[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
FEDERAL RESERVE OVERSIGHT:
EXAMINING THE CENTRAL BANK'S
ROLE IN CREDIT ALLOCATION
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON MONETARY
POLICY AND TRADE
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
SECOND SESSION
__________
MARCH 12, 2014
__________
Printed for the use of the Committee on Financial Services
Serial No. 113-70
______
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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
Subcommittee on Monetary Policy and Trade
JOHN CAMPBELL, California, Chairman
BILL HUIZENGA, Michigan, Vice WM. LACY CLAY, Missouri, Ranking
Chairman Member
FRANK D. LUCAS, Oklahoma GWEN MOORE, Wisconsin
STEVAN PEARCE, New Mexico GARY C. PETERS, Michigan
BILL POSEY, Florida ED PERLMUTTER, Colorado
MICHAEL G. GRIMM, New York BILL FOSTER, Illinois
STEPHEN LEE FINCHER, Tennessee JOHN C. CARNEY, Jr., Delaware
MARLIN A. STUTZMAN, Indiana TERRI A. SEWELL, Alabama
MICK MULVANEY, South Carolina DANIEL T. KILDEE, Michigan
ROBERT PITTENGER, North Carolina PATRICK MURPHY, Florida
TOM COTTON, Arkansas
C O N T E N T S
----------
Page
Hearing held on:
March 12, 2014............................................... 1
Appendix:
March 12, 2014............................................... 27
WITNESSES
Wednesday, March 12, 2014
Bivens, Josh, Research and Policy Director, Economic Policy
Institute...................................................... 8
Goodfriend, Marvin, Friends of Allan Meltzer Professor of
Economics, Tepper School of Business, Carnegie Mellon
University..................................................... 2
Kupiec, Paul H., Resident Scholar, American Enterprise Institute
(AEI).......................................................... 4
White, Lawrence H., Professor of Economics, George Mason
University..................................................... 7
APPENDIX
Prepared statements:
Bivens, Josh................................................. 28
Goodfriend, Marvin........................................... 40
Kupiec, Paul H............................................... 51
White, Lawrence H............................................ 71
FEDERAL RESERVE OVERSIGHT:
EXAMINING THE CENTRAL BANK'S
ROLE IN CREDIT ALLOCATION
----------
Wednesday, March 12, 2014
U.S. House of Representatives,
Subcommittee on Monetary
Policy and Trade,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:03 a.m., in
room 2128, Rayburn House Office Building, Hon. John Campbell
[chairman of the subcommittee] presiding.
Members present: Representatives Campbell, Huizenga,
Pearce, Posey, Stutzman, Mulvaney, Pittenger, Cotton; Clay,
Foster, and Kildee.
Ex officio present: Representative Hensarling.
Chairman Campbell. The Subcommittee on Monetary Policy and
Trade will come to order.
Without objection, the Chair is authorized to declare a
recess of the subcommittee at any time. And the Chair now
recognizes himself for 5 minutes for an opening statement,
which will not be anywhere near that long.
This is another chapter in our continuing examination of
the Federal Reserve (Fed) on the occasion of the 100th
anniversary of the Fed this year--last year, technically. I am
not going to make any pontifications about what I think things
are or ought to be, because that is what our distinguished
panel is for, but we want to examine the idea of quantitative
easing, and of setting interest rates, and of what the Fed is
doing right now and how that is impacting markets, and how that
is impacting credit.
Is it helping some and hurting others? And just what are
the ramifications of those actions and those decisions, both
currently and with a perspective on history and on things the
Fed has done in the past?
So, I will look forward to the testimony, and I now
recognize the ranking member of the subcommittee, the gentleman
from Missouri, Mr. Clay, for 5 minutes for his opening
statement.
Mr. Clay. Thank you, Mr. Chairman, especially for holding
this hearing regarding the Federal Reserve's role in credit
allocation. Due to the financial crisis of 2008, the Federal
Reserve Bank purchased commercial paper, made loans, and
provided dollar funding through liquidity swaps with foreign
central banks. Because of this action, the Federal Reserve Bank
balance sheet expanded.
Currently, the Federal Reserve Bank has gradually tapered
its asset purchases from $85 billion per month to $75 billion
per month due to evidence that the economy is improving. The
Federal Reserve Bank will purchase a total of $65 billion in
Treasury and mortgage-backed securities each month. This is a
$20 billion decrease, and this action was taken due to the
improvement in the labor market.
And there has been no other period since 1939 in which
government employment has been so weak for so long. This is
twice as long as the 26 months of the double-dip recessions in
the Reagan Administration cutbacks of the 1980s.
The U.S. economy was vastly affected by the financial
crisis in 2008, and one of the most affected markets was the
housing market, and one of the major factors that affects the
housing market is employment and wage level. I will stop there,
Mr. Chairman, because I am also anxious to hear the testimony.
I yield back.
Chairman Campbell. The gentleman yields back.
The Chair now recognizes the vice chairman of the
subcommittee, the gentleman from Michigan, Mr. Huizenga, for 5
minutes.
Mr. Huizenga. Thank you, Mr. Chairman. I don't intend to
utilize all that, because I, too, want to get to these
presentations. And I think, gentlemen, what I am looking for is
an answer to my question: What has all this spending in QE2 and
3 and Twist and all the others really accomplished?
The effectiveness of the Fed's efforts to stimulate the
economy, I think, has a lot of us questioning some of those
decisions. And, I have a serious concern that their
encroachment into fiscal policy through credit allocation seems
to me to break down the historical safeguards in a way that is
independent from the Federal Government.
Even former Fed Chairman Bernanke noted in his book, ``The
Federal Reserve and the Financial Crisis,'' that ``Central
banks that operate independently will deliver better results
than those that are dominated by the government.'' And I
appreciate, Mr. Chairman, you setting this time aside so we can
explore it, so thank you.
Chairman Campbell. The gentleman yields back. Thank you
very much.
Any other opening statements from anyone? Hearing none, we
will move straight to the witnesses. So, I would like to
welcome you all.
First, Dr. Marvin Goodfriend is a Professor of Economics at
Carnegie Mellon University. He previously served as the Chief
Monetary Policy Adviser to the Federal Reserve Bank of
Richmond. He also worked as Senior Staff Economist for the
White House Council of Economic Advisers. Dr. Goodfriend, you
are 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.
I am pleased to be invited to testify this morning. I am
going to argue that the 1951 Treasury-Federal Reserve Accord on
monetary policy should be supplemented with a Treasury-Federal
Reserve Accord on credit policy.
Monetary policy can be conducted independently by a central
bank because the objectives of monetary policy--price stability
and full employment--are reasonably clear and coherent.
Moreover, monetary policy is about managing aggregate bank
reserves and currency to influence the general level of
interest rates for the whole economy. Assets are acquired only
as a means of injecting bank reserves and currency into the
economy. Hence, monetary policy can be implemented by confining
asset purchases to Treasuries-only.
Treasuries-only keeps the independent central bank free of
politics, because it avoids credit risk and because the central
bank simply returns the interest to the Treasury that the
Treasury pays to the central bank for the Treasury securities
that the central bank holds.
Credit policy satisfies none of the conditions that make
monetary policy suitable for management by an independent
central bank. Credit policy involves selling Treasury
securities from the central bank portfolio and lending the
proceeds to private financial institutions or using the
proceeds to acquire non-Treasury debt, such as mortgage-backed
securities. Credit policy has no effect on the general level of
interest rates, because it doesn't change aggregate bank
reserves or interest paid on reserves.
Credit policy really is debt-financed fiscal policy carried
out by the central bank. Why? The central bank returns to the
Treasury interest earned on the Treasuries that it holds. So
when the central bank sells Treasuries to finance credit
policy, it is as if the Treasury financed credit policy by
issuing new Treasury debt.
Credit policy works by exploiting the government's
creditworthiness--the power to borrow credibly against future
taxes--to facilitate flows to distressed or favored borrowers.
Doing so involves a fiscal policy decision to put taxpayer
funds at risk in the interest of particular borrowers. All
central bank credit initiatives carry some credit risk and
expose the central bank, and ultimately the taxpayers, to
losses and controversial disputes involving credit allocation.
The 1951 Accord between the Treasury and the Fed was one of
the most dramatic events in financial history. The Accord ended
an arrangement dating from World War II in which the Fed agreed
to use its monetary policy powers to keep interest rates low to
help finance the war effort. The Accord famously reasserted the
principle of Fed independence so that monetary policy might
serve exclusively to stabilize inflation and macroeconomic
activity.
Central bank credit policy, too, must be circumscribed with
clear, coherent boundaries. Conventional last resort lending by
a central bank is reasonably compatible with central bank
independence. Last resort lending to supervised, solvent
depositories, on a short-term basis, against good collateral
provides multiple layers of protection against ex post losses
and ex ante distortions. So, the fiscal policy consequences of
conventional last resort lending are likely to be minimal and
the scope for conflict with the fiscal authorities small.
On the other hand, expansive credit initiatives--such as
those undertaken in the wake of the 2007-2009 credit turmoil--
that extend credit reach in scale, in maturity, and in
collateral to unsupervised nondepository institutions and the
purchase of non-Treasury securities inevitably carry
substantial credit risk and have significant allocative
consequences. Expansive credit initiatives infringe
significantly on the fiscal policy prerogatives of Treasury and
Congress and properly draw the scrutiny of fiscal authorities.
Hence, expansive credit initiatives jeopardize central bank
independence and should be circumscribed by agreement between
the fiscal authorities and the central bank.
Furthermore, an ambiguous boundary of expansive central
bank credit policy creates expectations of accommodation in
financial crises which blunts the incentive of private entities
to take preventive measures beforehand to shrink their
counterparty risk and their reliance on short-term finance.
Moreover, an ambiguous central bank credit reach also blunts
the incentive of the fiscal authorities to prepare procedures
by which fiscal policy could act systematically and
productively in times of financial crisis.
The chaotic, reluctant involvement of Congress in the
credit turmoil contributed to the financial panic and worsened
the Great Recession, precisely because of the ambiguity about
the boundary between Fed policy and the Congress.
Such reasoning suggests the following three principles as
the basis for a Treasury-Fed Accord for credit policy: first,
as a long-run matter, a significant, sustained departure from
Treasuries-only asset acquisition is incompatible with the
Fed's independence; second, the Fed should adhere to
Treasuries-only except for occasional, temporary, well-
collateralized, ordinary last resort lending to solvent,
supervised depositories; and third, Fed credit initiatives
beyond ordinary last resort lending, in my view, should be
undertaken only with prior agreement of the fiscal authorities
and only as bridge loans accompanied by takeouts arranged and
guaranteed in advance by the fiscal authorities.
Thank you.
[The prepared statement of Dr. Goodfriend can be found on
page 40 of the appendix.]
Chairman Campbell. Thank you, Dr. Goodfriend.
Next, we have Dr. Paul Kupiec, a resident scholar at the
American Enterprise Institute. In the past, he has served as
the chairman of the research task force at the Basel Committee
on Banking Supervision. He was also the deputy chief of the
Department of Monetary and Financial Systems at the IMF and a
Senior Economist in the Division of Research and Statistics at
the Federal Reserve Board of Governors.
Welcome, Dr. Kupiec. You are recognized for 5 minutes.
STATEMENT OF PAUL H. KUPIEC, RESIDENT SCHOLAR, AMERICAN
ENTERPRISE INSTITUTE (AEI)
Mr. Kupiec. Thank you.
Thank you. Chairman Campbell, Ranking Member Clay, and
distinguished members of the subcommittee, thank you for
convening today's hearing and for inviting me to testify.
First, let me say these are my personal views and not the views
of the AEI.
Banking regulations can have important impacts on economic
growth and financial stability. In the aftermath of the crisis,
the government introduced sweeping changes in bank and
financial market regulation, and today I will discuss the
economic consequences of some of these changes. But before
discussing them, let me first mention that the government
housing policies that encouraged the housing bubble and
triggered a financial crisis are still in place today.
Let me move first to the qualified mortgage (QM) and
ability-to-repay (ATR) regulations that were issued by the
Consumer Financial Protection Bureau (CFPB). They were intended
to limit the risk of new mortgage originations and protect
consumers from predatory lending. But the QM and ATR rules that
went into effect in January do not accomplish these intended
goals. They are reducing consumer access to mortgage credit
without providing financial stability or consumer protection
benefits. These rules raise compliance costs for originating
mortgages, especially for smaller banks.
New evidence has come to the fore which shows that
community banks have decided to stop offering their customers
mortgages because the business is no longer profitable. The
impact of community bank withdrawal from mortgage lending will
be especially large in rural markets and small towns that are
not served by a large bank.
Another issue in credit is fair lending enforcement. The
regulators are using a new statistical approach for enforcing
fair lending laws. In a nutshell, the enforcement approach
creates an entitlement for bank credit to high-risk borrowers
with protected characteristics. A so-called disparate impact
enforcement standard will discriminate against high-quality
borrowers because banks will be forced to pass the costs of
lending to high-risk borrowers with protected characteristics
onto their unprotected low-risk customers.
Some legal scholars think that enforcement actions based on
disparate impact will eventually be overturned by the courts.
Still, the CFPB is making aggressive use of this policy, most
recently in a high-profile action against an auto lender.
As you know, the Volcker Rule is intended to ban banks from
proprietary trading. However, restrictions in the Volcker Rule
are causing unintended consequences for banks that own
collateralized loan obligations (CLOs). Because many CLO pools
include debt securities, and their senior tranches exercise
limited power over the CLO manager, they appear to be
inadmissible investments under the final Volcker regulations.
If banks have to sell their CLOs, it is likely to impose
significant costs on the banks, and it won't provide any
measurable gain in bank safety or soundness. The rule should be
amended without delay to remove regulatory uncertainty and
allow banks to retain their legacy CLOs.
Moving to other powers that came under the Dodd-Frank Act,
mandatory stress tests. There is no scientific evidence that
supports the use of macroeconomic stress scenario simulations
for the regulation of individual financial institutions, yet
the Dodd-Frank Act imposes multiple new stress test
requirements on large bank holding companies. Stress test
models have very limited accuracy for explaining individual
bank historical profits and losses. Perhaps this is one reason
the Fed keeps its stress test models a secret, even from the
other bank regulatory agencies that are involved in the CCAR
stress tests.
The stress test requirement gives the Fed unchallenged
power to exercise regulatory discretion over bank operations
and shareholder property rights. The Fed can and has failed
banks without providing the banks with the Fed's projection
methodology that predicts the bank's future capital shortfall.
The methodology remains a Federal Reserve trade secret.
Bank regulators have also used systemic powers to stop
banks from making high-yield syndicated loans. They argue that
the loans are creating a systemic risk by fueling a bubble in
high-yield mutual funds. If there is a bubble, stopping the
supply of these loans would be the wrong policy. It would only
drive yields lower, further distorting the price of credit
risk, which would only make the bubble worse.
Mutual fund investors are demanding high-yield floating-
rate corporate loans as a rational response to the Federal
Reserve's continuing zero interest rate monetary policy and its
announced plans to taper its QE purchases. The Dodd-Frank Act
grants financial regulators broad new powers and
responsibilities to prevent systemic risk without providing a
clear definition of systemic risk. This ambiguity gives
regulators wide latitude to exercise their judgment to identify
firms, products, specific financial deals, and market practices
that create systemic risk and impose new regulatory
constraints, and regulators, especially bank regulators, are
aggressively exercising this authority, both to designate non-
bank firms as SIFIs over objections of other FSOC members and
to direct bank lending decisions with the goal of altering
investments made by mutual funds that they do not regulate.
Indeed, non-bank SIFIs are being identified well before the
Federal Reserve has revealed their enhanced prudential
standards that will apply to these non-bank institutions. The
FSOC can and has designated non-financial institutions as
systemically important using only the most general of
arguments. For example, in its designation decision, the FSOC
is not required to explain the changes a newly designated
institution might take to reverse the decision.
Regulatory systemic risk powers and SIFI designation create
enormous regulatory uncertainty for many private sector
financial firms and Congress should act to limit this power.
Thank you very much for the opportunity to testify, and I look
forward to your questions.
[The prepared statement of Dr. Kupiec can be found on page
51 of the appendix.]
Chairman Campbell. Thank you, Dr. Kupiec. And by the way,
without objection, all of your written statements will be made
a part of the record, in case any of you are unable to finish.
Next, Dr. Larry H. White is a senior scholar at the
Mercatus Center and a professor of economics at George Mason
University. He also serves as a member of the Financial Markets
Working Group; previously taught at the University of Missouri,
St. Louis, and at the University of Belfast; and previously
worked as a visiting scholar at the Federal Reserve Bank of
Atlanta.
Dr. White, you are recognized for 5 minutes.
STATEMENT OF LAWRENCE H. WHITE, PROFESSOR OF ECONOMICS, GEORGE
MASON UNIVERSITY
Mr. White. Thank you, Chairman Campbell, Ranking Member
Clay, and members of the subcommittee.
I think my written testimony in many ways complements that
of Professor Goodfriend, in that I argue that the Federal
Reserve's attempts to direct the allocation of credit,
especially since 2007, are an overreach that not only conflicts
with independent monetary policy and the independence of
monetary policy from fiscal policy, but it is also wasteful, it
is inefficient, and it is fraught with serious governance
problems.
The Fed has traditionally had five main roles. Two of them
are routine--clearing checks; and issuing paper currency--and
three are more important--supervision and regulation of
commercial banks; serving as a lender of last resort; and
conducting monetary policy. Since 2007, and at its own
initiative, the Fed has greatly expanded the range of its
activities by undertaking unprecedented credit allocation
policies that don't fit into any of these traditional
categories.
A central bank that is already charged with these five
tasks and is not excelling at all of them shouldn't be
expanding the range of its activities beyond them, so I think
the Fed should be removed or should remove itself from the
formulation and implementation of credit policy.
Now, what I mean by credit policy is not only QE1 and QE3
that have been mentioned, but all the special lending programs
that the Fed undertook during the financial crisis, ranging
from dollar swap lines for foreign-domiciled commercial banks
doing U.S. dollar business, to asset-backed commercial paper
money market mutual fund liquidity facility, to bridge loans to
JPMorgan Chase, to the Maiden Lane subsidiaries of the New York
Fed. There is a long list in my written testimony, 22 programs
in all.
To the extent that these programs actually do affect the
allocation of credit, they are more likely than not to have
directed credit to less productive uses than would otherwise
have occurred, even if Fed policymakers have the best of
intentions. We have to consider the costs of these programs,
which is to divert credit away from those who have been judged
creditworthy in the market toward those who are favored by
Federal Reserve policy, and when we throw good money after bad,
when we lend money to insolvent institutions, we are not
increasing the efficiency of financial markets, but the
reverse.
Now, the Dodd-Frank Act recognized a problem with the
lending programs that were directed at specific institutions,
and it imposes a restriction on the Fed to limit its lending in
the future to broad-based programs. I think this is a step in
the right direction. If this rule had been in place before
2010, though, it would have only ruled out about half of the
credit allocation programs on the list.
The logic of broadening credit programs leads to wanting
the Fed to behave in the broadest way possible, and that means
not lending to segments of the financial market, money market
funds here, credit broker-dealers here, and so on, but to the
entire market, which is monetary policy, which is open-market
purchases of Treasury securities to make more bank reserves
available to where the market will allocate them.
The QE1 and QE3 purchases of mortgage-backed securities
have been defended as monetary policy, but they are not
monetary policy. The purchase of securities is monetary policy,
but the choice of mortgage-backed rather than Treasuries is not
monetary policy, because it doesn't affect monetary aggregates
or things that depend on monetary aggregates. It is a credit
allocation choice.
And the Fed has, in fact, used interest on reserves to
negate the monetary policy impact of the huge purchases of
mortgage-backed securities. In my written testimony, I have a
figure showing that, as the monetary base has spiked, M2 has
just chugged along on a very smooth path, so the Fed has
deliberately offset the monetary policy effect of these
purchases.
The targeted lending programs are not lender of last resort
programs, as they have sometimes been defended. They don't fit
the classical criteria for lender of last resort, which is
lending liquidity to solvent institutions. They have been
lending or providing capital and boosting net worth for
insolvent institutions. Traditional lender of last resort is
for banks, and the special lending programs have extended it
way beyond banks to other kinds of financial institutions.
The bailout programs, of course, go way beyond that to the
sort of thing that used to be considered the responsibility of
the fiscal authorities. And the Fed, by paying interest on
reserves, is, in effect, borrowing money and spending it the
way the Fed sees fit, which is the description of a fiscal
policy. Thank you very much.
[The prepared statement of Dr. White can be found on page
71 of the appendix.]
Chairman Campbell. Thank you, Dr. White.
Next, Dr. Josh Bivens is the research and policy director
at the Economic Policy Institute. He is the author of,
``Everybody Wins, Except for Most of Us: What Economics Teaches
About Globalization.'' He is also a frequent communicator on
many high-profile news outlets.
Dr. Bivens, welcome. You are recognized for 5 minutes.
STATEMENT OF JOSH BIVENS, RESEARCH AND POLICY DIRECTOR,
ECONOMIC POLICY INSTITUTE
Mr. Bivens. Thank you. My name is Josh Bivens, and I am the
research and policy director at the Economic Policy Institute.
My remarks are just my personal views. I thank the committee
members for the invitation to testify today.
My remarks and my testimony are largely framed as responses
to the concerns raised about the Fed's quantitative easing
program in the introductory memorandum for this hearing. Before
moving on to some of those specific concerns, most of which
center around threats to the Fed's independence, I am going to
just say a couple of words about useful ways to define that
central bank independence.
I think for far too many in this debate, independence seems
synonymous with putting very little or even zero weight on the
maximum employment target that is part of the Fed's dual
mandate. And sometimes this demand for independence gets
translated into an implicit demand that the Fed sort of always
and everywhere lean against the stance of fiscal policy, and
the presumption seems to be that most policymakers have an
inflationary bias that will reap short-term gains in economic
activity and employment, but only at the long-run cost of
overheating the economy and sending up interest rates and
prices.
If you took this presumption as a given, then it would make
sense that for a Fed that cared only about price stability, it
would, indeed, always have to lean against what other
macroeconomic policymakers, especially fiscal policymakers, are
doing.
And while there have been historical episodes where central
bank independence was surrendered and bankers became
excessively deferential to other policymakers' desires for
inflationary policy, that is just not what is happening in the
U.S. economy today.
Since the beginning of 2008, the U.S. economy has been
plagued by a large shortfall in aggregate demand, a shortfall
that has put downward pressure on prices and interest rates and
has kept joblessness excessively high. In this kind of
situation, pursuing stability of inflation and maximum output
is not a delicate tradeoff. Both demand that all levers of
macroeconomic policy try to push the economy back to potential
by generating more spending from households, firms, and
governments.
Quantitative easing is one such lever. While long-term
interest rates have generally been driven very low by the
extraordinary economic weakness in recent years, interest rates
low enough to drive a full employment recovery by themselves
requires they be even lower, but they are hampered in this by
the zero bound on short-term interest rates.
Through its forward guidance and quantitative easing
programs, the Fed has aimed to push long-term rates even lower
than the economic weakness has pushed them, and this policy
action has led to higher rates of economic activity in
employment and higher rates of inflationary expectations, which
today is a good thing.
How much have they contributed? There is a lot of
uncertainty about just the precise degree of economic impact of
the quantitative easing programs. There is almost no
uncertainty that the direction is positive, that is the
quantitative easing programs have surely pushed the economy in
the direction of more activity and more employment.
With this backdrop, I will move very quickly onto the three
specific concerns raised in the introductory memorandum for
this hearing. The first one is, has quantitative easing enabled
higher government spending? The short answer is, it has not,
and that is actually a bad thing.
Between 2008 and 2010, it is true that fiscal policy and
monetary policy generally pulled in the same direction, leading
to expansion in the economy. This wasn't a problem. This is
what the economy needed. There is a huge shortfall in demand
relative to productive potential.
Since then, however, the empirical fact is that Federal
spending has slowed so much that it is now the slowest growth
of Federal spending during any recovery of comparable length in
postwar history. And the very slow growth of public spending
overall can essentially explain entirely why economic growth in
this recovery has been the slowest on record.
So in summary, the quantitative easing programs have been
associated in recent years with very slow, not fast, growth of
spending, and we would have a much healthier economy today if
that hadn't been the case.
The second concern raised in the memo was, have QE
purchases of mortgage-backed securities disproportionately
aided the housing finance sector? Yes, they have, but that is a
perfectly appropriate response to the financial crisis
accompanying the bursting of the housing bubble. This sector
was extraordinarily impaired. A primary channel through which
lower interest rates are supposed to help boost economic growth
is through the mortgage refinance channel, and the impairment
in the mortgage-backed security sector was impeding that
channel, so I would say, yes, it is true that by targeting that
sector, they were going after a sector that was extraordinarily
impaired by the crisis, and that is exactly what they should
have done.
And then lastly, have regulations promulgated since the
Great Recession provided an incentive for banks to favor
certain asset classes over others? I would say, yes, they have,
and, again, that is an entirely appropriate response to the
crisis. The crisis was caused in large part because financial
institutions took on too much leverage in far too little
liquidity when they were unregulated in the run-up to it.
Basically, the regulations mentioned in the memorandum
require banks to hold a higher share of liquid assets on their
books. A big problem with the crisis was that the assets which
banks had were not liquid when markets went bad. Treasuries are
very, very liquid, so regulations that encourage them to have a
higher share of those on their books is a very good thing.
I am happy to answer any questions from the committee, and
thank you again for the invitation.
[The prepared statement of Dr. Bivens can be found on page
28 of the appendix.]
Chairman Campbell. Thank you, Dr. Bivens. And I thank all
four members of our panel of doctors today.
I now recognize myself for 5 minutes for questioning. And
in these hearings, I always like to pursue it when I hear
something I hadn't necessarily heard before--we had a hearing a
month or so ago on how QE was affecting international finance,
where a group of people, which may have included one of you,
talked about the fragile five and how we were creating
instability in Turkey and Argentina and, boom, about 3 weeks
later, said instability showed up.
Something I heard today from Dr. Goodfriend and Dr. White
that I haven't heard before or if I have heard it, it went in
one ear and out the other, which is entirely possible, is that
what we see the Fed doing, ranging into credit policy or credit
allocation, as you have suggested, and various other things,
actually threatens the Fed's independence, or is incompatible,
as you said, Dr. Goodfriend.
You would think that it would be logical to assume that
when the Fed does other things that is showing their
independence, rather than threatening or being incompatible
with their independence. So would either of you like to expound
on why this thing, which seems counterintuitive, is what you
believe to be the case?
Mr. Goodfriend. I will start. So you are right, Mr.
Chairman. If the Fed pursues expansive actions, it demonstrates
its power to do things independently. And if you didn't
understand the difference between credit policy and monetary
policy and the boundaries that Larry and I have been
describing, you might think that is a good thing.
But Congress grants the Fed's independence grudgingly, and
only because monetary policy can be independently monitored and
because monetary policy, as I describe it, does not involve
fiscal policy at all. And so, let me revisit this issue and
describe why.
Monetary policy is about changing currency and bank
reserves in the economy. The assets that the Federal Reserve
acquires to change currency and bank reserves are immaterial
for monetary policy to work. So the Fed can acquire Treasury
securities in expanding the money supply, currency and
reserves. And when the Fed buys Treasury securities, it simply
returns all the interest that the fiscal authorities give it
back to the Treasury to spend as they see fit.
So, monetary policy is really beautifully suitable for
delegation to an independent central bank because it separates
monetary and fiscal policy very well.
When the Fed expands policies in the credit direction, it
really has nothing to do with monetary policy, per se. Why?
Because credit policy is a policy where the Fed sells Treasury
securities, it takes the money that it gets and immediately
puts the money back into circulation without changing the
quantity of money in order to channel credit to distressed or
favored borrowers, financed by the sale of Treasury securities
from its portfolio.
Now, the trick about credit policy is that when the Fed is
holding those Treasury securities, the interest that it earns
from the Treasury is simply round-tripped back to the Treasury.
So when the Fed sells Treasuries in order to take the funds and
allocate those funds somewhere else, it is exactly as if the
Treasury issued new securities, took the cash, and made loans.
Chairman Campbell. Okay, I get that. Why does it make them
less independent? Or why is that incompatible or threatening?
Mr. Goodfriend. Because credit policy is a fiscal policy
action that is not essential for the Fed to do monetary policy,
which is its primary mission, and there is no way to do a
credit policy action without favoring one particular group or
another. You have to make a loan to somebody or some sector,
and so credit policy is a matter for public policy, for the due
process of law under the Congress, to decide who should get the
loan and who shouldn't.
Chairman Campbell. I want to make sure Dr. White has some
time.
Mr. White. Yes, some Fed officials have suggested that
criticizing the Fed's lending decisions during the crisis are
challenges to its independence, but the principle of
independence applies to monetary policy, not to fiscal policy.
So it doesn't challenge the Fed's traditional independence to
conduct monetary policy when people want to know what the Fed
has done, who it has lent to, even when they want to audit the
Fed's lending programs, because then the Fed is straying into
fiscal policy.
So we don't want backseat-driving of monetary policy,
right? But we do need oversight when the Fed is lending to some
people and not to other people, especially when it is lending
to insolvent institutions, especially when we have the
governance problems that we see at the New York Fed.
Chairman Campbell. Okay, thank you. My time has expired.
Dr. Bivens, I will be interested in your viewpoint on this, but
it will have to be in later questioning or whatever, because my
time has expired.
I now recognize for 5 minutes the ranking member, the
gentleman from Missouri, Mr. Clay.
Mr. Clay. Thank you, Mr. Chairman.
Dr. Bivens, in his testimony today Dr. White wrote that it
is desirable to retain member banks' influence for the sake of
monetary policy, because Reserve Bank Presidents as a group
have a better track record in Federal Open Market Committee
(FOMC) voting than do members of the Board of Governors.
In your view, how would further empowering the influence of
the regional banks in FOMC decision-making affect policy
outcomes and Federal Reserve independence?
Mr. Bivens. I think as an empirical matter, we definitely
disagree on who has the better voting record on Federal Open
Market Committee decisions. From my perspective, the Board of
Governors, the Members of the Board of Governors have
consistently been more aggressive in pursuing the maximum
employment part of the mandate in recent years, which is the
appropriate way to go.
And I think as a more structural matter, I would say the
one case where I think there is some real worry about Federal
Reserve independence is the influence of the financial sector
on their decisions. If you look at the regional Federal Reserve
Bank Presidents, they are largely chosen by the commercial
banks in their districts, so anything that provides them with
more authority and more sway over the decisions of the FOMC
will be surrendering even more Federal Reserve independence to
the desires of the financial sector.
So as an empirical matter, I don't think the regional Fed
Presidents have done a better job at responding to the crisis,
and I think as a structural matter, that would actually be
moved backwards if you were actually concerned about Federal
Reserve independence.
Mr. Clay. How might further empowering the regional banks'
influence affect the Fed's focus on the employment part of its
dual mandate?
Mr. Bivens. There are two reasons. One, I think, again,
empirically, it is just a fact that the regional presidents
have seemed much more concerned about the price stability part
of the mandate in recent years, which I think is the wrong part
of the mandate to be overly concerned about. To me, the maximum
employment mandate is the bigger one.
And just as a central fact, the financial sector has an
interest in very low rates of inflation that sometimes
conflicts with other sectors' desire for pursuing maximum
employment. And so anything that gives a louder voice to the
concerns of the financial sector in setting Open Market
Committee decisions I think would be a bad thing.
Mr. Clay. And in your testimony, you note that it is too
bad that the Fed's QE actions have not encouraged higher levels
of Federal spending. You also wrote that very slow rates of
Federal spending are the primary reason why at this stage in
the recovery, demand remains so muffled. How might additional
spending today impact the short- and medium-term macroeconomic
outlook?
Mr. Bivens. We still have a very large shortfall of
aggregate demand relative to productive capacity in the
economy. Demand is too low, and to reduce that gap, we need
more spending. I think, for example, a large package of
infrastructure investments would go a long way to boosting
employment in the short run, and boosting productivity in the
long run. And then something that has fallen off the radar,
which is too bad, extending the unemployment insurance extended
benefits would provide a good economic boost in the next year,
as they increase spending, it would provide real relief to
people who need it.
Mr. Clay. If the Congress and the Fed push stimulative
policies at the same time, is there any inherent reason this
would call the Fed's independence into question?
Mr. Bivens. Not as long as the economy remains so weak that
the inflation rate that we now see is well below the Fed's, I
would argue, probably too conservative target and joblessness
remains high. Theoretically, there could be a point where
recovery was reached, unemployment was very low, inflation
started rising off the charts. In that case, independence on
the part of the Fed would require they start to reduce their
stimulus, but starting from today, no, a coordinated response
to push joblessness lower and try to meet the inflation target
from below would be a good thing.
Mr. Clay. Thank you for your responses.
Dr. Goodfriend, would you consider full employment monetary
policy or fiscal policy?
Mr. Goodfriend. Full employment is an aggregate condition,
and in general, you need an aggregate policy to pursue it. And
monetary policy is an aggregate policy that affects the general
level of interest rates. Credit policy favors necessarily
lending to one group or one sector of the country. So credit
policy is not going to be a suitable policy to achieve full
employment for the country as a whole.
Mr. Clay. Thank you. And, Mr. Chairman, I yield back.
Chairman Campbell. The gentleman yields back.
We will move now to the vice chairman of the subcommittee,
the gentleman from Michigan, Mr. Huizenga, for 5 minutes.
Mr. Huizenga. Thank you, Mr. Chairman.
The ranking member started down a path that I am curious
about, and, Dr. Bivens, I would like you to clarify for me,
because I heard the word in your testimony ``entirely,''
government growth is entirely the reason--or lack of government
growth is entirely the reason why we have a slow economic
recovery right now. Is that, in fact, what you believe or what
you said?
Mr. Bivens. I probably said it. I might say almost
entirely, but more than 90 percent. If you sort of look at the
gap in growth at this point in the recovery compared to all
other postwar recoveries, and then you look at the impact of
government spending on that growth, the slow government
spending at all levels--I said that pretty specifically in the
testimony--can explain almost entirely the gap.
Mr. Huizenga. So if we had simply doubled our level of
stimulus spending, we wouldn't be where we are at?
Mr. Bivens. Doubled, that is about right.
Mr. Huizenga. Okay, so we needed to go $1.8 trillion in
debt instead of $900 billion more in debt, and then we would
have been okay?
Mr. Bivens. We would have been much closer to a full
recovery. And it should have been spread over years. The
problem with it right now--
Mr. Huizenga. And have you looked at long term what an
additional trillion dollars on our long-term debt would have
been in the interest rate situation that we are at?
Mr. Bivens. Yes, interest rates will begin to rise when we
reach full recovery and not before. So basically, if we had
done the degree of spending needed to push us back to recovery,
we would have higher interest rates today, and that would be a
sign of recovery for--
Mr. Huizenga. Are we doing anything, though, to then
mitigate that--what would be $18.5 trillion in debt instead of
$17 trillion in debt for our long term? Because, hey, I pay
attention to the Fed, too, and the Fed has said that interest
rates are going to be going up. At some point or another, we
have to service that debt, not through artificially low
interest rates through QE, but through actual market rates.
And I think as Dr. Goodfriend was pointing out, on page 3
of your testimony, you skipped over the part about the 1951
agreement where--the sentence that you did not use is the Fed
officials argued that keeping interest rates low would require
inflationary money growth that would destabilize the economy
and ultimately fail.
That is where my concern is, because the shovel-ready jobs
from the first tranche of $900 billion weren't so shovel-ready.
The key, as I understand it, is we have to return to private
sector productivity, not government sector productivity, to
build and sustain true wealth. And what I hear from business
owners and from those that are those private sector
productivity makers is uncertainty with their health care
costs, uncertainty what is going to be happening with their
unemployment obligations, their tax uncertainty, their
regulatory uncertainty.
These policies--in addition to what the Fed has done to
drive more activity into the stock market, which then gives
them more incentive to play on Wall Street than it is to buy
equipment or hire people, is what has stalled out a lot of that
recovery.
So I would appreciate your take on this, Dr. Goodfriend,
especially, as you had sort of kind of gone through that.
Mr. Goodfriend. I would distinguish the Fed's policy
actions in the wake of the credit turmoil in the following
ways. In the turmoil itself, the Fed's expansive policy was
called for because the economy was collapsing. Later, you get
QE1, QE2, QE3. QE1, okay. QE2, not so--I wasn't so favorably
disposed to QE2. And QE3, I thought was premature and
unnecessary, and I think the fact that the Fed pulled the plug
rhetorically within 6 months indicated that they found that it
was premature and unnecessary, as well.
Mr. Huizenga. Does anybody else believe that if we had
simply doubled our stimulus spending, we wouldn't be where we
are at economically?
Mr. Goodfriend. I would not want to take that bet.
Mr. Huizenga. Dr. White?
Mr. White. No, I don't think so.
Mr. Huizenga. Dr. Kupiec?
Mr. Kupiec. I would offer that we got into the problems we
got into because we had very much a bubble in the housing
markets. And to use credit policy to try to stimulate housing
markets, we are back to the same policies that caused the
bubble, so it is very much in line with the fact that the use
of credit policy can distort the allocation of resources.
Mr. Huizenga. My fear is that we are whitewashing the long-
term effects here. My fear is that these are serious financial
instruments that affect the global economy, whether it is the
fragile five, as the chairman has talked a bit about. We are in
uncharted waters here, and we are not selling cupcakes, you
know? This is serious stuff that affects the global economy.
And how we are going to unwind this, I think, is my biggest
fear and question that I have, so--and I have run out of time.
And we need to double these to--just like Dr. Bivens, maybe we
need to double our question time, Mr. Chairman, so we can
really get at the heart of this. So with that, I yield back.
Chairman Campbell. I will take that up with the House
majority leader and the chairman of the committee.
The gentleman from Illinois, Mr. Foster, is recognized for
5 minutes.
Mr. Foster. Thank you all for your testimony here. Just a
quick yes-or-no question for all four witnesses. If you were in
charge of management of the financial crisis in October of
2008, would you have let the money markets collapse? Just give
a quick yes-or-no answer.
Mr. Goodfriend. No.
Mr. Kupiec. No.
Mr. White. I am not sure what not letting the money markets
collapse would have meant, but--
Mr. Foster. Extraordinary support necessary--
Mr. White. --no, of course, we don't want the money markets
to collapse.
Mr. Bivens. No.
Mr. Foster. No, okay. And so is this--it seems to me that
is allocation of credit to a specific sector in trouble, and so
that is not an absolute principle with any of you here. In
fact, you acknowledge there are times when adults in the room
have to allocate credit to segments of the industry that are in
trouble, despite the moral hazard? Okay. Thank you. That is not
a universally held point of view around here, and it got our
economy into a tremendous range of difficulty.
Now, during the financial collapse and the extraordinary
accommodation in response to it, many of my colleagues on the
right routinely predicted runaway inflation. You saw talk about
debasing our currency and so on. And in terms of the runaway
inflation, which I think we have not seen in the 5 or so years
since then, how could they have been that wrong? And if we just
go down the line and understand why the predictions of runaway
inflation that we heard so much were so wrong.
Mr. Goodfriend. We had--the typical model of money supply
in the textbooks that uses a money multiplier which says, for
every $1 of reserves the banks have, they create $10 of money.
That is the way the world worked, as long as--this is a little
technical--the interbank interest rate was above zero and
interest on reserves was zero, so there was an opportunity cost
of holding reserves so that banks had a fraction of reserves
that they would hold against their money.
Now, what happened when the Fed dumped reserves into the
system was the interbank interest rate went to zero, which was
the interest on reserves. In the jargon of academics, there was
a zero opportunity cost of holding reserves. We hardly ever see
that. And so people who aren't taking money and banking, my
class, they are not going to notice that, but that is what
happened.
The Fed, by dumping so many reserves in the system, created
a zero opportunity cost environment, and the banks just held
their reserves. The last time we saw anything like that was in
the 1930s. So I forgive people who kind of didn't catch what
the Fed was doing and what would happen.
Mr. Foster. Yes. Dr. Kupiec?
Mr. Kupiec. I would just like to add to that, it was worse
than that, because they pay them 25 basis points on holding the
reserves.
Mr. Goodfriend. Yes, that is true.
Mr. White. Yes, so I think that is right. If you just look
at the monetary base and see it double and triple the Fed's
balance sheet, that is, then you think high inflation is
coming, but you have to recognize that the Fed has sterilized
those injections it is paying on those reserves.
Mr. Foster. Yes, so you would generally attribute--
Mr. White. I just said attribute them to--
Mr. Foster. Right, so you would attribute the failure of
those on the right to correctly anticipate the fact that there
wasn't runaway inflation to a lack of economic sophistication,
roughly speaking?
Mr. White. On the right and on the left, yes.
Mr. Foster. Okay. Those on the left, I think, did not share
this mania about runaway inflation. Dr. Bivens, do you have a
diagnosis of this failure to understand the problem?
Mr. Bivens. Yes, I think inflation remains so low despite
those predictions because people totally overestimated how
quickly the economy would recover. We still have a deeply
depressed aggregate demand in the economy. That is what is
keeping prices low.
I just don't buy that a quarter percent interest rate on
reserves is what is keeping all those reserves from flying out
into the economy. What is keeping prices low is the enormous
gap between potential supply and demand in the economy even
today.
Mr. Foster. Okay. Now, in terms of the housing market, the
enormous intervention--if you look at the history of housing
bubbles, when they burst, they often undershoot, so that if you
look at the long-term trend line of house prices, a bubble
develops, and then the prices crash, and they actually go below
the long-term trend line, which is tremendously destructive to
families and the economy as a whole.
And so the timing of the massive intervention in the big
volume mortgage-backed securities and so on had the effect,
whether intended or not, of actually flattening out housing
prices along their long-term trend line, which is where they
have to return.
And I was wondering if you had comments on whether this
actually ended up--the fact that housing prices have steadied
down on their long-term trend line, whether this is actually a
correct and good result of the massive intervention, in terms
of the housing market?
Mr. Goodfriend. I would start by saying the question in my
mind is, what is the policy vis-a-vis housing in the future?
Because subsidizing or directing credit toward housing is
taking it away from other sectors. I want to turn it over to
Dr. Kupiec in a minute, but I am worried that the housing
policy, should it continue, is draining credit from other
sectors where we would get more productive capital.
Mr. Kupiec. I would agree with that. I think that when you
try to figure out what the long-term trend in housing would
have been, you have to take out all the growth that happened
with the bubble before. Housing was way overpriced. There was
way too much investment in housing for a number of reasons--
financial policies, tax policies, and housing. The building of
housing creates new GDP, but after that, it is not a productive
tradable good.
Mr. Foster. Okay, now would--
Chairman Campbell. The gentleman's time--
Mr. Foster. I will yield back.
Chairman Campbell. --has expired. Thank you.
Now, we will move over here to the gentleman from New
Mexico, Mr. Pearce, who is recognized for 5 minutes.
Mr. Pearce. Thank you, Mr. Chairman. And I appreciate each
one of your testimonies.
I guess I would start with Dr. Goodfriend. My question is
actually sort of a follow up to Mr. Foster's questions about
the speculations of what was going to happen to inflation based
on the creating of money kind of out of thin air. What would
happen if the United States is removed as the world's reserve
currency? What would happen to inflation with all these printed
dollars out there that have yet to be pulled back in?
Mr. Goodfriend. If--
Mr. Pearce. Dr. Kupiec, I will follow up with you, too.
Mr. Goodfriend. --the United States loses its status as a
reserve currency country, essentially that means in practice
that holdings of dollar-denominated Treasury securities abroad,
which are the vehicle by which the dollars are held, would be
returned to the United States. There would be a big
depreciation of the external value of the dollar. In other
words, the currency would depreciate on foreign exchange
markets, and that would create inflation at home.
Mr. Pearce. I will just let each one of you comment on
that.
Mr. Kupiec. I agree with that. We get enormous benefits
vis-a-vis the rest of the world, because we have reserve
currency status.
Mr. White. I would agree with those two statements that the
danger is a collapse in the exchange value of the dollar.
Mr. Pearce. Dr. Bivens?
Mr. Bivens. I think the reserve status also hurts us by
keeping the dollar too strong. We have very large trade
deficits and have for a long time, and that is because the
dollar is too strong to balance our trade, and so there would
actually be a countervailing benefit of we would get some
export growth if we actually had less demand for foreign
reserves of our currency.
Mr. Pearce. What would happen to the value--what would
happen to inflation, in your opinion, if we are removed?
Mr. Bivens. There would definitely be upward pressure on
inflation. It would not be mammoth. We only import 15 percent
to 20 percent of our GDP, so there would be an increase in
import prices, but actually I think we need higher inflationary
expectations, so it is hard for me to see that as a
catastrophe.
Mr. Pearce. We need higher inflationary expectations? That
is somewhat curious. I represent one of the poorest districts
in America, and inflation hurts the poor worse than anybody
else. And so basically, these policies which are being
implemented are devastating to the retirees and to the poor.
The zero interest rate is helping Wall Street on the backs of
the retirees who tell me in my town halls, ``We have lived our
lives correctly, we paid for our house, and we saved money, and
we have money in the bank.'' Retirees typically have less
sophisticated investment instruments. And so, that is a curious
statement.
In a previous hearing, that effect on seniors and the poor
was called collateral damage that has to just be acceptable,
and I sort of disagree with that, because, again, these are
people's lives.
But I think that this whole idea that we can export
inflation to 200 other countries, we can export this fabricated
money to 200 other countries is one that, I think, holds alarm.
And then you get the additional effect that other countries now
are beginning to respond in kind, so they are beginning to
create their own currencies, too. If it is good for us, and it
seems like that the people who really strongly favor this
quantitative easing policy, they don't have an answer when you
ask, if it is okay for us, it ought to be okay for Japan and
the other countries.
I was interested in Dr. Bivens' comment on page nine, and
so I was wondering if maybe, Dr. Kupiec, if you have some
comment about it, but he makes the point that--because the
sector was so impaired by the burst housing bubble and
resulting financial crisis, and because QE works best when
focused on impaired markets, I think this was economically
appropriate thing to do, and that is the buying of MBS
certificates. Is that the same perception that you would have?
Is Would you agree with that particular take on the matter?
Mr. Kupiec. I view the need to support housing after the
housing bust as sort of a political constraint on the system.
From a purely economic standpoint, we had too much investment
in housing, and housing prices were too high before the crisis.
And the need to try to create a recovery in housing was a
purely political need at the time. But long term, more emphasis
on investing in housing is probably not the right way to create
new GDP growth.
Mr. Pearce. Okay. Thank you, Mr. Chairman. My time has
expired.
Chairman Campbell. The gentleman's time has expired.
The gentleman from Michigan, Mr. Kildee, is now recognized
for 5 minutes.
Mr. Kildee. Thank you, Mr. Chairman.
And thank you to the witnesses for being here today. This
is obviously an important hearing, and one that I thank the
Chair for calling.
So today's hearing--while it concerns the independence of
the Fed in its role in credit allocation, I do want to just
focus in on--I have been here a year-and-a-half, that Chairman
Bernanke in his role did come to Congress several times,
referencing the independence of the Fed, imploring this
Congress to fulfill its role in strengthening the economy and
supporting the economy and dealing with our set of
responsibilities regarding the important mandates that also
relate to the role of the Federal Reserve.
And although while there were lots of folks here in
Congress who were ready to act, and, in fact, structurally
Congress, even before my arrival, had sort of set in motion an
effort that was purported to create a condition that would
force Congress to act, creating the sequester, the fact is that
somewhere along the way, there were some who simply embraced
that policy. And obviously, from the perspective of many, that
has weakened economic growth.
The point being that the Fed took some of the few steps
that it could to improve the economy, holding down interest
rates, and then pursuing the purchase of Treasury and mortgage-
backed securities. And now that the economy is improving, as it
said it would, the Fed is reducing those security purchases.
In many respects, it appears to me that the Fed stepped in
to address a number of the challenges that were not confronted
as they should have been by Congress. So while some question
the independence of these actions because the Fed stepped in
when Congress would not or did not, and because the Fed
basically directed these actions, and they did have, in fact,
by most accounts, positive outcomes, it does feel a tad
disingenuous to me that because Congress was unwilling to do
its job, one could presume that nobody else should do theirs or
use the tools that are available to them to deal with the
weakness in our economy.
In particular, I am concerned about this, because I think
too often we tend to look at data, particularly economic data,
on a national scale and completely aggregate it. I represent an
older industrial corridor that includes cities like Flint,
Saginaw, and Bay City, Michigan, which even during periods of
economic growth and expansion have not experienced that growth
and expansion, so I am particularly concerned, and I would ask
Mr. Bivens and perhaps others to comment on actions that you
think, from the standpoint of the Federal Reserve, the Fed
might take in order to promote economic growth and development
in places that have not experienced growth even during those
periods of economic expansion, the 1990s being a good example?
Could you specifically address policies that you think the Fed
might pursue in that regard?
Mr. Bivens. In that regard, I think that the best thing the
Fed can do is actually to focus on the aggregate national labor
market and to not withdraw support from boosting employment and
economic activity until there is something like genuine full
employment.
I think even the Fed's decision to begin tapering its
purchases is a worrisome signal to me that mostly because of
political constraints, they are going to sort of take the foot
off the accelerator a little prematurely and that is going to
keep the recovery from reaching really deep into distressed
communities.
I think other policymakers are much better positioned to do
targeted interventions. To me, the Fed can set the overall
conditions to make sure the overall economy and labor market is
as strong as possible, and then if there are still pockets of
distress, I think that is actually a case for other
policymakers to step in.
Mr. Kildee. So even in the event where other policymakers
are either unwilling or unable in the--does the Fed have tools?
Because to me, it seems that in order to meet the mandates of
the Fed, looking at the aggregate data is obviously important,
but it is sort like the old line about an economist: If your
head is in the freezer and your feet are in the oven, but on
average you feel fine, you should leave things alone. I
represent one of those communities in the freezer. And I am
just curious as to whether you think the Fed has specific tools
that could be targeted for those sorts of places.
Mr. Bivens. I actually don't think the Fed has very good
tools for targeting sort of pockets of distress when the
overall economy is generally doing okay. It is too bad, but I
actually don't think that they really have the right tools for
that.
Mr. Kildee. Thank you.
Chairman Campbell. The gentleman's time has expired.
We will now move to the gentleman from South Carolina, Mr.
Mulvaney, who is recognized for 5 minutes.
Mr. Mulvaney. Thank you, Mr. Chairman. I have a couple of
different questions on a couple of different topics.
I was having a conversation with a friend of mine at
Heritage the other day about whether or not the Fed was fixing
the price of money, fixing the price of debt through fixing an
interest rate. So let see if I can bring any clarity to this
discussion, if you have any thoughts on this: If QE was to go
to zero tomorrow, if they were to simply stop quantitative
easing tomorrow, do you gentlemen have any opinions as to what
the yield would be on the 1-year Treasury? The last couple of
weeks, it has stayed pretty stable at about 12 basis points.
Have you given any thought to that topic as to what would
happen--what we would have to pay to borrow money in this
country if the Fed wasn't providing us essentially with all of
our debt through QE?
Dr. Goodfriend?
Mr. Goodfriend. I think as a technical matter the Fed could
stop QE tomorrow. And because it can promise within the 1-year
timeframe and because its promise is credible to keep the
Federal funds rate near zero, that 1-year rate would not move.
Mr. Mulvaney. What about the 3-year?
Mr. Goodfriend. Now, you are getting interesting. The 3-
year might move and, of course--and I believe that the Fed
would have relatively little control over rates 4, 5, 6 years
and beyond. I do think that the Fed is overselling its ability
to manage longer-term interest rates today with its so-called
forward guidance and QE. I agree with you.
Mr. Mulvaney. Interesting. If they were to not give any
forward guidance, or if the forward guidance was that QE has
ended and we are not going to do it anymore, would that impact
the 1-year?
Mr. Goodfriend. I don't think so, just because it is short
enough that, again, the Fed's promise on the overnight so-
called Federal funds rate is credible at 1-year horizon.
Mr. Mulvaney. Anybody else on that topic? Dr. Bivens?
Mr. Bivens. I think it would have really modest effects
on--especially even long-term rates, but especially short-term,
for two reasons. One, I actually don't--and most of the
empirical estimates of what QE has done to long-term rates,
they are pretty modest. The reason why long-term rates are
extraordinary low in historic perspective, it is just because
the economy is so weak.
And then I would also say, there are two countervailing
impacts of QE on interest rates. Part of a long-term interest
rate, it is the sum of inflationary expectations, expectations
about what the short-term rate is going to do, and then the
term premium. But if people think inflationary expectations are
a little higher because of QE, if people because of the QE and
forward guidance combined think short-term rates are going to
stay low for a long time, I think--and if you reverse that, I
think both those could put upward pressure, it would be very
modest effects on interest rates if we just stopped QE
tomorrow.
Mr. Mulvaney. Okay. I guess in a roundabout sort of way,
that ties in to my next question. I want to come to what Dr.
White mentioned in his testimony, and also went into more
detail in his written testimony about the differences or the
comparison, I guess, the juxtaposition between the monetary
base and M2. And I have not read anybody else saying this, that
really what the Fed is doing is using its monetary tools to
effectuate fiscal policy, that they have manipulated the
monetary base through QE, but they are sucking the money back
out of the system through the interest rates they pay on excess
reserves.
Dr. White, is it appropriate for the Federal Reserve to
be--let me ask it this way. Dr. Bivens, do you agree with Dr.
White that the Fed is exercising fiscal policy in this
particular circumstance?
Mr. Bivens. I don't.
Mr. Mulvaney. If they were, would that be appropriate?
Could we agree that they shouldn't be doing fiscal policy? This
goes back to Mr. Kildee's question, and I think what you were
getting at is that you can't get at specific sub-pockets,
specific communities, specific parts of the economy through
monetary policy. That is the role of fiscal policy. That is
correct?
Mr. Bivens. I think that is fair to say, yes.
Mr. Mulvaney. And I think we can generally agree across
both sides of the aisle that the Federal Reserve should not be
doing fiscal policy. That is our job. Is that an accurate
statement?
Mr. Bivens. I would--yes, I would say that. I would also
say it is impossible to think of a completely allocatively
neutral monetary policy. So just the fact that there are
allocative implications of the Fed doing something does not
automatically mean it is not monetary policy.
Mr. Mulvaney. And that is what I want to go back to Dr.
White on, because I have seen the graphs you have provided. I
have read your testimony. And here is my question. Is it--you
think they are doing--you would think they are doing it on
purpose. What you have suggested is that they are using their
monetary tools to effectuate fiscal policy. Defend that against
somebody who simply says, it looks like that on paper, but
really this is just an accident, we are exercising monetary
policy that might look on a graph like it is fiscal policy, but
we are actually not exercising fiscal policy. So defend your
position a little bit more if you would, please.
Mr. White. If the Fed were borrowing money by issuing bonds
that were IOUs of the Federal Reserve System and paid interest,
and then used the proceeds to, say, subsidize development in
Michigan, I think everybody would agree that is a fiscal
policy.
Mr. Mulvaney. Yes, sir.
Mr. White. The way the Fed is borrowing money is not by
issuing bonds, but by paying interest on bank reserves, which
amounts to the same thing. It is a different way of borrowing
money. And then they have used the proceeds not to promote
development in Michigan, but to promote housing development, to
buy mortgage-backed securities, pump their prices up, and that
is directing it to one sector of the economy and not the
economy as a whole.
Mr. Mulvaney. And I wish we did have a chance to talk more
about credit allocation, because one of the things that you and
I have talked about, Mr. Chairman, is really what we think they
are doing is allocation--they are practicing credit allocation,
and one of their favored areas is government, and they are
making it easier for us to borrow money, just like they are
propping up the prices of mortgage-backed securities, but we
won't get that chance today.
Thank you, Mr. Chairman.
Chairman Campbell. Thank you.
Moving up the road a little bit to North Carolina, Mr.
Pittenger is recognized for 5 minutes.
Mr. Pittenger. Thank you, Mr. Chairman. And I thank each of
you for being here.
Chairman Campbell. Wait. He lives south of you?
Mr. Mulvaney. The State runs--
Chairman Campbell. Okay, don't confuse me with these
things. Yes, we are starting the 5 minutes over again for Mr.
Pittenger, who lives in North Carolina, which is south of South
Carolina, apparently.
Mr. Pittenger. I have to think about that one. Thank you,
Mr. Chairman.
Dr. White, do you think the government has taken advantage
of the low interest rate environment to run larger deficits
than it otherwise would have?
Mr. White. I don't see any evidence that Congress looks at
the interest rate on Treasury bills before it decides the size
of the deficit to run, but maybe I am wrong about that.
Mr. Pittenger. All right. Dr. Kupiec, this committee has
focused extensively on the QM rule and how it affects consumers
and lending institutions. Dr. Kupiec, you stated the following:
``The QM rule on its own does not seem to force a particular
lending outcome. A bank can impose underwriting rules stricter
than those specified in the QM rule and underwrite only high-
quality mortgages. The problem with this strategy is that such
an underwriting rule risks fair lending legal challenges.''
What are your concerns regarding the QM rule? Are there
things that this committee should consider doing to reaffirm a
non-distorted allocation of credit? And what steps would those
be?
Mr. Kupiec. As I discuss at length earlier in my testimony
on the QM rule, it imposes a scorecard- or model-based approach
to underwriting mortgages that is typically not the approach
used in community banks. In many small community banks, loans
are made on a relationship basis, where the bankers are
familiar with the people in the community and what they do, and
they don't have a very model-driven computer, data-driven
approach to lending.
And what the QM rule does is, the QM rules makes them adopt
these type of approaches, which are expensive, and the extra
expense of making mortgages originations is they just can't
cover it in small markets, so it is really forcing small
community banks in more rural areas and towns out of the
mortgage market. They are not making mortgages for their
customers, and there is some recent evidence in a survey just
out in February that a significant share of banks are just
getting out of the business.
Mr. Pittenger. Correct. Can you give some other examples
outside of QM where the U.S. regulatory policy has begun to
influence how credit is allocated in our economy?
Mr. Kupiec. There has been this new phenomenon where the
big Federal banking regulators have stopped some of the banks
from making syndicated loans. And this is kind of unusual,
because they are stopping specific syndicated loan deals on the
premise that these loans are part of a credit bubble that is
fueling a bubble essentially in high-yield mutual funds.
And so they are trying to stop banks from originating loans
that aren't even staying in the banks. They are going to the
mutual fund sector and arguing that they are trying to quash a
bubble.
The real source of the demand for this, though, is the zero
interest rate policy in the QE easing. Investors, as you may
all have experienced, savers over the last 6 or 8 years, you
make more money on your credit card rebates than you do by any
money you have in a bank account or a savings account, and it
is rational to look for yield. And these particular types of
loans are floating-rate loans. They are high-yield floating-
rate loans. There is risk in them, for sure, but at least they
pay a decent rate of return, and they are not subject to long-
term interest rate risk, because the rate floats.
And so it is a very natural sort of demand that savers
would have in this type of environment, and essentially the
bank regulators are trying to shut that down, and that is sort
of a new use of regulatory powers to direct credit that I don't
think we have seen in the past.
Mr. Pittenger. Thank you. Let's go back to the question,
Dr. Kupiec, that I asked Dr. White. Do you think the government
has taken advantage of this low interest rate environment to
drive larger deficits than it otherwise would have?
Mr. Kupiec. I really don't have an opinion on that. That is
not my area, exactly.
Mr. Pittenger. Dr. Goodfriend?
Mr. Goodfriend. No opinion.
Mr. Pittenger. No opinion. I have some, but I won't labor
through that at this time.
I yield back my time. Thank you.
Mr. Mulvaney [presiding]. The gentleman yields back.
We now recognize the gentleman from Illinois, Mr. Foster,
for 5 minutes.
Mr. Foster. Yes, I would like to return to something that
was mentioned, which is the implicit credit allocation effects
of stress tests, which are real, and I think probably
unavoidable. In just a simple example, imagine that you had--
one of the macroeconomic stress factors was simply that housing
prices revert to where they were several years ago. Had that
been applied to a bank with a large exposure in Las Vegas,
where prices had doubled in 2 years, that would have resulted
in very strong capital requirements and a restriction in
lending in Las Vegas as the bubble developed, whereas the same
identical requirements applied to a bank with a heavy exposure
in Cleveland, for example, which never experienced a bubble
would have no credit allocation, no credit restrictions applied
to it.
And so I was wondering what your attitude is toward general
policies, for example, requiring that you stay well-capitalized
if housing prices revert to where they were previously, even if
they have very specific effects, for example, constricting
credit in one area of the United States and not in another. Is
that necessarily a bad thing? And how do you--and a related
question is, what is the appropriate level of public
disclosure? The big banks might not be too enthusiastic about
having public disclosure of exactly why they failed or came
close to failing a stress test. So I was wondering if we could
just have another round of comments on that, starting,
actually, on the right this time with Dr. Bivens.
Mr. Bivens. On the appropriateness of sort of national-
level stressors affecting sort of regional banks differently, I
haven't thought extensively about it. It does strike me as a
little reasonable, though, to at least ask how regional banks
would react to, say, a fall in national home prices. It is just
not the case anymore that financial institutions only have a
portfolio of regional assets that affect regional prices. They
probably hold some assets that are correlated with national
home prices. And so as long as the proper weight of national
home price movements on the effect--on regional bank assets is
given, that strikes me as appropriate.
And in regards to public disclosure, my general view is the
more, the better. I would like to see more transparency in the
stress test models being used, so, yes.
Mr. Foster. Dr. White?
Mr. White. I think the important thing at the most general
level is to get the incentives right for banks to take
accurately into account the risks they are undertaking in their
portfolio decisions. And it seems to me the wrong way to
approach that to ask if we tweak this rule and look in
retrospect at how it would have affected the regional
allocation of credit, would that have been a good thing? We
don't want banks to put unrealistic values on the assets in
their portfolio and thereby overstate their capital. But that
is sort of a supervision and regulation question, rather than
what we have mostly been addressing today.
Mr. Kupiec. I would be happy to take that on. I ran the
stress testing group in the FDIC for a number of years, and so
I am very intimately familiar with these issues. The problem is
when you do a stress test, the Fed will specify some national
path for housing. And as you are quite right, regional housing
prices don't follow the same path.
Now, what happens is, the banks have to translate the
national path and the GDP path into something that happens in
their own area, and there are different ways to do that. The
problem is, it is not easy to do it, and econometrically, these
models fit very badly, so it is a guess. It is a guess how
housing prices are going to change.
But when the bank does its stress test and presents its
models, the Federal Reserve does its own, and it doesn't tell
you how it models it. And if the Federal Reserve wants to
assume a different transfer of the national house price path
to, say, Cleveland versus Las Vegas, it can do it, and it can
claim, this is what we think, and what we think is what
matters.
So the stress test ends up allocating capital in these
different markets because the Federal Reserve is the one
deciding what the right way to translate this overall very
fuzzy macro scenario into specific things that happens in
specific markets. And if the bank disagrees, well, it is too
bad. There is no scientific give-and-take. There is no
objectivity here. It is all an art. It is all a simulation. And
the models fit very badly anyway. So having any discussion on
it based on, really, sound economic grounds is a very difficult
thing to do.
Mr. Foster. Are you a fan of larger disclosure of the
debate that happens or not? When you said that the Fed did not
tell you why you passed or failed, are you then a supporter of
more disclosure, more public discussion of the factors that led
to banks--
Mr. Kupiec. The first point I would make is, it is a very
arbitrary regulatory rule, since so much of it depends on the
interpretation of the central bank or the regulator versus the
interpretation of the bank, so it is very arbitrary. In an
arbitrary setting like that, there is no--the property rights,
the ability for a business to make decisions, it is all sort of
overturned.
So transparency would be a first step, but in general, the
science isn't there--isn't really developed enough, nor do I
think it ever will be that you could actually make this a hard
and fast rule that was totally objective. There is a lot of
subjectivity in it, and in general, it is imposing government
regulators' views on business decisions that should be the
banks in the area.
Mr. Foster. I yield back.
Mr. Mulvaney. Thank you, Mr. Foster. And that appears to be
the end of the questions.
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.
And without any further objections, we will be adjourned.
Thank you, gentlemen.
[Whereupon, at 11:18 a.m., the hearing was adjourned.]
A P P E N D I X
March 12, 2014
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