Chairman Bernanke provided some prepared testimony and then was thoroughly grilled by the Senate Banking Committee on a wide range of issues related to the conduct of monetary policy, the Fed's role as banking regulator/supervisor, consumer protection, the Fed's exit strategy, and fiscal policy.
Bernanke faced a very tough set of questions from all committee members, including those who favor his re-nomination. Bottom-line: Bernanke's re-nomination is still very likely. Nevertheless, the Fed faces major threats from proposed legislation that would have a major impact on the mandate and scope of the Federal Reserve—threats that Bernanke will have to fend off with considerable forcefulness.
While Bernanke's performance in dealing with the crisis was praised by the Chairman of the Committee and several other committee members, Bernanke and the Federal Reserve were excoriated for major supervisory lapses prior to the crisis and failing to see the dire consequences for the economy as whole from the busting of the housing bubble.
There is a proposed bill in the House that would have the Fed's monetary policy decisions and procedures subject to some kind of audit or review, presumably by the GAO or other third-party authority. This bill does not appear to have much support, as it would be a direct threat to the political independence of the Fed on monetary policy decisions, and reverse a Congressional decision in 1978 that exempts the monetary policy function of the Fed from review.
A larger threat comes from a proposed bill in the Senate, supported by Senator Dodd, the Chairman of the Senate Banking Committee, which would remove banking and financial regulation and supervision from the Fed's mandate. Senator Dodd argued rather convincingly that the Federal Reserve did not do a good job on financial regulation and supervision prior to the crisis, and furthermore this function serves as a "distraction" from its primarily mandate of setting the course for monetary policy.
Bernanke did his best to defend the Fed from harsh criticism on a number of fronts, arguing that many of the severe problems in the financial crisis arose outside of the bank holding company regulatory purview of the Fed, and he did make a strong case against having the Fed's monetary policy decisions subject to GAO or Congressional review.
Bernanke's views on retaining the Fed's role in regulation and supervision of the banking system, which were recently published in an article in the Washington Post, is that the Fed's regulatory function works hand-in-hand with its monetary policy function. The bank review and examination process can inform much better decisions about monetary policy and the Fed's lending decisions, while the Fed's expertise on the financial markets, forecasting, and business cycle fluctuation can assist with regulatory reviews (as was the case with the recent SCAP review of the capital positions of the largest bank holding companies). This spirited defense of retaining the Fed's supervisory and regulatory functions has strong merits, but they are relatively subtle and they did not appear to have a strong impact on the Committee's deliberations.
With respect to fiscal policy, Bernanke made crystal clear that the Fed is committed to price stability and the Fed would not monetize the federal debt. However, he mentioned that even under conditions of price stability, (real) interest rates would have to rise if the debt to GDP burden continues to escalate. Bernanke flagged the rapid rise of entitlement spending as a major risk to the fiscal outlook, and said that healthcare reform must include a major focus on controlling costs.
While Bernanke's re-nomination is very likely, the Fed faces some major opposition from the Senate and the House in terms of continuing with its traditional dual mandate of setting monetary policy and serving as the primary regulator and supervisor of bank holding companies. Bernanke will have his work cut out for him in terms of defending the Fed from these attacks.
Beyond the issues relating to the role and mandate of the Federal Reserve, Congress has other major fish to fry in the financial regulation domain, including dealing with supervision and regulation of large financial institutions that pose a systemic risk to the economy, as well as how to set up a new resolution authority to deal with the "too big to fail" problem.
by Brian Bethune