in side and composition by 2017. do you agree with this baseline trajectory and what are the factors that will influence this trajectory towards balance sheet normalization and will the price stability or maximum employment drive the decision-making? >> well, senator, we had had earlier discussions about the pace of normalization and one concern we had was not to sell off our securities so quickly that it would disrupt the ma market. the sense was that most likely it would be a relatively slow process and one that would be clearly announced in advance and so that markets would be able to anticipate. what i need to emphasize here is that does not mean that qe will continue for 2017 or easy money will continue to 2017. we have tools that will allow us to tighten monetary policy in more or less the normal way, even if the balance sheet remains large. for example, we have the authority to pay interest on

reserves by raising the rate that we pay on reserves to banks, we can effectively raise the short-term money market rate and that will work through the financial system just pretty much the same way that a higher federal funds rate target will work. so there are different i was for us to unwind. obviously ultimately as senator shelby pointed out, it is important for us to get back to a more normal size of our balance sheet. we will do so. but the pace at which we do that is not -- does not constrain us from tightening monetary policy at the appropriate time. as i was trying to explain also to senator shelby, the criterion we'll be using will be first we want to be sure that price stability is maintained, that inflation remains low and stable, and in doing that we'll have to look ahe to where inflation is going, not just where it's been, but also to the extent that'consistent with that, we want to make sure that recovery is self-sustaining, that the private sector is -- is

leading the recovery so that the artificial support from the fed and from fiscal authorities and so on can be withdrawn and that the private economy lead the recovery. >> thank you, mr. chairman. >> senator warner. >> am i next? >> yes. >> thank you. let me see if i understand an answer that i believe you gave, senato merkley. you said the commercial mortgage-backed security market is coming back to a small extent. >> correct. >> and i assume that's a good thing. >> yes because that's an important source of finance for a commercial real estate. given the banks are not expanding their balance sheets, we need alternative sources o finance. >> right.

and i got information from crs yesterday that was compared to residential mortgage-backed securities. that market is virtually dead, is that correct? >> yes. >> would it be a good thing if that came back? >> well, i would think so. although it is important to remember that a lot of bad lending took place through that -- through that market and helped contribute to the crisis. but conditional on unrwriting standas or other oversight that makes the loans created through that process sufficiently good quality, then, again, it would be good to have multiple sources of financing for the housing market. >> okay. and that's what i'm -- that's what my question is sort of directed toward as to what standards you might recommend in that regard. you know, most of us have had to

go to school since 2008 on this whole issue of mortgage-backed securities. what we learned is that as they were leading up to 2008, they were outside many of the s.e.c.'s regulatory structures because they were privately placed transactions. and so with regard to the definition of delinquency or being in default, or the classification of the mortgages or how those mortgages are worked out when they get in trouble, there were not those standards in place because generay they were considered transactions involving the big board. so would it be helpful and what suggestions would you have in this regard of having standards,

greater disclosures and structural reforms put in place to perhaps revive the private mortgage-backed security market and bring back more private mortgage capital into the residential market. >> well, a number of steps were takenin the dodd-frank act that tried to address this. for example, one of the problems in the crisis was conflicts of interest or shopping around for credit ratings. and so the -- there are some new regulations, regulatory authorities, s.e.c., to reduce those -- reduce those conflicts of interest and th credit rating agencies have been rewoing their models for securitized products. and so the -- the -- what we saw in the cris where firms would take a whole bunch of lousy

mortgages and then use financial engineering to make them into aaa securities, that should not be possible anymore if the credit rating agencies are forced to meet certain standards. secondly -- >> let me intersec >> sure. >> have we adequately addressed that issue in dodd-frank? >> before i can answer that question, i would like to see the full panoply of steps that the s.e.c. takes. i know they're serious about trying to address particularly the shopping around problem where a securitizer would try different agencies until they found one who gave them the rating they wanted. so with more disclosures on that, for example, would be helpful. then just talking to senator hagan about the qrn, the called residential mortgage, which would set standards for high quality mortgages, and mortgages that didn't meet that would have to have a skin in the game

credit risk retention element. that's provided by dodd-frank. i thk that supervisors will be paying more attention to this in the future and we should pay more attention to it. and finally one thing that the fed reserve is very interested in and we have been talking about this with congress and other agencies is to have national servicing standards. that turns out to be an important part of the process of making sure that people who do run into trouble are able to get restructured mortgages and our chance to keep our home. so there are a number of things in the bill, but i -- i think as we go forward, we want to make sure that we have sufficient oversight that we can assure that the mortgages are of good ality. i think that as the gses begin to pull back, as they will, we

will see private label mortgage-backed securities coming back into the market, but it is pretty limited right now. there some. >> my time isexpired. would you take for the record the question of some recommentions about how to go further on structural changes that might make the mortgage-backed security market more viable with regard to residents? >> certainly. >> thank you. >> senator warner. >> thank you, mr. chairman. mr. chairman, good tsee you again as well. i think one of the comments you made earlier we all need to bear and some level of mind that while you had to take some traordinary actions, when ywe reflect back where we were spring 2009 and how big a ditch we were in and the prognostications at that point, while clearly employment numbers is not where we would like, some

other recovery has been frankly more dramatic and i think many of us would even predict. one thing -- i have two issues want to raise in my short time, one thing i think and hopefully we will have a wise way to avoid a government shutdown right now, but i do think at times with the public, there is some confusion between these issues around shutdown and an issue that we will have to address in the next few months around the debt ceiling limit. and as we heard from your testimony and i absolutely believe we need to put in place a long-term plan to deal with our debt and deficit and i'm proud of the bipartisan work that is being done on that, but as we are still kind of in this hopefully strengthening recovery, cayou, in as plain a language as a central banker could -- can make clear what the ramifications would be? maybe to an average american or

to our economic recovery if we were to default on -- and not raise that debt ceiling limit d the ramifications that would have to our general recovery and to an average american family, two or three examples. >> well, it would be extremely dangerous and very likely recovery ending event. first, it would almost certainly create a new financial crisis as firms that rely on receiving their interest and principal do not receive it. and they're unable to make payments and so that would cascade through the financial markets. then there would be a massive loss of confidence in the u.s. treasury securities, the deepest, most liquid market in the world. interest rates would spike. and that would, in turn, affect, you know, many other assets as well as treasuries.

so the near term effect would be a sharp resumption of the kind of instabilities we saw in 2008. even if we were able, somehow, say because it was only 20 minutes long or something like that, even if we were able to avoid those kinds of effects, very likely the interest rate that lender would dend of the u.s. to finance our debt going forward would be higher, reflecting the greater riskiness and uncertainty associated with funding u.s. government. and that would make our fiscal problems all the more severe because interestayments are part of thedeficit. it means that cuts would have to be sharper and tax increases larg and those things themselves would also be a negative for the recovery. so broadly speaking it would be, i think, a very bad outcome for the u.s. economy. >> it would be safe tosay that

two years of extraordinary actions, many of them politically unpopular, could all be washed away, whatever recovery we have got could all be put in jeopardy if we as members of congress and the american public doesn't realize there is a major distinction between the questions around debt ceilingimit and, you know, equally important questions around government shutdown. government shutdown compared to messing with the debt ceiling limit could have dramatically different ramifications. >> we have never had a failure to raise the debt limit, we had a number of government shutdowns and they have created problems, but they haven't been as destructive as a debt limit failure would be. >> all right. well, being sensitive to those of us on the end who have been waiting a while, try to get my last question in and observe the time limit, one thing i know -- i won't try to pin you down on the deficit commission report, you won't go on to specifics. i would like to ask, there are

many folks here who feel we can solve this crisis on the spending side. the nature and size of this challenge is so great, do you believe that we can rlly get there without having an open mind on both sides of the balance sheet? >> well, hope there will be an open mind and plenty of discussion about all possible ways forward, certainly. so certainly i can't disagree with that. >> but both spending and revenues have to be part of this discussion. >> i hope there will be an open mind and discussion of all options including reforms of the tax code, including restructuring of spending and the like. yes. >> wish i had another 30 seconds. >> senator moran. >> mr. chairman, thank you very much. chairman bernanke, thank you for the opportunity to question and make comments. mr. menendez asked earlier about, i think, at least from my

perspective that the crux of his point was that despite significant monetary policy changes designed to put additional dollars into the banking system, loans do not -- are not being made. credit is not being extended to the degree that we need to increase the economy. and i'm interested in knowing whether that is accurate. still trying to assume our goal is still trying to increase loan demand and do you think the regulatory environment that particularly community banks face has a consequence in the fact that credit is not being extended and is there something we should do? >> well, first, the qe-2 is not intended to work primarily through banks. it is intended to work through broader markets and we have seen, for example, very open corporate bond markets in part because of the monetary policy

actions we have taken. so that's not the direct object of the qe and what we have seen is easier, broader credit conditions as opposed to bank lending specifically. we have tried to address the bank lending issues in different ways from a supervisory perspective and i don't want to take all your time, but we have a long list of steps we have taken in terms of guidance, in terms of examining trading, in terms of outreach to try to make banks appreciate and make our own examiners appreciate that what we're looking for here is an appropriate balance. on one hand, we don't want bank making bad loans. on the other hand, it is good for everybody if they make loans to credit worthy borrowers. we're encouraging that and encouraging our examiners to encourage that. my sense is that although credit conditions are still tight that they are improving. i mentioned that in my testimony. we have seen, for example, in our surveys banks that terms and conditions have stopped tight enning and have been to loosen a bit.

many banks have fro duce e intr programs like second look programs for new loans. my sense that this year we'll see some improvement, not anything like we saw before the crisis and that's in fact a good thing, but we'll see improvement in bank lending. we'll continue to follow that cafully. it is a very high priority for us. >> i raised this top nick your last appearance with other regulators before our committee and i would again tell you that bankers continue to suggest that the ability to make loans is significantly hampered by the regulatory environment. and in most instances the suggestion at least is that those regulations are not keeping them from making bad loans, keeping them from making good loans. and so, again, i would encourage the fed to pursue what you outline as your current course of action in a more significant or strenuous way. ofn your policy is criticized on qe-2 and doing so the comparisens made to japan.

and i would like to note your thoughts about the correlation between what occurred in the japanese economy and its central bank's response and your and our economy and then you indicated earlier that long term our deficit aren' sustainable and you had some conversation with my colleagues here on the committee about not extending the debt ceiling, for example. what are the precipitating factors that you are concerned about? i know every central banker has got to portray confidence and what are the things that are out there that may make this, when you say long term not sustainable, long term becomes significantly shorter term? what are the things in the world economy that may -- that we ought to keep our eye on that may ange the time frame in which we have to operate? >> first, t me say on your bank issue that we do have an ombudsman. i would encourage any bank with concerns about federal

federal reserve examiners to get in touch with us. we will try to followhrough on that. >> thank you. >> on japan, the japanese did a lot of things earlier because they had a bubble and a collapse earlier than we did, but you know, we have focused our purchases, one important difference is that we have instead of simply focusing on bank reserves which have not been lent out very much, which in fact, you know, we don't want it to be excessively lent ou in the sense that we want it to be controlled, otherwise it would tend to create higher money supply and pose an inflation risk. what we've done instead is focus on longer term securities, taking duration out of the market and that has the effect of pushing investors into other types of investments and for example, again, making the corporate bond market mor attractive, making the stock market stronger and the like.

so our approach has been somewhat different than what the japanese took, but we have faced, you know, the same concern that following a financial crisis, recovery can be quite slow and deflation can be a risk. we saw those things happening last summer and that's why we decided to take additional steps as we have. on terms of what could bring the fiscal crisis into the present, it's very hard to know. there's no way really to judge when markets will change their mind. currently of course, ten-year bonds are still 5% and currently, they seem to still have the confidence of the bond markets. i think what would be a real problem would be if investors saw not so much the economic capacity but the political capacity of the united states as being inadequate to address these problems. if it became clear that ese problems were not going to be adequately addressed because we were just in a perpetual gridlock, i think that would raise significant concerns, it would risk bringing these

things, these problem forward into the present. >> mr. chairman, thank you. i think we often in congress tend to criticize the fed when so much of this as you id earlier is determined by decisions made here on spending deficits and revenues. thank you, mr. chairman. >> thank you. >> senator? >> thank you, mr. chairman. thank you, mr. chairman. first question relates to concentration limits in your le as the fsoc group. section 622 prohibits any firms whose total liabilities are greater than 10% of all financial rms liabilities from merging with or acquiring another company. i'm concerned the way those numbers are calculated could put u.s. companies at a competitive disadvantage. that's because for u.s. companies, the number in the numerator includes all liabilities worldwide but for all non-u.s. companies, only their u.s. liabilities. that means if a u.s. company and

swiss company simultaneously bought a brazilian bank, the concentration ratio for the u.s. company would go up and the ratio for the swiss company would go down. as i understand it, the committee has the ability to change that and make it fairer. what are your thoughts and what should fsoc do? >> i fully agree with your concern. it is unfair in the sense that as you say, a foreign bank that has operations in the u.s. could purcha a domestic u.s. bank where a u.s. bank of the same size could not buy that bank. >> or a foreign bank of the same size. >> or a foreign bank. i may be mistaken but my understanding is that we didn't have discretion -- >> you do. >> well, i will look at that. because i do think it's a problem. >> the fsoc, the statute says

fsoc can take competitiveness into account and b, that any rules are subject to the recommendations of fsoc. so you have some discretion and i hope you will. second issue. you have persistently, wisely, in my view, you defer to congress on taxing and spending but i want to ask you a more general question about the when of deficit reduction rather than the how, about the timing of our efforts to reduce the deficit. last mnth when you were testifying before the house budget committee, you said the following, i'm quoting. the very -- this very moment is not time to radically reduce our spending or raise our taxes, because the economy is still in a recovery mode and needs that support. now, pvate economists seem to agree. mark zandy yesterday in his report said too much cutting too soon would be counterproductive and would be taking an unnecessary chance with recovery. do you agree with those sentiments? >> yes. if i may add a small

qualification -- >> no. don't do that. >> only -- thank you, senator. only that it is important to be showing progress and therefore, i hope that we'll take a long-term perspective and do things that will be persuasive to the market over time. we are committed to -- >> i don't disagree with that caveat at all. that's a fair caveat. but in the short term, we better be careful not to snuff out this nascent recovery by doing too much cutting in the words of zandy. that's correct, in your opinion? >> yes. >> okay. do you also agree, he said that cuts, significant cuts could cause job loss, those cuts would create job loss. i don't mean overall job loss, macro, but those cuts could. you agree with that? >> the cuts would presumably lower overall demand and the economy woulhave some effect on growth and employment. >> good. the answer is yes. >> yes. >> thank you, mr. chairman.

>> senator kirk. >> thank you, mr. chairman. i would just like to briefly comment for you on the work this time is different by rinehart rogoff. what did you think? >> he's one of my long-term colleagues and friends. i have great respect for both him and miss rinehart. i think it's a very interesting piece of work. it's particularly instructive because it uses a lot of historical episodes, data, as opposed to purely theoretical approach to the problem. >> it's an important piece of work. you were effusive in your praise at least on amazon, i saw. i thought the title is important because every central banker, economic official says this time is different. yet th basic themes of debasing a currency, inflation, lack of spending discipline, rinehart

and rogoff highlight the similarity of poor action by bankers and governments to destroy their economy through a lack of discipline. it's an important lesson for us. we have a report from the national council of state legislators that talk about financial stress now in 12 american state just recently the state of illinois borrowed another $3.7 billion, paying 50 basis points more to borrow than corporate debt at the lowest investment grade. you and i talked earlier about the potential of states posing a systemic risk to our economy. you feel that they could pose a systemic risk? >> it's possible but currently, while states are facing very tough financial conditions, at least as long as the recovery continues, they are seeing higher tax revenues and that will at least be helpful to some

of them in trying to address these problems. but obviously, this is something we have to wch carefully. >> certainly a panic in the state and municipal bond market could trigger a systemic risk, in your view? >> if it was sufficiently severe, yes. >> when you have expressed opposition to any federal bailout the states, that is correct? >> i think that it's a congressional federal matter. it's n a federal reserve matter. the federal resve is not going to be involved in that. if congress wants to address it -- >> what would your view be to accelerate federal borrowing to give money to the states? >> again, i think that's a congressional decision. if you're going to be increasing borrowing, though, obviously it bears its own risks, obviously. >> i think tremendous. would you regard the proposal to

defer state payments of principal and debts on loans made from the federal government as a state bailout? >> well, it has -- to some extent, it has -- it has fiscal implications for the federal government. >> i would think so. also, maybe we could use a language that is more clear in your testimony on page five, you talked about we are considering providing additional monetary accommodation through further asset purchases. in november the committee announced it intended to purchase an additional $600 billion in longer term financial securities in the middle of this year. in more layman's terms, you're talking about lending money to the u.s. government, correct? >> well, not exactlyecause we are buying these securities on the secondary market so somebody's already lent the money directly but yes, we are holding government debt. >> my point exactly. section 14 of the federal reserve act legally pvents you

from -- this woulday from buying newly issued securities which in a more layman's term would be lending directly to the u.s. government. >> that's why we're not doing that. >> right. instead, what you do is others lend to the u.s. government and then you buy tir loans. >> we do that all the time. even in most normal conditions. >> correct. in modern times, the fed has always held treasury securities as part of normal operations but now under qe-2 it's a $600 billion commitment. but the crs goes on to say the effect of the fed's purchase of treasury securities on federal budget is similar to monetization, whether the fed buys securities on the secondary market or directly from treasury. when the fed holds treasury securities, treasury must pay interest to the fed as it would to any private investor. these interest payments after expenses become part of the profits of the fed. the fed in turnremits 95% of

the profits to the treasury, where it is added to the general revenues. it concludes in essence the fed has made an interest-free loan to the treasury because almost all of the interest paid by the treasury to the fed is subsequently sent back to the treasury. would you agree withhat? >> yes. we've remitted $125 billion to the treasury in the last two years. it's important to understand that what we're doing is not fial spending. it is in fact, you know, purchasing securities which we'll then sell back to the market. >> so because of section 14 of the act, maybe the simple way of saying it is others are lending money to the federal government, you are purchasing those loans, and then the interest payments being made to you, because you're now the holder or the official maker of the loan, are then remitted back to the treasury, so maybe in layman's