 This hearing will now come to order. Without objection, all members' opening statements will be made a part of the record. The Chair notes that some members may have additional questions for the panel which they may wish to submit in writing. Without objection, the hearing record will remain open for 30 days for members to submit written questions to these witnesses and to place their responses in the record. I now recognize myself for five minutes to make an opening statement. First I'd like to thank Dr. Cayman and Mr. Dudley for appearing today to visit on a very important subject that the world is looking at constantly, a major debt crisis that exists around the world. And it has a great deal of significance not only for world finance, but it also has a great deal of significance for the American taxpayer, the value of the U.S. dollar, and indirectly the deficits that are run up because they're all interconnected. The crisis we face right now is a crisis in debt and how we handle this debt, who gets stuck with the debt, who gets the bailout, how does the debt get defaulted on? How do you liquidate debt? And there are different ways of liquidating debt. When you can't pay the bills and you write them off the books, that's liquidating debt and that helps to solve the problem. Other times governments and central banks participate in liquidating debt by diminishing real debt, and that is by purposely devaluing the currency and of course that has been used historically many, many times and is one of the most common ways of liquidating debt. So if you can devalue a currency by 50 percent, you can get rid of real debt by half if your prices go up. And there certainly seems to be a concerted effort around the world, even within our own country, to handle debt in that fashion. But in the process the question really is who gets stuck with it, who gets the most penalties. And if you happen to be on the receiving end of being too big to fail and you get some benefits from the system, but the debt is not liquidated, it's passed on. It's transferred from one group of individuals off to another. But nevertheless it's still a pain, but it's just a matter of picking and choosing who will receive the most harm. The problem I see right now in dealing with this debt crisis is can the U.S. dollar and the U.S. economy and the U.S. taxpayer bear the burden? And this is the way it seems because now the European Central Bank is asking us as we continue to do over these last few years to use the dollar to actually bail them out. And yet on paper it looks like the balance sheet is better with the Europeans, their assets to capital ratio is better than our bank. And yet the dependency is for the United States to bail them out. And it seems like it's working. Of course we have the advantage of issuing the reserve currency of the world which has given us in a deceptive way some advantages over many, many decades. But the big question is how long can that happen? Can we always have the benefits? Will other countries finally get together as they talk about constantly and replace the dollar? And certainly the dollar isn't getting to be a stronger reserve currency. If anything it's getting slightly weaker. And someday there may be some real challenges to the dollar. So there has to be a limit to this. And we talk about the Greek crisis, which is major and significant and we're dealing with it on a daily basis, but this might just be the beginning of a much bigger crisis when you look at the different countries, whether it's Portugal or Spain or Italy. And this thing could, I think it's much bigger than we're willing to admit. In many ways, I think we're in denial of how serious this problem is. So we have to face up to the fact that there is a cost. I see it's going to be a cost against the value of the dollar. Now some people say, well, this is good. We want a weaker dollar because it's going to help our trade. It's going to help our exports. And now there are currency wars going on. I mean, all we do is complain about the Chinese having two weaker currency. At the same time, we triple our balance sheet and triple the monetary base. Now that's deliberately trying to weaken currency too. So there will be limits on that. I think we're facing that. We're up against the wall on this. And very soon I think we're going to have to admit that you can't solve the problem of debt with more debt. You can't solve the problem of a weak currency by making the currency even weaker. You can't solve the problem by having the moral hazard of a guaranteed bailout that people always has the lender of last resort. And if you're too big to fail, you're going to be taken care of. Some people may suffer, but others will be taken care of. I think there's limits. I think we're facing that. I think we're in denial. We won't admit how serious it is. But I believe that we will be forced to, not because of the politics of it as much as because of the economics. I complain about the power of governments and central banks. But ultimately, there's economic rules and laws. Economic laws are probably much stronger than all of us. And you can't dictate and mandate forever. You can kid people for a long time. But right now, it's an illusion that we can trust the dollar to bail out the world. And soon, we're going to see the end of that. And that's why many of us believe that the crisis is far from over and that we have to face up to those facts. Now, I'd like to recognize Mr. Clay for his opening statement. Thank you, Chairman Powell. And thank you for holding this hearing to examine the Federal Reserve's assistance to the Eurozone and the effect of the assistance on the U.S. economy monetary system and the dollar. The focus of this hearing is to examine the Federal Reserve's central bank's currency swap line arrangements with central banks of Europe, England, Switzerland, Japan, and Canada. Also I want to thank the witnesses for appearing before us today. When the new Greek government came into power in late 2009, they revealed that the previous Greek government had not been reporting the budget deficit accurately. This has led to major economic challenges and concerns to other parts of Europe and the United States. The first concern is the high levels of public debt in some Eurozone countries. Three Eurozone nations governments, Greece, Ireland, and Portugal, have had to borrow money from the European central bank and the International Monetary Fund in order to avoid defaulting on their debt. Currently the Greek government is negotiating losses on bonds held by private creditors and investors have started to demand higher interest rates for buying and holding Italian and Spanish bonds. The Italian government debt is forecast to be $2.8 billion in 2012, and in Spain, Portugal, Greece, and Ireland combined. The second concern is the lack of growth and high unemployment in the Eurozone. In January of this year, the IMF downgraded its growth forecast for the Eurozone by growing from growing by 1.1 percent in 2012 to contracting by 0.5 percent. The third concern is the weakness in the Eurozone's banking system, which holds high levels of public debt. In December of last year, the European Banking Authority estimated that European banks need about $152 billion in additional capital in order to withstand a range of shocks and still maintain adequate capital. The fourth concern is the persistent trade imbalances within the Eurozone. The Eurozone core countries tend to run trade surpluses with the Eurozone periphery countries, and the periphery countries tend to run trade deficits with the core country. To help ease the financial crisis in the Eurozone, the Federal Reserve opened the currency swap line. Under a swap line with the European Central Bank, the ECB temporarily received U.S. dollars, and the Federal Reserve temporarily received Euros. After a fixed period of time, the transaction is reversed. Interest on swaps is paid to the Federal Reserve at the rate that the foreign central bank charges to its dollar borrowers. The temporary swaps are repaid at the exchange rate prevailing at the time of the original swap, meaning that there is no downside risk for the Federal Reserve if the dollar appreciates in the meantime. All of these concerns have raised questions about the economic stability of the Eurozone country, and I look forward to the witness's comments regarding these concerns and actions taken by the Federal Reserve Bank to address these concerns. And again, thank you for conducting this hearing. I yield back. Thank you, gentlemen. I now recognize Mr. Luchemaier from history for his opening statement. Thank you, Mr. Chairman. Over the past several years, many of my colleagues and I have expressed serious concerns regarding U.S. exposure to the Eurozone. Like many of my colleagues, my concerns have been met at times with cynicism and assurances of an efficient recovery with little or no contagion. Yet here we sit today continuing to talk about the Eurozone crisis and hearing once again that our nation won't be dramatically impacted. Certain scholars and Federal officials said that the crisis wouldn't spread. It has now impacted several European nations with effects ranging from default and upheaval in Greece to bank failures and increased risks in the perceived financial stalwart of France. This has undoubtedly taken a toll on U.S. markets, and I believe it has the potential to take a toll on our nation's economy as a whole. Chairman Bernanke testified recently in this committee that the two greatest threats to our economy are rising gas prices and the Eurozone problems. Secretary Geithner testified in this community just last week and seemed concerned as well about the possibility of a Eurozone contagion. Although he was optimistic, things would work themselves out. Regardless of what we hear today, we are in fact exposed. Our financial institutions, industries and government are all exposed, and as a result, so are the taxpayers. Our economies are and always will be deeply connected. It is our responsibility to ensure that this exposure is managed thoughtfully and to ensure that the U.S. taxpayers are not again on the hook for the failure of the financial institutions, not only domestic but foreign as well. Mr. Chairman, I look forward to a live discussion with our panel. This is an important topic and one that merits great transparency and attention. I thank you, and I yield back. I thank the gentleman. And I would like to introduce our witnesses for today. Mr. William Dudley is the President and Chief Executive Officer of the Federal Reserve Bank of New York. Before taking over as President of the New York Fed in 2009, Mr. Dudley had been Executive Vice President of the Markets Group at the New York Fed, where he managed the system's open market account for the Federal Open Market Committee. Prior to joining the New York Fed in 2007, Mr. Dudley was a partner and managing Director at Goldman Sachs and Company and was Goldman's Chief U.S. Economist for a decade. Mr. Dudley also serves as Chairman of the Committee on Payments and Settlement Systems of the Bank of International Settlements and is a member of the Board of Directors of the Bank for International Settlements. Mr. Dudley received his bachelor degree from a new College of Florida and his Ph.D. in Economics from the University of California, Berkeley. Dr. Stephen Cayman is the Director of the Division of International Finance for the Board of Governors of the Federal Reserve System. He joined the Federal Reserve System Board in 1987 and was appointed to the official staff in 1999. Prior to taking over the Division of International Finance in December 2011, Dr. Cayman was Deputy Director of the Division. He has also served as a Visiting Economist at the Bank of International Settlement, a Senior Economist for International Financial Affairs at the Council of Economic Advisers, and as a Consultant for the World Bank, Dr. Cayman received his bachelor's degree from the University of California, Berkeley, and received his Ph.D. in Economics from the Massachusetts Institute of Technology. Without objection, your written statements will be made a part of the record. You will now be recognized for a five-minute summary of your testimony. Mr. Dudley. Thank you. Chairman Paul, Ranking Member Clay, and members of the subcommittee. My name is Bill Dudley, and I am the President of the Federal Reserve Bank of New York. It is an honor to testify today about the economic and fiscal challenges facing Europe and the Federal Reserve's efforts to support financial stability in the United States. Let me preference these remarks by stating that the views expressed in my written and oral testimony are solely my own and do not represent the official views of the Federal Reserve Board, the Federal Open Market Committee, or any other part of the Federal Reserve system. Additionally, because I am precluded by law from discussing confidential supervisory information, I will not be able to speak about the financial condition or regulatory treatment or rating of any individual financial institution. The economic situation in Europe has been unsettled for the better part of two years with pressure on sovereign debt markets and local banking systems. The strains in European markets have affected the U.S. economy. The Euro area has the capacity, including the fiscal capacity, to overcome its challenges. However, the politics are very difficult, both because the problem has many dimensions and because many different countries and institutions in the Euro area have to coordinate their actions in order to achieve a coherent and effective policy response. Europe's leadership has affirmed its commitment to the European Union and a single currency union on numerous occasions, and the leadership is working harder than ever to achieve greater policy coordination in areas such as fiscal policy. A more robust and resilient European Union would be a welcome development for the United States. Three recent developments are especially encouraging in that regard. First, liquidity concerns have eased significantly following the European Central Bank's long-term financing operations in December and February. Through this program, the ECB provides three-year loans to European banks at low rates, accepting a wider range of collateral in return. Second, earlier this month, the Greek government, working with European leaders and its largest creditors, to restructure the bulk of its 206 billion euros of outstanding privately held bonds. This not only helped reduce Greeks' total indebtedness, it also helped calm persistent worries that a disorderly Greek default could become the trigger for global economic crisis. Third, leaders in most Euro area countries have approved a new treaty designed to increase fiscal coordination. The new rules already appear to be making a difference. While difficult work still lies ahead, countries in the Euro area have made meaningful progress towards achieving long-term fiscal sustainability. Looking to the future, the difficult work that remains also presents special risks, both for Europe and for the United States. If Europe fails to chart an effective course forward, this could have a number of negative implications here. In particular, there are three areas of potential risks that I would like to highlight for the subcommittee today. First, if economic conditions in Europe were to weaken significantly, the demand for U.S. exports would decrease. This would hurt domestic growth and have a negative impact on U.S. jobs. It's important to recognize that the Euro area is the world's second largest economy after the United States, and it's an important trading partner for us. Also, Europe is a significant investor in the U.S. economy and vice versa. Second, deterioration in the European economy could put pressure on the U.S. banking system. As the recent round of stress tests revealed, U.S. banks are much more robust and resilient than they were a few years ago. They have bolstered their capital significantly, built up their loan loss reserves, and have significantly higher liquidity buffers. The good news in the United States means that we are better able to handle bad news from Europe. With that said, the exposures of U.S. banks climb sharply when one also considers their exposures to the core European countries and to the overall European banking system. Third, severe stresses in European financial markets would disrupt financial markets here, which could harm the real economy. Stress in the financial markets causes banks to more carefully husband their balance sheets. When that phenomenon occurs, the availability of credit to U.S. households and businesses becomes constrained. Such conditions could also cause equity prices to fall, impairing the value of Americans' pension and 401K holdings. This would damage the U.S. recovery and result in slower output growth and less job creation. At a time when the U.S. employment rate is very high, this is a particularly unacceptable outcome. In the extreme, U.S. financial markets could become so impaired that the flow of credit to households and businesses could dry up. In today's globally integrated economy, banks headquartered abroad play an important role in providing credit and other financial services in the United States. About $1 trillion in worldwide dollar financing comes from foreign banks, $700 billion in the form of loans within the U.S. For these banks to provide U.S. dollar loans, they have to maintain access to U.S. dollar funding. At a time when it's already hard enough for American families and businesses to get the credit they need, we have a strong interest in making sure that these banks can continue to be active in U.S. dollar markets. It's in our national interest to make sure that non-U.S. banks remain able to access the U.S. dollar funding that they need to be able to continue to finance their U.S. dollar assets. If access to dollar funding were to become severely impaired, this could necessitate the abrupt force sales of dollar assets by these banks, which could seriously disrupt U.S. markets and adversely affect American businesses, consumers, and jobs. One way we can help to support the availability of dollar funding and ensure that the credit continues to flow to American households and businesses is by engaging in currency swaps with other central banks. Such swaps are a policy tool that the Federal Reserve has used to support dollar liquidity for nearly 50 years. More recently, the Federal Reserve established dollar swap lines with major central banks during the global financial crisis of 2008, and we reactivated again in May 2010. The swaps are intended to create a credible backstop to support but not supplant private markets. Banks with surplus dollars are more likely to lend to banks in need of dollars if they know that the borrowing bank will return the dollars it needs to repay the loan if necessary from its central bank. Our principal aim is to protect U.S. banks, businesses, and consumers from adverse economic trends abroad. I'm pleased that the swaps seem to be working. In conjunction with ECB's long-term refinancing operations, the swaps have helped European banks avoid the significant liquidity pressures we feared a few months ago and they have reduced the risk that they would need to sell off their U.S. dollar assets abruptly. In conclusion, I'm hopeful that the Europeans effectively address its current fiscal challenges. The Federal Reserve is actively and carefully assessing the situation and the potential impact on the U.S. economy. At this time, although I do not anticipate further efforts by the Federal Reserve to address the potential spillover effects of Europe on the United States, we will continue to monitor the situation closely. Thank you for your invitation to testify today and I look forward to answering your questions. Thank you, Chairman Paul. Is your mic on? Is your mic on? Thank you, Chairman Paul, and members of the subcommittee for inviting me to talk about the economic situation in Europe and actions taken by the Federal Reserve in response to this situation. In the past several months, European authorities have provided additional liquidity to banks, bolstered bank capital requirements, develop rules to strengthen fiscal discipline, and explored means of enlarging the Euro area financial backstop. Stresses in financial markets have eased, but these markets remain under strain. The fiscal and financial strains in Europe have spilled over to the United States by restraining our exports, depressing confidence, and adding to pressures on U.S. financial markets. Of note, foreign financial institutions, especially those in Europe, have found it more difficult to borrow dollars. These institutions make loans to U.S. households and firms, as well as to borrowers in other countries who use those loans to purchase U.S. goods and services. While strains have eased somewhat of late, difficulties borrowing dollars by European institutions may make it harder for U.S. households and firms to get loans and for U.S. businesses to sell their products abroad. Moreover, these disruptions could spill over into U.S. money markets, raising the cost of funding for U.S. financial institutions. To address these risks to the U.S., we read the Federal Reserve announced jointly with the European Central Bank, or ECB, and the Central Banks of Canada, Japan, Switzerland, and the United Kingdom that it would revise, extend, and expand its swap lines with these institutions. The measures were motivated by the need to ease strains in global financial markets which, if left unchecked, could impair the supply of credit to households and businesses in the United States and impede our economic recovery. Three steps were applied in the announcement. First, we reduced the pricing of the dollar swap lines from a spread of 100 basis points over the overnight index swap rate to 50 basis points over that rate. This has enabled foreign central banks to reduce the cost of the dollar loans they provide to financial institutions in their jurisdictions. This, in turn, has helped alleviate global financial strains and put foreign institutions in a better position to maintain their supply of credit, including to U.S. Second, we extended the closing date for these lines from August 1, 2012 to February 1, 2013, demonstrating that central banks are prepared to work together for a sustained period to support global liquidity conditions. Third, we agreed to establish swap lines in the currencies of other participating central banks. These lines would allow the Federal Reserve to draw foreign currencies and provide them to U.S. financial institutions on a secured basis. U.S. financial institutions are not experiencing any foreign currency liquidity pressures at present, but we judged it prudent to make such arrangements should the need arise in the future. Information on the swap lines is fully disclosed on the websites of the Federal Reserve Board and the Federal Reserve Bank of New York. I also want to underscore that the swap transactions are safe and secure. First, the swap transactions present no exchange rate or interest rate risk because the terms of each drawing are set at the time the draws initiated. Second, each drawing on the swap lines must be approved by the Fed, providing us with control over use to the facility. Third, the foreign currency held by the Fed during the term of the swap provides an important safeguard. Fourth, our counterparties are the foreign central banks, not the private institutions to which the central banks lend. The Fed's history of close interaction with the central banks provides a track record of identifying a high degree of trust and cooperation. Finally, the short tenor of the swaps means that positions could be wound down relatively quickly, where it judged appropriate to do so. Notably, the Fed has not lost a penny on these swap lines since they were established in 2007. In fact, fees on these swaps have added to the earnings that the Fed remits to taxpayers. To conclude, following the changes we made to our swap line arrangements last November, the amount of dollar funding through the swap lines increased substantially. Subsequently, as measures of dollar funding costs declined, usage of the swap lines has fallen back. Ultimately, however, a sustained further easing of financial strains here and abroad will require European authorities to follow through on their policy commitments in the months ahead. We are closely monitoring events in Europe and their spillovers to the U.S. economy and financial system. Thank you again for inviting me to appear before you today. I would be happy to answer any questions you may have. I thank you, Dr. Kamen. I'll start off with the questioning for Mr. Dudley. I wanted to see if we could start off by seeing if we could agree with what the problem is. In my opening statement, I emphasize that the debt is the problem that we're in a worldwide debt crisis. Do you generally agree with that and how serious do you think it is? I think you're certainly correct that there's a question of debt sustainability in Europe in terms of the fiscal budget deficit path for some countries, not all countries, some countries, and that's also implicated some of the European banks that have large exposures to that sovereign debt, and so what's important is that these countries have an opportunity to undertake the fiscal consolidations that they need to demonstrate to the market that they can actually be on a sustainable path. The ECB's long-term refinancing operations and I think the dollar swaps have helped create some time for this to take place, but for this to work out well these countries still have to take the appropriate steps. But so far if we date the crisis back to 008 and 09 and if it was a debt crisis that was a problem, if you look at everybody's debt, I mean it's exploding, including ours. How do you solve the problem of debt with exponentially increasing the debt? It seems like our problems just are compounded. How do you get around to either stop accumulating more debt or do you believe you have to liquidate debt? Is it necessary, some people believe you have to get rid of the debt in order to get growth again because the debt will consume us and interest rates are bumping up already and ultimately, like I said in my opening statement, the Fed will have some ability to manipulate interest rates and the economy, but ultimately the economic laws are pretty powerful so interest rates are allowable to go up. So how can we solve the problem of debt with more debt and what is your opinion about liquidating debt? Is that important? I think that you're right that obviously more debt does not solve the problem of too much debt. I think the good news in the United States and I'll speak about the United States is that there's actually been significant amount of deleveraging that's in the U.S. Households over the last few years. Debt to income ratios have come down, debt service relative to income has come down so U.S. Households, I think, are significantly better shaped than they were a few years ago. The secondary where we see a pretty big change in terms of deleveraging in the United States is in the state of health of the U.S. banking system. U.S. banks compared to five or six years ago have much more capital and much bigger liquidity buffers. So I think it's too soon to say that the deleveraging process in the United States is over. We've made a considerable amount of progress in working our way out of the problems that we faced in 2007 and 2008. But isn't it true that mortgage debt is still on the books? It's been transferred, maybe the Fed owns that debt. We don't even know what the real value is of most of it and banks still hold some mortgage debt and it might be at a nominal value. So in that sense of debt being liquidated maybe some individuals have straightened up their bank accounts but there's still millions of people if they really were improving they could make their payments again. But debt is still the problem. But what about you say that some are deleveraged but has there been any real liquidation of debt when it comes to mortgage and the derivatives because governments are involved in that, either the central bank or some of our programs are involved. It seems like none of that has been deleveraged of anything that looks like it's getting worse. Well on the mortgage front there has been some deleveraging because banks have taken mortgage losses also in certain cases especially among private holders of mortgage debt there's been some principal forgiveness, principal reductions. So you've actually seen for example last year that total household debt is outstanding according to the flow of funds which is the broadest measure of household credit was roughly flat last year. So nominal GDP was growing debt held by households was flat so you're actually seeing the debt burden become less overwhelming. But we yes the promises that we made in the involvement we have with Europe that our finances are so good with our debt and our dollar that we have been standing and saying yes we'll be there. I mean the chairman of the Fed has said you know we're not ignoring this if necessary we've been there before we'll be back again. What is the limit to this? What is the limit to us making these promises that we can always be available? Isn't there a limit to what the dollar will sustain? Won't eventually it has to stop? Or do you think we can do this you know if another crisis hit it's a big downturn you have to inject trillions of dollars again. What is the limiting factor to the dollar in the United States economy bailing out the world? Well I think that from my perspective we want to make the decisions based on what's in our self-interest as a country what's best for U.S. households and businesses and in that calculation if we decide that an intervention can help U.S. households and businesses has higher benefits and costs than we want to proceed if we don't reach that calculation if we think that there's too much risk involved in the program or that the program was going to lead to moral hazard and it's going to be kind of productive then we don't want to undertake it. So I don't think that the Federal Reserve has made any decisions about what future interventions we would or would not do except that we'll do interventions that are consistent with our dual mandate is set by Congress to achieve the sustained financial stability in U.S. and do what's best for households and businesses here. That's why we're doing this program not for Europe but for ourselves. Did you want to make a comment? Yeah, could I add a few words Chairman Paul? Just to add to the comments that President Dudley made our purpose in the swap lines in particular is not to in some sense fully back or make whole all the debts that have been accumulated around the world. That's very far from our purpose. Our key strategy and our key intent in this regard is to make sure that foreign financial institutions could maintain the flow of credit both to U.S. households and firms and to firms and households around the world that in turn buy U.S. goods and services. So the intent was mainly to help alleviate the liquidity pressures that could lead these foreign institutions to wind down their assets too quickly and thus injure the U.S. recovery. Thank you. Mr. Clay. Thank you, Dr. Paul. Let me follow Chairman Paul's line of questioning. Mr. Dudley, in your opening statement you mentioned that severe stress in the European markets will create stress in the U.S. economy. Are we that tied to the European economy and that married to that system that it would have that kind of reaction or chain reaction? I think we live in a global economy and what happens in the other big economies of the world definitely affect us. In my testimony there are sort of three channels by which Europe could affect us in a negative fashion. One, if the European economy is in recession or very weak that's going to reduce the demand for our exports so that has effects on U.S. production and employment here in the U.S. Number two, if Europe were to be in a difficult position and the European banking system were to worsen that would have consequences for U.S. banks that have exposure to the European banks. Sadly that would have negative effects on financial markets around the world and that would have implication for our financial markets and therefore investment and growth here in the United States. So there are definitely significant channels by how Europe can affect the United States. Mr. Dunley, have actions taken by the Federal Reserve regarding the currency swap arrangements been beneficial or detrimental to the U.S. economy? We think that the swap lines have had their desired effects because they've basically given a backstop to other sources of funding to European banks so as a consequence of them having this backstop available if they were to need it they don't have to be as fearful about their ability to obtain funding and therefore they can manage their dollar to U.S. businesses and households in a more orderly fashion. We follow the activities of European banks in the U.S. through their U.S. branches and subsidiaries and they are definitely reducing their exposure in the U.S. but I think because of the dollar swaps this is happening in an orderly way rather than a disorderly way and so we don't see that their reduction in the business that they're doing in the U.S. is damaging effects on the U.S. economy which is really what our goal is to prevent any damaging effects on the U.S. economy. Yes, thank you. If I could just add to those remarks over the past couple of years as the crisis in Europe has progressed we've seen several periods when the financial situation in Europe deteriorated fairly dramatically and during those periods we could see some very obvious bill-overs to financial markets both in the United States and around the world. During those periods of deterioration investors became worried and around the world they retreated from assets they perceived to be more risky and what that led to both in Europe and the United States and elsewhere were sharp declines in stock prices increases in interest rates on credit and other developments that were associated with retreats from risk and flights to quality. So we've seen those episodes very clearly now more recently since we changed the pricing of our swap lines since the ECB introduced many measures to add liquidity to banks and since European leaders have taken other actions we've seen financial conditions in Europe this is more or less since December improved quite markedly and has been an important contributing factor to the improvement of the tone in financial markets in the United States so those connections are definitely there. Dr. Cayman share with us the effects that the rise in gasoline prices around the world and in the U.S. what effects will this rise in gas prices have on the economies of Europe and the U.S. Well the effects that higher oil prices will have on both the United States and on Europe are in broad qualitative terms relatively similar both broad economies import oil there's a greater dependence on imported oil in Europe than in the United States but both do and so when oil prices rise that acts as a tax on consumers of oil in both countries and as a result that diminishes the purchasing power that consumers in those countries have to basically spend on other goods and so it basically acts as a break on economic recovery and all else equal may make it more difficult to create jobs in addition to the effects on unemployment and economic activity increases oil prices have the effect of raising at least some portion of the consumer basket of prices as long as oil prices don't continue to rise that should lead to a temporary increase in inflation but that also poses concerns so obviously recent increases in oil and gasoline prices are something that we monitor very carefully Thank you I thank the gentleman now I recognize Mr. Leukemeyer from Missouri Thank you Mr. Chairman gentlemen correct me if I'm wrong but I believe that the the swamp dollars that are I guess euros that are on the other end with the European Central Bank they secure those do they not whenever they loan them back out on their other end the problem from the standpoint that what we've been told and what we find recently is they're taking a little bit more exposure a little more risk with some of the investments that they're taking as collateral for those would that be a fair statement they've broadened out the collateral eligibility but they also have significant haircuts for that cloud so they take more collateral than the value of the money that they're actually lending out so instead of one to one it may be two to one to take additional because I know that Farmer Executive Board member Jurgen Stark recently said that the balance sheet of the ECBA is not only gigantic in dimension but also alarming in its quality would you agree with that statement I don't have enough information to assess the quality of the ECB balance sheet but my dealings with ECB suggest that they're quite prudent in terms of how they run their operations aren't you one of the leading swap lines between our leading experts on swaps between the U.S. and Europe but I don't conduct the daily operations of the ECB lending money to their banks versus collateral that they take okay one of the concerns that I have is with regards to the quality of the economies over there we keep talking about well they've dodged the bullet they're getting better, they're improving and yet we see and we had you know Secretary Geithner just last week and he acknowledged that the European continent as a whole is still struggling I think the comment was made in testimony today that it's a negative position as far as the growth of the economy yet, Greece is probably 4% a negative growth you know it's fine to sit here and go through a work out and restructure your debt but if you don't have the ability to repay it because you have an economy that can grow fast enough to repay it where have you gone and I think we have to look at the revenue side you know we may be able to restructure the debt so that they can work but if you have enough cash flow and the revenue is coming in we're still in trouble, where do you see that going? I certainly accept your observation that the European economy is very weak and that weakness is going to persist for a while as these governments engage in further fiscal actions to get their budget deficits on a sustainable course but that fact I think in no way creates risk for us in terms of our swap agreements with the European Central Bank we think we are very well secured in those transactions we fully anticipate to be fully repaid during the depths of the financial crisis in 2008 and 2009 far worse economic environment which we are today, far greater amounts of swaps outstanding, we were fully repaid we didn't lose a penny in fact the total profit to the U.S. taxpayer through the swaps that were engaged in during that period was about $4 billion of profit to the U.S. taxpayer well the point I'm getting to though is if you've got weak collateral for the European Central Bank swap lines and your economy is not going anywhere that even gets to me, that makes that the debt or the collateral is securing a line even weaker and so therefore we may have 2 to 1 or 3 to 1, if you've got nothing 2 to 3 times nothing, securing the debt, that's pretty concerning to me. Quick question for it do you think that the swap lines enhance the dollar as a reserve currency or do you think it hurts it? I'd like to comment from both of you please. I think it doesn't I don't think it's a major factor but I think at the margin it probably enhances the dollar as a reserve currency in other words the fact that the Federal Reserve is willing to engage in swaps probably makes people more comfortable to use the dollars to finance international transactions around the world. I don't think this is a major factor though in terms of why we're engaging in swaps or should it be a major factor in terms of why we're engaging in swaps? I think the main reason why we're engaging in swaps is we don't want European banks to quickly exit their dollar lending business here in the U.S. and that exit causing harm to U.S. households and businesses. If I could add to that so clearly key factors that are underpinning the dollars status as a global reserve currency is the breadth and depth of U.S. financial markets and in particular including but not limited to the status of U.S. Treasuries. All that is underpinned by the vitality of the U.S. economy and its consistent record of being able to innovate and grow. The purpose of the swap lines is ultimately focused on continuing to preserve the vitality of the American economy and by making sure that foreign financial institutions have the funding they need to continue the flow of credit to American households and firms. So in so far then as the swap lines can contribute to the continued vitality, the continued recovery of the U.S. economy, it undoubtedly is a plus as far as the dollar's reserve status. Although as President Dudley has pointed out it's probably one of many factors and not necessarily the most important. Thank you very much. I'll see you in my time's experiment. Thank you, Mr. Chairman. Thank you. I now recognize the general lady from New York, Ms. Mulally. Thank you, and I particularly want to welcome both of the panelists, and particularly Mr. William Dudley, who is the President and Chief Executive Officer of the Federal Reserve Banks of New York. So welcome, Mr. Dudley. And I'd like to begin questioning by asking you regarding the Federal Reserve's foreign exchange swap lines, can you tell me what your track record has been with these programs? Have they been successful? Have there been any losses to the taxpayers? Have there been any gains for the taxpayers? And if so, how much? And welcome. Thank you. Thank you. Thank you for your service, both of you. Thank you. Thank you, Congressman Mulally. The track record is excellent. I mean, in two dimensions. One, the swap lines that we've engaged with have accomplished the goal that we set for them, which is basically to support U.S. financial markets and ensure the flow of credit to U.S. businesses. And two, we've managed to do this in a way that has been extraordinarily safe. As I noted earlier, no losses on any swap programs that we've ever engaged in going back to 1962. And in terms of the swaps that we enacted during the financial crisis in 2008 and 2009, and ongoing total profits for the taxpayer of about $4 billion. So no losses, profit for the taxpayer has had the beneficial effect that we wanted in terms of supporting the financial system and supporting the flow of credit to U.S. households and businesses. So I think that they've worked very well. Thank you. Thank you very much. And I'd like to ask Dr. Kemen about a statement that the Treasury Under Secretary Bernard has stated that the administration's position in Europe is not to seek additional funding for the IMF. And to quote her directly, she said, the challenge Europe faces is within the capacity of the Europeans to manage. End quote. Europe accounts for roughly 16 percent of our exports, in my opinion, correct me if I'm wrong, accounting for the stabilization of many jobs here in the United States, probably thousands of jobs. What occurs abroad is going to have a direct effect on the recovery here at home in the United States. And do you believe the stabilization of European markets is critical to our economic recovery here at home, making systems like the Federal Reserve, Foreign Exchange, swap lines crucial? Thank you Congresswoman Maloney. In response to your questions, first of all I absolutely agree that it is critical that the Europe financial and economic situation be stabilized. As you've pointed out Europe is a major trading partner of the United States and as we discussed earlier its financial conditions in Europe are highly intertwined with those in the United States. So a stabilization European situation really is very important both for the United States financial conditions as well as the continued growth of exports and the real economy and those jobs. Now as regards the issue of IMF policy the Treasury Department is our lead on that and so on the issue of IMF policy so I can't speak directly to their statements but I will note as Treasury officials have noted as well as Federal Reserve officials that Europe is a very the Euro area is a very large and comparatively wealthy economy relative to many others in the world and they do have very many substantial resources that could be brought to bear on their situation and so it's critical for them to do so. Thank you. Thank you and Mr. Dudley I'd like to ask you as countries and international markets form individual firewalls to stave off residual financial distress are we always likewise creating firewalls through various other areas in policies involving capital and liquidity requirements that could have an effect on our economy here in the United States? We think it's very important to have a financial system that's resilient and robust and in towards that end Congress Administration the regulatory community in the U.S. has been working hard to bolster the capital and liquidity among U.S. financial firms and I have to say that we're in much better shape than we were a few years ago in both those regards and I think that's good news because it means that if there are shocks emanating from abroad or emanating in the United States it's great to absorb those shocks and to continue to function and supply credit to U.S. households and businesses. Could I ask additional 10 seconds? So roughly I'd just like to hear a yes or no do you believe that we should do everything we can to contain the European crisis to ensure that there is no spill over here in the United States and to stabilize that region and our own economy yes or no? It's prudent to stabilize the European economy obviously we should do what's in our self-interest in terms of what's best for the United States and all our policies are enacted with that through that prism. Dr. Cameron? Yes, that was exactly my thought everything that is prudent is appropriate. Thank you. Thank you Mr. Chairman. Thank you. Did Mr. Lukimer have his consent request? Yes Mr. Chairman I would like to place in the record the article from which I was referring this morning it's a Market Watch article by Andrea Thomas with regards to the comment of Executive Board Member Jurgen Stark. Without objection. Thank you sir. Now recognize Mr. Schweikert from Arizona. Thank you Mr. Chairman and Congressman Lukimer stole one of the number one questions I was wondering about the credit quality of what's being pledged can I get into something that's a little more conceptual but this one actually really does bother me. I'm trying to get my head around the interconnectivity of Euro Yen Euros relationship Singapore's Euro and ultimately as we are providing interlocking swap facilities what happens when the debt cascade happens somewhere else in the world. Does that cascade end up tagging Europe which tags us and how much ultimately is there in true net reserves in central banks around the world when you start looking at the net borrowing compared to the net savings countries and Doctor I'd love if you would start with that one. Thank you I'll be happy to. So to start with as we've come to recognize only too well we have a very globalized financial system and the services that occur in one part of the world are transmitted around the world through numerous channels and through numerous markets. So and that is we saw that quite evidently during the global financial crisis of 2008-2009 and we've seen it more recently during the European fiscal and financial crisis as deterioration. Can I beg of you to pull it a little closer those mics are a little tough. Oh thank you. We've seen it more recently during the European financial crisis in 2000 in the last couple of years. So and almost to that what I'm somewhat hunting is I've been tracking some data coming out of Japan and there's some very worrisome signs and the net debt. How does that play into this interconnectivity? So what we've seen then is that in situations that occur like this some dollar funding problems which is to say problems with banks getting funding in dollars in order to continue their flow of financing. They tend not to basically stay in one part of the world. There's a very easy capacity for those problems to spill out all over the world and it was in large part for that reason that we didn't just establish the swap lines with the ECB. We also established them with central banks around the world so that problems as they arose in different parts of the world could be addressed and as is evident from the data on the swap lines that we publish on our websites the take up of the swap lines in other words the distribution of funds to institutions in different regions has not been limited exclusively to the Euro area although that's where most of the money has gone. Mr. Deadley. I certainly agree with Dr. Cayman's answer that the world is very interconnected and problems in one part of the world can definitely have ripple effects through the other parts of the world. That's why we did set up these swap lines with five central banks rather than just the European central bank and there are some draws on those swap lines from other central from these other central banks. Mr. Chairman, Mr. Deadley and almost to the concept help me get my head around considering the nature of our balance sheets today after the 2008 crisis both Europe United States some of our partners in Japan are around other places of the world if today Europe this became a very hard recession and we had something like the tequila crisis from 15 years ago some sort of cascade out there do we have enough capacity particularly if we also had different regions of the world competing also for access to the swap lines do you believe our balance sheets are capable of stabilizing? I mean it's hard to know what would happen in a given scenario so it's hard to speculate I think one thing that I think isn't important though is that the foreign countries around the world are a bit more better protected themselves in terms of sharp changes in capital inflows to capital outflows in the sense that they have very large foreign exchange reserves today compared to what they had 20 or 30 years ago so the ability of countries to bear a reversal from capital inflows to capital outflows is much better generally around the world than it was 20 or 30 years ago. So I think it's important to look over the interest rates spike particularly with our net debt coverage the interest rate spike and where our WAM is on our U.S. sovereign debt a couple years of higher interest rates would be pretty devastating budget wise so I'm fearful of a cascade somewhere else of truly affecting us. I talked in a recent speech about the debt service problems for the U.S. because U.S. interest rates are so low and if the U.S. does not get its fiscal house in order over the medium term there is a chance that U.S. interest rates will rise and that debt interest burden on the U.S. fiscal position will become quite significant so this is just another reason why U.S. does need to get its fiscal house in order over the medium to longer term. Thank you for your tolerance Mr. Chairman. Thank you. Thank you Mr. Chairman and thank you both for being back. We had a similar hearing in my subcommittee on oversight and government reform and times have changed slightly in the last couple of months so I do want to touch on some of the things that I raised then just to see if things have changed. Mr. Dudley can you explain under what circumstances the Fed would consider purchasing European sovereigns directly? The Federal Reserve has a small foreign exchange reserve portfolio that we manage for ourselves and for Treasury and so we do actually own a very small amount of European sovereign debts as part of that foreign exchange reserve portfolio. With the exception of that portfolio which we periodically roll over maturing securities I think the bar as I said in our hearing a few months ago was extraordinarily high for the U.S. for the Federal Reserve to actually go out and buy foreign sovereign debt for its own portfolio apart from this very small foreign exchange reserve holdings that we have. So roughly what are those what dollar amount do we have? I think it's on the order of twenty, twenty five billion dollars total, consists of cash sovereign debt of a couple countries and then there's some reverse repurchase agreements where we basically have executed against dealers in the context. It's tiny, it's tiny. Twenty five billion to what of your total holdings? Our total portfolio is about almost three trillion not quite three trillion. So it's de minimis and it hasn't changed in size or composition Do you have statutory authority to expand that? Could you ramp it up to five hundred billion? Well we have legal authority to buy foreign sovereign debt but I don't see the circumstances under which we would ever be willing to do that with the exception of managing this foreign exchange reserve portfolio. Okay, okay. Now in terms of the long term refinancing operation the European Central Bank has undertaken with three years three year notes in essence it looks similar in sort of concept to tarp doesn't it? It's a little different in the sense that tarp was money that Congress appropriated and then was used by the Treasury as capital to put into banks or put into other entities to recapitalize them. The long term refinancing operation is a loan from the European Central Bank to its banks against collateral that they pledged. So it's a lending operation not a capital investment. So the tarp really wasn't a lending operation because they had to pay it back with fines and penalties and interest seems to me. Tarp could be used for many purposes I mean it could be lent out and it could be used as capital but if you look at how the tarp money was used in the bulk of it bulk of it was used for capital investment. Well I think we are battling semantics here because in essence they are similar in dollar amounts similar in terms of their intent. Now really at the root is the European problem? Is it a problem of indebted countries? Is that the root of what we are contending with right now? I think that's part of it. I mean part of it is you have some countries in Europe that have budget deficits that are unsustainably high and debt burdens that are continuing to climb so that's problem number one. But the problem number two is they are doing so in a system of 17 countries with a common currency and a monetary policy they don't have their own currency and there is a lack of fiscal transfers within Europe to support countries that are in weaker position relative to those that are in stronger position. So there are some things that are very special about Europe that are part of the European Union the system of how the system is arranged that are very different than anything that applies to the United States. So what would happen with much of this long term refinancing and flowed into sovereign debt of a few countries in large part that's where much of this flowed but Dr. Cayman in terms of what that actually did we've actually bought some time and space for a few highly indebted countries is that basically what's happened? Well I think that it's possible that the oh it's possible that the effects of the LTRO in combination with the other measures that have been taken basically might have some somewhat longer term benefits to be specific about that it is true as you say that probably some of the LTRO money did flow to the purchase of sovereign bonds but perhaps the more important thing that the LTRO funds did was that it alleviated many concerns by the market about the liquidity position and the financial position more generally of European banks and so the way in which that may have led to reductions in the sovereign yields of some embattled European governments was not just directly they had the funds they could use them but indirectly because European banks felt more solid in their financial position and more comfortable being able to buy these bonds. In turn that improved situation in terms of European banks in the eyes of the markets may have led investors to believe that therefore European governments would not in turn be called upon to support banks. So there was sort of a virtuous circle in process here which is so far been very beneficial in terms of improving the tenor of markets. Now all that said you are absolutely right that this the LTRO vision of liquidity by itself cannot be the only thing that will solve the European crisis. It is very important the European leaders work on a number of more lasting and fundamental issues. One of them is they need to actually make the financial backstops for European governments higher and stronger and that is a discussion they are having. They also need quite obviously and this is very challenging to actually follow through on their many commitments to improve their fiscal situation. And finally as we have discussed here today improved fiscal performance must be buttressed by improved growth performance and that is particularly challenging for the peripheral European economies and so they are going to have to follow through on a lot of fairly rigorous structural reforms. Thank you. Thank you Mr. Chairman. It sounds like psychology and economics are getting closer and closer in these current crisis times. I think they always have been. I thank the gentlemen. I want to follow up on this issue about how it is going to help our consumers here at home when we make these loans overseas and I think Mr. that you indicated that you already have some evidence that that has been helpful or are you just saying that if we do it it could be helpful? I think I mean the evidence is soft evidence rather than hard evidence but we have been monitoring the performance of the European banks who do business in the U.S. quite closely because they were having trouble getting dollar funding. Money market mutual funds who were providing dollar funding to the European banks during the summer and fall were pulling back. Other lenders, large asset managers were also pulling back from the European banks and this was causing those banks to start to get out of their dollar book of business. They were trying to sell off loans and pull back in terms of their willingness to provide credit. This was going on at a pretty fierce pitch through the late fall and through the early winter and I wouldn't say that it stopped but the sense we get is it is happening now in a much more orderly way not leading to the fire sale of assets at low prices, not leading to downward pressure on financial markets, not leading to a constrained and credit availability to U.S. households and businesses. So from what I can tell we're seeing the the leveraging of the European banks is continuing but it's happening in an orderly way rather than a disorderly way which is what our objective is. You don't actually have a quantity a number that you can say that they did such and such to the consumers back here at home. We don't have the detailed data on that but we do have discussions with those banks. It seems like there's a conflict at least in my mind of the need to send more currency swaps over there when the banks I think the top 8 banks in Europe actually had a tremendous increase in their reserves, a 50 percent increase in one year. So why do they need more money? Why do they need more? It's already there. What about our banks? Our banks have $1.5 trillion. If it's a good deal and these bailouts or these purchases that you want them to do by having these currency swaps to help the banks and give the central banks to help buy some of this debt if it's a good deal for anybody why wouldn't some of our banks have $1.5 trillion it seems like you're doing something that the market doesn't want you to do and there's a reason maybe it's way too risky and if we're sending money over to the European banks with the hope but no evidence actually some of this money coming back and actually stimulating our economy why is it that just more credit and more money in the system is going to work if our banks are holding $1.5 trillion there's something more to it than lack of the ability or the lack of the willingness of the Fed to just endlessly create more and more credit why why is it going to work better by just pumping more into say a European bank if the goal, see you emphasize the help it's going to do out of the interest of the American consumer you diminish the possibility that it might be done to just prop up the banks because they're in over their heads that they may have credit default swaps and the banks over there they're all it's global they have branches over there it's just to prop up a system that is not viable so why is there a disconnect there seems to be a lot of money there why do you feel compelled that we have to keep sending more hopefully it will help our consumers here at home well I think that the US banking system is a very different place than the European banking system the US banks have plenty of dollar assets that they can lend they gather deposits through their retail branch networks here so they don't have any shortage of funds in which they can lend the European banks were in a different position because they were dependent on the wholesale funding market provide them with dollars and as the European situation deteriorated last summer and fall US investors that had been providing dollars to these European banks were pulling back and it was that pulling back and that difficulty for European banks to gain access to the wholesale dollar funding market which was forcing them to pull back in terms of their willingness to lend to US households and businesses US banks don't need dollar liquidity right now so there's no and they're not deleveraging the issue is the European banks their dollar book of business they were having trouble funding that book of business and that's why they were pulling back but when they're holding all these reserves if it were any advantage at all they would do it obviously there's no advantage to even helping out Europe they're loaning the money is there why do you feel compelled that you have to do something that the banks that are holding all this money won't won't do it well I think that the European situation was creating a lot of anxiety about the health of the European banking system because the health of the European banking system was tied up with the health of the individual national economies in terms of their fiscal positions and the ECB basically has been trying to find a way to cut that tie and I think that the long-term refinancing operations and the dollar swaps has sort of calmed down the anxiety in the market and what we've actually seen now since the long-term refinancing operations have been put in place by the ECB and the dollar swaps have been put in place by us we've actually seen financing pressures in Europe subside so the rates that the European banks have to borrow from other European banks or to borrow from US banks in dollars those rates have actually been coming down so that's actually a beneficial consequence of the long-term refinancing operations and the dollar swap programs the pressure in the markets are abating which I think is a good thing I recognize Mr. Luka Maher from Missouri thank you Mr. Chairman kind of curious where who determines the rate for the swap lines, interest rate the interest rate is established by the Federal Open Market Committee in discussions with the foreign central banks obviously they have to agree to the rate that we are willing to how often is it reviewed to go up or down, how often do you review that quarterly, semi-annually once a year well the swap lines are outstanding for example the current set of swap lines are outstanding until February 1st, 2013 but we certainly, you know, we certainly could review them at any rate doesn't float at any point in time, the rate is set at the, essentially at the Federal Fund rates plus 50 basis points right now, about 6 tenths of a percent interest rate but the amount above the Fed Fund's rate that stays constant for the entire length of the swap or do you float that or adjust that as well? It had been at 100 basis points over the Federal Fund's rate up until last fall and then we lowered that spread from 100 basis points to 50 basis points and the reason why we lowered that rate is that banks were reluctant to use the swaps because they felt that using the swaps at that rate would be a sign of weakness and so the swaps were actually not being very effective in containing pressure in financial markets so a decision was made by us and the foreign central banks in which we've engaged with the swaps was to lower the rate from 100 basis points over the Federal Fund's rate to 50 basis points over the fund. If the European banks felt it was in their own best interest not to borrow money, not to swap because the rate was too high why would you want to entice them into this with a lower rate? They were reluctant to use the swap because they felt that if they used it it would be a sign that they were a particularly weak institution. Why is it why are they not viewed as weak now because they're using it now? Because when the swap rate was lower from 100 basis points over the Federal Fund's rate to 50 basis points over the Federal Fund's it became broadly attractive to the rates that were then in place in markets. It made them look like better investors better money managers? It made them there was an economic rationale for borrowing from the swap lines at the lower rate so lots of banks participated and since lots of banks participated there was very little stigma from participating in that program. This whole thing is held together by confidence and perception that everybody is doing okay, isn't it? I think we've seen both in the case of the swaps and the case of our own discount window in the U.S. that there's times that banks don't want to use liquidity facilities, backstop facilities because they're afraid that it's going to show that they're weak relative to other institutions and that's just a problem in terms of these type of liquidity facilities. I'm just kind of curious, you know, I follow up on Jerome Paul's line of questioning with regards to the ECB loaning it to the banks and the banks who are American, I guess, companies and investors here. Why would they do that? Why are they not borrowing the money from us directly? Our banks here? Well, the European banks have, you know, big books of business in the U.S. especially in areas like trade finance, project finance, reserve energy, you know, the end against oil and gas drilling energy reserves and they have specialized expertise in these areas and so that's why they undertake this around the world and in the U.S. when they partake in this business, they do it in terms of lending dollars because obviously that's what the currency that we do business here in the United States and so they have a need for dollars to be able to sustain that business. So what you're saying is that there are banks in Europe that are better experts at lending in certain areas, certain fields and we have lending institutions in this country, is that what you just said? I'm saying that there are European banks that are specialized in certain areas. They are better or worse than U.S. banks that participate in the same areas. You know, there's some overlap in terms of competitive, you know, in areas of competition, but there are certain areas where European banks historically have concentrated their lending. Project finance, trade finance and energy reserve lending are probably three of the most predominant examples. Now, do the American corporations or entities that borrow from them, are they buying goods and services from Europe then? Are they buying goods and services someplace else in the world, the United States, or is it kind of worked like our export import bank here or how does that work? Well, I would presume that if you're borrowing in dollars you're using those dollars to buy U.S. goods and services, otherwise you wouldn't need the dollars, you'd need some other form of currency. Congressman, if I could add, we're in the middle, this is a very global financial system and we're in the middle of a very global economic system. So large banks operate all around the world and compete with each other and that actually ends up being beneficial to non-financial corporations. Well, I understand that, Dr. Campbell, but I'm trying to get at I'm kind of concerned here because we have foreign banks that are apparently competing against American banks, which you just said, yet we are loaning money through the ECB to those banks to be able to loan back and compete against our banks. Is that what you just said? What I said was that both financial institutions and non-financial institutions compete with each other all around the world. Yeah, but my concern is that if we through these swap lines are funding these international banks and they are in turn competing against our banks, I don't think we need to be doing that. Do you? Well, the primary concern of the Federal Reserve in setting up the swap lines was to maintain the flow of credit to American households and firms. That was key because that's what's needed in order to maintain the economic recovery and to move toward achieving our dual mandate of both price stability and maximum sustainable employment. So that was the critical factor that motivated. I think the U.S. banks also are interested in having a healthy U.S. economy, just like the European banks are. And I think that they probably broadly recognize that a forced liquidation of assets by European banks would have, you know, negative consequences for the U.S. economy and for their banks. I see my time is up. Thank you, Mr. Chairman. I'll recognize Mr. McHenry. Five minutes. Thank you, Mr. Chairman. To follow up on the earlier question I had about the long-term refinancing operation. Now, it's interesting to me, Dr. Cayman, you did walk through the whole thought process, and I do appreciate that. I mean, the willingness to have a witness from an independent institution that Congress oversees to walk through in sort of a very broad form your thinking on this is rather impressive and daresay revolutionary. But it was very much appreciated because, you know, this is really just about trying to make sure policy makers on the Hill have an awareness of what the Fed is doing, and I don't have to explain to the Fed that the chairman of this subcommittee's vigorous intention of oversight of the Federal Reserve. That may be the understatement of the day. So with this injection of funds of, you know, low interest rate loans for an extended period of time, much of this capital, a large portion of this capital, I should say, of all the categories has gone to sovereign debt. This is now T. L. Rose. Yes. Thank you. Yes. I'm sorry. So in that operation the money has flowed to sovereign debt, so it has had one of the intended effects of what the Federal Reserve is doing to make sure that the amount of money that it receives, the amount of money that it receives, maybe it appears. Now, the question is, of course, what is our exposure to Europe in terms of a quantifiable dollar amount by our private sector? It's one question, but really the bigger question here for policy makers is what is our exposure to Europe? Thank you for your kind remarks earlier for these questions. The Federal Reserve exposure to Europe would be basically encompassed by the value of our swap lines which is around $50 billion or so to the ECB and then a very small amount to the Swiss National Bank. As we had discussed earlier we think that those exposures are very secure. We've provided them with dollars in exchange. They've provided us with their currency and we appreciate the prudent management and strong financial position of the ECB. The exposure of our private financial institutions to Europe is obviously much, much larger. Our banks and our money market funds. Those exposures to the most embattled so-called countries in Europe particularly like Greece and Portugal and Ireland are really very small. The exposures to Spain and Italy are somewhat larger but we've had many discussions with the banks that we supervise and those are viewed to be quite manageable. Obviously the exposures to core European banks who are in turn exposed to peripheral Europe are much larger. But we are in terms of thinking about the channels of spillover and how this exposure really works. What's probably more of concern is not so much these direct financial exposures to European institutions but rather the fact that if situation in Europe took a turn for the worse there will be these ancillar channels that we've talked about before. The disruptions of financial markets, the retreat from risk taking that could disrupt financial markets around the world and that's really a matter of the greater concern and that's where we focused a lot of our efforts in working with the banks that we supervise and other regulatory institutions taking the same standpoint to the banks. So explain to me how the swap lines benefit the American economy just in layman's terms. Sure. To begin with many European financial institutions as we've discussed are engaged in direct extensions of credit to U.S. households and firms. In a situation where these European banks were unable to get the dollar funding they needed, they would be forced to pull back on lending from U.S. households and firms. They might be forced to sell assets which would then depress asset values in the U.S. economy more generally and both of those effects would directly affect the ability of U.S. households and firms to grow and prosper. On top of that, funding difficulties by these European banks would lead to their cut back on credit in terms of dollar lending to other firms around the world. Firms which buy a lot of U.S. exports and so that would be an additional channel through which a funding shortage could hurt the U.S. economy and that's what we intend hope to alleviate to the provision of these funds. Finally in the event that the dollar funding were not available, say in the absence of our swap lines and European banks ran into more severe difficulties, this could be a contributing factor to a further and renewed deterioration of European financial conditions that not only could severely impact the European economy but lead to distress conditions around the world. There might be more larger ancillary effects from dollar funding problems that again the dollar swap lines are intended to alleviate. Thank you, Mr. Chairman. Thank you. I recognize the gentleman from Michigan Mr. Heisinger. Thank you, Mr. Chairman. I appreciate the opportunity for you coming in. I wanted to maybe touch on a couple of quick things and continue on that currency swaps. How far are we going to bring this along? I guess would be part of my question. How long are we going to stick into this game to be a part of it? If Europe remains dependent on currency swaps, these same swaps become increasingly risky. Are you prepared to allow these currency swaps to wind down or what's going to happen there and then the short-term dollar funding in Europe seem to be the discussion point, right? How would you define short-term versus medium-term and long-term? I'll start. I think that what we would hope is that the European countries do the right things in terms of getting their fiscal houses in order and improving their competitiveness so that investors start to have more confidence in the sustainability of the European Union and how all these countries are going to persist. If that happens and at the same time the European banks are shown to have good earnings, liquidity and capital, then I think that the willingness of private lenders to provide dollar liquidity to the European banks will emerge very much intact. And in that situation our swaps will be at rates that are actually higher than the market and the swap programs will just sort of wind down automatically. This is what we saw during 2007, 2008, 2009 during the first big wave of swaps that as market conditions normalized the swap usage came down pretty automatically. I'm kind of curious about that because I'm looking at some information in front of me here that says interest rates on dollar loans from 0.6 percent, interest rate on ECB charges for its euro loans is 1 percent. I don't have my Ph.D. in economics. However, I can see the incentive there. Why, by making dollar financing cheaper than euro financing, how are they ever going to get out of that cycle? I'm not sure that I would agree with that. That's the right comparison. The 1 percent is to borrow euros, the 0.6 percent is to borrow dollars, and the alternative is to borrow dollars from a U.S. bank when the Federal Reserve is paying 25 basis points on the interest rate that we pay on excess reserve. So there's quite a bit of room between the 25 basis points we pay on reserves here in the U.S. and the 0.6 percent on the dollar swap. We would expect that if conditions in Europe were to continue to improve that the rate at which European banks could borrow dollars would be somewhat north of 25 basis points perhaps, but below that 0.6 percent. So we would think that there's plenty of room in that difference for the European banks to obtain credit from private entities. In fact, we've actually seen private suppliers of dollars to the European banks return subsequent to the large, long-term refinancing operations and the dollar swap programs. So it looks like the market is already starting to normalize. But doesn't that weaken the value of the euro, what they're doing? If you look at, you know, I think the euro is really basically being trading in line with how the situation in Europe looks. If as the European situation worsens the euro depreciates as the European situation improves the euro appreciates. So it's really based on the outlook for Europe, of course, relative to the outlook in the U.S. Help me understand though, if a weaker euro doesn't that mean a typically a weaker euro zone since we've sort of flagged this off as a European issue and are trying not to get dragged into it here from the U.S. side? Well, you're certainly right that if the European outlook were to deteriorate, the euro would probably weaken as a consequence. The good news is over the last four or five months the euro's actually strengthened a bit because Europe has actually made some progress in terms of addressing some of their issues. Okay, and then my time is almost up and I know Dr. Cayman you want to say something as well, but I'm curious what keeps you up at night? What other countries? I mean you specifically I think Dr. Cayman's testimony talked briefly about Greece and then you just were touching on Spain and Portugal, but you know where are we at Italy, Ireland and are we on solid footing or I'm sorry are they on solid footing in France and Germany and some of those other countries that have been leading this? Well certainly the euro crisis in general is what keeps me up at night and what occupies much of my thinking time during the day as well. Obviously the situation of Greece has been very difficult and we've been following that very closely. We also obviously are very focused on basically you know Ireland and Portugal which are the recipients of IMF funds and we think it's critically important that these problems not move further into Spain and Italy which have also been the focus of market attention. And we think it's absolutely critical to make sure that you don't have further contagion beyond that. So far things have been looking on the brighter side, there have been improvement in markets but we have continued to monitor the situation as closely as ever. And then while most of my thinking lately is focused on Europe obviously I'm thinking about oil prices as well because that is another area that poses a potential threat at least down the road. Thank you. I have a couple additional questions I'd like to ask. I'm interested in the one line on the Federal Reserve sheet each week on other assets other Federal Reserve assets. And it's been growing a bit. It used to be a small number but even in recent years it's gone up I think it's about $160 billion now. What does that include? Does that include anything foreign? Is there any type of foreign asset or a swamp or anything involved in there that would help me further understand this international financial crisis that we're in? Go ahead. Chairman Paul, the we definitely put in on our balance sheet our holdings of foreign assets. I don't recall offhand if that's where the other assets is. I don't think so. The other assets have, as you point out, have risen over time and there's one main contributing factor to that, which is when we buy securities in the market sometimes we buy them at a value that's above their par or face value because interest rates had declined since they were first issued and that raises the value of those securities. So then we place the par value of the securities in one line on our balance sheet and then that additional part that's over the par value, the premium, that's placed in our other assets line. So as we have continued to purchase securities in the market that the amount of those, the premium part of our purchases, which has gone into the other assets line, has continued to rise. So you say you're buying securities, would this be mortgage securities? This would be predominantly the maturity extension program in which we're selling short dated Treasury securities and buying long dated Treasury securities. We are also buying mortgage back securities, but that's just rolling over existing maturing mortgage back securities. So the size of the mortgage back securities portfolio is pretty constant. So the significant increase up to $160 billion of just saying there are other, it's definitely related to the international financial crisis that we're involved in right now? As Steve related, it's related to the expansion of the Fed's balance sheet and the types of assets that we're buying in the market. So the maturity extension program, we're selling short dated Treasury, we're buying long dated Treasury, to the extent that we're buying Treasury that are selling above par because interest rates have declined, that difference is what Steve was saying is booked in the other assets category. What does this mean that this would continue to grow at the rate it's growing now? No, I mean I would expect that once the maturity extension program and other asset purchase programs are ended, then I would expect the other assets category actually would probably come down over time as that premium was amortized over time. I would view this as a temporary phenomenon. But there's no one place in the Federal Reserve reports that would give me a full explanation of exactly what the $160 is, you don't send out a report each month and say exactly what that's made up of. There is an interactive portion of our website that offers more analysis of the different lines. The second thing I want to follow up on is having checked the other assets the other assets category does indeed as you suggest also include foreign currency denominated assets, but not the swap lines. It's the other European and yen denominated securities that we hold. Okay, the other thing I've noticed since 08 is if you look at a long term chart of currency in circulation it's a steady increase and very predictable. But since 08 it's been going up much more rapidly. Where's the cash? This is cash currency. Where's the demand for more cash? Do you know exactly where that goes? Does that end up overseas or is that in circulation here or is it in a shoebox someplace? Probably in both places. With interest rates this low the opportunity cost of holding more currency obviously is very low. If you hold the currency you get a 0% return but as you've gone to your bank these days you don't get much more than that. People probably are carrying around more currency in their pockets because there's less cost of holding the currency versus holding it in a bank. This may also be true internationally although I'm not familiar with how much currency is held here versus abroad. I know historically it's been about 1 third here, 2 thirds abroad, but I don't know how that's been changing recently. Our hearing is going to finish but I have one quick question for both of you. You can probably answer this easily. You're very much involved in dealing with the value of our money, the value of our dollar and our financial system but I have trouble finding a legal definition for the unit of account that we have and as a dollar could you tell me your definition of what is a dollar? I view the dollar as the legal tender in the United States so that if someone pays a dollar as a payment the shopkeeper has to accept that dollar for that transaction. It's also the classic definition of money I think is that it has three things. It's a value which it's a medium of transactions and usually it has portability. It's a medium of accounts in other words you measure value by using the dollar. You do realize there was a more precise definition of a dollar most of our history where you could actually know what it meant but it seems like that's no definition at all to say it's just a unit of account and that's probably the reason why we've lost about 98% of the value of that dollar since 1913 since it's been the responsibility of the Federal Reserve to protect the value of our currency. I have trouble believing that we'll be able to solve any of our problems financially or even fiscally if we can create money endlessly and out of thin air and accommodate the politicians who spend money, who spend money overseas, who spend money on foreign policies, indirectly you have to deal with. Look how the sanctions and the threat of war in Iran affects the finances of the world. Not only perception wise and trade and pushing up oil prices but also the need to keep monetizing this debt. Federal Reserve Chairman endlessly for all the years I've been here I've always said well if the Congress would quit spending so much money and didn't have so much debt we wouldn't have such a tough problem managing the currency at the same time the debt wouldn't be there if the Federal Reserve wasn't there willing to monetize the debt because you are the lender of last resort. You guarantee the moral hazard that politicians are going to spend money and it seems like to coordinate to two and have a sound economic system instead of a financial bubble that's based on debt and a monetary standard based on debt with a world of wash and exploding amount of debt. It seems I don't know how we'll ever get out of this unless we come up with finally a definition once again of what the unit of account is and what a dollar means. This hearing is now adjourned. Thank you.