[Senate Hearing 109-956]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 109-956
 
                   NOMINATIONS OF: EDWARD P. LAZEAR, 
                RANDALL S. KROSZNER, AND KEVIN M. WARSH

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                       ONE HUNDRED NINTH CONGRESS

                             SECOND SESSION

                                   ON

                            NOMINATIONS OF:

          EDWARD P. LAZEAR, OF CALIFORNIA, TO BE CHAIRMAN OF 
                    THE COUNCIL OF ECONOMIC ADVISERS

                               __________

         RANDALL S. KROSZNER, OF NEW JERSEY, TO BE A MEMBER OF 
          THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

                               __________

            KEVIN M. WARSH, OF NEW YORK, TO BE A MEMBER OF 
          THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

                               __________

                           FEBRUARY 14, 2006

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


      Available at: http: //www.access.gpo.gov /congress /senate/
                            senate05sh.html

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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  RICHARD C. SHELBY, Alabama, Chairman

ROBERT F. BENNETT, Utah              PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado               CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming             TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska                JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania          CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky                EVAN BAYH, Indiana
MIKE CRAPO, Idaho                    THOMAS R. CARPER, Delaware
JOHN E. SUNUNU, New Hampshire        DEBBIE STABENOW, Michigan
ELIZABETH DOLE, North Carolina       ROBERT MENENDEZ, New Jersey
MEL MARTINEZ, Florida

             Kathleen L. Casey, Staff Director and Counsel
     Steven B. Harris, Democratic Staff Director and Chief Counsel
               Peggy R. Kuhn, Senior Financial Economist
                       Mark F. Oesterle, Counsel
                    Mike Nielsen, Professional Staff
                Aaron Klein, Democratic Chief Economist
                 Dean V. Shahinian, Democratic Counsel
   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
                       George E. Whittle, Editor

                                  (ii)






















                            C O N T E N T S

                              ----------                              

                       TUESDAY, FEBRUARY 14, 2006

                                                                   Page

Opening statement of Chairman Shelby.............................     1

Opening statements, comments, or prepared statements of:
    Senator Bennett..............................................     2
    Senator Schumer..............................................     3
    Senator Sarbanes.............................................     4
    Senator Carper...............................................    18
    Senator Reed.................................................    24

                                NOMINEES

Edward P. Lazear, of California, to be Chairman of the Council of 
  Economic Advisers..............................................     6
    Prepared statement...........................................    32
    Biograpical sketch of nominee................................    35
Randall S. Kroszner, of New Jersey, to be a Member of the Board 
  of Governors of the Federal Reserve System.....................     6
    Prepared statement...........................................    32
    Biograpical sketch of nominee................................    57
Kevin M. Warsh, of New York, to be a Member of the Board of 
  Governors of the Federal Reserve System........................     8
    Prepared statement...........................................    33
    Biograpical sketch of nominee................................    72

                                 (iii)



















                            NOMINATIONS OF:

                    EDWARD P. LAZEAR, OF CALIFORNIA,

                           TO BE CHAIRMAN OF

                   THE COUNCIL OF ECONOMIC ADVISERS;

                  RANDALL S. KROSZNER, OF NEW JERSEY,

                    AND KEVIN M. WARSH, OF NEW YORK,

               TO BE MEMBERS OF THE BOARD OF GOVERNORS OF

                       THE FEDERAL RESERVE SYSTEM

                              ----------                              


                       TUESDAY, FEBRUARY 14, 2006

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.

    The Committee met at 2:36 p.m., in room SD-538, Dirksen 
Senate Office Building, Senator Richard C. Shelby (Chairman of 
the Committee) presiding.

        OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

    Chairman Shelby. The hearing will come to order. We are 
sorry about this morning, but as I said to you privately, the 
floor takes precedence over everything.
    This afternoon, we will consider the nominations of three 
very distinguished individuals. Our first nominee is Dr. Edward 
Lazear, nominated by President Bush to be a Member of the 
Council of Economic Advisers. The Council of Economic Advisers, 
established by the Employment Act of 1946, provides the 
President with economic analysis and advice on the development 
and the implementation of domestic and international policy 
issues. Upon Senate confirmation, President Bush would 
designate Dr. Lazear to serve as Chairman of the CEA.
    Dr. Lazear currently serves as Professor of Human Resources 
Management at Stanford University, and as the Morris Arnold Cox 
Senior Fellow at the Hoover Institution. Previously, Dr. Lazear 
taught at the University of Chicago's Graduate School of 
Business, and he has been a visiting professor at many 
universities and institutes around the world. Dr. Lazear 
received a Ph.D. in economics in 1974 from Harvard and has a 
B.A. and M.A. in economics in 1971 from UCLA.
    Dr. Lazear also serves as a Research Associate at the 
National Bureau of Economic Research. Many people are also 
familiar with his work on the President's Advisory Panel on Tax 
Reform. Dr. Lazear is a Founding Editor of the Journal of Labor 
Economics, published by the University of Chicago. His 1996 
book, Personnel Economics, was selected by MIT Press as an 
outstanding book and by Princeton as one of the 10 most 
important books in labor economics. Dr. Lazear is well-
respected for his wide ranging research on employee incentives, 
promotions, compensations, and productivity in companies.
    The Committee will also consider two nominees to serve as 
Members of the Board of Governors of the Federal Reserve 
System, Dr. Randall S. Kroszner of New Jersey and Mr. Kevin M. 
Warsh of New York.
    This afternoon will be Dr. Kroszner's second nomination 
hearing before the Committee. In November 2001, this Committee 
considered his nomination to serve as a Member of the Council 
of Economic Advisers. He was confirmed by the Senate for this 
position and served at the CEA through July 2003.
    He currently serves as Editor of the Journal of Law and 
Economics, on the Board of Directors of the National 
Association of Business Economists, as a Research Associate at 
the National Bureau of Economic Research, and as a Senior 
Fellow at the FDIC Center for Financial Research. He has also 
edited a number of academic journals, including the Journal of 
Financial Services Research, the Journal of Economics and 
Business and Economics and Governance. He has been a Visiting 
Scholar at the International Monetary Fund and the London 
School of Economics.
    He has spent time as a Visiting Scholar at the Federal 
Reserve in Washington, DC, and at regional Federal Reserve 
Banks in New York, Kansas City, St. Louis, Minneapolis, and 
Chicago. He received his Ph.D. from the Economics Department of 
Harvard University and graduated magna cum laude in 1984.
    Our second nominee to the Board of Governors is Mr. Kevin 
M. Warsh, who currently serves on the President's National 
Economic Committee. Mr. Warsh is also no stranger to this 
Committee. During his tenure on the NEC, Mr. Warsh directed 
policy on a wide array of financial issues, including the 
implementation of Sarbanes-Oxley, regulatory reform for 
Government Sponsored Enterprises and terrorism risk insurance.
    Mr. Warsh worked closely with Members of this Committee and 
has earned our respect. Mr. Warsh is also Executive Secretary 
of the National Economic Council. Prior to coming to 
Washington, he was the Executive Director of the Mergers and 
Acquisitions Department of Morgan Stanley's Investment Banking 
Division. Mr. Warsh is a graduate of Stanford University, where 
he graduated with honors in economics. He received his J.D. 
from Harvard Law School, where he graduated cum laude.
    We look forward to hearing your statements this afternoon 
and to an interesting discussion to follow. At this time, I 
will recognize Senator Bennett, and then, I will recognize 
Senator Schumer for any introduction he wants to make.

             STATEMENT OF SENATOR ROBERT F. BENNETT

    Senator Bennett. Thank you, Mr. Chairman.
    I will just withhold my prepared statement and ask 
questions at the appropriate time. I have met Dr. Lazear, who 
has been in the office, and I am very impressed, and he and I 
had a long conversation which I will not repeat here, but we 
are on the same page on a number of very important issues.
    Chairman Shelby. Senator Schumer is a Member of the 
Committee. We generally do not have him down there; he is up 
here, but----
    Senator Schumer. Here I am.
    Chairman Shelby. Senator Schumer, for any introduction you 
want to have.
    Senator Schumer. If you would like to nominate me to the 
Federal Reserve Board, maybe----
    [Laughter.]
    Chairman Shelby. I did not go that far.
    Senator Schumer. Exactly.
    Senator Bennett. Would that get you out of the Senate?
    [Laughter.]
    Senator Schumer. Silver lining to every cloud.
    Chairman Shelby. That would be a big cost, though.

            STATEMENT OF SENATOR CHARLES E. SCHUMER

    Senator Schumer. Thank you. Thank you, Mr. Chairman.
    I would like to welcome all the nominees here today. I want 
to welcome Mr. Kroszner and I want to welcome Mr. Lazear, who 
was born in New York but who left awhile ago; and a special 
welcome to Mr. Warsh, a New Yorker.
    I have said many times before this Committee to Mr. Warsh 
and to recent nominees in our meetings that our country is in 
need of economic leadership. Leadership, in my opinion, is, for 
the most part, nonideological and nonpartisan; true leaders 
that are committed to keeping America great by creating policy 
that will once again, for instance, get the United States to 
the top of rankings in areas like math education.
    Right now, we are in 21st place, tied with Poland, Hungary, 
and Spain, according to the OECD. We will not stay the greatest 
country in the world if that continues to happen. Creating 
policy that will cut our budget deficit as opposed to creating 
a budget deficit larger than nondefense, nonsecurity, 
discretionary spending and creating sound trade policy that 
demands that our trading partners, like China, play by world 
economic rules to further avoid the widening trade gap.
    All three of our nominees today, Mr. Chairman, have an 
opportunity, as a matter of fact a responsibility, to be the 
economic leaders that I am speaking of, and I will be watching 
all of them. And I am particularly pleased to be here to 
nominate one of those potential leaders. I am here today to 
introduce Kevin Warsh, who is nominated to be a Member of the 
Federal Reserve Board of Governors. Mr. Warsh is a lifelong New 
Yorker. He was born and raised in the capital region near 
Albany in the City of Loudonville, where he attended Shaker 
Senior High School, a high school I have had the occasion to 
visit.
    From Shaker, Mr. Warsh went on to Stanford University, 
where he graduated Phi Beta Kappa with a degree in public 
policy. Later, he studied economics and regulatory policy at 
Harvard Law School, where he focused his coursework on market 
economics and debt capital markets, taking classes at the 
Harvard Business School and the MIT Sloane School of Business.
    I know that you are proud to be here to support Kevin 
Warsh--I am saying this to Jane, I want to welcome her, another 
New Yorker, whose family I am proud to know, and I know that 
Jane is proud to support Kevin, who decided shortly after 
September 11 to leave Wall Street and accept his calling to 
public service, a commitment he is now clearly stating he is 
willing to make for 14 years, which is a long time.
    For the last 4 years, Mr. Warsh has served as the Special 
Assistant to the President for Economic Policy and Executive 
Secretary of the National Economic Council. His areas of 
expertise have ranged from domestic finance, banking, and 
securities regulatory policy to consumer protection. He has 
advised the President and senior administration officials on 
issues related to the U.S. economy, particularly fund flows and 
capital markets, securities, banking, and insurance issues, and 
he participated in meetings of the President's Working Group on 
Financial Markets.
    Prior to working in Washington, Mr. Warsh had a 
distinguished career on Wall Street as a Member of the Mergers 
and Acquisitions Department at Morgan Stanley, where he 
ultimately served as Vice President and Executive Director.
    So it is without question, Mr. Chairman, that Mr. Warsh is 
tremendously accomplished for a man his age, and for that 
reason, it is no surprise that he is already no stranger to the 
Federal Reserve. He spent a considerable amount of time over 
the past few years working with the System. He worked closely 
with Federal Reserve Governors, including Chairman Greenspan, 
on a host of economic issues and worked closely with Timothy 
Geithner, another gentleman I am proud to know, he is President 
of the New York Federal Reserve Bank, on broad issues facing 
the securities and banking industries.
    In our conversations, Mr. Warsh has assured me he will 
continue to focus on consumer protection issues at the Fed, an 
area many do not always see the Fed having oversight of, but 
protecting the rights of consumers through increased and 
significant disclosure mechanisms is very important as well.
    His significant finance experience as a banker and 
regulatory experience on the NEC will prove valuable, as the 
Fed carries out its responsibility beyond monetary policy, its 
responsibility beyond monetary policy, its responsibility to 
the supervision and regulation of bank and financial holding 
companies and State-chartered banks.
    He is committed to strong capital standards, effective 
supervision, and meaningful market discipline of these 
institutions. He knows unequivocally that the Fed must be 
independent, nonideological, and nonpartisan, and for this 
reason, I am proud to support his nomination.
    Chairman Shelby. Thank you, Senator Schumer.
    Senator Sarbanes, any opening statement?

             STATEMENT OF SENATOR PAUL S. SARBANES

    Senator Sarbanes. I will take just a moment, Mr. Chairman.
    I am pleased to join with you in welcoming the nominees 
before the Committee. The positions that we are considering 
today, one for the Council of Economic Advisers and two for the 
Board of Governors of the Federal Reserve System, are among the 
more significant economic positions in our national government.
    Dr. Lazear has been nominated by the President to be a 
Member of the Council of Economic Advisers, and I understand 
the President under the Act has the authority to designate one 
of the Members of the Council as Chairman, and it is the 
intention that if Dr. Lazear is confirmed, he will be appointed 
as Chairman of the Council of Economic Advisers.
    I have a longstanding interest in the CEA. I worked for 
Walter Heller when he was the Chairman, and I just want to 
quote into the record from the Employment Act of 1946 which 
established the Council of Economic Advisers: ``The Council 
shall be composed of three Members, who shall be appointed by 
the President and with the advice and consent of the Senate, 
and each of whom shall be a person who, as a result of his 
training, experience, and attainments, is exceptionally 
qualified to analyze and interpret economic developments, to 
appraise programs and activities of the Government, and to 
formulate and recommend national economic policy to promote 
employment, production, and purchasing power under free 
competitive enterprise.'' That is quite a charge, I might say.
    Dr. Lazear has been an academic economist for 30 years now. 
He has received a number of awards for his scholarly work. In 
addition to his work at Stanford, he has also been an adviser 
to a number of governments that have moved from command to 
market economies, and he recently served on the President's 
panel on Federal tax reform.
    Our two nominees to be on the Federal Reserve System's 
Board of Governors, of course, in addition to having a vote on 
the Open Market Committee, which determines the Nation's 
monetary policy, the Fed plays a critical role in regulating 
and protecting the safety and soundness of our Nation's banking 
system and enforcing many of our consumer protection laws.
    The two nominees are replacing Governors who, in my 
opinion, have served with great distinction. Dr. Kroszner's 
seat was previously held by Governor Gramlich, and Mr. Warsh's 
seat was previously held by Chairman Bernanke. Both of these 
nominees have worked in important roles as part of President 
Bush's economic team. Dr. Kroszner served on the President's 
Council of Economic Advisers for 2 years in addition to his 
career as an Economics Professor at the University of Chicago. 
Mr. Warsh is, of course, well-known to the Committee, having 
worked in the White House as Special Assistant to the President 
for Economic Policy and as the Executive Secretary of the 
National Economic Council to the President for the past 3 
years. Prior to this experience, he worked on Wall Street at 
Morgan Stanley.
    Mr. Chairman, I look forward to hearing the witnesses.
    Chairman Shelby. Thank you. If you would stand and be 
sworn.
    [Witnesses sworn.]
    Dr. Lazear, we will start with you. All of your written 
statements will be made part of the record. If you have anyone 
you want to introduce your family you have here with you, you 
may proceed.

          STATEMENT OF EDWARD P. LAZEAR, OF CALIFORNIA

                  TO BE A MEMBER AND CHAIRMAN

                THE COUNCIL OF ECONOMIC ADVISERS

    Mr. Lazear. Thank you. I would like to introduce my wife, 
Vicky, who is right behind me.
    Chairman Shelby. Thank you.
    Mr. Lazear. Chairman Shelby, Ranking Member Sarbanes, and 
Members of the Committee, it is a great honor to be here today 
to be the President's nominee to be Chairman of the Council of 
Economic Advisers. The Council, which has been in existence for 
60 years now, is charged with the task of advising the 
President on economic issues. Throughout its history, it has 
remained a body of experts and academicians who have taken it 
to be their duty to inform policymakers in an unbiased and 
professional manner.
    One colleague recently told me that in Washington, when 
people want the correct answer on economics, they go to the 
Council of Economic Advisers. The best compliment that can be 
paid to the CEA is that the CEA ``tells it like it is,'' so 
that the President and Congress, who are charged with the 
responsibility of weighing all factors, can make the best 
decisions possible.
    I was going to give you a bit of my background, but the 
Senators have done such a great job of describing, and I think 
I will skip that and simply close by mentioning that before I 
left California to testify, my senior colleague, Secretary 
George Schultz, told me that the role of the Chairman of the 
Council of Economic Advisers is to be an economist, to be 
straight, and to bring economics to the table, leaving the 
politics to others. If confirmed, I will devote all of my 
energy to ensuring that policymakers have the best economic 
analysis possible.
    Thank you, and I welcome your questions.
    Chairman Shelby. Mr. Kroszner.

        STATEMENT OF RANDALL S. KROSZNER, OF NEW JERSEY

          TO BE A MEMBER OF THE BOARD OF GOVERNORS OF

                   THE FEDERAL RESERVE SYSTEM

    Mr. Kroszner. Thank you very much. I would like to 
introduce my mother, Helen Kroszner, and my niece, Kimberly 
Kroszner.
    Chairman Shelby. Thank you.
    Mr. Kroszner. Chairman Shelby, Senator Sarbanes, Senator 
Bennett, and other Members of the Committee, I am pleased to 
have the opportunity to appear before you today as one of 
President Bush's nominees to serve on the Board of Governors of 
the Federal Reserve System. I am honored that the President has 
nominated me to serve on the Board. If I am confirmed by the 
Senate, I will work to the best of my abilities to fulfill the 
significant responsibilities of this office.
    After studying economics as an undergraduate at Brown 
University, I earned a master's and Ph.D. degrees in economics 
from Harvard University. I then joined the Graduate School of 
Business at the University of Chicago, where I am a Professor 
of Economics and have been teaching money and banking since 
1990. I will not go through the details of my background, 
because again, the Senators have done a terrific job of 
summarizing those background qualifications.
    As a Member of the President's Council of Economic Advisers 
from 2001 to 2003, I have had policy experience in a variety of 
areas, including banking and financial regulation, 
international financial crises, and macroeconomic forecasting. 
In this capacity, I witnessed firsthand the importance of 
having accurate and timely economic statistics in order to make 
sensible policy judgments and decisions. I spearheaded an 
initiative to improve the quality of government statistics and 
enhance the protection of confidential information reported to 
the Government, resulting in the Confidential Information 
Protection and Statistical Efficiency Act of 2002. After 
returning to the University, I was delighted to be appointed by 
the Secretary of Labor to the Federal Economics Statistics 
Advisory Committee, which meets regularly with the major 
official statistical agencies to discuss how to improve 
measurement of economic activity. If confirmed, I would be 
devoted to further enhancement of the quality of economic 
statistics.
    Monetary policy is a fundamental responsibility of the 
Federal Reserve. Long-run price level stability is crucial to 
achieving maximum employment and overall economic stability. 
Under Chairman Greenspan and Chairman Volcker before him, the 
Federal Reserve has achieved much success in reducing and 
stabilizing inflation and inflation expectations. This success 
has helped to contribute to a tendency for the fluctuations in 
employment and output to be lower than in the past, and a 
reduction in the frequency and severity of recessions. If 
confirmed, I would look forward to working with Chairman 
Bernanke and other Members of the Federal Open Market Committee 
to continue to underscore the role that long-term price level 
stability has in achieving prosperity and maximum employment. I 
also applaud the increase under Chairman Greenspan in monetary 
policy transparency, which helps to reduce uncertainty for 
households, entrepreneurs, and investors, and thereby 
contributes to economic stability and growth.
    The Federal Reserve also has a fundamental responsibility 
for protecting the stability of the country's banking and 
financial system. Much of my research and work with central 
banks has been devoted to analyzing banking and financial 
regulation as well as banking and financial crises. The safety 
and soundness of the U.S. banking and payment system is 
critical to achieving economic growth, maximum employment, and 
general economic stability, and the Federal Reserve works 
closely with other regulators to achieve this goal. The Federal 
Reserve also has an important role to play in responding to and 
mitigating the impact of financial crises and shocks. If 
confirmed, I will work vigorously to protect and promote the 
safety and soundness of the system.
    The Federal Reserve has an additional important 
responsibility to consumers and users of the banking and 
financial system. Discriminatory or abusive lending practices 
should not be tolerated, and the privacy of individuals and 
their financial data must be protected.
    The Federal Reserve is active in promoting financial 
literacy, and as an educator, I believe that financial literacy 
is fundamental to the proper functioning of the financial 
system. If confirmed, I will place a high priority on these 
responsibilities and look forward to being actively involved in 
promoting financial literacy.
    Thank you once again for holding this hearing, and I look 
forward to your questions.
    Chairman Shelby. Mr. Warsh.

            STATEMENT OF KEVIN M. WARSH, OF NEW YORK

          TO BE A MEMBER OF THE BOARD OF GOVERNORS OF

                   THE FEDERAL RESERVE SYSTEM

    Mr. Warsh. Chairman Shelby, Senator Sarbanes, Senator 
Bennett, thank you very much for allowing my colleagues and I 
to appear before the Committee, and before I get started, allow 
me to introduce my wife, Jane, and some dear friends who have 
joined us today.
    First off, I wish to express my sincere appreciation to 
President Bush for nominating me to serve as a Member of the 
Board of Governors of the Federal Reserve System.
    As the Members and staff on this Committee know, I have 
served on the National Economic Council for about the last 4 
years, focusing on matters of domestic finance, capital 
markets, banking, securities, and insurance-related issues. In 
that capacity, I have had the privilege of working, Chairman 
Shelby, with you; Senator Sarbanes, with you and your staff as 
we have tackled many of these issues together. If confirmed, I 
look forward to continuing that productive close relationship 
going forward in carrying out the important responsibilities 
that this Committee and this Congress have assigned to the 
Federal Reserve.
    Market participants, policymakers, and the American people 
have all come to rely on the good judgment that flows from the 
Federal Reserve's independence and credibility. If confirmed, I 
can assure this Committee I will be devoted solely to the 
Federal Reserve's statutory mandate for monetary policy; that 
is, to ensure price stability and to ensure maximum output in 
employment and growth and will work to promote a secure, fair, 
and efficient financial system.
    The flexibility of our capital markets from which I come 
have really been tested in recent years, and they have been 
matched only by the resiliency of the American labor force. The 
Federal Reserve has been successful in chartering these waters 
but must remain attuned to any economic consequences that might 
arise.
    Under Chairman Greenspan's leadership, the Federal Reserve 
has made significant progress in explaining its policies with 
greater transparency. As a result, market volatility is lower; 
our markets are deeper, broader, and more dynamic than ever 
before. Pools of free-flowing capital, in turn, have provided 
real-time, forward-looking information to help Federal Reserve 
officials make appropriate decisions. I hope that my prior 
experience on Wall Street, particularly my nearly 7 years at 
Morgan Stanley, would prove beneficial to the deliberations and 
communications of the Federal Reserve.
    Over the course of the last generation, the Federal Reserve 
has compiled an enviable track record in achieving price 
stability and successfully anchoring long-term inflation 
expectations. This stability has contributed to low long-term 
interest rates and promoted strong employment growth and 
productivity gains.
    The Federal Reserve's work, however, goes on. Its 
responsibilities, of course, extend beyond monetary policy to 
the supervision and regulation of bank and financial holding 
companies. In working with other financial regulators, the 
Federal Reserve should continue to promote three complementary 
pillars of prudential oversight to which Senator Schumer 
referred: Strong capital standards, effective regulatory 
discipline, and meaningful market discipline, and these are 
principles to which I am committed.
    Finally, if confirmed, I would work to ensure that the 
Federal Reserve continues its important role in promoting 
literacy and fair dealing for consumers. The knowledge and 
credibility that the Federal Reserve brings to bear should help 
to bring people on the fringes of our financial system into the 
mainstream.
    The Federal Reserve's decisions significantly impact 
America's families and businesses, and I would take on the 
responsibility of joining the Board of Governors of the Federal 
Reserve System with great humility and would be honored if the 
Senate saw fit to approve my nomination.
    Thank you, and like my colleagues, I would be happy to 
respond to your questions.
    Chairman Shelby. Thank you, Mr. Warsh.
    Dr. Lazear, you recently spent several months reviewing 
various aspects of the U.S. tax system and methods for 
reforming it to enhance economic growth. I am a strong 
proponent of a simplified tax structure, which would eliminate 
the inefficiencies of our current system and end the waste of 
vast resources currently dedicated to taking advantage of all 
the complexities that we have.
    What three words would you use, if you could, to describe 
our current system?
    Mr. Lazear. Three words? Chaotic, somewhat inflexible, and 
not necessarily conducive to economic growth.
    Chairman Shelby. What would be the benefits of moving to a 
more straightforward structure?
    Mr. Lazear. Mr. Chairman, as you know, the President, in 
setting up the tax panel, instructed us to think about some of 
the things you mentioned; simplification in particular, but 
also growth and fairness.
    Now, when we think about these different aspects of tax 
policy, we have to realize that sometimes, there are tradeoffs, 
and that is one of the things that confronted the tax panel.
    When we thought about it, we came to the conclusion that 
the most important thing that we could do for the economy was 
to propose a tax system that would be not only simple but that 
would also focus on growth. And the reason is that if we think 
about the importance of economic growth, although 
simplification is extremely important, economic growth swamps 
it over any period of time.
    So if we are thinking about a 10-year period or so, and we 
could raise the growth rate by even a quarter of a percent per 
year, we would have very significant effects on the economy.
    Chairman Shelby. What aspects of our tax structure would, 
in your judgment, be most in need of reform?
    Mr. Lazear. There are a number of issues that come to my 
mind in terms of thinking about the tax system. As you know, I 
am sure, the tax panel recommended that we eliminate the AMT. 
The AMT is a tax structure that has really run amok. There was 
a good purpose for it initially. The idea was to make sure that 
every American citizen paid taxes if they were able to do so, 
and there were some people who were escaping that.
    So the AMT targeted certain individuals, but over time, 
because of some quirks in the code, the AMT actually ended up 
going after individuals who it was not intended to go after.
    Chairman Shelby. Unintended consequences, perhaps?
    Mr. Lazear. Absolutely, Mr. Chairman.
    Chairman Shelby. Mr. Kroszner and Mr. Warsh, the new Fed 
Chairman, Dr. Bernanke, is a well-known proponent of inflation 
targeting. He talks of price stability, which you both alluded 
to. What are your views, both of you, on inflation targeting? 
Do you believe an inflation targeting regime is consistent with 
the Fed's other goals, those of long-term sustainable growth 
and full employment? We will start with you.
    Mr. Kroszner. Thank you very much, Mr. Chairman. The 
credibility of the Fed is crucial. It is really what contains 
expectations about inflation, and that has a large effect on 
interest rates and ultimately on economic activity.
    The Fed very clearly has a dual mandate from Congress to 
pursue low and stable prices as well as maximum employment. 
There are different monetary policy approaches for the Federal 
Reserve to achieve this, and one is the way that Chairman 
Bernanke has proposed, some variation of an inflation targeting 
regime. There are many different approaches that fall under the 
rubric of inflation targeting.
    I think the key behind it is trying to provide clarity and 
transparency about monetary policymaking and monetary policy 
processes, because I think what the Fed should be doing is not 
increasing volatility but trying to reduce volatility, trying 
to make it clear what the Fed is going to do, and that is the 
best way for individuals, for entrepreneurs, for households, 
and investors to make good decisions.
    So it is one possible way to increase transparency. I have 
an openness to different kinds of approaches, but the key is to 
have a policy and approach that reduces uncertainty, reduces 
volatility, provides a good backdrop for individuals and 
investors to make decisions and for the Fed to maintain its 
dual mandate of pursuing low and stable prices, at the same 
time maximizing employment.
    Chairman Shelby. Mr. Warsh.
    Mr. Warsh. Chairman Shelby, I, too, strongly share the 
Federal Reserve's dual mandate, and in that context, I think 
the questions about inflation targeting really are ripe for 
discussion. I think a discussion that Chairman Bernanke has 
suggested that if confirmed, we would be party to, because it 
is likely to be an ongoing deliberation.
    I think the transparency that has come to the Fed--really 
over the course of the last 10 or 12 years--has been 
incremental in nature, and I think it has been able to provide 
guidance to the capital markets that are keenly focused on the 
Federal Reserve's moves and its actions.
    Inflation targeting may well be the next step--if we mean 
or suggest a numerical range which is further reinforcing the 
types of estimates that the markets expect of the Federal 
Reserve and that range is really an objective guided by market 
facts and does not in any way restrict the ability of Governors 
or of the Chairman to make policy judgments.
    Because at the end of the day, at the FOMC, there will be 
imperfect information, and I think it is essential that 
inflation targeting, if it is thought of really as an 
objective, another data point for the markets, the markets 
might well see that as additional clarity and provide some 
incremental benefit going forward. I think that is a 
deliberation we look forward to participating in.
    Chairman Shelby. Mr. Warsh, I want to ask you a question 
about the Basel II capital requirements. The Federal Reserve, 
as you well know, is presently in the process of implementing 
the Basel II Capital Accord, which will establish new capital 
requirements for our largest banks. Due to the vital role 
capital requirements play in protecting the safety and 
soundness of the U.S. banking system, I believe it is important 
that there be no surprises in the implementation of Basel II, 
especially unanticipated reductions in capital requirements.
    Last year, this Committee held a hearing at which several 
witnesses expressed concerns that the adoption of Basel II 
would result in the lowering of capital requirements. In 
addition, last year, the fourth Quantitative Impact Study 
unexpectedly showed that Basel II would result in substantially 
lower capital requirements.
    What steps need to be taken to make sure that Federal 
banking regulators, Congress, and the public at large are 
confident that the implementation of Basel II will not 
adversely impact the safety and soundness of the U.S. banking 
system?
    Mr. Warsh. Thank you for that question, Chairman Shelby. I 
share the view of the importance of getting these capital 
standards right. The Basel II process, upon which this 
Committee has really spent a lot of time and attention, has 
been much debated among our various banking regulators, and I 
would say that there has been a meaningful and open dialogue 
between and among them and with this Committee.
    The QIS-IV results that you reference were a surprise. I 
think that the ``doctrine of no surprises'' should be the rule 
of thumb going forward. My understanding is that the Federal 
Reserve, working with the other bank regulators, have decided 
to go forward sometime this spring with a new proposed 
rulemaking to try to address some of the unexpected results of 
the QIS-IV results.
    Chairman Shelby. Including capital?
    Mr. Warsh. Including capital, absolutely, Senator, and I 
think what you rightly do is point out that the capital 
standards are very important. The risk-based capital standards 
are very important, but so, too, are the rest of the tools in 
the supervisor's toolkit.
    So as we proceed in the Basel II process, I think it is 
very important that the leverage ratio, another important 
measure of capital, be maintained; that the rest of the prompt 
corrective action authority be maintained, and our regulators 
are going to evaluate these standards during a lengthy process 
over the course of the next several years.
    One of the things that I think would be very helpful, which 
the regulators are keen to adopt, I believe, is as the Basel II 
standards are practiced, to really make sure there is a 
parallel run of Basel I and Basel II to ensure that these 
capital standards stay robust, because at the end of the day, 
as bank regulators and as the Committee of oversight, there are 
really few things as important as the safety and supervision of 
these underlying entities.
    Chairman Shelby. Do you know of any bank, any financial 
institution, that has been well-capitalized, well-managed, and 
well-regulated that has gone under?
    Mr. Warsh. I do not, Senator, but I think the most 
important thing you point out is that these capital standards 
must remain robust, and they must taken into account risks that 
were hard to envision when Basel I and other capital standards 
were put in place.
    Chairman Shelby. Thank you.
    Senator Sarbanes.
    Senator Sarbanes. Mr. Chairman, I have a number of 
questions, but why do I not just follow-up on the Basel II 
inquiry first?
    Chairman Shelby. Go ahead.
    Senator Sarbanes. And this is obviously directed to Mr. 
Kroszner and Mr. Warsh. As I understand it, the Federal bank 
regulatory agencies have indicated that even if the Basel II 
risk-based capital agreement is implemented, the minimum 
leverage capital ratio will be preserved as a critical feature 
of the U.S. bank capital regulation. Is that your 
understanding, and do you agree with that?
    Mr. Kroszner. Yes, that is my understanding, Senator.
    Senator Sarbanes. And do you agree with it?
    Mr. Kroszner. I certainly do agree with it.
    Senator Sarbanes. Mr. Warsh.
    Mr. Warsh. Yes, I concur, Senator Sarbanes, and I think it 
is an extremely important supplement to the Basel II Accord.
    Senator Sarbanes. Now, this latest QIS-IV study showed a 
much larger reduction in capital than the study that had 
previously been cited to the Committee at our hearings. It 
showed an aggregate capital reduction of 15.5 percent, a median 
capital reduction for the participating institutions of 26 
percent; one participating institution had a capital reduction 
of nearly 50 percent.
    Now, even though the QIS-IV resulted in capital reductions 
that apparently all the bank regulators viewed as acceptable, 
the decision was made to go forward this year with a proposed 
regulation utilizing the same formula that produced the QIS 
results. Is that your understanding?
    Mr. Kroszner. I am not familiar with the specifics of what 
the Federal Reserve has gone forward with, but I certainly do 
know that I was concerned about the reductions in capital that 
were suggested by the QIS-IV. I know that there are others in 
the regulatory community who are concerned about that and are 
continuing to take comment and working to make sure that we do 
not have significant reductions in capital if we were to go 
forward with this regulation.
    Senator Sarbanes. Mr. Warsh.
    Mr. Warsh. Yes; I am again also not specifically familiar 
with the changes that are being contemplated in anticipation of 
the next proposed rulemaking. My understanding, Senator, is 
that the comments and the results from the QIS-IV process, 
particularly when you have cases of individual institutions 
that have very different capital even though they have very 
substantially similar assets, is something which ought to be 
considered, and hopefully will be considered, in the context of 
this rulemaking.
    Senator Sarbanes. If we run an impact study, and it gives 
us these kinds of results, we should not just be continuing 
along the path, should we? Should we not be pulling back and 
reexamining what is out there if it is producing these kinds of 
results in an impact study? Do either of you think that the 
results of the impact study are acceptable results?
    Mr. Warsh. Senator, in my view, I think those results 
proved to be a surprise that, again, having similar assets with 
different capital----
    Senator Sarbanes. It is not satisfactory.
    Mr. Warsh. I do not think it is satisfactory if a company 
that has similar assets ends up holding very different capital, 
and my understanding is that safeguards are being built into 
the Basel II process going forward to address just your 
concerns.
    Senator Sarbanes. If they had similar capital but at much 
lower levels, would that be acceptable to you?
    Mr. Warsh. It strikes me, Senator, as though the most 
important thing is that the modern risk management techniques 
be taken into consideration so that the Basel II standard 
matches that underlying risk but, again, not to the detriment 
of the other parts of the supervisor's toolbox that I mentioned 
before, such as the leverage ratio.
    Senator Sarbanes. Mr. Kroszner.
    Mr. Kroszner. It is very important not to allow capital to 
get too low. I think we saw that in the United States with the 
savings and loan crisis. I have done a lot of research that 
conforms with what many others had found, that low capital led 
to bad choices by the savings and loan industry, an inefficient 
banking and financial system, and a large cost to taxpayers.
    I can assure you, Senator, that I would not support any 
regulatory moves that would subject the taxpayer to excess risk 
or undue risk. And certainly, capital is an important 
protection in that system.
    Senator Sarbanes. Let us examine this phrase ``too low.'' 
When Vice Chairman Ferguson of the Fed was before us, and this 
was one of the issues that we looked into, that the Chairman 
focused some attention on, and the question was raised that 
Basel II was going to lower some capital standards. Chairman 
Ferguson said, ``I would not jump to conclusions yet that it is 
going to lower capital overall in the industry. I think it will 
create greater dispersion of capital because there will be 
those banks that need to have higher regulatory minimum 
capital, and there will be some that will need to have lower 
regulatory minimum capital. When this Basel Committee got 
started in this process, the goal was to keep capital at about 
the same level as it is now, and thus far, first indications 
from early quantitative study,'' this was before this QIS-IV 
that we referred to, ``suggest that indeed if it lowers 
capital, it will be a very small amount, maybe 6 percent or 
so.'' Do you agree with the Ferguson statement that the goal of 
Basel II was to keep capital at about the same level as it is 
now?
    Mr. Kroszner. Senator, I was not privy to the discussions 
that led to the initiation of Basel II. My understanding was 
that there is general dissatisfaction with the ability of Basel 
I to take into account the more complex risks that have 
developed since Basel I was first implemented. So, I cannot 
comment directly on the initial motivation, but I do think it 
is important to ensure that capital is sufficient when we have 
new and more complex risks.
    Senator Sarbanes. What does that mean in relation to the 
current level of capital? Are you open to substantially 
reducing the current levels of capital?
    Mr. Kroszner. As I had said before, Senator, it is very 
important to maintain the minimum leverage ratio, and so, I 
would not, regardless of what processes we have in Basel II, I 
would certainly not want to reduce that at all. So that being 
part of the initial capital level from Basel I, I certainly 
would not want any reduction of that.
    Senator Sarbanes. Of course, the purpose of Basel I was to 
increase the amount of capital in the banking system, was it 
not?
    Mr. Kroszner. Again, I do not know what the particulars 
were for that motivation. Certainly, we have seen a large 
increase in the average amount of capital in the U.S. banking 
system over the last decade or so.
    Senator Sarbanes. Mr. Warsh.
    Mr. Warsh. I, too, Senator, look forward to getting our 
hands on the data, seeing on a bank-by-bank basis what the QIS 
results would suggest and to make sure that the risk inherent 
in each of these banking institutions demands a degree of 
capital that is appropriate. And it strikes me that this is the 
overwhelming goal of Basel II, which is to make sure that the 
capital is more than sufficient to make sure that the safety 
and soundness is strong and to make sure that the safety net 
exists. And beyond that, it is hard for me to judge based on 
the data that we have seen at this point.
    I would only note that I think it is important going 
forward that there be a parallel run of the new proposed 
standards with the old standards, so to the extent there are 
surprises, that they would come to the attention not only of 
the Federal Reserve but also, of course, to other people such 
as Members of this Committee that are looking at the issue.
    Senator Sarbanes. Now, the Fed has taken the lead in 
negotiating this internationally, but it is my understanding 
that any decision on how the United States acts has to be a 
shared decision by all the bank regulators. Is that your 
understanding?
    Mr. Kroszner. Again, Senator, I am not sure of the 
specifics of how things work with respect to the law and 
regulation. Certainly, I think it would be very important to 
have agreement among the regulators on something so important 
as capital, and certainly, I would strive for that.
    Mr. Warsh. And Senator Sarbanes, I do think we would be 
well-served by having our four regulators on an issue of this 
level of importance speak at the end of the day with one voice.
    The only other note that I would make, Senator Sarbanes, is 
that U.S. financial institutions are exceptionally well-
capitalized generally and are able to provide their products 
and services on an international basis. And their 
capitalization is a focus not only of the bank regulators but 
also of the marketplace and of their customers domestically and 
overseas, which should provide another important check on their 
capital levels.
    Senator Sarbanes. I have used a lot of time. I will come 
back.
    Thank you, Mr. Chairman.
    Chairman Shelby. Thank you. We will have another round.
    Dr. Lazear, productivity for the fourth quarter of 2005 
declined 0.2 percent in the business sector and 0.6 percent in 
the nonfarm business sector. The productivity declines were 
unexpected by a lot of the market watchers. What is your 
assessment of these numbers? Do they represent a one-time 
aberration, or do they signal something else? And given your 
extensive background in labor economics, what advice would you 
be giving us, and what advice would you be giving to the 
President, maybe, would be better on long-term growth prospects 
in the economy?
    Mr. Lazear. Thank you, Chairman Shelby. That is obviously 
an extremely important issue.
    Labor productivity is a key determinant of wages. If we 
look over even the very short-run, we know there is an 
extremely close relationship between wages and productivity, so 
we want to make sure that productivity continues to grow. In 
the fourth quarter, productivity was down, and that was a 
reflection of the fact that GDP did not grow at the rate that 
we had expected.
    Most view that as an aberration and a result primarily of 
three factors: First, Federal spending was down in the fourth 
quarter; second, there was a drop in auto sales, which was 
really a reflection of the fact auto sales in the third quarter 
had been accelerated; and third, the hurricanes had an enormous 
impact on petroleum.
    Those are not expected to continue into the future, so most 
who have been looking at the fourth quarter view that as a blip 
rather than a trend and expect a continued strong economy.
    Chairman Shelby. Dr. Kroszner and Mr. Warsh, housing 
markets: The possibility of a housing bubble has been 
circulating in the popular press for a long time. Households 
have used interest rates-only loans and more exotic adjustable 
rate mortgages to make homes affordable while at the same time 
increasing household vulnerability to financial risk.
    What effect would a slowdown in the housing sector, we have 
already seen some of it but a real slowdown, have for our 
overall economy, and how do you believe the Federal Reserve 
should respond?
    Mr. Kroszner. Thank you very much, Senator.
    Certainly, the former Chairman of the Federal Reserve, 
Chairman Greenspan, had suggested that there may be some 
markets that have some froth associated with them, particularly 
some localized housing markets. I do not think it is the role 
of the Federal Reserve to be second guessing asset prices or 
asset price movements, but as you point out, Mr. Chairman, it 
is extremely important for the Federal Reserve to think about 
how to respond to such changes and to such movements.
    So first, of utmost importance is making sure that the 
safety and soundness of the banking system is not at risk, and 
so, ensuring that there are proper standards for lending, 
making sure that the banks and other financial institutions who 
are lending into the housing market fully understand those 
risks and appropriately capitalize against them is of first 
order importance. I believe the Federal Reserve has been 
monitoring that issue, and obviously, that is something that 
needs attention to ensure that the safety and soundness of the 
banking system and that lending in the mortgage market is not 
subject to difficulties.
    Second, I think the important thing is as there are any 
changes in asset prices to just be fully aware of them and be 
very careful to respond to any changes that would affect 
household wealth, that would affect consumption, that would 
affect overall economic growth. And so, again, being very aware 
of what is going on and then thinking about what the 
appropriate monetary policy responses would be to that are key.
    Mr. Warsh. Chairman Shelby, I share the view that the 
housing price run-up in recent years is part of what has 
contributed to a strong consumer demand that has impacted GDP. 
If you look at the underlying fundamentals for housing over 
large parts of the country, however, with a low interest rate, 
low inflation environment, it should not surprise us that 
housing prices have been on the up slope.
    When you look at what the impact would be on Federal 
Reserve monetary policy in particular, we would look at the 
outputs, what are the results of that, and what are the results 
if, for example, home equity withdrawals were to dissipate here 
early in 2006.
    One thing that the regulators did some months ago was to 
provide some increased coordination of regulatory guidance--
with respect particularly to nontraditional mortgages--to make 
sure that the underlying banks and financial institutions are 
safe and sound and, at least as important, to make sure that 
they are providing these sorts of nontraditional products to 
people that are fully qualified for those products. The 
purpose, of course, is to try to mitigate any dislocations and 
any troubles that might impact consumer demand.
    Chairman Shelby. Thank you.
    Dr. Lazear, the Social Security system clearly faces 
challenges in its future financing that will prove difficult to 
resolve the longer we wait. The Medicare program probably faces 
a more significant financial problem.
    As a key economic adviser to the President, if you are 
confirmed, and you will be, how would you recommend that the 
Administration approach these problems? That is, is there a set 
of guiding principles that should be kept in mind as the 
Administration proposes various reform options, because we know 
what the entitlement are slated to do to the budget.
    Mr. Lazear. Mr. Chairman, as you point out, entitlements 
are growing and continuing to grow, and they are becoming a 
larger and larger part of the total budget. So if we do not 
succeed in getting entitlements under control, we will not be 
able to get the budget under control. So everything having to 
do with deficits and everything else that is of concern to us 
today are related to the issue that you raise.
    There are a number of possibilities for constraining the 
growth of entitlements and expenditures and doing so in a way 
that does not create harm to the typical American. I think that 
a number of things can be done in terms of solvency of the 
system. I think that we need to think about removing regulatory 
risk from the structure by getting the money back into the 
private sector. I think there are a number of ways suggested by 
the President and that your Committee, the Senate, and Congress 
in general has thought about, and those would be the lines 
along which I would go.
    Chairman Shelby. Thank you.
    The Fed is a bank regulator, which you both will be part 
of. Much of the attention surrounding the Federal Reserve has 
to do with implementation of monetary policy. However, we all 
know that some of the duties of the Fed is bank regulation, and 
that also poses unique challenges. The largest and the most 
sophisticated banks develop, and market, complex financial 
products.
    Do you believe the current structure of financial 
regulation under the Fed and the other regulators is adequate 
to the task of overseeing the increasingly complex institutions 
and the products that they bring forth? In other words, it has 
to be one of the challenges to you as regulators at the Fed.
    Mr. Warsh. Chairman Shelby, I think that the question is 
particularly valid today, as we have seen an increase in 
sophistication of products, and we have seen the capital 
markets, in effect, providing credit that a generation or two 
ago was really coming from commercial banks on their own 
balance sheet.
    Chairman Shelby. Right.
    Mr. Warsh. I think the challenges remain more robust and 
real today than perhaps they have been in some time. My 
understanding and knowledge of our existing regulatory 
structure, however, does not suggest to me that it should be 
scrapped; that is, our regulatory structure has built into it a 
degree of competition between the States and the Federal 
regulators and between and among Federal regulators, including 
the bank regulators and the SEC.
    So, I think it is incumbent upon us, if confirmed, as 
regulators to continue to reach out so that as a Government, we 
better understand these products, we are better able to ensure 
we understand who is taking that risk and who are the 
counterparties to that risk.
    But I think our existing system, including such mechanisms 
as the President's Working Group on Financial Markets, is a 
very effective way for regulators to share this information and 
try to come to some broad policy prescriptions as these 
challenges move forward.
    Mr. Kroszner. I would agree with that greater complexity of 
financial products in the financial markets present greater 
difficulties for the regulators to assess the risks, who is 
bearing those risks, and what the extent of the risks are.
    I think the regulators do have the tools to be able to 
approach those, to be able to understand those, but it is very 
important to have a coordinated approach amongst the different 
regulators so that there is a good sharing of information, that 
there is a good working relationship among them. The 
President's Working Group is one such example, to make sure 
that we are aware, that the regulators are aware of the risks 
both to the individual institutions, to individual borrowers as 
well as to counterparties; who those counterparties are, who is 
bearing that risk, and if something goes wrong with one of 
those counterparties, if they cannot pay, what is the 
consequence for the rest of the system? Is that just limited to 
the two parties who are associated with one particular 
contract, or will that have a broader systemwide effect?
    And obviously, that is something that the regulators need 
to be aware of, and my understanding is that the regulators are 
looking at many of these issues and broadly have the tools in 
principle to be able to deal with them.
    Chairman Shelby. How important is it for the Fed as a 
regulator, now, to work with the other regulators?
    Mr. Kroszner. I think it is certainly important to work 
with the other regulators. In our discussion of Basel II 
earlier, we had discussed how important it was to have an 
agreement on something as important as capital. And so, I think 
it is very important that the regulators try to coordinate and 
have similar views.
    Will it always be the case that the regulators have the 
same views? No; we have a system that has different regulators, 
and we will have some differences of opinion. And I think some 
differences of opinion are not a bad thing, and having fora 
where there are people with differences to try to work them out 
is very valuable.
    Chairman Shelby. Senator Sarbanes.
    Oh, excuse me, Senator?

             STATEMENT OF SENATOR THOMAS R. CARPER

    Senator Carper. Thank you, Mr. Chairman.
    To our guests, welcome. Thank you for joining us today. I 
am looking for an email that I just read from someone who knows 
you, Mr. Warsh, and who had some very nice things to say about 
you. I do not often read this thing in public. Is your wife 
here with you today?
    Mr. Warsh. She is, behind me.
    Senator Carper. Mrs. Warsh, this is a valentine to your 
husband.
    [Laughter.]
    Mr. Warsh. This is just where she wanted to spend 
Valentine's Day.
    Senator Carper. This comes from someone who previously 
served at a senior level for one of our senior colleagues on 
the Democratic side, and here is what he said: ``I do not 
ordinarily have much nice to say about President Bush's 
nominees, but I have had the opportunity to work with Kevin 
Warsh on a number of issues in the past few years, and he is 
really a rarity. Even when we have disagreed on the policy at 
issue, I have on every occasion found Kevin to be a remarkably 
balanced, even-handed, thoughtful, and astute person. I have 
always been struck how someone that smart, brilliant, actually, 
could also be so gracious. Kevin also has a terrific quality 
that is increasingly rare in Washington. He is a great listener 
and is always in learning mode. And every time I have met with 
him, I have come away smarter.''
    Now, I would just like to ask you for the record, how did 
you end up to be the person who is described in this email?
    [Laughter.]
    Mr. Warsh. Well, Senator, thank you for reading the email. 
When I came to Washington 4 years ago, I must admit I did not 
understand much of Banking Committee issues from the 
Government's perspective. Having been in the capital markets, 
on Wall Street for nearly 7 years before, I came to these 
issues with some of that background and really arrived here 
seeking a whole lot of knowledge and seeking to make sure I 
understood how work got done effectively and efficiently here.
    So, I suspect it is at least in part because I came here 
knowing so little about this process and have had the 
opportunity to work with this Committee among others, and it 
has really been a very productive relationship during this 
period.
    Senator Carper. My follow-up question is why do you suppose 
I received an email like this about you but not about the two 
colleagues sitting next to you?
    Mr. Kroszner. I think my mother does not use email very 
well.
    [Laughter.]
    Senator Carper. I do not think his mother was ever on the 
Senate staff, so I think her hands and his are clean in all of 
this.
    Actually, the person who sent this, I know him pretty well. 
For him to say these things about you is really high praise, 
and I understand Senator Schumer did as well.
    May I ask a question of Mr. Lazear, if I may. Talk to us 
about savings rate. You may have already talked a bit at some 
length, but I am going to ask you to revisit it. How do we go 
about fostering savings, not from people whose incomes are in 
the top 2, 3, 4, 5, percent in this country; the Administration 
seems always interested in expanding IRA's or expanding health 
savings accounts to give upper income people an opportunity to 
participate more.
    I worry not so much about the more affluent people saving. 
I worry about less affluent people saving, and I would welcome 
your thoughts in that regard.
    Mr. Lazear. Thank you, Senator.
    One of the things that came up when I was on the tax panel 
was thinking very carefully about saving. As you mentioned, the 
savings rate is low, and it is not only low across the board; 
but it is also low particularly for low-income individuals.
    We thought hard about that, and a number of the suggestions 
that we came up with try to address saving not only among the 
rich but also among middle and low-income individuals. One of 
the things that we came up with that I would support was saving 
at the level of the family, so there would be tax advantages 
for individuals even at the low end.
    Some of these would take the form of credits, refundable 
credits to low-income individuals. One took the form of a 
credit up to $500, that would be 25 percent of the savings for 
low-income individuals, and we were trying to encourage 
individuals to save. We had also suggested a saving-at-work 
plan that would allow individuals to take some of their current 
income and save it tax-free. And although taxes are not the 
only consideration, obviously, we thought that these would be 
steps in the right direction. So, I would support those.
    Senator Carper. And I thank you very much for that. A 
follow-up question, if I may.
    I was reading in the paper today, I think we have actually 
finally calculated the trade deficit from this past year. I 
think it came in at about $725 billion. I think the trade 
deficit just for the month of January alone is probably greater 
than the trade deficits that we have had in most years that we 
have been alive.
    And just talk to us just a little bit of a primer about 
how, when we run a large trade deficit like this, how does it 
get financed? Who provides the money for us? How do we go about 
continuing on this path. Is it sustainable? What do we need to 
do?
    Mr. Lazear. Well, as you mentioned, Senator, the trade 
deficit is large. It has been large for a long period of time.
    Senator Carper. Not at this rate. Even in the last 3, 4, 5 
years, it has more than doubled, I believe. It was already big 
then.
    Mr. Lazear. Yes, it has gone up. It has gone up steadily. 
We have been running a trade deficit for quite awhile, but as 
you point out, it has gone up in recent years.
    On the other side of the trade deficit, of course, is the 
capital account surplus. And so, there are always two 
interpretations of a trade deficit. One is that we are buying 
more goods than we are selling, but on the other hand, the 
capital account surplus means that the United States is such an 
attractive market for investment opportunity that individuals 
from abroad are investing in the United States and doing so at 
a record rate.
    Senator Carper. Can you give us an example of the kinds of 
investments you are referring to?
    Mr. Lazear. Okay; there are a number of investments. 
Obviously, Government investment is one, and we do see 
significant investment in Government securities in the United 
States, primarily to----
    Senator Carper. To help us finance our deficit?
    Mr. Lazear. It does help us finance our deficit, because 
the United States has to get these funds from somewhere, and as 
you pointed out earlier, unfortunately, we are not saving 
currently at the level that we should be. So in order to have 
very high levels of investment without high interest rates, 
which is key in terms of spurring the private economy to 
economic growth, we have to make sure that we do have funds 
from abroad.
    So when we look at the trade deficit, it is a double-edged 
sword. As you point out, it is not something that we want to 
have persist over time, for very long periods of time. On the 
other hand, we would like to see a soft landing. If, for some 
reason, the trade deficit immediately reversed or went to zero, 
that would also mean that our source of funds from abroad would 
go to zero, and that would not be a very good thing for the 
economy.
    So we want to make sure that things happen in moderation, 
that things occur at a gradual pace, and I would look forward 
to advising policies that would make that kind of----
    Senator Carper. In an article I was reading yesterday, one 
of the suggestions, instead of continuing to watch imports grow 
more rapidly than more exports, we should try the opposite. And 
how might we go about doing that?
    Mr. Lazear. One of the things that actually did happen very 
recently was that the percentage increase in exports actually 
exceeded the percentage increase in imports for the first time, 
I think, in 15 years. What we need to see happen, of course, is 
that----
    Senator Carper. For what period of time? I am sorry.
    Mr. Lazear. It was just the last quarter of last year.
    What we need to see happen, though, over a prolonged period 
of time is for other countries to make sure they open up their 
markets to us. Ninety-five percent of the consumers in the 
world lie outside the United States. One in five jobs in the 
United States is associated with export trade, and it is 
extremely important that we make sure that we have 
opportunities to compete abroad.
    As you know, the productivity of the American worker is 
higher than the productivity of any worker in the world. If we 
are on a level playing field, the American worker can compete 
anywhere. So, I would work hard to make sure that we have 
opportunities abroad to have our goods and services compete on 
a fair basis.
    Senator Carper. You will have no quarrel with me or I 
suspect with any of us on that.
    But I have heard through several people who have led the 
Federal Reserve and people who have sat in the chair that you 
are about to take and raising this question about rising trade 
deficits, Federal budget deficits, the willingness of the rest 
of the world to lend us money, and this is just not 
sustainable. And for us to continue along this path and not 
figure out how to get out of it, we are on a--I call it--the 
road to destruction.
    We have an opportunity to do something about it I think 
later this week, maybe the following week. We watched the loss 
of manufacturing jobs, and they are exiting our country at a 
rapid clip, and one of the reasons why I think they are leaving 
is because--there are a lot of reasons: Energy costs are one of 
the reasons, especially natural gas, but another reason deals 
with our civil justice system, and particularly, this week, we 
are taking up the issue of asbestos litigation reform to see if 
there is a way to come up with a system that is fair to people 
that have been injured, to make sure that the people who pay 
for their injuries and their impairment and breathing is the 
defendants and the insurance companies, in this case, but to 
try to make sure that we have a system at the end of the day 
that increases the likelihood that the claims that are paid 
will end up actually in the pockets of people who have been 
hurt and frankly not in the pockets of people who may have been 
exposed to asbestos or who will never be exposed to asbestos.
    I will close with this. My colleagues, I asked somebody the 
other day, I said do you think some of our policies in this 
country are contributing to the loss of manufacturing jobs, and 
he said we could not hasten their departure any more if we were 
taking a stick and chasing them out of this country, and there 
is an opportunity to do a number of things to stop chasing them 
out of this country, and we have a chance to make a little 
progress on it this week, and I hope to pursue some of the 
other things that you have suggested here.
    Thank you. Thanks, Mr. Chairman.
    Chairman Shelby. Senator Sarbanes.
    Senator Sarbanes. Thank you very much, Mr. Chairman.
    Just to follow-up on what Senator Carper has been asking 
about, this is the U.S. trade deficit. Now, you said, Mr. 
Lazear, that it was worsening at a continuing pace or something 
of that sort. This seems to be at a fast accelerating pace. I 
mean, $725 billion, this is by far the worst we have ever 
experienced. The trade deficit with China last year was $200 
billion, the largest we have ever had with any one country.
    What are we to make of this? I mean, the current account 
deficit now exceeds 6 percent of our GDP. Do you regard this as 
a problem for our economy?
    Mr. Lazear. Yes, Senator, I think it is a problem if it is 
sustained into the long-run.
    It is certainly the case that we can have at any period in 
time trade deficits or trade surpluses, but over the long haul, 
it has to be the case that these trade deficits are going to be 
reversed, because countries are not going to be willing to 
continue to give us goods in return for our capital forever.
    So there is no question; I certainly agree with your 
premise that over time, this has to be reversed. Just to 
follow-up on your point, and that is that if we look at 
manufacturing jobs and the concern that they might be related 
to this, manufacturing productivity in the United States, as 
you know, is very high and has grown more rapidly, actually, 
than productivity in any other sector. Manufacturing 
productivity was up over 4 percent last year.
    That is a very good sign for the American worker, because 
it means, again, that we do have the opportunity to compete 
with anyone as long as we are given a fair access to their 
market, and I think that would be the way to help erase some of 
the deficits that you are concerned about.
    Senator Sarbanes. Mr. Kroszner, do you agree that this is a 
problem?
    Mr. Kroszner. Certainly, the rate of growth of the deficit 
could not be sustained forever. And so, exactly as Professor 
Lazear had said, ultimately, there will have to be some 
balancing. We have been experiencing much greater demand growth 
in the United States than in the rest of the world. This is 
really a reflection of that, that we are buying a lot more than 
the rest of the world is buying from us.
    Something that would be very valuable is to pursue policies 
that generated prosperity around the world, increased demand 
abroad, increased demand at home and also increased savings at 
home.
    Senator Sarbanes. Now, Mr. Kroszner, you gave a speech in 
December in which you said, ``the economy continues to post a 
solid and consistent performance, no matter what Mother Nature 
nor nattering nabobs of negativism may throw at it.''
    Interesting turn of phrase, I might say. It is not 
original, though.
    [Laughter.]
    Mr. Kroszner. I claim no originality for it, Senator.
    Senator Sarbanes. No, I think there was an official from my 
State who was the originator.
    [Laughter.]
    Mr. Kroszner. I believe you are correct, Senator.
    Senator Sarbanes. Paul Volcker wrote an editorial in the 
Washington Post. He said the following about our economy: 
``Under the placid surface, there are disturbing trends: Huge 
imbalances, disequilibria, risks; call them what you will. 
Altogether, the circumstances seem to me as dangerous and 
intractable as any I can remember, and I can remember quite a 
lot.''
    Warren Buffett recently said ``Right now, the rest of the 
world owns $3 trillion more of us than we own of them. In my 
view, it will create political turmoil at some point. Pretty 
soon, I think there will be a big adjustment.''
    And Robert Rubin, writing in The Wall Street Journal, said 
``Virtually all mainstream economists take the view that 
sustained long-term deficits will crowd out private investment, 
increase interest rates, reduce productivity, and reduce 
growth. The far greater danger is that these various imbalances 
could at some point lead to fear of fiscal disarray and concern 
about our currency, causing sharply higher interest rates in 
our bond markets and the risk of a sharp exchange rate 
decline.''
    Do you consider Volcker, Buffett, and Rubin, to be 
nattering nabobs of negativism?
    [Laughter.]
    Mr. Kroszner. Senator, there certainly are a number of 
risks and challenges out there in the economy, and I would 
certainly not want to minimize that. The reference there to the 
nattering nabobs of negativism was, in terms of the speech, 
focusing more precisely on consumer confidence numbers, and at 
the time the speech was given, consumer confidence numbers were 
relatively low. There were a number of challenges to them, but 
consumers continued to spend.
    And so, that was the particular focus of that comment. But 
obviously, there are a lot of challenges, a lot of risks both 
domestically and internationally. And as I had said in my 
opening statement, it is extremely important for the Federal 
Reserve to be monitoring the sources of those risks, to be 
ensuring that there is sufficient capital in the banking system 
so that if there is a change in the asset markets that the 
banking system is sound, that credit will continue to flow, and 
that it is very important to think about where the potential 
risks may lie.
    Senator Sarbanes. Mr. Kroszner and Mr. Warsh, what do you 
understand the mandate of the Federal Reserve to be?
    Mr. Warsh. Senator Sarbanes, I take the Federal Reserve's 
mandate to be both price stability and achieving sustainable 
growth in employment and outputs, along with, of course, a 
third mandate to try to do that consistent with moderate long-
term interest rates. That mandate, as it has come to be known, 
the dual mandate, is a mandate that I strongly believe in and 
support.
    Senator Sarbanes. Mr. Kroszner.
    Mr. Kroszner. I certainly also agree that the dual mandate 
is extremely important. It is very clear in the law that we are 
to pursue both low and stable prices and maximum employment.
    Senator Sarbanes. Where did that mandate come from?
    Mr. Kroszner. My understanding is that is part of the 
Federal Reserve Act and the amendments to the Federal Reserve 
Act over time.
    Mr. Warsh. I concur; that is a judgment that Congress made 
for the Federal Reserve.
    Senator Sarbanes. Do you believe the mandate could be 
changed without changing the law?
    Mr. Kroszner. Senator, I think the law speaks clearly so 
that the mandate is set in law, and my understanding, although 
not a lawyer, my understanding is that the Federal Reserve must 
follow the mandate from this Act.
    Senator Sarbanes. Mr. Warsh.
    Mr. Warsh. I concur, Senator Sarbanes.
    Chairman Shelby. Senator Reed.

                 STATEMENT OF SENATOR JACK REED

    Senator Reed. Thank you very much, Mr. Chairman, Senator 
Sarbanes. Gentlemen, welcome.
    Let me ask a question to all of you that concerns me, even 
though I understand that you have different obligations and 
duties in your prospective jobs. One of the most troublesome 
aspects of the present economy is that people are working 
harder, but they are not seeing any significant increase in 
their wages.
    Family income seems to be flattening out or even going 
down. And I think we all feel that one of the fundamental 
values or benefits of the free market system is that it is able 
to give people who work sufficient wages to not only get by but 
to also save, to provide for their families in a very 
meaningful way.
    And when that is not working, something might be wrong with 
the economy, even if the stock market is doing well, and even 
if capital transfers are doing well, and all these other 
measures are doing well. So, I would begin with Mr. Warsh and 
Mr. Kroszner, understanding from the Federal Reserve's 
perspective, you will have a different one from Mr. Lazear. But 
Mr. Warsh, what do you think we can do? What can the Fed do to 
try to get at this issue?
    Mr. Warsh. Senator Reed, the Federal Reserve's role, 
obviously, is different from the role that Chairman-Designee 
Lazear would have. But I think the Federal Reserve must remain 
attuned to these issues, because included in the Federal 
Reserve's economic forecasts are forecasts for what is the 
state of the U.S. consumer, what is the consumer's ability to 
contribute to the GDP growth that we have seen in recent years.
    And with respect to wages, I would make two points: First, 
historically, when we have seen massive ramp-ups in 
productivity, as we saw in the late 1990's and have really seen 
over the course of the last 5 years, we have typically seen 
wage growth ultimately catch up to those productivity gains. I 
think, Senator, you are making the valid point, which is we 
have seen the productivity, but we have not yet seen the full 
benefit of those wage gains accrue to this point. But those 
lines have crossed historically, and I would be surprised if 
that ultimate path is not repeated here.
    Senator Reed. Not to interrupt, but the last take on 
productivity, it seems to be dipping downwards, I think, the 
last numbers I have seen, which might be a transitory event, 
but if we have not caught up, and it is dipping down, then, we 
are really in trouble under your analysis.
    Mr. Warsh. Senator Reed, I share your view. I think there 
is likely to have been a good bit of noise in that fourth 
quarter data. I think when the fourth quarter data is restated, 
we are likely to see that improve. And more importantly, as we 
look to 2006 and 2007, again from the Federal Reserve's 
perspective, trying to evaluate the economy, I think we are 
going to continue to see productivity growth that is robust.
    If you look at the period, for example, from 1973 to 1995, 
productivity here in the United States was growing rather 
smartly at about 1.5 percent. If we looked at productivity 
growth rates from 1995 to 2001, they nearly doubled. What that 
doubling means effectively is that our standards of living are 
able to double that much more quickly, and the productivity 
growth over the last 5 years is up yet again.
    I think it is extremely difficult for policymakers to rely 
on those sorts of productivity gains which may well have been 
outsized in years past with any high degree of certainty.
    The only point I am trying to make was that the wage growth 
that we would have expected has probably been delayed by many 
of the things that have impacted the economy in recent years, 
including the war on terrorism, including the market 
consequence of some of the corporate scandals. I would expect 
wage growth to increase.
    The second point I would make, Senator Reed, is when you 
look at labor wages as to corporate costs, those costs have 
been increasing over the last 5 years. But when we look at 
take-home wages to median workers, they have not increased at 
that same rate.
    So what explains that difference? I think part of that 
difference is that many of the costs of labor in corporations, 
large and small, have gone in to fund health care, with costs 
which have grown much faster than inflation, much faster even 
than productivity. So while the worker is costing more to the 
company, that worker does not feel richer when he or she gets 
his or her paycheck.
    So, I think the health care cost challenges, which are 
before this Congress, continue to explain part of the 
differential which you reference.
    Senator Reed. Mr. Kroszner, please.
    Mr. Kroszner. Yes, thank you. Family income is incredibly 
important. Roughly 70 percent of GDP is consumption, and so, 
that has to be the income of individuals, the income of 
families in making their consumption choices. So it is 
certainly important for the Fed to be cognizant of and 
concerned about total income in pursuing the goal of maximum 
employment and maximum growth in a low and stable inflation 
environment. And so, certainly, we want to be very much aware 
of that.
    I think, as Mr. Warsh has pointed out, one sees a 
difference in the total costs of compensation and the take-home 
wages that individuals have been receiving, because there are 
many benefits that they do not receive directly in their wages 
but are a part of their total costs and compensation, and these 
are areas that require a great deal of attention because they 
are increasingly costly. They are causing the differential 
between the take home pay and the amount of pay or the cost of 
each of the individual workers, and that is something that 
certainly is important to look at going forward.
    Senator Reed. I thank both the answers, and I think it sets 
it up very well for Mr. Lazear, who is the policy guy, not the 
Fed guy, but just one other perhaps footnote is that what I am 
observing anecdotally is that a lot of companies are trying to 
solve this difficult medical cost dilemma by dropping people 
off coverage.
    So for some families, you are getting a double whammy: The 
wages are flat, and they lost what they had before, which were 
reasonably good benefits. But I think your points are well-
taken, and I would hope that on the Fed, you would consider 
this issue as very central to what we all should be about.
    And Mr. Lazear, please.
    Mr. Lazear. Senator Reed, as you know, I spent my life 
thinking about labor issues, and so, your concern about wages 
is one that is certainly near and dear to my heart as well.
    The one thing we do know is that wages are very closely 
related to productivity, as pointed out, and productivity is 
very closely related to two kinds of investment: Investment in 
physical capital and investment in human capital.
    One of the issues that we need to focus on in this country 
is making sure that individuals have sufficient human capital, 
sufficient skills to be productive in the labor market, and 
that is particularly true at the bottom end and for some of our 
more disadvantaged citizens.
    I think that if we look at some of the programs that we 
think about in terms of K-12 education, that would certainly be 
one of the key aspects to focus on. We have done tremendously 
well at the college level and the graduate level of education. 
The United States leads the world in that. It is one of our big 
export industries. We have many people coming into the country 
for our education.
    We have not done quite so well at the K through 12 level, 
and I think that we need to focus on that, because individuals 
who do not get to go on to college or graduate school suffer as 
a result of a system that is not serving them well right now.
    So in terms of even the short-run but certainly in terms of 
the long-run, I think that the focus needs to be on the human 
capital side.
    Senator Reed. I do not want to presume--any more questions? 
I just have a general question. One of the areas that concerns 
me also is the abysmal household savings rate, and I appreciate 
your answer before, but my time has expired, so if someone 
wants to comment briefly, particularly--perhaps Mr. Kroszner, 
from the Fed, from your perspective, your aspiration to the 
Fed, what would you do about household savings?
    Mr. Kroszner. I think it is very important for the Federal 
Reserve to provide a stable macroeconomic environment, because 
that is the best one in which individuals will have much more 
certainty about their future, will be able to make their 
savings and consumption plans most sensibly.
    I think if the Federal Reserve causes uncertainty, causes 
volatility, that is problematic for individual decisions. If 
the Federal Reserve provides a very stable, very transparent, 
clear environment that is pursuing its goals of long-term price 
level stability that will maximize employment and maximize 
economic growth, that is the best--from the Federal Reserve 
perspective--that the Fed can do to provide an environment to 
try to foster good decisions on individuals' parts and 
particularly fostering savings.
    Senator Reed. If I may, Mr. Lazear, from the policy 
perspective of the Council of Economic Advisers, what is the 
significant thing that can be done to raise household savings?
    Mr. Lazear. Senator Reed, again, I would focus on tax 
issues. Our tax system right now penalizes future consumption 
relative to present consumption. We would be well-served by 
moving to a structure that is more flat, flat in the sense of 
treating present and future consumption in the same way. I 
think that would encourage saving.
    Some of the things that we focused on when I was on the tax 
panel involved helping low-income individuals save and trying 
to provide some refundable tax credits that would be 
instrumental in getting those individuals into the saving 
picture, and I think all of those things could be useful.
    Senator Reed. Thank you.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Sarbanes.
    Senator Sarbanes. Mr. Kroszner, I welcome the statement in 
your opening testimony about the importance of accurate and 
timely economic statistics.
    I remember often in his testimony before this Committee, 
former Chairman Greenspan would say that one area where he 
supported more government investment was with respect to 
statistics and that for a very small investment, he thought we 
could get a very large payoff in terms of the accuracy of the 
basis on which we were making important policy judgments. Dr. 
Lazear, why do we not get you on the record on statistics and 
then Mr. Warsh?
    Mr. Lazear. One of the things we talked about in your 
office, Senator Sarbanes, was the need for better statistics. 
And actually, right after leaving your office, I started 
thinking about some of the things that we really need to focus 
on.
    One involves some of these issues that came up earlier with 
respect to jobs. We do not have very good data right now about 
the kinds of jobs that the economy is creating and the kinds of 
jobs that are being lost, and that would be one of the things 
that I would like to focus on as Chairman of the Council of 
Economic Advisers if confirmed.
    There are a large number of other possible ways that we 
could beef up the statistics. I know that you have a connection 
to the CEA earlier, and you started working on those things 
even when you were on the CEA. I think we need to be even more 
diligent in terms of thinking about additional areas where 
statistics could be useful to provide information to us and 
then to you.
    Senator Sarbanes. Mr. Warsh.
    Mr. Warsh. Senator Sarbanes, I would say the underlying 
dynamism in our economy has proven relatively difficult to be 
measured by Government data, which is put together in somewhat 
traditional ways. I think a lot of progress has been made in 
trying to improve the quality of that data, but in light of 
that problem, it strikes me that our markets, particularly our 
capital markets, are able to provide some important price 
signals with respect to the current account deficit, with 
respect to policy actions, which is not a perfect measure of 
how the economy is doing but is a necessary supplement given 
the data that we have.
    If U.S. companies were to try to make judgments based on 
the sorts of data that you, Senator, have at your disposal as a 
policymaker, they would be struggling. In fact, U.S. companies 
have moved to just-in-time inventory, real-time data that 
allows them to be much more nimble in their policy decisions, 
and I think it is a helpful model for us all to consider.
    Senator Sarbanes. The President's latest budget proposal 
calls for the elimination of the Survey of Income and Program 
Participation, the SIPP, which has been regarded as a unique 
source of high quality policy-relevant data on the economic 
well-being of the U.S. population.
    And I really would put this to you to take with you as 
something to examine. I think it would be a major step backward 
to drop the SIPP, and since you have this concern for 
statistics, I commend that to you for your thinking. I do not 
know whether any of you is either aware of this or conversant 
with this particular series.
    Mr. Lazear. I certainly know the data set. I have not used 
it, but many of my colleagues have, and I am certainly 
interested in following through on finding out more about that.
    Senator Sarbanes. The money laundering title of the USA 
PATRIOT Act came out of this Committee. Chairman Shelby has had 
a number of oversight hearings on money laundering, and I want 
to ask the nominees for the Federal Reserve Board their 
evaluation of where the Fed is in terms of its supervisory 
activity with respect to money laundering.
    There have been some serious criminal investigations by the 
Department of Justice, which to some extent might suggest that 
the regulatory authorities were not doing all that they should 
have been doing for the matter to progress to the point where 
the Department of Justice would come along and undertake 
criminal investigations. I would like to hear from both of you 
about this money laundering issue.
    Mr. Warsh. Senator Sarbanes, while not privy to the details 
of what the Federal Reserve is contemplating currently, I do 
know that our bank regulators, along with different parts of 
the Administration, have been trying to increasingly speak with 
one voice and be coordinated; that is, FinCEN, the bank 
regulators, other parts of the Government that are aware of 
possible violations of the Bank Secrecy Act must, and I think 
are, continuing to take that responsibility very seriously.
    I believe that there was guidance offered toward the end of 
last year to try to provide an ability for these regulators to 
communicate, share information better between and among 
themselves. But I would take that responsibility, if confirmed 
at the Federal Reserve, very seriously, and I think part of the 
supervisory role is to ensure that the Bank Secrecy Act, the 
antimoney laundering initiatives which have been brought before 
this Committee, are taken very seriously so that our banking 
system is not used by people who are trying to circumvent our 
laws and engage in terrorist activities.
    Senator Sarbanes. Mr. Kroszner.
    Mr. Kroszner. Senator, this is a very important issue. It 
is intolerable to have our financial system be used to finance 
terrorist activities or aid and abet terrorists in any way in 
the United States or around the world. So it is very important 
to vigorously enforce the antimoney laundering statutes, to 
enforce the Bank Secrecy Act, and to ensure that we do not, in 
any way, allow our system to be used by terrorists.
    Again, I do not have the specific knowledge of exactly what 
the Federal Reserve has been doing with respect to enforcement 
activities, but I certainly do support maximal deterrence and 
making sure that our system is not used by terrorists in any 
way to aid or abet their activities.
    Senator Sarbanes. Mr. Chairman, I just want to point out 
because you have taken such a strong interest in this issue 
that the September 11 Commission issued a final report on their 
recommendations in December. Of course, they had made a whole 
series of recommendations. They issued a final report on how 
well they were working and how well they were being 
implemented.
    The only recommendation they got an A, an A-minus, was with 
respect to terrorist financing. So they seem to have regarded 
the work we did here, not only the statutory work but also the 
oversight hearings, the follow-up, I remember a meeting the 
Chairman convened in his office with representatives of the 
Treasury to examine carefully what they were doing I think have 
all produced a result.
    Finally, the other issue I wanted to touch with you, 
because it is one that, again, this Committee has had a keen 
interest in is privacy and data security. We have had some 
horror stories about the loss of people's sensitive 
information, the breaches of the privacy of Social Security 
numbers, credit and debit card numbers, security codes, bank 
account information.
    In fact, the Chairman convened, I think, three or four 
hearings of this Committee on data privacy. How important do 
you regard that issue? Everyone thinks the Federal Reserve 
does--I mean, obviously, it does monetary policy, but it does 
not only do monetary policy, and issues of this sort come 
directly under your jurisdiction.
    Mr. Kroszner. Certainly, protecting people's privacy is of 
the utmost importance. In that Act of 2002, the Confidential 
Information Protection and Statistical Efficiency Act of 2002 
that I was very much involved in, the first part of it is 
confidential information protection.
    And so, one of the things that I wanted to ensure is not 
only that we allow the statistical agencies to be more 
efficient in the use of the data that they have but also that 
the information collected from individuals and firms has the 
highest level of protection possible. What this Act did was 
actually raise the safeguards and raise the protections for 
those. Obviously, this is an extremely important issue, and the 
Federal Reserve has a role to play.
    Some of the incidents that we have heard about have been 
outside of the Federal Reserve's mandate, however. Some of them 
have been associated with institutions that are not banks or 
not regulated institutions by the Fed. But certainly, to the 
extent that the Fed can ensure the confidentiality of and 
protection of people's privacy, of their information in 
financial institutions, I would work the utmost to make sure 
that does occur.
    Senator Sarbanes. Mr. Warsh.
    Mr. Warsh. Senator, I think that part of the success of the 
domestic economy has been an increasing reliance by consumers 
in providing their financial information to those institution 
which they believe are really trusted intermediaries.
    So part of the reason why home mortgages are more prevalent 
in the United States than they are among our European trading 
partners is because of the depth and breadth of those 
commercial financing and securities markets, all of which are 
really critically important, then, to make sure that data is 
private so that those people continue to participate in these 
marketplaces.
    I think this Committee took on the challenge of identity 
theft in the reauthorization and signing by the President of 
the FACT Act, which is an important step down that road. But 
vigorous oversight by the regulators and oversight by this 
Congress is probably necessary going forward.
    Senator Sarbanes. The final question I want to put: Mr. 
Lazear, you are going to be the President's Chief Economist, in 
effect; I mean, that is the theory of it, at least, as Chairman 
of the Council of Economic Advisers. But the two Fed nominees 
are moving from being part of the President's economic team to 
being members of the Federal Reserve Board.
    We give Members of the Federal Reserve Board a 14-year term 
if they get the full term. And of course, the purpose behind 
that is to give them independence so that they will call it as 
they see it and that the judgments will not be political 
judgments but represent well considered economic judgments.
    Given your past experiences as members of the President's 
economic team, I think you need to address this question of the 
independence of the Federal Reserve.
    Mr. Kroszner and then Mr. Warsh.
    Mr. Kroszner. The independence of the Federal Reserve is 
fundamental to the Federal Reserve's mission. In order to be 
credible and make sure to reduce volatility, to reduce 
uncertainty, the central bank cannot be a political animal; it 
must be an independent animal, and that was the Congressional 
mandate in setting up the structure as you had discussed.
    I have been an academic for most of my life. I did take 2 
years to have the honor to be confirmed by this Committee and 
to work in the White House as a Member of the President's 
Council of Economic Advisers, which I think has given me a very 
useful perspective on taking the academic and bringing it to 
the policy world.
    I fully understand that when I am at the Federal Reserve, I 
am at the Federal Reserve; I am not part of any administration. 
I am there as an independent person. The vast majority of my 
life has been in academia, which, as you know, especially in 
the University of Chicago tradition, is one in which there is a 
lot of independence. Regardless of who may be giving a paper, 
who may be putting ideas forward, whether it is a new assistant 
professor, whether it is a Nobel Prize winner, those ideas are 
debated on their merits, and it is not the source of them; it 
is the substance of them.
    And at the Federal Reserve Board, I assure you, Senator, 
that is the approach that I would take, and I understand the 
independence is fundamental to the successful mission of the 
Federal Reserve Board.
    Mr. Warsh. Senator, if confirmed, I think it is essential 
that I take on the role to call them the way that I see them. 
And I absolutely intend to do just that. I think it is a 
dramatically different role than I have served and had the 
privilege to serve over the course of the last 4 years. I am 
very really comfortable taking off one hat and putting on the 
other.
    I think what is at least as important is the credibility 
the Federal Reserve in the marketplace; given the 
responsibilities that this Committee has given the Federal 
Reserve, it is at least as essential that the markets believe 
the judgments of the Federal Reserve, both Chairman Bernanke 
and the Governors, are really impartial judgments that are 
based on the best data and the best information that is 
available. I think that is part of the reason why the markets 
pay so much attention to the reactions of the Federal Reserve.
    Senator Sarbanes. Thank you very much, Mr. Chairman.
    Chairman Shelby. Thank you, Senator Sarbanes.
    I just want to throw out something you know just for 
emphasis: Identity theft is costing billions and billions of 
dollars. We have heard this. And we are trying to get a hold of 
it. As regulators, you will be right in the midst of it, but it 
seems to be not an issue that is going away despite our robust 
economy and the use of everything, the legislation that we have 
passed and the oversight that we do here. So we do want to work 
with you at the Fed and the other regulators to try to combat 
this, because it has reached epidemic stages, and I think it 
could get worse. I pray it will not.
    Thank all of you for your appearance here today. We will 
try to schedule a vote on your nomination as soon as we can. 
Thank you very much. The hearing is adjourned.
    [Whereupon, at 4:19 p.m., the hearing was adjourned.]
    [Prepared statements and biographical sketches of nominees 
supplied for the record follow:]
                 PREPARED STATEMENT OF EDWARD P. LAZEAR
            Chairman-Designate, Council of Economic Advisers
                           February 14, 2006
    Chairman Shelby, Ranking Member Sarbanes, and Members of the 
Committee, it is a great honor to be here today as the President's 
nominee to be Chairman of the Council of Economic Advisers. The 
Council, which has been in existence for 60 years now, is charged with 
the task of advising the President on economic issues. Throughout its 
history, it has remained a body of experts and academicians who have 
taken it to be their duty to inform policymakers in an unbiased and 
professional manner.
    One colleague recently told me that in Washington, when people want 
the correct answer on economics, they go to the Council of Economic 
Advisers. The best compliment that can be paid to the CEA is that the 
CEA ``tells it like it is'' so that the President and Congress, who are 
charged with the responsibility of weighing all factors, can make the 
best decisions possible.
    Let me offer a brief summary of my background. I was born in New 
York, but raised in the San Francisco Bay Area, when my father, who 
worked as a machinist in the defense industry, followed the work to 
California. I attended UCLA where I obtained Bachelor's and Master's 
degrees and then went to Harvard to get my Ph.D., all in economics. 
After graduating, I taught at the University of Chicago for 19 years 
and moved to Stanford University full-time in 1992, where I am 
currently a Professor in the Graduate School of Business and a Fellow 
of the Hoover Institution. I have founded two businesses and was the 
chairman of my company from 2001 until recently.
    I am primarily an applied economist and have worked in a number of 
different areas. My specialty is issues involving incentives and 
productivity. Although most of my work has been in microeconomics, 
broadly defined, I have some well-known research in macroeconomics that 
examines the effects of government policies on employment. I have also 
spent much of my career studying education and am currently the sole 
economist on a National Academy of Sciences standing board that deals 
with education issues.
    My government experience is varied. I have advised a number of 
countries on economic growth and reform, specifically Eastern European 
nations as they moved from command to market economies. I was also a 
Member of the President's Advisory Panel on Tax Reform last year. I am 
currently a Member of Governor Schwarzenneger's Council of Economic 
Advisers.
    Before I left California to testify, my senior Stanford colleague, 
Secretary George Shultz, told me that the role of the Chairman of the 
Council of Economic Advisers is to be an economist to be straight and 
to bring the economics to the table, leaving the politics to others. If 
confirmed, I will devote all of my energy to ensuring that policymakers 
have the best economic analysis possible.
    Thank you. I welcome your questions.
                               ----------
               PREPARED STATEMENT OF RANDALL S. KROSZNER
                            Member-Designate
            Board of Governors of the Federal Reserve System
                           February 14, 2006
    Chairman Shelby, Senator Sarbanes, and Members of the Committee, I 
am pleased to have the opportunity to appear before you today as one of 
President Bush's nominees to serve on the Board of the Governors of the 
Federal Reserve System. I am honored that President Bush has nominated 
me to serve on the Board. If I am confirmed by the Senate, I will work 
to the best of my abilities to fulfill the significant responsibilities 
of this office.
    After studying economics as an undergraduate at Brown University, I 
earned M.A. and Ph.D. degrees in economics from Harvard University. I 
then joined the faculty of the Graduate School of Business of the 
University of Chicago, where I am Professor of Economics and have been 
teaching Money & Banking since 1990. I have researched and published on 
topics including domestic and international banking and financial 
regulation, corporate governance at both financial and nonfinancial 
firms, international banking and financial crises, debt defaults, and 
monetary economics. I am Editor of the Journal of Law and Economics and 
have been Associate Editor of a number of scholarly journals, including 
the Journal of Financial Services Research.
    I have had extensive and regular contact with the Federal Reserve 
System as a visiting scholar and consultant to regional Federal Reserve 
Banks including Chicago, New York, Kansas City, Minneapolis, and St. 
Louis, as well as to the Federal Board in Washington. I also serve on 
the Academic Advisory Committee of the Federal Reserve Bank of Chicago. 
I have visited and consulted for many central banks and finance 
ministries around the world, including Central Bank of Argentina, Bank 
of Sweden, Swedish Finance Ministry, Bundesbank (Germany), and the 
European Central Bank. I have also visited and consulted for 
international financial institutions, including the Bank for 
International Settlements, the International Monetary Fund, World Bank, 
Inter-American Development Bank, and Asian Development Bank.
    As a Member of the President's Council of Economic Advisers (2001-
2003), I have had policy experience in a variety of areas including 
banking and financial regulation, international financial crises, and 
macroeconomic forecasting. In this capacity, I witnessed first-hand the 
importance of having accurate and timely economic statistics in order 
to make sensible policy judgments and decisions. I spearheaded an 
initiative to improve the quality of Government statistics and enhance 
the protection of confidential data reported to the Government, 
resulting in the Confidential Information Protection and Statistical 
Efficiency Act of 2002. After returning to the University, I was 
delighted to be appointed by the Secretary of Labor to the Federal 
Economic Statistics Advisory Committee (FESAC) which meets regularly 
with the major official statistical agencies to discuss how to improve 
measurement of economic activity. If confirmed, I would be devoted to 
further enhancement of the quality of economic statistics.
    Monetary policy is a fundamental responsibility of the Federal 
Reserve. Long-run price stability is crucial to achieving maximum 
employment and overall economic stability. Under Chairman Greenspan and 
Chairman Volcker before him, the Federal Reserve has achieved much 
success in reducing and stabilizing inflation and inflation 
expectations. This success has helped to contribute to a tendency for 
the fluctuations in employment and output to be lower than in the past 
and a reduction in the frequency and severity of recessions. If 
confirmed, I would look forward to working with Chairman Bernanke and 
the other members of the Federal Open Market Committee (FOMC) to 
continue to underscore the role of long-term price stability in 
achieving prosperity and maximum employment. I also applaud the 
increase under Chairman Greenspan in monetary policy transparency, 
which helps to reduce uncertainty for households, entrepreneurs, and 
investors, and thereby contributes to economic stability and growth.
    The Federal Reserve also has a fundamental responsibility for 
protecting the stability of the country's banking and financial system. 
Much of my research and work with central banks has been devoted to 
analyzing banking and financial regulation as well as banking and 
financial crises. The safety and soundness of the U.S. banking and 
payments systems is critical to achieving economic growth, maximum 
employment, and general economic stability, and the Federal Reserve 
works closely with other regulators to achieve this goal. The Federal 
Reserve also has an important role to play in responding to and 
mitigating the impact of financial crises and shocks. If confirmed, I 
would work vigorously to protect and promote the safety and soundness 
of the system.
    The Federal Reserve has an additional important responsibility to 
consumers and users of the banking and financial system. Discriminatory 
or abusive lending practices should not be tolerated, and the privacy 
of individuals and their financial data must be protected. The Federal 
Reserve is active in promoting financial literacy and, as an educator, 
I believe that financial literacy is fundamental to the proper 
functioning of the financial system. If I am confirmed, I will place a 
high priority on these responsibilities and look forward to being 
actively involved in promoting financial literacy.
    Thank you for holding this hearing, and I look forward to your 
questions.
                               ----------
                  PREPARED STATEMENT OF KEVIN M. WARSH
                           Member-Designate,
            Board of Governors of the Federal Reserve System
                           February 14, 2006
    Chairman Shelby, Senator Sarbanes, and Members of the Committee, 
thank you for the opportunity to appear today and for the expeditious 
scheduling of this hearing.
    I wish to express my sincere appreciation to President Bush for 
nominating me to serve as a Member of the Board of Governors of the 
Federal Reserve System.
    I have served on the National Economic Council for the past 4 
years, focusing on domestic finance, capital markets, banking, 
securities and insurance related issues. In that capacity, I have had 
the privilege of working closely and productively with Members and 
staff of this Committee. If confirmed, I look forward to continuing 
that cooperative relationship, along with Chairman Bernanke and the 
Board of Governors, in carrying out the important responsibilities that 
Congress has assigned to the Federal Reserve.
    Market participants, policymakers, and the American people rely on 
the credibility and sound judgment that flows from the Federal 
Reserve's independence. If confirmed, I will be devoted solely to the 
Federal Reserve's statutory mandate for monetary policy--to preserve 
price stability and foster maximum sustainable growth in employment and 
output--and will work to promote a secure, fair, and efficient 
financial system.
    The flexibility and resiliency of the U.S. capital markets are 
matched only by the remarkable innovation and adaptability of our 
Nation's workers. Both of these markets--capital and labor--are a 
source of great strength to the American economy, and have proven in 
recent years equal to the task of cushioning external shocks to the 
economy.
    The capital markets, from which I come, are the transmission 
mechanism for monetary policy. Under Chairman Greenspan's leadership, 
the Federal Reserve took meaningful steps during the past decade to 
describe and explain its policies with greater transparency. As a 
result, market volatility is lower, and our capital markets are deeper, 
broader, and more dynamic than ever before. Pools of free-flowing 
capital, in turn, are able to provide real-time, forward-looking 
information to help Federal Reserve officials make appropriate policy 
decisions. I hope and believe that my prior experience of nearly 7 
years at Morgan Stanley--as an investment banker and mergers and 
acquisitions adviser--would prove beneficial to the deliberations and 
communications of the Federal Reserve.
    Over the course of the last generation, the Federal Reserve has 
compiled an enviable track record in achieving price stability and 
successfully anchoring long-term inflation expectations. This stability 
has contributed to low long-term interest rates and has promoted strong 
employment growth and significant productivity gains. The Federal 
Reserve must remain attuned, however, to the possibility of unexpected 
shocks.
    The Federal Reserve's responsibilities extend, of course, beyond 
monetary policy. It is responsible for the supervision and regulation 
of bank and financial holding companies and State-chartered banks that 
are members of the Federal Reserve System. Working with other financial 
regulators, the Federal Reserve should continue to promote three 
complementary pillars of prudential oversight: Strong capital 
standards, effective supervision, and meaningful market discipline of 
these institutions. I am fully committed to these principles.
    The Federal Reserve also maintains significant responsibility for 
promoting an efficient and effective financial system, including 
protection from systemic risks. As a staff participant on the 
President's Working Group on Financial Markets since 2002, I would hope 
to continue to contribute as a Member of the Board to its important 
work in the years to come. The Federal Reserve remains on the front 
lines in avoiding financial crises--or mitigating their consequences--
should they occur. The American people have come to rely upon the 
Federal Reserve in times of significant financial distress, and it is a 
responsibility that I take seriously.
    Finally, if confirmed, I will work to ensure that the Federal 
Reserve continues its important role in promoting financial literacy 
and fair dealing for consumers. The Federal Reserve's knowledge and 
credibility should continue to be brought to bear to help bring those 
on the fringes of the U.S. financial system into the mainstream.
    In conclusion, the Federal Reserve System's decisions significantly 
impact America's families and businesses. I would take on the 
responsibility of joining the Board of Governors of the Federal Reserve 
System with humility, and would be honored if the Senate sought fit to 
confirm my nomination.
    Thank you. I am happy to respond to your questions.

    
    
    
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