Hearing of the House Financial Services Committee - Systemic Risk and the Financial Markets

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REP. SCOTT GARRETT: Thank you, Mr. Chairman.

And thank you, Mr. Chairman, Mr. Secretary, for your service to the country.

Secretary Paulson, I was very pleased to see your comments on Tuesday regarding covered bonds and how they can be maybe another way to increase the availability and lower the cost of mortgage financing to hopefully get us back to normal home buying in this country.

I agree with covered bonds, both in the commercial area and in the residential area, present a great way to provide more liquidity to the U.S. housing market during this credit crunch. I've spoken to Chairwoman Bair directly about covered bonds, and I know my staff has been in touch over the weeks with your colleagues at the Treasury. And over the last three months, I've been working with outside interested parties to see whether we can work together on coming up with legislation to help -- (inaudible) -- covered bonds.

Chairman Bernanke, on this topic, I've not heard -- maybe you made the statement, but I have not heard it. Do you have a position generally in favor, support of Secretary Paulson with regard to helping address the mortgage situation?

MR. BERNANKE: Like you, Congressman, I think it's very important for us to be -- here we mean both the regulatory community, but also the private sector -- to be looking for new ways to get financing. Covered bonds are a very successful financing vehicle in Europe, and therefore it's an attractive thing for us to look at here.

The FDIC has got a rule it's gotten worked out that will clarify some of the issues associated with the priority of covered bond collateral versus deposit insurance fund. I'm in favor --

REP. GARRETT: (Inaudible.) Sorry. You're in favor of --

MR. BERNANKE: I'm in favor of working in this direction. I wonder -- I think it's not yet known whether this can be successful without legislation. I think that's a question we want to --

REP. GARRETT: Well, I look forward to working on this legislation.

Turning now to the issue that most of us have talked about so far, the Bear Stearns situation, I had a chart, but I know the numbers are pretty small. But you should be familiar with it because it comes from your own folks on your own website. It's the Federal Reserve balance sheet as of June 25th, 2008.

As I read it and others explain it, it indicates that there's only roughly $22 billion, generally speaking, of Treasury bills remaining, and the Fed has already exchanged $255 billion, roughly, for a variety of types of private debt, some of which you've questioned the quality of.

Now, today the secretary has made remarks of the need for a new statutory framework to deal with the unwinding of the situation. I'm sure you've seen a number of the articles that talk about this, and the press indicates there are several other brokers out there that might be facing significant problems as well going forward. And you've already indicated you hate to have to deal with the situation as you've had with Bear Stearns in the past.

So, Mr. Chairman, it appears to me that if one of these highly interconnected investment banks were to fail in the near-future, the Fed's balance sheet then has limited or no room left on it, coupled with there being no legislative framework in place going into this.

Would the Fed, in essence, have to monetize the situation to bail them out? Would the Fed have to deal with new Treasury paper to bail out bondholders, which is what you really incurred with the Bear Stearns situation, if another situation came?

So my questions to you is three. Can you assure us -- I think I know the answer to this question, but can you assure us that you will not conduct any similar Bear Stearns transaction if another investment bank or GSE gets in trouble without prior explicit authorization of the Congress via some sort of enabling legislation?

Two, if you decide that there is no alternative than to conduct another bailout or support, however you want to call it, to one of these troubled organizations, will you be willing to monetize the debt to finance such a transaction due to the current limitations on your balance sheet?

And thirdly, your claim that your actions with the Bear Stearns transactions are granted to you under Section 13 of the Federal Reserve Act, are there any limitations within that section or elsewhere as to your abilities going forward to deal with these situations?

MR. BERNANKE: I'll try to address those range of questions. Over the weekend, when we were working on the Bear Stearns issue, I was in touch with congressional leaders and kept them informed. And the sense I got was that, you know, there was not an objection to pursuing it. I also, of course, worked very closely with the Treasury and with the SEC and other authorities to develop a consensus for the actions we took. And as I've argued before, I think they were necessary.

So, you know, I don't want to make any commitments. I don't think a situation like this is at all likely. But unless I hear from Congress that I should not be responding to a crisis situation, I think that it's a long-standing role of the central bank to use lender-of-last-resort facilities to address --

REP. GARRETT: Your first answer is yes. So the second question, then, is would you potentially monetize the situation if the balance sheet --

MR. BERNANKE: There's no monetization. This is a sterilized operation. There's no effect on the money supply. And in addition, I would add that our lending, not only to the Bear Stearns issue, but more generally to the banks and so on, is not only collateralized with good haircuts; it's also recoursed to the banks themselves. We have not lost a penny on any of this lending. And it is just lending. You're not purchasing any of it. It goes back to the bank when the term of the loan is over.

REP. GARRETT: So there's no limit to the amount --

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