At a House Oversight and Government Reform Committee hearing on March 21, members heard from Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner on the European sovereign debt crisis and its effects on the United States.
Chairman Darrell Issa (R-Calif.) said the focus of the hearing was not the United States’ economy but if the European Union and International Monetary Fund (IMF) spend hundreds of billions of euros to aid Greece, Ireland, and others, whether it would cause America to be drawn into the problem.
“I believe after over a year of watching the Greece on again, off again crisis there is a certain assumption that eventually it will be solved,” Issa said.
But Issa said he wanted to look to the future and ask questions to prevent another crisis from occurring.
Ranking Member Elijah Cummings (D-Md.) said that while no one is declaring a “mission accomplished” in Europe, “the signs of improvement are impossible to miss.”
“If we want to ensure that our economy at home is strong enough to weather the euro crisis or turbulence from slowdowns in other foreign economies, we must end the housing crisis here at home,” Cummings said, adding that the U.S. needs policies that allow for principal reduction.
In his opening statement, Geithner said European leaders have taken encouraging steps to address the economic crisis and they must continue with further action. He said the causes of the crisis were years in the making and different across Europe. Long-lasting low interest rates, increased borrowing and spending, and the erosion of private competitiveness all contributed to the crisis. He said that countries have put in place reforms to address these underlying issues, including the reduction of governments’ structural budget deficits, reforms that restore competitiveness by improving business environments and labor laws, and acting to restructure and repair Europe’s banking system. He said that for reforms to work fiscal consolidation must be gradual.
“If every time economic growth disappoints governments are forced to cut spending or raise taxes immediately to make up for the impact of weaker growth on deficits, this would risk a self-reinforcing negative spiral of growth-killing austerity,” Geithner said.
Geithner said it is necessary to build a stronger European firewall “to provide a backstop for the governments undertaking reform.”
“It is in the interests of the United States that the IMF continues its efforts in Europe, but the IMF's resources cannot substitute for a strong and credible European firewall,” he said.
He said the US is encouraged by the progress Europe has made so far and hope it can continue to build on these efforts, but that Europe is still at the initial stages of what will be a long and difficult path of reform.
“And for these reforms to work, policy-makers in the euro area are going to have to carefully calibrate the mix of financial support and the pace of consolidation -- fiscal consolidation – ahead,” Geithner said.
In his opening statement, Bernanke said the developments of high debt and deficits along with poor growth prospects causes concern about fiscal sustainability, borrowing costs, and confidence in financial institutions in Europe. He said U.S. exports have suffered due to the European crisis, stating “U.S. exports to Europe over the past two years have underperformed our exports to the rest of the world.”
He said progress has been made, but more action is needed to strengthen the European banking system, expand financial firewalls to guard contagion in sovereign debt markets, and to increase competitiveness and reduce external imbalances.
Bernanke said actions taken by the Federal Reserve are “focused on protecting U.S. financial institutions, businesses, and consumers from adverse financial and economic developments in Europe.”
He said the Fed has worked with foreign central banks to enhance the U.S. dollar swap facilities and has collaborated with other agencies to monitor potential vulnerabilities of U.S. financial institutions.
Bernanke noted that the total amount of swap lines has fallen back to about $65 billion currently.
He said that even though U.S. banks have limited exposure to the peripheral European countries, risk of contagion remains a concern.
Bernanke noted that there are some exposures arising from the sale of credit default swaps (CDS) on sovereign debt.
“But our assessment is that those are broadly hedged with CDS and in the other direction, and that the counter parties to those CDS are broadly disbursed and are strong banks in Europe,” he said.
Bernanke noted that although U.S. banks have limited exposure to peripheral European countries, their exposures to European banks and to the larger core countries is much more material. He noted that European holdings represent 35 percent of the assets of prime U.S. money market funds, which is causing those funds to remain structurally vulnerable, despite some constructive steps taken since the recent financial crisis.
Bernanke said that if the situation in Europe were to take a severe turn for the worse, the U.S. financial sector “likely would have to contend not only with problems stemming from its direct European exposures, but also with an array of broader market movements, including declines in global equity prices, increased credit costs and reduced availability of funding.”
Bernanke noted the recent release of its stress tests of the largest banks or bank-holding companies.
Bernanke said the hypothetical stress scenario on the banks included a deep recession in the United States, with unemployment reaching 13 percent, a decline in activity abroad, combined with sharp decreases in both domestic and global asset prices.
“The results show that a significant majority of the largest U.S. banks would continue to meet supervisory expectations for capital adequacy despite large projected losses in an extremely adverse hypothetical scenario,” Bernanke said.
Question and Answer
In response to questions on international counterparties’ concerns about the proposed Volcker Rule, Geithner said “we are going to look at all the concerns expressed by these rules, and it is my view that we have the capacity to address those concerns.”
Cummings questioned Geithner’s involvement in negotiations with Federal Housing Finance Agency (FHFA) and asked why Acting Director Edward DeMarco has not begun principle reductions even though Treasury has offered “triple incentives of principal reductions.”
“There are certain cases where we think there is a pretty strong economic case for principal reduction as part of a strategy to limit the future losses to the [government-sponsored enterprises],” Geithner said, adding that Treasury is having discussions with FHFA about how to “narrow the differences between us. But he will have to make these choices."
Rep. Patrick McHenry (R-N.C.) asked Bernanke whether the Fed can purchase other countries' sovereign debt.
Bernanke said he has legal authority to purchase small amounts for the purposes of reserve holdings, but “we are not engaging in purchasing debt of troubled countries” and “we are not considering it.”
McHenry asked Geithner whether the Treasury is considering additional contributions to the IMF.
Geithner said Treasury is not and it is the Department’s judgment that the IMF already has $400 billion of available resources it can use if necessary to help support the needs of its members.
“Europe, of course, has very substantial financial capacity to put behind their strategy to resolve this crisis,” he said. “And therefore, we do not see the case for coming to Congress and asking for more authority in this context.”
McHenry also asked Bernanke about comments he made at an earlier hearing that if Congress fails to address several expiring tax provisions, deal with the sequestration that is set to go into effect at the end of the fiscal year, and other issues that the inaction would result in a “fiscal cliff.”
Bernanke said that “for a number of reasons if under current law, if no further action is taken, there'll be what I've termed a ‘fiscal cliff on’ January 1 of 2013 as a number of tax and other provisions expire, including the Bush tax cuts, the payroll tax, U.I. benefits and at the same time on the spending side if sequestration arising from the failure of the Supercommittee to agree kicks in.”
“And if all those things happen I think there would be a very sharp and rapid fiscal contraction that would be a serious negative for the recovery,” he said. “I hope that Congress will take the opportunity to think through where they want fiscal policy to go and this will be in some sense a forcing event.”
For a webcast of this hearing, click here.