Dec 03 2009
U.S. Senator Richard Shelby (R-Ala.), ranking Republican on the Committee on Banking, Housing, and Urban Affairs, today at a hearing on President Obama's nomination of Ben Bernanke to remain Chairman of the Board of Governors of the Federal Reserve System, raised a number of questions regarding Bernanke's role at the Fed - as a Governor and Chairman, and with respect to monetary policy and bank supervision - prior to the recent financial crisis:
"While we learned a great deal about crisis management from the Great Depression, it appears that we learned precious little about how to avoid the situation in the first place. Prior to the recent financial crisis, the Federal Reserve kept interest rates too low for too long, encouraging a housing bubble and excessive risk taking. In addition, the Fed failed to use its available powers to mitigate those risks."
Shelby also criticized the Fed's ad hoc and piecemeal response to the financial crisis:
"Many of the Fed's responses, in my view, greatly amplified the problem of moral hazard stemming from too big to fail treatment of large financial institutions and activities...
"Using powers granted under Section 13(3) of the Federal Reserve Act, the Fed made it explicit that certain institutions and activities would not be allowed to fail...
"Taxpayers simply should not be subjected to possible losses from private risks."
"Certainly, we are still deep in the woods. The question is whether Chairman Bernanke is the person best suited to lead us out and keep us out."
The full text of Shelby's statement is below.
OPENING STATEMENT OF SENATOR RICHARD C. SHELBY
On the Nomination of Ben Bernanke to Remain
Chairman of the Board of Governors of the Federal Reserve System
December 3, 2009
“Thank you, Mr. Chairman.
“We all know well Chairman Bernanke’s academic accomplishments prior to joining the Board of Governors, first as a member, and then as its chairman.
“He was, and remains, one of our nation’s leading scholars on the Great Depression. I believe that his expertise in this area has served him well during our current crisis.
“It is important to note, however, that every crisis has a beginning, a middle and an end.
“While we learned a great deal about crisis management from the Great Depression, it appears that we learned precious little about how to avoid the situation in the first place.
“Prior to the recent financial crisis, the Federal Reserve kept interest rates too low for too long, encouraging a housing bubble and excessive risk taking.
“In addition, the Fed failed to use its available powers to mitigate those risks.
“Congress also bears some responsibility.
“Often over my objections, we enacted housing policies that imprudently encouraged home ownership to levels we now know were unsustainable. We also failed to curtail the activities of the housing GSEs, Fannie and Freddie. My record on that topic is well known.
“After the recession that ended in 2001 which was preceded by a bursting of the dot-com bubble, the Fed was concerned about a sluggish economy and the specter of deflation.
“Given those concerns, the Fed chose to hold interest rates remarkably low for years. Indeed, the effective federal funds rate was below 2 percent between December 2001 and November 2004. During most of that period, now-Chairman Bernanke served as a member of the Board of Governors of the Federal Reserve and supported the low interest rate policies.
“In 2002, then-Governor Bernanke warned of deflation. He stated:
‘… the Fed should take most seriously . . . its responsibility to ensure financial stability in the economy. Irving Fisher (1933) was perhaps the first economist to emphasize the potential connections between violent financial crises, which lead to ‘fire sales’ of assets and falling asset prices, with general declines in aggregate demand and the price level. A healthy, well capitalized banking system and smoothly functioning capital markets are an important line of defense against deflationary shocks. The Fed should and does use its regulatory and supervisory powers to ensure that the financial system will remain resilient if financial conditions change rapidly.’
“The Governor’s warning was clear: deflation is a potential danger which could ignite a financial crisis. The policy prescription seemed equally clear: keep interest rates low, liquidity flows high, and lean against deflation pressures.
“However, while keeping interest rates low for a protracted period of time, the Fed appeared remarkably unconcerned about the possibility of igniting a financial crisis by inflating a housing price bubble which, ironically, led to the same result – a violent financial crisis and a fire sale of assets.
“As housing prices soared and risk-taking escalated, Wall Street investors pressed on as if a ‘Fed put’ was assured.
“The notion was that – in adverse market conditions – the Fed would absorb faltering assets and flood the markets with liquidity.
“Indeed, Governor Bernanke assured markets that the Fed stood ready to use the discount window and other tools to protect the financial system — a reassurance that the ‘Fed put’ was in place.
“In 2004 and 2005, Chairman Bernanke and other members of the Board of Governors spoke of the possibility of a ‘Great Moderation’ involving a potential permanent reduction in macroeconomic volatility and risks – no doubt a result of vigilant and adept monetary policy.
“In retrospect, this misperception left market participants believing that large risks had been mitigated, opening the door for greater risk taking.
“In the face of rising home prices and risky mortgage underwriting, the Fed failed to act. The Fed chose not to use its rule-making authority over mortgages to arrest risky lending and underwriting practices.
“Although numerous statutes such as TILA, HOEPA, the Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act, and the Home Mortgage Disclosure Act gave the Fed the authority to act, nothing was done.
“The Fed also made major forecasting errors leading up to the recent crisis. Then, after the housing market bubble began to burst in 2006, the Fed was slow to entertain possible spillovers from the housing sector into the general economy and the financial system. Finally, in response to the growing crisis, the Fed took actions that often appeared to be ad hoc and piecemeal.
“Many of the Fed’s responses, in my view, greatly amplified the problem of moral hazard stemming from too big to fail treatment of large financial institutions and activities.
“In addition, some Fed actions were taken in concert with the Treasury, blurring the distinction between the fiscal policy functions of the Congress and Treasury and the central bank’s monetary policy and lender of last resort functions.
“Under Chairman Bernanke’s watch, the Federal Reserve vastly expanded use of its discount window, including the provision of funds to some institutions over which the Fed had no oversight.
“The Fed also created new lending facilities to channel liquidity and credit to markets that were deemed most stressed and systemically important.
“Consequently, the Fed’s balance sheet has ballooned from a pre-crisis level of around $800 billion to more than $2.2 trillion through credit extensions and purchases of risky private assets, GSE debt, and U.S. Treasury debt.
“Many Fed actions were innovative ways to provide liquidity to a wide variety of financial institutions and market participants. Some actions, however, amounted to bailouts.
“When dealing with individual institutions deemed systemically important by the Fed, shareholders were wiped out and management replaced.
“However, in many instances, bondholders were made whole, even though they were not legally entitled to such favorable treatment.
“Using powers granted under Section 13(3) of the Federal Reserve Act, the Fed made it explicit that certain institutions and activities would not be allowed to fail.
“Recently, certain Fed Governors have stated that private risks absorbed by the Fed involve only a small portion of its enormous asset holdings. Furthermore, some have suggested that the government might even make money on some of its risky deals.
“While this may true, I don’t believe potential profit is the appropriate metric for evaluating government support of private risk. Taxpayers simply should not be subjected to possible losses from private risks.
“Mr. Chairman, for many years I held the Federal Reserve in very high regard. I had a great deal of respect for not only its critical role in U.S. monetary policy, but also for its role as a prudential regulator.
“I believed it to be this nation’s repository of financial expertise and excellence.
“Over the years, we have enacted a number of laws which demonstrated our confidence in this institution. We trusted it to execute those laws when deemed prudent and necessary. I fear now, however, that our trust and confidence were misplaced.
“The question before us now is: What are we to do about it?
“Currently, the Committee is discussing the future of our regulatory system.
“To the extent that we can identify weaknesses that contributed to the crisis, we should address them.
“But, not everything that went wrong can be blamed on the system, because the system also depends upon the people who run it. It is those individuals who need to account for their actions or their failure to act.
“Mr. Chairman, I believe in accountability.
“The Senate’s constitutional authority to advise and consent can be a highly effective means by which this body can hold individuals accountable.
“It is a process through which we can express our disapproval of past deeds, or our lack of confidence in future performance.
“We continue to face considerable challenges, including: still-stressed financial markets; rising nonperforming commercial real estate loans; tight credit conditions; record-high mortgage delinquency rates; double-digit unemployment; hemorrhaging deficits and public debt; and concerns about the size of the Fed’s balance sheet, the value of the dollar, and possibilities of yet more bubbles.
“Certainly, we are still deep in the woods. The question is whether Chairman Bernanke is the person best suited to lead us out and keep us out.
“Thank you, Mr. Chairman.”