The following are highlights of Federal Reserve Chairman Ben Bernanke's testimony on Thursday to the Senate Banking Committee as part of his semiannual testimony on the U.S. economy and monetary policy. Bernanke repeated prepared testimony he delivered to a House of Representatives panel on Wednesday.

For a text of Bernanke's prepared remarks, see http://financialservices.house.gov/UploadedFiles/071311bernanke.pdf

BERNANKE ON MORTGAGE RATES AND DISTRESSED HOUSE SALES:

We are trying to keep mortgage rates low, and we are trying to encourage lending -- an appropriate balance of lending between making sure the loans are safe and sound and making sure credit-rated borrowers have access to credit.

I think one area where Congress might want to take a look at, is one of the basic problems is that we have such a large overhang of empty, distressed sale, foreclosed upon houses -- that's pulling down prices, that's pulling down appraisals.

It's hurting neighborhoods, it's hurting cities. I think that scenario is worth looking at and maybe we find a way to reduce that overhang, or try to provide incentives for investors to convert them, or something like that. That's one of the main problems that the Fed can't directly address.

ON BANK PENALTIES FOR FAULTY MORTGAGE SERVICERS:

We had an investigation of the servicing concerns jointly with the other banking agencies. As you know, we found many bad practices.

The Federal Reserve, along with other agencies, has an order on the servicers to fix up their act and to go back and look at every foreclosure going back over several years, and to compensate anyone who was injured by their practices. And we will be imposing some civil penalties at some point.

BERNANKE ON U.S. NOT PAYING ALL OBLIGATIONS:

I think that not paying our obligations, whether they be financial obligations or payment to Social Security recipients or others, any of those things would involve default.

Sure, of course (that would hurt the economy).

BERNANKE ON A SHORT-TERM DEBT LIMIT EXTENSION:

It's important both to raise the debt ceiling to avoid the extensive problems we discussed, it's also important to show we can make progress on the long-term deficit.

There are political and tactical issues here, but clearly what we want to do is get as big a deal as we can to show we are serious and going to address the long term.

The risk (of repeated one-month extensions) is that you would lose credibility in the markets about your willingness to carry through. And so, if you did that, it would be important to send signals somehow that you have a plan.

BERNANKE ON FED KEEPING ALL POLICY OPTIONS READY:

Given that there is a lot of uncertainty about how the economy will evolve, we have to keep all options, both for tightening and for easing, on the table. Again, we are doing that.

But again we are already providing an exceptional amount of accommodation and the recovery is still pretty slow.

BERNANKE ON DEBT LIMIT TALKS:

I don't want to inject myself into these discussions on how to solve budget issues fairly.

We want to have shared sacrifice, we want to make sure we maintain a strong economy, there are a whole bunch of issues there. Again these are not issues that pure economic analysis can answer, these are values issues, and that is what ... elected officials are supposed to be determining. I really can't, you know, make those decisions for you.

BERNANKE ON WHAT WOULD HAPPEN IF DEBT LIMIT AGREEMENT IS NOT REACHED;

It certainly could slow the economy through higher interest rates and through financial volatility but you actually make a different point that I think is worth emphasizing. The higher interest rates would add to the deficit but also a slowdown in economic activity, by reducing revenues, would also add to the deficit, so it really is going in the wrong direction in terms of fiscal stability.

BERNANKE ON PRODUCTIVITY:

There's little bit of an irony here, which is that generally speaking, productivity gains are a really good thing and helps make the country rich over time, but over very short periods, and in this crisis for example, a lot of firms got very scared.

They reduced their labor forces and they tried to find ways to produce the same output you mentioned without as many workers and in doing so, they increased productivity remarkably. But given the low level of demand, their demand for workers is not as strong as we would like.

BERNANKE ON IMF RESOURCES IN CASE SPAIN AND ITALY SEEK FINANCIAL AID:

Spain and Italy are much bigger economies than the three that have already been addressed, and if it came to that point -- and I don't anticipate that happening -- the Europeans would have to make a very substantial contribution to stabilize those countries.

BERNANKE ON MARKET CONCERNS ABOUT ITALY:

My sense of Italy is that the first line of defense is for Italy to take necessary steps. It is true that Italy has a very high debt-to-GDP ratio, but it has some strengths, notably it currently has a primary surplus so its fiscal position, in terms of the current deficit, is much better than Greece for example.

Its banks are in decent shape and they have taken some extra capital in recently.

BERNANKE ON MONITORING STATES' DEBTS, LIABILITIES:

States don't generally have the same kinds of levels of debt that our U.S. government or European governments have. And, indeed, they rely on federal money for, say, Social Security, medical care, and other things. So, there are some states -- Illinois, California -- that are having more difficulty. We watch those very carefully. We also look at the exposures of banks and other institutions to those states. We don't see any immediate risk there. But it is true that a number of states do need to be thinking about their longer-term sustainability, given the unfunded liabilities they may have for state pensions and, in some cases, for healthcare programs as well. We are monitoring that situation, but we don't think it's analogous to the European situation.

BERNANKE ON LOWER MORTGAGE LOAN LIMITS:

The increase in the loan limits was made on an emergency basis, obviously, to try and address the housing crisis. The administration -- or I guess the GSEs -- are making the determination that it is time to begin to wean a little bit of the mortgage market from those higher conforming limits.

Nationally, there has been I think some improvements in the willingness of banks to make jumbo loans.

It will impose some extra costs of borrowers of very large mortgages, but I don't think in most cases that they will be squeezed out of the market. Those are some of the trade-offs that the GSEs and of course the Congress are looking at.

BERNANKE ON MONETARY EASING, ASSET PURCHASES

These asset purchases -- I recognize they're unconventional. But, in terms of their effects on the economy, they work more or less much in the same way as ordinary monetary policy works by easing financial conditions, lowering interest rates, and providing stimulus through that mechanism. Now, you may be entirely correct a) that it may not be needed, and b) that it might not be entirely effective given the configuration of problems that we have ...

We're not proposing anything today. The main message I want to leave is that this is a serious situation. It involves a significant loss of human and economic potential. The Federal Reserve has a mandate and we want to meet that mandate, and to do that we just want to make sure we have the options when they become necessary. But at this point, we're not proposing to undertake that option.

BERNANKE ON EUROPEAN EXPOSURE:

It is causing a good bit of anxiety in markets and that's been affecting our economy both last summer and now recently as well. We are spending a lot of time evaluating the exposures of U.S. financial institutions to these countries, including money market mutual funds and so on.

The direct exposures to the three counties you mentioned are quite small and manageable, so we would not expect those direct impacts to be the critical channel if there were problems, a default for example. But I think that nevertheless, the U.S. economy is at risk from those developments, because were there to be a significant deterioration in conditions in Europe, we would see a general increase in risk aversion, declining asset prices, a lot of volatility in markets and we would suffer from that more ... than we would from the direct exposures to those sovereign countries.

BERNANKE ON GLOBAL EFFECTS OF TREASURY DEFAULT:

It would be a calamitous outcome. It would create a very severe financial shock that would have effects not only on the U.S. economy but the global economy. Treasury securities are critical to the entire financial system. They are used in many ways. For example, as collateral or as margin. Default on those securities would throw the financial system potentially into chaos. In any case, what would certainly be the case is that we would destroy the trust and confidence that global investors have in U.S. Treasury securities as being the safest and the most liquid assets in the world.

BERNANKE ON THE IMPACT OF HOUSING MARKET ON RECOVERY:

The housing market is really at the epicenter of the problem we're having at the moment.

Weakness in the housing market is one of the major sources of this slow recovery. Normally in an expansion, you would see the housing market strengthening, and adding jobs, and creating new opportunities. We're not seeing that.

The big overhang of distressed sales, open, vacant homes, foreclosed homes, which are weighing on prices is creating a vicious circle where people don't want to buy because prices are falling and prices are falling because people don't want to buy.

Ben Bernanke Federal reserve