U.S. Congress Joint Economic Committee Hearing - The Economic Outlook

SEN. SCHUMER: The committee will come to order. Thank you.

Well, Chairman Bernanke, we want to thank you for joining us today in what will be your third appearance at the Joint Economic Committee during this session, this term of Congress. And of course you're here to talk about the economy, not just housing, not just financial markets and not just the regulation of those markets.

The economic news continues to be alarming, whether it's employment, inflation, housing, financial industry turmoil or consumer confidence.

Last month you looked into the precipice of financial meltdown and acted. It is hard to disagree with the need to take quick and dramatic action to spare our financial system of the risk of the kind of meltdown we saw in the Great Depression. Those who in retrospect say they wouldn't have acted, in my judgment, are showing an unfortunate degree of intellectual arrogance and maybe even some disingenuousness. To look into the abyss of imminent financial collapse or the potential and do nothing is irresponsible.

Your actions to rescue Bear Stearns provided some much needed breathing room to the financial markets, for now. But there are many legitimate looming and unanswered questions about the before and the after, what happened both before and after the Bear Stearns action.

On the before, as early as last summer there were warning signs that Bear Stearns was in trouble when two of Bear's hedge funds, funds that were heavily invested in subprime mortgages, were forced to declare bankruptcy. At that time were the members of the Fed concerned about the long-term viability of Bear Stearns? Did you receive any consultation from other agencies, like the SEC? If you were concerned, did you take any actions behind the scenes to help shore up Bear's tenuous position? And if not, at what point did you know that Bear Stearns was in serious jeopardy? What action did you take at that point? Could earlier, more aggressive action by the Fed, by the SEC or some other agency have saved Bear?

And the after -- in the wake of the Bear Stearns debacle, a number of concerns have been raised about the precedent of the Fed's actions -- about the precedent that the Fed's actions set for other Wall Street firms. In order to avoid a similar future situation, what actions has the Fed taken to deal with a possible similar situation? Do you now have established criteria for when intervention is appropriate? To avoid a future Bear Stearns situation, do you expect the Fed and the SEC to be more proactive in protecting investors from a potential Bear-like situation?

Now, maybe if we had a single financial regulator, this wouldn't have happened. Imagine how much better off we would have been if a strong regulator who could have called in Bear Stearns far earlier and forced them to take steps that would have prevented the disaster we confronted two weeks ago -- how much better off we would be.

And there are serious questions about housing as well, and many people ask the -- juxtapose -- many people juxtapose the action that Bear -- that was taken in regard to Bear and then not taken in regard to housing.

What is the justice of helping Bear Stearns and not millions of homeowners? A single homeowner going under does not pose systemic risk, as Bear did, but millions of homeowners going under do. I worry that as quickly as the federal government moved to save Bear Stearns from complete failure, it has moved at a snail's pace, if at all, to save homeowners from foreclosures.

The administration was all for government action in the case of Bear Stearns, but what about government action to help homeowners? Yes, Bear Stearns was in trouble, but millions of homeowners are also in trouble. Yes, Bear Stearns needed government intervention, but what about government intervention for homeowners?

I'm hopeful that this week the Senate will redouble its efforts to respond to the housing crisis by passing much-needed legislation. And while I know that you don't take positions on specific legislation -- no fair chairman does, and Fed chairmen shouldn't, in my opinion -- I hope that you will privately use your influence to convince those in the administration that this modest effort is needed to bolster homeowners and the economy.

We will, hopefully, get bipartisan support for the Foreclosure Prevention Act, which, among other things, would add $200 million in pre-foreclosure counseling funds which could help 500,000 families keep their homes, and strengthen the housing markets and the economy, and provide $4 billion in Community Development Block Grant funds for the purchase and rehab of foreclosed properties so that property values, particularly those in certain areas afflicted by foreclosure, don't decline even more precipitously than they have already.

Beyond the immediate response demanded for the housing crisis, it is now also crystal clear we must rethink the regulatory framework that governs our financial system. Over the past decade, consolidation has become the norm in the financial industry. There are no longer distinct commercial banks, investment banks, broker dealers, traders, insurers. Instead, there are large number of financial institutions offering a constellation of financial products surrounded by many smaller institutions, such as hedge funds and private equity funds with their own specialities. It's as though we have a handful of large financial Jupiters that are becoming more and more similar, encircled by numerous small asteroids. The U.S. financial regulatory system is still based on the crisis we responded to in the '20s and '30s, not on the 21st century financial institutions we have now.

We want entrepreneurial vigor in our system, and over-regulation can stifle that. but we also need robust regulation, particularly to guard against systemic risk. I said this week that Secretary Paulson's blueprint is a good foundation for updating the regulation of U.S. markets, but it leaves much to be desired, and most importantly, doesn't address the housing and economic crisis we face right now. If we focus only on the consolidation of regulatory bodies and also don't adopt a careful but more pro-regulation approach, then we will have approached this modernizing task with a pre-Bear Stearns mindset.

I believe there are six principles that we should follow as we re-regulate.

First, we must focus on controlling systemic risk. Second, we need to look closely at a unifying and simplifying -- we need to look closely at unifying and simplifying our regulatory structure, perhaps moving towards a single regulator. Third, we must figure out how to regulate the currently unregulated parts of financial markets, especially opaque and complex financial instruments that now put the entire system at risk. Fourth, we must recognize that a global financial world requires global solutions. Fifth, we must have greater transparency. And sixth, the laissez-faire view that predominates in this administration, far greater than it did under Ronald Reagan or George Bush Sr.'s, has to change. Regulators ought to regulate.

I hope that you'll use your position to jawbone this administration to get behind the housing relief effort before Congress this week. They have not committed to it. Addressing the housing crisis head-on will do as much to instill confidence in the markets as lowering interest rates or bolstering regulatory oversight of wayward mortgage lenders and financial institutions. We need to do all of it.

Thank you, Mr. Chairman. Now, normally I encourage all of our members to make opening statements, but because you only have limited time and we have many, many questions, I'm going to ask only our vice chairman and the Senate, House -- and ranking members, that is usually Representative Saxton, but today Congressman Brady will take his place, and Senator Brownback to make opening remarks. Other members may submit their full statements into the record and can use their question time as they wish.

Let me now call on my colleague Senator Brownback for an opening statement.

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SEN. SCHUMER: Well, thank you, Mr. Chairman.

And just to notify my colleagues, because we didn't have time for opening statements, and everyone has so much to ask, we're going to do seven-minute rounds for everybody.

Mr. Chairman, on page four of your testimony, you say that the economy could, quote, "even contract slightly." I think this is the most pessimistic you have been about the possibility of recession.

Am I correct in understanding that you now believe a recession is possible, certainly more likely than it was a few months ago?

MR. BERNANKE: A recession is possible but a recession is a technical term, defined by the National Bureau of Economic Research, depending on data which will be available quite a while from now. So I'm not yet ready to say whether or not the U.S. economy will face such a situation.

However it's clearly a period of very slow growth extending back to the fourth quarter of last year. And we are trying to set our policies appropriately for that situation.

SEN. SCHUMER: Do you believe the economy is contracting right now?

MR. BERNANKE: Our estimates are that we are slightly growing at the moment. But we think that there's a chance that for the first half as a whole, there might be a slight contraction.

SEN. SCHUMER: Thank you, Mr. Chairman.

Next I just want to go to some of the Bear Stearns. As I mentioned, there are before-and-after questions. I'm going to ask you a few of those, and then you can speak at some time.

The first question everyone wants to know, I think, is, at what time did the members of the Fed and you become concerned about the long-term viability of Bear? What happened after the two hedge funds became in trouble?

Did you have any idea that Bear might go bankrupt before they notified the Fed? And could earlier, more aggressive action by one of the government regulators, private action most probably, saved Bear?

And in the future, there are two issues.

One, in order to avoid a future situation, what actions has the Fed taken subsequently to deal with a possible similar situation? That is a freeze-up of liquidity. I know you've gone to the window. Well, you don't have to elaborate that.

Are there any other actions taken, particularly in regard to individual firms? I don't want you to mention which ones; just in general. And do you expect the Bear Stearns situation to, in light of Bear Stearns, do you expect the Fed and the SEC to be more proactive in protecting investors from a future Bear-like situation?

And then finally and you can again answers these at some length, how is this different than housing? In other words, housing: One of the things that bothers many of us is not the necessity of government intervention at Bear. But what about government intervention in the housing market?

Admittedly each housing -- each homeowner does not pose systemic risk but as a group, they do. And how can one justify going in with government backup for Bear, or any large financial institution, but not for the millions of homeowners?

So you have the time to answer to answer all --

MR. BERNANKE: Thank you, Senator. I'll try to be responsive to those questions.

We do not, of course, have direct supervisory authority for Bear Stearns. We have monitored the company for some time through direct contacts at the SEC. And there obviously have been periods where the market was concerned about Bear Stearns -- its share prices fallen, its credit default swap spreads had risen and so on.

We did not have early warning on the most recent episode. The SEC viewed Bear Stearns as having adequate capital, relatively, a short period before the events.

SEN. SCHUMER: In retrospect, do you agree with that? Did they have adequate capital?

MR. BERNANKE: They may have had adequate regulatory capital, but their problem was more liquidity than capital. What happened was that -- there were certainly market concerns about their positions and confidence began to erode and they began to lose their funding.

We were not informed of the imminence of the situation until about 24 hours before the event, probably on Thursday, with the announcement -- their information that they were going to be likely in default on Friday morning. And it was at that time that we began our emergency response. More normally, we would have more warning and we would have more time to develop a more effective response.

Going forward, you know, we continue to monitor financial institutions. We hope to improve the liquidity situation by extending liquidity to investment banks and dealers as well as to depository institutions. We -- as supervisors, we continue to insist on strong capital and push banks to raise capital. We also have a particularly interest -- particularly strong interest now in liquidity as we have done over the last few months. I certainly hope and do not expect a repeat of this episode, but the future is uncertain and we will obviously just have to keep monitoring what's happening.

With respect to housing, I'm very glad you asked that question --

SEN. SCHUMER: But is it -- are you working closely with the SEC to monitor individual firms more carefully? Because I don't think relationship between capital and liquidity is as removed as you're implying. Other companies had similar exposure to Bear, but because they had more capital -- Bear, I think, cut the capital as low as they could. More capital might help deal with a liquidity crisis. So my -- I guess I'm just asking, are you, in concert with the SEC, keeping an eye on individual firms and making sure they have a large capital cushion, given what has happened?

MR. BERNANKE: Yes, Senator. Both capital and liquidity are important, and we are urging firms to raise more capital. The fact that we saw yesterday a large bank and an investment bank raise capital is suggestive that capital is available in the marketplace.

Since we've begun lending to dealers, including the remaining investment banks, we have been -- we've put examiners on the ground in those firms, and we've established off-site teams that coordinate with them. So we want to be sure that any lending we do to the investment banks will be done on an appropriately sound basis. So we are now currently on-site, in the investment banks, working with the SEC. We're getting excellent cooperation both from the SEC and from the firms to make sure that we're comfortable with the financial positions of those firms.

On housing, I'm very glad you asked this, because I think there's a -- there's sort of a false dichotomy here. We did not bail out Bear Stearns. Bear Stearns shareholders took a very significant loss. An 85-year-old company lost its independence and became acquired by another firm. Many Bear Stearns employees, as you know, are concerned about their jobs. I don't think any company's interested in repeating the experience of Bear Stearns.

We did what we did because we felt it was necessary to preserve the integrity and viability of the American financial system, which in turn is critical for the health of the economy. Anybody who wants to borrow for a mortgage for a house or for other purposes, anyone who has a(n) investment account with stocks and other assets in it, anyone whose company wants to acquire capital to expand employment needs to have a healthy functioning financial system.

What we did -- always in my mind was that -- what was the best thing for the American public. That's why we took that action, and I believe that was the benefit of that action, not to help individual Wall Street people.

I would just like to say one thing, which is the Federal Reserve has done a great deal to try and help on the housing front. Our interest rate cuts and our liquidity measures in particular have significantly reduced the interest rate reset problem faced by many mortgage holders, and we have extensive efforts on the ground at our reserve banks and our branches to work with community groups, including NeighborWorks, for example, to help reduce delinquencies and the problems of foreclosure.

So I do believe, to complete my thought -- Representative Maloney raised the question -- I do think Congress needs to be looking at housing. I think it is the center of the situation, the center of the problem at this point. I do think that strengthening the FHA, strengthening GSEs to do their mission -- those are all constructive things, and I hope Congress will address housing issues going forward.

SEN. SCHUMER: But don't you feel there is a dichotomy between federal intervention, taxpayer money, to prevent systemic risk -- it's appropriate to do for a large investment bank. Isn't it just as appropriate to do it in the housing market? Because that also prevents -- as a whole, presents systemic risk issues. That's the dichotomy many of us are troubled about, not saying one is a bailout and one is not a bailout or anything like that.

MR. BERNANKE: Well, the Federal Reserve was acting in its sphere of influence to address financial issues. As I said, I think housing is very important, and we need to address it, but of course that's the Congress's sphere of influence, not the Fed's.

SEN. SCHUMER: Thank you.

Just go to go over the order here of when people came in, so people know. It's Senator Brownback, Vice Chair Maloney, Representative Brady, Senator Bingaman, Senator Sununu, Senator Casey, Representative Paul, Senator Klobuchar, Senator Bennett, Representative Doggett, Representative Sanchez, Representative Cummings.

And I have, with the permission of both -- Senator -- and Senator Webb just came in. I have permission -- I've asked permission, and I hope the committee will give it to us -- Senator Kennedy -- I asked Senator Brownback and Congresswoman Maloney -- he's involved in something else and wanted to come in and ask questions. He was here earlier to preserve his place, and I'm going to recognize that authority, if nobody objects.

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SEN. SCHUMER: The human capacity to speculate and create bubbles goes back to the beginning of the human race. The most dramatic example we have of it, which I refer to as "tulip time" was when people were buying tulip bulbs in Holland. The tulip is not indigenous to Holland. It was imported there, and people fell so in love with it they would buy a tulip bulb for the purpose of selling to somebody else for a higher price who bought it for the purpose of selling to somebody else for a higher price. And at the end, people were mortgaging their farms for the sole purpose of buying a single tulip bulb. And when it suddenly became clear there was no greater fool finally out there to buy the last tulip bulb, the devastation that occurred in the Dutch economy destroyed it for 100 years.

The human capacity to do that with dot com stocks and houses continues to assert itself, and I don't think there's any government program that can ever stop humans from wanting to do that.

MR. BERNANKE: I'll refrain from commenting, although you guys are always back in the 17th century. (Laughter.) SEN. SCHUMER: Actually, I think that was the 14th or 15th.

MR. BERNANKE: Fourteenth.

SEN. SCHUMER: Whatever.

MR. BERNANKE: I gave you too much credit.

SEN. SCHUMER: I'll go look it up.

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SEN. SCHUMER: Thank you, Congressman Cummings.

And Congressman Hinchey has come in, but he's going to get his -- look over what was asked and not, and so we'll begin our second round and we'll go to Congressman Hinchey whenever he's ready.

So I would just like to go back to this issue of Main Street versus Wall Street as it was aptly put. And I know my colleagues on this side have said Wall Street's connected to Main Street. Of course it is. And I don't hear anyone saying we shouldn't have -- you shouldn't have done what you did with Bear Stearns. They might tweak the dial a little bit.

But the reason you did it -- and let's face it, it will help some people, not maybe the shareholders but bondholders and others at Bear -- was not to help anybody who had anything to do with Bear, but rather because of the systemic risk that it presented, potential for real dramatic systemic risk. And that's correct.

But the housing market presents in macro the same systemic risk. And one of the things we're all always up against -- if you're very big, you get helped, and if you're very little, you don't. But we're not saying, just help one individual homeowner. We're saying, help the macro housing market.

And so I'm a little -- I'm not asking you to choose a policy. But we do have, with this administration, a full-fledged support of helping the big guys on the basis of systemic risk, but not the little folks. And you know, there's trickle down and there's trickle up and some of each actually happens in the economy. Part of it is an ideological perspective. Isn't it reasonable to ask for intervention in the housing market on the basis of systemic risk, just as it's reasonable to ask for intervention in the financial market?

MR. BERNANKE: Again, Senator, I supported housing actions. I think about it a great deal. My own analysts work on many --

SEN. SCHUMER: How do I know?

MR. BERNANKE: The difficulty is not obvious, exactly, what the most effective policies are. And that's an issue.

SEN. SCHUMER: Well, that's true in financial markets as well.

MR. BERNANKE: That's true as well. So all I can say is that I do support efforts to try to improve the housing situation. I think it is critical to the current situation.

SEN. SCHUMER: Do you think the administration's view on housing has been adequate?

MR. BERNANKE: I can't answer that question. All I know is that I have talked extensively with members of the administration, and we -- obviously, there are concerns there, and we've discussed possible options --

SEN. SCHUMER: Thank you. I'd urge you to quietly and not in front of all of us continue to prod them to do more, because they seem to have these ideological handcuffs that have no real distinction.

Let me go to the next question. With regards to the $29 billion that the federal government guaranteed in the Bear Stearns-JPMorgan Chase deal, how concerned should U.S. public be that taxpayers will be left holding the bag? How confident can we be that these assets won't decline in value?

MR. BERNANKE: Well, based on our evaluation by our investment and advisory firm, based on the fact that the prices -- the Bear Stearns prices were based on a illiquid market, and we are able to sell the assets over an extended period of time, based on the fact that we have a $1 billion first loss provision from JPMorgan --

SEN. SCHUMER: That's why I said 29 (billion dollars), not 30 (billion dollars).

MR. BERNANKE: But there's $30 billion of assets and $29 billion of money at stake.

SEN. SCHUMER: Right.

MR. BERNANKE: You know, I can't tell the future, but I feel reasonable confident that we'll be able to recover all the principal and indeed some interest, and there's some chance of even upside beyond that.

SEN. SCHUMER: Chrysler redux. They made money on Chrysler. You can ignore that.

One of my major concerns is been the opaque nature of the derivatives markets, particularly credit default swaps. One of the places I disagreed with Treasury Secretary Paulson when he talked about restructuring was that he didn't mention those instruments. We've got these complex instruments. Some of the CEOs of the companies that trade in them told me they don't know, they don't really understand them. Counterparty risk that these instruments can create is greater than anyone ever expected and can threaten the stability of the financial system, even if they're held by a rather small entity because of the ping-ponging effect. They're entirely unregulated.

Now, we certainly have a difficulty -- if we regulate them here, they can just go to London and nothing will change, so we have to deal with this on an international basis, but do you agree that we need to bring credit default swaps and other derivatives in some way more under our regulatory tent? Certainly in terms of transparency?

MR. BERNANKE: Well, there -- some derivatives are traded on exchanges.

SEN. SCHUMER: Yes.

MR. BERNANKE: And those already have various controls and measures. For over-the-counter derivatives, which are bilateral agreements, in almost all cases, one of the parties involved is a regulated institution.

And so, perhaps in some cases, the best way to address the issue is to make sure that the parties involved have good information and clear understanding of what their risks are and what the counterparty risks are and the like. There is a natural --

SEN. SCHUMER: If they didn't in mortgages, it's sort of -- it may be a bit naive to assume --

MR. BERNANKE: (Off mike.)

SEN. SCHUMER: -- or presumptuous, that they know it about these complex instruments.

MR. BERNANKE: So we need to do better on that. But there is a natural lifecycle in these instruments. Some of them start off as bilateral, over-the-counter, and as they become more standardized then they move to an exchange. In the case of credit default swap, the Federal Reserve Bank of New York, as you probably know, has been working very hard to try to improve the clarity of the trading process, the record-keeping process and the like and try to avoid problems, try to develop new protocols like the cash-basis protocol for CDS resolution.

SEN. SCHUMER: Right. Right.

MR. BERNANKE: So, you know, we're moving in the direction of more and more information on these things. But you can't go from zero to 60 --

SEN. SCHUMER: Sure. I mean, do you think there should be some move in that direction? I'm not asking you to specify how much.

MR. BERNANKE: Well, I think at a minimum that those institutions which use these instruments need to be -- obviously need to understand what they're doing, and they need to have clarity for the supervisor as well on their position.

SEN. SCHUMER: Okay. But one final question. When you appeared last November in this committee, you said that businesses appear to enjoy relatively good access to credit despite the emerging problems in the credit market. Given the deterioration of credit markets over the last few months, would you say it's still true that businesses enjoy good access to credit? Can a business outside of the financial sector get access to credit it needs to make necessary investments?

MR. BERNANKE: Senator, as I indicated in my testimony, sort of high-grade corporations, you know, with high ratings are still able to get credit, investment of high-grade bonds has not actually declined very much, and moreover those firms have a great deal of internal cash and other resources.

SEN. SCHUMER: Right. I've heard from commercial real estate people -- even triple-A types -- that they're having real trouble.

MR. BERNANKE: Well, that's -- we're talking -- so that my answer was responsive to corporations, nonfinancial corporations. Lower quality nonfinancial corporations, so-called high-yield issuers, and on a more mixed basis small business -- my answer to Senator Bennett, which is, depends to some extent on the circumstances of the individual company -- have done less well and have more restrictions.

And we are certainly seeing less credit available for commercial real estate, in particular, commercial mortgage-backed securities are -- almost none of them are being securitized at this point, which is a drain of an important source of capital that had been flowing into commercial real estate.

SEN. SCHUMER: So does this present real worries to you about the future in our economy?

MR. BERNANKE: Well, it does suggest that as we look at the forecast, that last year's very rapid increase in nonresidential construction is unlikely to be repeated in part because of the slowing economy, but in part because of a tighter credit situation.

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SEN. SCHUMER: Thank you, Congressman.

Well, Mr. Chairman, I want to thank you for being here. You've been chair two years. You're getting the knack of this. Carolyn Maloney and I were commenting to one another that we really appreciate your forthrightness on these, and you are very forthright, but when you can't go over the -- you get up to the point that you can answer and then you stop, and that's probably what you should do.

I just have one final statement I'd like to ask your comment, and it follows up on what Congressman Hinchey was talking about particularly in this first round. So I'm going to make this statement, and then you just comment on it.

And that is, you know, for the last 15 or 20 years -- maybe 10, but certainly the last while -- America is like a giant, a strong giant who's getting very overweight. We import more than we export, we consume more than we produce, we borrow more than we save.

And while one couldn't guess where the financial problems and crisis would occur, when things -- when you do that, they certainly occur. No one would have predicted mortgages, even three years ago.

But maybe that's less relevant than the fundamental imbalances that we had in our economy, and sooner or later, the chickens would come home to roost, even though we couldn't predict where.

Would you comment on that?

MR. BERNANKE: Well, I think there are a number of factors at work in the current situation, some short-term, some long-term. But I think that achieving greater balance over the longer term is extremely important. And all the areas you mentioned I basically agree with.

SEN. SCHUMER: Thank you very much.

MR. BERNANKE: Thank you.

SEN. SCHUMER: The hearing's adjourned.

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