it about that model that i relevant to what we have been dealing with over the last couple of years and what is not? >> well, i have done a lot of work on the depression and thought about it quite a bit. there are two basic lessons that i personally took from my studies of the depression, the first had to do with monetary policy. the federal reserve and other countries re very, very passive on monetary policy and as a result permitted a deflation of actually about 10% a year for several years, which was highly destructive to the economy. this was a point that milton friedman made in his history of the -- monetary history of the united states and he argued that was the primary cause of the great depression. so we were, in the federal reserve in this particular episode was actively more proactive and aggressive in

terms of easing monetary policy to ensure that we didn't have deflation risk and excessively tight monetary policy. the other -- the other aspect, the other lesson i take is that financial instability can be extremely caustic to the economy. and we had in the fall of 2008 a financial crisis which was in many ways as big or bigger than anything they saw in the 1930s. but we know that the 1930s the collapse of a big austrian bank and a number of other problems including the failure of about a third of the banks of the united states was a major blow to credit extension, to confidence and to prices and was a big source of the depression. and so for that reason we -- we were very aressive working with the treasuryand others to try to stabilize the financial system as quickly as possible.

even so, as you know, the impact on the economy was quite substantial. >> my time is up. i thank you for your testimony. >> senator bennet. >> thank you, mr. chairman. chairman bernanke, nice to see you again. thank you for your testimony. you talked a little bit in your remarks about the importance of not just about cutting, what the composition of the spending looks like, what the comprehensive approach to taxation looks like. your view is more nuanced than the headlines that come out of this place and i appreciate it very much. and i wanted to ask you in that context how you evaluate the product of the fiscal commission. what do you think of their suggestions about their mixes of cuts versus -- cuts to spending versus revenue? do you think it should weighted one way or another? i know you're here to talk about monetary policy, but n fiscal

policy. i wondered if you would spend a few minutes sharing your views on it. >> what i think was impressive about thedeficit commission is that it -- first of all, it highlighted the size of the problem. secondly it, for the most part made a set of proposals that while obviously painful would address the problem. i say that for the most part because, you know, in some areas they kind of punted, like in health care spending, fo example, which is really the biggest single issue. they just sort of assumed that cuts would be made and they didn't give many details. so i -- i appreciate that it was a bipartisan effort and i think it was very sssful in the sense that it showed, you know, gave a sense of the magnitude of the response that is needed and showed least one path forward to addressing the problem.

and some other commissions like the rivlin commission and others have done similar things. i wouldn't want to tie myself down too much to the details of that commission. i'm sorry. but -- because i think there are many different ways you could address it. and ultimately, of course, fiscal priorities are the congressional productive, not the federal reserve's. but one -- certainly one element there was pointing out the importance after dressing the long-term entitlement issues which are going to become bigger and bigger and needs somehow to be managed in a way that will provide essential services, but will be affordable to the country. >> i appreciate your not wanting to endorse the specifics of the plan. i guess directionally, let me try this way. we're in place now where we have 1.5 trillion, roughly, trillion dollar deficit, $14 trillion of

debt, fed's balance sheet expanded dramatically to deal with this crisis. one of the things that i worry about is that if the capital markets decide one day that they don't want to buy our debt at the price that they're now buying it, that the result of that is going to be catastrophic and because of the position we're in today with our -- your balance sheet and with the federal government's balance sheet that there is no room for a policy response at that point. so while you talkedabout how painful some of the suggestions are from the commission report, i wonder if you could tell the committee a little bit how painless that would seem compared to the pain we would go through in the scenario that i just described. >> no. there i'm in complete agreement. the -- i think the thing to understand is that the long-term imbalances are not just the long-term risk.

they're near and present danger. to the extent that markets lose confidencen the congress' ability to make tough choices and they're going to be tough, there is the risk of a -- an increase in interest rates, which would just make things worse because it means that a higher defici you know, it would increase the deficit because of higher interest rates. so i think the sooner that a long-term plan is put in place to make significant and credible reductions in the path of the deficit, that it would have -- the better it will be and it will have benefits in the near te, not just 20 years from now. >> right. i think that's very important because earlier there was some discussion about ten years, 20 years. i want to underscore and underline your observation that this is actually a near and present danger, and that the sooner we get after it, the less painful it is actually ultimately goingo be and the more likely we are to protect rselves. you said financial instability

is extremely costly to the economy. i would argue that the financial instability that would come in this scenario i was talking about actually would be more costly than what we have just been through. i wonr if you've got a view on that. >> no. that's very possible. it would create both a fiscal crisis and require a scramble by the congress to try to find any kind of cut or tax increase to address the problem. but a spike in interest rates would have also very adverse effects on a lot of institutions and portfolios and could create a financial panic as well. so it is real a very worrisome situation. now, fortunately, the markets to this point seem to have a lot o confidence that we will address the problem and i hope we can, you know, make that confidence that we can meet that expectation. >> thank you.

thank you, mr. chairman. >> senator vitter. >> chairman, thank you, mr. chairman, for your work and your testimony. i want to build on some of the discussion we have been having about the fiscal situation. i think you've said we're on -- fiscally we're on an unsustainable path. that challenge is a long-term challenge. however, it can have very immediate consequences. who knows when it can break in terms of the consequences if we don't start to deal with it. is that a fair summary of some of the things you've said? >> yes, senator. >> in that context i'm wondering the following, we're coming up on a big deadline, several big deadlines, probably the biggest is our reaching our debt limit as a nation sometime bween late march and may. what do you think it would do to

the viewpoint o all of this, on our seriousness about our correcting our fiscal situation if congress increased that debt limit without at the same time passing some meaningful budget reform? >> well, senator, as i hope i made clear, i think it is extremely important that you adess this issue. so in no way am i, you know, disagreeing with your basic premise that you have to address this long-term budget issue. i'm just worried about using the debt limit as the vehicle, the reason being that if it were even a possibility that the government would default on its existing debt and not pay the interest and principal on existing debt, some of the nancial crisis issues that senator bennet mentioned would immediately happen because

currently the is absolute confidence that the u.s. government will pay its bills. and if you don't do that, it would have very negative effects on financial markets and the economy. for a very long time afterwards, the u.s. would have to pay higher interest rates in the market and that would make our deficit problems even more retractable. so, again, i very strongly support efforts to address the long-term deficit problem, but i'm a little nervous about taking the chance that we would not be paying the interest and principal on our debt. >> let me ask the same question a different way. would it be better to increase the debt limit and go along our merry way on the present fiscal path or would it be better to increase the debt limit and at the same time pass meaningful budget reform? >> well, clearly the latter. you want to make sure that the debt is paid, interest is paid, meaningful budget reform is

highly desirable. i'm just concerned that there be a significant probability that we would not raise the debt limit and that would cause real chaos. so i'm completely with you, senator, on the need for budget reform and i hope that congress will be able to come together and make some tough decisions. >> well, again, let me go back to my first point. i understand your concerns about the consequences of not raising the debt limit. however, that event is so big, it seems to me if we do it and don't do any meaningful budget reform, that is a very clear, very strong negative signal about how serious we are about correcting our fiscal path. that's my point. would you disagree with that? >> i guess i would draw a distinction between not increasing the debt limit and maybe, you know, even shutting down the government. those sorts of things.

not increasing the debtimit is like saying, you know, we're gog to solve our family's financial problems by refusing to pay our credit card bills. these are bills that have already been accrued as opposed to cutting up the credit card and say going forward, we're not going to do any more spending. these are -- this is money we have already borrowed. these are commitments we have already made to contractors, to senior citizens and so on and what we're saying here is we're not going to make these payments that we promised. so i would rather that we be forward looking and say, you ow, we're gog to hold -- we're going to restrict new spending or new commitments untile have reform. >> well, maybe you misunderstood me. i wasn't suggesting doing -- i wasn't suggesting not acting on the first. i was just suggesting that we should act on both together because if we don't, i think that is a very strong negative signal about our lack of commitment to changing our

fiscal path. >> i really support a program to improve the long-term fiscal sustainability. >> thankou. >> senator merkley. >> thank you, mr. chair. and thank you mr. chairman. you commented that our deficit is not a single year problem, but a long-term problem, our deficit, our debt. the budget committee planned from last year sought to essentially stop digging the hole any deeper after about four years. the -- but to avoid driving us into a double dip recession, a more serious recession in the short term, when you're talking about a long-tm problem and as we wrestle with the short-term impacts, is that type of framework where within a couple of years you're getting to a point you don't dig the hole any deeper and than at that point

you're reducing it, is that the kind of type of profile you're talking about in terms of the long-term/short-term trade-offs? >> well, one criterion which is very useful, i think, is looking at the primary budget deficit which is the deficit less interest payments. and currently you need to get the primary budget deficit down to zero in order to avoid increases in the debt to gdp ratio. currently under current cbo projtions, the primary budget deficit is 2% in 2015 and 3% in 2020 of gdp. that gives a sense of the kind of cuts we would like to see over the next ten years, that over the next ten years would help stabilize that gdp ratio over that period. that's the criterion i'm looking for, over the next ten years, reducing the deficit, the structural deficit by 2% to 3%. >> thank you. let me switch to energy policy.

there is a lot of discussion now about the impact of foreign oil, price shocks and the possibility that oil at $125 or higher might trigger a real challenge. does it make sense for us to have a tional strategy to radically reduce our dependence on foreign oil? >> i think that anything we can do to diversify our energy sources is probably helpful. we want to make sure what we do is economic. but it is true that oil does come -- bring with it geopolitical risks and uncertainties that other forms of energy might not have. and that probably should be taken into account as we think about the range of energy sources. i think the recent developments in natural gas here in the united states and increased

supply of that is a very good development. it is going to be very helpful. i know that some people are support additional nuclear powe utilities, energy producing. so, yes, i think some attention to diversifyg the energy sources that we use is a -- is a good idea to avoid some of these risks. >> i'll keep jumping topics here, given the short time i have. but commercial ending has been in a real challenging position with a lot of balloon mortgages, 7 to 10 year mortgages coming through and banks reluctant to relend because of the declining value of the buildings. the fed was involved in the term asset-backed loan security or talf which helped in the short term but pulled back from that. where are we now with it being a

major structural challenge for our economy? >> well, the talf was about stimulating the commercial mortgage-backed securities market, and that was a story in the paper this morning that the cmbs market, not in a big way, but a modest way, is coming back and that at least for the better -- better properties. so that's a positive develoent. we have also -- the fed has also worked with banks providing guidance about how to rework, restructure cre loans which seems to be having some beneficial effects as well. i would say overall and we had a fed testimony by pat parkinson recently on this topic, i would say overall that some of the worst fears about commercial real estate seem not to be coming true, that there is some stabilization of vacancy rates and prices and so on in this market.

that being said, there is still a lot of, as you say, a lot of properties that are going to have to be refinanced, and probably some losses the banks are still going to have to take. it is still a risk to the financial system, but it does seem to be looking at least marginally better than we were fearing six months ago. >> thank you. >> senator johanns. >> m cirman, thank you. mr. chairman, good to see you again. as i was listening to the discussion about qe-2, which you know i've been a critic of that, i'm not supportive of what you're doing, but having said that, it occurred to me that maybe we're focusing on consequences and not focusing enough on the reasons that maybe got you to that decision point. so let me, if i might, offer a

thought about that and i would like your reaction to it. never in the history of this country has there been a greater need for people, foreign countries, whoever, to buy our debt than now. in fact, nothing comes close to it. it is kind of breathtaking in its magnitude. just week after week after month after month, somebody has to be out there buying this massive amount of debt. i look at what has happened to commodity prices, which have been so very strong. i look at what has happened to the dow and the nasdaq and that also has been strong, it has been on quite a run. there is so much competition out there. until the economy improves, there is more reason to be in

the investments than getting less than a percent return on a two-year treasury or on a 2% plus on a ten-year treasury. so it just occurs to me, mr. chairman, that part of what is driving this is the real genuine bona fide worry that in order to attract people to buy treasuries, the government would have to entice them with higher yields. and eventually, you know, heaven forbid, good lord forbid there is a day at which there just isn't an appetite to buy more paper because those who are in that marketplace look at the united states government and say, you know, you've so detached the joy of spending from the pain of taxation that

you don't have a fiscal plan. and then i look at the impact on real people like there was talk, well, we don't haveo do anything about social security, well, that assumes we can keep borrowing because there is no trust fund. it is just paper again. and if we're not able to borrow more money, we can't even pay current beneficiaries. so it seems with those kinds of weighty issues, all of which i think are accurate, if i'm reading this correctly, you most had no choice. you've got to be in this marketplace keep intert rates slow to start out with. and you've become a big player in buying our debt and you must lay awake at night wondering if i exit this marketplace, what happens? tell me where i'm wrong in that thinking. >> well, that was not our motivation for getting into

this. our motivation was the state of the economy, which as la summer and fall we were -- we had significant concerns that the recovery was going to stall, that growth was not sufficiently fast to bring down unemplment, and that inflation was moving down and down and down to where we'reetting closer and closer to the deflation zone. that was the reason we took the action and we felt although there are admittedly risks with the qe-2 program that there are also very significant risks to not taking the action. so we did it for the same reasons that monetary policy is always used, which is to try to meet our dual mandate for employment and inflation. going forward, i think it is, you know, our policies affect interest rates in two ways, one is as we promote growth, that's causing interest rates to rise for the reasons you were describing because other investments become attractive, but also it is important for us to keep inflation low and well under control because inflation so affects the level of

nominal interest rates. so we were not motivated by anything related to the deficit or the debt, and i don't -- i make two points. one is, whenever we stop buying, whenever that may be, our previous experience suggests that the market takes it in stride because the market anticipates that at some point that the purchases will stop. and then we are not monetizing the debt because we will be returning our balance sheet to a more normal level ultimately. i think what is all comes down to, and this is the point we have made in the discussion several times already is that what the markets are looking at is the long-term fiscal discipline of the u.s. government and whether or not interest rates will spike or whether they will remain reasonable depends far more on congress' decisions about long-term fiscal planning than anything the fed is going to do. >> thank you, mr. chairman.

>> senator hagan. >> thank you, mr. chairman. i'm honored to be on this committee. thank you so much. chairman bernanke, in your last monetary policy report to congress, you touched on housing finance. when you noted that on balance inrest rates on fixed rate mortgages decreased over the first half of 2010. but you also acknowledged that despite the further fallin mortgage rates, the availability of mortgageinance continued to be constrained. and i hear time and time again from constituents throughout my state in north carolina that they're having difficulty taking advantage of the low rates that are out there. and as you know, one of my biggest priorities during the dodd-frank was to include a qualified resintial mortgage standard in the bill. i worked th senators landrieu and senator isakson and we worked to include a standard that would provide access to a safe, stable and affordable ho

loans for credit worthry borrowers. i understand that risk retention may serve as a deterrent to types of excessive risk taking. but i am concerned that risk retention could impose significant costs and reduce liquidity in the mortgage market. as a result, we tried to shion an amendment that addressed the primary causes of the problem directly and yet also provide an inisn incentive for lenders. was hoping you would talk more about the impact that the qualified mortgage definition that is currently being written will have on housing finance and are we going to continue to see constraint credit and if regulators were to draw too narrow an exemption, for example if they required 20% down advocated by some would credit further be constrained? and i'm really concerned that if

loans don't meet the qualified residential mortgage standards and lenders have to set aside the extra capital to meet this risk retention requirements, we're going to see constrained credit going forward. >> well,senator, of course we're working very hard on the qrm in conjunction with the fdic and other agencies and we expect to have some rules available for mment very shortly. we have been discussing in particular, you no he, to what extent servicing requirements should be attached to the qrm. so the goal there, as i understand it, is to have a definition of mortgages that are sufficiely high quality and meets sufficiently high underwting standards that the risk retention is not necessary and that would reduce the cost of the mortgages. on the one hand, i understand you don't want it to be too narrow or too tough, but on the other hand you don't wan to make it -- you want this to be a good mortgage, one that will be safe and well underwritten and

that invests aors will be happy buy even without the risk retention. on terms of the mortgage market, most of the mortgage market is still fannie and freddie at this point. and so we know directly what is happening there, which is that they are continuing to keep pretty tight standards in terms of de facto 20% down, pretty high fico scores, so conditions -- terms and conditions for getting a mortgage are quite tight, particularly relative to the excessively loose terms that were in play before the crisis. my own guess is that for the most part that improving the economy will cause lenders to be, you know, a little bit less restrictive. but on the other hand, as we

move towards a fully privatized market, you know, gses become less and less important, you know, the private sector may decide to keep, you know, to keep terms moderately tight. so currently the terms are pretty tight. that is a problem for the housing market. i expect some modest improvement, but probably not anything dramatic in the near term. we continue to work on the qrm and i think that will be a constructive addition to the housing finance programs that we have. >> i'm sure you'll continue to be hearing from us that are really concerned about not making it so restrictive that we can't have -- as many well qualified loans as possible. obviously recognizing that there

does need to be a good definition of that. >> okay. thank you. >> also the fomc used connecticconventio conventional monetary polls to promoe promote economic recovery and price stability. you've been talking about the quantitative easing and the purchase of government bonds with newly printed money has made monetary policy more complicated. and as we still don't know the long-term effects of this policy may have and moremportantly what effects unwinding these policies may have, i understand that these tools, especially the asset purchases, will take time to unwind and that economic conditions will dictate much of the decision-making. a recent study by a group of fed economists constructed a baseline scenario for unwinding the large scale asset purchases that would see the fed's $2.6