going to the Chinese. They are concerned about the future of the housing market. They are particularly concerned about the effects the potential repeal of the Bush taxes will have on our economic recovery.
You inherited an economy that was approaching a tipping point, and so far you have managed not to push it over. I urge you to act with caution and deliberation in the coming year.
Finally, soon there will be two vacancies on the Board of Governors. I hope the president moves quickly to fill these positions with people who have real experience in the financial service and commercial banking, not just ivory tower academics.
I look forward to your remarks.
Thank you, Mr. Chairman.
DODD: Thank you, Senator Bunning.
BAYH: Thank you, Mr. Chairman.
Chairman Bernanke, I suspect that most of the people here today are -- have gathered to listen to you, not me. And I will, therefore, reserve my comments for the question period.
DODD: Very good.
MARTINEZ: I will almost resist the temptation, but I will...
DODD: OK, that was a standard he set there...
MARTINEZ: I'll be very brief, Mr. Chairman. Thank you very much.
Mr. Bernanke, Chairman, welcome. And I, again, join in the high praise that you've been receiving from your first year in the job.
I will simply look forward to hearing your comments as it relates to the housing market: great concern to me, housing affordability; also the issue that we dealt with last week in this committee, which is subprime lending and the rate of defaults in that area; and just in general the effect of the hurricanes in the Gulf Coast, which continue to be an impact on the economies of the Gulf states.
MARTINEZ: So I look forward to your comments. And thank you for being with us today.
DODD: Thank you very much.
MENENDEZ: Thank you, Mr. Chairman.
Chairman Bernanke, welcome. It's great to welcome a fellow New Jerseyian back again to the committee.
Today some people say the economy is solid, due to some of the leading economic indicators appearing generally healthy, with unemployment below 5 percent, with moderate economic growth, with inflation stabilized.
And I certainly want to commend you for the stewardship you're showing at the Fed in working on this economy.
But at the same time, I also worry about who's benefiting from this economy and who is being left behind.
Indeed, there are serious limitations, I think, in judging a situation solely through looking at the big-picture numbers, as this view often hides the details of the situation. And specifically, I'm talking about the burden being placed on our middle class.
So while some in this country might believe that our economy is chugging along quite well because our gross domestic product continues to grow, there seems to be an increasing gap between the average citizen and those at the top of our economic ladder. And the disparity that continues to grow in my mind is widening at an alarming rate.
When I'm back in New Jersey, I hear more and more from New Jerseyians that our current economic policies are not working for them. The middle class continues to shrink. Poverty is increasing. The gap between the rich and the poor is growing wider. We have a record-breaking national debt and a record-breaking trade deficit.
Personal savings rate is now below zero, which hasn't happened since the Great Depression. Millions of Americans are seeing their wages stagnant and their pension and health care benefits slashed, while the wealthiest people in the country are doing better than ever.
So ultimately, my concern is that our economy is not working for the broadest scope of Americans that we would hope. The middle class is shrinking instead of growing, and we seem far more concerned about boosting the incomes of the wealthiest Americans, while denying our responsibility to those struggling to make ends meet.
I don't think we can sustain that position over the long term. We're borrowing to pay for tax cuts and the war effort. It's an unfair burden we're placing on our children and grandchildren.
So I look forward to your testimony today and hearing your thoughts on some of these things I've mentioned; some of the other things I hope you'll address, like the cooling off of the housing market, what that may mean, energy prices, the consequences of deficit and debt, from large budget deficits to record personal debt.
And I understand that in your capacity as chairman of the Federal Reserve, you're responsible for keeping inflation low and stable while maintaining economic growth, not economic equality. But I do hope, either in your opening statements or subsequently in the questions, that we'll have an opportunity to ask to hear your views about how we get this economy working in a direction that really helps middle-class families in this country.
Thank you, Mr. Chairman.
DODD: Thank you very much.
HAGEL: Mr. Chairman, thank you.
Mr. Chairman, welcome. We're glad you're here.
I want to personally thank you for you taking time to address the Greater Omaha Chamber of Commerce at their annual meeting two weeks ago. It was a rather significant event, as it always is. And your speech matched the expectations that many had. And I appreciate you very much, taking a day of your time to come to my state and deliver that speech and spend some time with our leaders in Nebraska.
And I look forward to your testimony.
DODD: Thank you very much.
TESTER: Thank you, Chairman Dodd.
Chairman Bernanke, I want to also welcome you here. This is one of those odd occasions where I don't have another committee; thank God for snow. So I look forward to your comments. And I'll have questions when you're done.
DODD: Thank you very much.
BENNETT: Thank you, Mr. Chairman.
I had planned to follow Senator Bayh's standard, but I've heard so many things being said here that I think at least one voice ought to rise in defense, if you will, of where certain things have been going.
Mr. Chairman, you know my personal affection for you, but it will not be a surprise that I disagree with your opening statement.
DODD: I'm shocked to hear that.
BENNETT: And by coincidence, I suppose the best rebuttal is in a piece that appeared in this morning's paper by Brian Wesbury, who is the chief economist at First Trust Advisers LP in Illinois, "A Portrait of the Economy."
BENNETT: And I would ask unanimous consent that the entire piece appear in the record.
DODD: Without objection.
BENNETT: But I would like to read a few appropriate words that I think are something of a response to what we've heard.
He starts out, "It's the best of times. It's the scariest of times. Last year U.S. exports, industrial production, real hourly compensation, corporate profits, federal tax revenues, retail sales, GDP, productivity, the number of people with jobs, the number of students in college, airline passenger traffic and the Dow Jones industrial average all hit record levels."
"For the third consecutive year, global growth was strong, continuing to lift and hold millions of people out of poverty.
"From 30,000 feet -- heck, from 1,000 feet, it sure looks like the best of times. In relative terms, the first five years of the current recovery have been much better than the first five years of the 1990s recovery.
"But this has not softened the pessimism of many pundits and politicians, who are either unimpressed or expect the whole thing to come crashing down any minute, unless the government firmly grabs the rein of a global economy and steers it clear of disaster."
And then he goes on to outline the history of how badly things have gone every time the government has tried to step in and steer it clear, starting with the '30s and then the '70s.
He makes this comment about the '70s, which I responded to. And it says, "Forgotten in the rush to pass judgment on capitalism is the fact that the last two times the government seriously tried to control the economy in the '30s and '70s, they made a terrible mess of it."
BENNETT: Well, I will leave the rest of it for people to read.
But the one thing I'd say to you, Mr. Chairman, if he's right -- and I think he is -- that in the year of your stewardship, the last year, exports, industrial production, real hourly compensation, profits, tax revenues, retail sales (inaudible) all are at record levels, you must have been doing a pretty good job.
And if you were running for office, you would take full credit for absolutely all of it.
Thank you, Mr. Chairman.
DODD: Thank you, Senator Bennett.
BROWN: Thank you, Mr. Chairman.
Chairman Bernanke, I appreciate your joining us today to share your thoughts on the direction of monetary policy in the months ahead. I also appreciate the comments you've made in Nebraska and other places before other groups on the steps you've taken toward greater transparency.
I'm sure that you can appreciate for most of the families in my state of Ohio and elsewhere many of the issues we discuss today are far-removed from their day-to-day lives. As Senator Menendez said, the uncertainties that middle-class families face are not uncertainties that columnists that Senator Bennett mentioned and others, economists, worry about as often, perhaps, as they should.
I know and appreciate your acknowledging the widening gap of income in our society. I commend you for adding your voice to that discussion.
I agree with you that we should look at ways to improve education and training of our citizens, but I don't think that's nearly enough.
Globalization has had a tremendous impact on workers in this country, on communities, on teachers, on firefighters, on cities' ability to deliver services to their constituents.
There's no question that good-paying manufacturing jobs have gone off shore. Fourteen years ago, the trade deficit in this country was $38 billion. Today, announced just this week, it exceeds $760 billion.
BROWN: George Bush the first said that a billion-dollar trade deficit translates into 13,000 lost jobs. You do the math.
Of course, we must trade with the world. The question is not if we will trade with other countries; rather it's how we will trade with them and who will benefit.
If the beneficiaries are limited to those with investment capital and the losers too often are workers and their communities across the country, we simply will not have a very sustainable trade policy.
We devote substantial time and effort to protecting intellectual property in our trade negotiations and enforcement. We need to do this. But we exert almost no effort in protecting the rights of our workers and their counterparts overseas. That simply has to change.
Many in the media and some in government label those of us who advocate for labor and environmental standards as protectionists, yet when our trade agreements protect the drug industry or Hollywood films, we call that simply "free trade."
If we can protect an Ohio inventor, if we can protect pharmaceuticals, if we can protect copyrights, as we should, we can do a much better job protecting workers and the environment.
I thank you for your time.
DODD: Thank you very much, Senator.
ALLARD: Thank you, Mr. Chairman. I'd like to thank you and Senator Shelby for holding this hearing. This is important. I always look forward to hearing from Chairman Bernanke.
I think that you have started off very well in your tenure as chairman of the Fed Reserve. And I want to congratulate you on that initial effort.
I think you've gained the confidence of the markets and I think you've gained the confidence of many members of the Congress, although there's a few skeptics still among us.
But I would like to emphasize that the economy is doing well. We look at economic growth: This last year, it's 3.4 percent. Previous year it's it's 3.2 percent. The average, over 20 years, is somewhere around 3.1 percent.
ALLARD: So we are above the average in economic growth. I think a lot of that is attributable to the economic growth package that we put in place in 2003 and the tax cuts that we had in 2001.
And we've heard a lot of comments here on this committee about how it's going to impact the family. In my view, the hardest-working American is the small-business man. And those economic growth packages were targeted to the small-business man. That's where our economic growth occurs.
And there are members in the Congress that are pushing hard to do away with those temporary tax reductions that we put in place to stimulate this economy.
My question to you is how would you -- and I hope you'll address this -- that, you know, if we let those become -- those temporary tax cuts go away, what kind of impact's that's going to have on the average family. I think it's going to be -- have a dramatic impact, particularly on the hard working men and women of this country who are in business for themselves.
And I hope that you can address that in your comments.
Thank you very much.
DODD: Thank you, Senator Allard.
REED: Well, thank you, Mr. Chairman.
And thank you, Chairman Bernanke, for joining us today.
And your task in setting the right course for monetary policy is complicated by fiscal policy and international imbalances. We no longer have the fiscal discipline that we had in the '90s, which allowed for a monetary policy that was more encouraging, I think, of robust investment and long-term growth.
The president's large and persistent budget deficits have led to an ever-widening trade deficit that forces us to borrow vast amounts from abroad and puts us at risk of a major financial collapse if foreign lenders suddenly stop accepting our IOUs.
Continued budget and trade deficits will be a drag on the growth of our standard of living and leave us ill-prepared to deal with the effects of retirement of the baby boom generation.
Strong investment, financed by our own national saving, not foreign borrowing, is the foundation of a strong and sustained economic growth and rising standards of living.
REED: One final issue that I'd like to raise is the growing inequality of income, earnings and wealth in the U.S. economy.
Between 2003 and 2005, GDP grew at a rate of 3.5 percent per year. However, after adjusting for inflation, the typical weekly earnings of full-time wage and salary workers at the median of the earnings distribution went up only 0.6 percent between the end of 2000 and the end of 2006. Obviously, these median workers are not sharing in that robust GDP.
Data from the Federal Reserve Board Survey of Consumer Finances show that household wealth is very unevenly distributed. The wealthiest 1 percent of families held more of the country's wealth than the bottom 90 percent of families combined.
Even more disturbing is the large number of families, particularly African-American and Hispanic communities, that have little or no net wealth.
Chairman Bernanke, I was heartened to read your comments in Omaha last week, emphasizing the importance of education and training in reducing this economic inequality, and I know you share the concern that widening inequality is not good for our democracy and the fabric of the country.
So I hope you'll agree that there is any consistency, at best, in the administration's pursuit of tax breaks for those who are already well off, including the permanent elimination of the estate tax, while continuing to propose cuts to elementary and secondary education, student aid and loan assistance for higher education, and job training for displaced workers.
The challenges facing our economy are compounded by the disarray that characterizes our fiscal policy. We've been running unsustainable fiscal deficits, and in order to make the necessary investments in training and education, we must reverse the course.
And I would be remiss if I did not note that the lead story today in most of the wire services is Chrysler is cutting 13,000 jobs. I suspect that that will probably raise the stock of Chrysler, make the investors happy and the investment bankers who are structuring this transformation of the company. It's necessary perhaps to do.
But the 13,000 who used to have good jobs with good health benefits, they're in a quandary. And our obligation is to them as well as it is to the shareholders of that company.
So I think we've got to do a lot more, and I think you do sense that. And I think, together, hopefully, we can make some progress.
DODD: Thank you, Senator Reed.
SUNUNU: Thank you very much, Mr. Chairman.
Senator Bennett I thought was somewhat eloquent in talking about the very positive trends we've seen in the economy: record job creation and above-average recovery period, record homeownership, rising income levels.
It's fair to say, though, for any member that's spent a little time back home, there is a sense of insecurity that can be felt even in what are relatively strong economic times.
SUNUNU: And I think that's an issue or set of issues dealing with their insecurity or uncertainty that we ought to deal with as policymakers, and, perhaps, that at some level can even be addressed by the Fed.
But I think it's important to understand that the role of the Fed is not to redistribute wealth, not to raise taxes not to establish protectionist trade measures. And I think that's a good thing.
I suspect maybe Chairman Bernanke thinks that's a good thing, because he has a tall enough order as it is.
The areas where the Fed can have a very positive impact within their mission are to deal with the uncertainties of inflation, the uncertainties of establishing a sustainable and steady record of economic growth, the security that comes from the establishment of safe and sound financial markets.
And those are all responsibilities of the Fed, I think responsibilities that Chairman Bernanke takes very seriously. You've spoken very well to those issues in the past. And I look forward to hearing your comments on those and other issues this morning.
Thank you, Mr. Chairman.
DODD: Thank you very much, Senator Sununu.
Mr. Chairman, we welcome you, again, to the committee. We're anxious to hear your comments. And a full statement and supporting documents will, of course, be a part of the record.
Welcome to the committee.
BERNANKE: Thank you.
Chairman Dodd, Senator Shelby and other members of the committee, I'm pleased to present the Federal Reserve's monetary policy report to the Congress.
Real activity in the United States expanded at a solid pace in 2006 although the pattern of growth was uneven. After a first quarter rebound from weakness associated with the effects of the hurricanes that ravaged the Gulf Coast the previous summer, output growth moderated somewhat on average over the remainder of 2006. Real gross domestic product is currently estimated to have increased at an annual rate of about 2.75 percent in the second half of the year.
As we anticipated in our July report, the U.S. economy appears to be making a transition from the rapid rate of expansion experienced over the preceding several years to a more sustainable average pace of growth. The principal source of the ongoing moderation has been a substantial cooling in the housing market, which has led to a marked slowdown in the pace of residential construction.
However, the weakness in housing market activity and the slower appreciation of house prices do not seem to have spilled over to any significant extent to other sectors of the economy.
Consumer spending has continued to expand at a solid rate, and the demand for labor has remained strong. On average, about 165,000 jobs per month have been added to nonfarm payrolls over the past six months, and the unemployment rate, at 4.6 percent in January, remains low.
BERNANKE: Inflation pressures appear to have abated somewhat following a run-up during the first half of 2006. Overall inflation has fallen, in large part as a result of declines in the price of crude oil.
Readings on core inflation -- that is inflation excluding the prices of food and energy -- have improved modestly in recent months. Nevertheless, the core inflation rate remains somewhat elevated.
In the five policy meetings since the July report, the Federal Open Market Committee, or FOMC, has maintained the federal funds rate at 5.25 percent.
So far, the incoming data have supported the view that the current stance of policy is likely to foster sustainable economic growth and a gradual ebbing of core inflation.
However, in the statement accompanying last month's policy decision, the FOMC again indicated that its predominant policy concern is the risk that inflation will fail to ease as expected and that it is prepared to take action to address inflation risks if developments warrant.
Let me now discuss the economic outlook in a little more detail, beginning with developments in the real economy, and then turning to inflation. I will conclude with some brief comments on monetary policy.
Consumer spending continues to be the mainstay of the current economic expansion. Personal consumption expenditures, which account for more than two-thirds of aggregate demand, increased at an annual rate of about 3.5 percent in real terms during the second half of last year, broadly matching the brisk pace of the previous three years.
Consumer outlays were supported by strong gains in personal income, reflecting both the ongoing increases in payroll employment and a pick-up in the growth of real wages.
Real hourly compensation, as measured by compensation per hour in the nonfarm business sector, deflated by the personal consumption expenditures price index, rose at an annual rate of around 3 percent in the latter half of 2006.
The resilience of consumer spending is all the more striking given the backdrop of the substantial correction in the housing market that became increasingly evident during the spring and summer of last year.
By the middle of 2006, monthly sales of new and existing homes were about 15 percent lower than a year earlier and the previously rapid rate of house appreciation had slowed markedly.
The fall in housing demand, in turn, prompted a sharp slowing in the pace of construction of new homes. Even so, the backlog of unsold homes rose from about four and a half months' supply in 2005 to nearly seven months' supply by the third quarter of last year.
Single-family housing starts have dropped more than 30 percent since the beginning of last year. And employment growth in the construction sector has slowed substantially.
Some tentative signs of stabilization have recently appeared in the housing market: New and existing home sales have flattened out in recent months, mortgage applications have picked up and some surveys find that homebuyer sentiment has improved.
However, even if housing demand falls no further, weakness in residential investment is likely to continue to weigh on economic growth over the next few quarters, as homebuilders seek to reduce their inventories of unsold homes to more comfortable levels.
Despite the ongoing adjustments in the housing sector, overall economic prospects for households remain good. Household finances appear generally solid, and delinquency rates on most types of consumer loans and residential mortgages remain low.
The exception is subprime mortgages with variable interest rates, for which delinquency rates have increased appreciably.
The labor market is expected to stay healthy. And real income should continue to rise, although the pace of employment gains may be slower than that to which we've become accustomed in recent years.
In part, slower average job growth may simply reflect the moderation of economic activity.
Also, the impending retirement of the leading edge of the baby boom generation and an apparent leveling out of women's participation in the work force, which had risen for several decades, will likely restrain the growth of the labor force in coming years.
With fewer job-seekers entering the labor force, the rate of job creation associated with the maintenance of stable conditions in the labor market will decline.
BERNANKE: All told, consumer expenditures appear likely to expand solidly in coming quarters, albeit a little less rapidly than the growth in personal incomes if, as we expect, households respond to the slow pace of home equity appreciation by saving more out of current income.
The business sector remains in excellent financial condition, with strong growth and profits, liquid balance sheets, and corporate leverage near historical lows.
Last year, those factors helped to support continued advances in business capital expenditures. Notably, investment in high-tech equipment rose 9 percent in 2006, and spending on non-residential structures, such as office buildings, factories and retail space, increased rapidly through much of the year after several years of weakness.
Growth in business spending slowed toward the end of last year, reflecting mainly a deceleration of spending on business structures, a drop in outlays in the transportation sector where spending is notably volatile, and some weakness in purchases of equipment related to construction and motor vehicle manufacturing.
Over the coming year, capital spending is poised to expand at a moderate pace, supported by steady gains in business output and favorable financial conditions.
Inventory levels in some sectors, most notably at motor vehicle dealers and at some construction-related manufacturing industries, rose over the course of last year, leaving some firms to cut production to better align inventories with sales.
Remaining imbalances may continue to impose modest restraint on industrial production during the early part of this year.
Outside of the United States, economic activity in our major trading partners has continued to grow briskly. The strength of demand abroad helped spur a robust expansion in U.S. real exports, which grew about 9 percent last year.
The pattern of real U.S. imports was somewhat uneven, partly because of fluctuations in oil imports over the course of the year. On balance, import growth slowed in 2006 to 3 percent.
Economic growth abroad should further support steady growth in U.S. exports this year.
BERNANKE: Despite the improvements in trade performance, the U.S. current account deficit remains large, averaging about 6.5 percent of nominal GDP during the first three quarters of 2006.
Overall, the U.S. economy seems likely to expand at a moderate pace this year and next, with growth strengthening somewhat as the drag from housing diminishes.
Such an outlook is reflected in the projections that the members of the Board of Governors and presidents of the Federal Reserve Banks made around the time of the FOMC meeting late last month. The central tendency of those forecasts -- which are based on the information available at that time and on the assumption of appropriate monetary policy -- is for real GDP to increase about 2.5 to 3 percent in 2007, and about 2.75 to 3 percent in 2008.
The projection for GDP growth in 2007 is slightly lower than our projection last July. The difference partly reflects an expectation of somewhat greater weakness in residential construction during the first part of this year than we anticipated last summer. The civilian unemployment rate is expected to finish both 2007 and 2008 around 4.5 to 4.75 percent.
The risks to this outlook are significant.
To the downside, the ultimate extent of the housing market correction is difficult to forecast and may prove greater than we anticipate. Similarly, spillover effects from developments in the housing market onto consumer spending and employment in housing- related industries may be more pronounced than expected.
To the upside, output may expand more quickly than expected if consumer spending continues to increase at the brisk pace seen in the second half of 2006.
I turn now to the inflation situation. As I noted earlier, there are some indications that inflation pressures are beginning to diminish. The monthly data are noisy, however, and it will consequently be some time before we can be confident that underlying inflation is moderating as anticipated.
Recent declines in overall inflation have primarily reflected lower prices for crude oil, which have fed through to the prices of gasoline, heating oil, and other energy products used by consumers.
After moving higher in the first half of 2006, core consumer price inflation has also edged lower recently, reflecting a relatively broad-based deceleration in the prices of core goods.
That deceleration is probably also due to some extent to lower energy prices, which have reduced costs of production and thereby lessened one source of pressure on the prices of final goods and services.
The ebbing of core inflation has likely been promoted as well by the stability of inflation expectations.
A waning of the temporary factors that boosted inflation in recent years will probably help to foster a continued edging down of core inflation. In particular, futures quotes imply that oil prices are expected to remain well below last year's peak.
If actual prices follow the path currently indicated by futures prices, inflation pressures would be reduced further as the benefits of the decline in oil prices from last year's high levels are passed through to a broader range of core goods and services.
Nonfuel import prices may also put less pressure on core inflation, particularly if price increases for some other commodities, such as metals, slow from last year's rapid rates.
BERNANKE: But as we've been reminded only too well in recent years, the price of oil and other commodities are notoriously difficult to predict, and they remain a key source of uncertainty to the inflation outlook.
The contribution from rents and shelter costs should also fall back, following a step-up last year.
The faster pace of rent increases last year may have been attributable in part to the reduced affordability of owner-occupied housing, which led to a greater demand for rental housing. Rents should rise somewhat less quickly this year and next, reflecting recovering demand for owner-occupied housing as well as increases in the supply of rental units. But the extent and pace of that adjustment are not yet clear.
Upward pressure on inflation could materialize if final demand were to exceed the underlying productive capacity of the economy for a sustained period. The rate of resource utilization is high, as can be seen in rates of capacity utilization above their long-term average and most evidently in the tightness of the labor market.
Indeed, anecdotal reports suggest that businesses are having difficulty recruiting well-qualified workers in certain occupations.
Measures of labor compensation, though still growing at a moderate pace, have shown some signs of acceleration over the past year, likely in part the result of tight labor market conditions.
The implications for inflation of faster growth in nominal labor compensation depend on several factors. Increases in compensation might be offset by higher labor productivity or absorbed by a narrowing of firms' profit margins, rather than passed on to consumers in the form of higher prices.
In these circumstances, gains in nominal compensation would translate into gains in real compensation as well.
Underlying productivity trends appear favorable and the markup of prices over unit labor costs is high by historical standards, so such an outcome is certainly possible.
BERNANKE: Moreover, if activity expands over the next year or so at the moderate pace anticipated by the FOMC, pressures in both labor and product markets should ease modestly.
That said, the possibility remains that tightness in product markets could allow firms to pass higher labor costs through to prices, adding to inflation and effectively nullifying the purchasing power of at least some portion of the increase in labor compensation. Thus, the high level of resource utilization remains an important upside risk to continued progress on inflation.
Another significant factor influencing medium-term trends in inflation is the public's expectations of inflation. These expectations have an important bearing on whether transitory influences on prices, such as those created by changes in energy costs, become embedded in wage and price decisions and so leave a lasting imprint on the rate of inflation. It is encouraging that inflation expectations appear to have remained contained.
The projections of the members of the Board of Governors and the presidents of the Federal Reserve Banks are for inflation to continue to ebb over this year and next.
In particular, the central tendency of those forecasts is for core inflation -- as measured by the price index for personal consumption expenditures excluding food and energy -- to be 2 to 2.25 percent this year and to edge lower, to 1.75 to 2 percent, next year. But as I noted earlier, the FOMC has continued to view the risk that inflation will not moderate as expected as the predominant policy concern.
Monetary policy affects spending and inflation with long and variable lags. Consequently, policy decisions must be based on an assessment of medium-term economic prospects.
At the same time, because economic forecasting is an uncertain enterprise, policymakers must be prepared to respond flexibly to developments in the economy when those developments lead to a reassessment of the outlook. The dependence of monetary policy actions on a broad range of incoming information complicates the public's attempts to understand and anticipate policy decisions.
Clear communication by the central bank about the economic outlook, the risks to that outlook, and its monetary policy strategy can help the public to understand the rationale behind policy decisions and to anticipate better the central bank's reaction to new information. This understanding should, in turn, enhance the effectiveness of policy and lead to improved economic outcomes.
By reducing uncertainty, central bank transparency may also help anchor the public's longer-term expectations of inflation. Much experience has shown that well-anchored inflation expectations tend to help stabilize inflation and promote maximum sustainable economic growth.
Good communication by the central bank is also vital for ensuring appropriate accountability for its policy actions, the full effects of which can be observed only after a lengthy period. A transparent policy process improves accountability by clarifying how a central bank expects to attain its policy objectives and by ensuring that policy is conducted in a manner that can be seen to be consistent with achieving those objectives.
Over the past decade or so, the Federal Reserve has significantly improved its methods of communication, but further progress is possible.
As you know, the FOMC last year established a subcommittee to help the full committee evaluate the next steps in this continuing process. Our discussions are directed at examining all aspects of our communications and have been deliberate and thorough. These discussions are continuing, and no decisions have been reached.
BERNANKE: My colleagues and I remain firmly committed to an open and transparent monetary policy process that enhances our ability to achieve our dual objectives of stable prices and maximum sustainable employment.
I will keep members of this committee apprised of the developments as our deliberations move forward. I look forward to continuing to work closely with the members of this committee and your colleagues in the Senate and House on the important issues pertaining to monetary policy and the other responsibilities with which the Congress has charged the Federal Reserve.
Thank you. I would be happy to take questions.
DODD: Thank you very, very much, Mr. Chairman, for a very comprehensive statement.
What I'm going to do is I'll allocate seven minutes per member. Not to hold that so tightly, I'll just ask members to be conscious of the time, and we have the clocks in front of you here, so we can make sure everyone has an adequate time to ask questions and give you an adequate time to respond to them as well.
Let me pick up, if I can -- and a number of my colleagues referred to your speech in Omaha. Senator Hagel talked about your reception there, and the comments you made about income and equality. And I want to pick up on those comments, if I can, as well.
I think all of us recognize here -- I say to my friend from Utah and colleague, we're all very conscious of the tremendous wealth that's been created in certain sectors of our economy, that there are good things that are happening. None of us are suggesting all is bad.
There is a sense, as Senator Sununu has said and others, of uncertainty that people are feeling across the country about the long- term economic growth and stability of the nation.
And I think those of us who trust in those views too, here, Mr. Chairman, probably reflect your comments as well, as I read them. Your quote in Omaha -- I'm quoting here -- "By many measures, inequality in economic outcomes has increased over time."
Your predecessor, Chairman Greenspan, was very concerned about the growth in income inequality as well. He testified, and I quote him. He said, "I think the income distribution issue is very critical, because we cannot have a significant inequality of income and expect to have support for the type of institutions that have made this country great," end of quote.
Do you share Chairman Greenspan's concern, Mr. Chairman, that continued economic growth of inequality is a significant threat to our nation's fundamental promise of economic opportunity? Do you suggest by your comments here that we ought to have a balanced view?
I just left a markup a few minutes ago, before coming here, marking up a new Head Start bill that will hopefully deal with greater accountability, but serving about 900,000 to a million young people in this country in the past 41 or 42 years that has tried to give those children an opportunity to become active and successful members of our economy in the future.
I'm concerned, as we look at this, that the decisions we make here will lack that kind of balance. And your comments seem to suggest a similar train of thought.
And I wonder if you might just take a few more minutes this morning to expound on those comments in Omaha. And just a general observation -- I'm not asking you to endorse a specific spending program here and there, but just your general observation about this inequality issue and your concerns that you obviously expressed in Omaha.
BERNANKE: Thank you, Mr. Chairman.
The very important drivers of economic growth and prosperity in this country include free and open trade and technological progress. It's very important to allow those forces to continue to operate in our economy.
However, we do have to recognize, as I discussed in Omaha, that the effects of these forces can be differential across the population. They may create greater income possibilities for some than others. They may create painful dislocations, for example, if the composition of industries changes or job skill requirements change.
I agree with Chairman Greenspan's general point that in order to support and retain support for policies of free trade, open borders, technological change, flexible labor markets, we need to make sure that the gains and benefits from these powerful, growth-producing forces are broadly shared and that people understand that these things are good for the American economy and good for people, generally, in the economy.
How to do that is very difficult. It's easy enough to say, "Let's promote economic opportunity." I certainly support that idea. Doing it is not necessarily easy.
I discussed in my speech some general issues, some general approaches, including education: not only K-12 education, but training throughout the lifespan, from early childhood through adult retraining. I think that's very important.
I think we need to help people who are dislocated by these powerful dynamic forces to find new jobs, to find new opportunities. And I think that's very important.
I would just say, though, I'm glad you didn't ask me to endorse specific policies, because making that work in practice is difficult. And we have to find ways to achieve these objectives -- you know, for example, retraining workers -- in ways that work well, that are effective and are effective in terms of the spending that we put into it.
And so, it's a great challenge for us, going forward, to look among all the possible approaches and decide, you know, which types of programs, which types of initiatives will be most effective at achieving this objective.
That being said, again, I do agree that we need to spread the benefits widely and make people understand that open trade and technological change are beneficial for not only the economy in the aggregate, but for the great majority of people in the economy.
DODD: I don't know if you had the chance to read a report called "The Gathering Storm" that was prepared by a number of senior retired corporate executives, along with some of our leading academicians in the country, about a year and a half ago; took a month off and examined where we were in K-12 in science and math -- again, without getting to the specifics of individual programs.
But they were very cautious -- in fact, they warned us, all of us, those of us who sit on this side of the dais as well as others across the country, that if we do not make some investments in the quality of education, particularly in the math and science, we could find abrupt changes occurring in our country very quickly in this century.
I don't know if you had an opportunity to look at that report or not, but if you had any -- whether or not you agreed with their conclusions about your concerns over whether or not this inequality could be exacerbated by the failure of us to have a level of education -- investments in education from that earliest -- early childhood area through the higher education opportunity.
BERNANKE: Mr. Chairman, I did read that report. I had a lot of interesting things to say.
I think if you look at it carefully it suggests that the issues are different in different parts of the educational system.
For example, our universities remain very strong. Our research universities lead the world. And so, in terms of research development, innovation and so on, the United States, I think, retains a substantial leadership in the world.
But at other parts of the educational system, perhaps in elementary school, for example, we're probably not doing what we should be doing in terms of ensuring that all children have opportunities to learn math and science and the applications of those areas.
Again, my wife is a teacher. I've been in education for a long time. I was on the school board for many years. I'm very sensitive to these issues.
But I also appreciate, from those particular positions that I've held -- you know, we've been worrying about educational quality for a long time, and it's a difficult thing to achieve. And I encourage continued thought and continued efforts to improve these vital components of our economy without having any delusions about how difficult that really is to accomplish effectively.
DODD: I thank you for that.
I'm going to turn to my colleague from Alabama.
But I want to -- I'll probably send this as a written question unless one of my colleagues raises it with you here.
Back in December, Senator Sarbanes, Senator Allard, Senator Reed, Senator Bunning, Senator Schumer and myself sent you and other regulators a letter regarding these exotic mortgages. We had a hearing here the other day -- and I've talked about this -- I'm a strong advocate of subprime lending. It's made a huge difference in assessability to homeownership. I'm also simultaneously very concerned about the predatory lending practices that go on. That concern about providing those subprime borrowers with the same kind of protections we do to the prime borrowers is a matter of concern to many here on this committee.
DODD: The letter we got back, frankly, Mr. Chairman, was a little inadequate. The notion "We're thinking about it" was nice to know, but I think many of us would like to know they're taking some additional steps.
And, again, I'll make this a written question to you. But I'm very concerned about this issue and some of the data we're receiving where as many as two million of our fellow citizens may be foreclosed out of their home because of predatory practices.
And so, again, I'll wait. I won't ask you. I want to turn to Senator Shelby, but I want to raise that issue with you and ask you to be thinking about it because it's an important concern for many of us.
SHELBY: Thank you, Chairman Dodd.
Chairman Bernanke, the Federal Open Market Committee has held the federal funds rate target at 5.25 percent since June of '06. In the FOMC statement following your most recent meeting in January, the FOMC noted, and I quote, "The high level of resource utilization has the potential to sustain inflation pressures. The committee judges that some inflation risks remain," end quote.
Mr. Chairman, what data related to resource utilization will you be paying the closest attention to between now and the next FOMC meeting in March?
BERNANKE: Senator, the, sort of, a flip answer is "everything."
I should be clear: Our concern is not about the labor market, per se. Our concern is about the overall balance of spending and productive capacity.
SHELBY: The whole picture.
BERNANKE: The whole picture.
The Federal Reserve contributes to setting overall financial conditions which, in turn, stimulate spending by consumers and businesses on the product of our companies.
If we have a situation where spending is growing more quickly than the underlying productive capacity for a sustained period, we risk creating inflation which will then make it more difficult to sustain a healthy expansion over a longer period of time.
So we are looking for evidence that consumption, spending and other components of spending growth are exceeding the underlying capacity.
In doing so, we look at a wide variety of indicators, including the strength of various spending components, measures of resource utilization, which include not only capacity utilization and unemployment, but many indicators on labor markets and capital markets.
BERNANKE: We also look very much at prices, because prices are the canary in the coal mine. If prices begin to rise, that's indicative that there's too much demand given the amount of supply.
We do not have any fixed speed limit in mind when we think about the economy going forward. We do not have any fixed number for the unemployment rate.
Rather, we are looking at the overall balance of supply and demand, looking at the evolution of inflation, and trying to ensure that there's a reasonable balance between demand and supply so that our economy can continue to grow at a sustainable, moderate pace going forward.
SHELBY: Is your economic goal here basically price stability?
BERNANKE: Price stability consistent with strong employment, as well.
SHELBY: Productivity: The president economic report noted that between 2000 and 2005, productivity growth in the U.S. accelerated to about 3 percent, Mr. Chairman, the fastest growth of any G-7 country, which includes Canada, France, Germany, Italy, Japan and the United Kingdom. Most other major industrialized countries suffered a slowdown in productivity growth.
What factors do you believe explain the difference in productivity growth, given that the other G-7 countries also have access to the same technological improvements and broad capital markets that the U.S. has? And could you explain -- expand on these differences in productivity, what productivity implies for our standard of living and our long-term growth?
BERNANKE: Senator, you're quite correct that productivity began to grow more quickly in the United States about a decade ago, and that's been a very important factor in the strength of our economy.
About 1995, we saw a step up in productivity growth from 1.5 to 2.5 percent, which seems to have been driven primarily by improved and more efficient methods of producing high-tech equipment: faster computers, stronger, better communications equipment and the like.
Over the succeeding few years -- and, in fact, we saw productivity growth step up further around 2000 -- those technological innovations have been diffused through the economy in helping industries across the economy manage their production more efficiently, distribute their output more efficiently, and reduce costs, increase productivity.
So in some sense, the underlying factor is the technological change, the investment in information and communications technologies, and the diffusion of those technologies throughout the economy.
Now, you ask quite properly why do we -- have seen better results here in the U.S. than in some other countries. And I've given some speeches on that subject.
I do believe that it's the interaction of the new technologies and our flexible, dynamic economic system, that includes flexible labor markets that can adjust to changes in the market associated with technological change, that includes deep and liquid capital markets that can allocate capital toward new ventures, toward new technologies.
BERNANKE: And I believe that flexibility has been essential in helping us take technological advances and create from them economic benefits.
And this relates to my answer to Chairman Dodd, that we need to maintain that flexibility in our economy and that providing broad opportunity and education is one way to support that going forward.
SHELBY: Mr. Chairman, I want to get to another part of your responsibilities. That's bank regulation.
Regulation Z -- Senator Dodd has already referred to this. The Banking Committee held a hearing on the credit card industry that was widely followed.
Witnesses at the hearing highlighted a number of troubling industry practices, many of which are subject to Federal Reserve oversight. I understand that the Federal Reserve Board is currently reviewing this Regulation Z, which implements the Truth in Lending Act.
What is the status of the board's Regulation Z review? And does the board intend to use its review to address any of the questionable industry practices raised in the committee's hearing?
BERNANKE: Senator, we've been putting a great deal of effort into our review of Regulation Z, with particular focus on short-term and revolving credit, like credit cards.
One of the real challenges in improving disclosures for credit cards and other times of lending is to make the disclosures both compliant with legal requirements, but also sufficiently clear and understandable that people can understand what it is that they're getting into.
In order to try to improve the understandability and the clarity of disclosures, the Federal Reserve has conducted extensive consumer testing.
We haven't just done it in the ivory tower, as somebody mentioned. We've gone out into the public and we've conducted focus groups, we've done psychological testing to try to figure out how to structure disclosures in a way that people will notice them, pay attention to them and understand them. And so that has been a big part of our effort.
We are very close to the end of that effort. We expect to have a proposed rule out within a few months, by the middle of this year.
BERNANKE: And I believe and hope that it will address many of the appropriate concerns that people have had about disclosures and practices in the credit card industry and other short-term debt.
SHELBY: Chairman Dodd, I know my time is up, but can I just ask the chairman a question for the record? I think it takes time.
We've been concerned for some time about the implementation of the Basel II capital accord and the impact that Basel II may have on safety and soundness of the U.S. banking system.
I'm worried that Basel II may lead to a sharp reduction in the amount of capital banks are required to hold, which would put U.S. taxpayers ultimately at risk of having to pay for expensive bank failures, if there are some.
I believe it's critical that Basel II be implemented with the utmost care and diligence.
Mr. Chairman, would you, for the record, update the committee on the status of Basel II capital accords, the current time frame for implementing Basel II, and also comment on whether there's enough time for banking regulators, including yourself, to finalize the rules in implementing Basel II so that banks adopting Basel II can start the test run for Basel II presently scheduled to begin next year?
If you care, you can do it for the record.
BERNANKE: Should I answer, Mr. Chairman?
DODD: We'll make that for the record.
Let me add to that quickly, before I turn to Senator Schumer.
Some of my bankers have raised the issue, too, about foreign acquisition of domestic banks and whether or not they're really meeting the capital requirements today. I've got some real concerns raised by my bankers in Connecticut about this issue, that follow it very closely.
And I'd add that to the question Senator Shelby has raised with you; whether or not that's something we ought to be looking more closely at -- are they actually meeting those criteria before these acquisitions occur?
SCHUMER: Well, thank you, Mr. Chairman.
And it's your first year. You've completed a year. You're getting good grades everywhere. And I'd concur. I think you're doing a fine job and have vindicated the support I think that you received almost unanimously from this committee.
My first question deals with the issues of income inequality and the speech you gave yesterday, where you pointed out that this is just in an ideas, almost instantaneous economy, wealth agglomerates to the top. You talked about Manny Ramirez.
I like to talk about Henry Ford, his great idea. He deserved to become rich from it, but he needed a million people to carry it out, and each of them made $10,000 a year to make the cars, distribute the cars.
Bill Gates, maybe the Henry Ford of our generation, had another.
SCHUMER: He mass-produced, in a certain sense, computer platforms. But he needed 10,000 people to carry it out. And they each made a couple of million dollars.
Given that this is happening -- and it is not the government's doing. This is just the nature of our economy, as you pointed out in our (ph) speech.
Doesn't it make sense, if this goes too far, to have a more progressive tax code, even though government didn't cause it, to keep a middle-class base, to keep too much wealth from agglomerating at the top?
I'm not asking you any specific policy, but just the general view that wouldn't progressivity -- further progressivity in the tax code help be an antidote to the natural flow of money to the very top, to the few who create those new ideas and deserve to make money from that and not get in the way of doing that?
BERNANKE: Senator, your comparison of Henry Ford and Bill Gates was very telling. Henry Ford developed the assembly line.
BERNANKE: And it allowed relatively low-skilled workers to be very productive in that context, and generated high wages for those workers.
BERNANKE: Bill Gates created a new model of operating systems in the high-tech industry. The kinds of workers he needed to execute...
BERNANKE: ... were much more skilled workers.
SCHUMER: Exactly, but many fewer of them as well.
BERNANKE: Fewer of them, certainly.
And so I think that one very important lesson from that comparison is that those who are going to benefit the most from globalization and technology are those who have the skills, who have the capabilities to benefit and to be productive in that context.
And so I would say, whatever we do with tax policy and transfer policy, I hope that we'll, you know, try to address the issues of skills and...
SCHUMER: I agree with you completely.
BERNANKE: ... individual productivity.
SCHUMER: But that's going to take a while.
BERNANKE: Senator, on the issue of progressivity, you'll be unsatisfied.
I'm the head of the nonpartisan central bank. I think it's very important for me not to take sides on issues where values are very important.
I mean, evidently, this is a decision, trading off issues of equity...
SCHUMER: Well, sir, talking about more money or more help for education is as much a policy decision as talking about the progressivity of the code.
I'm not asking you about a specific policy. And I think you should address it.
BERNANKE: Senator, I'm sorry. I decline because there really is a value judgment involved in trading off -- I talked about this in my inequality speech.
I said, on one hand, you have the importance of promoting incentives, you know. Senator Bennett, I think, mentioned entrepreneurs, the people who take risks. We have to give them incentives to take risks. On the other hand, as you point out, correctly, you know, the tax code has an important role to play in generation more equality.
I can't -- I don't -- I'm not an elected official, I can't...
SCHUMER: OK, I think you're ducking it, in all due respect, because you do talk about other policy issues. But let me move on.
Trade deficit: Are you happy with the size of the trade deficit, at the rate of its growth? And do think stronger policies, particularly against those who we have huge balance of trade deficits with, to open their markets, not particularly to close ours, would be helpful in reducing the trade deficit? Obviously, my focus is on China, but I'd ask a more general question.
So the first question, are you happy with the size of the deficit and its rate of growth?
BERNANKE: No, I'm not happy with it.
SCHUMER: OK. Do you think policies that would importune other countries whose markets are not as open as ours to open theirs would be a salutary change and that we ought to emphasize that as a, if you will, pro-free-trade way to deal with the trade deficit?
BERNANKE: Senator, I'm entirely in favor of trying to open markets. We have the World Trade Organization. China is a signatory to the World Trade Organization. We should aggressively pursue attempts to open markets to foreign investments and...
SCHUMER: Do you think the Chinese have done enough on their currency?
BERNANKE: They've moved in the right direction but, no, I don't think they've done enough.
With respect to trade though, I would like to add that trade policies alone are not going to resolve the trade deficit.
BERNANKE: There's also the issue of saving and investment, which we do need to address as well.
SCHUMER: I think I agree with you on that.
Senators Graham and myself and Baucus and Grassley are going to try to do a WTO-friendly way or compliant way of getting the Chinese to do more on currency. And I hope you will look at the carefully and be supportive.
Final question is on competitiveness of our financial institutions and industries. Coming from New York, I'm obviously concerned, but so should my colleagues from many other states: the Carolinas, South Dakota, so many in New Jersey. So many other states have a stake here.
And the problem we seem to be facing is this: that other regulatory and legal regimen in other countries are looser than ours. And now that capital can flow quite freely, companies who are international -- and their loyalty to their stockholders means they're not going to be loyal to the United States or may precede their loyalty to the United States -- may seek the lowest common denominator or a lower common denominator.
And the pretty exquisite balance between regulation and entrepreneurialness that we've had over the last quarter of the last century seems to be in some trouble; that people are fleeing to go to less regulated places for their short-term gain, even if it creates problems in the system as a whole.
SCHUMER: Could you comment on that problem? Do you think it's a real one? Do you think it is only caused by simply knowledge spreading and the Internet, or is caused by some of these regulatory differences? And do you think we ought to look at that in a policy way to do something about it?
BERNANKE: Senator, to some extent, it's caused by the diffusion of knowledge and the growth of other markets. And to the extent that we're having a more competitive, deeper, broader capital market around the world, that's probably good for world growth, it's probably good for even our companies because they have more options for raising funds.
There is, though, I think, an issue of regulation, as has been pointed out in the two reports that you're quite familiar with. And there's a subtle distinction to make.
If you take Sarbanes-Oxley as an example, to the extent that Sarbanes-Oxley appropriately balances disclosures and governance against the costs of achieving those disclosures and governance, I think it's worthwhile to keep even if there's some short-run tendency for firms to run away from that. Because the investor wants that protection, and ultimately the investor will reward firms that list on exchanges that have appropriate, adequate protections, such as a well- designed Sarbanes-Oxley.
That being said, there are always concerns about Sarbanes-Oxley, about Basel II, about the regulatory structure, about the securities litigation, about CFIUS, many other things that we could point to, where legitimate questions can be raised about whether the costs of those regulatory schemes exceed the actual benefits to investors and to others of implementing them.
And I think, as a general matter, not just in the context of competitiveness of our exchanges, we should always be looking to try to restore that balance and make sure that the costs that we're imposing from a regulatory side are justified in terms of the social benefits.
So I think, for example, it is a good step that the Public Company Accounting Oversight Board and the SEC have taken some steps in revising the audit standard to reduce the burden of SOX 404 while maintaining, I believe, so far many of the benefits in terms of disclosure and controls that that law was intended to achieve.
DODD: Thank you, Senator Schumer.
BUNNING: Thank you, Mr. Chairman.
Two of your predecessors, Paul Volcker and Alan Greenspan, always expressed great concern. I happened to serve on the House Banking Committee when Mr. Volcker was the head of the Federal Reserve and then Chairman Greenspan, both the House Banking and now the Senate Banking.
And yesterday in The Washington Post, there was an article about the inverted inversion of the yield curve for eight straight months, and how local banks and banking in general -- and since that's the Fed's charge, to make sure that our banks are sound and secure -- were having difficulty with the inverted yield curve.
I've questioned you about this before and you have always said it's not very important in this day and time.
I'm going to ask you again: How long can we stand to have -- and we've had it eight straight months now -- an inverted yield curve where short-term rates are higher than our 30-year bond rate?
BERNANKE: Senator, the usual context of this question is, does an inverted yield curve presage a recession or a slow-down in the economy?
BUNNING: Well, it also hurts our banks very badly.
BERNANKE: I'll address that, sir.
Just very quickly, though, on the forecasting power of the yield curve, there's been a good bit of evidence that declines in the term premium and perhaps a great deal of saving, chasing a relatively limited number of investment opportunities around the world, have led to a somewhat permanent flattening, or even inversion, of the yield curve, and that that pattern does not necessarily predict slowing in the economy or a recession.
Indeed, if you look at other measures of financial markets, such as corporate bond spreads, you don't see anything that suggests anticipations of future stress.
The question you raised is a different one, of course, which is the effects on the banking system, specifically. Banks that do their traditional business of taking deposits and making loans are going to be put under pressure because the short-term deposit rates tend to be higher than the loan rates they can get.
BERNANKE: I recognize that's a problem for some banks. Other banks have been able to deal with it by hedging interest rate risk, by getting fees and doing other ways of doing their business.
So, overall, I don't see the banking sector as being under tremendous pressure in terms of its profits and asset quality at the moment. But I recognize that particularly for smaller banks, which have fewer options in terms of funds, raising funds, and in terms of earning fees and income, that the inverted yield curve does produce some pressure.
From the Federal Reserve's points of view, we're entirely cognizant of that. We hear about it from bankers. We have to set monetary policy, of course, to try to achieve overall price stability and maximum sustainable employment growth. And we sometimes find that in the context of various industries that that policy could create some pressure on individual industries.
But we only have this one tool and we try to use it to achieve overall macroeconomic stability while fully recognizing that it does create some problems for some sectors.
BUNNING: You're telling us today that an inverted yield curve down the road will not affect the economy. Did I misunderstand that, or is that accurate?
BERNANKE: I think the yield curve can be inverted for a considerable period without significant implications for the economy as a whole, yes. Possible for some banks, but not for the economy as a whole.
BUNNING: How does this economic cycle that we're in, in recovery and expansion, compare to previous recoveries and expansions, in other words, when we hit the wall in '92 and also in 2002? And how does this recovery that we're involved in now compare to those recoveries?
BERNANKE: I would say that qualitatively, it's fairly similar to the recovery that followed the '90, '91 recession, many of the same features. There was weakness for sometime after the recession ended. There was a period of jobless growth, so-called.
BUNNING: But we didn't have a housing market that...
BERNANKE: Well, the housing market was actually quite weak during the recession itself. The decline in residential starts during '90 and '91 was not quite as large, but in the same neighborhood as what we've recently.
BERNANKE: But during the recovery period, we didn't have that particular pattern.
But in many ways, it was a fairly similar expansion.
BUNNING: Could you estimate how close we are to a full employment in the United States?
BERNANKE: It's very hard to say specifically, and I don't pretend to know an exact number or an exact estimate.
But the economy has certainly been growing faster than potential for a number of years. And that can be seen in the tightening of labor markets and capacity utilization.
So, clearly, we are much closer today, I think it's safe to say, to full employment to the sustainable level of growth than we were a few years ago. And we've moved, clearly, in that direction.
BUNNING: And in your opening statement, you made the remarks to the effect that you have not seen any new evidence of inflation since your last Fed meeting in January or February.
BERNANKE: We haven't had much information on inflation since just two weeks ago. But the recent readings on inflation have been encouraging.
BERNANKE: But as I've indicated in my remarks, they are somewhat noisy, the data, and we don't want to draw an entirely, you know, complete conclusion...
BUNNING: Well, that's why we have Fed meetings every month or two.
BERNANKE: That's correct, Senator.
BUNNING: Thank you very much, Mr. Chairman.
DODD: Thank you very much, Senator Bunning.
CASEY: Thank you, Mr. Chairman.
And the other chairman in the room, thank you for your time and for your service.
I have two general questions: one on debt and one on children.
With regard to debt, I was looking at the report that the Federal Reserve Board is submitting in connection with your appearance here today and your testimony. And in particular, on pages 12 and 13, I wanted to direct your attention and the attention of others to the report.
I note here that on page 12, which deals with the federal government and expenditures and outlays by the federal government, it says that -- and I'm reading in part on the second column on page 12 -- net interest payments increased 23 percent in fiscal 2006 as interest rates rose and federal debt continued to grow.
Then it goes on from there; talks about the outlays for Medicare Part D -- Medicare itself up 10.5 percent. It talks about disaster relief, Medicaid spending. And then it gets to the next part of the paragraph: "Outlays for defense" -- defense -- "in fiscal 2006 slowed to their lowest rate of increase since fiscal 2001, although the rise was still about 6 percent." That's the first predicate of my question.
Then I go to page 13 and it talks about debt: The federal debt subject to the statutory limit has increased. Now we're at the $8.6 trillion level.
And I guess, with that as a predicate, let me tell you what I think about think about this. I think that that's unsustainable. and as much as we've talked -- as important as it is to talk about the good, sound bite, "reducing our dependence on foreign oil," I think we need a lot more effort in this Congress and in this town on reducing our dependence on foreign debt.
I think it's making us less safe in the fight against terrorism. I think it's making us less safe in terms of our ability to spend money on defense, not to mention our ability to spend money on good investments in the economy, as you talked about: education, training and the rest.
So I guess my basic question is, in light of that data -- and any other data you want to factor into this question -- are these numbers sustainable: an $8.6 trillion debt and a 23 percent increase in net interest payments? Is that sustainable over time?
BERNANKE: I recently testified before the Senate Budget Committee, and I pointed out that it's not exactly a secret, but that the long-term prospects for the U.S. fiscal situation are quite serious.
In particular, as the population ages, we're going to start seeing expanded costs of entitlements, Social Security and Medicare. Those grow very quickly and, if no action is taken, will generate an increasing spiral of higher interest payments and debt.
I quoted in that testimony several interesting, useful simulations by the Congressional Budget Office. The intermediate simulation suggests that by the year 2030, the deficit will be 9 percent of GDP, and the debt-to-GDP ratio, which is currently about 37 percent, would be closer to 100 percent of GDP, a number which we've not seen since World War II.
So, obviously, there are a lot of issues that Congress will debate about the short-term spending and tax proposals. I'm certainly aware of that.
But I think if you think about the fiscal sustainability in a longer timeframe, dealing with the fiscal implications of the aging population and rising health care costs are going to be dominant, and essentially there won't be any way to address fiscal sustainability without addressing that issue in some way.
CASEY: I wanted to pick up, in the remaining time I have, on the issue of how we invest in children -- pick up on what Chairman Dodd spoke of earlier.
There's a great organization out there that has, as its moniker or as its message, "Fight crime, invest in kids." It's a great, great sound bite. Sometimes we need sound bites to make the point.
I would also assert -- and I'd ask for your sense of this and your reflections on this -- and you could use the same construct for the impact on how we invest in children and how we grow our economy. You could -- instead of saying, "Fight crime, invest in kids," you could say "Grow the gross national product," or, "Grow GDP," or, "Grow the economy, invest in kids."
And I ask you that, because we're going to be making some critically important decisions in the next couple of months and certainly in this 110th Congress.
Chairman Dodd talked about the issue of the Head Start program. There have been votes cast in the United States Senate in the last couple of years where the choice was clearly and unambiguously a choice between investing in Head Start or investing in education or investing in any other support for children and their economic future -- not to mention their future -- and tax cuts.
CASEY: Sometimes the votes have been that stark. And there are people here who voted for the tax cuts over Head Start and over some other priorities.
So I ask you about your opinion -- and this is a policy question, but I think you can answer this -- your opinion on the level of investment in children, whether it's with regard to education or Head Start, early learning -- all of these initiatives to give kids a healthy and smart start in life -- how you see that in the context of economic growth and GDP growth and whether or not you think the investment currently is adequate.
BERNANKE: I think that investing in children is extremely important. I think it has economic benefits. It also has social benefits. And I hope that Congress will continue to look very carefully at that.
What I don't know is precisely how best to do that. And I think you're going to have to bring real experts here to talk about different approaches and what works and what doesn't work. But I urge you to continue to do that.
In terms of priorities, you can -- to go back to Senator Schumer's question, I mean, clearly, there's always priorities. But you can weigh these things against tax cuts. You can weigh them against other kinds of spending. Clearly, you have to have an overall picture of what's important.
Again, I can't speak to the overall combination of taxes and spending, other than to say that they should be in balance. But I will go so far as to say that I think that there's a significant return to investing in young kids.
In my remarks in Omaha, I even cited some Federal Reserve research from the Federal Reserve Bank of Minneapolis which showed the very substantial economic returns associated with early childhood education. And I do think that's certainly worth investigating.
CASEY: Thank you.
DODD: Thank you, Senator Casey. Very good questions; I appreciate your focusing attention on that.
DODD: I want to just mention, before turning to Senator Martinez, your response, Mr. Chairman, to Senator Schumer's questions about Sarbanes-Oxley and competitiveness.
I appreciated your answer very much to that question. There are some things clearly can be done to try and show some balance and making sure we're not overburdening smaller public companies. But your thrust was that this is working pretty well.
And, frankly, anecdotally, I suspect most of here ask the question of every business we talk to, "How is this working?" And I must tell you, overall, the response I get is a good one.
I had one company the other day say to me that, "Even if Congress decided tomorrow to repeal Sarbanes-Oxley, we would decide to stay with all the things that's been required of us. We've found it's been very worthwhile for our company."
So I appreciate your comments about that.
MARTINEZ: Mr. Chairman, thank you very much.
I hate to differ with the chairman, but I must say that the experience that I hear on the competitiveness and Sarbanes-Oxley issue is far different from that. I hear a great deal of concern about the incredible cost and the burden on competitiveness that it has created.
And, in fact, I'll begin with this area, because I intended to get into it.
But our colleague from New York Senator Schumer and Mayor Bloomberg recently released a report that I found quite interesting, detailing an analysis of market conditions in the U.S. and abroad and about the concern that there is about whether New York will continue to be the financial capital of the world or whether, in fact, there seems to be others competing for that title, which might include London. And there were some rather dramatic statistics of declines and increases in New York vis-a-vis London.
And one of the things that was mentioned in the report was that U.S. regulatory framework being too complicated and the implementation of Sarbanes-Oxley having produced heavier costs than were expected at the beginning or when we initiated that effort.
MARTINEZ: Also, it was mentioned, immigration policies which create problems for those from abroad who might wish to come here to do business, to invest in America, and the difficulties that occur in immigration -- problems (inaudible) that, and some of them coming to be educated, others coming just as business people and investors.
In any event, I wondered if you had an opportunity to see that report and whether its findings caused the same concerns to you that they raised to me.
BERNANKE: Senator, as I indicated, I do think that we should be looking to try to reduce regulatory burden, and in particular to ensure that the costs of the burden are commensurate with the benefits arising from the particular rule.
With respect to Sarbanes-Oxley, my intent was to say that I do believe that there are benefits from that legislation, including improved controls, improved disclosures, improved governance of corporations. So there are certainly some benefits.
It's important to decide whether the costs -- you know, if we can reduce the costs and retain the benefits.
And in that respect, I think that the recent change in audit standard, or the recent proposed change in audit standard being put forth by the SEC and the PCAOB is a step in the right direction because it attempts to focus on the most materially important issues. And it also makes allowance for the size and complexity of a firm, in setting up the audit standard.
So, to try to -- you know, to summarize, I think that Sarbanes- Oxley accomplishes some important objectives, but I do believe it can be -- those objectives can be accomplished at lower costs. And I think the new audit standard moves in that direction.
And we should, on all other regulatory areas, including those the Federal Reserve is involved in, we should continually be looking to find ways to accomplish the social or economic objectives of the regulation at a lower cost.
MARTINEZ: Well, I agree that there are many good features to Sarbanes-Oxley.
MARTINEZ: What I was speaking out is some of the excesses, particularly in the auditing arena and some of the areas that have caused such an overburden of costs. So I appreciate your comment on that.
Shifting to the issue of home sales, I used to sit in that very chair when I was housing secretary before this committee. And at times, I would be asked a question about a housing bubble, and in the overinflated and -- overheating, rather, housing market, whether, in fact, we were headed for a collapse and a bubble that would burst.
In fact, we've seen a significant decrease in housing starts. We've seen the market cool down significantly, but we have not seen a bursting bubble. I always said, at the time, that the fears of a bubble were misplaced, and that the housing market is more regional than it is national and there were many different features between that and a localized market.
But do you feel that the fear of a bubble has receded, given the fact that the market cooled off, that it has done so in a fairly modest way without any cataclysmic consequences?
BERNANKE: Senator, as I indicated in my opening testimony, we think we see some tentative signs of stabilization in demand in the housing market. That would, nevertheless, take some time yet to work its way out because of the inventories of unsold homes that still exist on the market.
And I would emphasize that the signs of stabilization are tentative and we don't want to jump to conclusions. It will be helpful to see what happens when the spring selling season begins and see how strong demand is at that time.
But it is interesting that so far the economy has done a good job of withstanding the slowdown in construction which, although substantial relative to the last couple of years, the level of construction is still similar to late '90s, for example. It isn't that we've had a complete collapse in construction, by any means.
So the decline in construction, while it slowed the economy, it has, obviously, not thrown us into a much slower growth situation, and we've not seen substantial spillovers from the housing slowdown to consumer spending or to other parts of the economy.
So it's early to say that this problem is over. I think we're going to have to watch it very careful. And as I indicated, I think it's a downside risk to the economy going forward. But so far the economy has reasonably adapted to this adjustment in the housing market.
MARTINEZ: You mentioned in your remarks also that household finance appears solid and that delinquency rates on most consumer loans, including residential mortgages, were low.
But you did note that the subprime mortgages with variable interest rates, where delinquency rates have increased appreciably.
MARTINEZ: And it's an issue that is of great concern to several of us on this committee, the issue of predatory lending, the abuse of some of our most vulnerable consumers. Any comments on that, or any issues that you see there which could impact the overall economy?
BERNANKE: I think, first of all, that this distress in the subprime area is a significant concern. I'm, obviously, following it very carefully, both in terms of the impact it has on the borrowers and also, you know, to see what effects it has on lenders, as well.
I don't think that it has, at this point, implications for the aggregate economy in terms of the ongoing expansion. But, as I said, it is an important issue for those sectors.
We at the Fed -- I won't take a long time. I could certainly list a wide variety of things that we do to try to address predatory lending, which I do think is an important issue and I think the subprime market, which is distinct from predatory lending, it's a legitimate market...
MARTINEZ: Right, It's a good distinction to make.
BERNANKE: ... also has some issues.
Just to note one action we've taken recently, along with the other federal banking agencies, we've issued guidance on nontraditional mortgages, mortgages that involve interest-only or option ARMs that may not be amortizing mortgages.
And we've emphasized to the lenders that they should be, first, very careful in their underwriting. That is, they should ensure that the borrower is equipped to deal with payment shock, if interest rates go up; that they have sufficient income to meet higher payments.
And secondly, that disclosures are adequate, so that the borrowers are fully informed about the nature of the contract that they're getting involved in.
So evidently there are some loans that have been made that are not turning out well, and to the detriment of both the lenders and the borrowers. We will certainly be watching that carefully and trying to provide guidance and oversight to minimize that risk going forward.
Thank you, Mr. Chairman.
DODD: Thank you very much, Senator Martinez.
BAYH: Mr. Chairman, I'd like to ask you some questions about our national security interests and the role of the Fed and our financial system in protecting those interests.
BAYH: As you probably have read, there are the tentative outlines of an agreement with North Korea to begin to get them to change their behavior with regard to their nuclear program.
One of the reasons that we were able to at least achieve a tentative understanding was because of pressure that we brought to bear on a bank in Macau that the North Koreans use to interact with the global banking system.
Iran, as you know, is pursuing nuclear ambitions, as well. Several Iranian banks do business in Western Europe. We are currently attempting to do something similar with regard to a couple of Iranian banks.
My question to you is, what can the Fed do, what can the U.S. banking system do to cut off Iranian access to the global banking system to exert some pressure on them to behave in a more responsible way with regard to their nuclear ambitions?
BERNANKE: Senator, the primary responsibility for initiating such measures and enforcing them is with the Treasury, the Financial Crimes Enforcement Network, for example, and OFAC. And they have taken the leadership in trying to ensure that American banks and, through negotiation, banks from other countries do not deal with the banks you're referring to in Iran and North Korea.
So we are not the leaders in that effort. However, we, as bank regulators and overseers, have an important responsibility to try to ensure that it's carried out as the rules dictate.
And we have -- as a very extensive part of our oversight responsibility, we evaluate banks' compliance with Bank Secrecy Act and other such rules.
BAYH: I hope you'll make this a priority and bring some sense of urgency to it.
Iran is a tremendous problem. The military option is, obviously, something that no one wants to have to resort to. And so we're looking for other levers that we can utilize to try and get them to do the right thing here. And this seems to have been effective in the North Korean context.
My investigations in this area tell me that it has increased the cost of doing business to the Iranians. It's made things more inconvenient for them. And perhaps if we continue to pursue this, we might encourage a change in behavior on their part, as well.
So I would encourage you to be vigorous in this effort because it does affect our national security interests in a very important area.
Staying on the subject of Iran for a moment -- you're busy with many other things; you may not have noticed -- but they have indicated publicly that their response, if we did get to the point of having to take some action against them because of their nuclear program, would be to try and cut off the flow of oil from the Persian Gulf by closing the Straits of Hormuz so that not only they would suffer, but the Saudis and others -- trying to maximize the pain on the global economy.
I hope that there's some contingency planning being undertaken. So my question to you is, if such an event were to occur, what would the impact be on the global economy, on the U.S. economy.
Obviously, the price of oil. You mentioned the role that the cost of energy plays on our inflation expectations and that sort of thing.
So what would the effect of such an act to be on the economy?
BAYH: And, secondly, are you aware of any steps that we can take to mitigate those consequences?
The president, in his State of the Union address, suggested doubling the Strategic Petroleum Reserve, for example. Are there other things that we could do to prepare for such an eventuality, so that we mitigate the consequences?
BERNANKE: Senator, you're pointing to an important problem. I'm not really equipped to say what the impact of these actions would be on aggregate supply of oil and on the oil price. I assume it would be dramatic, but I don't know exactly how big the effect would be.
It would certainly have an impact on the world economy; there's no question about that. And I doubt that there's anything we can do in advance that would completely offset that impact.
In the short run, one of the tools we have, as you already mentioned, is the Strategic Petroleum Reserve, which does provide some protection for a certain number of months, anyway, against those kinds of disruptions. And I think that would be helpful.
In the longer term, as many people have noted, reducing our dependence on oil would be beneficial, if we could find ways to diversify our energy portfolio and have, therefore, less reliance on this particular source, that would be helpful, probably from a national security perspective.
BAYH: Well, I hope -- I know your people are probably stretched to their limits dealing with a variety of things, but I do think that some part of the government, whether it's your shop or Treasury or working through concert with some of the national security agencies, we need to at least begin to do some thinking about this.
God willing, we have a number of years before we get to such an event, and God willing it will never happen. But I'm always a big believer in you start with the worst case, protect yourself from that, and you kind of work back from there.
When Secretary Paulson was before us a couple weeks ago, he reiterated the comments that have become routine by his predecessors, and that is the Treasury's belief that a strong dollar is in the interest of the United States of America.
Do you agree with that point of view?
BERNANKE: Senator, I do agree with it. And I would add that I defer to the secretary of the treasury on matters related to currency policy.
I would only add that the Federal Reserve, to the extent we can keep our economy strong and attractive to foreign investment, it will help keep a strong dollar.
BAYH: Well, I agree with that. And this relates in some regard to what Senator Casey was asking about. You may recall that previously there have been -- oh, there was a rumor in Seoul at one point that they were going to diversify out of dollar-denominated assets. And that caused a run on our currency.
A similar rumor went through Japan not long thereafter.
What would be the impact on the value of the dollar and our economy if the Chinese were to, for example, that they were going to either diversify out of dollar-denominated assets or were to, in fact, begin a precipitous sale of such assets?
BERNANKE: Well, Senator, first I think it's important to understand that that's not a very likely scenario, and the Chinese's own interests would not be well-served by such actions. They would take portfolio losses themselves, and so...
BAYH: Forgive me for interrupting. This is something similar to what the Treasury secretary said, and the reason for my question, Chairman, is this. You're right. It may not be in their pecuniary best interests, but nation-states do have interests other than their financial concerns.
Let's just say, hypothetically, bringing pressures to bear on Taiwan and Taiwan's allies might be worth the loss of some money to the Chinese at some point in time.
So my concern is simply this: Global interdependence is one thing; but dependency is another. And it puts us in the position of being somewhat vulnerable to another country's view of their own best interests. And I have real concerns about whether that is in our best interest.
BERNANKE: I will answer your question, but just wanted to reiterate that I think the cost to them of doing this would be greater than the cost to us. That being said, I think a substantial move in that part will be disruptive in the market in the short time.
I think in the longer term that the dollar, the Treasury yield and so on would largely recover. And part of the reason that I say that is that Chinese holdings of U.S. fixed income securities -- which, of course, include not only Treasury but GSEs and corporate debt and other instruments as well -- amount to something less than 5 percent of the outstanding fixed income securities in a global market, which is a very significant amount but is not, by itself, enough to be a monopoly of some sort in this market.
So, if they were to do that -- which, again, I don't anticipate -- it would have short-term disruptive effects. I think that most of those effects would be short-term as the market, which is very deep in liquid, began to adjust to that shock.
BAYH: Thank you, Chairman. My time has expired again. The reason for my question is simply, as a great power, I am reluctant to see us, even for a short duration, to be in a position of vulnerability to the actions of another government. Thank you.
DODD: Senator Bayh, thank you. Those were excellent questions and I appreciate you raising them.
DODD: Senator Allard?
ALLARD: Thank you, Mr. Chairman. We're working on our budget now. And it's a five-year budget. And you have assumed, with the five-year projections, as far as how our economy is going to (OFF- MIKE).
If I remember correctly, you know, you pretty much feel that we're going to have a pretty good economy for the next five years, certainly within the average. Is that correct?
BERNANKE: We haven't released any forecasts of the economy beyond a couple of years. The projections I gave today suggest reasonable growth and inflation over the next two years.
The underlying fundamentals of the economy, in terms of productivity and so on, look good to me.
And so my expectation is that the economy will continue to be strong after that period. But we've not released any specific forecasts.
ALLARD: Now, in 2009, our Social Security surplus begins to decline. And that's the projection that we're looking at now, where we've had the surpluses, but now they begin to reduce.
Is that -- how does that get factored in?
And that's within the next two years. We will be working on the 2009 budget a year from now.
How does that factor into your economic growth projections, or is it too early to begin to have much validity to that?
BERNANKE: It's a bit early to be thinking about that. From a macroeconomic point of view, if we focus on the cash flows of the deficits, current in, current out, it looks like the deficit will not be rising significantly. It may even be declining for the next few years, for various reasons.
And so I don't anticipate that fiscal policy will be a major force shaping the near-term growth pattern of the economy.
The concerns that I emphasized in my Senate budget testimony were really the longer-term issues of solvency and fiscal responsibility in the context of the aging of the population and the large increase in entitlement spending.
ALLARD: The deficit is going down. In my view, it's more attributable -- attached to revenues, not where we've done anything particularly to hold down on spending.
If we do something -- and I don't know how you factor in the expiration of these temporary taxes that have put in place. It looks to me like they've had a positive impact on the economy and the revenues that are coming in.
If those expire, what kind of adjustments do you think we'll have to make in our budget projections from that point on?
BERNANKE: Well, again, I mean, I couldn't take a position on whether they should be allowed to expire or not. I think if they do expire, that they would probably increase revenue somewhat. It would have other effects on the economy in terms of incentives and growth potential, as well.
I think from the Federal Reserve's point of view, we're simply going to look at the fiscal situation as it evolves and make our adjustments to try and maintain full employment as the economy goes forward.
So I think the considerations that the Congress should have with respect to near-term tax policy should be less to do with maintaining short-term full employment. We will, I think, be able to address that; but, rather, think about the long-term tradeoffs between the benefits of lower taxes and the costs of lower taxes, essentially.
ALLARD: I'm going to move over to the small business question. When you look at the economy, it seems -- most of the figures I look at on the small-business sector, they contribute about 50 percent -- 52, 53 percent of the growth in the economy. Is that about what you look at?
BERNANKE: It's similar. The small and large businesses are similar in magnitude and so in that respect you're correct, yes.
ALLARD: So you're saying that the small-business sector would grow -- you think it's 50/50, then, between economic growth from a large business and economic growth from small business?
BERNANKE: I don't recall the exact data, but I believe I've heard that number for job creation as opposed to growth. but it would be similar, yes.
Thank you for that. That was just a point of information. I wanted to see how you were looking at that.
BERNANKE: We can provide you with more detailed information.
ALLARD: I would appreciate that if you could.
The other question is Sarbanes-Oxley. Apparently, there's a rise in private equity firms. And they are increasingly acquiring some public companies and apparently taking them private. Does that phenomenon concern you?
BERNANKE: Not necessarily. It can be a good method of enforcing discipline on corporations and on management. By taking the firms private, they essentially create a situation where the private equity investors have a short period of time in which to create a more productive, more effective, firm, a more profitable firm.
And they usually try to bring the firm back into the public markets. And so it's not, in some sense, an attempt to permanently escape Sarbanes-Oxley because they do eventually want to come back into the public markets.
So, generally, it's a positive development in the sense that it creates more competition for corporate control and should increase discipline among management. There may be some circumstances where the leverage is excessive or there are other problems associated with it.
ALLARD: When I was taking economics in college, I think full employment was considered five percent. Is there a figure like that that most people generally agree is a full employment figure, or are there other variables you have to bring in, you can't use a static number like that?
BERNANKE: There are various numbers that present (ph). The Congressional Budget Office uses, I think, 5.2 percent. But the Federal Reserve doesn't have a fixed number that we use. Again, as I indicated earlier, we try to look at a wide variety of indicators, both of the labor market and of the general economy in terms of prices, for example.
In the past, we have found that the amount of employment the economy can sustain in a long-term basis changes over time. It changes with demographics, it changes with the structure of the labor market, it changes with the structure of industry.
And it's not, I think, good policy to have a fixed number in mind. I think it's important to be flexible, look at all the information that's coming in and try to make an ongoing judgment about how the capacity of the economy is adjusting.
ALLARD: And do you think the unemployment is at a desirable place in the economy right now?
BERNANKE: Well, as I indicated earlier to Senator Bunning, we are certainly much closer to the capacity of the economy now than we were a few years ago. And as we've seen unemployment come down, as we've seen capacity utilization go up, whether we are at that level or not, again, I can't say.
We will be looking at a wide variety of indicators and trying to make a judgment about where the economy should go.
ALLARD: In addition to that, wages have gone up, haven't they?
BERNANKE: Nominal wages have gone up, and we've seen some increase in real wages as well. And that's a good development.
ALLARD: Thank you, Mr. Chairman.
DODD: Thank you, Senator.
MENENDEZ: Thank you, Mr. Chairman.
Chairman Bernanke, I want to start where I started off in my opening comments to you. And I am very concerned about the economic squeeze that has been put on the middle class, particularly since the turn of the 21st century.
Since the beginning of 2001, middle-class families have experienced increased levels of debt, economic growth in real wages. All the while, essential costs for food, housing, medical services have increased at levels drastically higher than inflation.
As a result, the financial security of the middle class has suffered, and more and more American families are unable to afford life emergencies such as an unexpected health problem or unemployment.
MENENDEZ: Unemployment opportunities are at their lowest levels since the Great Depression. Since the recession ended in November of 2001, job growth has averaged a mere 0.8 percent per month, less than a third of the 2.7 percent average growth we experienced in previous recovery periods since World War II.
For the first time since the 1950s, job opportunities have actually decreased, from a 16 percent growth rate in the 1990s to a 14 percent decrease since March of 2001.
I look at that, and I add to that factor that families seem to me to be living on thin ice. I hear these stories of families in New Jersey that are only one unexpected illness or layoff from sinking into perpetual debt.
I think one measure of this economic insecurity is the percentage of middle-class families who have at least three months of their salary in savings. The percentage of middle-class families who had three or more months salary in savings rose 72 percent, from 16.7 percent in 1992 to 28.8 percent in 2001. So families, middle-class families, were becoming more secure, year by year.
But unfortunately, in the span of less than four years, that percentage dropped by over 36 percent, down to 18.3 percent in 2004.
Finally, I noted with interest on page 2, when you were giving your opening statement, you said consumer spending continues to be the mainstay of the current economic expansion. Well, that's true. But when you add that reality to economic anemic growth in wages and sharp increases in the cost of necessities, household debt in America has risen to record levels over the past five years.
By the third quarter of 2006, outstanding household debt was 130 percent relative to disposable income. That means that the average family is in debt of over $130 for every $100 it has to spend.
And, additionally, the average household savings rate has actually been negative for the past seven quarters, averaging about a negative 1 percent rate for 2006.
So I look at all of this, and I say to myself, you know, I have my friends and colleagues who are heralding this great economy. I don't get the sense that people back at home and in other parts of the country feel that good about it. You see it every poll of the barometer of their feelings. They feel really squeezed and really put upon.
And so, my question to you is, isn't these indicators a real cause for concern, as it relates to the struggle that the middle-class families in this country are facing? And how do we create an economy that is more inclusive, in which the macro benefits end up being achieved by those who are the great center of those who keep this country afloat?
BERNANKE: Senator, in my remarks in Omaha, I did the usual economist -- on the one hand, on the other hand -- approach.
On the one hand, average living standards in the United States have risen very substantially since World War II, very substantially. And that's true for the majority of the population. And even in the last 10, 15 years, we've seen on average or even into median, middle parts of the income distribution, we've seen pretty good overall growth -- not year to year, but over a period of time we have seen growth.
So there has been a general improvement in living standards, which has affected a very large part of the population.
That being said, on the other hand there are various issues. As I talked about in my remarks, inequality has increased. We've seen more concerns about job security related to trade and technology, those sorts of issues. Health care remains a concern. People are concerned if they lose their job that they won't be able to afford new health care or move their health care between their existing employer and a potential new employer.
You mentioned wealth. Wealth is very unequally distributed in the United States. I think the big challenge is to help people in the lower part of the wealth distribution begin to save and begin to accumulate assets, so they can have some reserve against the kinds of problems you refer to, like a health emergency or unemployment or some other problem that may arise.
BERNANKE: So my broad answer is that I do think the economy has strengthened over time. I do think that the benefits have been felt by a large part of the population. But there are persistent issues that relate to people's sense of security or insecurity. And there's no single answer, because each of these issues -- wealth creation, health care, inequality are all large issues and the each require individual attention.
MENENDEZ: I appreciate that.
It seems to me that policies that would both in the taxing side as well as in the incentive side and in the programmatic side that would go to narrow these divisions -- you've mentioned education. I certainly agree with you on that. But we've seen educational outcomes rise, and yet we're still seeing inequality rise.
We have a challenge as it relates to how families achieve health care. We have challenges, maybe, policy that incentivizes savings, and find ways to help that segment of the society save.
It seems to me that this is consumer-driven expansion of the economy at some point that the cost of debt has a consequence to it. And so it's a real concern.
One last question, in the written version of your remarks to the Chinese Academy of Social Sciences in December, you referred to China's currency policies as, quote, "an effective subsidy for the country's exporting industries."
I'm just wondering why you omitted that reference in your presentation on December 15th.
BERNANKE: I omitted it because I thought at the time that it would be more clear to my audience there in Beijing if I explained it a little bit differently. But I stand by my written comment. I think it's accurate.
MENENDEZ: Thank you, Mr. Chairman.
DODD: Thank you very much, Senator.
SUNUNU: Thank you, Mr. Chairman.
I want to first begin by going back to a subject that was brought up -- and, I think, inappropriately so -- in the discussion about whether you should -- you, Chairman Bernanke -- should be willing to talk about, quote, "policy" before this committee.
As everyone has noted -- most everyone has noted, you talk abut education in your opening statement. And the suggestion was made by, I think, more than one senator, that while education is policy, and if you talked about education therefore you should be willing to talk about policy prescriptions on the tax side, and, in particular, talk about raising tax rates. And I think a lot of this discussion about income inequality, quite frankly, is a prelude to a policy recommendation from some on the other side of the aisle to raise tax rates on entrepreneurs and individuals in certain income brackets.
Well, I think that that sequence of conclusions is just flat wrong, because it is entirely appropriate for the Fed chairman to talk about education as an input, like productivity or technology.
SUNUNU: Education and technology affect productivity. Productivity affects growth rates and perhaps inflation. That's entirely appropriate.
But it's, of course, not appropriate for Chairman Bernanke to talk about or recommend specific policy prescriptions in the area of education at the state or the federal or the local level, spending on a particular program, particular school vouchers or issues that people on various sides of the aisle might support.
So I think we need to make this distinction. I think it's unfair to the chairman to suggest that because he talks about the value of education, generally speaking, to the workforce in terms of its flexibility, that he should be willing to weigh in on education legislation or tax legislation that members might be writing.
I guess that's the opinion piece, and now I'll go onto my questions. You noted that growth in the second half of 2006 was 2.75 percent. Was that higher or lower than you originally expected, or expected say a year prior, a year out? And why was it higher or lower than your expectations?
BERNANKE: It was close to our expectation. Our assessment was that the economy was making a transition to a more moderate, sustainable pace, which would be something in that general vicinity. It does look that the fourth quarter GDP growth number is going to be revised down, somewhat, and so the actual number will be a bit lower.
But probably the implications will be a slightly stronger first quarter, so it doesn't really change the overall picture, which is that we see the economy growing at a healthy pace, but it's one that is sustainable and not overheated.
SUNUNU: Thank you, and I want to apologize for not presenting the option that you might have been correct in your projection. I suppose that should have been one of the choices.
You noted in your testimony that, "Real incomes should continue to rise." At what rate do you project real incomes to rise over the next four to six quarters?
BERNANKE: Well, it depends on what your definition of income is. We've seen real wages growing the last half of 2006 by about 3 percent in real terms. I hope to see continued strong growth in real wages. I'm not quite sure whether they'll be quite that strong, but I think as long as energy prices don't rise quickly again, I think we should continue to see good growth in real wages.
Broader measures of income should grow broadly at the same pace as GDP, and our forecasts are for something between 2.5 and 3 percent...
SUNUNU: And when you talk about broader measure of income...
BERNANKE: Including capital income and so on.
SUNUNU: You talked about the fact that there was a seven-month supply in unsold homes in the third quarter of 2006. Where do you expect that inventory to go in the next six to 12 months? Has it peaked, or do you expect the inventories to increase further?
BERNANKE: The predicate is that we have seen what we think or what we call tentative signs of stabilization in demand for housing. If, in fact, the demand for housing is stabilizing -- and, again, we won't know that for sure, I think, until we see sales figures in the spring -- then we should see from here a gradual decline in the months for sale inventory.
The normal is, at least for the last eight to 10 years, four-and- a-half months of homes for sale. And my anticipation would be that we would get back towards that general level by the end of next, assuming that demand stabilizes.
SUNUNU: By the end of 2008, not the end of 2007?
SUNUNU: Last question -- I guess the question is: Please explain this to me.
It's one of the charts. And the monetary policy booklet is, I think, very well written and very informative -- no surprise there because you know you have very good staff.
But on page 5, there's the graph of the savings rate, from 1983 to 2006. From 1983 to 2006, we had two recessions, three bull markets, two market crashes. We had rising and falling deficits.
We did have a relatively steady trend in improving employment numbers and lowering of the rate of unemployment, and a fairly strong record of dealing with and containing inflation.
And yet, the personal savings rate -- you know, that chart is steady downward trend, through all of these things.
And I'm curious to know what the factors are that go into that steady decline in savings rate. I mean, we know it means that people are consuming more than they're earning, or a greater proportion of what they're earning.
But what's contributing to that trend?
And is this something that the Fed is worried about?
BERNANKE: Well, you raise a question that a lot of people have weighed in on. It's a complicated question.
I think that several factors have been pointed to. One is demographics. Different cohorts, or different generations have different propensities to save.
The Baby Boomers have not been particularly impressive in that respect. And as they have become the biggest recipients of income, their savings rates have shown through.
SUNUNU: I apologize for interrupting. But have their been an evaluation of the propensities of different cohorts...
SUNUNU: ... currently?
And how much of this declining savings rate can be attributed to that one cohort?
BERNANKE: Well, there have been a number of papers. And we'll be happy to send you a few surveys or summaries of some of the research that's been done.
A number of papers have looked at this demographic issue and viewed it as being important, although not necessarily the whole story.
The other important part of the story is that personal savings rates are out of current income, and they do not include capital gains of any kind.
So the general strength of the stock market and then, more recently, of the housing market has meant that people could increase their wealth without saving.
And that has been, I think, an important factor in leading to lower savings rate, you know, more recently.
The other, sort of, technical point to make is that private saving actually consists of the sum of the household of personal saving, together with the savings done by corporations.
And savings done by corporations has become a larger share of the private saving done over all.
And in a sense, though, that is -- the corporations ultimately belong to the households, whether you're a small-business owner who's keeping profits in their business, whether you're an investor who's receiving -- who's enjoying capital gains in their stocks, some of that saving is not appearing in households because it's taking place in corporations.
It's, sort of, a measurement issue. But I think it is an issue because the national saving rate has come down. And it contributes to issues like the current account deficit we've talked about.
Our anticipation, as I've even mentioned in the testimony, is that the household saving rate should rise a bit in the next couple of years, partly because housing prices are not rising as fast, and people will turn back to saving from their current income.
But we don't anticipate anything like the 12 percent in 1985 anytime soon. It's going to be a slow process.
SUNUNU: Thank you very much. I thank you, Mr. Chairman.
And I would note, since I'm not a member of the Baby Boom generation and you are, that I'd look at every possible opportunity to blame something bad on your generation.
DODD: Well, you haven't proven you're part of the greatest generation either, yet.
And I'm just going to note: I've been on this committee some 25 years.
DODD: I recall with great fondness your predecessor appearing here on numerous occasions. And I can't recall specifically the members who may have raised it, but the number of times Chairman Greenspan was asked to support specific tax cut policies was rather frequent on the committee. So this was not a first-time occurrence a policy question was raised of the chairman of the Federal Reserve.
BERNANKE: But my point is that he would never answer the question, and that was the right thing to do.
DODD: And I suspect my colleague from New Hampshire may have been one of the people who asked those questions a lot.
I was just going to note, as well, on the savings rate issue here, I'm told, and maybe you can correct me on this if I'm wrong, Mr. Chairman. But the last time we had a negative savings rate of this magnitude, it was the Great Depression. Is that correct, historically?
BERNANKE: I think that's correct, yes.
DODD: Someone mentioned to me the other day as well that, of course, consumer debt issues are staggering, and at least the revolving debt, a good part of which is probably credit card debt, on the average is around $9,300 per individual. Does that number ring true with you?
BERNANKE: I don't know the number for revolving debt specifically. The incidence of debt issues varies quite a bit across the population. For a good bit of population, particularly those with higher incomes, there's been asset accumulation which offsets the debt.
So, in particular, the average -- over the economy as a whole, the average loan-to-value ratio for homes is about 50 percent, that is, the mortgage companies own half the housing stock and the public owns half the housing stock.
But there are certainly segments of the population who are facing very high debt loads, either through the mortgage borrowing or through credit card and revolving debt. For them, it's obviously a hardship.
TESTER: Mr. Chairman, I do have questions, and I do hope to ask them, but my comrade, Senator Brown, has a commitment, and I'll defer to him for now.
BROWN: I thank my friend from Montana. Thank you, Senator Tester.
Chairman Bernanke, in your remarks, and last week in Omaha, you noted that our policy responses to economic inequality must be informed by our ethics and our values, and are ultimately political questions.
You said a moment ago that inflation was the canary in the mine. I, for five or six years, wore a depiction of a canary in a cage on my lapel to signify sort of the government's role in everything from mine safety to the environment to minimum wage to Medicare.
You also express -- and I think that the ethics and values in our domestic economy, I think that those ethics and values are reflected in what we do in our domestic economy, like the canary in the cage. It is minimum wage, and it's Medicare and it's Social Security and it's helping the middle class thrive, as it has done in the last 100 years.
And there has been clearly a consensus in this country, differences on the edges, perhaps, but a consensus that those ethics and values drive what we do in our domestic economy.
Seems to me, those values and ethics don't stop at the water's edge, that as a nation we should continue to propagate and promote those same ethics and values as we've done in our country in our policies and our domestic economic issues, we ought to look at those internationally.
I know you express concern that inhibiting trade flows would do more harm than good. But I would argue that if our country is, in fact, going to live its values and going to live the ethics that we discuss and that we sometimes pat ourselves on the back about, that we would look internationally in some of those cases.
And I would just start by asking if we have -- as a nation, our values say that we shouldn't buy products manufactured by slave labor in China. Do you agree with that?
BROWN: OK. And then, would you say then that we shouldn't import products made by child labor?
BERNANKE: Yes. I agree that we should not.
BROWN: OK. Then, I guess that would be -- the next step would be we should not import products produced by sweatshops, in sweatshops, if we, in fact, can agree on a workable definition of sweatshops.
BERNANKE: Well, that's a very difficult -- that's a very difficult qualification you just added at the end.
Just to get where you're going, I think it's probably not a good idea to try to enforce western level standards of worker benefits in emerging market countries, the reason being that since those workers are such low productivity that if we were to insist on the same standards we have in the United States in terms of benefits and the like, that the workers would either have very low wages or no job at all.
And I think the way to get to the kinds of living standards we have in America is to allow people to participate in the market, and to produce.
BERNANKE: We in the United States, of course, have come a long way starting from situations where workers did not have very good protections to a situation now where we have much better protections...
BROWN: Mr. Chairman, if I could, we also didn't have a foreign government implanting on us an economic structure with foreign investment and that international economic structure we have.
Let me take this in a little bit different direction. I agree, we should not impose -- we should not have imposed under NAFTA or CAFTA a minimum wage -- the minimum wage we have in the United States. Of course, we should not have imposed it on Guatemala.
But these are not Western -- when you talk about International Labour Organization standards -- that's an arm of the United Nations, I believe. And that's not Western economic standards.
And would you, then -- does that mean, then, you would support -- looking more internationally, would you support International Labour Organization standards in these trade agreements that we negotiate?
BERNANKE: I believe those standards come in many different levels. And there are literally hundreds of them...
BROWN: There are five central International Labour Organization provisions and standards. There are questions within those, but the right to organize and bargain collectively, the prohibition on forced labor, the prohibition on child labor; those kinds of general standard that we have not -- we did in the Jordan trade agreement, but we have not in the last six or seven years.
Is that a policy question reflecting our ethics and values that we should pursue?
BERNANKE: I think it is. I think I would be reasonable to look to basic human rights, such as slave labor and forced labor. I think those are, you know, not something we want to countenance.
When it becomes a question of whether we should require a minimum wage, for example, it's a much more difficult issue.
BROWN: And that's not one of the ILO standards.
OK, fair enough.
Let me shift for a moment to industrial loan companies briefly. As you know, the FDIC has extended for one year a moratorium on commercial firms like Wal-Mart owning a bank through an ILC charter. This committee, Congress (inaudible) just a short time, have a year, to address the important issues involved before the moratorium expires.
Do you have any concerns on the, sort of, uneven regulatory structure between banks and what would be -- perhaps be an unlimited number of commercial firms owning ILCs?
BERNANKE: The Federal Reserve is concerned about an unlimited expansion of the industrial loan company exception. We have two particular concerns, which we've talked about on a number of occasions. First is the mixing of banking and commerce.
The Congress in Gramm-Leach-Bliley and other contexts have expressed its desire to keep banking and commerce separated.
BERNANKE: I agree with that, and I think that's an issue for the Wal-Mart acquisition, for example.
The other concern is about consolidated supervision. If there is an acquisition of an ILC by either a commercial or non-commercial firm, I think it's important that the oversight of that combined entity be done at the higher level to be sure that there is sufficient financial strength in the holding company to ensure the safety of the deposit insurance funds for the ILC itself. So those two principles, I think, are important to keep in mind as we debate this question.
BROWN: Thank you.
And, Chairman Dodd, Senator Johnson, as you know, has been very involved in the ILCSU.
BROWN: And we clearly, in this committee, need to pursue that.
Thank you, Senator Tester, very much.
DODD: Thank you very much, and I'm sorry Senator Bennett wasn't here to engage. I know he has some strong interest in this subject matter.
And I was going to give you the opportunity -- I think Senator Brown for raising the question. There's been some issue about whether or not turf issues have been raised. And I want to give you a chance to respond to this.
And some have suggested that the reason the Fed has taken the position it has is because it's an area of jurisdiction that they'd like to have.
I think I know the answer to this question, but what is your response to that particular concern?
BERNANKE: If the ILC exemption is limited and not allowed to expand indefinitely, we are perfect comfortable with the FDIC doing the consolidated supervision, and we think they do a very good job.
DODD: Thank you, Mr. Chairman, very much.
CRAPO: Thank you very much, Mr. Chairman.
And, Chairman Bernanke, we appreciate you being here with us.
I want to return to the global competitiveness issue for a minute. I know that others have spoken to you about this already. And first and foremost, I want to commend Senator Schumer for working with Mayor Bloomberg for the McKinsey report.
There's also, as you know, the new interim report of the Committee on Capital Markets Regulation, and both of those reports, I think, add significantly to this debate and to the issue.
I'm working on a resolution, and talking with Senator Schumer about it as well, and hope to be working with him on a resolution to help highlight this and to express the sense of the Senate about what steps we need to take in terms of better dealing with our global competitiveness.
And what I want to focus my questioning on with you is derivatives and hedge funds. And I'll start by noting that in the McKinsey report, this following quote occurs: "London already enjoys clear leadership in the fast-growing and innovative over the counter derivatives market. This is significant because of the trading flow that surrounds derivative markets, and because of the innovation these markets drive, both of which are key, competitive factors for financial centers.
"Dealers and investors increasingly see derivatives in cash markets as interchangeable, and are, therefore, combining trading operations for both products. Indeed, the derivatives markets can be more liquid than the underlying cash markets.
"Therefore, as London takes the global lead in derivatives, America's competitiveness in both cash and derivatives flow trading is at risk, as is its position as a center for financial innovation."
Would you agree with that portion of the McKinsey report?
BERNANKE: I agree that derivatives are an incredibly important part of our expanding financial market, part of financial innovation, and I would like to see the United States remain competitive in those areas.
CRAPO: And so you think it would be appropriate for us to focus, in this Congress, on things that we can do or not do to assure that we remain competitive or that we become more competitive in those arenas?
BERNANKE: Again, I think the best way to be competitive is to make sure that your regulatory structure has minimal costs as needed to justify the benefits that seem to be attained from those regulations.
CRAPO: Well, one of the common themes that we are seeing, in terms of the movement of business away from the United States to London and other capital markets, is just that, the regulatory burdens and the regulatory regime that we impose here in the United States.
And I don't think anybody would say that we should simply take down our regulatory position, because we do have one of the strongest markets in the world.
But the question is: Are we over-regulating?
And I want to go specifically to an issue that you and I have talked about many times before, and that is the regulation of energy derivatives.
As you know, we've faced proposals, in Congress, in the Senate, now, for the last four or five years, to increase the regulatory climate around the handling of energy derivatives.
And there has yet been another bill introduced, just yesterday or today, I think, to do the same thing. So we're back into this same issue.
And you've expressed a position on this in the past. I have in front of me the last letter that was put out by the president's working group, of which you are a member.
And the last paragraph of that letter says, "Several times in recent years, the PWG has been asked for its views on various legislative proposals to expand regulation of energy derivatives. Most recently, in testimony before the Senate Banking Committee on September 8, 2005, representatives of the PWG agencies reaffirmed the position of the PWG that additional regulation of energy derivatives is not warranted."
Is that still the position of the PWG, and is it still your position, that we do not need to further increase the regulatory regime surrounding energy derivatives?
BERNANKE: The PWG has not discussed it recently, but I have no reason to think the position has changed. I believe it's a reasonable position, that we should be very careful about additional regulatory costs in this market.
There are two reasons to regulate. Potentially, one is inventory protection. But in this market, of course, we have very large institutions, very sophisticated institutions who are, I think, able to take care of themselves.
The other would be a concern about price manipulation. There the CFTC does have, of course, ex post powers to investigate potential frauds and manipulation.
But it seems unlikely that manipulation, in most cases, would come from the OTC market, since the exchanges provide a good venue for determining prices.
So I have not changed the position I expressed before.
CRAPO: Well, thank you. And I appreciate you sharing that with us. I suspect that we'll be asking the entire PWG to reevaluate this issue, since we now have legislation, yet again, introduced on the issue.
So I'll just give you that advance warning that we'll be coming to you for some guidance as we once more enter into this debate.
Just one last question: Moving a little bit to hedge funds, can you explain what is involved in fostering market discipline in the hedge fund context?
And it's my understanding that you believe that that is a superior approach to direct regulation.
BERNANKE: That's correct, Senator.
The proposal of the president's working group, once again, in their report following the LTCM crisis, focused on the so-called indirect or market-based of hedge funds.
And that has essentially two components. The first is the works through the counterparties. That is the investment banks, or the banks, who lend money to the hedge funds or service their prime brokers.
The supervision process requires that these large counter-parties manage their counterparty risk effectively. That is that they have good information about the risks being taken by the hedge funds, their financial positions and so on.
BERNANKE: And it is both in the interests of those counterparties, obviously, that since they don't want to lose money, that they pay close attention to what their counterparties are doing. And the supervisors give addition encouragement and incentive for the counterparties to manage those risks effectively.
The other type of counterparty is the investor himself or herself, particularly large institutions like endowments or insurance companies and the like, which also provide a good bit of market discipline on the hedge funds by gathering information as they make their investment decisions.
So we believe that's a very important and, so far, successful method of overseeing hedge funds. I would be very reluctant to get involved in heavy-handed, direct regulation of hedge funds.
They are a very diverse group of institutions. They have a wide variety of strategies, and one of their key characteristics is that they're very nimble. They change very quickly, and that's good for the economy, because they help to create more liquidity in markets. They help to spread risks around more broadly.
And a regulatory regime that inhibited that flexibility and nimbleness would eliminate a lot of the economic benefits of the hedge funds and the other types of private pools, the capital that use sophisticated instruments to share risk.
That being said, it's always useful for regulators, supervisors to keep abreast of what's happening in the hedge fund market, to speak to hedge fund managers, to understand recent developments.
The G-7, a meeting which I attended over the weekend, in the spirit of information gathering, proposed that the Financial Stability Forum, which is an international group consisting of central bankers and supervisors, update a report they did in 2000 about the status of this market.
And I think that's consistent with us simply trying to keep up our information base that we know enough, just so that we are keeping up with developments in that industry.
CRAPO: Well, thank you very much, Mr. Chairman, and I want to just say, personally, I appreciate your candor and the candor that we get from the president's working group as we face these kinds of issues. The expertise that you and the other members of the working group can bring to the issue to help us evaluate them is invaluable. And so thank you for providing that.
DODD: Those are great questions, Senator. I appreciate you very much raising them as well. Very well done.
TESTER: Thank you, Mr. Chairman, and I also want to thank Chairman Bernanke for being here today and being forthright in your answers. It's very nice.
The reason I want to stick around ask these questions, quite frankly, is because I value your opinion. It's not for political reasons. It's not for anything other than I want to know your perspective, because, quite frankly, from my perspective of being a farmer in north central Montana, there's a lot of things that are just flat backwards in this country right now.
And so the first thing, the first question I wanted to ask is, what is the number one factor that concerns you as a potential impediment for our economic growth here in this country?
BERNANKE: Well, over the medium term, it's the demographic transition that we're going through. We're getting older. Our society is aging. We're going to have a much larger share of the population in retirement age or even in the oldest of the old, 80 and 90 years old.
And we haven't really made good preparation for that, either in terms of broader savings in the society or in terms of fiscal policy, which I've discussed in previous context.
TESTER: Does the $8.6 trillion debt fall into that issue then, or is that somewhere else?
BERNANKE: Well, it's closely related because if we don't take some measures to address how we're going to deal with the fiscal implications of an aging society the debt and deficits are going to grow. Interest payments on those debt and deficits are going to grow, and we'll be in an unsustainable fiscal situation. So the fiscal picture is closely linked to the underlying demographic changes that are going on.
TESTER: I've had a tough time struggling with it because, quite frankly, tax load is something I'm very concerned about too, as I think everybody on this committee is. But the debt load concerns me too, very, very much.
Could you rank them as what could be the most severe impediment? Is it the debt load, or is tax policy that's flawed?
BERNANKE: I don't think I can rank those. The main concern would be that Congress has to decide, you know, how big the government is going to be and what share of national resources are going to flow through the government, either for government spending or through entitlement programs.
BERNANKE: The tax collections need to be commensurate with that, and that's the main decision. I'm not qualified or in a position to tell you how big that share should be.
TESTER: OK. Foreign investment -- I hear occasionally on TV, I hear from some of my constituents in Montana that those folks that are able to save some dough are being encouraged to put a certain percentage -- I think 20, 25 percent is what I'm hearing -- into foreign markets. Is that a concern?
BERNANKE: No, not necessarily. Foreign markets have strengthened considerably in terms of their quality. Clearly, the world is experiencing a lot of growth and so there are a lot of opportunity out there. And by investing broadly, an investor diversifies his or her portfolio and reduces the overall risk that they face.
TESTER: How about from an economic growth standpoint here in this country? I think from an investor standpoint, I hear you. But what about an economic growth standpoint here? Is it a negative factor, positive factor, or no impact?
BERNANKE: I think it's probably slightly positive in the sense that it gives American investors greater diversification. Implicit in your question is, well, what happens, where do we get the funds for domestic investment? Well, they flow in from abroad, and so by swapping, essentially, between foreign and domestic investors, you get better diversification for everybody.
TESTER: Sounds good. Last question, and this deals with employment versus inflation. It's been talked about here a lot today, but when we get near full employment, does that necessary drive inflation up?
BERNANKE: There's no specific level of employment of unemployment that is a trigger, in some sense, for inflation. The main concern is to make sure that the overall spending in the economy, which is driven, in turn, by financial conditions, doesn't exceed the underlying productive capacity for a sustained period. That tends to generate inflation.
But as I've mentioned a couple of times, it's not easy to determine exactly where that balance should be struck and simply looking at the unemployment rate, for example, is not going to tell you. You need to look at a wide variety of indicators, including price indicators, to get a sense of when the economy is overheating and when it's more of less in balance.
TESTER: That's great. And that's actually what I was hoping to hear, so we should be continuing to strive to make employment complete, full, to the best of our ability.
BERNANKE: Certainly. The Federal Reserve has a mandate for maximum sustainable employment.
BERNANKE: And we certainly want to achieve that. We don't want to achieve employment which is high for a short moment but then crashes.
BERNANKE: We want something that's sustainable.
TESTER: Exactly. Well, once again, I just want to go back -- thank you, Mr. Chairman. I think this has been a great hearing.
And I want to thank you, Chairman, for your honest and forthright answers. Thank you very much.
DODD: Thank you, Senator Tester, very good.
REED: Well, thank you very much, Mr. Chairman. Again, thank you, Chairman Bernanke, for your testimony. And I was very impressed, as so many of my colleagues were, with your speech in Omaha.
I thought it was thoughtful, comprehensive and balanced, which is typical of your leadership at the Fed.
At least one phrase or section struck me as interesting. And that is, you talk not only about technological change and international trade as causing this divergence between equality of incomes. But you also talked about institutional arrangements.
And the principal one you alluded to was labor unions. And you say in your speech, whatever the precise mechanism through which lower rates of unionization affected the wage structure, the available research suggests that it can explain between 10 percent and 20 percent of the rise in wage inequality among men during the 1970s and 1980s.
I would suspect, if it's 10 percent and 20 percent in the '70s and '80s, it's at least that much now, perhaps more, since unions have declined since that period of time.
It begs the question, you know, is one of the responses to wage inequality, a more robust representation of the labor unions in the United States?
BERNANKE: It's difficult to know the answer because, as I indicated in the remarks, there have also been structural changes like changes in the share of manufacturing employment in the economy as a whole which have affected the rate of unionization.
It's a little hard to tell whether it's the decline of unionization itself or the structural reasons for that that are the causes of the inequality.
I do think that, if workers want to be represented by a union, of course, that's -- they should be allowed to do that.
REED: One of the issues here is that this is not just, sort of, the hidden hand of the marketplace and technological change. There's government policies, policies which, until recently, one might say favored more -- encouraged more participation in unions.
Policies pursued by this administration seem to go against it, the National Labor Relations Board, court decisions, congressional activities.
So this is an area, too, I think, that should be on the table, I presume, in terms of, at least, consideration by the Congress, if we're really concerned about narrowing this gap in terms of the economic equality.
Is that a fair statement?
BERNANKE: Well, again, there is the problem of deciding how much of the effect comes from the structural changes that underlie the changes in unionization patterns and how much comes from changes in unionization propensity itself.
So I don't really know how much effect that would have.
REED: Well, I think you've opened up a very serious line of inquiry, and I applaud you for doing that. Because, once again, I think this is an issue that is there.
REED: And maybe -- anecdotally, I grew up in a state where everyone seemed to be in a union and they seemed to make pretty good wages and had health benefits, and now that is declining dramatically. And that, I think, contributes to this anxiety we've all referred to.
Today, of course, I alluded in my opening statement, 13,000 workers from Chrysler -- presumably, I would guess with some sense of probability that they're all union workers -- are losing their jobs and probably will not find union employment again.
So I think this is something we should consider and, again, I think mentioning it in your speech opens up a line of inquiry that's important.
There's another issue too, that you talked about sort of, and we all talk about the average income being stagnant for many working Americans.
There's something else that I'm hearing, is that the volatility of incomes for individual Americans fluctuates so widely and causes huge problems. You could be a vice president for sales in a jewelry manufacturing company in Rhode Island making a handsome salary of $100,000. The next year you're making $35,000 because you're working at a lumberyard doing -- that seems to be more common these days.
And, again, you know, it gets lost in the aggregate, but for individuals, we have to do something. Do you have any first thoughts about this phenomenon?
BERNANKE: Well, it's an issue that's been raised by Mr. Hacker (ph) and others. And I have a footnote on it in my speech about some of the impact it might have on measures of inequality. It's a little bit mysterious exactly what the source of this is. It could be, more or less, benign things like job changes and so on. It could be less benign things like periods of unemployment or health problems.
There doesn't seem to be an increase in this pattern. In the '90s, if anything, it seemed a little bit less volatile in that respect. There's no data that I know of for the most recent years.
So it's a little bit of a black box, a little bit not clear of what the policy implications of that volatility should be.
REED: By the way, anyone who has footnotes to this speech, you should be commended, so you're commended on that.
Is this an area of inquiry though, that you intend to pursue at the Federal Reserve in terms of this volatility, as well as the aggregate income levels?
BERNANKE: Well, we looked at that in preparing the speech, and we did discuss it. And we weren't, again, able to come to a strong conclusion about what the policy implications might be and so we didn't highlight it in the remarks.
REED: I know that you are -- and I think you do this very well -- weary of making endorsements of, particularly, policies. But in your speech, you did allude to some policies that should be considered.
So in the spirit of what we should be considering, you talk about portability of health and pension benefits as one area. There are other areas, for example, wage insurance proposals that have been made. Again, rather than taking a position, is that something that we should be considering?
BERNANKE: The general principle I was trying to address was the insecurity that people feel about job loss and job change. And I think it would be beneficial if we could reduce that insecurity. One way to do that would be to increase portability of benefits across jobs. There are many ways to do that, so I'm not taking a specific means.
Wage insurance is an interesting idea that's been advocated by a number of economists. Again, I'm not sure I can take a specific position on it. One of the things I have said, and I should reiterate, is that it's easy enough for me to say we should address these issues.
The actual implementation is quite difficult. These are very complex problems, and I just urge Congress to look at them and to try to get as much good input and advice as they can in thinking about how to best address these issues.
REED: A final issue, which is the earned income tax credit, which seems to me to be a very efficient way to deal with this issue that's been the constant source of discussion this morning -- inequality of wages, inequality of opportunity -- is that something that we should be looking at seriously to expand it or to...
BERNANKE: Well, I was asked in the past about the minimum wage. And I, at that time, said the earned income tax credit had some advantages, compared to the minimum wage, and that it was better targeted to the poor, to the lower-income people. And I still believe that to be the case.
BERNANKE: Of course, like -- you know, it doesn't come without costs. But I think it does have some advantages.
REED: Well, thank you very much, Mr. Chairman. Thank you.
DODD: Thank you.
CARPER: Chairman, I'd like to say that we've saved the best to the last. It's probably not true, but I may be the last, and I figure it's probably blessed relief.
Thanks for coming today. Thanks for sharing your thoughts with all of us and responding to our questions.
Senator Reed mentioned an announcement earlier today by DaimlerChrysler. They're taking steps to cut their workforce by, it sounds like, by as much 13,000, across the country.
Sometimes we listen to those announcements and they don't strike very close to home.
In our case, in Delaware, they do. We have a DaimlerChrysler assembly plant we've had for over 50 years, in Newark, Delaware, close to the university. And so this one is one that's -- it's troubling to us.
Having said that, I want to ask you a question. I'd just (inaudible) my pitch, and then I want to say a couple of other things.
But I'm going back and talk to rates, an issue that the leaders of the Big Three -- G.M., Ford, Chrysler -- raised with President Bush two months ago, when they came to Washington.
Among the concerns that they raised was concerns about whether or not the Japanese are manipulating their currency in order to make their products more competitive in this country. So that's where I'm going with this.
But with respect to our own state, we build all the Dodge Durangos and the Chrysler Aspens at our plant. We have a reputation for doing a good job, and have had for a long time.
About 14 years ago, literally the month I was elected governor of Delaware, November of '92, our friends at General Motors announced that they were going to close their assembly plant in Wilmington, Delaware, along with a bunch of other plants, assembly plants and parts plants across the country.
They ended up closing, I think, just about all of them, except this one. And Wilmington, Delaware is one of two auto assembly plants that's still operating on the East Coast, when, I think, the Ford Taurus plant down in Norfolk is going to close fairly soon.
Then it will just be two plants, and one is the G.M. plant in our state. The other is the DaimlerChrysler plant.
Our friends at DaimlerChrysler have announced today that they're going to go back to (inaudible) our plant in Newark. They're going to prepare to idle the plant at the end of 2009 if we don't have a new product for the plant then. Then the plant might close, which is worrisome to us all.
But we've seen this movie before. And we didn't just wait for the inevitable to happen. We fought very hard to make sure that it didn't happen. And the workers at G.M., labor and management folks did a great job. I hope the state did as well. And we averted what could have been a bad situation. Now, they have a very successful operation there.
There are a number of things, I think, that can be done. And this question, sort of, relates to how do we revitalize manufacturing in our country, particularly auto manufacturing, which I hope we can do, and think we ought to.
But there are a number of things, in my own view, that can be done and should be done.
I'll just start with Chrysler, and then I'm leading up to monetary policy.
CARPER: The folks at Chrysler, they've got to make vehicles that people want to buy. They've got to make vehicles that are energy- efficient, environmentally friendly, have good quality.
The people at Chrysler, they've got to go do what Toyota has done very well with its flexible manufacturing where the people of Toyota make maybe three, four vehicles at a plant and if the demand for product A is stronger than B, they make more A. Product C gets hot, they make more C.
They usually have a fourth vehicle that's a pilot vehicle that they're getting ready to develop and to sell when it's time to launch it on the market. So there's a lot of things that DaimlerChrysler can do. Those are some.
There are things that we can do at the local level in Delaware or any other state. The fact that announcements like this can take a page from what happened at what happened at our G.M. plant and be more committed to quality, more committed to productivity, more committed to good labor-management relations, more committed to innovation and willing to work and think outside the box. And we did that 14 years ago, and we need to do that again here in our Newark plant.
The state can work even harder to provide a nurturing environment for manufacturing jobs. There's a lot we have done and there's more that can still be done.
And at the federal level -- and I'm finally coming to my question for you, but at the federal level, we do a fair amount with R&D. The president has proposed in his budget significant investments in research and development with respect to new battery technology, these lithium ion batteries that can be used for plug-in hybrid vehicles, flex fuel, plug-in hybrid vehicles which I think is a very promising technology.
We have an opportunity to use the government's purchasing power on the civilian side and on the defense side to help commercialize technologies that have a great deal of promise, whether they're variable fuel, flex fuel plug-in hybrids or next generation hybrids or low-emission diesel.
We have tax credits in our law. We have a tax credit for folks who buy highly energy efficient hybrids and it caps out at 60,000. After 60,000 units have been sold by a manufacturer, I think that tax credit begins to go away. But until it does, there's a tax credit that can incentivize people to buy highly energy efficient hybrids.
We have sort of a mirror tax credit that not many people know about but they're going to be learning about, that works on the diesel side, highly energy efficient, low-emission diesel which DaimlerChrysler is beginning to bring onto the roads here -- also qualifies for a similar sort of tax credit.
We can do better work on the health care costs and harnessing information technology and all kinds of things to work on the health care side.
So those are things that are something for the people at Chrysler to do, DaimlerChrysler to do, state and local at the plants, plants themselves that are put here in harm's way, and there are opportunities for the federal level.
Now to you. The folks who run these three companies -- G.M., Ford, Chrysler -- suggested to the president that the Japanese were manipulated the currency. And Secretary Paulson was there, pushed back and said no. In fact, we talked about this here in the last month, and he said, "No, I think they are. Maybe they were at one time, but we don't think they are today."
There was a time not long ago when the Japanese economy was in such a funk, they were going through deflation and we wanted them to sort of take strong actions to change that.
But sort of fast-forwarding to the present, what's going on? Are these concerns, allegations, are they baseless? Is there some basis to them? Is this something that we ought to be mindful of, concerned about and do something about? Please.
BERNANKE: The Treasury and the Federal Reserve have expressed a view that exchange rates ought to be determined in free and open markets. As best as we can tell, the yen's value is being determined in a free, open, competitive market. There is no evidence of any intervention going on. The last time the Japanese purchased dollars was in March 2004.
The behavior of the yen appears to be consistent with the monetary policies they're conducting, which, in turn, are closely related to the state of their domestic economy. So we don't see any manipulation or intervention in the value of the yen.
CARPER: How would we know if they were doing it?
BERNANKE: Well, we can see it, for example, in the case of a China, where there is very closely managed exchanged rate, it moves very slowly, and there's large capital inflows. In order to maintain the yuan within the range that they're trying to achieve, they have to acquire huge amounts of reserves, and they have to sterilize the effects of those reserves on the domestic money supply, and so there's a very clear type of behavior that we can see.
Now, it's true that there are many factors that affect the value of a currency, to my knowledge, there are no overt interventions of any such factors affecting the yen at this time.
CARPER: And my last, if I could, just in closing, if you're giving advice to auto manufacturers, domestic auto manufacturers, to what to do to regain market share to return to profitability, what are some of the steps that you would suggest that they and we take?
BERNANKE: Well, you make a number of good points, and one of them, I think, is R&D. It's not really true that U.S. manufacturing is disappearing. That's not the case. The output of U.S. manufacturing has grown more quickly than almost any other industrial country in the last 10 years, and it's been supported by enormous increases in productivity, which is one of the reasons why we need fewer and fewer workers but the output continues to rise.
BERNANKE: The other feature of U.S. manufacturing is that it has shifted very much from lower-tech type productions to most high-tech type production. We see that in airplane exports and sophisticated capital equipment, in medical equipment, silicon chips and so on, things that we currently export.
And, indeed, one more point, one effect of that has been that the demand for labor in manufacturing has shifted very dramatically from low-skilled workers to the highest-skilled workers.
One of things that has really supported those successful areas of manufacturing has been our leadership in R&D and technology. And the government can support that in various ways, among them, helping to support basic research which may not be in the interests of any specific company to undertake on its own, but with government assistance or government coordination, the industry as a whole can undertake and find, in the case of automobiles, new fuel-efficient technologies, for example, or other changes that make the cars more attractive.
CARPER: Mr. Chairman, you've made good with your time. Thank you, Chairman Bernanke.
Thank you, Mr. Chairman.
DODD: Thank you very...
CARPER: That's probably good advice not just for auto manufacturers, but for people running for president.
DODD: Hey, or any office for that matter.
CARPER: There you go. Thank you.
DODD: The basic research point is an excellent one, and I don't have the numbers on the top of my head here, but the decline of the United States government's commitment to basic research has dropped precipitously, I think, over the last number of years.
DODD: It isn't something that occurred in the last couple of years. And I'm pleased to hear you say that. That's something we don't pay enough attention to, and how much we've benefited, over the years, for applied research to live off the basic research commitments we've made in the past. So it's worthwhile.
If I can, Mr. Chair, just a couple of points I wanted to raise with you. And I thank my colleague from Delaware for his comments.
Just a couple of clean-up things: I mentioned earlier, to the issue of -- of the issue we had in the hearings on the predatory lending issue, we didn't bring up GSEs today.
My colleague from Delaware has a strong interest, as I do, and we're going to move fairly quickly here on a Senate bill. It's an important issue, although I think things are in pretty good control. It's not as if there's some immediate threat out there. There are a number of things we need to do doing. And we intend to move in that direction.
One of the things I want to raise with you -- because, with Fannie Mae and Freddie Mac, it is the purchasing of some these arms that are pretty abusive.
I mean, understand that these things here -- the broker and the bank is out of it pretty quickly, 10 to 12 weeks. These things are bundled and then go up -- securitized.
And the fact that Fannie and Freddie are purchasing these at a pretty high standard, at double layer or triple layer, whatever the standard is they're applying to them concerns me in a sense.
And one good way to begin to try and reverse some of these practices, in addition to what regulators may be able to do, is to have some different requirements here, in terms of the securitization of these products.
I wonder if you have any comment on that at all you'd care to share.
BERNANKE: I'm not quite sure about how one distinguishes so- called legitimate arm products from those which may be less legitimate. If you could do, then that would be the direction to go.
I think, more broadly, that it would be a good thing for the GSA portfolios to be more consistent with their housing mission.
According to OFHEO, the GSA portfolios are only 30 percent related to affordable housing. The rest is all different other kinds of things.
So, to match their mission with their portfolios would be, I think, very desirable. The specific suggestion you make would require -- might be feasible but would require some way of determining which types of loans are to be acceptable or not.
DODD: Well, I just wanted to raise that point with you. Let me come back, if I can, to the points that Senator Carper was raising, about trade and foreign governments.
It was reported yesterday -- I've heard this again from some of the other witnesses -- from some of the colleagues this morning -- that our trade deficit has now reached a record $763 billion last year.
DODD: And that's the fifth straight year that we've had a record trade deficit. The Wall Street Journal reported that -- and I'm quoting -- "Following yesterday's report, economists on Wall Street said the government later this month would likely lower its final growth estimate sharply for the fourth quarter."
And in order to finance our trade budget and current account deficits, we're required to have an influx of something in the neighborhood of a little less than $2.5 billion of foreign capital on a daily basis, as I'm told.
Now, some have argued that this is all right and it's no great threat because it's coming from the private investors offshore. But in your report, the Fed states -- and I quote it here -- it says, "On net, private foreigners purchased few U.S. treasuries." The obvious question is, then it's governments who appear to be buying them. I put that upon request. I shouldn't make that statement.
Is it your conclusion that the decline in private investors here, it is governments that are purchasing this?
BERNANKE: Governments are purchasing an important -- are you referring to private foreign investors or private domestic?
DODD: Yes, private foreign investors.
BERNANKE: Private foreign investors are still holding significant U.S. assets, but it's true that acquisition of treasuries and other fixed-income instruments to the purposes of foreign reserves are an important component of the inflow.
DODD: Well, the end of the in was, in fact, that "foreign direct investment flows in the United States remains robust." So, again, it's that public commitment that we're relying on at this particular junction. So it's not so much the private foreign investor, it's the governmental investor that we're...
BERNANKE: We can send you some numbers. I think there's -- it depends on the instrument. Foreign and private investors are more likely to buy equities, for example, than central banks.
DODD: Well, going back to the issues raised earlier about trying -- again, the question is a good question Senator Carper was raising. He talked about the yen, and I agree with your answer on the yen, based upon what I've known. It's troubling that something we have to cost, like a health care cost, I think in a G.M. automobile is $1,500. I think someone has made that conclusion. In a Toyota, it's $150.
So in addition to what other factors may exist out there, we have got some built-in costs that I think have contributed to the lack of competitiveness in some cases in our American-produced automobiles.
But there's an issue of China's manipulation of their currency. What would you recommend if anything at all? I accept the fact that they're getting better, and I heard what you say, is that's the case.
But we get this all the time. When Senator Carper and I go back to our constituencies, one of the first questions that come up, if we get into any discussion of economics at all, is this issue.DODD: And I'm just wondering if we're not doing enough or there's something else we could be doing to take what you said here and call it what it is.
I agree with you. It is manipulation of their currency. There's no question about it. And what do we do about that?
How do we respond to this?
BERNANKE: Senator, I didn't use the manipulation.
DODD: I thought I heard you say that.
BERNANKE: No, sir. If I did, it was a mistake.
DODD: Well, I tried to get...
BERNANKE: I think a point to make -- and this is, to some extent, recognized in Secretary Paulson's strategic economic dialogue, is that, while the exchange rate is a very important issue and one that we are continuing to press China on, we have many, many other issues of mutual concern in economics.
Just to talk specifically about the trade balance, another dimension besides the exchange rate is whether China can become more reliant on its domestic demands, its own consumption spending, to -- as a source of growth rather than relying on exports to the United States.
And I think it's somewhat encouraging that the Chinese have officially recognized the problem of a growing trade surplus and both the economic and political risks that that poses.
And they have proposed a plan for trying to increase domestic consumption, which, over time, ought to reduce the reliance of China on exports, and ought to reduce their trade surplus.
So there are some other measures that they're taking, albeit ones that will take some time to work.
But again, I think, rather than putting everything on that particular issue of the exchange rate, we should also note that we have common interests with the Chinese on matters of the environment, for example, and matters of energy, on matters of trade investment, on matters of immigration and visas.
So I would hope that, while we continue to press China to make progress on this very important issue of the exchange rate, that we not do so exclusive of all the other issues that we have -- very important issues that we have in common and that we could collectively benefit from if we were to work with the Chinese to come to better arrangements than we have.
DODD: Well, I appreciate that. And again -- and I know you appreciate the concerns we hear about in using your language in China, the subsidy notion here.
Clearly, when you've lost your job because you're just -- the company you work for can no longer compete because your competitor is able to adjust that currency to such an extent that it causes your job to disappear, that level of frustration is beyond just an intellectual exercise, if you're walking home that night to face your family because there's no longer the job there, and what it means.
I want to return one last -- if I can, to one point. Again, your candor has been terrific and your comments. And the quote that Jack Reed raised in your Omaha speech, where, too often, this discussion about unionization -- it falls on an ideological fault line.
DODD: And I appreciate immensely here that you talked about it based on just data here, rather than drawing conclusions about whether you like or dislike unions; but the important role they played in terms, historically, of closing income gaps.
This is not the first time we're talking about income. In fact, income gaps are far more pronounced, or in earlier days, in the early part of the 20th century.
And what I read from your quote here is that, if you can -- and I'll ask the question here, in a sense -- you talk about these numbers back in the '70s and '80s, and I presume even earlier, some of those income gaps that closed up you attribute to the fact that there was the ability of people to organize and to negotiate for better wages and working conditions for themselves.
And I wonder if you might just expound on that a little bit without getting involved in the ideological discussion. I'm not asking you to do that. But it's a very important point, I think, as those of us try to assist in this effort of closing that gap, to realize how important that particular element can play and making it possible for people to move up that economic ladder.
BERNANKE: I was reporting some research...
DODD: I know you were.
BERNANKE: ... which I think is good research. Again, I think that, you know, workers who wish to be represented by unions have every right to do so and we should not block that in any way. I mean, we should give them the opportunities to do that.
The implications of unionization for income equality or inequality, as I indicated before, are a bit difficult to tease out because there have been changes in union rates, but there have also been changes in the structure of the economy -- and the most notable one being the decline in manufacturing jobs, manufacturing employment; and also the increase of international competition.
I mean, there certainly was a time when G.M., for example, had a certain amount of monopoly power and was able to charge probably a higher price than it otherwise could. And now, of course, G.M. is in very intense competition with other companies around the world.
So it's an open question, a very interesting question, to what extent that association between wage changes and unionization is causal; that the changes in unionization have changed the wage pattern or what extent they are both the product of a third force such as the change in manufacturing employment or the change in the extent of international competition.
And the kinds of studies we've seen so far really can't distinguish between those two hypotheses.
DODD: Well, I appreciate your comments. This will be part of an ongoing conversation. But the comments here, based on the just hard data, I thought, were very valuable to contribute to the debate and discussion as to what we need to be doing to move forward in closing that gap that you spoke about so eloquently.
Thank you immensely. I thank my colleagues -- they've had to leave here. But there were great questions that came up this morning, and your answers were very candid and very straightforward and forthright. And we appreciate it immensely.
So we look forward to having an ongoing conversation with you. And we thank you for your appearance here this morning.
This committee will stand adjourned. Thank you.
Feb 14, 2007 17:39 ET .EOF
Source: CQ Transcriptions © 2007, Congressional Quarterly Inc., All Rights Reserved