[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]

FEDERAL RESERVE AID TO THE EUROZONE:
ITS IMPACT ON THE U.S. AND THE DOLLAR

=======================================================================

HEARING

BEFORE THE

SUBCOMMITTEE ON

DOMESTIC MONETARY POLICY

AND TECHNOLOGY

OF THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED TWELFTH CONGRESS

SECOND SESSION

__________

MARCH 27, 2012

__________

Printed for the use of the Committee on Financial Services

Serial No. 112-111

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75-083 WASHINGTON : 2012
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HOUSE COMMITTEE ON FINANCIAL SERVICES

SPENCER BACHUS, Alabama, Chairman

JEB HENSARLING, Texas, Vice BARNEY FRANK, Massachusetts,
Chairman Ranking Member
PETER T. KING, New York MAXINE WATERS, California
EDWARD R. ROYCE, California CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas NYDIA M. VELAZQUEZ, New York
DONALD A. MANZULLO, Illinois MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina GARY L. ACKERMAN, New York
JUDY BIGGERT, Illinois BRAD SHERMAN, California
GARY G. MILLER, California GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California JOE BACA, California
MICHELE BACHMANN, Minnesota STEPHEN F. LYNCH, Massachusetts
THADDEUS G. McCOTTER, Michigan BRAD MILLER, North Carolina
KEVIN McCARTHY, California DAVID SCOTT, Georgia
STEVAN PEARCE, New Mexico AL GREEN, Texas
BILL POSEY, Florida EMANUEL CLEAVER, Missouri
MICHAEL G. FITZPATRICK, GWEN MOORE, Wisconsin
Pennsylvania KEITH ELLISON, Minnesota
LYNN A. WESTMORELAND, Georgia ED PERLMUTTER, Colorado
BLAINE LUETKEMEYER, Missouri JOE DONNELLY, Indiana
BILL HUIZENGA, Michigan ANDRE CARSON, Indiana
SEAN P. DUFFY, Wisconsin JAMES A. HIMES, Connecticut
NAN A. S. HAYWORTH, New York GARY C. PETERS, Michigan
JAMES B. RENACCI, Ohio JOHN C. CARNEY, Jr., Delaware
ROBERT HURT, Virginia
ROBERT J. DOLD, Illinois
DAVID SCHWEIKERT, Arizona
MICHAEL G. GRIMM, New York
FRANCISCO R. CANSECO, Texas
STEVE STIVERS, Ohio
STEPHEN LEE FINCHER, Tennessee

James H. Clinger, Staff Director and Chief Counsel
Subcommittee on Domestic Monetary Policy and Technology

RON PAUL, Texas, Chairman

WALTER B. JONES, North Carolina, WM. LACY CLAY, Missouri, Ranking
Vice Chairman Member
FRANK D. LUCAS, Oklahoma CAROLYN B. MALONEY, New York
PATRICK T. McHENRY, North Carolina GREGORY W. MEEKS, New York
BLAINE LUETKEMEYER, Missouri AL GREEN, Texas
BILL HUIZENGA, Michigan EMANUEL CLEAVER, Missouri
NAN A. S. HAYWORTH, New York GARY C. PETERS, Michigan
DAVID SCHWEIKERT, Arizona

C O N T E N T S

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Page
Hearing held on:
March 27, 2012............................................... 1
Appendix:
March 27, 2012............................................... 33

WITNESSES
Tuesday, March 27, 2012

Dudley, William C., President, Federal Reserve Bank of New York.. 5
Kamin, Steven B., Director, Division of International Finance,
Board of Governors of the Federal Reserve System............... 8

APPENDIX

Prepared statements:
Paul, Hon. Ron............................................... 34
Dudley, William C............................................ 36
Kamin, Steven B.............................................. 43

Additional Material Submitted for the Record

Paul, Hon. Ron:
Written responses to questions submitted to William C. Dudley 50
Written responses to questions submitted to Steven B. Kamin.. 55
Luetkemeyer, Hon. Blaine:
MarketWatch article by Andrea Thomas, dated March 8, 2012.... 57

FEDERAL RESERVE AID TO THE
EUROZONE: ITS IMPACT ON THE
U.S. AND THE DOLLAR

----------

Tuesday, March 27, 2012

U.S. House of Representatives,
Subcommittee on Domestic Monetary
Policy and Technology,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:03 a.m., in
room 2128, Rayburn House Office Building, Hon. Ron Paul
[chairman of the subcommittee] presiding.
Members present: Representatives Paul, McHenry,
Luetkemeyer, Huizenga, Schweikert; Clay, Maloney, and Green.
Chairman Paul. This hearing will now come to order.
Without objection, all Members' opening statements will be
made a part of the record.
I will now recognize myself for 5 minutes to make an
opening statement.
First, I would like to thank Dr. Kamin and Dr. Dudley for
appearing today to discuss a very important subject that the
world is looking at constantly: a major debt crisis that exists
around the world.
It has a great deal of significance not only for world
finance, but also for the American taxpayer and the value of
the U.S. dollar, and indirectly, the deficits that are run up
because they are all interconnected.
The crisis we face right now is a crisis in debt and how we
handle this debt. Who gets stuck with the debt? Who gets the
bailout? How does the debt get defaulted on? How do you
liquidate the debt?
And there are different ways of liquidating debt. When you
can't pay the bills and you write them off the books, that is
liquidating debt and that helps to solve the problem.
Other times, governments and central banks participate in
liquidating debt by diminishing real debt, and that is by
purposely devaluing the currency and, of course, that has been
used historically many, many times and is one of the most
common ways of liquidating debt.
So if you can devalue a currency by 50 percent, you can get
rid of real debt by half if your prices go up. And there
certainly seems to be a concerted effort around the world, and
even within our own country, to handle debt in that fashion.
But in the process, the question really is: Who gets stuck
with it? Who gets the most penalties? And if you happen to be
on the receiving end of being too-big-to-fail and you get some
benefits from the system, but the debt is not liquidated, it is
passed on, it is transferred from one group of individuals to
another. Nevertheless, it is still a pain. But it is just a
matter of picking and choosing who will receive the most harm.
The problem I see right now in dealing with this debt
crisis is can the U.S. dollar and the U.S. economy and the U.S.
taxpayer bear the burden? And this is the way it seems because
now, the European Central Bank (ECB) is asking us to continue
to do what we have done over these last few years, to use the
dollar to actually bail them out.
On paper, it looks like the balance sheet is better with
the Europeans. Their assets-to-capital ratio is better than our
bank. And yet, the dependency is for the United States to bail
them out and it seems like it is working.
Of course, we have the advantage of issuing the reserve
currency of the world which has given us, in a deceptive way,
some advantages over many, many decades. But the big question
is: How long can that happen? Will we always have the benefits?
Will other countries finally get together, as they talk about
constantly, and replace the dollar? And certainly, the dollar
isn't getting to be a stronger reserve currency; if anything,
it is getting slightly weaker. And someday, there may be some
real challenges to the dollar, so there has to be a limit to
this.
We talk about the Greek crisis, which is major and
significant, and we are dealing with it on a daily basis. This
might just be the beginning of a much bigger crisis when you
look at the different countries, whether it is Portugal or
Spain or Italy. And this thing could--it is much bigger than we
are willing to admit. In many, many ways, I think we are in
denial of how serious this problem is.
So we have to face up to the fact that there is a cost. I
see it is going to be a cost against the value of the dollar.
Some people say, ``This is good. We want a weaker dollar
because it is going to help our trade; it is going to help our
exports.''
And now, there are currency wars going on. All we do is
complain about the Chinese having too weak a currency. At the
same time, we triple our balance sheet and triple the monetary
base.
Now, that is deliberately trying to weaken a currency too.
So there will be limits on that. I think we are facing that. We
are up against the wall on this. And very soon, I think we are
going to have to admit that you can't solve the problem of debt
with more debt.
You can't solve the problem of a weak currency by making
the currency even weaker. You can't solve the problem by having
the moral hazard of a guaranteed bailout that people--there is
always going to be a lender of last resort, and if you are too-
big-to-fail, you are going to be taken care of. Some people may
suffer, but others will be taken care of.
I think there are limits. I think we are facing that. I
think we are in denial. We won't admit how serious it is; but I
believe that we will be forced to, not because of the politics
of it as much as because of the economics.
I complain about the power of governments and central
banks, but ultimately, there are economic rules and laws--
economic laws probably much stronger than all of us. And you
can't dictate and mandate forever. You can kid people for a
long time. But right now, it is an illusion that we can trust
the dollar to bail out the world. And soon, we are going to see
the end of that and that is why many of us believe that the
crisis is far from over and that we have to face up to those
facts.
Now, I would like to recognize Mr. Clay for his opening
statement.
Mr. Clay. Thank you, Chairman Paul, and thank you for
holding this hearing to examine the Federal Reserve's
assistance to the Eurozone and the effect of that assistance on
the U.S. economy, monetary system, and the dollar.
The focus of this hearing is to examine the Federal
Reserve's Central Bank's currency swap-line arrangements with
central banks of Europe, England, Switzerland, Japan, and
Canada.
Also, I want to thank the witnesses for appearing before us
today.
When the new Greek government came into power in late 2009,
they revealed that the previous Greek government had not been
reporting the budget deficit accurately. This has led to major
economic challenges and concerns to other parts of Europe and
the United States.
The first concern is the high levels of public debt in some
Eurozone countries. Three Eurozone major governments--Greece,
Ireland and Portugal--have had to borrow money from the
European Central Bank and the International Monetary Fund in
order to avoid defaulting on their debt.
Currently, the Greek government is negotiating losses on
bonds held by private creditors. Investors have started to
demand higher interest rates for buying and holding Italian and
Spanish bonds. The Italian government debt is forecast to be
$2.8 billion in 2012, which is greater than Spain, Portugal,
Greece, and Ireland combined.
The second concern is the lack of growth and the high
unemployment in the Eurozone. In January of this year, the IMF
downgraded its growth forecast for the Eurozone from growing by
1.1 percent in 2012 to contracting by 0.5 percent.
The third concern is the weakness of the Eurozone's banking
system, which holds high levels of public debt. In December of
last year, the European Banking Authority estimated that
European banks need about $152 billion of additional capital in
order to withstand a range of shocks and still maintain
adequate capital.
The fourth concern is persistent trade imbalances within
the Eurozone. The Eurozone core countries tend to run trade
surpluses with the Eurozone periphery countries. And the
periphery countries tend to run trade deficits with the core
countries.
To help ease the financial crisis in the Eurozone, the
Federal Reserve opened the currency swap line. Under a swap
line with the European Central Bank, the ECB temporarily
receives U.S. dollars and the Federal Reserve temporarily
receives euros.
After a fixed period of time, the transaction is reversed.
Interest on swaps is paid to the Federal Reserve at the rate
that the foreign central bank charges to its dollar borrower.
The temporary swaps are repaid at the exchange rate prevailing
at the time of the original swap, meaning that there is no
downside risk for the Federal Reserve if the dollar appreciates
in the meantime.
All of these concerns have raised questions about the
economic stability of the Eurozone countries. I look forward to
the witnesses' comments regarding these concerns and actions
taken by the Federal Reserve Bank to address these concerns.
And again, thank you for conducting this hearing. I yield
back.
Chairman Paul. I thank the gentleman.
Now, I will recognize Mr. Luetkemeyer for his opening
statement.
Mr. Luetkemeyer. Thank you, Mr. Chairman. Over the past
several years, many of my colleagues and I have expressed
serious concerns regarding U.S. exposure to the Eurozone.
Like many of my colleagues, my concerns have been met at
times with cynicism and assurance of an efficient recovery with
little or no contagion. Yet here we sit today, continuing to
talk about the Eurozone crisis, and hearing once again that our
Nation won't be dramatically impacted.
Certain scholars and fellow officials said that the crisis
wouldn't spread. It has now impacted several European nations
with effects ranging from default and upheaval in Greece to
bank failures and increased risk in the perceived financial
stalwart of France. This hasn't badly taken a toll on U.S.
markets. I believe it has a potential to take a toll on our
Nation's economy as a whole.
Chairman Bernanke testified recently in this committee that
the two greatest threats to our economy are rising gas prices
and the Eurozone problems. Secretary Geithner testified in this
committee just last week, and seemed concerned as well about
the possibility of a eurozone contagion, although he was
optimistic things would work themselves out.
Regardless of what we hear today, we are in fact exposed.
Our financial institutions, industries, and government are all
exposed, and as a result, so are the taxpayers. Our economies
are and always will be deeply connected. It is our
responsibility to ensure that this exposure is managed
thoughtfully and to ensure that the U.S. taxpayers are not
again on the hook for the failure of the financial institutions
not only domestic but foreign as well.
Mr. Chairman, I look forward to an enlightened discussion
with our panel. This is an important topic and one that merits
great transparency and attention. I thank you, and I yield
back.
Chairman Paul. I thank the gentleman.
Now, I would like to introduce our witnesses for today. Dr.
William Dudley is the President of the Federal Reserve Bank of
New York. Before taking over as President of the New York Fed
in 2009, Dr. Dudley had been Executive Vice President of the
Markets Group at the New York Fed, where he managed the
System's open market account for the Federal Open Market
Committee.
Prior to joining the New York Fed in 2007, Dr. Dudley was a
partner and managing director at Goldman Sachs and company, and
was Goldman's chief U.S. economist for a decade. Dr. Dudley
also serves as chairman of the Committee on Payments and
Settlement Systems of the Bank for International Settlements
and as a member of the Board of Directors of the Bank for
International Settlements. Dr. Dudley received his bachelor's
degree from New College of Florida and received his Ph.D. in
economics from the University of California, Berkeley.
Dr. Steven Kamin is the Director of the Division of
International Finance for the Board of Governors of the Federal
Reserve System. He joined the Federal Reserve System Board in
1987, and was appointed to the official staff in 1999.
Prior to taking over the Division of International Finance
in December of 2011, Dr. Kamin was Deputy Director of the
Division. He has also served as a visiting economist at the
Bank for International Settlements, a senior economist for
international financial affairs at the Council of Economic
Advisors, and as a consultant for the World Bank.
Dr. Kamin received his bachelor's degree from the
University of California, Berkeley and received his Ph.D. in
economics from the Massachusetts Institute of Technology.
Without objection, your full written statements will be
made a part of the record. You will now each be recognized for
a 5-minute summary of your testimony.
Dr. Dudley?

STATEMENT OF WILLIAM C. DUDLEY, PRESIDENT, FEDERAL RESERVE BANK
OF NEW YORK

Mr. Dudley. Thank you. Chairman Paul, Ranking Member Clay,
and members of the subcommittee, my name is Bill Dudley and I
am the President of the Federal Reserve Bank of New York. It is
an honor to testify today about the economic and fiscal
challenges facing Europe and the Federal Reserve's effort to
support financial stability in the United States.
Let me preface these remarks by stating that the views
expressed in my written and oral testimony are solely my own
and do not represent the official views of the Federal Reserve
Board, the Federal Open Market Committee or any other part of
the Federal Reserve System.
Additionally, because I am precluded by law from discussing
confidential supervisory information, I will not be able to
speak about the financial condition or regulatory treatment or
rating of any individual financial institution.
The economic situation in Europe has been unsettled for the
better part of 2 years with pressure on sovereign debt markets
and local banking systems. The strains in European markets have
affected the U.S. economy.
The euro area has the capacity, including the fiscal
capacity, to overcome its challenges. However, the politics are
very difficult, both because the problem has many dimensions
and because many different countries and institutions in the
euro area have to coordinate their actions in order to achieve
a coherent and effective policy response.
Europe's leadership has affirmed its commitment to the
European Union and a single-currency union on numerous
occasions. And the leadership is working harder than ever to
achieve greater policy coordination in areas such as fiscal
policy. A more robust and resilient European Union would be a
welcome development for the United States. Three recent
developments are especially encouraging in that regard.
First, liquidity concerns have eased significantly
following the European Central Bank's long-term financing
operations in December and February. Through this program, the
ECB provides 3-year loans to European banks at low rates,
accepting a wider range of collateral in return.
Second, earlier this month the Greek government worked with
European leaders and its largest creditors to restructure the
bulk of its 206 billion euros of outstanding privately held
bonds. This not only helped reduce Greeks' total indebtedness,
it also helped calm persistent worries that a disorderly Greek
default could become the trigger for a global economic crisis.
Third, leaders in most euro-area countries have approved a
new treaty designed to increase fiscal coordination. The new
rules already appear to be making a difference. While difficult
work still lies ahead, countries in the euro area have made
meaningful progress towards achieving long-term fiscal
sustainability.
Looking to the future, the difficult work that remains also
presents special risks, both for Europe and for the United
States. If Europe fails to chart an effective course forward,
this could have a number of negative implications here. In
particular, there are three areas of potential risk that I
would like to highlight for the subcommittee today.
First, if economic conditions in Europe were to weaken
significantly, the demand for U.S. exports would decrease. This
would hurt domestic growth and have a negative impact on U.S.
jobs. It is important to recognize that the euro area is the
world's second largest economy after the United States, and it
is an important trading partner for us. Also, Europe is a
significant investor in the U.S. economy and vice versa.
Second, deterioration in the European economy could put
pressure on U.S. banking systems. As the recent round of stress
tests reveals, U.S. banks are much more robust and resilient
than they were a few years ago. They have bolstered their
capital significantly, built up their loan loss reserves, and
have significantly higher liquidity bumpers.
The good news in the United States means that we are better
able to handle bad news from Europe. With that said, the
exposures of U.S. banks climb sharply when one also considers
their exposures to the core European countries and to the
overall European banking system.
Third, severe stresses in European financial markets would
disrupt financial markets here, which could harm the real
economy. Stress in the financial markets causes banks to more
carefully husband their balance sheets. When that phenomenon
occurs, the availability of credit to U.S. households and
businesses becomes constrained.
Such conditions could also cause equity prices to fall,
impairing the value of American pension and 401(k) holdings.
This would damage the U.S. recovery and result in slower output
growth and less job creation. At a time when the U.S.
employment rate is very high, this is a particularly
unacceptable outcome.
In the extreme, U.S. financial markets could become so
impaired that the flow of credit to households and businesses
could dry up. In today's globally integrated economy, banks
headquartered abroad play an important role in providing credit
and other financial services in the United States. About $1
trillion in worldwide dollar financing comes from foreign
banks; $700 billion in the form of loans within the United
States.
For these banks to provide U.S. dollar loans, they have to
maintain access to U.S. dollar funding. At a time when it is
already hard enough for American families and businesses to get
the credit they need, they have a strong interest in making
sure these banks continue to be active in the U.S. dollar
markets.
It is in our national interest to make sure that non-U.S.
banks remain able to access the U.S. dollar funding that they
need to be able to continue to finance their U.S. dollar
assets. If access to dollar funding were to become severely
impaired, this could necessitate the abrupt forward sales of
dollar assets by these banks, which could seriously disrupt
U.S. markets and adversely affect American businesses,
consumers, and jobs.
One way we can help to support the availability of dollar
funding and ensure that credit continues to flow to American
households and businesses is by engaging in currency swaps with
other central banks. Such swaps are a policy tool that the
Federal Reserve has used to support dollar liquidity for nearly
50 years.
More recently, the Federal Reserve established dollar-swap
lines with major central banks during the global financial
crisis of 2008, and reactivated them in May 2010. The swaps are
intended to create a credible backstop to support but not
supplant private markets. Banks with surplus dollars are more
likely to lend to banks in need of dollars if they know that
the borrowing bank will be able to obtain the dollars it needs
to repay the loan if necessary from its central bank.
Our principal aim is to protect U.S. banks, businesses, and
consumers from adverse economic trends abroad. I am pleased
that the swaps seem to be working. In conjunction with ECB's
long-term refinancing operations, the swaps have helped
European banks avoid the significant liquidity pressures we
feared a few months ago. And they have reduced the risks that
they would need to sell off their U.S. dollar assets abruptly.
In conclusion, I am hopeful that Europe can effectively
address its current fiscal challenges. The Federal Reserve is
actively and carefully assessing the situation and the
potential impact on the U.S. economy.
At this time, although I do not anticipate further efforts
by the Federal Reserve to address the potential spillover
effect of Europe on the United States, we will continue to
monitor the situation closely.
Thank you for your invitation to testify today and I look
forward to answering your questions.
[The prepared statement of Dr. Dudley can be found on page
36 of the appendix.]
Chairman Paul. Thank you, Dr. Dudley.
Dr. Kamin?

STATEMENT OF STEVEN B. KAMIN, DIRECTOR, DIVISION OF
INTERNATIONAL FINANCE, BOARD OF GOVERNORS OF THE FEDERAL
RESERVE SYSTEM

Mr. Kamin. Thank you, Chairman Paul, and members of the
subcommittee, for inviting me to talk about the economic
situation in Europe and actions taken by the Federal Reserve in
response to this situation.
In the past several months, European authorities have
provided additional liquidity to banks, bolstered bank capital
requirements, developed rules to strengthen fiscal discipline,
and explored means of enlarging the euro-area financial
backstop.
Stresses in financial markets have eased, but these markets
remain under strain. The fiscal and financial strains in Europe
have spilled over to the United States by restraining our
exports, depressing confidence, and adding to the pressure on
U.S. financial markets.
Of note, foreign financial institutions, especially those
in Europe, have found it more difficult to borrow dollars.
These institutions make loans to U.S. households and firms as
well as to borrowers in other countries who use those loans to
purchase U.S. goods and services.
While strains have eased somewhat of late, difficulties
borrowing dollars by European institutions may make it harder
for U.S. households and firms to get loans and for U.S.
businesses to sell their products abroad. Moreover, these
disruptions could spill over into U.S. money markets, raising
the cost of funding for U.S. financial institutions.
To address these risks to the United States, on November
30th, the Federal Reserve announced, jointly with the European
Central Bank or ECB, and the central banks of Canada, Japan,
Switzerland, and the United Kingdom that it would revise,
extend, and expand its swap lines with these institutions.
The measures were motivated by the need to ease strains in
global financial markets which, if left unchecked, could impair
the supply of credit to households and businesses in the United
States and impede our economic recovery.
Three steps were described in the announcement.
First, we reduced the pricing of the dollar swap lines from
a spread of 100 basis points over the overnight index swap rate
to 50 basis points over that rate. This has enabled foreign
central banks to reduce the cost of the dollar loans they
provide to financial institutions in their jurisdictions. This,
in turn, has helped alleviate global financial strains and put
foreign institutions in a better position to maintain their
supply of credit, including to U.S. residents.
Second, we extended the closing date for these lines from
August 1, 2012, to February 1, 2013, demonstrating that central
banks are prepared to work together for a sustained period to
support global liquidity conditions.
Third, we agreed to establish swap lines in the currencies
of other participating central banks. These lines would allow
the Federal Reserve to draw foreign currencies and provide them
to U.S. financial institutions on a secured basis. U.S.
financial institutions are not experiencing any foreign
currency liquidity pressures at present, but we judged it
prudent to make such arrangements should the need arise in the
future.
Information on the swap lines is fully disclosed on the Web
sites of the Federal Reserve Board and the Federal Reserve Bank
of New York. I also want to underscore that the swap
transactions are safe and secure.
First, the swap transactions present no exchange rate or
interest rate risk because the terms of each drawing and
repayment are set at the time the draw is initiated.
Second, each drawing on the swap lines must be approved by
the Fed, providing us with control over the use of the
facility.
Third, the foreign currency held by the Fed during the term
of the swap provides an important safeguard.
Fourth, our counterparties are the foreign central banks,
not the private institutions to which the central banks lend.
The Fed's history of close interaction with these central banks
provides a track record justifying a high degree of trust and
cooperation.
Finally, the short tenor of the swaps means that positions
could be wound down relatively quickly were it judged
appropriate to do so. Notable, the Fed has not lost a penny on
these swap lines since they were established in 2007. In fact,
fees on these swaps have added to the earnings that the Fed
remits to taxpayers.
To conclude, following the changes that we made to our swap
line arrangements last November, the amount of dollar funding
for the swap lines increased substantially. Subsequently, as
measures of dollar funding costs declined, usage of the swap
lines has fallen back.
Ultimately, however, a sustained further easing of
financial strains here and abroad will require European
authorities to follow through on their policy commitments in
the months ahead. We are closely monitoring events in Europe
and their spillovers to the U.S. economy and financial system.
Thank you, again, for inviting me to appear before you
today. I would be happy to answer any questions you may have.
[The prepared statement of Dr. Kamin can be found on page
43 of the appendix.]
Chairman Paul. Thank you, Dr. Kamin.
I will start off with the questioning.
For Dr. Dudley, I wanted to see if we could start off by
seeing if we could agree with what the problem is--in my
opening statement, I emphasize that the debt is the problem;
that we are in a worldwide debt crisis.
Do you generally agree with that and how serious to you
think it is?
Mr. Dudley. I think you are certainly correct that there is
a question of debt sustainability in Europe in terms of the
fiscal budget deficit path for some countries--not all
countries, some countries--and there is also--and that is also
implicated some of the European banks to have large exposures
to that sovereign debt.
And so what is important is that these countries have an
opportunity to undertake the fiscal consolidations that they
need to demonstrate to the market that they can actually be on
a sustainable path.
ECB's long-term refinancing operations and, I think, the
dollar swaps have helped create some time for this to take
place, but for this to work out well, these countries still
have to take the appropriate steps.
Chairman Paul. So far, if we date the crisis back to 2008
and 2009, and if it was a debt crisis that was a problem, if
you look at everybody's debt, it is exploding, including ours.
How do you solve the problem of debt with exponentially
increasing the debt? It seems like our problems are just
compounded.
How do you get around to either stop accumulating more debt
or do you believe you have to liquidate debt? Some people
believe you have to get rid of the debt in order to get growth
again because the debt will consume us and interest rates are
bumping up already.
And as I said in my opening statement, the Fed will have
some ability to manipulate interest rates in the economy, but
ultimately, the economic laws are pretty powerful, so interest
rates are liable to go up.
So how can we solve the problem of debt with more debt, and
what is your opinion of liquidating that? Is that important?
Mr. Dudley. I think that you are right, obviously, more
debt does not solve the problem of too much debt. I think the
good news in the United States, and I will speak about the
United States, is that there has actually been a significant
amount of deleveraging that has taken place among U.S.
households over the last few years.
Debt-to-income ratios have come down. Debt service relative
to income has come down. So U.S. households, I think, are in
significantly better shape than they were a few years ago.
The second area where we see a pretty big change in terms
of deleveraging of the United States is in the state of health
of the U.S. banking system. U.S. banks, compared to 5 or 6
years ago, have much more capital and much bigger liquidity
buffers.
So while I think it is too soon to say that the
deleveraging process in the United States is over, we have made
a considerable amount of progress in working our way out of the
problems that we faced in 2007 and 2008.
Chairman Paul. But isn't it true that mortgage debt is
still on the books? It has been transferred; maybe the Fed owns
that debt. We don't even know what the real value is of most of
it.
And banks still hold some mortgage debt and it might be at
a nominal value so in that sense of that debt being liquidated,
maybe some individuals have straightened out their bank
accounts, but there are still millions of people--if they
really were improving, they could make their payments again,
but debt is still the problem.
You say that some are deleveraged, but has there been any
real liquidation of debt when it comes to mortgage and the
derivatives because governments are involved in that--either
the Central Bank or some of our programs are involved. It seems
like none of that has been deleveraged. If anything, that looks
like it is getting worse.
Mr. Dudley. On the mortgage front, there has been some
deleveraging, because banks have taken mortgage losses. Also,
in certain cases, especially among private holders of mortgage
debt, there has been some principal forgiveness, principal
reductions.
So you have actually seen, for example, last year, total
household debt outstanding, according to the flow of funds,
which is the broadest measure of household credit, was roughly
flat last year; so nominal GDP was growing. Debt that was held
by households was flat. So you are actually seeing the debt
burden become less overwhelming.
Chairman Paul. Yes. The promises that we made and the
involvement we have with Europe that our finances are so good
with our debt and our dollar that we have been standing and
saying, ``Yes, we will be there.''
The Chairman of the Fed has said, ``We are not ignoring
this. If necessary, we have been there before, we will be back
again.''
What is the limit to this? What is the limit to us making
these promises that we can always be available? Isn't there a
limit to what the dollar will sustain?
Won't it eventually have to stop or do you think we can do
this--if another crisis hits and there is a big downturn, and
you have to inject trillions of dollars again, what is the
limiting factor to the dollar and the United States economy
bailing out the world?
Mr. Dudley. I think that, from my perspective, we want to
make the decisions based on what is in our self-interest, what
is best for U.S. households and businesses.
And, in that calculation, if we decide that intervention
can help U.S. household and businesses, at higher benefits than
cost, then we want to proceed. If we don't reach that
calculation, if we think that there is too much risk involved
in the program or that the program is going to lead to moral
hazard and is going to be counterproductive, then we don't want
to undertake it.
So I don't think that the Federal Reserve has made any
decisions about what future interventions we would or would not
do, except that we will do interventions that are consistent
with our dual mandate, as set by Congress, to achieve maximum
employment and price stability, sustain financial stability in
the United States, and do what is best for households and
businesses here.
That is why we are doing this program; not for Europe, but
for ourselves.
Chairman Paul. Dr. Kamin, did you want to make a comment?
Mr. Kamin. Yes, do you mind? Could I add a few words,
Chairman Paul?
Just to add to the comments that President Dudley made--our
purpose in the swap lines, in particular, is not to, in some
sense, fully back or to make whole all the debts that have
accumulated around the world. That is very far from our
purpose.
Our key strategy and our key intent in this regard is to
make sure that foreign financial institutions could maintain
the flow of credit, both to U.S. households and firms, and to
firms and households around the world that in turn buy U.S.
goods and services.
So the intent was mainly to help alleviate the liquidity
pressures that could lead these foreign institutions to wind
down their assets too quickly, and thus injure the U.S.
recovery.
Thank you.
Chairman Paul. Thank you.
Mr. Clay?
Mr. Clay. Thank you, Chairman Paul.
Let me follow Chairman Paul's line of questioning.
Dr. Dudley, in your opening statement you mention that
severe stress in European markets will create stress in the
U.S. economy. Are we that tied to the European economy and that
married to that system that it would have that kind of
reaction, a chain reaction?
Mr. Dudley. I think we live in a global economy, and what
happens in the other big economies of the world definitely
affects us. As I noted in my testimony, there are sort of three
channels by which Europe could affect us in a negative fashion.
One, if the European economy is in recession or very weak, that
is going to reduce the demand for our exports. So that has
effects on U.S. production and employment here in the United
States.
Two, if Europe were to be in a difficult position, and the
European banking system were to worsen, that would have
consequences for U.S. banks that have exposure to the European
banks.
And three, if Europe were to perform badly, that would have
negative effects on financial markets around the world. And
that would have implications for our financial markets, and
therefore, investment and growth here in the United States.
So there are definitely significant channels by how Europe
can affect the United States.
Mr. Clay. Dr. Dudley, have actions taken by the Federal
Reserve regarding the currency swap line arrangements been
beneficial or detrimental to the U.S. economy?
Mr. Dudley. We think that the swap lines have had their
desired effects, because they have basically given a source of
a backstop to other sources of funding to European banks. So as
a consequence of them having this backstop available, if they
were to need it, they don't have to be as fearful about their
ability to obtain funding. And therefore, they can manage their
dollar loans to U.S. businesses and households in a more
orderly fashion.
We follow the activities of European banks in the United
States through their U.S. branches and subsidiaries, and they
are definitely reducing their exposure in the United States.
But I think because of the dollar swaps, this is happening in
an orderly way, rather than a disorderly way.
And so, we don't see that their reduction in the business
that they are doing in the United States is having any damaging
effects on the U.S. economy, which is really what our goal is;
to prevent any damaging effects on the U.S. economy.
Mr. Clay. Okay.
Dr. Kamin, would you like to add something?
Mr. Kamin. Yes, thank you, if I could just add to those
remarks.
Over the past couple of years, as the crisis in Europe has
progressed, we have seen several periods when the financial
situation in Europe deteriorated fairly dramatically. And
during those periods, we could see some very obvious spillovers
to financial markets, both in the United States and around the
world.
During those periods of deterioration, investors became
worried, and around the world they retreated from assets they
perceived to be more risky. And what that led to, both in
Europe and the United States and elsewhere, was sharp declines
in stock prices, increases in interest rates line of credits,
and other developments that were associated with retreats from
risk and flights to quality. So, we have seen those episodes
very clearly.
Now, more recently, since we changed the pricing of our
swap lines, since the ECD introduced many measures to add
liquidity to banks, and since European leaders have taken other
actions, we have seen financial conditions in Europe--this is
more or less since December--improve quite markedly. And that
has been an important contributing factor to the improvement to
the tone in financial markets in the United States. So those
connections are definitely there.
Mr. Clay. Dr. Kamin, share with us the effects that the
rise in gasoline prices around the world and in the United
States--what effects will this rise in gas prices have on the
economies of Europe and the United States?
Mr. Kamin. The effects that higher oil prices will have on
both the United States and on Europe are, in broad qualitative
terms, relatively similar. Both broad economies import oil.
There is a greater dependence on imported oil in Europe than in
the United States, but both do.
So, when oil prices rise, that acts as a tax on consumers
of oil in both countries. And as a result, that diminishes the
purchasing power that consumers in those counties have to
basically spend on other goods. So, it basically acts as a
brake on economic recovery and all else being equal, may make
it more difficult to create jobs.
In addition to the effects on unemployment and economic
activity, increases in oil prices have the effect of raising at
least some portion of the consumer basket of prices. As long as
oil prices will continue to rise, that should lead to a
temporary increase in inflation. But that also poses concerns.
So obviously, recent increases in oil and gasoline prices
are something that we monitor very carefully.
Mr. Clay. Thank you.
And my time is up.
Chairman Paul. I thank the gentleman.
Now, I recognize Mr. Luetkemeyer from Missouri.
Mr. Luetkemeyer. Thank you, Mr. Chairman.
Gentlemen, correct me if I am wrong, but I believe that the
swap dollars that are--I guess euros--that are on the other end
with the European Central Bank, they secure those, do they not,
whenever they loan them back out on their other end?
And would you agree that there is a problem from the
standpoint that what we have been told and what we find
recently is they are taking a little more exposure, a little
more risk, with some of the investments that they are taking as
collateral for those? Would that be a fair statement?
Mr. Dudley. They have broadened out the collateral
eligibility, but they also have significant haircuts for that
collateral. So, they take more collateral than the value of the
money that they are actually lending out.
Mr. Luetkemeyer. Instead of one-to-one, it may be two-to-
one, as they take additional collateral?
Mr. Dudley. They adjust for what they perceive to be the
quality of the collateral.
Mr. Luetkemeyer. Because I know that former executive board
member Juergen Stark recently said that the balance sheet of
the ECB is not only gigantic in dimension, but also alarming in
its quality. Would you agree with that statement?
Mr. Dudley. I don't have enough information to assess the
quality of the ECB balance sheet. But my dealings with the ECB
suggest that they are quite prudent in terms of how they run
their operations.
Mr. Luetkemeyer. Yes, but aren't you one of the leading
experts on swaps between the United States and Europe?
Mr. Dudley. But I do not conduct the daily operations of
the ECB in lending money to their banks, versus collateral that
they take.
Mr. Luetkemeyer. Okay.
One of the concerns that I have is with regard to the
quality of the economies over there. We keep talking saying,
``They have dodged the bullet. They are getting better. They
are improving.''
And yet, we see, and we had Secretary Geithner here just
last week, and he acknowledged that the European continent as a
whole is still struggling. I think the comment was made in
testimony today that it is a negative position as far as the
growth of the economy yet. Greece is probably 4/10ths or 4
percent negative growth.
It is fine to sit here and go through a workout and
restructure your debt, but if you don't have the ability to
repay it, because you don't have an economy that grows fast
enough to repay it, what do you have? I think we have to look
at the revenue side.
We may be able to restructure the debt so that it can work.
But if you don't have enough cash flow, enough revenue coming
in, we are still in trouble. Where do you see that going?
Mr. Dudley. I certainly accept your observation that the
European economy is very weak, and that weakness is going to
persist for a while as these governments engage in further
fiscal actions to get their budget deficits on a sustainable
course.
But that fact I think in no way creates risk for us in
terms of our swap agreements with the European Central Bank. We
think we are very well secured in those transactions. We fully
anticipate being fully repaid.
During the depths of the financial crisis in 2008 and 2009,
a far worse economic environment than the one in which we are
today, with far greater amounts of swaps outstanding, we were
fully repaid. We didn't lose a penny. In fact, the total profit
to the U.S. taxpayers for the swaps that were engaged in during
that period was about $4 billion of profit to the U.S.
taxpayer.
Mr. Luetkemeyer. The point I am getting to, though, is if
you have weak collateral for the European Central Bank swap
lines and their economy is not going anywhere, that even gets--
to me, that makes the debt that is--or the collateral that is
securing that line--even weaker.
And so therefore, whether we may have two-to-one or three-
to-one, if you have nothing supplying--you have 2 or 3 times
nothing securing the debt, that is pretty concerning to me.
Quick question for you--do you think that the swap lines
enhance the dollar as the world reserve currency, or do you
think it hurts it?
Mr. Dudley. I think--
Mr. Luetkemeyer. I would like a comment from both of you,
please.
Mr. Dudley. I don't think it is a major factor, but I think
at the margin it probably enhances the dollar as a reserve
currency. In other words, the fact that the Federal Reserve is
willing to engage in dollar swaps probably makes people more
comfortable to use the dollars to finance international
transactions around the world.
I don't think this is a major factor though in terms of why
we are engaging in swaps, or should be a major factor in terms
of why we are engaging in swaps. I think the main reason why we
are engaging in swaps is we don't want European banks to
quickly exit their dollar lending business here in the United
States, with that exit causing harm to U.S. households and
businesses.
Mr. Luetkemeyer. Dr. Kamin?
Mr. Kamin. If I could add to that, clearly, key factors
that are underpinning the dollar's status as a global reserve
currency are the breadth and depth of U.S. financial markets.
And in particular, including but not limited to the status of
U.S. Treasuries. All that is underpinned by the vitality of the
U.S. economy and its consistent record of being able to
innovate and grow.
The purpose of the swap lines is ultimately focused on
continuing to preserve the vitality of the American economy and
by making sure that foreign financial institutions have the
funding they need to continue the flow of credit to American
households and firms.
Insofar, then, as the swap lines can contribute to the
continued vitality, the continued recovery of the U.S. economy,
it undoubtedly is a plus as far as the dollar's reserve status.
Although, as President Dudley has pointed out, it is probably
one of many factors and not necessarily the most important.
Mr. Luetkemeyer. Okay. Thank you very much. I see my time
has expired.
Thank you, Mr. Chairman.
Chairman Paul. Thank you.
I now recognize the gentlelady from New York, Mrs. Maloney.
Mrs. Maloney. Thank you.
I want to welcome both of the panelists, particularly Dr.
William Dudley, who is the President of the Federal Reserve
Banks of New York. So welcome, Dr. Dudley.
And I would like to begin questioning by asking you,
regarding the Federal Reserve's foreign exchange swap lines,
can you tell me what your track record has been with these
programs? Have they been successful? Have there been any losses
to the taxpayers? Have there been any gains for the taxpayers;
and if so, how much? And welcome.
Mr. Dudley. Thank you.
Mrs. Maloney. Thank you for your service, both of you.
Thank you.
Mr. Dudley. Thank you, Congressman Maloney. The track
record is excellent, in two dimensions. One, the swap lines
that we have engaged with have accomplished the goal that we
set for them, which is basically to support U.S. financial
markets and ensure the flow of credit to U.S. households and
businesses.
And two, we have managed to do so in a way that has been
extraordinarily safe. As I noted earlier, there have been no
losses on any swap programs that we have ever engaged in, going
back to 1962; and in terms of the swaps that we enacted during
the financial crisis in 2008 and 2009 and ongoing, total
profits for the taxpayers of about $4 billion.
So no losses, profit for the taxpayers; has had the
beneficial effect that we wanted in terms of supporting the
financial system and supporting the flow of credit to U.S.
households and businesses. So I think that they have worked
very well. Thank you.
Mrs. Maloney. Thank you very much.
And I would like to ask Dr. Kamin about a statement that
Treasury Undersecretary Brainard has stated; that the
Administration's position in Europe is not to seek additional
funding for the IMF. And to quote her directly, she said, ``The
challenge Europe faces is within the capacity of the Europeans
to manage.''
Europe accounts for roughly 16 percent of our exports; in
my opinion, and correct me if I am wrong, accounting for the
stabilization of many jobs here in the United States, probably
thousands of jobs. What occurs abroad is going to have a direct
effect on the recovery here at home in the United States.
Do you believe the stabilization of European markets is
critical to our economic recovery here at home, making systems
like the Federal Reserve foreign exchange swap lines crucial?
Mr. Kamin. Thank you, Congresswoman Maloney.
In response to your questions, first of all, I absolutely
agree that it is critical that the Europe financial and
economic situation be stabilized. As you have pointed out,
Europe is a major trading partner of the United States. And as
we discussed earlier, its financial conditions in Europe are
highly intertwined with those in the United States.
So a stabilization of the European situation really is very
important, both for the United States financial conditions as
well as the continued growth of exports and the real economy,
and thus jobs. Now, as regards the issue of IMF policy, the
Treasury Department is our liege on that, on the issue of IMF
policy, so I can't speak directly to their statements.
But I will note, as Treasury officials have noted as well,
as well as Federal Reserve officials, that Europe is a very--
the euro area is a very large and comparatively wealthy economy
relative to many others in the world. And they do have very
many substantial resources that could be brought to bear on
their situation. And so it is critical for them to do so. Thank
you.
Mrs. Maloney. Thank you.
And Dr. Dudley, I would like to ask you, as countries and
international markets form individual firewalls to stave off
residual financial distress, are we always and likewise
creating firewalls through various other areas in policies
involving capital and liquidity requirements that could have an
effect on our economy here in the United States?
Mr. Dudley. We think it is very important to have a
financial system that is resilient and robust. And towards that
end, Congress, the Administration, and the regulatory community
in the United States have been working hard to bolster the
capital and liquidity among U.S. financial firms.
I have to say that we are in much better shape than we were
a few years ago in both those regards. And I think that is good
news because it means that if there are shocks emanating from
abroad or emanating in the United States, that U.S. banks are
in much better shape to absorb those shocks and to continue to
function and supply credit to U.S. households and businesses.
Mrs. Maloney. Could I ask for an additional 10 seconds?
Do you believe that we should do everything we can to
contain the European crisis, to ensure that there is no
spillover here in the United States, and to stabilize that
region and our own economy? Yes or no?
Mr. Dudley. I think we should do everything that is prudent
to stabilize the European economy. Obviously, we should do what
is in our self-interest in terms of what is best for the United
States; and all our policies are enacted through that prism.
Mrs. Maloney. Okay.
Dr. Kamin?
Mr. Kamin. Yes. That was exactly my thought. Definitely
everything that is prudent and appropriate.
Mrs. Maloney. Okay. Thank you.
I yield back. Thank you, Mr. Chairman.
Chairman Paul. Thank you.
Did Mr. Luetkemeyer have a unanimous consent request?
Mr. Luetkemeyer. Yes, Mr. Chairman. I would like to ask
unanimous consent to place in the record the article which I
referred to this morning. It is a MarketWatch article by Andrea
Thomas with regards to the comment of executive board member
Juergen Stark.
Chairman Paul. Without objection, it is so ordered.
Mr. Luetkemeyer. Thank you, sir.
Chairman Paul. I now recognize Mr. Schweikert from Arizona.
Mr. Schweikert. Thank you, Mr. Chairman. Congressman
Luetkemeyer stole one of the number-one questions I was
interested in pursuing, and that was the credit quality of what
is being pledged.
Can I get into something that is a little more conceptual?
But this one actually really does bother me.
I am trying to get my head around the interconnectivity of
euro-yen, euro's relationship to Singapore. And ultimately, as
we are providing interlocking swap facilities, what happens
when the debt cascade happens somewhere else in the world? Does
that cascade end up tagging Europe, which tags us?
And how much ultimately is there in true net reserves in
central banks around the world when you start looking at the
net borrowing compared to the net savings countries? Dr. Kamin,
I would love it if you would start with that one.
Mr. Kamin. Thank you. I will be happy to.
So to start with, as we have come to recognize only too
well, we have a very globalized financial system. And
disturbances that occur in one part of the world are
transmitted around the world through numerous channels and
through numerous markets.
That was quite evident during the global financial crisis
of 2008 and 2009. And we have seen it more recently with the
European fiscal and financial crisis as deteriorations there--
Mr. Schweikert. Can I beg of you to pull the microphone a
little closer to you?
Mr. Kamin. Thank you. We have seen it more recently during
the European financial crisis in the last couple of years. So--
Mr. Schweikert. And almost to the--what I am somewhat
hunting is I have been tracking some data coming out of Japan,
and there are some very worrisome signs in the net debt. How
does that play into this interconnectivity?
Mr. Kamin. What we have seen, then, is that in situations
that occur like this, some dollar-funding problems, which is to
say problems with banks getting funding in dollars in order to
continue their flow of financing, they tend not to basically
stay in one part of the world. There is a very easy capacity
for those problems to spill out all over the world.
And it was in large part for that reason that we didn't
just establish the swap lines with the ECB. We also established
them with central banks around the world so that problems as
they arose in different parts of the world could be addressed.
And as is evident from the data on the swap lines that we
publish on our Web site, the take-up of these swap lines, in
other words the distribution of funds to institutions in
different regions, has not been limited exclusively to the euro
area, although that is where most of the money has gone.
Mr. Schweikert. Dr. Dudley?
Mr. Dudley. I certainly agree with Dr. Kamin's answer to
that. The world is very interconnected, and problems in one
part of the world can definitely have ripple effects through
the other parts of the world.
That is why we did set up these swap lines with five
central banks rather than just the European Central Bank. And
there are some draws on those swap lines from some of these
other central banks.
Mr. Schweikert. Dr. Dudley, as to that concept, help me get
my head around it.
Considering the nature of our balance sheets today after
the 2008 crisis, both Europe and the United States, some of our
partners in Japan, around other places in the world, if today
Europe--this became a very hard recession and we had something
like the Tequila Crisis from 15 years ago or some sort of
cascade out there, do we have enough capacity, particularly if
we also had different regions of the world competing for access
to those swap lines? Do you believe our balance sheets are
capable of stabilizing?
Mr. Dudley. It is hard to know what would happen in a given
scenario, so it is hard to speculate.
One thing that I think is important though is that the
foreign countries around the world are a bit better protected
themselves in terms of sharp changes in capital inflows to
capital outflows in the sense that they have very large foreign
exchange reserves compared to what they had 20 or 30 years ago.
So, the ability of countries to bear a reversal from
capital inflows to capital outflows is much better generally
around the world than it was 20 or 30 years ago.
And part of that is my concern over the interest-rate
spike, particularly with our net debt coverage; the interest
rate spike and where our WAM is on our U.S. sovereign debt. A
couple of years of higher interest rates would be devastating
budget-wise. So, I am fearful of a cascade somewhere else truly
affecting us.
Mr. Schweikert. I talked in a recent speech about debt
service problems for the United States that are not really
visible yet because U.S. interest rates are so low.
And if the United States does not get its fiscal house in
order over the medium term, there is a chance that U.S.
interest rates will rise. And that debt interest burden on the
U.S. fiscal position will become quite significant. So, this is
just another reason why the United States does need to get its
fiscal house in order over the medium to longer term.
Thank you for your tolerance, Mr. Chairman. Thank you.
Chairman Paul. I thank the gentleman.
Now, I recognize the gentleman from North Carolina, Mr.
McHenry.
Mr. McHenry. Thank you, Mr. Chairman.
And thank you both for being here. We had a similar hearing
in my subcommittee of the Committee on Oversight and Government
Reform. And the times have changed slightly in the last couple
of months, so I do want to touch on some of the things that I
raised then, just to see if things have changed.
Dr. Dudley, can you explain under what circumstances the
Fed would consider purchasing European sovereigns directly?
Mr. Dudley. The Federal Reserve has a small foreign
exchange reserve portfolio that we manage for ourselves and for
Treasury. And so we do actually own a very small amount of
European sovereign debt as part of that foreign exchange
reserve portfolio.
With the exception of that portfolio, which we periodically
roll over maturing securities, I think the bar, as I said in
our hearing a few months ago, was extraordinarily high for the
Federal Reserve to actually go out and buy foreign sovereign
debt for its own portfolio apart from these very small foreign
exchange reserves holdings that we have.
Mr. McHenry. So, roughly what dollar amount do we have?
Mr. Dudley. I think it is on the order of $20 billion, $25
billion total. It consists of cash, sovereign debt of a couple
countries, and then there are some reversed repurchase
agreements where we basically have executed against dealers and
taken--
Mr. McHenry. So, for context--
Mr. Dudley. It is a tiny--and it is based--
Mr. McHenry. $25 billion to what of your total holdings,
just so we have--
Mr. Dudley. The total portfolio is about almost $3
trillion, not quite $3 trillion.
Mr. McHenry. Okay. So, it is de minimis--
Mr. Dudley. It is de minimis and it hasn't changed in size
or composition over--
Mr. McHenry. Do you have statutory authority to expand
that? Could you ramp it up to $500 billion?
Mr. Dudley. We have legal authority under the Federal
Reserve Act to buy foreign sovereign debt. I don't see the
circumstances under which we would ever be willing to do that,
except with the exception of managing this foreign exchange
reserve portfolio.
Mr. McHenry. Okay. Now, in terms of the long-term
refinancing operation the European Central Bank has undertaken
with the 3-year notes, in essence it looks similar in concept
to TARP, doesn't it?
Mr. Dudley. It is a little different in the sense that TARP
was money that Congress appropriated and then was used by the
Treasury as capital to put into banks or put into other
entities to recapitalize them.
The long-term refinancing operation is a loan from the
European Central Bank to its banks against collateral that they
pledged. So, it is a lending operation, not a capital
investment.
Mr. McHenry. So, the TARP really wasn't a lending operation
so you had to pay it back with fines and penalties and
interest? It seems to me--
Mr. Dudley. TARP could be used for many purposes. It could
be lent out and it could be used as capital. But if you look at
how the TARP money was used and the bulk of it, the bulk of it
was used for capital investments.
Mr. McHenry. I think we are battling semantics here because
in essence they are similar in dollar amounts, similar in terms
of their intent.
Now, really at the root, what is the European problem? Is
it a problem of indebted countries? Is that the root of what we
are contending with right now?
Mr. Dudley. I think that is part of it. Part of it is you
have some countries in Europe that have budget deficits that
are unsustainably high and debt burdens that are continuing to
climb. So, that is problem number one.
But problem number two is they are doing so in a system of
17 countries with a common currency where the individual
countries don't have control over their own monetary policy.
They don't have their own currency and there is a lack of
fiscal transfers within Europe to support countries that are in
a weaker position relative to those that are in a stronger
position.
So, there are some things that are very special about
Europe's that are part of the European Union, the system of how
the system is arranged that are very different than anything
that applies to the United States.
Mr. McHenry. So, what happened with much of this long-term
refinancing operation, that capital; it flowed into sovereign
debt of a few countries and in large part that is where much of
this flowed.
But Dr. Kamin, in terms of what that actually did--we have
actually bought some time and space for a few highly indebted
countries. Is that basically what has happened?
Mr. Kamin. I think that it is possible that the sect of the
Long-Term Refinancing Operations (LTRO), in combination with
the other measures that have been taken, basically might have
some somewhat longer-term benefits.
To be specific about that, it is true, as you say, that
probably some of the LTRO money did flow to the purchase of
sovereign bonds. But perhaps the more important thing that the
LTRO funds did was alleviate many concerns by the market about
the liquidity position and the financial position more
generally of European banks.
And so the way in which that may have led to reductions in
the sovereign yields of some embattled European governments was
not just directly--they had the funds and they could use them;
but indirectly because European banks felt more solid in their
financial position and more comfortable being able to buy these
bonds.
In turn, that improved situation in terms of European banks
in the eyes of the markets may have led investors to believe
that, therefore, European governments would not in turn be
called upon to support banks. So, there was sort of a virtuous
circle in process here, which has so far been very beneficial
in terms of improving the tenor of markets.
Now, all that said, you are absolutely right that the LTRO
is the provision of liquidity by itself cannot be the only
thing that will solve the European crisis. It is very important
that European leaders work on a number of more lasting
fundamental issues.
One of them is they need to actually make the financial
backstops for European governments higher and stronger, and
that is a discussion they are having. They also need, quite
obviously, and this is very challenging, to actually follow
through on their many commitments to improve their fiscal
situation.
And finally, as we have discussed here today, improved
fiscal performance must be buttressed by improved growth
performance, and that is particularly challenging for the
peripheral European economies. And so, they are going to have
to follow through on a lot of fairly rigorous structural
reforms.
Thank you.
Mr. McHenry. Thank you.
It sounds like psychology and economics are getting closer
and closer in these current crisis times.
Mr. Kamin. I think they always have been.
Chairman Paul. I thank the gentleman.
I want to follow up on this issue about how it is going to
help our consumers here at home when we make these loans
overseas. And I think, Dr. Dudley, you indicated that you
already have some evidence that it has been helpful? Or are you
just saying that if we do it, it could be helpful?
Mr. Dudley. The evidence is--it is soft evidence rather
than hard evidence. But we have been monitoring the performance
of the European banks who do business in the United States
quite closely because they were having trouble getting dollar
funding.
Money market mutual funds which were providing dollar
funding to the European banks during the summer and fall were
pulling back. Other lenders, large asset managers, were also
pulling back from the European banks. And this was causing
those banks to start to get out of their dollar book of
business. They were trying to sell off loans and pull back in
terms of their willingness to provide credit.
This was going on at a pretty feverish pitch through the
late fall and in through the early winter. And I wouldn't say
that it stopped, but the sense we get is it is happening now in
a much more orderly way and not leading to the fire sale of
assets at low prices; not leading to downward pressure on
financial markets; not leading to a constraint in credit
availability of U.S. households and businesses.
So, from what I can tell, we are seeing that the leveraging
of the European banks is continuing. But it is happening in an
orderly way rather than a disorderly way, which is what our
objective is.
Chairman Paul. You don't actually have a quantity, a number
that you can--
Mr. Dudley. No, we don't have--
Chairman Paul. --to say that they did such and such to the
consumers back here at home?
Mr. Dudley. We don't have the details or data on that. But
we do have discussions with those banks.
Chairman Paul. It seems like there is a conflict, at least
in my mind, of the need to send more currency swaps over there
when the banks--I think the top eight banks in Europe actually
had a tremendous increase in their reserves, a 50 percent
increase in 1 year. So, why do they need more money? Why do
they need more? It is already there.
What about our banks? Our banks have $1.5 trillion. If it
is a good deal and it needs these bailouts or these purchases
that you want them to do by having these currency swaps to help
the banks--give the central banks to help buy some of this
debt. If it is a good deal for anybody, why wouldn't some of
our banks--they have $1.5 trillion?
It seems like you are doing something that the market
doesn't want you to do. And there is a reason. Maybe it is way
too risky. And if we are sending money over to the European
banks with the hope, but no evidence, actually, of some of this
money coming back and actually stimulating our economy, why is
it that just more credit and more money in the system is going
to work if our banks are holding $1.5 trillion?
There is something more to it than the lack of the ability
or the lack of the willingness of the Fed to just endlessly
create more and more credit. Why is it going to work better by
just pumping more into, say, a European bank if the goal--see,
you emphasized the help it is going to--you do it out of the
interest of the American consumer.
You diminish the possibility that it might be done to just
prop up the banks because they are in over their heads--that
they may have credit default swaps. And the banks over there
are--it is global. They have branches over there. It is just to
prop up a system that is not viable.
So why is there a disconnect? There seems to be a lot of
money there. Why do you feel compelled that we have to keep
sending more in order that hopefully it will help our consumers
here at home?
Mr. Dudley. I think that the U.S. banking system is a very
different place than the European banking system. The U.S.
banks have plenty of dollar assets that they can--monies that
they can lend. They gather deposits through their retail branch
networks here. So they don't have any shortage of dollar funds
which they can lend.
The European banks were in a different position because
they were dependent on the wholesale funding market providing
them with dollars. And as the European situation deteriorated
last summer and fall, U.S. investors that had been providing
dollars to these European banks were pulling back.
And it was that pulling back and that difficulty for
European banks to gain access to the wholesale dollar funding
markets which was forcing them to pull back in terms of their
willingness to lend to U.S. households and businesses. U.S.
banks don't need dollar liquidity right now, so there is no--
and they are not deleveraging.
The issue is the European banks, their dollar book of
business. They were having trouble funding that book of
business, and that is why they were pulling back.
Chairman Paul. But they are holding all the reserves. If it
were any advantage at all, they would do it. Obviously, there
is no advantage to even helping out Europe. There is no law
against them loaning the money, is there? Why do you feel
compelled that you have to do something that the banks that are
holding all this money won't do?
Mr. Dudley. I think that the European situation was
creating a lot of anxiety about the health of the European
banking system because the health of the European banking
system was tied up with the health of the individual national
economies in terms of their fiscal positions. And the ECB
basically has been trying to find a way to cut that tie.
I think that long-term refinancing operations and the
dollar swaps have sort of calmed down the anxiety in the
market. And what we have actually seen now since the long-term
refinancing operations have been put in place by the ECB and
the dollar swaps have been put in place by us, is we have
actually seen financing pressures in Europe subside.
So the rates that the European banks have to borrow from
other European banks or to borrow from U.S. banks in dollars,
those rates have actually been coming down. So that is actually
a beneficial consequence of the long-term refinancing
operations and the dollar-swap programs. The pressure on the
markets is abating, which I think is a good thing.
Chairman Paul. I will recognize Mr. Luetkemeyer from
Missouri.
Mr. Luetkemeyer. Thank you, Mr. Chairman.
I am kind of curious. Who determines the rate for the swap
lines, the interest rate?
Mr. Dudley. The interest rate is established by the Federal
Open Market Committee in discussions with the foreign central
banks. Obviously, they have to agree to the rate that we are
willing to--
Mr. Luetkemeyer. How often is it reviewed to go up or down?
How often do you review that: quarterly; semi-annually; once a
year?
Mr. Dudley. The swap lines are outstanding. For example,
the current set of swap lines are outstanding until February 1,
2013. But we certainly could review them at any--
Mr. Luetkemeyer. The rate doesn't float?
Mr. Dudley. --at any point in time. The rate is set
essentially at the Federal funds rate plus 50 basis points. So
right now, it is about 0.6 percent of the interest rate.
Mr. Luetkemeyer. Okay, but the amount above the Fed funds
rate--that stays constant for the entire length of the swap? Or
do you float that or adjust that as well?
Mr. Dudley. It had been at 100 basis points over the
Federal funds rate up until last fall. And then, we lowered
that spread from 100 basis points to 50 basis points. And the
reason why we lowered that rate is that European banks were
reluctant to use the swaps because they felt that using the
swaps at that rate would be a sign of weakness.
The swaps were actually not being very effective in
containing pressure in financial markets. So a decision was
made by us and the foreign central banks in which we have
engaged with the swaps to lower the rate from 100 basis points
over the Federal funds rate to 50 basis points over the Federal
funds rate.
Mr. Luetkemeyer. If the European banks felt it was in their
own best interests not to borrow money, not to swap because the
rate was too high, why would you want to entice them into this
with a lower rate?
Mr. Dudley. They were reluctant to use the swap because
they felt that if they used it, it would be a sign that they
were particularly weak institutions.
Mr. Luetkemeyer. Why are they not viewed as weak now
because they are using it now?
Mr. Dudley. Because when the swap rate was lowered from 100
basis points over the Federal funds rate to 50 basis points
over the Federal funds rate, it became broadly attractive to
the rates that were then in place in markets.
Mr. Luetkemeyer. It made them look like better investors?
Mr. Dudley. Pardon?
Mr. Luetkemeyer. It made them look like better investors,
better money managers?
Mr. Dudley. There was an economic rationale for borrowing
from the swap lines at the lower rate, so lots of banks
participated. And since lots of banks participated, there was
very little stigma from participating in that program.
Mr. Luetkemeyer. This whole thing is held together by
confidence and the perception that everybody is doing okay,
isn't it?
Mr. Dudley. I think we have seen both in the case of the
swaps and in the case of our own discount window in the United
States, that there are times that banks don't want to use
liquidity facilities, backstop facilities, because they are
afraid that it is going to show that they are weak relative to
other institutions. And that is just a problem in terms of
these type of liquidity facilities.
Mr. Luetkemeyer. I am just kind of curious. I will follow
up on Chairman Paul's line of questioning with regards to the
ECB loaning it to the banks, and the banks turning around and
loaning it to our American, I guess, companies and investors
here.
Why would they do that? Why are they not borrowing the
money from us directly, our banks here?
Mr. Dudley. The European banks have big books of business
in the United States, especially in areas like trade finance,
project finance, and reserve energy. They lend against oil-and-
gas drilling, energy reserves. And they have specialized
expertise in these areas. And so, that is why they undertake
this business around the world.
And in the United States, when they partake in this
business, they do it in terms of lending dollars because
obviously that is what the currency that we do business here in
the United States. And so, they have a need for dollars to be
able to sustain that business.
Mr. Luetkemeyer. So what you are saying is that there are
banks in Europe that are better experts at lending in certain
areas, certain fields, than we have lending institutions in
this country. Is that what you just said?
Mr. Dudley. I am saying that there are European banks that
are specialized in certain areas. Now whether they are better
or worse than U.S. banks that participate in the same areas,
there is some overlap in the areas of competition.
But there are certain areas where European banks
historically have concentrated their lending. Project finance,
trade finance, and energy reserve lending are probably three of
the most predominant examples.
Mr. Luetkemeyer. Do the American corporations or entities
that borrow from them, are they buying goods and services from
Europe then, or are they buying goods and services from
someplace else in the world, or the United States? Or is it
kind of--does it kind of work like our export-import bank here,
or how does that work?
Mr. Dudley. I would presume that if you are borrowing in
dollars, you are using those dollars to buy U.S. goods and
services. Otherwise, you wouldn't need the dollars. You would
need some other form of currency.
Mr. Kamin. Congressman, if I could add--this is a very
global financial system, and we are in the middle of a very
global economic system.
So, large banks operate all around the world and compete
with each other. And that actually ends up being beneficial to
non-financial--
Mr. Luetkemeyer. I understand that, Dr. Kamin, but I am
trying to get at--I am kind of concerned here because we have
foreign banks that are apparently competing against American
banks, which is what you just said, yet we are loaning money to
the ECB, to those banks, to be able to loan back and compete
against our banks. Is that what you just said?
Mr. Kamin. What I said was just that both financial
institutions and non-financial institutions compete with each
other all around the world.
Mr. Luetkemeyer. Yes, but my concern is that if we, through
these swap lines, are funding these international banks, and
they are in turn competing against our banks, I don't think we
need to be doing that. Do you?
Mr. Kamin. The primary concern of the Federal Reserve in
setting up the swap lines was to maintain the flow of credit to
American households and firms. That was key because that is
what is needed in order to maintain the economic recovery and
to move toward achieving our dual mandate of both price
stability and maximum sustainable employment.
So, that was the critical factor that motivated.
Mr. Dudley. I think the U.S. banks also are interested in
having a healthy U.S. economy, just like the European banks
are. And I think that they probably broadly recognize that a
forced liquidation of assets by Europeans banks would have
negative consequences for the U.S. economy and for their banks.
Mr. Luetkemeyer. I see my time is up. Thank you, Mr.
Chairman.
Chairman Paul. I now recognize Mr. McHenry for 5 minutes.
Mr. McHenry. Thank you, Mr. Chairman. To follow up on the
earlier question I had about the long-term refinancing
operation, it is interesting to me, Dr. Kamin--you did walk
through the whole thought process. And I do appreciate that,
the willingness of a witness from an independent institution
the Congress oversees to walk through in sort of a very broad
form; your thinking on this is rather impressive, and, dare I
say, revolutionary.
But it was very much appreciated because this is really
just about trying to make sure policymakers on the Hill have an
awareness of what the Fed is doing. And I don't have to explain
to the Fed the chairman of this subcommittee's vigorous
intention of oversight of the Federal Reserve. That may be the
understatement of the day.
So with this injection of funds, of low-interest-rate loans
for an extended period of time, much of this capital--a large
portion of this capital, I should say--of all the categories
has gone to sovereign debt.
Mr. Kamin. This is the LTROs?
Mr. McHenry. Yes.
Mr. Kamin. Thank you.
Mr. McHenry. Yes. I am sorry.
So in that operation, money is flowed to sovereign debt. So
it has had one of the intended effects from the ECB, it
appears. The question is, of course, ``What is our exposure to
Europe?'' Right? In terms of a quantifiable dollar amount, by
our private sector; that is one question.
But really the bigger question here for policymakers is
what is our exposure as a government, and the Federal Reserve's
exposure to Europe?
Mr. Kamin. Thank you, Congressman McHenry, for your kind
remarks earlier, and for these questions.
The Federal Reserve exposure to Europe would be basically
encompassed by the value of our swap lines, which is around $50
billion or so, to the ECB, and then a very small amount to the
Swiss National Bank.
As we have discussed earlier, we think that those exposures
are very secure. We have provided them with dollars. In
exchange, they have provided us with their currency. And we
appreciate the prudent management and the strong financial
position of the ECB.
The exposure of our private financial institutions to
Europe is obviously much, much larger, both our banks and our
money market funds. Those exposures to the most embattled so-
called countries in Europe, particularly like Greece and
Portugal and Ireland, are really very small; the exposures to
Spain and Italy--somewhat larger. But we have had many
discussions with the banks that we supervise, and those are
viewed to be quite manageable. Obviously, the exposures to core
European banks which are, in turn, exposed to peripheral Europe
are much larger.
But we are, in terms of thinking about the channels of
spillover and how this exposure really works--what is probably
more of concern is not so much these direct financial exposures
to European institutions, but rather the fact that if the
situation in Europe took a turn for the worse, there will be
these ancillary channels that we have talked about before; the
disruptions of financial markets; the retreat from risk-taking
that could disrupt financial markets around the world.
And that is really the matter of greater concern, and that
is where we focus a lot of our efforts in working with the
banks that we supervise, and other regulatory institutions
taking the same standpoint that the banks--
Mr. McHenry. Sir, explain to me how the swap lines benefit
the American economy. Just in layman's terms.
Mr. Kamin. Sure. To begin with, many European financial
institutions, as we have discussed, are engaged in direct
extensions of credit to U.S. households and firms. Any
situation where these European banks were unable to get the
dollar funding they needed, they would be forced to pull back
on lending from U.S. households and firms. They might be forced
to sell assets, which would then depress asset values in the
U.S. economy more generally. And both of those effects would
directly affect the ability of the U.S. households and firms to
grow and prosper.
On top of that, funding difficulties by these European
banks would lead to their cutback on credit, in terms of dollar
lending, to other firms around the world; firms which buy a lot
of the U.S. exports. And so, that would be an additional
channel through which a funding shortage could hurt the U.S.
economy. And that is what we hope to alleviate through the
provision of these funds.
Finally, in the event that the dollar funding was not
available--say in the absence of our swaps lines--and European
banks ran into more severe difficulties, this could be a
contributing factor to a further and renewed deterioration of
European financial conditions, that not only could severely
impact the European economy and prolong the recession, but lead
to distressed conditions around the world.
So there might be larger, more ancillary effects from
dollar funding problems then, again, the dollar swap lines are
intended to alleviate.
Mr. McHenry. Thank you, Mr. Chairman.
Chairman Paul. Thank you.
I recognize the gentleman from Michigan, Mr. Huizenga.
Mr. Huizenga. Thank you, Mr. Chairman.
I appreciate the opportunity, and I thank the witnesses for
coming in. I want to maybe touch on a couple of quick things
and continue on the currency swaps.
How far are we going to bring this along, I guess would be
part of my question? How long are we going to stick into this
game and be part of it? If Europe remains dependent on currency
swaps, these same swaps become increasingly risky. Are you
prepared to allow these currency swaps to wind down? Or what is
going to happen there?
And then, the short-term dollar funding in Europe seemed to
be the discussion point; right? How would you define short term
versus medium term and long term?
Mr. Kamin. I will start. Or, why don't you go ahead?
Mr. Dudley. Okay.
What we would hope is that the European countries do the
right thing in terms of getting their fiscal houses in order
and improving their competitiveness, so that investors start to
have more confidence in the sustainability of the European
Union and how all these countries are going to persist.
If that happens, and at the same time, the European banks
are shown to have good earnings, liquidity, and capital, then I
think that the willingness of private lenders to provide dollar
liquidity to the European banks will emerge very much intact.
And in that situation, our swaps will be at rates that are
actually higher than the market, and the swap programs will
just sort of wind down automatically.
This is what we saw during 2007, 2008, 2009, during the
first big wave of swaps; that as market conditions normalized,
the swap usage came down pretty automatically.
Mr. Huizenga. I am kind of curious about that, because I am
looking at some information in front of me here that says
interest rates on dollar loans from the ECB are around 0.6
percent; interest rate on ECB charges for its euro loans is 1
percent. I don't have my Ph.D. in economics, however, I can see
the incentive there. Why by making dollar financing cheaper
than euro financing, how are they ever going to get out of that
cycle?
Mr. Dudley. I am not sure that I would agree with that, if
that is the right comparison. The 1 percent is to borrow euros.
The 0.6 percent is to borrow dollars. And the alternative is to
borrow dollars from a U.S. bank when the Federal Reserve is
paying 25 basis points on the interest rate that we pay on
excess reserves.
There is quite a bit of room between the 25 basis points we
pay on the reserves here in the United States, and the 0.6
percent on the dollar swaps. So we would expect that if the
conditions in Europe were to continue to improve, that the rate
at which European banks could borrow dollars would be somewhat
north of 25 basis points perhaps, but below that 0.6 percent.
So we would think that there is plenty of room in that
difference for the European banks to obtain credit from private
entities.
And, in fact, we have actually seen private suppliers of
dollars to the European banks return subsequently to the large,
long-term refinancing operations and the dollar swap programs.
So it looks like--
Mr. Huizenga. But doesn't that--
Mr. Dudley. --the market is already starting to normalize
the dollar swaps.
Mr. Huizenga. But doesn't that weaken the value of the
euro, what they are doing?
Mr. Dudley. I think the euro has really basically been
trading in line with how the situation in Europe looks. As the
European situation worsens, the euro depreciates. As the
European situation improves, the euro appreciates. So it is
really based on the outlook for Europe, of course relative to
the outlook in the United States.
Mr. Huizenga. Help me to understand how if it is a weaker
euro, doesn't that mean a typically a weaker Eurozone, since we
have sort of flagged this off as a European issue, and trying
not to get dragged into it here from the U.S. side?
Mr. Dudley. You are certainly right that if the European
outlook were to deteriorate, the euro would probably weaken as
a consequence. The good news is that over the last 4 or 5
months, the euro has actually strengthened a bit, because
Europe has actually made some progress in terms of addressing
some of their issues.
Mr. Huizenga. Okay.
And then, my time is almost up, and I will--Dr. Kamin, do
you want to say something as well?
But I am just curious: What keeps you up at night? What
other countries? You specifically--I think in Dr. Kamin's
testimony, he talked briefly about Greece.
And then, you just were touching on Spain and Portugal. But
where are we at with Italy and Ireland? Are we on solid
footing--are they on solid footing in France and Germany and
some of those other countries that have been leading this?
Mr. Kamin. Certainly, the euro crisis in general is what
keeps me up at night, and what occupies much of my thinking
time during the day as well.
Obviously, the situation in Greece has been very difficult.
And we have been following that very closely. We also,
obviously, are very focused on, basically, Ireland and
Portugal, which are the recipients of IMF funds. And we think
it is critically important that these problems not move further
into Spain and Italy, which have also been the focus of market
attention.
And we think it is absolutely critical to make sure that
you don't have further contagion beyond that. So far, things
have been looking on the brighter side. There have been
improvement in markets. But we have continued to monitor the
situation as closely as ever.
And then, while most of my thinking lately is focused on
Europe, obviously I am thinking about oil prices as well,
because that is another area that poses a potential threat at
least down the road.
Mr. Huizenga. Thank you.
Chairman Paul. Thank you.
I have a couple of additional questions I would like to
ask.
I am interested in one line on the Federal Reserve sheet at
each week on other assets, other Federal Reserve assets. And it
has been growing a bit. It used to be a small number, but even
in recent years, it has gone up. I think it is about $160
billion now.
What does that include? Does that include anything foreign?
Is there any type of a foreign asset or a swap or anything
involved in there that would help me understand this
international financial crisis that we are in?
Mr. Kamin. Chairman Paul, we definitely put on our balance
sheet--we list our holdings of foreign assets. I don't recall
offhand if that is where the ``other assets'' are. I don't
think so. The ``other assets'' have, as you point out, risen
over time. And there is one main contributing factor to that,
which is when we buy securities in the markets, sometimes we
buy them at a value that is above their par or face value,
because interest rates had declined since they were first
issued. That raises the value of those securities.
So then, we place the par value of the securities in one
line on our balance sheet, and then that additional part that
is over the par value, the premium, that is placed in our
``other assets'' line. So as we have continued to purchase
securities in the market, the amount of the premium part of our
purchases, which has gone into the ``other assets'' line, has
continued to rise.
Chairman Paul. So you say you are buying securities. Would
this be like mortgage securities?
Mr. Dudley. This would be predominantly the maturity
extension program, in which we are selling short-dated Treasury
securities and buying long-dated Treasury securities. We are
also buying mortgage-backed securities, but with emphasis to
rolling over existing maturing mortgage-backed securities, so
the size of the mortgage-backed securities portfolio is pretty
constant.
Chairman Paul. So, the significant increase of $160 billion
of just saying they are ``other,'' it is definitely related to
the international financial crisis that we are involved in
right now?
Mr. Dudley. As Steve related, it is related to the
expansion of the Fed's balance sheet and the types of assets
that we are buying in the market. The maturity extension
program--we are selling short-dated Treasuries; we are buying
long-dated Treasuries. To the extent that we are buying
Treasuries that are selling above par because interest rates
has declined, that is different than what Steve was saying is
booked in the other assets category.
Chairman Paul. What does this mean, if this were to
continue to grow at the rate it is growing now?
Mr. Dudley. No. I would expect that once the maturity
extension program or other asset purchase programs are ended,
then I would expect the other assets category actually to
probably come down over time as that premium was amortized over
time. So, I would view this as a temporary phenomenon.
Chairman Paul. But there is no one place in the Federal
Reserve reports that would give me a full explanation of
exactly what the $160 billion is? You don't send out a report
each month and say exactly what that is made up of?
Mr. Kamin. There is an interactive portion of our Web site
that offers more analysis of the different lines. That is the
first thing.
The second thing I want to follow up on is having checked,
the ``other assets''--I just think the ``other assets''
category does indeed, as you suggest, also include foreign
currency denominative assets, but not the swap lines. It is the
other European and the undenominated securities that we hold.
Chairman Paul. Okay.
The other thing I have noticed since 2008 is if you look at
a long-term chart of currency in circulation, it is a steady
increase and very predictable. But since 2008, it has been
going up much more rapidly. This is cash as currency. Where is
the demand for more cash? Do you know exactly where that goes?
Does that end up overseas? Is that in circulation here? Or is
it in a shoebox someplace?
Mr. Dudley. Probably in both places. With interest rates
this low, the opportunity costs of holding more currency
obviously is very low. If you hold the currency, you get a 0
percent return. But if you have gone to your bank these days,
you don't get much more than that.
So, people probably are carrying around more currency in
their pockets because there is less cost of holding the
currency versus holding it in a bank. This may also be true
internationally, although I am not familiar with how much
currency is held here versus abroad. I know historically, it
has been about one third here, and two thirds abroad. But I
don't know how that has been changing recently.
Chairman Paul. I have one quick question for both of you.
You can probably answer this rather easily.
You are very much involved in dealing with the value of our
money, the value of our dollar and our financial system. But I
have trouble finding the legal definition for the unit of
account that we have as a dollar. Can you tell me your
definition of--what is a dollar?
Mr. Dudley. I view the dollar as the legal tender in the
United States, so that if someone pays a dollar as payment, the
shopkeeper has to accept that dollar for that transaction.
Mr. Kamin. Also the classic definition of money, I think of
it as three things. It is store value, which it is a medium of
transaction.
Mr. Dudley. And usually has portability.
Mr. Kamin. Yes. And then it is a medium of accounts. In
other words, you measure value by using a dollar.
Chairman Paul. But you do realize there was a more precise
definition of a dollar most of our history where you could
actually know what it meant. But it seems like there is no
definition at all. You say it is just a unit of account. And
that is probably the reason why we have lost about 98 percent
of the value of that dollar since 1913, since it has been the
responsibility of the Federal Reserve to protect the value of
our currency.
So, I have trouble believing that we will be able to solve
any of our problems financially or even fiscally if we can
create money endlessly and out of thin air and accommodate the
politicians who spend money, who spend money overseas, who
spend money on foreign policy that indirectly you have to deal
with. Look how the sanctions and the threat of war in Iran
affects the finances of the world, not only perception-wise in
trade and pushing up oil prices, but also the need to keep
monetizing this debt.
Federal Reserve Chairmen endlessly, for all the years I
have been here, have said, ``If the Congress would quit
spending so much money and didn't have so much debt, we
wouldn't have such a tough problem managing the currency.'' At
the same time, the debt wouldn't be there if the Federal
Reserve wasn't there willing to monetize the debt, because you
are the lender of last resort.
You guarantee the moral hazard that politicians are going
to spend money. And it seems like to coordinate the two and
have a sound economic system instead of a financial bubble that
is based on debt and a monetary standard based on debt with the
world awash in an exploding amount of debt. I don't know how we
will ever get out of this unless we finally come up with a
definition, once again, of what the unit of account is and what
a dollar means.
This hearing is now adjourned.
The Chair notes that some Members may have additional
questions for the panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 30 days for Members to submit written questions to these
witnesses and to place their responses in the record.
[Whereupon, at 11:42 a.m., the hearing was adjourned.]

A P P E N D I X

March 27, 2012

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