June 3, 2009 / 2:06 PM / 11 years ago

TEXT-Bernanke's prepared testimony to House Budget panel

 WASHINGTON, June 3 (Reuters) - The following is the prepared text of U.S. Federal Reserve
Chairman Ben Bernanke's testimony to the House Budget Committee on Wednesday.
Chairman Spratt, Ranking Member Ryan, and other members of the Committee, I am
pleased to have this opportunity to offer my views on current economic and financial conditions
and on issues pertaining to the federal budget.
Economic Developments and Outlook
The U.S. economy has contracted sharply since last fall, with real gross domestic product
(GDP) having dropped at an average annual rate of about 6 percent during the fourth quarter of
2008 and the first quarter of this year. Among the enormous costs of the downturn is the loss of
nearly 6 million jobs since the beginning of 2008. The most recent information on the labor
market--the number of new and continuing claims for unemployment insurance through late
May--suggests that sizable job losses and further increases in unemployment are likely over the
next few months.
However, the recent data also suggest that the pace of economic contraction may be
slowing. Notably, consumer spending, which dropped sharply in the second half of last year, has
been roughly flat since the turn of the year, and consumer sentiment has improved. In coming
months, households' spending power will be boosted by the fiscal stimulus program.
Nonetheless, a number of factors are likely to continue to weigh on consumer spending, among
them the weak labor market, the declines in equity and housing wealth that households have
experienced over the past two years, and still-tight credit conditions.
Activity in the housing market, after a long period of decline, has also shown some signs
of bottoming. Sales of existing homes have been fairly stable since late last year, and sales of
new homes seem to have flattened out in the past couple of monthly readings, though both
remain at depressed levels. Meanwhile, construction of new homes has been sufficiently
restrained to allow the backlog of unsold new homes to decline--a precondition for any recovery
in homebuilding.
Businesses remain very cautious and continue to reduce their workforces and capital
investments. On a more positive note, firms are making progress in shedding the unwanted
inventories that they accumulated following last fall's sharp downturn in sales. The Commerce
Department estimates that the pace of inventory liquidation quickened in the first quarter,
accounting for a sizable portion of the reported decline in real GDP in that period. As inventory
stocks move into better alignment with sales, firms should become more willing to increase
We continue to expect overall economic activity to bottom out, and then to turn up later
this year. Our assessments that consumer spending and housing demand will stabilize and that
the pace of inventory liquidation will slow are key building blocks of that forecast. Final
demand should also be supported by fiscal and monetary stimulus, and U.S. exports may benefit
if recent signs of stabilization in foreign economic activity prove accurate. An important caveat
is that our forecast also assumes continuing gradual repair of the financial system and an
associated improvement in credit conditions; a relapse in the financial sector would be a
significant drag on economic activity and could cause the incipient recovery to stall. I will
provide a brief update on financial markets in a moment.
Even after a recovery gets under way, the rate of growth of real economic activity is
likely to remain below its longer-run potential for a while, implying that the current slack in
resource utilization will increase further. We expect that the recovery will only gradually gain
momentum and that economic slack will diminish slowly. In particular, businesses are likely to
be cautious about hiring, and the unemployment rate is likely to rise for a time, even after
economic growth resumes.
In this environment, we anticipate that inflation will remain low. The slack in resource
utilization remains sizable, and, notwithstanding recent increases in the prices of oil and other
commodities, cost pressures generally remain subdued. As a consequence, inflation is likely to
move down some over the next year relative to its pace in 2008. That said, improving economic
conditions and stable inflation expectations should limit further declines in inflation.
Conditions in Financial Markets
Conditions in a number of financial markets have improved since earlier this year, likely
reflecting both policy actions taken by the Federal Reserve and other agencies as well as the
somewhat better economic outlook. Nevertheless, financial markets and financial institutions
remain under stress, and low asset prices and tight credit conditions continue to restrain
economic activity.
Among the markets where functioning has improved recently are those for short-term
funding, including the interbank lending markets and the commercial paper market. Risk
spreads in those markets appear to have moderated, and more lending is taking place at longer
maturities. The better performance of short-term funding markets in part reflects the support
afforded by Federal Reserve lending programs. It is encouraging that the private sector's
reliance on the Fed's programs has declined as market stresses have eased, an outcome that was
one of our key objectives when we designed our interventions. The issuance of asset-backed
securities (ABS) backed by credit card, auto, and student loans has also picked up this spring,
and ABS funding rates have declined, developments supported by the availability of the Federal
Reserve's Term Asset-Backed Securities Loan Facility as a market backstop.
In markets for longer-term credit, bond issuance by nonfinancial firms has been relatively
strong recently, and spreads between Treasury yields and rates paid by corporate borrowers have
narrowed some, though they remain wide. Mortgage rates and spreads have also been reduced
by the Federal Reserve's program of purchasing agency debt and agency mortgage-backed
securities. However, in recent weeks, yields on longer-term Treasury securities and fixed-rate
mortgages have risen. These increases appear to reflect concerns about large federal deficits but
also other causes, including greater optimism about the economic outlook, a reversal of flight-to
quality flows, and technical factors related to the hedging of mortgage holdings.
As you know, last month, the federal bank regulatory agencies released the results of the
Supervisory Capital Assessment Program (SCAP). The purpose of the exercise was to
determine, for each of the 19 U.S.-owned bank holding companies with assets exceeding
$100 billion, a capital buffer sufficient for them to remain strongly capitalized and able to lend
to creditworthy borrowers even if economic conditions over the next two years turn out to be worse
than we currently expect. According to the findings of the SCAP exercise, under the more
adverse economic outlook, losses at the 19 bank holding companies would total an estimated
$600 billion during 2009 and 2010. After taking account of potential resources to absorb those
losses, including expected revenues, reserves, and existing capital cushions, we determined that
10 of the 19 institutions should raise, collectively, additional common equity of $75 billion.
Each of the 10 bank holding companies requiring an additional buffer has committed to
raise this capital by November 9. We are in discussions with these firms on their capital plans,
which are due by June 8. Even in advance of those plans being approved, the 10 firms have
among them already raised more than $36 billion of new common equity, with a number of their
offerings of common shares being over-subscribed. In addition, these firms have announced
actions that would generate up to an additional $12 billon of common equity. We expect further
announcements shortly as their capital plans are finalized and submitted to supervisors. The
substantial progress these firms have made in meeting their required capital buffers, and their
success in raising private capital, suggests that investors are gaining greater confidence in the
banking system.
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