Author: WSJ.com: Real Time Economics

A roundup of economic news from around the Web.

• Spending Freeze: Writing for the Tax Policy Center’s TaxVox blog, Len Burman characterizes the president’s proposed spending freeze as a statement on government payrolls. ” But I’ve concluded that Obama’s freeze isn’t aimed at either Republicans or the Democratic base. It’s a populist move meant to assuage those who are ticked off that the federal payroll has grown while private-sector jobs have been vanishing at an alarming rate. The message in the freeze is that government jobs no longer come with life tenure. To that end, Pelosi and Reid’s protestations are a plus—if the president can put together a coalition to implement the freeze. And such a bipartisan coalition would provide comfort to the independents who are fleeing Obama’s camp.”
• Fake Homeowners: Mike Konczal of Rortybomb looks at home ownership in the age of subprime foreclosures. “I saw an ad on craigslist (though most story that starts with that line are shady, this one is not especially so) for apartment rental opportunities in Sacramento, CA. The rent was very cheap, but you had to post a gigantic security deposit, sign away rights related to eviction and give proof that you’ve never been convicted of a crime. Digging a bit deeper, it was clear that the owner was an out of state company that was buying up sections of foreclosed homes in abandoned neighborhoods. And what they needed was less a “renter” but a controlled “squatter.” If left alone, these buildings would become homes for the homeless, gang activity, looters and pranksters, etc. So what the investment company wanted to do, since they wanted to sell the properties as homes in the long run but couldn’t in the short run, was get someone to squat in these buildings for them; they were looking to hire a respectable squatter, get him on the payroll through really cheap rent, and he or she who could do whatever in the building as long as it wasn’t destructive of value.”
• Animals’ Animal Spirits: On Marginal Revolution, Alex Tabarrok wonders whether animals have animal spirits. “Can there be a Keynesian business cycle in the pond? i.e. Could animal spirits drive a natural business cycle? It’s harder for me to see exactly how this would work. We would need “money” or something similar to generate a rush to liquidity and a decline in investment. We could perhaps get a coordination type business cycle (ala Roger Farmer) with herd behavior. Interestingly, the trend in biology–as I read it at least–has been to think of herd behavior as optimal for the herd but this is not necessarily the case. We know that slime molds self-organize and aggregate during times of stress could this process be set off with no or little exogenous shock? Could a natural system provide a model for business cycle behavior? It would be odd if only people had animal spirits. Biology and economics have much to offer one another.”

Compiled by Phil Izzo

Women were more likely to be in college or have graduated by the age of 22 than men. That’s good news for them for an array of reasons.

Not only is higher education necessary in the future economy where nearly a third of jobs are expected to require a post-high school degree, but it apparently will make them happier in their marriages too.

And on a side note, women were more likely to have volunteered in the past year too.

Both are findings from the latest deluge of data from the Labor Department, which released a report on volunteering in the U.S. and the latest findings from the National Longitudinal Survey of Youth 1997 this week.

Data from the longitudinal study showed that 29% of women were attending college in October when they were 22 compared to 25% of men. Another 13% of women had earned a bachelor’s degree, more than the 7% of men. There are three main reasons for that: Women are more likely to graduate from high school, more likely to attend college and less likely to drop out of college.

The data comes after the 11th round of interviews, conducted in 2007 and 2008 among about 9,000 people, when the respondents were between 22 and 28 years old.

Overall just 10% of young people had received a bachelor’s degree by the time they were 22. Some 27% were enrolled in college, 44% finished high school but didn’t attend college and 7% received their General Educational Development (GED) credential and were not enrolled in college. Another 11% were high school dropouts.

The new data also sheds some light on young people’s work attachments. They held an average of 4.4 jobs between ages 18 and 22. The youngest baby boomers, born between 1957 and 1964,  held an average of 3.8 jobs between 18 and 21-years-old. By the time they were 40, they had held an average of 10.5 jobs.

For today’s young adults, they were employed, on average, 69% of the weeks between when they were 18 and 22 years old. They were looking for work but unable to find it 6% of the weeks and they were neither working, nor searching for jobs, 25% of those weeks.

As for volunteerism, 26.8% of the population – or 63.4 million people – volunteered at least once between September 2008 and 2009.That’s up from 26.4% in 2008. Some 30.1% of women volunteered, compared to 23.3% of men.

“As in previous years, women volunteered at a higher rate than did men across all age groups, educational levels, and other major demographic characteristics,” the Labor Department noted.

But men volunteered for longer. They spent a median of 52 hours volunteering compared to 50 hours for women.

Whites, people with higher education levels, married people or those between the ages of 35 and 54 were more likely to volunteer than their counterparts,

A week ago, Ben Bernanke’s confirmation appeared in doubt. But after some strong lobbying from the Obama White House, less than a quarter of the Senate voted against the Federal Reserve chairman in the key procedural vote.

Fed Chairman Ben Bernanke (Reuters)

Among the 23 senators who sought to block a vote on the confirmation were five Democrats and one independent who usually sides with Democrats, and 17 Republicans. That group included a couple of senators facing tough re-election fights this year, such as Sen. Arlen Specter (D., Pa.), as well as outspoken Fed critics Jim Bunning (R., Ky.) and Bernie Sanders (I., Vt.). (See a full tally of how senators voted.)

“A vote for Ben Bernanke is a vote for bailouts,” Sen. Bunning said on the Senate floor. “If you want to put an end to bailouts and send a message to Wall Street, this vote is your chance.”

Election-year politics and deeply held antipathy to the Fed weren’t the only factors driving senators to oppose a second term for Mr. Bernanke, who won confirmation four years ago on a voice vote.

Some “no” voters cited concerns about the Fed chairman’s track record on regulation ahead of the crisis, an area in which even Mr. Bernanke has acknowledged the Fed’s shortcomings. Others criticized his response to the financial crisis, with some liberals charging he didn’t do enough for Main Street and some conservatives saying the Fed is sowing the seeds of the next crisis.

“The Fed chairman has to realize the urgency with which the big banks have been saved and bailed out,” Sen. Maria Cantwell (D., Wash.) “That urgency has to be applied to Main Street.”

After the procedural vote, the Senate voted 70-30 to confirm Mr. Bernanke. Some of the seven senators who switched explained they didn’t want to stand in the way of President Barack Obama’s nominee, but wanted to show disapproval of Mr. Bernanke’s tenure. Among those were Sen. Barbara Boxer (D., Calif.), who faces a tough re-election race, and Sen. Byron Dorgan (D., N.D.), who is retiring.

Mr. Dorgan said he wanted to highlight what he called a “bright line in America between those who are too big to fail and those who are too small to matter.”

“The biggest financial institutions were engaged in wholesale gambling,” Mr. Dorgan said. “They run their company and their country into the ground. They are told, ‘Well you know what? You’re so big we can’t possibly let you fail, so we’re going to give you a big bailout.’”

Senators who aren’t seeking re-election mainly backed a second term for Mr. Bernanke, including Christopher Bond (R., Mo.), Roland Burris, (D., Ill.), Christopher Dodd (D., Conn.), Judd Gregg, (R., N.H.), and George Voinovich (R., Ohio). But three — Sens. Bunning and Dorgan and Sen. Edward Kaufman (D., Del.) opposed him.

Several senators said they expected Mr. Bernanke to notice the strength of the opposition. “After what I can imagine has been a pretty harrowing experience for the Fed chairman, my guess is he’s going to redouble his efforts to make sure that the Fed is in a position of strength,” said Sen. Bob Corker (R., Tenn.), who supported the nomination. “I’ve got to believe after all of this, the Fed is going to conduct itself at a better level, at a higher level, than in the past.”

Federal Reserve Chairman Ben Bernanke was reappointed in a Senate vote of 70-30 Thursday. Earlier, the Senate voted to end debate on the nomination, a vote Bernanke won by a wider margin of 77-23.

The tally of Senators who voted for confirmation:

Voting “Yes”: 70 (47 Democrats, 22 Republicans, 1 Independent)
Voting “No”: 30 (11 Democrats, 18 Republicans, 1 Independent)

The tally of Senators who voted for cloture:

Voting “Yes”: 77 (53 Democrats, 23 Republicans, 1 Independent)
Voting “No”: 23 (5 Democrats, 17 Republicans, 1 Independent)

The Senate Banking Committee voted 16-7 last month to move the Bernanke confirmation to the full Senate.

The following full list of U.S. Senators is sortable by their votes on confirmation and cloture.

Sen. Richard Shelby (R., Ala.) said Thursday he was skeptical of a new White House plan to use $30 billion banks have returned from the Troubled Asset Relief Program and to help small banks offer more business loans.

President Barack Obama briefly mentioned the plan during his State of the Union speech Wednesday night but provided few details. People familiar with the matter said the plan could allow small banks to obtain government loans up to the equivalent of 5% of their assets. The dividend these banks would have to repay the government could be reduced if their loan volume to small businesses increased, these people said. Obama administration officials have already approached some lawmakers and regulators with outlines for their idea, which could be finalized by next week.

“It’s just another use, maybe a good use, but just another use of TARP funds that wasn’t originally intended,” Mr. Shelby said. He said government officials should push to recoup all of the outstanding TARP money and then begin discussions about any new program.

“I do believe the banks can make a difference if they are not overtaxed, and can make a difference in our economy,” he said in an interview. “But right now we are still in the crisis mode. A lot of banks are sick, and I don’t believe temporary things will work. We need to get to the fundamentals.”

The Obama administration would likely need bipartisan support for their plan, as any changes to the way TARP funds are used could need congressional approval. Banks will likely want fewer strings attached to the funds than the original TARP capital purchase program, which forced some banks to limit their executive compensation and eventually carried a “bailout” stigma.

The White House might be able to win support for the plan even if Sen. Shelby doesn’t eventually sign on. Several Republican lawmakers have complained about a lack of access to credit for small businesses, and White House officials could try to pitch their plan as a way to free up more credit to companies.

Read WSJ.com’s 1/26/10 description of the program.

Over the past couple decades, various U.S. states have made great strides toward getting more children to wear helmets when riding a bicycle — an effort that saves hundreds of lives each year. Only one problem, according to new research: Helmet laws are also turning kids off from riding bikes at all.

A helmet didn’t slow down this little stunt rider. (Mirrorpix/Courtesy Everett Collection)

In a working paper just published by the National Bureau of Economic Research, Christopher Carpenter of UC Irvine and Mark Stehr of Drexel University quantify the unintended consequence of helmet laws: In states that adopted such laws — a total of 21 states over the past 15 years — the kids affected became about 4% to 5% less likely to ride a bike.

Messrs. Carpenter and Stehr offer a couple possible explanations for the decline. For one, the cost of a helmet, which can be as high as $40, might discourage some kids from becoming bike riders — particularly if they can ride a skateboard or scooter without one. Also, according to surveys, kids don’t like wearing helmets because they’re uncomfortable and make them look like “geeks” or “nerds”.

None of this, of course, means that helmet laws should be scrapped. The researchers found that the laws not only increase helmet use by 20% to 34%, but also reduce bicycling fatalities among the kids affected by about 19%. So keep those helmets on.

A roundup of economic news from around the Web.

• Most Overvalued Cities: CNNMoney ranks the most overvalued housing markets in the U.S. ” In January 2006, CNNMoney published a ranking of 299 U.S. housing markets, showing where home prices were most overvalued. Little was undervalued: Real estate was white-hot and prices were at or near what later proved to be their tops. A total of 213 cities were overpriced, and Naples, Fla., was deemed the most insane, with 84% of homes valued over a fair market price, according to statistics compiled by National City Corp. and IHS Global Insight. That finding so rankled the Naples Chamber of Commerce and area real estate agents that they hired economists to dispute the evaluation, according to Richard DeKaser, the real estate consultant who engineered the report for National City. What a difference four years makes.”
• Fed Mortgage Buys: On voxeu, Johannes Stroebel and John Taylor say the Fed’s purchases on mortgage backed securities have had little effect. “Should the Fed scale back its ownership of mortgage-backed securities? This column analyses the effect of the programme on mortgage interest rates. Controlling for prepayment and default risk suggests the programme has had little or no impact, and that the Fed could gradually cut the size of its portfolio without a significant impact on the mortgage market.”
• Recession Jobs: Enrique Martínez-García and Janet Koech at the Dallas Fed look at the labor market during recessions. “A historical look shows that the labor market impact hasn’t been as severe in the current recession as it was in the Great Depression. While the latest episode has a lot in common with the post-World War II experience, it’s unusual in the length and depth of its labor market reach. It was the acceleration of employment losses after October 2008 that transformed an otherwise average recession into the worst episode since World War II. Different labor market data sources use different conceptual definitions and methodologies. Measurement issues can complicate the interpretation of aggregate data, and sometimes aggregation itself can mask important structural changes.”

Compiled by Phil Izzo

Businesses may not have begun their hiring sprees yet, but they’ve cut back on the layoffs.

A seasonally adjusted 153,127 workers were let go in 1,726 mass layoff events in December, the Labor Department said Wednesday. A mass layoff is an incident in which a single employer terminates 50 or more workers.

Employers laid off 10,696 fewer workers in December than the previous month, resulting in the smallest number of mass layoffs – and people laid off as a result – since July 2008.

Of the major industries the Labor Department tracks, manufacturing accounted for the largest number of workers terminated in mass layoffs last month: 64,540. But the sector has been making up a smaller share of mass layoffs. Manufacturing was responsible for 30% of the people let go in mass layoffs in December, down from 49% a year earlier.

As the budget pain in states and cities has become more acute, sub-industries, such as food service contractors; highway, street, and bridge construction and school and employee bus transportation shed the most workers in mass layoffs of any sub-industries last month. The number of workers cut in mass layoffs in the food service contractors industry was 14.9% higher than the same time last year. For the road construction group it was 6.6% higher.

Some of the spike may have been influenced by seasonal variations. For example, layoffs appeared high among school and employee bus transportation workers last month, but the number of people let go was actually down 5.7% from the same time last year. With many schools taking breaks in December, can be a peak time for layoffs in industries such as busing.

The number of workers laid off in the three leading subgroups combined is still lower than the number let go by manufacturers.

Since the recession began in December 2007, there have been 51,978 mass layoff events, seasonally adjusted, resulting in companies letting go of more than 5.2 million workers.

Last year set a new record high for the number of mass layoff events, 28,030, and the workers shed as a result, more than 2.8 million, since the Labor Department began tracking the annual data in 1996.

Global manufacturers, reliant on China as a growth engine, are keeping a close eye on that nation’s moves to cool its economic expansion to avoid inflation.

Caterpillar and other manufacturers keep a close eye on China. (Associated Press)

Reporting fourth-quarter results earlier today, Caterpillar Inc. CEO Jim Owens said it is “prudent” for China to step on the financial brakes, as long as they “tap on the brakes and not send everyone through the windshield.” He added that China has done a good job managing through the financial crisis so far and he expects them to continue making the right moves.

Mr. Owens added, “There’s a lot of monetary stimulus awash in the global economy” which gives the company confidence that the global recovery will continue.

But there is reason for Caterpillar and other big producers to worry. China has taken steps to discourage bank lending, signaling growing concern on the part of the Beijing government that galloping growth could stoke inflation. China’s GDP grew 10.7% in the fourth quarter from a year earlier, well above China’s targeted 8% growth.

Only about 7% of Caterpillar’s $33 billion in sales last year were in China, but China’s growth is also driving up commodity prices. That filters through the global economy in ways that create demand for machinery all over the world: For instance, not only do copper miners in Chile need more of Cat’s mining machines, but copper miners with fat paychecks then fuel another wave of demand for machines to build new houses, highways and shopping centers.

The Federal Reserve’s first Federal Open Market Committee meeting of 2010 brought a new voting lineup among regional Federal Reserve bank presidents. One hawkish president took the place of another hawk, and the transition appears to have been seamless — bringing a dissenting vote to the committee for the first time in a year.

Hoenig

The FOMC voted 9-1 to keep its interest-rate target unchanged at near zero and maintain its language that economic conditions “are likely to warrant exceptionally low levels of the federal funds rate for an extended period.” That wording has remained in the FOMC’s post-meeting statement since last March.

The lone dissenter, Kansas City Fed President Thomas Hoenig, “believed that economic and financial conditions had changed sufficiently that the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted,” the statement said.

Mr. Hoenig knows what it’s like to lead the Lone Dissenter Club. He last dissented in October 2007 — his second-to-last meeting in the voting lineup before this year — when he wanted the Fed to keep its rate target unchanged, rather than cut by a quarter point. But it’s the first time the FOMC has seen any dissent since Richmond Fed President Jeffrey Lacker almost exactly a year ago. Mr. Hoenig was also the Lone Dissenter twice in 2001 and once in 1995, always in the hawkish direction (preferring either no cut or a smaller one than the rest of the committee).

With today’s move, Mr. Hoenig tied the record for dissents among current FOMC members, according to a tally by Wrightson ICAP. Both Mr. Lacker and Dallas Fed President Richard Fisher have five dissents each.

It may be a sign of more debate to come this year on the FOMC, which already had been pondering when it should change the “extended period” language. Mr. Hoenig, long known as one of the committee’s most hawkish members, made his position rather clear in his latest public comments.

“Maintaining excessively low interest rates for a lengthy period runs the risk of creating new kinds of asset misallocations, more volatile and higher long-run inflation, and more unemployment–not today, perhaps, but in the medium and longer run,” he said earlier this month. “Maintaining short-term interest rates near zero could actually impede the recovery process in financial markets.”

Welcome back, Mr. Hoenig.

The Fed’s statement following the January meeting was very similar to December remarks, regarding its intentions. The central bank continues to see economic improvement and expects to scale back emergency programs, but makes no signal that rates are going to rise in the near term. But January featured the first dissent since the first meeting of 2009. (Read the full January statement.)

January meeting:
Business spending on equipment and software appears to be picking up, but investment in structures is still contracting and employers remain reluctant to add to payrolls. Firms have brought inventory stocks into better alignment with sales.
December meeting:
Businesses are still cutting back on fixed investment, though at a slower pace, and remain reluctant to add to payrolls; they continue to make progress in bringing inventory stocks into better alignment with sales.

The paragraph on the economic outlook, the Fed dropped its sentence about concerns in the housing market and upgraded its analysis of business spending.

January meeting:
While bank lending continues to contract, financial market conditions remain supportive of economic growth. Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability.
December meeting:
Financial market conditions have become more supportive of economic growth. Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.

The recovery is characterized as moderate compared to last month’s framing of economic activity as “weak.” But the Fed acknowledges concerns over bank lending.

January meeting:
With substantial resource slack continuing to restrain cost pressures and with longer-term inflation expectations stable, inflation is likely to be subdued for some time.
December meeting:
With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.

The paragraph on inflation is essentially unchanged.

January meeting:
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.
December meeting:
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

The section on interest rates is the same, with the Fed continuing to commit to low interest rates for “an extended period.”

January meeting:
[T]he temporary liquidity swap arrangements between the Federal Reserve and other central banks will expire on February 1. The Federal Reserve is in the process of winding down its Term Auction Facility: $50 billion in 28-day credit will be offered on February 8 and $25 billion in 28-day credit wil be offered at the final auction on March 8… The Federal Reserve is prepared to modify these plans if necessary to support financial stability and economic growth.
December meeting:
The Federal Reserve will also be working with its central bank counterparties to close its temporary liquidity swap arrangements by February 1. The Federal Reserve expects that amounts provided under the Term Auction Facility will continue to be scaled back in early 2010… The Federal Reserve is prepared to modify these plans if necessary to support financial stability and economic growth.

The paragraph on winding down emergency programs is largely unchanged, though the Fed adds concrete dates for the end of some facilities.

January meeting:
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh. Voting against the policy action was Thomas M. Hoenig, who believed that economic and financial conditions had changed sufficiently that the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted.
December meeting:
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.

The voting roster reflects the new makeup of the Federal Open Market Committee for 2010. It also marks the first dissent since January 2009. The statement explains that Hoenig didn’t object to the rate decision, but to the commitment to keep rates low for a long time.

The following is the full text of the Fed’s statement on rates following its January meeting.

Information received since the Federal Open Market Committee met in December suggests that economic activity has continued to strengthen and that the deterioration in the labor market is abating. Household spending is expanding at a moderate rate but remains constrained by a weak labor market, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software appears to be picking up, but investment in structures is still contracting and employers remain reluctant to add to payrolls. Firms have brought inventory stocks into better alignment with sales. While bank lending continues to contract, financial market conditions remain supportive of economic growth. Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability.

With substantial resource slack continuing to restrain cost pressures and with longer-term inflation expectations stable, inflation is likely to be subdued for some time.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve is in the process of purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. In order to promote a smooth transition in markets, the Committee is gradually slowing the pace of these purchases, and it anticipates that these transactions will be executed by the end of the first quarter. The Committee will continue to evaluate its purchases of securities in light of the evolving economic outlook and conditions in financial markets.

In light of improved functioning of financial markets, the Federal Reserve will be closing the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, and the Term Securities Lending Facility on February 1, as previously announced. In addition, the temporary liquidity swap arrangements between the Federal Reserve and other central banks will expire on February 1. The Federal Reserve is in the process of winding down its Term Auction Facility: $50 billion in 28-day credit will be offered on February 8 and $25 billion in 28-day credit wil be offered at the final auction on March 8. The anticipated expiration dates for the Term Asset-Backed Securities Loan Facility remain set at June 30 for loans backed by new-issue commercial mortgage-backed securities and March 31 for loans backed by all other types of collateral. The Federal Reserve is prepared to modify these plans if necessary to support financial stability and economic growth.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh. Voting against the policy action was Thomas M. Hoenig, who believed that economic and financial conditions had changed sufficiently that the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted.

In the following letter sent to Rep. Darrell Issa (R., Calif.) Fed Chairman Ben Bernanke responds to questions about American International Group:

The Honorable Darrell Issa
Ranking Member
Committee on Oversight and Government Reform
House of Representatives
Washington, D.C. 20515

Dear Congressman:

This is in response to your letter of January 22, 2010, asking questions about the role of the Federal Reserve in the transactions involving the American International Group, Inc. (AIG), the Federal Reserve, and certain counterparties ofcredit default swaps written by AIG on multi-sector collateralized debt obligations (CDOs).

In September 2008, the Federal Reserve extended emergency credit to AIG to prevent the imminent disorderly failure of the company, an event that would likely have led to a significant intensification of an already severe financial crisis and a further worsening of global economic conditions. We have provided significant information to Congress and the public on our actions with respect to AIG. Thomas Baxter, Executive Vice President and General Counsel of the Federal Reserve Bank of New York, will testify on this matter before your Committee today.

Because ofthe public interest, to afford the public the most complete possible understanding of our decisions and actions in this matter, and to provide a comprehensive response to questions that have been raised by members of Congress, I have welcomed a full review by the Government Accountability Office of all aspects of our involvement in the extension of credit to AIG.
Responses to your specific questions about these transactions are enclosed.

Sincerely,
Ben Bernanke

Responses to questions from Ranking Member Issa dated January 22, 2010, concerning certain counterparties of credit default swaps written by AIG on multisector collateralized debt obligations

Following the Federal Reserve’s initial secured loan, the ongoing stress in the financial markets continued to place substantial pressure on AIG. The CDS protection that AIG had written on multi-sector CDOs was a significant source of AIG’s capital and liquidity strains during 2008. These contracts require AIG to provide its counterparties collateral as the market value of the underlying CDOs, AIG credit rating, or the credit rating on the reference assets declined. As of November 5, 2008, AIG had posted or agreed to post approximately $37 billion in collateral against these exposures, and these exposures contributed significantly to the $24.5 billion in losses that AIG reported for the third quarter of 2008.

As a part ofthe restructuring of the government’s assistance to AIG by the Treasury and the Federal Reserve in November 2008, Maiden Lane III LLC (ML III) was formed to ease this continued pressure on AI G. ML III purchased from the CDS counterparties multi-sector CDOs with the par value of $62 billion referenced in the CDS at their current market value (approximately $29 billion), a substantial discount to par value. The purchase of the CDOs was funded in part by a loan of approximately $24 billion from the Federal Reserve Bank of New York (FRBNY) to ML III and a $5 billion equity contribution to ML III by AIG. In addition, the counterparties were allowed to retain approximately $35 billion in collateral already posted with the counterparties by AIG pursuant to its obligations under the CDS contracts. In return, the counterparties agreed to terminate the CDS, relieving AIG of, among other things, the obligation to post additional collateral pursuant to the CDS.

1. In deciding on how FRBNY would pay AIG’s CDS counterparties in return for tearing up their CDS contracts, did Federal Reserve officials take into consideration the financial health of the counterparties themselves?
Because of its concerns about the stability ofthe financial markets during this . period, the Federal Reserve was monitoring the financial condition of maj or banking and investment banking participants in the markets, which included many firms that were not counterparties to AIG’s CDS and some that were. However, the overriding motivating factor in structuring the payments to the counterparties was to relieve AIG ofthe destabilizing drains on its liquidity caused by the requirement to continue to post collateral as required by the CDS contracts. All counterparties were treated the same for payment purposes. Whether the individual counterparties were in relatively sound financial condition or not was not a factor in the decision regarding the amount paid to the counterparties or whether concessions should be sought from them.

2. Did you ever personally discuss the payment of AIG’s counterparties with employees or representatives of AIG’s counterparties?
I was not directly involved in the negotiations with the counterparties. These negotiations were handled primarily by the staff of the: FRBNY on behalf of the Federal Reserve. I participated in and supported the Board’s final action to authorize lending to ML III for the purpose of purchasing the CDOs in order to remove an enormous obstacle to AIG’s financial stability and thereby help prevent a disorderly failure of AIG during troubled economic times.

3. Were you ever personally involved in discussions about what AIG should disclose to the public or Congress about the payments to AIG’s CDS counterparties?
I was not directly involved in the discussions with AIG related to this decision. I fully supported AIG’s decision to release publicly in March 2009 the identities of the AIG’s CDS counterparties that received payments from ML III.

4. Did you ever recuse yourself from involvement with decisions related to the disclosure of the payments to AIG’s CDS counterparties and, if so, when?
I did not recuse myself from involvement with any decisions related to the disclosure ofpayments made to AIG’s CDS counterparties because I have no financial or other interest that would have made a recusal necessary or appropriate. However, as explained above, I was not involved in discussions with AIG regarding counterparties or the disclosure matters you raise. As I have previously indicated, I supported AIG’s decision to make public the identities of the counterparties, and those names were disclosed nearly a year ago. In addition, I was actively involved in Federal Reserve initiatives to expand disclosure of information relating to various Federal Reserve credit facilities, including the Monthly Report on Credit and Liquidity Programs and the Balance Sheet, and the weekly HA.l. release, which include detailed information on the status ofthe ML III credit facility. These and other publications of the Federal Reserve provide substantial information about all of our credit facilities, including the loans to AIG, ML III, and Maiden Lane II LLC, and the value of collateral supporting those loans.

5. What alternatives to the course FRBNY ultimately took in paying AIG’s CDS counterparties were considered and why were they rejected?
The alternatives considered by the FRBNY are explained in the testimony of Thomas Baxter, Executive Vice President and General Counsel, FRBNY, before the Committee on Government Oversight and Reform.
As I and other Federal Reserve officials have made clear in congressional testimony and elsewhere, the situation faced by AIG and the Federal Reserve in the fall of 2008 with respect to AIG’s CDS contracts pointedly demonstrates the urgent need for adoption of new resolution procedures for systemically important nonbank financial firms. Such a resolution authority would provide a wider range of tools for addressing the potential disorderly failure of a systemically significant firm, such as receivership or conservatorship powers, than are available to the Federal Reserve, which is limited to lending authority.

6. Did FRBNY consider assuming or guaranteeing AIG’s obligations to its CDS counterparties and, if so, why was this course of action rejected?
See answer to Question 5 above.

7. Ifthe Federal Reserve felt it lacked the statutory authority to pursue alternatives to the course FRBNY ultimately took in paying AIG’s CDS counterparties, why didn’t the Federal Reserve seek additional authority from Congress?
As I and other Federal Reserve officials have made clear in congressional testimony and elsewhere, the situation faced by AIG and the Federal Reserve in the fall of 2008 with respect to AIG’s CDS contracts pointedly demonstrates the urgent need for adoption of new resolution procedures for systemically important nonbank financial firms. Such a resolution authority would provide a wider range of tools for addressing the potential disorderly failure of a systemically significant firm, such as receivership or conservatorship powers, than are available to the Federal Reserve, which is limited to lending authority. Given the extremely compressed time frame in which a solution to the liquidity threat to AIG posed by its CDS had to be found, obtaining additional statutory authority for additional powers was not possible.

8. How did FRBNY determine the price it paid for the CDOs it purchased through Maiden Lane III (”ML3″)?
As explained in Mr. Baxter’s testimony, ML III purchased the multi-sector CDOs underlying AIG’s CDS at their current market value (approximately $29 billion), which represented a significant discount to their par value ($62 billion). Before agreeing to the transaction, the Federal Reserve consulted independent financial advisors to assess the value ofthe underlying CDOs and the expectation that the value ofthe CDOs would be recovered. The advisors believed that the cash flow and returns on the CDOs would be sufficient, even under highly stressed conditions, to fully repay the Federal Reserve’s loan to ML III. Under the terms ofthe agreement negotiated with AIG, the Federal Reserve will also receive two-thirds ofany profits received on the CDOs after the Federal Reserve’s loan and AIG’s subordinated equity position are repaid in fulL

9. Do you believe that FRBNY paid a fair price for the CDOs it purchased through ML3 and, if so, what basis do you support that belief?
See answer to Question 8 above.

10. Are you aware of any attempts by Federal Reserve officials, staff or outside counsel to prevent public disclosure of information about the payment of AIG’s CDS counterparties by seeking special procedures from the Securities and Exchange Commission (”SEC”)?
I was not involved in discussions with the SEC about any disclosure issues involving AIG. I understand that the Federal Reserve staff and its outside advisors supported AIG’s initial application to the SEC to have the names of the CDS counterparties that sold CDOs to ML III remain confidential in public disclosures. I understand that the material sought to be kept confidential was handled under the special procedures created by the SEC for handling certain types of information for which confidential treatment has been requested. Under these procedures, the SEC keeps the confidential information in a separate safe so that the confidential version of the relevant document is not mistakenly treated as the public version. The procedures do not relate to the SEC’s decision with regard to whether the information at issue warrants confidentiality under applicable standards.
Three months later AIG changed its view and decided to reveal the counterparty names. The Federal Reserve supported that decision. The counterparty names were disclosed nearly one year ago. I also understand that AIG has continued to ask the SEC to keep confidential certain commercially sensitive information, including CUSIP numbers and tranche names, that would identify the individual CD Os that ML III acquired from the counterparties. The Federal Reserve has supported this request. The FRBNY and its advisors believed that public disclosure of the identifying details concerning individual securities in ML Ill’s portfolio, including to market participants, would undercut the ability of ML III to sell those assets for a maximum return to the detriment of taxpayers. In May 2009, the SEC independently concluded that this commercially sensitive information need not be disclosed. All other material information concerning the ML III transaction has been disclosed in AIG public filings with the SEC.

11. Are you aware of any attempts by Federal Reserve officials, staff or outside counsel to prevent Congress from obtaining information about the payment of AIG’s CDS counterparties?
The Federal Reserve has made a tremendous amount of information about its actions with respect to AIG available to Congress in testimony, correspondence, and reports as well as to the public on the Federal Reserve website. I strongly support the goal of transparency with respect to the Federal Reserve’s actions in connection with the creation of the ML III credit facility and the other actions we have taken regarding AIG. To further this goal, I have welcomed a full review by the Government Accountability Office of all aspects of our involvement in the extension of credit to AIG.

12. Are you aware of any attempt by Federal Reserve officials, staff or outside counsel to prevent public disclosure, either through the SEC or Congress, of any AIG employee compensation packages?
See answer to Question 11.

Ben Bernanke now appears increasingly likely to get the 60 votes in the Senate that he needs to stay on the job as Federal Reserve chairman for another four years, thanks to lobbying from the White House, the queasiness of financial markets and a boost from Warren Buffett (who persuaded a home-state senator).

No nominee for chairman of the Federal Reserve has ever been rejected by the Senate, as has been noted widely. But it wouldn’t have been the first time that the Senate killed a White House nomination for a Fed post.

Thomas D. Jones, a Chicago businessman, was nominated by Woodrow Wilson to be one of the original members of the Federal Reserve Board in 1914. Jones was controversial because he was a director of the International Harvester Company, unpopular with farmers and progressives and then facing state and federal charges that it was an illegal business combination in restraint of trade.   But he was a friend and supporter of Wilson, and the president was embarrassed and embittered by opposition to the nomination, according to a history of the Fed prepared by the Federal Reserve Bank of Boston.  The Banking Committee rejected the nomination 7-4. Wilson initially refused to back down, prompting a headline-making showdown on the Senate floor over whether to make Jones’ testimony public. Wilson eventually relented and the nomination was withdrawn.

More recently, President George W. Bush nominated sitting Fed governor Randall Kroszner for a full 14-year term as a Fed governor. Because of opposition from Senate Banking Committee Chairman Chris Dodd, among others, the Senate never considered the nomination. Mr. Kroszner, who served on the Fed board from 2006 to 2009, is now back at the University of Chicago’s Booth School of Business.

The Obama administration is taking on some of the nation’s biggest banks, proposing to raise their taxes and limit their size. The latest research from finance professors at the University of Chicago and Northwestern University underscores why the moves are so popular with the public: Americans’ trust in national banks, compared to smaller community banks, is slow to recover from the depths of the financial crisis.

The latest Chicago Booth/Kellogg School Financial Trust Index, released late Tuesday night, found that overall trust in banking institutions rose to just 33% in late December 2009 from 29% in March 2009, during one of the worst points of the financial crisis. “In relative terms, trust in banks over the last year hasn’t been restored in the same way as trust in stocks, mutual funds, or large corporations,” Northwestern’s Paola Sapienza said in releasing the latest quarterly results.

Credit unions had a 58% approval rating, according to the study based on phone surveys of Americans. Local banks came in at 53%. National banks registered a 31% approval. Banks in which the government has a stake were trusted the least, with a 21% approval rating.

Public support for financial regulation stood at 61% in late December. That was down slightly from 65% in June 2009. And more Americans seem to have doubts about the government’s intervention in the economy.  In the latest survey, 32% said economic policies were designed to favor the financial industry. That’s up from 22% in September 2009.

“People still view government intervention favorably on actions such as helping out homeowners, but they have moved away from wanting the government to be involved in running major financial institutions,” said the University of Chicago’s Luigi Zingales.

The split in the U.S. Senate on Federal Reserve Chairman Ben Bernanke’s nomination for a second term mirrors a divide among the American public, according to the latest Wall Street Journal/NBC News poll.

About 18% of those surveyed said they were “positive” about Mr. Bernanke, the same share that said they were “negative.” Of the rest, 19% called themselves “neutral” and 45% said they were unsure. That puts Mr. Bernanke’s ratings slightly ahead of those of Treasury Secretary Timothy Geithner, who had a smaller “positive” share.

About 37% of those polled Jan. 23-25 opposed Mr. Bernanke’s reappointment and 34% supported it with the rest not sure. That was little changed from a June poll. The new poll has a margin of error of plus or minus 3.46 percentage points.

Of those who have investments, 38% supported his reappointment and 35% were opposed. Those with $50,000 or more in investments favor a second term by 42% to 37%. Of those without investments, 28% supported reappointment while 40% were opposed.

Mr. Bernanke first became Fed chairman in 2006 under President George W. Bush.  President Barack Obama nominated him for a second term as chairman last August.  Of those polled who said they voted for Mr. Obama in 2008, 42% supported Mr. Bernanke’s reappointment while 33% were opposed.  Voters for Sen. John McCain in 2008 opposed Mr. Bernanke’s reappointment 45% to 26%.

The poll found that Mr. Bernanke has a gender gap. Men favor a second term, 40% to 36%; women oppose, 39% to 28%.

People with a high school education or less opposed Mr. Bernanke 43% to 22%, while those with at least some college supported him 39% to 32%. People with a postgraduate education supported Mr. Bernanke 41% to 33%.

In an October 1999 Journal/NBC poll, 61% said Alan Greenspan should be reappointed while just 16% were opposed.

The Senate Banking Committee is expected to have a hearing Tuesday, Feb. 2, to hear from former Federal Reserve Chairman Paul Volcker about the White House’s recent proposal to limit the size and risk of big U.S. banks.

The White House announced the new plan last week and is calling part of it the “Volcker Rule,” but they haven’t provided many details about how exactly the new limits would work. The plan would make it harder for big banks to grow and would also prohibit companies with federally insured deposits from certain trading activities.

The hearing is part of an effort by lawmakers on the panel to come up with a bipartisan plan to overhaul financial regulation.

Final details of the hearing haven’t been nailed down, such as whether other witnesses will attend.

In what could be seen as a veiled swipe at the Federal Reserve’s “extended period” language, European Central Bank executive board member Lorenzo Bini Smaghi warned that if rates stay low for too long, they could fuel another asset bubble.

“Any commitment to prolonged periods of low interest rates is risky,” Bini Smaghi said in a speech posted on the ECB’s Web site Tuesday. “If the aim is to lower long-term rates, it may also encourage market participants to take substantial long positions in the fixed income market,” he said, and risk suffering heavy losses when policymakers exit from their accommodative policies.

The risk of such losses “may induce the central bank to further delay the exit to avoid penalizing banks,” Bini Smaghi said, which “seems to be the experience of 2002-2004.”

“As a result, interest rates may remain below the desired level for too long, fueling a possible bubble,” he said.

That appears to contradict Ben Bernanke’s recent assertion that low interest rates during that time didn’t fuel the U.S. housing bubble.

Bini Smaghi’s comments were posted on the first day of a two-day meeting of the Federal Reserve, where officials are expected to maintain their longstanding commitment to keep rates “exceptionally low…for an extended period.”

The ECB official’s worry? That policymakers — he didn’t cite any central bank in particular — will send a signal that they’re less worried about exiting too late then they are exiting too early. If that’s the case, market participants could expect low rates “to be extended beyond what is necessary,” Bini Smaghi said.

He even disputed the “textbook example” of exiting too early: the US experience in 1936, largely seen as a “mistake not to be repeated” since it preceded the 1937-38 recession. “In fact, examining closely the 1936 episode in the U.S., it might not even be considered as an early exit,” Bini Smaghi said.

“The 1936 episode might be considered as an example of a badly calibrated and badly communicated exit, rather than a wrongly timed exit.”

In the latest broadside from Democrats against big banks, U.S. Rep. John Dingell (D., Mich.) introduced a bill Tuesday that would direct the government to simply break up banks deemed too large to fail. Banks ordered to restructure would also face higher capital requirements.

The bill, called the “Financial Services Industry Stability Act of 2010,” goes much further than legislation that passed the House of Representatives in December, which would give the government more power and discretion to determine if a company is too big to fail (that bill wouldn’t necessarily require these firms be broken up). It’s unclear whether Rep. Dingell’s bill will attract much support, though there is at least one ominous sign for banks: his proposal was modeled after a section of the Endangered Species Act.

“Amazingly, more than a year after these superbanks nearly bankrupt our country, they continue to be very big, very powerful, very arrogant and very greedy,” Mr. Dingell said. “Nothing has changed from this time 15 months ago, including the banks’ desire to make big bets that produce even bigger bonuses for executives. We need to send a clear message to our banks and the executives who run them this behavior has to change.”

The steps of the U.S. Treasury were hit by a blast from the past on Tuesday.

Former U.S. Treasury Secretary Henry Paulson was at the Treasury filming an interview with CBS. A Treasury spokesman said Paulson, who is expected to release a book on the financial meltdown in the near future, did not meet with any Treasury officials during his visit to the building.