[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
RETHINKING THE FEDERAL RESERVE'S
MANY MANDATES ON ITS
100-YEAR ANNIVERSARY
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
__________
DECEMBER 12, 2013
__________
Printed for the use of the Committee on Financial Services
Serial No. 113-56
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
U.S. GOVERNMENT PRINTING OFFICE
86-691 PDF WASHINGTON : 2014
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800
DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC,
Washington, DC 20402-0001
HOUSE COMMITTEE ON FINANCIAL SERVICES
JEB HENSARLING, Texas, Chairman
GARY G. MILLER, California, Vice MAXINE WATERS, California, Ranking
Chairman Member
SPENCER BACHUS, Alabama, Chairman CAROLYN B. MALONEY, New York
Emeritus NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma 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 STEPHEN F. LYNCH, Massachusetts
MICHELE BACHMANN, Minnesota DAVID SCOTT, Georgia
KEVIN McCARTHY, California AL GREEN, Texas
STEVAN PEARCE, New Mexico EMANUEL CLEAVER, Missouri
BILL POSEY, Florida GWEN MOORE, Wisconsin
MICHAEL G. FITZPATRICK, KEITH ELLISON, Minnesota
Pennsylvania ED PERLMUTTER, Colorado
LYNN A. WESTMORELAND, Georgia JAMES A. HIMES, Connecticut
BLAINE LUETKEMEYER, Missouri GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan JOHN C. CARNEY, Jr., Delaware
SEAN P. DUFFY, Wisconsin TERRI A. SEWELL, Alabama
ROBERT HURT, Virginia BILL FOSTER, Illinois
MICHAEL G. GRIMM, New York DANIEL T. KILDEE, Michigan
STEVE STIVERS, Ohio PATRICK MURPHY, Florida
STEPHEN LEE FINCHER, Tennessee JOHN K. DELANEY, Maryland
MARLIN A. STUTZMAN, Indiana KYRSTEN SINEMA, Arizona
MICK MULVANEY, South Carolina JOYCE BEATTY, Ohio
RANDY HULTGREN, Illinois DENNY HECK, Washington
DENNIS A. ROSS, Florida
ROBERT PITTENGER, North Carolina
ANN WAGNER, Missouri
ANDY BARR, Kentucky
TOM COTTON, Arkansas
KEITH J. ROTHFUS, Pennsylvania
Shannon McGahn, Staff Director
James H. Clinger, Chief Counsel
C O N T E N T S
----------
Page
Hearing held on:
December 12, 2013............................................ 1
Appendix:
December 12, 2013............................................ 37
WITNESSES
Thursday, December 12, 2013
Goodfriend, Marvin, Friends of Allan Meltzer Professor of
Economics, Tepper School of Business, Carnegie-Mellon
University..................................................... 11
Holtz-Eakin, Douglas, President, the American Action Forum....... 10
Peirce, Hester, Senior Research Fellow, Mercatus Center, George
Mason University............................................... 15
Rivlin, Hon. Alice M., Senior Fellow, Brookings Institution...... 13
APPENDIX
Prepared statements:
Goodfriend, Marvin........................................... 38
Holtz-Eakin, Douglas......................................... 48
Peirce, Hester............................................... 59
Rivlin, Hon. Alice M......................................... 65
Additional Material Submitted for the Record
Hensarling, Hon. Jeb:
Written statement of Alex J. Pollock, Resident Fellow, the
American Enterprise Institute.............................. 68
RETHINKING THE FEDERAL RESERVE'S
MANY MANDATES ON ITS
100-YEAR ANNIVERSARY
----------
Thursday, December 12, 2013
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.
The committee met, pursuant to notice, at 3:08 p.m., in
room 2128, Rayburn House Office Building, Hon. Jeb Hensarling
[chairman of the committee] presiding.
Members present: Representatives Hensarling, Garrett,
McHenry, Campbell, Posey, Luetkemeyer, Huizenga, Stivers,
Stutzman, Mulvaney, Hultgren, Pittenger, Barr, Cotton, Rothfus;
Waters, Maloney, Watt, Sherman, Capuano, Clay, Scott, Green,
Himes, Carney, and Sinema.
Chairman Hensarling. The committee will come to order.
Without objection, the Chair is authorized to declare a recess
of the committee at any time.
I, first, want to thank the panelists for their patience
and indulgence on our rescheduling. The committee is most
appreciative.
Before getting to our opening statements and testimony, I
am going to recognized myself to speak out of order for 1
minute. I am going to recognize the ranking member and one
other member, and then the rest of you are out of luck.
On Tuesday night, Mel Watt, the Congressman of the 12th
Congressional District of North Carolina, and an 11-term Member
of the United States House of Representatives, was confirmed by
the United States Senate to be the next Director of the Federal
Housing Finance Administration (FHFA). Since coming to this
committee, I have known Mel Watt to be a man of honor. A senior
leader on this committee, he has served with distinction and
led on many critical issues.
At the time that he was confirmed, I sent out a release,
and somebody Twittered to the committee that they were
surprised I was saying something nice about Mel Watt. And I am
still trying to figure out if that was a comment upon me or Mr.
Watt.
[laughter]
It is a long journey from Mecklenburg County, North
Carolina, to Yale, and a long journey from Mecklenburg County
to Congress. Fortunately, it is a short distance from Congress
to the FHFA; I am told it is 5/8th of one mile. Thank you,
MapQuest.
I do not know the exact timing of our colleague's
departure. This may be his last hearing as inquisitor. I will
assure the gentleman from North Carolina that it will not be
your last hearing as inquisitee.
But on behalf of the Republican side of the aisle, and on
behalf of the entire committee, I wish to congratulate you, and
we look forward to continuing to work with you.
And for all the other members, I have spoken to the ranking
member, and after we return from our Christmas break, we will
have a reception so that our colleague can be sufficiently
hosted, toasted, and roasted.
With that, I am happy to recognize the ranking member for 1
minute out of order.
Ms. Waters. Thank you very much, Mr. Chairman.
I certainly appreciate your comments. And I would like the
committee to know that you have been supportive in your own way
and in your own style, and that your offer to have a bipartisan
reception, with all of us participating, in order to wish our
friend and colleague a farewell to this committee and to
congratulate him is something that you initiated. And I
appreciate that. I appreciate that very much.
As a matter of fact, we have been talking about more
bipartisan receptions. We talked about it for perhaps
Christmas. I said, ``Oh, I don't know if we want to do that.''
But when you said for Mel, right away I said yes.
And so, Mr. Chairman, it is with a heavy heart and a strong
sense of pride that I congratulate my dear friend, Mel Watt, on
his confirmation as Director of the Federal Housing Finance
Agency.
For more than 2 decades, I have served alongside Mel on
this committee, and I have watched him use his knowledge and
experience on real estate issues and housing issues to earn the
respect of colleagues on both sides of the aisle. And I am very
pleased to say that Mel Watt understood what was going on with
predatory lending and securitizing and packaging and all of
that long before most Members really got in touch with those
issues.
Because of his leadership, we were able to follow and to
build on what he had initiated so that we could get to the
issues of understanding what was happening in the housing
market and how we should address some of those issues. So his
experience that he brought to this committee was considerable,
again, working on real estate issues and housing issues.
Mel is a thoughtful, well-informed, principled, and fair
human being. These qualities, and his well-known temperament,
will serve him well as he works to address some of the most
important challenges facing our economy and our housing market.
His reputation as a legislator focused on openness,
collaboration, and good public policy is second to none. Over
his distinguished career, he has demonstrated an unwavering
commitment to protecting consumers, expanding affordable rental
housing, and providing prudent oversight of financial
institutions. I know these values will be embodied in Director
Watt's leadership of the FHFA.
Today, I am sad to say goodbye to a long-time friend and
collaborator, but I am heartened to know that in Director Mel
Watt, this committee and this Nation will have a strong partner
in one of its most important government agencies.
Let me just say that I learned from Barney Frank that when
you have difficult issues which require that someone who is
smart, who is patient, and who is not only knowledgeable, but
willing to listen to both sides, when you have someone like
that you can go and ask to put both sides together and work out
a solution, then you should certainly avail yourself of that
person's expertise.
That is what Barney Frank did with Mel Watt. He often asked
Mel Watt to get in the middle of some of the toughest issues
and work with both sides, all sides of those issues, and bring
us back a solution.
And so, we are going to miss those qualities in Mel, but we
look forward to working with him, because I sincerely believe
that in this new position he will help us to understand where
we need to go and what we need to do on the great issues
confronting us on housing in particular today.
So with that, Mel, congratulations.
[applause]
Chairman Hensarling. The Chair now recognizes the gentleman
from North Carolina for one of the last times, for 1 minute of
rebuttal.
[laughter]
Mr. Watt. Thank you. Thank you.
Thank you, Mr. Chairman, and thanks to you and Ranking
Member Waters, both friends and colleagues on this committee.
I will be very brief because I am delighted to know you all
are inviting me back to host me and roast me before I get to
sit on the other side of the table and you really get to go
after me. So, I am sure today is a lot more pleasant than it
will be sitting on the other side of the table when I come
back.
I would just make one comment to put this in perspective,
because one of the things you have to recognize about our
country and be reminded of quite often is that only in America
could somebody be confirmed to this position that has the
regulatory authority over the bulk of housing in this country,
only in America could somebody come from a beginning, being
born in a house with no running water, no electricity, a tin
roof where you could look up through it and see the sky at
night, and look down through the wooden floor and see the
ground, and have the opportunity to get an education, to
practice law, and gain experience in some of the most complex
real estate issues that the country faces, to come to Congress
and serve on this committee, and serve with wonderful people
like my colleagues on this committee have been over the years.
Only in America can that happen. That is the great thing
about our country, and we have to keep faith in that process.
So, I thank you for your kind comments, and I look forward to
coming back to visit with you. And I hope you all will be as
kind to me when I come back as you have been today.
Chairman Hensarling. Don't count on it.
[laughter]
And the gentleman yields back.
[applause]
I thank the panelists yet again for their continued
indulgence.
Now returning to regular order, I recognize myself for 5
minutes to give an opening statement.
This month marks the 100th anniversary of the Federal
Reserve Act. It is on this occasion that I announce the House
Committee on Financial Service's Federal Reserve Centennial
Oversight Project. Our committee will overtake the most
rigorous examination of the Fed's purposes, policies, and track
record in its history. At the end of the project, scheduled for
next fall, the committee stands prepared to mark up legislation
to reform the Federal Reserve, based upon its findings.
The Fed was created in response to the financial panic of
1907. An American Banker article argued at the time, ``The
financial disorders that have marked the history of the past
generation will pass away forever.'' The Comptroller of the
Currency at the time said, ``Financial and commercial crises or
panics seem to be mathematically impossible.''
Clearly, these predictions proved to be somewhat overly
optimistic, as well-established by economists Milton Friedman
and Anna Schwartz, and economist Chairman Ben Bernanke, that
the Fed played a significant role in bringing about the Great
Depression. Loose monetary policy, coordinated with fiscal
deficits, helped cause the great inflation of 1965 to 1986, in
which inflation rates exceeded 13 percent.
Most economists will argue that loose monetary policy
between 2003 and 2005 contributed to the housing bubble in our
most recent financial crisis. This history is not meant to be
an indictment of the Fed, but is intended in the spirit of
looking behind the curtain, not unlike the Wizard of Oz, to
discover a human face, a human face capable of making mistakes,
mistakes sometimes with dire consequences for the lives of
millions of Americans.
Not only were the authors of the Federal Reserve Act wrong
about its effectiveness, I do not believe they would recognize
today's central bank. Classic central bankers followed
Bagehot's dictum to lend freely during panics to solvent banks
at a penalty rate and against good collateral. Recently, the
Fed has lent freely to insolvent non-banks at subpenalty rates
against questionable collateral. To paraphrase an old
automobile advertising phrase, ``This is not your father's
Fed.''
The Fed's foray into credit allocation policy, distinct
from monetary policy, was not confined to the immediate events
of 2008, but continues to this day in the Fed's unprecedented
purchase of mortgage-backed securities. The Fed's additional
extraordinary purchases of Treasury bonds have supported the
Obama Administration's trillion-dollar deficits, a threat to
the Fed's independence, and one that in prior decades has been
a harbinger of runaway inflation.
These extraordinary powers rest with a creature of
government that the founders of our republic, who have vested
the authority to coin money with the Congress, would not have
envisioned: a public-private entity exempt from budgetary
appropriation with effective control over much of the economy.
Our first hearing will consider many mandates of the
Federal Reserve, including classic monetary policy, prudential
regulatory policy, full employment, systemic risk regulator,
lender of last resort, and effective financier of our
unsustainable debt.
We will also consider the Fed's role in credit allocation,
arguably picking winners and losers, particularly the burdens
this has placed--low interest rates have placed on fixed-income
seniors.
We will ask questions again about the Fed's role in our
unsustainable debt. While most of us maintain our commitment to
permit the U.S. Government Accountability Office (GAO) to audit
the Fed's operations, we will explore the issues of
independence, accountability, and transparency, since rarely
has an agency of government been given or assumed greater
discretionary power over the economy than the Federal Reserve.
We will consider how other financial market regulators
operate under a statutory requirement to measure the cost of
the new rules on the economy against the benefits, so we will
help ensure that new rules do not violate the Hippocratic Oath
principle to first do no harm.
The Fed's role as lender of last resort has expanded over
the last few decades and remains ill-defined. We will consider
the appropriate boundaries of that emergency power. We will
certainly consider the classic debate in monetary policy
between rules and discretion in monetary policy. Many would
argue that in successful periods in the Fed's history, like the
great moderation of 1987 to 2003, the Fed appears to follow a
clear rule. In 1995, then-Fed Governor Janet Yellen described
the Taylor Rule as ``what sensible central banks do.''
Milton Friedman once said that, ``Money is much too serious
a matter to be left to central bankers. None of us are
infallible.'' I respect the dedicated men and women who lead
the Federal Reserve, but we have a responsibility to ensure
that the Federal Reserve effectively meets whatever mandates it
may have.
The Chair now recognizes the ranking member for 5 minutes.
Ms. Waters. Thank you, Chairman Hensarling, for holding
today's hearing to discuss the mandates of the Federal Reserve
on its 100th anniversary.
At a critical inflection point such as this, it is
important to take stock of the lessons of the past and reflect
on whether the Fed has been effective in meeting its charge to
keep inflation in check, financial markets stable, and maximize
employment.
Although there have been ups and downs in its history, the
Federal Reserve has learned from the lessons of the past.
Today, it plays an important role in fostering the conditions
necessary for both stability and growth in the American
economy.
One of the many truths over the last century that holds
today is the interdependency between a stable economy and a
stable financial system and, in this sense, the Fed's mandate
to reduce systemic risk and promote financial stability
complements its monetary objectives.
The Fed's regulatory shortcomings in the years prior to the
most recent financial crisis were significant. But since the
crisis began, the Federal Reserve has been one of the most
effective policymaking bodies in stabilizing the financial
sector and continuing to support the recovery.
When the first signs of this crisis emerged in 2007, the
Fed responded swiftly to address the weak economy. It cut the
discount rate, extended credit to banks, and brought the
Federal funds rate to its lower bound. When this wasn't enough,
the Fed took extraordinary steps to provide emergency liquidity
directly to institutions and foreign central banks around the
globe.
However, the severe nature of the crisis forced the Fed to
enter uncharted territory, recognizing the need to act. It took
unprecedented steps by engaging in large-scale asset
purchases--a policy known as quantitative easing--which lowered
long-term interest rates and has provided a needed boost to our
recovery.
As a result of the Fed's stimulus, economists estimate that
the economy is 3 million jobs stronger than it would have been
without the Fed's courageous efforts. Further, the drop in
interest rates triggered by quantitative easing has spurred
improvements in the housing sector and, by extension, the
larger economy.
This housing recovery has been accompanied by a rise in
home prices that has reduced the number of borrowers who are
underwater on their mortgages, and expanded the pool of
homeowners who are eligible to refinance. While the economic
outlook for our Nation continues to improve, we still have a
long way to go until we can say that maximum employment has
been achieved and the economy has fully recovered from the
trauma of the financial crisis.
With close to 11 million Americans still out of work, it is
astonishing to me that members of this body would even consider
striking the employment aspect of the Fed's dual mandate. What
kind of signal does this send to hardworking Americans across
the country?
Of course, Congress should do its part, too. I am hopeful
that Members will come together to pass a budget that moves
away from the antigrowth austerity policies enshrined by the
sequester in favor of a responsible budget that puts our long-
term spending on a sustainable path.
Mr. Chairman, I believe it is worth noting that before we
contemplate legislative changes to the Fed or its mandate,
Congress should allow the Fed to finalize the important reforms
included in the Dodd-Frank Act that reduce the likelihood of
future financial crisis.
The Fed is making important progress on this front. Just
this week, the Fed approved the final Volcker Rule, a critical
rule which will make our financial system safer. We should not
rush into reform merely for the sake of doing so.
So I look forward to the discussion, and again, this
hearing, and I thank the chairman for scheduling today's
hearing. I yield back.
Chairman Hensarling. The gentlelady yields back.
The Chair now recognizes the gentleman from California, Mr.
Campbell, the chairman of our Monetary Policy and Trade
Subcommittee, for 3 minutes.
Mr. Campbell. That is fine. Thank you, Mr. Chairman.
So we are talking about the many mandates of the Federal
Reserve today. And those mandates have not ever been thus, as
we are doing a little history lesson here. The original
architects of the Fed had simple goals, like managing an
elastic currency and serving as a lender of last resort. It
wasn't until 1977, many decades after the creation of the Fed,
that it received the additional mandates of maximum employment,
stable prices, and moderate long-term interest rates. The first
two are commonly referred to as the ``dual mandate,'' although
there are more than that.
But since then, other responsibilities have been added or
increased. The Federal Reserve now has explicit
responsibilities in regulating commercial banking activity,
conducting macroeconomic surveillance, even serving as the
funding source for the Consumer Financial Protection Bureau
(CFPB).
It has served other implicit roles, as well, such as
providing indirect support to mortgage finance markets and
lowering borrowing costs for the Federal Government, which have
had direct impacts on house prices and have enabled deficit
spending.
So with all of these mandates and responsibilities, whether
they are implicit or explicit, that have been piled onto the
Federal Reserve in the last few decades, the question we are
asking here, that we must ask ourselves is, can the Federal
Reserve do as much as it is being asked to do, as well as we
expect it to do it?
The primary job of a central bank--to monitor the money
supply and monetary policy--is tough enough and has enough
impacts on the economy. When we have all of these other things
out there, and mandates for this and mandates for that, are we
giving the Fed more than it can handle effectively, or are we
not?
These are some of the questions that, over the period of
the next few months, as we do this--what did you call it, Mr.
Chairman, centennial review of the Fed--we want to get to, but
we certainly are starting today, right now, with you all in
trying to understand your different views on the mandates that
are there, whether they are correct, whether they are implicit
or explicit, and whether they should be revised.
The Federal Reserve, as I have said several times in the
last few days and will continue to say, is independent, but it
is not unaccountable. And part of what we are talking about
here is accountability for the Fed and its functions and its
actions.
And with that, I yield back, Mr. Chairman.
Chairman Hensarling. The gentleman yields back.
The Chair now recognizes the gentleman from Missouri, Mr.
Clay, the ranking member of the Monetary Policy and Trade
Subcommittee, for 3 minutes.
Mr. Clay. Thank you, Mr. Chairman, especially for holding
this hearing regarding the Federal Reserve's mandate. As we
know, in 1913 Congress enacted the Federal Reserve Act to
provide for the establishment of the Federal Reserve Bank.
In 1977, Congress amended the Federal Reserve Act to
promote price stability and full employment. This amendment is
better known as the Humphrey-Hawkins Act. Price stability is
viewed as stable with low inflation, and full employment is
viewed as maximum sustainable employment.
The Federal Reserve's dual mandate is in contrast to the
European Central Bank's (ECB's) single mandate. The ECB's
single mandate of price stability is a primary objective of
their monetary policy.
The Consumer Price Index (CPI) produces monthly data on
changes in the prices paid by consumers for goods and services.
Currently, the U.S. CPI decreased 0.1 percent in October on a
seasonally-adjusted basis.
For the past year, all-items index increased 1 percent
before seasonal adjustment. Gasoline fell 2.9 percent in
October, and that led to a decline in the entire index. The
electricity index rose, but the indexes for fuel oil and
natural gas declined.
From the mid-1960s to the mid-1980s, the CPI showed major
swings in inflation from low to high to low, and an
unemployment rate reaching 11 percent. The economy went through
many recessions during that time, with both high inflation and
high unemployment.
Currently, the U.S. unemployment rate stands at 7 percent.
In Europe, the unemployment rate in several nations is as high
as 27 percent. In other nations, the unemployment rate is 15
percent and above. The euro area is around 12 percent and E.U.-
27 is around 11 percent.
Still, there are some people who believe that the United
States would be better off with a single mandate as opposed to
a dual mandate. They believe that monetary policy can achieve
the same outcomes with a single mandate as it can with a dual
mandate, and I certainly do not agree with that analysis.
Mr. Chairman, thank you. I look forward to the witnesses'
comments. I yield back.
Chairman Hensarling. The gentleman yields back.
The Chair now recognizes the gentleman from Michigan, Mr.
Huizenga, the vice chairman of the Monetary Policy and Trade
Subcommittee, for 2 minutes.
Mr. Huizenga. Thank you, Mr. Chairman. And I appreciate
that. I, too, much like my previous colleagues have talked
about, the Humphrey-Hawkins Act, the dual or multiple mandate
that has been laid out, I think it is worthy to explore to what
goal and what end we are utilizing that.
I have an economist friend back in Michigan who is from
Chicago, Dr. Robert Genetski, who--he and I have had some
interesting conversations about the Fed. He has pointed out
that over the last 5 years, there has been about $2.3 trillion
of reserves that have been built up in the Fed over the last 5
years. He points to the fact that the Fed is offering 0.25
percent of interest, while Treasuries are at basically zero. It
is not a hard decision for some of these banks as they are
going in there. He believes that it has destroyed liquidity, as
well. And I am inclined to agree with him. I would love to hear
that from you all.
But as we are looking at quantitative easing, QE1,-2,-3,-
infinity, whatever may be happening, Operation Twist, it
certainly seems to me that we are outside the bounds of not
only where traditionally the Fed had been, but maybe where it
should be and legally should be. And how you put that
toothpaste back in the tube is something that has not been
clear, and it is all theoretical, as Mr. Bernanke had pointed
out here in this committee room.
Earlier today, we had a hearing with Treasury Secretary
Lew, where a couple of my colleagues, fellow colleagues from
Michigan, talked about the effects of Japan, and their
quantitative easing, and their ``currency manipulation'' they
are under.
They believe that should exclude Japan from the Trans
Pacific Partnership (TPP) discussions that are going on because
of, literally, the quantitative easing that Japan has been
doing to make the yen cheaper, and therefore, Japanese products
cheaper. I would like some reflections on how that shouldn't
apply to us, and what our own Fed has been doing.
So, thank you, Mr. Chairman.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes the gentleman from California, Mr.
Sherman, for 2 minutes.
Mr. Sherman. This comatose economy still needs stimulus.
Monetary stimulus reduces the Federal deficit by reducing
borrowing costs of the Federal Government. Fiscal stimulus,
which is, in many ways, the alternative, increases the Federal
deficit. A 2 percent target inflation rate is reasonable,
especially given the disaster that can occur to our economy if
we have deflation. Look at Japan or look at our own Great
Depression.
Another part of the dual mandate is the dual function that
the Fed has: on the one hand, it is a bank regulator; and on
the other hand, it is a monetary policy-setting body. I hope
our witnesses address that part of the dual mandate dealing
with both unemployment and inflation.
We also have the Fed dual governance, where, on the one
hand, it is a Federal Government agency, appointed through a
democratic government. And on the other hand, its regional
executives are appointed, in part, by banks. One bank, one
voter, actually, $1 billion of banking, one vote, which is not
democracy. And given the tremendous governmental power the Fed
has, should all of its Board Members be Presidentially
appointed for whatever terms are reasonable?
I hope we look at Section 13(3), which remains the most
dangerous economic provision in our statute books. It allows
unlimited lending by the Fed, trillions of dollars at times.
And we at least ought to make sure that those loans are
default-risk-free, or as close to that as they can achieve.
And finally, when it comes to auditing the Fed, as an old
CPA, I will just say that given our limited auditing resources,
we would normally want to direct them, first, to whichever
agency a Federal Government is working hardest to avoid being
audited.
So I look forward to these hearings, looking not at just
one controversial issue of inflation versus unemployment, as a
focus of the Fed's policy, but a broader range of issues, as
well.
I yield back.
Chairman Hensarling. Today, we welcome four witnesses to
our panel.
Dr. Douglas Holtz-Eakin is the president of the American
Action Forum. Dr. Holtz-Eakin has a distinguished career in the
economics field in academia and, like another one of our
witnesses, Dr. Rivlin, also served as a former Director of the
Congressional Budget Office. He earned his Ph.D. from
Princeton, and his undergraduate degree from Denison
University.
Dr. Marvin Goodfriend holds the Friends of Allan Meltzer
Professorship as a professor of economics at Carnegie Mellon's
Tepper School of Business in Pittsburgh. He has previously
served on the Economic Advisory and Monetary Policy panels of
the New York Fed. He received his Ph.D. from Brown University,
and his undergraduate degree from Union College.
Dr. Alice Rivlin is currently a senior fellow in economic
studies at the Brookings Institution, a visiting professor at
the Public Policy Institute at Georgetown, and the director of
the Engelberg Center for Health Care Reform. As most of us
know, she, too, has a distinguished public service career,
including service, along with myself, on the President's debt
commission, also known as Simpson-Bowles. Somehow, she managed
to dodge the bullet on the super-committee; I did not.
She also served as the Founding Director of the
Congressional Budget Office, OMB Director, and as Vice Chair of
the Federal Reserve Board. She earned her Ph.D. at Harvard, and
her undergraduate degree at Bryn Mawr College.
Last, but not least, Hester Peirce is a senior research
fellow at the Mercatus Center at George Mason University. Her
primary research interests relate to the regulation of
financial markets. We welcome her back to the Hill. Ms. Peirce
formerly served on the Senate Banking Committee. She earned her
law degree at Yale, and her undergraduate degree from Case
Western Reserve University.
I think each and every one of you have testified before, so
you know that you will each be recognized for 5 minutes. And,
no doubt, you know the lighting system. Without objection, each
of your written statements will be made a part of the record.
Dr. Holtz-Eakin, you are now recognized for 5 minutes.
STATEMENT OF DOUGLAS HOLTZ-EAKIN, PRESIDENT, THE AMERICAN
ACTION FORUM
Mr. Holtz-Eakin. Thank you, Mr. Chairman, Ranking Member,
and members of the committee. It is a privilege to be here
today.
Certainly, I want to applaud the chairman and the committee
for holding this series of hearings. The 100th anniversary of
the Federal Reserve is an appropriate time for a comprehensive
review. And it is especially timely, because since 2007, the
Fed has navigated unprecedented and extraordinary events and
undertaken unprecedented and extraordinary measures in response
to those events. It would be useful to have a systematic
evaluation of their efficacy and their desirability as future
tools for the Federal Reserve under the purview of the
Congress.
My written testimony points out four major functions for
the Federal Reserve: the conduct of monetary policy; acting as
a lender of last resort; microprudential regulation, the
oversight of bank-holding companies, in particular; and
macroprudential regulation, the management of systemic risks.
And I think there is fruitful area of inquiry for all four.
Probably the most familiar is the debate over the conduct
of monetary policy, rule-based monetary policy versus
discretion, the desirability of a single mandate versus a dual
mandate. I won't belabor those here. I simply encourage the
committee to look into that.
I do think that the lender-of-last-resort function needs
some examination. I was privileged to serve under appointment
from the Congress on the Financial Crisis Inquiry Commission.
That experience left me with the very strong belief that the
Federal Reserve was the single best policy response to the
crisis and deserves the lion's share of the credit for the
relatively quick turnaround that the United States experienced
in response to the downturn in financial markets.
And that involves a traditional and large-scale lending of
liquidity against collateral. I am not a big fan of the things
they have done since. I will go into that later, but I think in
that moment, it did an extraordinary job for the United States.
But it left behind as a legacy some serious questions about
the transparency of their actions. It left behind an
extraordinary expansion of the balance sheet, which is exposed
to interest rate risks, and may constrain further Federal
Reserve policy. And I think it is a useful thing for the
committee to look at where the limits should be on the lending
of last resort and what serves as useful collateral. I will
confess that I don't have a firm answer to that question, but I
think it is something that is certainly worth investigating and
thinking hard about.
In the area of microprudential regulations, the Fed has a
very extensive supervision of regime. It had one leading into
the crisis, and it missed some material weaknesses in the bank
holding companies under its supervision. And I think it has,
since that time, been given even greater supervision
obligations.
For example, the Volcker Rule that was just announced looks
to me to be an extraordinary undertaking, one that is
ambiguous, at best, and is going to strain the abilities of
supervisors. I think it really is a good question as to whether
we are asking too much of the Fed in that area.
And then finally, on the macroprudential, the systemic risk
issue--with the finance--the FSOC and the Fed's role in the
FSOC, and worrying about systemic risk, I worry about whether
we have gone too far. I look at the FSOC's designation of life
insurance companies, for example, as systemically important
financial institutions (SIFIs), when they have little or
nothing to do with the crisis that we experienced, and I think
perhaps we have drawn the boundaries too widely and it might be
time to rein in the macroprudential regulatory obligations and
authorities of the Fed and others.
I look forward to answering your questions. I, again,
applaud the committee for deciding to take on this task and
think about these issues. They are perhaps among the most
pressing public policy issues we face today. Thank you.
[The prepared statement of Dr. Holtz-Eakin can be found on
page 48 of the appendix.]
Chairman Hensarling. Dr. Goodfriend, you are now recognized
for 5 minutes.
STATEMENT OF MARVIN GOODFRIEND, FRIENDS OF ALLAN MELTZER
PROFESSOR OF ECONOMICS, TEPPER SCHOOL OF BUSINESS, CARNEGIE-
MELLON UNIVERSITY
Mr. Goodfriend. Thank you, Mr. Chairman, and Ranking Member
Waters.
My testimony today will talk about lessons from the
financial crisis for Fed credit policy. I am going to
reconsider the Fed's performance in meeting its financial
stability and employment mandates in the 2008-2009 financial
crisis and Great Recession. I am going to emphasize three
points, and then I am going to make one recommendation.
First, Fed credit policy employed without bound, and not
conventional monetary policy, played the preeminent role in
stabilizing financial markets in the fall of 2008 and 2009.
Second, Fed credit policy involves fiscal policy
initiatives that are ordinarily the prerogative of Congress,
but are not part of conventional monetary policy.
And third, the financial panic and Great Recession were
triggered in September 2008 in large part when prominent
Members of Congress openly condemned expansive Fed credit
support for AIG, and the public became frightened that neither
the Fed nor Congress would offer further effective support for
the financial system. I will elaborate on that as we go
forward.
Let's see if I can turn the page. On the basis of that
experience, I would recommend that the Fed's credit policy
responsibilities, vis-a-vis the fiscal authorities, be
clarified explicitly and narrowed so as to avert a mishandling
of the boundary in the future.
Fed credit policy worked successfully on a massive scale,
as Doug said, in the fall of 2008 by reintermediating banking
and money markets. The Fed sold Treasury Securities from its
portfolio, and it is no longer willing to lend to money
markets. And the Fed loaned the proceeds from its sale of
Treasuries to entities no longer able to borrow at reasonable
rates, if at all, in money markets.
While quickly reducing short-term interest rates to near
zero, the Fed employed its monetary policy powers mainly to
create reserves with which to fund credit policy.
Crucially, the reintermediation powers of Fed credit policy
involve fiscal policy, lending to particular private entities,
whether financed by sales of Treasuries against future taxes or
financed by the creation of reserve money.
Unfortunately, the Fed's very independence, the ambiguous
boundary of expansive Fed credit policy, would help trigger the
financial crisis of September 2008 and produce the Great
Recession, a story that I will tell in the remaining time I
have.
Paul Volcker alluded to the problem in an April 2008 speech
to the Economic Club of New York, where he described the Fed as
having acted at the very edge of its lawful and implied powers
when, in March, the Fed employed credit policy to facilitate
the acquisition of Bear Stearns by JPMorgan Chase (JPMC).
In retrospect, Volcker's remarks can be seen as a life
preserver to help the Fed persuade Congress at that point to
make fiscal resources available, if need be, to stabilize
financial markets. Instead, the fiscal authorities were not
then so involved, and the Fed remained exposed to having its
balance sheet utilized, in my term, as an off-budget arm of
fiscal policy without formal authorization by Congress.
The problem is this: The Fed credit policy cannot be the
front line of fiscal support for the financial system. A Fed
credit policy decision that commits taxpayer resources in
support or one that denies taxpayer resources is an inherently
highly charged political fiscal policy matter.
Initiatives that extend the Fed's credit reach in scale,
maturity, eligible collateral, or to unsupervised or
potentially insolvent institutions inevitably carry credit
risks, incite questions of fairness, and potentially threaten
conflict between the Fed and the fiscal authorities, with the
potential to destabilize financial markets and employment.
Worse, an ambiguous boundary of expansive Fed credit policy
initiatives creates expectations of Fed accommodation in
financial crises, which blunts the incentive of private
entities to take preventive measures beforehand to shrink their
counterparty risk or their reliance on short-term finance and
build up financial capital. Events surrounding the Fed's rescue
of AIG in the fall of 2008 illustrate the problem.
On September 16th, the Fed chose to lend $85 billion on
equity collateral to rescue AIG in order to make AIG's
counterparties whole rather than risk worldwide collapse. The
politics were such that prominent Members of Congress
criticized the Fed's credit policy as overreach and a
questionable commitment of taxpayer funds. And the Fed, under
Chairman Bernanke, replied the next day that it was stretched
and could do no more.
The U.S. Government appeared paralyzed. A run on money
market funds was abated only after the U.S. Treasury, on
September 19th, guaranteed all money mutual fund assets.
The best evidence of how severe the crisis became was that
high-yield spreads over Treasuries then jumped to 16 percentage
points and remained elevated for months, well above the 6
percentage point spread that had been their peak since the
credit turmoil began.
How did all this result in the Great Recession? Well, the
ensuing chaos got the public's attention. The paralysis of
government, the conflict between the Fed and the Congress, on
the boundary of fiscal policy, frightened the public.
Prudence demanded more saving. Households around the
country, on average, saved 5 cents more of every dollar they
would have spent in the next 3 months. The national household
saving rate jumped by 5 percentage points. In macroeconomics,
that is a disaster. It rarely, if ever, has happened in so
short a time period.
The collapse in demand pushed unemployment up sharply from
6 percent to 10 percent in a matter of months. And the
relatively mild contraction that had begun in December 2007
became the Great Recession.
[The prepared statement of Dr. Goodfriend can be found on
page 38 of the appendix.]
Chairman Hensarling. The Chair now recognizes Dr. Rivlin
for 5 minutes.
STATEMENT OF THE HONORABLE ALICE M. RIVLIN, SENIOR FELLOW,
BROOKINGS INSTITUTION
Ms. Rivlin. Thank you, Mr. Chairman, Mr. Sherman, and
members of the committee.
I am really pleased to be here to testify on this very
important question, which I interpret as, what economic goals
should Americans expect of their central bank?
I don't believe there is a simple answer to this question.
We can't tell the Federal Reserve, just control inflation or
just maximize employment or just keep the financial system
stable.
Americans, quite rightly, have multiple objectives for the
performance of their economy, including high employment, low
inflation, and financial stability. The job of the Fed and
other policymakers is to balance those multiple objectives as
well as they can.
And that is not an easy task. It requires analysis and
judgment in the face of necessarily uncertain forecasts. But
focusing on any single objective would lead to less
satisfactory outcomes than we have.
First, we do want the economy to create jobs, preferably
good jobs, for almost everyone who wants to work.
Second, we want low inflation, or a fairly stable price
level. We should not aim for zero inflation, because that makes
it harder for resources to move out of falling demand sectors
and risks tipping the economy into deflation. But persistent
inflation above moderate rates is really dangerous.
Third, we want to avoid financial crises with the potential
to endanger economic activity in a major way. And the recent
crisis illustrates how bad that can be.
In general, these goals reinforce each other, but sometimes
balancing is necessary. For example, reducing the risk of
inflation or financial instability may require slowing growth
and job creation.
The economy is extremely complicated, and it is impossible
to predict accurately. As my colleagues have pointed out, the
Fed's past track record is clearly mixed. Skillful monetary
policy deserves some of the credit for the fact that inflation
has been quiescent for more than 3 decades, although partial
credit goes to fiscal policy, for example, the restrictive
fiscal policy of much of the 1990s and an increasingly flexible
and competitive economy.
The Fed certainly bears some of the blame, along with many
other culprits, public and private, for its failure to spot the
dangers of the deteriorating lending standards that contributed
to the housing bubble and inaction in the face of the
overleveraged pyramid of housing-related derivatives whose
crash brought the world economy to its knees.
This was a house of cards that would have come down
somehow. I am not sure that the AIG actions--although I wasn't
very enthusiastic about those either--were actually the
triggering event.
Once the unnecessary crisis happened, the Fed moved
aggressively and imaginatively, in cooperation with the
Treasury, to mitigate the economic damage. The Fed and other
regulators had inadequate tools at that time. They now have
more, thanks to this committee and your counterpart in the
Senate, which, if used courageously and intelligently, can
reduce the chances of a similar catastrophe.
I believe that the Fed's policy of aggressive and
continuous monetary easing, keeping short-term interest rates
close to zero and announcing its intention not to raise them
without strong signs of recovery, plus substantial ongoing
purchases of Treasury and mortgage-backed securities has
contributed substantially to recovery from the Great Recession.
The question now is, how much accommodation is enough?
There are downsides to extremely low interest rates, which
discourage saving and may encourage unproductive trading and
risk-taking. Moreover, the Fed should not go on increasing its
portfolio indefinitely.
So the question is, does the recovery have enough momentum
to absorb a gradual tapering of the Fed's asset purchases,
followed by a slow reduction of the Fed's portfolio as the
assets mature? This is a judgment call, and people will differ.
But to come back to the mandate, it seems to me that the
drafters of the multiple statutes that define the Fed's
responsibilities did a good job of encapsulating the major
objectives which Fed policymakers should have in mind as they
decide on specific policy moves.
I think it would be risky and unfortunate to change the
basic mandates under which the Fed operates, although there is
plenty to talk about in your series of hearings.
Thank you.
[The prepared statement of Dr. Rivlin can be found on page
65 of the appendix.]
Chairman Hensarling. The Chair now recognizes Ms. Peirce
for 5 minutes.
STATEMENT OF HESTER PEIRCE, SENIOR RESEARCH FELLOW, MERCATUS
CENTER, GEORGE MASON UNIVERSITY
Ms. Peirce. Chairman Hensarling, Congressman Sherman, and
members of the committee, thanks for the opportunity to be part
of your centennial look at the Fed. Although the Federal
Reserve is turning 100, it has the regulatory appetite of a
teenager, and that is what I am here to talk about today. So I
would like to talk specifically about some of the new
regulatory authorities they have, a little bit about the
Volcker Rule, and then, finally, about economic analysis.
Coming out of the crisis, it was not clear that the Fed
would get more regulatory power. In fact, there was talk about
taking some of their powers away.
But persistent presence during deliberations paid off for
the Fed, and they came out with new powers. That included
getting new entities that they would oversee. Savings and loan
holding companies are one example, certain designated financial
market utilities, which are the plumbing of the financial
system are another example, and then, of course, systemically
important financial institutions.
So we have seen already some of the non-bank systemically
important financial institutions have been named and handed
over to the Fed for regulation, and that is definitely an area
to keep an eye on. The Fed tends to look at the world through a
bank-centric lens. It is not clear whether they will be able to
realize that these entities are not banks and really can't be
regulated as if they were.
Another area in which the Fed got new powers is a little
more subtle. They now have a regulatory mandate to consider
financial stability. That is really a very nebulous term, and
it gives the Fed quite a bit of discretion in how they will
interpret it.
The Fed does not seem satisfied with the regulatory power
it has. It has been making noises, Fed Governors and officials
have been talking about unregulated areas, or areas they
perceive not to be regulated enough in the market, and sort of
implicit in that is, they are saying, hey, if you are looking
for a regulator, you can look at us.
And so, that includes money market funds. They have been
very active in the debate, and quite critical of the Securities
and Exchange Commission and its proposals for reforming money
market funds. They are also very interested in the short-term
financing market.
As was mentioned this week, the Fed, along with four other
regulators, finalized the Volcker Rule. The motive for this
rule was certainly a good one: protecting taxpayers. It is
being done through limiting proprietary trading and
relationships with private funds like hedge funds.
Unfortunately, the implementation is quite difficult, and
we don't know the full ramifications. A thousand new pages of
regulatory text came out this week, and so that will take some
time to absorb and figure out what was done.
But there are a couple of things that are really clear. One
is that by setting up this massive compliance operation--and it
is a massive compliance operation not only for the banking
entities that are affected, but also for regulators--we are
going to be having folks concentrate on this ambiguous line
that the regulation sets up about prohibited proprietary
trading versus hedging and market-making, which are allowed to
some degree.
And so, you are going to have people spending a lot of
resources trying to make sure they are on the right side of
that line. Meanwhile, we could have risks over here that are
real risks to the banks and financial systems that are
completely not paid attention to because so much effort and
energy is being spent on Volcker Rule compliance.
Banks will be limited in their ability to hedge their own
risks, so that is another area of concern. And then there is
very much uncertainty about the effect on market-making, which
is really an important function in our markets. It is a
function that makes securities trade, ensures that there is a
buyer for every seller and a seller for every buyer. So, it is
really an area that we want to be careful to protect.
One of the reasons that the Volcker Rule was so poorly done
is because of the lack of analysis. There was no thorough,
comprehensive economic analysis. And I think this was an area
where the Fed really could have taken a leadership position. It
is an agency that is rare in the sense that it is not run by
lawyers like me. It is run by economists. And so, they didn't
take that opportunity, and actually that is not that rare for
the Fed. It has a really spotty record on economic analysis.
It is an independent regulatory agency, which means that it
is not covered by Presidential Executive Orders requiring
economic analysis. But interestingly, in 1979 the Fed put out a
policy statement which was basically an endorsement of good
regulation. And included in that was really the importance of
bringing in public participation, but also required for every
rulemaking a regulatory impact analysis, which would include a
look at what is the problem we are trying to solve, what are
the options for solving it, and then what are the costs and
benefits of those different options, trying to make sure that
the costs are proportional to the benefit. Unfortunately, we
ended up with a Fed that has this policy, but doesn't actually
abide by it.
So just in closing, I think there are a number of things
you should consider in your 100-year look: first, does the Fed
need a statutory mandate to do economic analysis to make sure
that it is disciplined about that; second, you should hold its
feet to the fire in the way it exercises its new regulatory
authority to make sure that they are doing that in an
accountable fashion and a transparent fashion; and third, I
think it is important to look at whether the Fed has too much
regulatory authority, especially because its main job is
monetary policy, and is all this regulatory authority
distracting it from that?
Thank you very much.
[The prepared statement of Ms. Peirce can be found on page
59 of the appendix.]
Chairman Hensarling. Thank you to the panelists for their
testimony.
Due to the rescheduling of this hearing, one of our
original witnesses, Alex Pollock of the American Enterprise
Institute, could not be here today. I ask unanimous consent to
make his written statement a part of the record. Without
objection, it is so ordered.
[The prepared statement of Mr. Pollock can be found on page
68 of the appendix.]
The Chair now yields himself 5 minutes for questioning.
I believe it was last year, Dr. Rivlin, you appeared before
our Monetary Policy Subcommittee, and you testified in that
hearing that you believed the dual mandate is ``consistent with
the principles enshrined in Dr. Taylor's famous rule.'' Do you
still believe that? And if so, could you elaborate?
Ms. Rivlin. Yes, definitely. I think the dual mandate is
nicely illustrated by the Taylor Rule, which actually says if
the economy is growing faster than its potential, the Fed
should look to raising interest rates. And if it is growing
below potential, it shouldn't. That is a very loose
translation, but that is what I get out of the Taylor Rule. And
John Taylor himself, who was at that hearing, has been critical
of the Fed for not raising rates faster early in the last
decade.
Chairman Hensarling. Some argue that the multiple mandates
of the Fed should be narrowed. Others, I believe, perhaps
believe there are others that should be expanded. So
hypothetically, what if the Fed had another mandate in the
conduct of monetary policy, and in some form or fashion, some
iteration was mandated to abide by the Taylor Rule? How would
you see that implemented? Would you advocate that policy? Would
you not advocate that policy?
Ms. Rivlin. No, I am not a rules person. In the first
place, there are quite a few versions of the Taylor Rule. And
when I was at the Fed, the staff used to provide us with
multiple versions for our edification. But my general point is
I think that you can't encapsulate anything as complicated as
the economy in a simple equation.
Chairman Hensarling. Let me follow up on a comment Ms.
Peirce had, and if we are looking at potentially increasing
mandates on the Fed, you said, Dr. Rivlin, in your testimony--I
am not sure if this is an exact quote--that the Fed has to
balance multiple objectives as best they can. I know that the
SEC and the CFTC as they are balancing multiple objectives, and
they are subject to statutory cost-benefit analysis. The Fed is
not. Should they be?
Ms. Rivlin. Oh, I agree with Ms. Peirce that they ought to
do more analysis of almost anything. Economists think that way.
But, no, I wouldn't put--it depends what you mean. I would
encourage them to do analysis, but I wouldn't say that there is
any way to quantify exactly the costs and benefits of any
particular monetary policy. And trying to do that would be more
trouble than it is worth.
Chairman Hensarling. I think I will go in a different
direction now. In viewing the multiple mandates of the Fed,
looking at the Humphrey-Hawkins mandate, specifically the full
employment mandate, which obviously should be the objective of
the government as a whole, as most economists would define full
employment still being commensurate with roughly 4 percent to 5
percent unemployment as people transition through.
But if the Federal Reserve's--I believe everybody still
believes its principal mandate is that of classic monetary
policy--full employment mandate is that critical, should the
FDIC have a full employment mandate? Should the CFPB have a
full employment mandate? Should the FSOC or the SEC have a full
employment mandate? And in the seconds I have remaining, I
would be happy to--
Ms. Rivlin. No, I don't think so. I don't think--the FDIC
is a very valuable agency, but I don't think it does anything
that influences aggregate employment directly. And the Fed
does. So I think it is quite different.
Chairman Hensarling. I only have 13 seconds left, so I will
set a good example and yield back the balance of my time.
The Chair now recognizes the gentleman from California, Mr.
Sherman, for 5 minutes.
Mr. Sherman. I will point out that the FDIC can discourage,
in effect, loans to small business. All of us here are besieged
by people who want to start or expand a business and aren't
able to get a loan. And all of those arguments are made on the
basis of employment.
I think the chairman illustrated well an odd paradox. And
that is in every other area, to be a really staunch Republican
means you have to be in favor of cost-benefit analysis. We have
had at least a dozen votes on the Floor about whether to
require cost-benefit analysis for this agency or that agency.
They are anxious to say an environmental regulator shouldn't
just look at how much cleaner the air can be, but what effect
is that going to have on the cost to the economy?
And the dual mandate of the Fed is, in effect, a required
cost-benefit analysis. The benefit or hoped for benefit of any
easing is to provide additional employment. The cost is an
increase at least in the risk of some undesirable inflation.
Likewise, tightening the risk is the possibility that
unemployment will go up and the benefit is, hopefully, a
reduction in the risk of inflation.
So I think what we should do with the dual mandate is
rephrase it as a cost-benefit analysis. That is to say, every
time you are seeking to reduce inflation, look also at the cost
to employment and vice versa. And I think that a 100-year-old
agency should modify its lingo to meet current political needs,
which is to say I think we should have a dual mandate, and I am
happy to rename it a cost-benefit analysis or a trip to
Disneyland or whatever other name we want to put on it.
Mr. Goodfriend, you spoke of the AIG bailout in such
glowing terms that you disparage those who would even criticize
it. That was done, I believe, under Section 13(3) of the
Federal Reserve Act, which allows--at that time, allowed
unlimited loans by the Fed. Now, there is a provision that we
added in Dodd-Frank which says you can do that for general
economic effect, but you cannot make loans under Section 13(3)
for the purpose of propping up, say, a company named AIG.
Should the Federal Reserve have unlimited authority to use
unlimited funds, well above $85 billion perhaps, for the
purpose of bailing out the creditors of a particular financial
actor?
Mr. Goodfriend. No, clearly not. My point there was that
those--that giving the Fed the latitude, the independent
latitude to use its balance sheet to make credit available to
private entities by any means is not a good policy, because the
boundaries are not clarified between what the Fed can do and
what the Congress can do. Ultimately--and I said this long
before--the Fed will be drawn into situations where it will
overreach, and the Congress for political reasons will have to
say, ``No, no, that is a mistake.''
And when the public sees the Congress and the Fed at odds
in crisis, that creates an increase in the saving rate, which
is a disaster for employment. So my point was about--
Mr. Sherman. I want to sneak in one more question for the
panel, and that is, nobody is proposing to put the Open Market
Committee on C-SPAN. Thank God the Democratic caucus is not on
C-SPAN. But what harm would be done to have an audit and
continuing audits by the GAO of the Fed? Does anybody have an
answer? Ms. Rivlin?
Ms. Rivlin. In the first place, in the usual sense of
audit, the Fed's books are audited. That is clear, and I don't
think the public always understands that.
What this other use of the term audit is--I think sort of
an independent study to second-guess them on monetary policy.
And there are lots of those, actually, that are done. I am not
sure commissioning the GAO to be the official kibitzer on Fed
policy is particularly useful.
Mr. Sherman. And should we somehow exclude the
international transactions of the Fed or are those the ones we
most want to report about?
Ms. Rivlin. We should know about international transactions
as we should know about all kinds of transactions.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes the gentleman from California, Mr.
Campbell, the chairman of the Monetary Policy and Trade
Subcommittee.
Mr. Campbell. Thank you, Mr. Chairman.
I am going to kind of follow up where the chairman left
off, but do so in a very open-ended manner. We talked about the
three mandates, if you will--the maximum employment, stable
prices, and moderate long-term interest rates. So, I am going
to ask each of you, and we can start with you, Dr. Holtz-Eakin,
about those mandates.
Would you support, or if you were king of the forest, would
you add to those mandates, reduce from those mandates, or make
a modification or amendment or rule or whatever with any of
those mandates?
Mr. Holtz-Eakin. I would not add; I would subtract.
Certainly, I would like to see far more of a rules-based
approach by the Federal Reserve. That doesn't rule out
discretion, because they can pick the rule they want to
operate.
But if they can provide it to the Congress, and the
American people will know what they are up to, they themselves
have said forward guidance is crucial. We need to know what
they are going to do. Rules provide that.
So, I think there is a much stronger case to be made for
that. And then the question becomes, what do you put in such a
rule of monetary policy. And I think there is a case to be made
for a single mandate focusing on price stability. It has been
done in the other central banks.
There is a lot of research to suggest that it produces good
employment outcomes, and that is what we want, in the end. And
so, I think those are all issues that are very, very sensible
things to discuss.
Mr. Campbell. I am going to change my order just a little
bit because you advocate a rule. Dr. Rivlin said she is not a
rules person. She said that--and I am putting words in her
mouth--that you can't simplify or boil this down to a single
rule or rules. How do you respond to that? And then, I will ask
Dr. Rivlin to respond to his suggestion.
Mr. Holtz-Eakin. Rules can be very complicated. And they
don't have to be simple. You don't have to simplify the
economy. You can have very complex decision-making.
But you can be clear about it. And I think, for example, a
way that the Fed could avoid this issue of auditing is it could
say, ``Here are the benefits and costs of what we are trying to
do.'' It could do the economic analysis and essentially provide
an evaluation of its rule so that you can see what it is trying
to do. That is very valuable.
Mr. Campbell. Okay, Dr. Rivlin, I probably butchered what
you said, but this is your chance to respond, agree, disagree.
Ms. Rivlin. I think the Fed should be very clear about its
objectives. It should be clear about how it is trying to get
there, and if it wants to have a mandate--have a rule like we
are trying to keep inflation around 2 percent, that is just
fine.
But what I meant was I just don't think that you can put
into a single equation and keep following it. An exact rule for
anything is complicated, as is the U.S. economy.
Mr. Campbell. So what about the three mandates as they
stand?
Ms. Rivlin. I would leave the three mandates as loosely
stated as they are, but urge the Fed to be more specific about
its objectives and its policies.
Mr. Campbell. Okay. Professor Goodfriend?
Mr. Goodfriend. Two of the three mandates actually are
achieved with one stone. Low inflation keeps long-term interest
rates low. High inflation is probably the most important factor
in raising long-term interest rates.
Fear of inflation, even without actual inflation, is
probably the most important in moving long-term rates up. So I
will take--low inflation should be a priority because it
achieves the first mandate and the third mandate.
What I would say about the second one, employment, is that
inflation should get the priority even in the short run. And
only if employment proves to be something that the Fed can deal
with in the short run in a way that is commensurate with
confident, stable inflation, should monetary actions be
undertaken to stimulate employment.
The Taylor Rule is a pretty good compromise, I would say.
And I think the Taylor Rule would, in any case, serve as a
great benchmark against which the Fed should be judged.
Mr. Campbell. Ms. Peirce?
Ms. Peirce. As a non-economist, I try to stay pretty far
away from monetary policy. But I do think, just as a general
matter, it is good to have people concentrate on the thing that
they are really able to achieve. And I don't think that is
employment for the Fed.
Mr. Campbell. Okay. I will set a good example, and I will
yield back the balance of my time, as well.
Chairman Hensarling. The Chair now recognizes the gentleman
from Connecticut, Mr. Himes, for 5 minutes.
Mr. Himes. Thank you, Mr. Chairman. I really do want to
thank you for holding these hearings. I think the hearings that
we have had, these are some of the more intellectually and
analytically interesting. They are not necessarily partisan, as
the discussion is playing out today, but they really are
critical.
One of the panelists--and, by the way, thank you all for
being here and for your patience--explicitly said that the
Federal Reserve's activities in the face of the financial
crisis were essential. And I got the sense from, at least most
of the panel, that there is general agreement on that.
Those authorities, of course, then, were I think looked on
somewhat askance by this Congress. And there are all sorts of
proposals to limit those authorities, even though I think most
of us would agree that they were, in fact, essential to helping
pull us out of the nosedive of 2008, very, very interesting
issues.
For what it is worth, Mr. Chairman, my own view is that we
as a Congress have a responsibility to conduct oversight. But
history would show, and country after country would show, that
if we compromised the independence of the monetary authorities,
we would be eroding one of the real cornerstones of American
economic stability and growth. The prospect of monetary policy
subjected to the tender mercies of the House of Representatives
horrifies me, frankly.
I would like to actually take up Dr. Peirce on some of her
comments on the Volcker Rule. I have been thinking about it and
following the Volcker Rule very closely for some time now. You
are very critical of the Volcker Rule. I am not, not because I
necessarily think it is a great rule, but simply just that I
have never been able to quite figure out an alternative.
You suggest that perhaps better market discipline would
work, by which I assume you mean incentives, supply-demand,
clear price signals, and that if shareholders and creditors
could evaluate proprietary risks taken, that perhaps that would
be a better alternative to the Volcker Rule. That is sort of
the core of your argument.
I would really like to explore that with you, because it is
not at all clear that in a system where a bank comes to believe
that they can take big bets, and that if those bets go wrong,
they will be able to go to the window, they will be able to
rely on Federal support, that the incentives are anything other
than to take large and irresponsible bets.
I would also point out that, having worked in a financial
institution, credit and exposure changes hour by hour, and it
is reported to shareholders, at best, quarter by quarter, and
frankly, even on an annual basis, the information is pretty
opaque. So I am wondering if you really think that given all of
those limitations and incentives, there is a market-based
approach to reducing proprietary risk in contrast to the
Volcker Rule?
Ms. Peirce. I do. I agree with you that we need to make
some changes to get there, but I think that the market is
actually more capable of monitoring these types of things than
regulators who are limited in the amount of information they
have.
Mr. Himes. But surely the market gets a lot less
information on day to day and quarter to quarter and even
annual risk positions than the regulators do and can.
Ms. Peirce. Yes, but I think if you have a market where the
incentives are correct so that the shareholders and the
creditors know that not only are they going to lose money when
something bad happens, but potentially even--in the case of
shareholders--be asked to fork over more money, I think then
they have a real incentive. And I think incentives are what
make people good monitors.
That doesn't mean that they are going to be able to be in
the institution and know moment by moment how the credit risks
are changing. What it does mean is that they have to put people
in place managing those institutions who are going to be on top
of that. And when they see a failure, they have to make the
call of whether they want to get rid of those people.
Mr. Himes. Okay. Long topic, but I have one other question,
and I hope you can help me with this. I have thought a lot
about cost-benefit analysis--economic analysis as well, too. As
we think about the costs of regulation, they are pretty clear.
And the cost of compliance with the Volcker Rule will be
meaningful. We can get pretty close on what those costs are,
pretty specific.
The benefits, of course, have to include the avoidance of
the kind of catastrophe that we saw in 2008, $17 trillion in
eliminated asset value at its trough, I guess. And we didn't
know if it was going to be $34 trillion or a hundred--who knew?
Who knew?
How do we factor in the benefits, which I assume are mainly
the avoidance of that sort of catastrophe. How do we factor in
the timing and magnitude and probability of those costs
avoided, i.e., benefits?
Ms. Peirce. You do have to take that into account. But
unfortunately, what usually happens when people have these
discussions is they say, ``Look, the financial crisis was
terrible, and so, any rule we put in place is good.'' But then
you have to link it back and say, ``Okay, would this rule
actually have helped?'' And in the case of the Volcker Rule,
proprietary trading really wasn't at the root of the last
crisis.
Now, it could be at the root of a future crisis. But the
question that you have to ask is, what will this rule actually
prohibit? And it may not be that it would prohibit something
really terrible. It may be that there is an option that would
be cheaper but that would achieve a better result and do it
more effectively.
Mr. Himes. Thank you.
Thank you, Mr. Chairman. I did not set a good example.
Chairman Hensarling. No, the gentleman from Connecticut did
not.
The Chair now recognizes the gentleman from Michigan, Mr.
Huizenga, the vice chairman of the Monetary Policy and Trade
Subcommittee.
Mr. Huizenga. Thank you, Mr. Chairman. And I don't have a
track record of setting a good example either, but I am trying
to work through that.
Sort of continuing on where my friend, Mr. Himes, was
going, Ms. Peirce, you had said that accountability with the
new responsibility was one of the things that you believe ought
to be held up for the Fed by us.
And I guess the question, sort of a rhetorical question
is--maybe not a rhetorical question, but the question you kind
of posed--does it have too much regulatory responsibility, is
sort of what I heard. I just want to confirm that is sort of
where you are at, and then I would like the rest to sort of
comment on that. Are we in waters that the Fed should be in,
and has the capability to handle?
Ms. Peirce. I absolutely believe they have too much
regulatory responsibility right now.
Mr. Huizenga. Okay. Dr. Rivlin?
Ms. Rivlin. I was very skeptical of giving the Fed as much
microprudential regulatory authority as it has, because I
thought that would detract from the concentration on these
other mandates, which I believe are really important, including
the financial stability. I actually favored the Dodd version of
Dodd-Frank, which would have--
Mr. Huizenga. He is looking down at--
Ms. Rivlin. --created a central regulatory agency, not the
Fed. But we didn't do that.
Mr. Huizenga. Didn't they attempt to do that basically with
the CFPB?
Ms. Rivlin. Pardon me?
Mr. Huizenga. Didn't they basically try to do that with the
CFPB, at least in some part, and then fund it through the Fed?
Ms. Rivlin. No, that is only consumer regulation, which I
also thought was a good thing to do. I wouldn't have funded it
through the Fed. But we needed an agency directed to consumer
product regulation.
Mr. Huizenga. Professor Goodfriend?
Mr. Goodfriend. I feel that the Fed's problem is the
problem of regulation in general in the finance area.
Regulation is trying to do the impossible. It is trying to
compensate for inordinately low capital minimums.
I would be happiest if capital minimums were raised by
Congress so as to remove some of the regulatory burden for
safety and soundness in the first place. I feel like trying to
substitute for excessively low capital minimums with regulation
policy is not going to work, and it is a dead end.
And I think the Fed should ultimately be doing less
regulatory policy and enforcing through Congress' will higher,
much higher capital requirements on banks.
Mr. Huizenga. Dr. Holtz-Eakin?
Mr. Holtz-Eakin. I want to echo my colleague, Alice
Rivlin's, thought. I think that it was a mistake to have more
of the microprudential regulation.
I am even less enthusiastic about the Volcker Rule than is
Ms. Peirce. I think it is a big misstep.
And I want to echo what I said in my opening remarks. I do
not believe the Fed should be involved, and I don't believe the
Financial Stability Oversight Council will be successful, in
this macroprudential effort to control systemic risks. And I
would take it out of that exercise, as well.
Mr. Huizenga. Okay. In my last minute-and-a-half,
quantitative easing and the necessity of it. Do you all agree
that it was a necessary step? Does anybody not agree?
Mr. Holtz-Eakin. It depends which one you are talking
about. I believe--
Mr. Huizenga. One, two, three, or--
Mr. Holtz-Eakin. No, I think the Fed, its initial response
is to be applauded. It moved from a very mistaken institution-
by-institution approach to opening liquidity to vast pieces of
the financial markets. That was exactly the right thing to do.
Since then, everything else has been a policy error.
Mr. Huizenga. It seems to me we might be caught in a catch-
22 at this point, because markets are going to react as they
have somewhat. But moving on, how do others around the world
view our QE stance, positively, negatively?
Mr. Goodfriend. So I think what you see around the world is
countries feel like they are kind of being whipsawed back and
forth by the talk of QE or not QE in the United States. And I
regard that as simply what markets are saying, the Fed is
trying to run an excessively discretionary policy with respect
to QE.
And so it is impossible--whether it is foreign governments
to plan, or U.S. businesses or financial participants to plan,
because the Fed refuses to specify anything about the glide
path where QE is going. Again, it comes back to the benefit of
rules from the Fed. But one of the benefits is letting other
countries, letting other businesses, plan for the future.
Mr. Huizenga. And can we possibly be critical of other
countries trying to essentially do the same thing? I see a
shaking of a head, but--
Mr. Holtz-Eakin. No.
Mr. Huizenga. I assume there is consensus on that?
Mr. Goodfriend. If you are talking about Japan, there is a
difference. Japan has deflation. I am for price stability. If a
country has outright deflation, then I think you can make a
case for stimulative monetary policy. The United States does
not and is nowhere near that.
Mr. Huizenga. Thank you. I yield back.
Chairman Hensarling. The nodding of a head goes with the
tapping of a gavel.
The Chair now recognizes the gentleman from Delaware, Mr.
Carney, for 5 minutes.
Mr. Carney. Thank you, Mr. Chairman. I want to second the
comments of my colleague from Connecticut, Mr. Himes, and thank
you for having these hearings, and for this, I think you said
year-long process. I find it very educational, and very good
for me as a relatively new Member. I want to thank all the
panelists for being here and bringing your expertise.
I have a lot of questions and very little time. So maybe
what I should do is go kind of to the end. The chairman, in his
opening remarks, envisioned a process where we would have these
reviews. We have actually had another hearing where it was the
international central bankers' perspective. And we heard a lot
from that panel, a very good panel, very good information, what
we are hearing today.
And they basically said that Congress should set the
mandate, set the goals, kind of get out of the way, monitor the
Fed's actions to those goals, and make adjustments
periodically. The chairman envisions the legislation.
How would you change the mandate that the Fed has now? You
have addressed this, each of you, I think a little bit. But
could you say it simply stated as well for me?
Mr. Holtz-Eakin. I personally would narrow its scope toward
a greater focus on monetary policy. I think some of these other
activities are a distraction to the Fed, and it is not going to
do them very well. And within monetary policy, I want to echo
the--you get two of those mandates with one by taking care of
inflation. I, for one, believe that inflation should be the
primary objective of the Fed. As I said, you can make a case
for a single mandate, a price stability mandate. I am not
religious about it, but I certainly think that the more clarity
the Fed gives to how it is pursuing its mandate, the better off
everyone will be.
Mr. Goodfriend. I would follow up on that by reiterating
the point that you get two goals for the price of one by
putting inflation first. I want to add something to that, also.
You not only get low interest rates in the long term, you
not only get stable inflation, but if you look back at the
history of unemployment fluctuations in the post-World War II
period, before Paul Volcker stabilized inflation, they were
literally the result of the Fed putting a priority on
unemployment first, and then allowing the inflation rate to get
out of control, and then creating recessions, one after the
other. This was called go-and-stop policy. So you get even
benefits for unemployment by putting a focus on--you get three-
for-one, actually.
Mr. Carney. So--right, so does the Taylor Rule mitigate
against that effect?
Mr. Goodfriend. Pardon me?
Mr. Carney. The Taylor Rule?
Mr. Goodfriend. The Taylor Rule is a way to simplify,
putting a priority on inflation, but allowing some room for
responding to fluctuations in output relative to--
Mr. Carney. So it does give some nod, if you will, to
employment? And you said--I think you said earlier that you
thought it was a good compromise?
Mr. Goodfriend. Yes. The Taylor Rule is a very good
benchmark against which central bankers should judge their own
actions and against which they should be judged by legislative
oversight.
Mr. Carney. Ms. Rivlin?
Ms. Rivlin. I would leave the mandates alone, at least the
three we have been talking about: low inflation; maximum
employment; and financial stability. It is certainly possible
to fold the employment goal into an inflation target, if you
recognize the deflation is a bad thing and the Fed should move
in both directions.
But right now, when inflation is not anywhere on the
horizon, and unemployment is high, for the Congress to suddenly
say, ``We don't want you to care about unemployment. We want
you only to concentrate on inflation,'' I think the average
citizen would say, ``Huh? What are they thinking?''
Mr. Carney. I think that is part of the problem. In some
ways, it is a political problem. Most people understand what
employment is. They don't always understand what inflation is,
and what causes it, and the relationship.
So if you are talking about just inflation, deflation,
price stability, you get--but if you talk about employment, and
at least as part of the conversation, then from our
perspective, representing the constituents that we do, there is
a balance there.
Dr. Holtz-Eakin, you are jumping out of your chair.
Mr. Holtz-Eakin. I agree with everything you said, but I
just want to point out something, that if you are very clear
about how this would work, it would be about inflation
expectations. What are people expecting in inflation?
And in the current situation, the fear of deflation,
expectations of price falling, would cause people to move
aggressively in exactly the way that Dr. Rivlin wants them to.
Mr. Carney. Thanks very much. If I had more time, Ms.
Peirce, I would ask you about the alternative to the Volcker
Rule. But I don't. Thank you.
Ms. Peirce. We can talk offline, if you like.
Mr. Carney. I yield back. Thank you.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes the gentleman from Ohio, Mr.
Stivers, for 5 minutes.
Mr. Stivers. Thank you, Mr. Chairman. I would like to thank
all of the witnesses for being here. And I am going to go ahead
and continue on with the line of questioning from the gentleman
from Delaware.
What do folks on the panel think would be an alternative
approach to the Volcker Rule that would work better, or is
there one?
Mr. Holtz-Eakin. I first want to say that I do not believe
that proprietary trading had anything to do with the crisis.
And for that reason, I would not have pursued something of the
type of the Volcker rule. So I think it is a misguided
enterprise at the outset.
If you are deeply concerned about the notion that
depositors' funds, which are backed by taxpayers' deposit
insurance, are being used for an inappropriate purpose, then
the answer is to create narrow banks that have the sole
function of taking deposits and then use them to invest only in
something like Treasuries. Those entities thus are very safe
and are not going to cost the taxpayer anything. And the
remainder of the financial institutions, labeled whatever you
want, are not narrow banks, and they can go do what they want.
Mr. Stivers. Let's go ahead and let everybody opine on that
if you have an opinion.
Mr. Goodfriend. To go back to my testimony, I don't believe
that the crisis had, at its core, the issues that proprietary
trading had to do with, so I completely agree with Doug.
I think what we should be focusing on is, as I said in my
testimony, excessive expansiveness of the Fed's willingness to
supply credit in crises, which I think had much to do with
exacerbating the crisis as it occurred in 2008, especially when
the Fed ran into conflict with the Treasury.
Once the government looked paralyzed, we really, in my
opinion, got the worst of it. Before that time, the Fed had
been handling things, and we were in a mild recession with some
difficult deflation of house prices. But once the public saw
that the government was at odds with itself, that, in my
opinion, caused the great panic, the rise in the saving rate
and so forth. And that is, above all, what we should avoid
going forward.
So rather than focusing on the Volcker Rule, I would focus
on the boundary of the Fed's credit policy powers vis-a-vis the
fiscal authorities, so that there can be some prearranged
agreement on how to handle crises.
Ms. Rivlin. I don't think the Volcker Rule is a
particularly promising avenue for controlling the real problem,
which is excessive risk-taking and bubbles of the sort that we
had.
The things that are actually prominent in the Dodd-Frank
Act, allowing the Fed together with other regulators to raise
the capital requirements and to control excessive leverage, are
much more important as general tools, as is the resolution
authority to avoid having to have a big institution fail in a
disruptive way. So, I would concentrate on those.
Ms. Peirce. I think it is important to recognize that
lending also can be quite risky, so it is not proprietary
trading that should be the target specifically. But it should
be putting in measures to make sure the market is watching.
And you can do that through contingent capital. You can do
it through having shareholders face--taking away their limited
liability, so that they actually have to pay in if there is a
problem. There are some creative ways to do that. And, of
course, higher capital requirements would be effective at this,
too.
Mr. Stivers. Do any of you--and several of you volunteered
in your answers--believe that proprietary trading in any way
caused the financial crisis in 2008 and 2009?
Ms. Rivlin. No, but I think it can be a problem for
commercial banks, if it gets out of hand.
Mr. Stivers. If it got out of hand. That is fair. And I
would want to follow up on a couple of things that folks said,
because, Dr. Holtz-Eakin, you talked about Treasuries. And
under the current Volcker Rule, Treasuries and GSEs are exempt
from--they are allowed investments.
But given our mounting national debt and record low
interest rates, is it really fair to say--you said they were
kind of risk-free. I don't think it is fair to say they are
risk-free anymore. They are a lower risk, certainly, than
equities.
Mr. Holtz-Eakin. They are. That was just an example of, if
you want to have entities that have insured deposits, you can
control their portfolios very tightly. And if you are not going
to provide insurance, let people trade and invest as they see
fit.
Mr. Stivers. I will yield back the balance of my time. And
actually--
Chairman Hensarling. The gentleman yields back his 2
seconds.
[laughter]
The Chair now recognizes the gentlelady from New York, Mrs.
Maloney, for 5 minutes.
Mrs. Maloney. I thank the chairman, the ranking member, and
the panelists for being here today.
Although some of you say that proprietary trading was not
part of the financial crisis, it has been documented to have
been the cause of the London Whale, which caused a loss of $6
billion. That is unquestionable. And some allege, or believe,
that the subprime proprietary trading in CDOs, or
collateralized debt obligations, was a severe cause of the
financial crisis.
But instead of debating it back and forth, we could call
for a GAO report on the role that proprietary trading played in
the financial crisis and have a legitimate report that comes
back to us. I would sponsor such a request. If any Republican
would like to join with me, then we could have an independent
analysis and research project which would document that.
One of the things I feel we don't have from the financial
crisis is what we had after 9/11, and that is a commission that
really went in and analyzed in depth and reported on what
caused 9/11, with examples, with funding, with staff. That was
never done, really, with the financial crisis. It has been many
different looks and perspectives, but I think that is worth
doing, if my colleagues would like to join in making such a
request.
I want to ask--Dr. Rivlin, it is good to see you again. And
thank you for your public service. And I thank all of you for
your hard work. In your testimony, you said that it is entirely
appropriate for the Fed to have multiple mandates, and I agree.
You also said that it is possible but not certain that the
Fed's low interest rates in 2003 and 2004 contributed to the
bubble that led to the financial crisis. Could you elaborate a
little bit on that?
Ms. Rivlin. Yes. I think there were multiple causes of the
financial crisis, and that the principal one was allowing the
decline of lending standards, an egregious decline. And I fault
all the regulators in not stopping that. But, unquestionably--
Mrs. Maloney. And then the trading of those, proprietary
trading--
Ms. Rivlin. Later.
Mrs. Maloney. --of those subprimes--
Ms. Rivlin. Certainly, there was a whole pyramid of
derivatives erected on top of the American housing mortgages,
and it was the very overleveraged pyramid that came crashing
down. But I think low interest rates always contribute to a
bubble. If you can borrow money--
Mrs. Maloney. I am curious if you would elaborate on how
you think the Fed should have balanced its mandates in that
situation.
Ms. Rivlin. I am not--
Mrs. Maloney. Should they have kept interest rates low to
maximize employment, but then adopted stronger bank regulations
to protect financial stability? Should they have raised
interest rates earlier than they did?
Some are arguing, and in one editorial, even, in The New
York Times today, that if you raised interest rates to 3
percent to 4 percent, that would help us in the recovery. And
what is your comment on that?
Ms. Rivlin. I don't think raising interest rates would help
the recovery. But to go back to the 2003-2004 period, I think
the Fed was in a box then, because it did not have appropriate
tools to deal with an asset price bubble, as it did not in the
1990s, when we had the stock market bubble, which was clearly a
bubble. I was at the Fed at the time, and we didn't really have
the right tools for dealing with that, because raising interest
rates at that moment would have damaged--would have slowed the
economy drastically. You would have had to raise them very high
to affect the bubble. And we didn't do it, and I think we were
right.
Mrs. Maloney. The Fed's unconventional monetary policies
during and after the crisis have been extensively debated and
commented on today, too. And, obviously, when the Fed adopted
many of these policies, they were in clearly uncharted waters.
We can debate whether they should use these policies in a
crisis, but do you think the Fed should use unconventional
policies only in a crisis? Or should they be willing to adopt
new unconventional policies in good times, too?
Ms. Rivlin. Good times don't challenge the Fed the way a
crisis does, so I am not sure exactly what unconventional
policies would be appropriate. The main thing is to avoid the
crisis. But once you have it, then you have to do everything
you can think of to stabilize the situation.
Chairman Hensarling. The time of the gentlelady has
expired.
The Chair now recognizes the gentleman from New Jersey, Mr.
Garrett, the chairman of our Capital Markets and GSE
Subcommittee.
Mr. Garrett. Thank you, Mr. Chairman.
And to the gentlelady of New York, that is an interesting
idea, as far as a study. So let's just think about--we should
probably get together and think about that some more, doing
something like that.
Maybe couple it with Ms. Rivlin's comment about the--you
were just talking about underwriting standards and the problems
in those areas, so there might be--if we are going to ask for
something, we might as well ask for a couple of points in--as
far as the study goes.
Mrs. Maloney. I would welcome any opportunity to work in a
bipartisan way on this committee. Thank you.
Mr. Garrett. Great. Thanks.
Earlier today, the committee heard from Secretary Lew to
get some answers, or at least we were attempting to get some
answers from him. And during that time, I expressed to him my
concerns regarding the lack of accountability and transparency
that has been part and parcel of, I said, this Administration.
So I want to carry that through here with this discussion
and the theme of accountability and transparency, as we examine
the broader theme of the Fed.
The gentleman from California has already sort of laid this
out, and we agree that the Fed has an awful lot on its plate,
and I would argue it has--just as he does, I think--it has too
much on its plate. On the monetary side, the Fed must contend,
as he said, with the dual mandates. The Fed also maintains
responsibility--I will get into those in a minute--on
supervising and regulating bank holding companies, providing
bank services to deposit institutions and so on. And Dodd-Frank
has just added to all that.
Now, with such vast powers, including an independent
funding stream outside of the appropriation process, its role
as lender of last resort, the Fed, then, should be held to a
very, very high bar in terms of accountability and transparency
to not only Congress, but also to the American people.
And I am really concerned that the level or lack of level
of accountability and transparency at the Fed is
disproportionate at this point to its power.
I just have a couple of questions. I am not sure which
order I will go in; maybe I will just run down the list this
way.
Ms. Peirce, by our count, the Federal Reserve has had only
5 meetings over the last 2 years, 5 open, public meetings over
the last 2 years. Considering this expansive power that they
have, and it is now as regulator as well, do you think that is
an appropriate amount of openness and public meetings?
Ms. Peirce. I think that is a really important concern that
you raised. They do a lot of their rulemaking behind closed
doors.
And as we saw this week with the Volcker open meeting, some
really valuable things come out of those open meetings. You get
the dialogue between the staff and the Chairman and the other
Governors, and that is very helpful.
Mr. Garrett. I don't have a lot of time. Can I ask you--and
anyone else from the panel--after we are done here, to send me
any recommendations that you might have on that area, if you
would, please?
I will swing down to the other end of the table, and say,
you are probably aware that earlier this year, the House passed
the SEC Regulatory Accountability Act. This legislation
enhances the SEC's existing economic analysis requirements,
requiring that it first clearly identify the nature of the
problem that would be addressed before issuing any new
regulations, and also require economic analysis to be performed
by the SEC's Chief Economist.
Under current law, the Fed is not obligated to perform such
a cost-benefit analysis. Given its role as--central role in
Dodd-Frank, do you think this is appropriate? And if not, what
would you recommend?
Mr. Holtz-Eakin. I think the Fed should be required to
provide such an analysis. I am cognizant of how difficult this
is to do sometimes. This came up earlier in the discussion
about quantifying the benefit, but that doesn't mean you
shouldn't do it. It tells you, then, if you can quantify the
costs exactly, that the benefits have to be at least that big,
or it is not worth doing, and you need to know that. So I would
ask the Fed to do that on a regular basis.
Mr. Garrett. Great. We have heard from a lot of community
banks that all the regulations under Dodd-Frank are creating a
huge problem for them. I will get right to the point here. Over
at the OCC, there is something called the community bank
ombudsman located within the OCC. In light of all the extra
powers now that the Fed has, should we have something akin to a
community bank ombudsman within the Fed?
Mr. Holtz-Eakin. I think I would like to have the
opportunity to think about that and get back to you. I worry
about creating favored constituencies who have their own
representative inside the Fed.
Mr. Garrett. Okay. Yes, sure?
Mr. Goodfriend. On cost-benefit, I would like to point out
something. The Fed's so-called QE policies today are really
what we call in finance a carry trade. Carry trade means you
are borrowing very short term to hold long-term securities.
That is not a monetary policy. A carry trade is a pure fiscal
policy.
So where I would start, if you want to argue that the Fed
should be undertaking cost-benefit analyses, I would ask them,
well, what do you think are the potential costs or value at
risk, so to speak, in the banking business, of a carry trade of
the nature that you are carrying on? Then, we can talk about
the benefits that you think there are.
Mr. Garrett. We have tried to get that number from them,
yes, but thank you. That is a good point.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes the gentleman from North Carolina,
Mr. Pittenger, for 5 minutes.
Mr. Pittenger. Thank you, Mr. Chairman.
And thank you, panelists, for being here today. It is very
good to have heard your responses.
I would like to ask each of you--Chairman Hensarling has
shown this debt clock running on either side of the room. I
really wanted to get your thoughts on how the policies of the
Fed could lead to compounding the problem when it comes to
interest rates on the debt. Do you believe when interest rates
rise over the coming years, and the spinning trajectory we are
on towards the close of this decade, the interest rate
payments, along with the annual deficits, will push America's
debt to unsustainable levels, perhaps close to what we are
seeing in Europe?
Would you like to start, Mr. Holtz-Eakin?
Mr. Holtz-Eakin. I am already so troubled by the trajectory
of the U.S. debt that it will not take higher interest rates to
trouble me further. Certainly, we are on an unsustainable
trajectory. If we were to get a normalization of interest
rates, either quicker or something above what people like the
CBO forecast, it is going to put enormous pressures further on
the Federal budget. So we are in a dangerous position as a
nation, and it should be fixed.
Mr. Pittenger. How would you fix it? How would you mitigate
it?
Mr. Holtz-Eakin. It would be up to the Members of Congress
and the Administration to fix the spending problem that
emanates from the mandatory spending programs in the budget.
That is our problem. That is what we haven't touched. That is
what needs to be fixed.
Mr. Pittenger. As it relates to the interest rates?
Mr. Holtz-Eakin. In the end, we want to pray for higher
interest rates. They will, in fact, reveal that the economy is
recovering. And so, at all costs, we don't want to avoid higher
interest rates. We want them to normalize. And we want the
fiscal policies to be put in place that allow us to sustain
those higher interest rates without a threat to the stability
of the Federal budget.
Mr. Pittenger. Very good. Thank you.
Mr. Goodfriend?
Mr. Goodfriend. I completely agree. I have nothing to add
to Doug's comments.
Mr. Pittenger. Ms. Rivlin?
Ms. Rivlin. I believe that the trajectory of debt is very
worrisome. That doesn't mean that I think we need more
austerity now. I think, actually, we need less. But I was very
disappointed that the budget deal--which admittedly is a lot
better than no budget deal--did not come to grips with the
longer-run problem of the debt rising faster than the GDP.
I think that means two big, difficult things. It means
entitlement reform, and it means tax reform that will raise
more revenues in the long run through a more pro-growth tax
system. I served on two commissions, one of them along with the
chairman, that explored those issues. I think we can get to a
bipartisan agreement on it, and we ought to do it as fast as
the Congress can.
Ms. Peirce. Again, I am not an economist, but I know we are
spending too much.
[laughter]
Mr. Pittenger. Well said. I concur with that.
Professor Goodfriend, recently I introduced some
legislation, H.R. 3240, and it deals with Regulation D as a
Study Act. This bill calls for the GAO to take a look at Reg D
as it relates to the number of transfers allowed for a given
individual, that being six. And working with the Fed, I just
wanted to get your take on this bill. If Congress were to
eliminate or modify the six-limit transfer under Reg D, would
that cause concerns to the Fed?
Mr. Goodfriend. I am not aware of what is in the bill. If
you can explain it to me a little bit--
Mr. Pittenger. It is a bill for credit unions. It is really
outdated. It is a bill that was--the policy was developed out
in the 1980s. And I think through the electronic transfers and
other forms of payment, there is a limit to how many transfers
can be made. And so, it is a simple bill, and I just wanted to
know if you--
Mr. Goodfriend. It sounds like there had been a limit on
transfers made by credit unions on behalf of their customers--
Mr. Pittenger. Yes. Yes, there is now.
Mr. Goodfriend. Credit unions started out as relatively
small collections of people who were allowed to set up banking
facilities independent of being commercial banks. And since
then, credit unions have gotten huge. They have become very
important banking centers.
I think it is time to treat them like banks under the law,
and it sounds like your bill would do that. There are different
sides of this debate that I am aware of, but I think that
credit unions have long since become more and more like banks,
and I don't see any reason why they should be treated
differently, if that is what this bill is about.
Mr. Pittenger. Yes, sir. Thank you.
I yield back.
Chairman Hensarling. The gentleman yields back.
The Chair now recognizes the gentleman from Kentucky, Mr.
Barr, for 5 minutes.
Mr. Barr. Thank you, Mr. Chairman. And thanks to the
witnesses for being here.
I want to start with Ms. Rivlin, and thank you for your
service to the country in many different capacities. I was
struck by your testimony just a few minutes ago about your
wanting the Congress to resist austerity measures. And just for
clarification purposes, the Federal budget, we spent presently,
what, $3.7 trillion, is that right?
Ms. Rivlin. Something like that.
Mr. Barr. And so for the last 5 years, we have had--we have
run deficits in excess of $1 trillion for 4 years and close to
$700 billion this past year. You are not suggesting that those
policy results in any way resemble austerity?
Ms. Rivlin. I am suggesting now that the deficit has come
down quite rapidly, and that puts a drag on the economy, and
that cutting discretionary spending as much as the Congress did
has retarded recovery. I am glad that part of the sequester was
set aside in this agreement. But, yes, I think we do have
austerity now.
Mr. Barr. And I noted your favorable comments related to
the budget agreement that the Congress will be taking up--the
House will be taking up this afternoon. Do I take your
testimony to mean that you generally agree with the concept
that I think Dr. Holtz-Eakin has advocated pretty vociferously
in the past, that replacing, or at least focusing the attention
on mandatory spending reforms is where our focus needs to be?
And to the extent that the budget agreement today does that, to
the extent that we replace some of the sequester with a focus
on mandatory spending reforms, are we heading in the right
direction, as modestly as we may be?
Ms. Rivlin. It is modest, but it did not come to grips with
the major entitlements or mandatory programs, very modestly
with Medicare. But it is the health entitlements over the long
run, not immediately, but over the long run, and Social
Security, which are driving Federal spending in the future.
Mr. Barr. Thank you.
Dr. Holtz-Eakin, in your testimony, when you talked about
the core functions of the Fed--monetary policy, lender of last
resort, bank holding supervision and systemic risk management--
one thing that the Fed is doing as a result of Dodd-Frank now,
which is somewhat unusual, I would argue, is providing the
funding for a new agency, the Consumer Financial Protection
Bureau. Where in those core functions is--where does this fit?
Mr. Holtz-Eakin. It doesn't. And I don't support that at
all. I think that is something that should go through the
congressional appropriation and oversight process.
Mr. Barr. Okay. And for all the witnesses, a final
question. I have about 2 minutes left in my time.
I wanted you all to comment on the testimony of Chairman
Bernanke before this committee earlier this year. And I asked
the question about the exit strategy. Obviously, Chairman
Bernanke has pursued a very aggressive quantitative easing and
accommodative policy. It appears that Ms. Yellen is going to
pursue that and continue that policy into the future.
And one thing that we heard from the Fed earlier this
summer, and from Chairman Bernanke, was a hint of possible
tapering in the event that unemployment comes down to a certain
level. And the mere suggestion of tapering resulted in a pretty
significant revolt from the market. We saw the 30-year fixed-
rate mortgage jump by 42 basis points. The Dow suffered back-
to-back declines of more than 200 points. Billions of dollars
fled the credit funds after just the hinting of the possibility
of tapering.
So my question is--and I asked this question then--how is
the Fed going to avoid a catastrophic spike in rates when
tapering actually starts? And the chairman's response was, we
just have to communicate, we have to be effective in telling
the markets what we are doing.
Do you think that is a satisfactory answer? Do you think,
given the fact that the Fed's balance sheet is where it is
today, is tapering inevitably going to lead to a kind of
catastrophic spike in rates that will be very, very damaging to
GDP?
Mr. Goodfriend. I think that what happened in May was a
pulling back on the Fed's tapering to the degree that a lot of
the damage has already been done. There might be some reaction
in rates. But I think the sooner the better they get on with
it. I think there will be a relatively muted reaction. They
should just not throw good money after bad, so to speak. And I
would start it as soon as possible, especially if the budget
deal is done in Congress.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes the gentleman from Pennsylvania,
Mr. Rothfus, for 5 minutes.
Mr. Rothfus. Thank you, Mr. Chairman. And thank you, panel.
This has been a very informative discussion this afternoon.
I would like to first talk to Professor Goodfriend. It is
always nice to see somebody from Western Pennsylvania, too, and
see somebody from the fantastic university up there, Carnegie
Mellon University.
Professor, in what ways, if any, do you think the Fed's
interventions in financial markets have impaired the efficiency
of banking in capital markets?
Mr. Goodfriend. I don't want to go over my testimony again,
but I think there was a big negative effect in the way the Fed
handled its interventions in the crisis. But even now, by
intervening in mortgage markets to the tune of $40 billion a
month in an ongoing way as part of this QE3, what the Fed is
doing is making it very hard for private parties, for private
entities to step back into the mortgage market, because what
the Fed is doing is keeping the spreads low.
One of the transitions that has to be made at some point is
the markets have to become confident that the spreads will be
allowed to rise to make it profitable to re-enter. And that is
the way the Fed ultimately has to hand off Federal Reserve
heavy intervention in these markets back to banking.
And unless the Fed specifies its taper, specifies the
extent to which it will go, get out, in a clear way, the
markets can't prepare to step in. So, I think the Fed has to
come first in this chicken-and-egg problem.
Mr. Rothfus. Thank you.
Dr. Holtz-Eakin, Chairman Bernanke has argued that the
Federal Reserve's participation in the oversight of banks of
all sizes significantly improves its ability to carry out its
central banking functions, including making monetary policy. Do
you agree with this sentiment?
Mr. Holtz-Eakin. Not entirely. We see other configurations
around the world, for example, where we have the central bank
not as the primary regulator, and those central banks are able
to conduct monetary policy very effectively, so England can do
this. And so I am unconvinced that as a matter of structure, it
needs to be that way.
The second thing that the Fed argues is that it gives them
information that is useful for the conduct of monetary policy.
I don't see why that information couldn't be conveyed in an
interagency fashion. And so I am certainly open to doing
business in other ways, because I think the Fed is
overstretched.
Mr. Rothfus. Where we sit today, we have an interventionist
Fed on the monetary policy side and an interventionist Fed on
the regulatory policy side. What are the potential implications
and risks for the health of the financial system and the
broader economy because of that?
Mr. Holtz-Eakin. My concern with aggressive monetary
policies has been essentially that they flunk a benefit-cost
test. I am utterly convinced that the Fed can drive investors
to riskier asset classes. I am utterly convinced that it has
enormous ability to change relative returns to financial
markets.
I don't think it has produced any real economic growth. And
so I think--or not enough to merit the potential costs in terms
of inflated asset classes and/or bubbles, and some of them
appear to be in the making.
And I worry, as this is all about financial instability
coming out of those asset classes, to the larger financial
system. I think those costs outweigh the benefits of the
policy.
Mr. Rothfus. Ms. Rivlin, when asked in October 2008 if
Gramm-Leach-Bliley was a mistake, you testified, ``I don't
think so. I don't think we can go back to a world in which we
separate different kinds of financial services and say these
lines cannot be crossed. That wasn't working very well. We
can't go back to those days. We have to figure out how to go
forward.''
This week, as you know, the Volcker Rule was promulgated,
which does precisely that, a rule that asked some 1,300
questions in the initial proposal, making it effectively a
concept release. As a result, the final rule skirted around the
notice and comment process.
Given this history and your thoughts back in 2008, wasn't
the Volcker Rule misguided and, at a minimum, shouldn't it have
been reproposed before final adoption?
Ms. Rivlin. I don't equate the Volcker Rule with repeal of
Gramm-Leach-Bliley or going back to Glass-Steagall, and I still
agree with what I said, that we can't do that. We have to
figure out how to regulate this complicated situation that we
have without reversing it.
As I said earlier, I am not a big enthusiast of the
importance of the Volcker Rule. I think other things, such as
capital requirements and leverage ratios and other things, are
much more important.
Mr. Rothfus. I thank the Chair, and I yield back.
Chairman Hensarling. The time of the gentleman has expired.
There are no other Members standing in the queue for questions,
so at this point, I would like to thank all of the witnesses
for your testimony today, and especially thank you for your
patience with rescheduling challenges.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
This hearing stands adjourned.
[Whereupon, at 5:06 p.m., the hearing was adjourned.]
A P P E N D I X
December 12, 2013
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]