[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]




                  FULL COMMITTEE HEARING ON THE STATE
                     OF THE SMALL BUSINESS ECONOMY

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



                      COMMITTEE ON SMALL BUSINESS
       
                         UNITED STATES HOUSE OF 

                             REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                               __________

                            NOVEMBER 7, 2007

                               __________

                          Serial Number 110-58

                               __________

         Printed for the use of the Committee on Small Business


 Available via the World Wide Web: http://www.access.gpo.gov/congress/
                                 house
















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                   HOUSE COMMITTEE ON SMALL BUSINESS

                NYDIA M. VELAZQUEZ, New York, Chairwoman


HEATH SHULER, North Carolina         STEVE CHABOT, Ohio, Ranking Member
CHARLIE GONZALEZ, Texas              ROSCOE BARTLETT, Maryland
RICK LARSEN, Washington              SAM GRAVES, Missouri
RAUL GRIJALVA, Arizona               TODD AKIN, Missouri
MICHAEL MICHAUD, Maine               BILL SHUSTER, Pennsylvania
MELISSA BEAN, Illinois               MARILYN MUSGRAVE, Colorado
HENRY CUELLAR, Texas                 STEVE KING, Iowa
DAN LIPINSKI, Illinois               JEFF FORTENBERRY, Nebraska
GWEN MOORE, Wisconsin                LYNN WESTMORELAND, Georgia
JASON ALTMIRE, Pennsylvania          LOUIE GOHMERT, Texas
BRUCE BRALEY, Iowa                   DEAN HELLER, Nevada
YVETTE CLARKE, New York              DAVID DAVIS, Tennessee
BRAD ELLSWORTH, Indiana              MARY FALLIN, Oklahoma
HANK JOHNSON, Georgia                VERN BUCHANAN, Florida
JOE SESTAK, Pennsylvania             JIM JORDAN, Ohio
BRIAN HIGGINS, New York
MAZIE HIRONO, Hawaii

                  Michael Day, Majority Staff Director
                 Adam Minehardt, Deputy Staff Director
                      Tim Slattery, Chief Counsel
               Kevin Fitzpatrick, Minority Staff Director

                                 ______

                         STANDING SUBCOMMITTEES

                    Subcommittee on Finance and Tax

                   MELISSA BEAN, Illinois, Chairwoman


RAUL GRIJALVA, Arizona               DEAN HELLER, Nevada, Ranking
MICHAEL MICHAUD, Maine               BILL SHUSTER, Pennsylvania
BRAD ELLSWORTH, Indiana              STEVE KING, Iowa
HANK JOHNSON, Georgia                VERN BUCHANAN, Florida
JOE SESTAK, Pennsylvania             JIM JORDAN, Ohio

                                 ______

               Subcommittee on Contracting and Technology

                      BRUCE BRALEY, IOWA, Chairman


HENRY CUELLAR, Texas                 DAVID DAVIS, Tennessee, Ranking
GWEN MOORE, Wisconsin                ROSCOE BARTLETT, Maryland
YVETTE CLARKE, New York              SAM GRAVES, Missouri
JOE SESTAK, Pennsylvania             TODD AKIN, Missouri
                                     MARY FALLIN, Oklahoma


                                  (ii)










           Subcommittee on Regulations, Health Care and Trade

                   CHARLES GONZALEZ, Texas, Chairman


RICK LARSEN, Washington              LYNN WESTMORELAND, Georgia, 
DAN LIPINSKI, Illinois               Ranking
MELISSA BEAN, Illinois               BILL SHUSTER, Pennsylvania
GWEN MOORE, Wisconsin                STEVE KING, Iowa
JASON ALTMIRE, Pennsylvania          MARILYN MUSGRAVE, Colorado
JOE SESTAK, Pennsylvania             MARY FALLIN, Oklahoma
                                     VERN BUCHANAN, Florida
                                     JIM JORDAN, Ohio

                                 ______

            Subcommittee on Urban and Rural Entrepreneurship

                 HEATH SHULER, North Carolina, Chairman


RICK LARSEN, Washington              JEFF FORTENBERRY, Nebraska, 
MICHAEL MICHAUD, Maine               Ranking
GWEN MOORE, Wisconsin                ROSCOE BARTLETT, Maryland
YVETTE CLARKE, New York              MARILYN MUSGRAVE, Colorado
BRAD ELLSWORTH, Indiana              DEAN HELLER, Nevada
HANK JOHNSON, Georgia                DAVID DAVIS, Tennessee

                                 ______

              Subcommittee on Investigations and Oversight

                 JASON ALTMIRE, PENNSYLVANIA, Chairman


CHARLIE GONZALEZ, Texas              LOUIE GOHMERT, Texas, Ranking
RAUL GRIJALVA, Arizona               LYNN WESTMORELAND, Georgia

                                 (iii)









?

                            C O N T E N T S

                              ----------                              

                           OPENING STATEMENTS

                                                                   Page

Velazquez, Hon. Nydia M..........................................     1
Chabot, Hon. Steve...............................................     2

                               WITNESSES

Mishkin, Hon. Governor Frederic S., Board of Governors of the 
  Federal Reserve System.........................................     4

                                APPENDIX


Prepared Statements:
Velazquez, Hon. Nydia M..........................................    26
Chabot, Hon. Steve...............................................    28
Mishkin, Hon. Governor Frederic S., Board of Governors of the 
  Federal Reserve System.........................................    30

                                  (v)














 
                        FULL COMITTEE HEARING ON
                         THE STATE OF THE SMALL
                            BUSINESS ECONOMY

                              ----------                              


                      Wednesday, November 7, 2007

                     U.S. House of Representatives,
                               Committee on Small Business,
                                                    Washington, DC.
    The Committee met, pursuant to call, at 9:05 a.m., inRoom 
2360, Rayburn House Office Building, Hon. Nydia M. Velazquez 
[Chairwoman of the Committee] Presiding.
    Present: Representatives Velazquez, GonzaAE1lez, Clarke, 
Sestak, Chabot, Bartlett, Akin, Fortenberry, Heller, Davis, 
Buchanan and Jordan.

           OPENING STATEMENT OF CHAIRWOMAN VELAZQUEZ

    ChairwomanVelazquez. Good morning. I am pleased to call 
this hearing to order. Thank you all for being here today.
    Today's hearing will examine the production, employment, 
and output of our Nation's small businesses as the driver of 
the U.S. economy. There can be little doubt that, at its heart, 
our Nation's economy is truly a small business economy. 
Research has shown that small businesses create most of the 
Nation's net new jobs and account for almost half of our 
employer firms. Additionally, they produce more than half of 
the country's nonfarm private output.
    It goes without question that small firms make significant 
contributions to the U.S. economy. Today's hearing will provide 
a forum to hear the Federal Reserve's perspective on small 
businesses' contributions to the economy. This comes at a time 
when we are seeing mounting challenges in the financial 
markets. These challenges, stemming mainly from the housing 
market, may spill over to other sectors of the economy. This 
would have broad ramifications, including an impact on small 
businesses.
    Despite this recent turmoil, small businesses remain a 
critical source of growth. A number of new businesses measured 
as the number of firms created has shown a net increase of over 
20,000 since 2004. Just last week, the Labor Department 
reported nationwide job growth of 156,000 new jobs and a stable 
rate of unemployment. Small businesses were at the heart of 
these metrics. And whatever our economic future may hold, we 
can be assured that small businesses will be the vanguard for 
production, job creation, and output nationwide.
    Recently, however, we have witnessed increased volatility 
in the capital markets. These conditions have been driven 
primarily by weaknesses in the mortgage sector, but virtually 
every business sector has been affected by these events. 
Mortgage market instability has resulted in a tightening of 
lending standards that has spilled over into the small business 
credit markets. Indicators reflect that entrepreneurs are 
experiencing difficulty obtaining credit, and more banks are 
reporting lower demands for small business loans.
    I am sure it comes as no surprise to members of this 
Committee that small businesses have more difficulty gaining 
access to an affordable source of credit compared to large 
businesses or other types of borrowers. Unfortunately, the most 
recent Federal Reserve report on the availability of credit to 
small businesses revealed that this continues to be the case.
    Small businesses continue to rely disproportionately upon 
more expensive alternatives to traditional credit than larger 
businesses. Additionally, the percentage of small businesses 
that use credit cards increased nearly 10 percent since the 
last Federal Reserve survey. These results demonstrate the need 
for strong Small Business Administration programs aimed at 
providing small firms with access to affordable sources of 
financing.
    Yet, despite the obvious importance of small businesses, 
there remains few studies on their economic role. In addressing 
the need for solid information on small businesses, few studies 
have been more influential than the Federal Reserve's report to 
Congress on the availability of credit to small businesses. 
Much of the information contained in the report is gleaned from 
the Survey of Small Business Finance, which is itself the most 
comprehensive and up-to-date assessment of small business 
finance. Over the past decade, this report has provided 
Congress with invaluable insight into the small business credit 
markets. Now, more than ever, such insight is the key resource 
in developing balanced and effective economic policies.
    With the economic turmoil we have seen recently, it is 
paramount that we all work together to restore financial market 
stability and upset the effects of tighter credit conditions. 
These developments have created uncertainty over our economic 
future. Our history has proven that as small businesses go, so 
goes the national economy. In this environment it is more 
important than ever that this Committee remain committed to 
ensuring that small businesses have access to the financial 
tools they need to grow and thrive.
    I want to thank Governor Mishkin for his testimony in 
advance, and I now yield to the Ranking Member Mr. Chabot for 
his opening statement.

                OPENING STATEMENT OF MR. CHABOT

    Mr.Chabot. Thank you, Madam Chair, for holding this hearing 
this morning to examine the state of the small business 
economy.
    And I think we all want to thank you as well, Governor 
Mishkin, for taking time out of your very busy schedule to be 
with us today to share your views on this very important topic.
    While the U.S. economy faces real challenges, credit 
worries, rising energy costs, and a slowing housing market, 
among others, the October Bureau of Labor and Statistics 
Employment Summary and the preliminary estimates of third 
quarter GDP growth show an economy that is expanding. Job 
growth in the third quarter was the strongest since the early 
spring of 2007, with an estimated 166,000 new jobs created just 
last month in October. The strongest month for job creation 
since May, October marked 50 months of consecutive job growth, 
50 months of consecutive job growth.
    In addition to these positive trends, we have seen wage 
increase and growth of the gross domestic product remain 
steady. These numbers surpassed expectations, indicating 
entrepreneurs and small businesses continue to create new jobs, 
and the labor market and overall economy remains strong. These 
numbers provide great insight into the strength of our small 
business economy.
    Because of their importance to our overall economic health, 
and we all know the statistics, we must continue to be mindful 
of how the policies we pursue and enact here in Congress will 
affect small businesses as we move forward.
    I am concerned over some of the tax policy initiatives that 
have been coming from the Ways and Means Committee leadership 
in the last few weeks. As the White House noted, the most 
recent legislation would dramatically raise taxes on millions 
of small businesses, stifling their ability to grow and create 
jobs. Coupling this legislation with runaway government 
spending, we are setting up a scenario that would put a wet 
blanket on future growth. Small businesses are vital to future 
economic growth, and I believe that these regressive tax-and-
spending policies put our economic well-being in danger.
    I am very eager to hear today how the Federal Reserve Board 
is responding to the credit crunch in the wake of the housing 
market downturn. I am interested to learn the Board's forecast 
for how the credit crunch is affecting our small businesses 
now, and how further trickle-down from the housing market 
fallout will affect them in the future.
    I think I speak for many of my colleagues when I say that 
we in Congress would like to know how we can help both 
individual Americans and businesses weather the current credit 
market crunch.
    I look forward to working with Chairwoman Velazquez and all 
of our colleagues in this Committee to ensure that this 
Congress does more than just talk about how small businesses 
are our economic engine, but also acts in accordance with that 
reality. Under the Chairwoman's leadership, this Committee has 
remained cognizant of small firms' proficiency in generating 
jobs and ability to grow our economy, and we will continue to 
ensure small businesses receive their fair shake.
    Just one point. I can't overemphasize how concerned I am 
about the proposed mother of all tax bills that is being 
considered in the Ways and Means Committee. That gives me and, 
I think, many other people great concern about the impact that 
could have on the small business community; because the taxes 
that the Chairman of that particular Committee is talking about 
would fall probably most heavily on small business owners. That 
is the people that would really be targeted by that. And I 
think we in this Committee should do everything within our 
power to get that less powerful Committee to back down to this 
more powerful Committee.

    ChairwomanVelazquez. Well, thank you, Mr. Chabot. But I 
just would like to add for the record that the mother of all 
taxes is a long way in front of us. What is more important for 
us today is the mortgage market instability and how that could 
spill over to other sectors of our economy, and the immediate 
impact on small businesses.
    So, Governor Mishkin, it is a pleasure to have you here 
today. Dr. Mishkin sits on the Federal Reserve Board of 
Governors, having taken office on September 5, 2006. Before 
becoming a member of the Board, Dr. Mishkin was the Alfred 
Lerner Professor of Banking and Financial Institutions and A. 
Barton Hepburn Professor of Economics at the Columbia 
University Grad School of Business. During his career, Dr. 
Mishkin has also served the Federal Reserve System in several 
roles, including executive vice president and director of 
research at the Federal Reserve Bank of New York, and an 
associate economist of the Federal Open Market Committee of the 
Federal Reserve System.
    Dr. Mishkin is the author of more than 15 books and 
numerous articles in professional journals and books. Dr. 
Mishkin is one of the most respected scholars on monetary 
policy and its impact on financial markets and the aggregate 
economy.
    You are most welcomed.

STATEMENT OF FREDERIC S. MISHKIN, MEMBER, BOARD OF GOVERNORS OF 
                   THE FEDERAL RESERVE SYSTEM

    Mr.Mishkin. Thank you very much for that kind introduction.
    Chairwoman Velazquez, Ranking Member Chabot, and members of 
the Committee, I am pleased to appear on behalf of the Board of 
Governors to discuss the availability of credit to small 
businesses.
    Small businesses play a critical role in the U.S. economy, 
and access to credit is essential for this success. As you 
know, the Board is required to report to the Congress every 5 
years on the status of small business access to credit, and our 
most recent report was submitted on October 26. While I cannot 
discuss all of the topics covered in our report, I would like 
to mention a few highlights. I will then briefly address how 
the unusual stresses imposed on credit markets in recent months 
may affect small businesses. So let me turn to the highlights 
of the 2007 report to Congress.
    Our 2007 report indicates that, since our last report in 
2002, financing flows to small firms generally increased along 
with economic activity. Credit conditions during the period 
were favorable for small firms, and we have no evidence that 
credit-worthy borrowers faced any substantial constraint on 
their access to credit.
    Although small businesses obtain credit from a wide range 
of sources, commercial banks are today, as in the past, the 
leading provider. Our report shows that, among small 
businesses, relatively large firms and a lot of the older firms 
were more likely than smaller, younger firms to use a wide 
range of types of credit and were more likely to have their 
credit applications approved. These results are consistent with 
the conventional view that smaller and younger firms are 
riskier, have shorter credit histories, or less collateral to 
pledge as security, and are generally harder for lenders to 
evaluate because they are less transparent.
    As was true in 2002, the 2007 report emphasized the 
importance to small businesses of geographic proximity to their 
sources of credit. The importance of local providers of credit 
to small businesses underscores the need to preserve 
competitive banking markets at the local level. Despite the 
significant consolidation that has occurred in the banking 
industry, competitive conditions in the Nation's local banking 
markets have remained quite stable.
    The use of credit scoring in assessing small business 
credit applications has become common only since the mid-1990s. 
Evidence suggests that the use of credit scoring increases 
credit availability to some small businesses. Users of credit 
scoring models generally report that, after their adoption, the 
riskiness of the small business portfolio remains about the 
same or it declines, and the quality of the typical credits 
decision increases.
    The obstacles to securitizing most loans to small 
businesses remain large. The securitization of small business 
loans has remained modest, and is unlikely to increase 
substantially over the foreseeable future.
    So let me turn to small businesses finances and recent 
financial market developments. I will now comment briefly on 
the possible effects of the recent financial market turmoil on 
small business access to credit. I emphasize that the possible 
effects are complex; that we do not yet have much hard 
evidence; and that it is far too early to draw any strong 
conclusions.
    That being said, there are good reasons to believe and some 
evidence to suggest that the recent financial market 
disruptions have not seriously harmed access to credit by small 
businesses; and, if the disruptions continue to be resolved in 
an orderly manner, it will be unlikely to do so in the near 
future.
    For example, the current turmoil has centered on securities 
backed by nonconforming residential real estate loans and loans 
or other debts of relatively large firms. Because the 
securitization of small business loans is still quite modest, 
we would not expect turmoil in the markets for securitized 
assets to have a large direct effect on small business lending.
    Recent events have nonetheless almost surely had some 
negative effects on small business access to credit, and we 
cannot rule out further effects. For example, recent surveys 
have found that the market for small business credit has 
tightened. These surveys also suggest that, at least for now, 
the effects have generally been quite limited.
    Perhaps one of the most important concerns for small 
business access to credit is that many small businesses use 
real estate assets as collateral. Looking forward, a reduction 
in the value of their real estate assets has the potential to 
adversely affect the ability of those small businesses to 
borrow. Similarly, declines in the value of real estate assets 
held by banks and other lenders may affect their ability to 
supply loans, as real estate losses use up capital that could 
otherwise be used for making new loans.
    Fortunately, the vast majority of U.S. Banks are well 
capitalized, and thus should be able to maintain their lending 
capacity. Still, the possibility remains that reductions in 
real estate values and other factors could affect small 
business access to credit. The Board will be monitoring the 
economy for signs of possible effects over the next few months.
    So, let me conclude. In conclusion, the health of the U.S. 
economy depends importantly on the vitality of the small 
business sector. Our 2007 report indicates that since our 2002 
report, small business access to credit has been robust. Credit 
conditions have no doubt tightened since mid-August, but small 
businesses seem generally to have been able to retain access to 
credit. However, the current level of uncertainty is unusually 
high. Thus, the Federal Reserve will continue to monitor 
closely the effects of financial market conditions on small 
business finances as part of our efforts to ensure that the 
stress on foreign financial markets does not spill over into 
the broader economy.
    Thank you. I would be happy to answer any questions you may 
have.
    ChairwomanVelazquez. Thank you, Governor Mishkin.
    [The prepared statement of Mr. Mishkin may be found in the 
Appendix on page 30.]

    ChairwomanVelazquez. In fact, you discussed the effect of 
the recent tightening of credit standards has on small 
businesses and financing. So my question to you is to what 
extent does the SBA's lending--Small Business Administration 
lending and investment programs bridge gaps in private markets 
for access to financing during periods of tighter credit 
conditions?
    Mr.Mishkin. Well, SBA financing, I am sure, does help; but 
the recognition is that it is actually only a small part of 
actually financing of small businesses, on the order of 5 
percent. So clearly what is really very key is the overall 
health of the U.S. economy and also the overall health of the 
financial system to be able to provide the credit to small 
businesses.
    ChairwomanVelazquez. The Federal Reserve makes policy 
decisions weighing both inflation and economic growth. During 
the September 18 Federal Open Market Committee meeting, the 
decline in inflation was expected to be sustained throughout 
the year, but needed to be watched carefully. The meeting 
minutes stated that inflation remained a risk due in part to 
the continuing weakness in the dollar. How has the recent slide 
in the value of the dollar affected your inflationary 
expectations?
    Mr.Mishkin. Well, clearly when the dollar declines in 
value, that increases both the prices of imports, what we buy 
from abroad, but actually also increases the demand for exports 
and therefore prices for exports. In fact, we think of these as 
just tradable goods, and it actually would lead to higher 
prices in those goods.
    However, the pass-through of the effects of exchange rate 
depreciation are very much affected by how anchored inflation 
expectations are. If inflation expectations are well anchored, 
which is extremely important and, in fact, part of what the 
Federal Reserve needs to achieve and has achieved in recent 
years, then we find that the impact of the dollar depreciation 
on the overall price level is actually quite limited.
    ChairwomanVelazquez. Sir, with the weaker dollar and 
inflation concerns expressed by the Board in meeting minutes, 
are some inflationary risks being ignored?
    Mr.Mishkin. Well, I hope not. We definitely don't want to 
ignore them. It is extremely important to the health of the 
economy that inflation, in fact, remains contained. This has 
been one of the great successes of the Federal Reserve System 
in recent years and, actually, also in other central banks 
throughout the world. Indeed, if you anchor inflation 
expectations and anchor inflation, it actually gives you more 
flexibility to deal with negative shocks to the economy.
    ChairwomanVelazquez. We all know that businesses of all 
sizes must plan and account for inflation. Would you please 
describe to us your view on the idea of an explicit target, 
explicit inflation target, and its likely effects on small 
business' ability to make informed decisions?
    Mr.Mishkin. Well, at this stage the Federal Reserve has 
been discussing communication strategies, so I really don't 
want to comment on the issue of inflation target. What I will 
say, however, is--
    ChairwomanVelazquez. But let me ask you, can you discuss 
how an inflation target impacts the small business sector?
    Mr.Mishkin. Well, I think the issue here is rather than 
thinking so much of an inflation target impacting the small 
business sector, the way I would think about this is the 
control of inflation and how that impacts the small business 
sector; that clearly having price stability, which is part of 
our dual mandate, and not only do we care about price 
stability, but we also care very much about what happens to 
economic growth and employment--but having price stability 
actually makes it much easier for small businesses to plan and 
make better investments and, therefore, do better actually.
    I come from a small business background, actually maybe 
even was in your district. There was manufacturing in 
Manhattan, quite extensive manufacturing, which, of course, is 
no longer there. And I worked in my father's plant, and, in 
fact, it is now a restaurant, by the way, which is what has 
happened to Manhattan. It was on West 14th street. So, I don't 
know where that is relative to your district. But, clearly, the 
years where, in fact, inflation was highly volatile actually 
created tremendous problems in terms of planning. So I saw this 
by talking to my father every day at the dinner table.
    When you have a stable price environment, it makes it much 
easier for businesses to plan. Secondly, when you have stable 
prices, it means that interest rates actually stay lower. So 
part of our so-called dual mandate, there is a third element to 
the congressional act for the Federal Reserve, which actually 
said not only do we want to have price stability, maximum 
sustainable employment, but also that we should have stable 
interest rates. Well, in order to get that, you also have to, 
in fact, make sure that inflation is under control.
    Also, we find that when central banks control inflation 
better, it means that you can be more aggressive when, in fact, 
there is negative hits to the economy. But always you must keep 
your eye on the inflation ball to make sure that you do not end 
up in a situation such as ones we have had in the past, 
particularly in the 1970s, where you actually had both high 
inflation and actually an economy that did not do very well.
    ChairwomanVelazquez. It is no secret, sir, that the 
turbulence we have recently witnessed in the markets grew out 
of the mortgage market. The Federal Reserve lowered the Federal 
funds rate at both of its last meetings in response to 
tightening credit conditions that could restrain growth. 
Housing prices have leaped, vacancy rates are rising, and home 
starts are declining. As a result, several prominent Wall 
Street firms had unexpected record write-downs. Given the 
length of a typical foreclosure process, is it possible that 
the worst is still to come?
    Mr.Mishkin. Well, clearly the situation in the housing 
sector is one that we have to monitor very closely. The 
weakness in housing has been a significant drag on the economy 
in the second half of this year, on the order of about 1.5 
percent of GDP. So this is a very significant impact. And, 
clearly, the housing market is not out of the woods yet. There 
is a big overhang of inventory, a lot of houses that builders 
have built and they have not yet sold, and this is actually 
depressing the effect on the housing market.
    So one of the difficult things for a central banker is that 
you actually have to look at the economy. And, unfortunately, 
we don't have a crystal ball. Luckily, we do have a very, very 
strong staff at the Federal Reserve to help us think about 
where the economy will head, and particularly monitoring the 
housing market and the housing sector is absolutely one of the 
key things that we have to do now, because we do have to worry 
about the fact that housing may not do well in the future and 
when it will turn around.
    ChairwomanVelazquez. And isn't it true that financial 
institutions cannot predict as to the extent the foreclosure 
crisis will have on them, since the process could take from 6 
months to a year?
    Mr.Mishkin. I am sure they do have some forecasts of how 
serious these foreclosures are going to be. It is clear that, 
in fact, there are going to be a lot of foreclosures down the 
road, and some of that has already been taken into account in 
terms of predictions in terms of the earnings of these 
financial institutions.
    This is actually part of the nature of lending, that they 
sometimes do make mistakes; and, in fact, clearly in this 
instance we have had a lot of mistakes made in terms of people 
not being able to pay back loans. And this is something clearly 
that the financial institutions do have to worry about and 
something that we have to be concerned about as well.
    ChairwomanVelazquez. Well, let's take, for example, that in 
January and July of this year, Chairman Bernanke testified 
before the House and Senate Banking Committees to report on the 
conduct of monetary policy. In both hearings, the Chairman 
expressed confidence that weaknesses in the housing market will 
not spill over in the wider financial markets. Clearly, the 
perspective was overly optimistic.
    If the downturn in the housing sector continues throughout 
the next year, what effect do you believe this may have on the 
broader markets?
    Mr.Mishkin. Well, clearly one of the things that has 
happened is that the problems in the mortgage sector have 
actually spilled over more widely to the financial markets in 
general. Indeed, when we think about what financial markets are 
supposed to do, they are basically solving information 
problems; they are trying to allow people to take funds and 
give it to people who have good, productive investment 
opportunities. And this is particularly important in the small 
business sector, which is one of the key drivers of the U.S. 
economies. It is really quite extraordinary how vibrant the 
small business sector is in this country.
    ChairwomanVelazquez. Will this affect commercial lending 
for the small businesses?
    Mr.Mishkin. So there are clearly a whole set of issues 
here, but one of the things that happened is that the markets 
had much more confidence in their understanding of not only 
what is going on in the mortgage markets, but the very complex 
products which are related to mortgages. And we have seen, in 
fact, that these surprises have meant that the financial 
markets have actually had a disruption, and that does have 
impacts on small businesses. In particular, we have seen a 
tightening of lending standards. We have a survey of senior 
loan officers, and there clearly has been a tightening of 
lending standards.
    However, it is important to note that because the problems 
in the financial markets have actually been more in the 
securitization part of the markets, and small businesses 
typically do not get credit through securitization the way some 
other sectors have, that the impact seems to have been greater 
for larger firms rather than for smaller businesses. So there 
clearly has been an impact that this is one of the issues in 
terms of an economy that is weaker than we might have expected 
a little while ago. It clearly is one of the reasons why the 
Federal Reserve has acted to lower the Federal funds rate by 75 
basis points in order to forestall or counteract the negative 
effects from this credit tightening.
    ChairwomanVelazquez. Thank you, Governor Mishkin. I have 
other questions, and I will come back in the second round.
    Now I recognize the Ranking Member Mr. Chabot.
    Mr.Chabot. Thank you, Madam Chair.
    First, I would like to talk about the credit crunch or the 
credit availability problem that we have. And many of us are 
concerned that the response to the long forecast housing and 
mortgage crisis has been insufficient and late in coming.
    Now that communities around the country, and we see this 
particularly in my State of Ohio, are suffering its effects, 
could you discuss what should have been done or could have been 
done sooner and what could or should be done now, in your 
opinion?
    Mr.Mishkin. Well, from a viewpoint of the firms that were 
engaged in the business of making mortgages, clearly there were 
mistakes made; that there was not as good an understanding of 
the kind of risks that were inherent in some of the products 
that were produced. In fact, when we look at financial 
development over time, this is very common, that you have new 
products which eventually can actually be very useful, but in 
the process--and particularly solving these information 
problems, to actually get funds to people with productive 
investment opportunities--but in the process of developing 
them, mistakes are made.
    So clearly one of the things, I think, that is going to 
happen is that people--that firms are going to be looking at 
whether the way they designed the products that they had for, 
in fact, getting funds to both businesses and households, 
whether, in fact, those were the best models for doing so. So 
clearly we are seeing a situation where people are trying to 
figure out how to, in fact, understand these products better, 
set the procedures up so we don't have some of the problems 
that have occurred in terms of loans being made to people who 
couldn't pay them back. And so we will see a process of getting 
the financial markets to work better. Unfortunately, mistakes 
were made, and we are paying some of the price of that at this 
particular juncture.
    Mr.Chabot. Thank you.
    How do you anticipate that these credit and lending issues 
will affect small business? And what is the Federal Reserve 
doing to reduce the negative impact on small businesses, and 
especially on their employees, because that is, after all, who 
oftentimes pays the price when the business suffers.
    Mr.Mishkin. One of the good things is that going into this 
situation where we have had this financial market disruption, 
that the balance sheets of firms has been quite strong, and 
this is true for small businesses as well as large businesses, 
which actually helps them have the resources to weather these 
kinds of problems better than they otherwise would.
    The other issue that I think that is important here is the 
nature of small businesses, which actually was pointed out in 
the opening statement of the Chairwoman of the Committee, that 
they actually have not been able to get access to certain 
credit vehicles the way other people have because the 
information about them is harder to get. Particularly if a firm 
is smaller and also it has been around less time, it is a 
younger firm, there is not as much information about it, it is 
actually harder to take the loan to that person and then bundle 
it together and then securitize it. The aspect of that actually 
helps small businesses now is that they are not quite as 
exposed as some of the other sectors of the economy.
    So, nonetheless, there clearly has been an impact on small 
businesses because of the tightening of credit conditions, and 
there has been an impact in this financial disruption on 
aggregate demand in the economy.
    In a situation like that, a central bank is supposed to act 
in order to counteract those negative shocks. Our job is to 
keep the economy on an even keel, which means prevent inflation 
from being too high or actually even preventing it from being 
too low. But it is similarly also trying to prevent economic 
fluctuations that are undesirable.
    So in this context what the Federal Reserve has done has 
been to lower interest rates in order to counteract the 
negative shock that has occurred from the financial disruption. 
And, clearly, not only is that going to help the overall 
economy, but particularly help small businesses as well.
    Mr.Chabot. Thank you.
    I had mentioned Chairman Charlie Rangel's so-called mother 
of all tax bills in my opening statement and voiced my concern 
about it. And it has been said that millions of Americans who 
own small businesses and who pay taxes on that income on their 
individual tax returns are going to face in effect what is a 
triple whammy. First, they will be hit with a 4 percent surtax 
on some of their income. Second, many of them will lose the 
section 199 manufacturing deduction that lowers taxes on their 
business income. And, third, this is happening at the same time 
as large corporations would be getting an across-the-board tax 
cut, making it even tougher for these small business engines of 
job creation to compete with the larger corporations and for 
those business owners to deal with these increases in taxes. Is 
that scenario one that should give us concern? Do you have any 
comments about that?
    Mr.Mishkin. Well, the Federal Reserve has plenty to do, but 
we actually don't decide on tax policy. In fact, this is 
exactly what our elected representatives are supposed to focus 
on; and so it is something that I am going to leave to you to 
make the decisions on.
    Mr.Chabot. All right. Well, as I said, a lot of us have an 
awful lot of concern about that. And hopefully reasonable minds 
will prevail, but only time will tell where we are at.
    Finally, and this may again get into an area where you may 
or may not want to comment, but I am going to jump into it 
anyway. Would you agree that permanency and certainty in the 
Tax Code is beneficial to our economy, because businesses can 
then determine what policies they are going to be faced with 
and how to deal with those kind of on a long-term basis? And, 
in general, do you believe that the tax relief that we passed 
back in 2001 and 2003 helped the recent growth in our economy? 
And do you believe that it would make sense to make those tax 
policies permanent so that small businesses can depend upon 
those in the future?
    Mr.Mishkin. Again, I don't want to comment on tax policy, 
but in general, clearly the less uncertainty that you have, the 
better. And this is clearly an issue in terms of Federal 
Reserve policy; that, in fact, making sure that people think 
that the economy is going to not be volatile is, in fact, 
something that actually helps both directly in terms of 
actually business decisions, but also just makes people much 
more comfortable. So clearly there is an issue about having 
less uncertainty, and then the question is, how do you achieve 
that? And, again, on tax policy, I am going to leave that up to 
you.
    Mr.Chabot. Thank you very much.
    ChairwomanVelazquez. Mr. Sestak.
    Mr.Sestak. Thank you, Madam Chairwoman.
    In your testimony, sir--if you don't mind, I very much 
appreciate all your comments about small business and all, but 
in your testimony, you made the very important point, I 
thought, the most important point, that half of all net new 
jobs annually come from small business.
    If I could disconnect the small business just for a moment 
and focus on jobs, because jobs lead to wages. What is your 
comment about the--if you don't mind just using your 
expertise--that the study by AEI, conservative, and Brookings, 
liberal, came together, and despite all the nice prose that has 
been presented, that for the very first time the 
intergenerational promise has not been achieved in America?
    It took two cohorts in the early 1970s, age 35, with some 
kids, about the time when you are in the prime of just 
beginning to say this is where I am going to be living for my 
kind of wages, and said, what did they earn in the 1970s real 
terms? AEI, with Brookings, jumped ahead 35 years when those 
children had grown up and were of similar age with children and 
said, in real terms today, the next generation for the first 
time in America is earning less than their parents.
    How do we address that issue? Love new jobs, but the median 
level of real wages has declined in the last 6 years. So jobs 
are interesting, but wages apparently is what we really want 
them for. How do you fix that? How do you address that 
intergenerational broken promise?
    Mr.Mishkin. Well, I am not going to comment on the studies 
themselves. There always are very complicated issues in 
measuring issues, but there clearly is an issue in terms of 
what is happening to the median job holder, and, in particular, 
when you have growth in the economy, actually, how does it get 
spread throughout the economy. And this is an issue, for 
example, about the whole question about income and equality and 
what this means for this society.
    The problem here is that the research on this indicates 
that it is hard to actually decide exactly what the source of 
these problems are. Some of the issue of what has been 
happening may also have to do with just the nature of 
technological change, which is something that central banks and 
even policies from the government may not be able to affect 
that strongly, and, in fact, some of the technological change, 
of course, can be very beneficial in the long run to the 
economy. So the problem here is that it is not obvious what the 
simple solution to this issue is.
    Mr.Sestak. But it is an issue, it is not the issue.
    Mr.Mishkin. It clearly is an issue that, in fact, you want 
to have all Americans benefit from economic growth. And this is 
not only true from the point of view of issues of equity, but 
issues from a point of view of getting everybody to buy into 
good policies for the country.
    Mr.Sestak. Thank you for that. I mean, because, please, 
take this right when I say your job is hard. I have never met a 
one-armed economist, because they are always saying on the one 
hand and on the other hand.
    My next question comes then; we are $9 trillion in debt. As 
President Clinton handed over to President Bush the economy, 
the Congressional Budget Office said by fiscal 2008 we would 
have a $5 trillion surplus. Well, we are $9 trillion in debt 
today.
    In 2002, this Congress, Republican Majority, decided no 
longer to do pay-as-you-go, which President Clinton with a 
Republican Congress had come to an agreement upon. And I 
understand your comments about uncertainty, but there was a lot 
of uncertainty when that was done away with.
    Do you believe that, in view of not just tax, but the 
principle here, that there is some tough decisions to be made 
as 23 million Americans, if we don't get this tax thing right, 
will enter the AMT area and pay more taxes? So, is pay-as-you-
go important, and should it be not just discretionary but 
mandatory funding?
    Mr.Mishkin. Again--
    Mr.Sestak. Because you talked about the principles of 
certainty, so I think this is kind of in your "principles of" 
area.
    Mr.Mishkin. Clearly having long-run fiscal sustainability 
is very important to the country. And in fact, not only is it 
important to the country; in order to do monetary policy well, 
you have to have fiscal sustainability. So one of the things we 
have learned from particularly looking at other countries, we 
haven't had as much problem here, but in the emerging market 
economies, in fact, that they frequently had big problems 
because they have not had fiscal sustainability. How you 
actually achieve that is again your responsibility.
    Mr.Sestak. Is pay-as-you-go--because the Federal Reserve 
Chairman spoke on this in years past. Is it a good principle to 
have?
    Mr.Mishkin. My view on this is that there are many 
different ways to actually try to solve the problem on fiscal 
responsibility.
    Mr.Sestak. On the one hand, but on the other hand.
    Mr.Mishkin. I not only have 2 hands, I also have 10 
fingers. So on this one I have got to leave this up to you as 
our elected representatives.
    Mr.Sestak. Thanks. It is tough to get advice in this town. 
Thank you.
    Mr.Mishkin. Depends on what kind of advice.
    ChairwomanVelazquez. Mr. Bartlett.
    Mr.Bartlett. Thank you.
    Yesterday, as you know, oil went through $97 a barrel. Is 
the small business community going to be more or less impacted 
by increasing oil prices as compared to the rest of the 
business world?
    Mr.Mishkin. Well, I am not sure whether there will be more 
or less impact because I just don't know the details. It 
clearly depends on what sector the small business is in. If 
they are very dependent on energy--so, for example, if the 
small business is one which is providing a service which 
doesn't use a lot of energy, then the impact will be fairly 
small. If it is a small business that is very energy-intensive, 
then of course the impact is larger. And I don't really have 
the information to tell you where small businesses--which 
sectors they are relative to large businesses, so I can't 
really be sure on this.
    Clearly, the issue of high oil prices is, in fact, going to 
impact American businesses in general because it is a factor 
increasing the cost of their doing business. The good news is 
that, over time, American businesses have become more and more 
efficient in terms of using energy, and so the impact on 
businesses in terms of the higher energy prices is much, much 
smaller than it was, let's say, 20, 30 years ago where the 
impact was much larger. And that is very good news. This is 
part of the ingenuity of the American capitalist structure, 
that when you have higher prices and a key product for you, 
that you figure out how to substitute away from it.
    So is it an issue in terms of businesses for higher energy 
prices, and also for households? Every time I know I am going 
to fill up my car, and it gets more and more expensive when oil 
prices go up, does it impact? Certainly, it does. But the 
potential problems from this are not what they used to be.
    Mr.Bartlett. In your role of being the primary entity that 
tries to stabilize our economy, you obviously need to be 
looking to the future. Where do you see oil prices going?
    Mr.Mishkin. Well, I am not a forecaster of oil prices. I 
can tell you the future markets do see that the oil prices will 
be coming down from their current very high levels. But the 
reality is that we have been very surprised, in fact the 
markets have been very surprised, by this very sharp run-up in 
oil prices that we have seen, and so there is a lot of 
uncertainty about oil prices. And, in fact, it is something 
that, because most oil is produced outside the United States, 
that we don't have a lot of control over.
    So I think the answer here is that the best bet is that oil 
prices will come down from their current elevated levels, but 
realize there is a huge amount of uncertainty about where oil 
prices may be heading.
    Mr.Chabot. Will the gentleman yield?
    Mr.Bartlett. Yes, sir.
    Mr.Chabot. When you say that they are likely to come down, 
I would assume what you mean is in the short term; whereas, I 
think what the gentleman may be asking is in the long term do 
we anticipate that they are ultimately probably going to be 
going up.
    Mr.Mishkin. This is really hard, hard to decide. We clearly 
have had a situation where the fact that many countries that 
were extremely poor have been developing very rapidly, and this 
is particularly true of China, has actually increased demand 
for petroleum products very substantially. And so in that 
context, that does have an impact. But we also may see these 
countries actually realizing that they need to conserve on the 
use of energy. So we see actually now policies where subsidies, 
for example, which keep energy prices exceedingly low in some 
of these countries, which therefore increases demand, that they 
are being rethought. So exactly what will happen here is hard 
to say.
    The other key issue here is that there is a geopolitical 
element to this, and a very key geopolitical element. And that 
is awfully hard to forecast, and there are people who are much 
more better qualified than I to do so.
    Mr.Bartlett. There is a bit of a scare factor in the oil 
price now, and for the short term oil prices may come down a 
little. For those who believe that in the long term oil prices 
will come down probably also believe in the tooth fairy.
    In 1970, our country went through a phenomenon that the 
world is now going through. We reached our maximum oil 
production in 1970. And in spite of drilling more oil wells 
than all the rest of the world put together, we now are 
producing about half the oil we produced in 1970. There is 
accumulating evidence that the world has reached its maximum 
production of oil now. There will be some temporary downturns, 
but the future is just up, up, and away as far as oil prices 
are concerned.
    Is there anything that the Federal Reserve or our Congress 
can do to minimize the negative effects of this for the future 
on our businesses?
    Mr.Mishkin. Well, I think that what the Federal Reserve can 
do is, in fact, to do our job properly. So one thing that is 
very important, and an important change in the success of 
monetary policy, is that in the 1970s when oil prices went up, 
the view was the that Federal Reserve was not going to be able 
to control inflation, and, in fact, policies were not such that 
inflation was controlled, and that then had very negative 
implications for the economy.
    So, clearly, we don't want to go through that again, and 
the Federal Reserve, as other central banks, now focuses very 
much on making sure that inflation is kept under control and, 
therefore, has the benefits that I mentioned not only in terms 
of inflation control, but also in terms of the second part of 
our dual mandate, stabilization of the economy.
    The problem here is that what can be done about oil prices. 
In fact, much of this is just out of control of the Federal 
Reserve. Clearly, there are issues in terms of, can technology 
help? For example, what kind of other energy sources might we 
be able to access? What kind of conservation can be done in 
terms of minimizing the use of oil?
    There have been positive developments in this regard. As I 
said, the use of oil per dollar of GDP has actually dropped 
very, very substantially since the 1970s, and this is one of 
the reasons why the fear of higher oil prices has been much 
lessened than it has in the past. The economy has been really 
quite resilient in the face of these higher oil prices.
    So, can more be done? I am sure more can be done. But the 
Federal Reserve, really the only thing that we can do is to 
make sure that higher oil prices don't spill over into higher 
inflation in the long run, and that also we monitor what the 
impact of oil prices will be also on what will happen with 
other economic activity.
    Mr.Bartlett. Thank you, Madam Chair.
    ChairwomanVelazquez. Ms. Clarke.
    Ms.Clarke. Thank you very much, Madam Chair, and thank you, 
Ranking Member Chabot.
    Good morning to you, Governor.
    Mr.Mishkin. Good morning.
    Ms.Clarke. I am glad we get this chance to explore the 
state of small business economy. Small businesses are the 
engine to our Nation's economy, and we must do all that we can 
to ensure that all the tools are in place to create new and 
more jobs in this country. As we all know, successful small 
businesses are beneficial both from a macroeconomic and 
microeconomic point of view by both increasing the gross 
national product and personal income.
    I just want to refer to what our Chairwoman has said in her 
statement about the mortgage market, its instability, and which 
has resulted in the tightening of lending standards that have 
spilled over into the small business credit markets, and also 
add to that what our colleagues have brought up about the 
rising oil prices, and then talk about tools that could perhaps 
insulate to a certain degree small business.
    Microfinance, for instance, tries to expand economic 
opportunities and community development by providing small 
loans and other business services to people who have not been 
able to get help from mainstream banks.
    Can you tell us today if there is any correlation between 
the microcredit movement and its impact on the national 
economy? And, if so, what is the economic outlook?
    Mr.Mishkin. Well, I think that improving the way financial 
markets work, particularly for not just small businesses, but 
very small businesses, is something that can be very helpful. 
And, in fact, in places where microfinance has been around 
longer, for example, in Bangladesh where it was originally set 
up, it actually has been able to alleviate a lot of poverty.
    The issue here, again, is that having funds get to people 
with productive investment opportunities, even if they are 
poor, is actually very, very beneficial. In fact, I have done 
actually research on this looking at the role of finance and 
growth. It is actually very critical for very poor countries to 
have better financial systems, and microfinance is one part of 
that picture. It is now actually happening in the U.S. To the 
extent that it can help--
    Ms.Clarke. Distressed communities.
    Mr.Mishkin. In distressed communities. I think that is a 
terrific thing. I do know, however, that because it is micro 
and the word "micro" is in there, that it is actually still 
going to be a small part of the economy, not necessarily 
unimportant, because for the people that it can help, it could 
be a very big deal. But there is the issue that, in general, 
our financial system is, in fact, very, very large, and 
microfinance is only going to be a small part of it, even 
though it can actually target and help a very important sector 
of our economy.
    Ms.Clarke. In your written testimony you stated that there 
are many reasons why lending to small business may be riskier 
and may be more costly than lending to larger firms. But it has 
been recently reported that small neighborhood banks have been 
immune to the credit crisis because their loans are backed by 
customer deposits and not by complex debt instruments favored 
by major corporations. It appears what favors small businesses 
is their robust local economies.
    Do you believe that these community banks play a pivotal 
role in making sure that small businesses can continue to be 
the engine to our country as we move forward in the 21st 
century?
    Mr.Mishkin. Yes. I think community banks are extremely 
important in this regard. In fact, research on the way 
financial systems work actually talks a lot about this issue, 
that small firms--and particularly the smaller they are and the 
younger they are, the more they are going to be dependent on 
what we call relationship finance, so that they actually have 
somebody who knows what they do. And particularly very small 
businesses, they don't necessarily have the records that a 
General Motors will have that you can take a look at. You 
actually have to have a lot of local knowledge.
    One of the things that we have seen is that community banks 
have been a very vibrant part of the banking community, and 
part of the reason that this occurs is because, number one, 
they can get local deposits; but importantly, they have 
information that the big guys don't have. Because they are 
actually in the community, they know who is a trustworthy 
person. And, in fact, this is not just, by the way, for 
businesses, but also for households. My wife's family, my wife 
grew up quite poor, but her parents were always able to get 
loans from the local community bank, and the reason was they 
knew these people would pay back that, no matter what happened.
    So, this idea of, in fact, having this relationship kind of 
financing is extremely important. And the U.S. actually has 
this very vibrant community banking sector which plays a very 
important role in exactly this regard.
    ChairwomanVelazquez. Would the gentlewoman yield?
    Governor, your agency noted that a significant amount of 
consolidation in the banking industry is taking place. That is 
the trend. We discussed how small businesses have this 
relationship with small bankers, small banks; and small banks 
are less exposed because those businesses will be able to pay. 
So, what is the risk of banking consolidation regarding 
availability of financing for small businesses?
    Mr.Mishkin. Well, we know that large banks do not do as 
much as small business lending because they are not always set 
up to do so. But what we found is when consolidation occurs, 
that there is less lending being done by the larger entity, 
that other banks come into the picture, and particularly the 
small banks will take up the slack because they can make money 
from it. So what we find is that the small business sector 
still has been able to access credit even with bank 
consolidation taking place.
    ChairwomanVelazquez. Thank you for yielding.
    Ms.Clarke. Thank you, Madam Chair. You sort of stole my 
thunder there with that question. Thank you very much.
    ChairwomanVelazquez. Mr. Fortenberry.
    Mr.Fortenberry. Thank you, Madam Chair, for holding this 
hearing.
    And, good morning, Governor.
    Before I make my comments, I would like to respond to the 
gentleman from Pennsylvania's assertion of an anti-PAYGO spirit 
among Republicans. I voted for the PAYGO rule.
    Mr.Sestak. May I correct that? I did not say that.
    Mr.Fortenberry. You accused the Republicans of being 
against PAYGO. I voted for PAYGO, and I did so because in the 
same spirit I think you did, that it is an important principle 
to uphold that we pay for what we spend. And yet I did so with 
some reservations, because it does not take into account some 
of the dynamic effects of tax reductions as they lead to 
increased revenue. So that is the point I wanted to make.
    The issue there raises the point as to how do we help 
stimulate small business capital investment, and one of the key 
ways was some of the tax reductions that took place that 
allowed for accelerated or higher levels of write-offs. We tend 
to point to the issues that we can quantify most easily in 
terms of helping small business, whether that is access to 
capital or education. But I don't think we have as clear of an 
understanding of how tax policies, such as the one implemented 
a few years ago that significantly raised the accelerated 
write-off levels, can stimulate investment, which leads to 
productivity, which leads to jobs, which leads to revenues and 
help for families. So I would like you to comment on that as 
well as any other barriers to entry or expansion for small 
businesses since it is such a critical component of our 
economy.
    Mr.Mishkin. Well, I am not a public finance economist, so, 
again, I really can't tell you what is a good tax system or 
not. I would rather have experts that do that for a living, 
focus on exactly that issue.
    Mr.Fortenberry. Well, that doesn't help. Let me find some 
common ground with my friend from Pennsylvania saying on the 
one hand--but it would be helpful to unpack, you are an expert 
and in charge of our financial system, to unpack some of the 
either barriers to entry or barriers to expansion that we don't 
commonly talk about. I will give you one that we commonly raise 
in this hearing, and it is health insurance. Health insurance 
tethers a person to what they are currently doing and increases 
the cost of risk-taking by venturing out into a new 
entrepreneurial venture; that is one. But again, tax policy I 
think is an absolute critical component as well. It helps 
accelerate decisions that might be pushed off to the future to 
the current moment. I think that was some of the dynamic 
effects that we saw regarding the particular tax reduction that 
allowed for accelerated write-off of capital purchases earlier 
in this decade.
    Mr.Mishkin. If I was in charge of tax policy, I would be 
very happy to give you my views on this, but what the Federal 
Reserve can do to help small businesses is to do our job under 
the mandate that has been given to us by Congress. If we do 
that well, small businesses, I think, will prosper.
    In general, the United States actually has one of the most, 
I don't know the exact figures, but I think we have one of the 
most vibrant small business economies. This is something that 
is a very important feature of the way that things work in this 
country, and it is an opportunity for people actually to 
actually grow rich by starting small businesses and actually 
working very hard.
    So this is extremely important. I think the kind of 
environment that we have to allow businesses to do their jobs 
well is very important. To have a financial system that works 
well, so that it can get access to credit; if somebody has a 
good idea, they can start small. They can start it in their 
garage with a couple of computers and then become one of the 
richest people in the world. This is what makes America great.
    However, the Federal Reserve, in terms of these 
microeconomic policies, it is not what we are actually in 
charge of, so on this basis, I really can't tell you exactly 
what the best way to solve these problems are. I think they are 
extremely important, and in fact, it is very important that you 
focus on exactly these issues.
    Mr.Fortenberry. Thank you, Madam Chair.
    ChairwomanVelazquez. Mr. Davis? .
    Mr.Davis. Thank you, Madam Chair.
    Thank you, Governor. I would like to go back to a question 
that was asked a moment ago about oil prices. One of the 
statements that you said, and this is a quote, your job is to 
make sure how a process doesn't spill over into higher 
inflation.
    Can you expand on how the Federal Reserve makes sure that 
it doesn't spill over.
    Mr.Mishkin. Let me qualify this. Clearly higher oil prices 
in the short run does spill over into inflation, but it is very 
important to understand that the Federal Reserve and any 
central bank can't determine what is going to happen, 
inflation, in the very short run when there are shocks, because 
our policies take a fairly long time to have an impact on the 
economy on the order of several years, particularly in terms of 
inflation.
    So what this means is, we have to look far out and ask, 
will this shock to oil prices have a potential effect on 
inflation further out? And if it does, what are we going to do 
about it? And this is one of the reasons why even though an oil 
price shock may have temporary effects on inflation, you have 
to make sure those temporary impacts on inflation don't spill 
over into long-term impacts on inflation.
    This is why it is important that the Federal Reserve make 
it clear that we will do what we need to, to make sure that 
inflation in the long run will stay stable, that is an 
incredibly important part of our mandate, that the great 
success of central banks throughout the world, or at least the 
Federal Reserve has been the leader in this, has been our focus 
on price stability. That was not always as true 30 years ago. 
In fact, not only did that mean we had high and variable 
inflation, which made it very difficult for firms to plan and 
actually hurt small businesses in exactly that way. But it 
actually led to an economy that under performed in terms of 
economic activity and in terms of producing jobs.
    So, in this context, we really do carefully monitor what 
happens to oil prices. We try to make our best guesses about 
what might happen in the future, but actually respond to 
information as it comes in, but always have this long run as 
perspective. And this is why it is very important to not, for 
example, overreact to a rise in oil prices, but actually to 
think about what is the impact in a longer run context and then 
take exactly the steps that will in fact create an environment 
which is one which is successful both in the inflation front 
and on the output front.
    Mr.Davis. I think I hear you say that part of your job is 
forecasting.
    Mr.Mishkin. Oh, it is a big part of our job, absolutely.
    Mr.Davis. And with that being said, where are you in your 
forecasting now in the foreseeable future?
    Mr.Mishkin. Well, we have actually talked about this in the 
statement that we made after last FOMC meeting. Clearly, there 
is an issue with potentially slower growth in the short term, 
but in fact, we see moderate growth in a longer-term horizon. 
Of course, having the right monetary policy is part of getting 
that to happen. And indeed a reason why in fact we felt a need 
to lower interest rates by three quarters of a percentage point 
was in fact to ensure that the economy would actually keep 
growing at a moderate pace, and felt that we could do that and 
actually not have a negative consequence on inflation because 
of the nature of the inflation numbers have come in favorably 
in recent months and also that the kind of situation in the 
overall economy, the balance of supply and demand indicates 
that we hope that inflation would not rise in the future. This 
is something that we have to really to keep our eye on.
    The difficult problem for central bankers and maybe we 
actually need five hands to think about, but we actually have 
to really balance these risks. And unfortunately, we don't have 
a crystal ball, but the Federal Reserve has been quite strong 
in its forecasting operation.
    One of the great pleasures for me having come to the 
Federal Reserve about a year ago is to interact with our staff 
and the extraordinary capability of our staff, which has been 
very strong in terms of thinking about where the economy might 
be heading and giving us a perspective which I think has 
enabled us to do pretty well in terms of the setting of policy 
instruments. So this is a part of what makes central banking 
interesting. There is a lot of science in central banking, but 
there is also a lot of art as well. And I think so far we have 
been doing pretty well in this, but it is a tough job.
    Mr.Davis. Let me change the question just a little bit. 
With small business being the backbone of our economy, the job 
creator in our economy, could you talk about as small business 
owners go out to find those loans, the increase in credit card 
debt amongst small businesses and what effect it is having in 
small businesses?
    Mr.Mishkin. There has been a substantial increase in the 
use of credit cards by small businesses. What we have found is 
that most small businesses are using it for transaction 
purposes, so that it is much easier to use a credit card. In 
fact, when I go in the store, I don't like to carry change, so 
I use a credit card for very small purchases. It doesn't always 
make me very popular with the store owner, but that's what I 
do. Small businesses are finding this is an important tool for 
them.
    It is not the main source for them in terms of their 
financing, because they find that there are other sources of 
financing that are cheaper. So the credit cards do have an 
important role here. There are firms, particularly sometimes 
start up firms, you hear stories about them starting up a firm 
in the garage, and they borrow with their credit card. And many 
of those cases actually help them to become successful. But 
clearly, because credit card debt is not usually the cheapest 
form of debt for small firms, that they actually seek out other 
sources of financing and have been able over the years to be 
pretty successful at getting it, and in fact, this sector has 
been an incredibly important engine that broadens the U.S. 
Economy.
    Mr.Davis. One last question, I am not sure if you are 
familiar with the Community Reinvestment Act, which doesn't 
require banks to lend to small business, but it does encourage. 
Could you talk about that?
    Mr.Mishkin. Clearly, one of the things, as a result of the 
Community Reinvestment Act, in fact, banks do worry about the 
communities that they serve. And in that context, it is not 
only dealing with households, which is what the Act tells them 
to do, but they also have outreach to small business as well. 
It is an important issue in terms of these communities. It is 
not good enough just to lend to households. Wealth generation 
and wealth creation is typically coming from businesses and 
small businesses can play a very important role in these 
communities.
    So the banks actually do in fact try to reach out to these 
communities, and in fact, I think the Community Reinvestment 
Act by getting them to think about this in terms of households 
has helped them to think about this in terms of small 
businesses as well as.
    One thing that should be said is that there is an 
interaction between households and small businesses. In fact, 
sometimes they are the same thing because--do you have a little 
business? I actually had something I set up for a while and 
then actually got rid of it, but I, at one point, was a 
corporation. So there was only one person in the corporation; 
it was me. And so, clearly, this issue of worrying about 
households actually means also that you indirectly worry about 
small businesses as well.
    Mr.Davis. Governor, thank you and I yield back.
    ChairwomanVelazquez. Governor, since 2001, our National 
debt has increased by $3 trillion. Factors, such as tax policy 
and spending, have been responsible for that increase. What 
impact is there on small businesses when the government has 
such a large debt?
    Mr.Mishkin. Well, there are several issues here, which are, 
if that debt expands too much, it actually can impact on 
interest rates and raise interest rates. Clearly, higher 
interest rates make it harder to finance investments, and so it 
can impact on small businesses. So, again, fiscal 
sustainability, in the long run having fiscal balance, is 
actually very important in many dimensions. Clearly one of the 
areas it is important to is potential impact to the cost of 
financing for small businesses.
    ChairwomanVelazquez. In the letter accompanying the most 
recent survey of small business finances, former Chairman 
Greenspan encouraged the business owners selected for the 
survey to participate, noting that the data collected by past 
surveys has been critical for policy decisions at the Federal 
Reserve and in other parts of government. If the survey is 
discontinued, what alternative source of direct information 
will your agency use to make policy decisions affecting small 
businesses?
    Mr.Mishkin. The issue of discontinuance, I think, is an 
important one. The question is, what is the best way to get 
information about small business finance? One of the things 
that is very important is that the Federal Reserve be an 
efficient organization. In fact, the Congress has insisted 
that, in fact, the Federal Reserve run its operation 
efficiently. Part of the efficiency is, how do we get the best 
information in the best way?
    The Federal Reserve has taken the view that we can do 
better by actually getting information, by getting it from the 
small--the Survey of Consumer Finances and that the advantage 
to that survey is that it is more frequent. It happens to be 3 
years rather than every 5. As I mentioned, there is interaction 
between households and small businesses. It is very important. 
So one of the things that the Federal Reserve has looked at is 
expanding the Survey of Consumer Finances both by expanding the 
number of people that are asked but also by asking a lot more 
questions on small business finance. Our view is that, in 
general, that can actually provide us with a better way of 
getting information and also do it more efficiently.
    ChairwomanVelazquez. Sir, and if you conclude after this 
new survey or instrument or tool is conducted, put together, 
that it doesn't reflect small businesses, will you go back to 
have your own small business survey?
    Mr.Mishkin. Well, certainly, if it is not getting the 
information we need about small businesses, we will in fact 
figure out how to improve it.
    ChairwomanVelazquez. I cannot stress enough how important 
this survey is for us Members of Congress when we are dealing 
with decisions, policy decisions. And I guess that you need to 
look at how we do business here. And when it comes to small 
businesses, quite often they are overlooked. Either tax 
policies or energy policies or any type of tax relief, they 
become an after thought. And I don't want for that to happen 
when you need to have information in order to make decisions 
that are important to small businesses.
    With that, I will recognize Mr. Chabot.
    Mr.Chabot. Thank you, Madam Chair. I just have a couple 
more questions. I don't think they will be too long.
    We have had a number of hearings here about more and more 
small businesses are engaging in trade. And as part of their 
profit and bottom line is their success or lack of success in 
trading. And we have got a couple of trade agreements before us 
now, Peru, Panama, South Korea, Colombia. And they are somewhat 
controversial, depending on the country. And I tend to be one 
who thinks it is good for us to be trading. We ought to keep 
tariffs down and all that sort of thing.
    We also have issues, such as China artificially 
manipulating. Their currency has been discussed, things of that 
nature. I don't want to ask a specific question, and say, hey, 
that is your job. I have thrown it out there. What can you tell 
us about trade that could be helpful to us?
    Mr.Mishkin. I think actually having the U.S. Economy 
participate very fully in the global economies is actually 
critical to our economic well-being. First of all, it promotes 
competition, and one of the things that makes the American 
economy so strong is, in fact, that you have to be competitive. 
This means you actually have to produce a better product, and 
by producing a better product, you do better. And indeed, 
having competitive markets is really the engine of our 
productivity growth, because when you have competition, you 
have to do a good job. And if you don't, you don't stay in 
business very long.
    So also being very open to global markets means that if 
somebody is making a product cheaper abroad, then in fact 
either you have to get better and improve the quality of your 
product and lower its price or you are going to find that you 
are going to be in trouble in not being able to sell the goods. 
What we have found is American businesses have been able to 
perform extremely well, and we have an economy in fact that has 
very high employment right now. So, in that context, my view is 
that trade is something that is an important element in a 
successful economy. And turning our backs on the global economy 
would not be very healthy, and it of course would be very 
unhealthy for other countries as well.
    Mr.Chabot. Thank you. Just to follow up on that, those that 
are more skeptical about trade and freer trade--I won't say 
free trade, but freer trade--argue that manufacturing jobs and 
other jobs end up going overseas, and there is a net loss of 
jobs they would argue. They would also argue, even if we do 
create more jobs here, they tend to be low-paying jobs that 
don't have benefits. They are flipping hamburgers at 
McDonald's, that type of thing. That is sort of the rhetoric 
that you hear out there. To the extent you are able to, could 
you shed any light on whether those allegations are for the 
most part true or for the most part not true?
    Mr.Mishkin. Well, we have certainly seen that, with this 
increase in globalization, that we have not had a problem 
producing jobs in this country. So it is true that there are 
people who are hurt because they lose jobs because they are in 
competition with workers abroad, but there are also new jobs 
that get created.
    So the issue, of course, is how do we deal with some people 
that maybe could get hurt by this. This is something again that 
I think the Congress has to think about because it is 
important. But on net, the global economy has been very helpful 
to the overall U.S. Economy. And clearly, our ability to 
actually come up with good ideas and actually have them used 
abroad is also helpful to countries elsewhere.
    So, in terms of employment, certainly the economy, which in 
fact has had employment grow very substantially over time, and 
in fact, during this period of increased globalization, 
employment growth has been very rapid in the United States.
    Mr.Chabot. Thank you.
    Finally, relative to the spending and the national debt and 
our deficit that we have each year, some would argue that we 
still have a few hundred billion dollar deficit each year, and 
to some extent, it went up. When I came up here and the 
Contract with America, that was one of the main things, balance 
the budget; it got balanced because of Congress and President 
Clinton. I will give him credit as well. We worked together and 
got it done, some credit, not all of the credit--
    Mr.Gonzalez. Yeah.
    Mr.Chabot. Not all the credit but at least some of it. As 
one of the House managers who was involved in the impeachment 
of the President, I am sure he'll appreciate me saying that. I 
will give him some credit for that.
    Now, unfortunately, since that time, we had September 11th. 
We had the stock market plunge. We had the bubble burst of the 
Internet stocks and all that stuff. And we're now fighting a 
war in Afghanistan and Iraq. And we have additional 
expenditures, et cetera, et cetera. So the deficit shot back 
up, and it seems to be coming down again, although not as fast 
as a lot of us would like it to. But what I am getting at, you 
will hear people say the deficit, even though it is X amount, 
if you look at it in terms of the overall GDP as a percentage, 
it is not as high as it was earlier, and therefore, it is not 
really as big a deal. I am not saying that, but I am saying 
that is what some will argue.
    The impact that all of that has on the economy and job 
growth in the future, could you comment on that?
    Mr.Mishkin. Again, I think this issue of fiscal 
sustainability is very important. The point here is not just 
what the deficit is now; it is the long run wrong fiscal 
sustainability that is very key. In fact, it is not just our 
current spending versus revenue, but also what kind of 
obligations do we have in the future, for example Social 
Security and Medicare? And this is something that I think is 
something that I do worry about. I think it is something that 
should be a major concern for Congress. But then how to 
actually deal with this and get fiscal sustainability to 
happen--that is why you get paid the big bucks.
    Mr.Chabot. Thank you very much.
    I yield back, Madam Chair.
    ChairwomanVelazquez. Mr. Gonzalez.
    Mr.Gonzalez. Thank you very much, Madam Chairwoman. My 
apologies to my colleagues and to the witness for being late. 
We always have two or three things and still try to make it, 
and I appreciate your patience. I don't know if you have 
covered this. If you have, I will just move onto the next 
question, but did you all cover the Community Reinvestment Act? 
I know you touch on it in your testimony.
    Mr.Mishkin. There was a question from Mr. Davis on exactly 
that issue.
    Mr.Gonzalez. The question really goes to how active the 
banks are today with the mergers and such. I know, in San 
Antonio, we only have fewer banks. In essence, community banks 
hardly compete anymore and, of course, with the mergers and 
such of the banks. Is there any attention being paid to the CRA 
obligations to the banks? Because we know when they comply, 
then small business men and women definitely benefit. And I 
don't know if Mr. Davis basically asked the same question. You 
already answered it, and if he did, I can move on.
    Mr.Mishkin. Certainly our compliance with the Community 
Reinvestment Act is something that the Federal Reserve 
scrutinizes carefully. It is part of what we are supposed to do 
to make sure that the banks are doing what they are supposed to 
be doing in these communities. And so part of our supervisory 
process is to look at banks in this regard and to ensure that 
they are complying with the Act.
    Mr.Gonzalez. And with the mergers, if you have fewer 
players, how does that impact, if anything?
    Mr.Mishkin. I think, if there are fewer players, it doesn't 
change the need for them to comply.
    Mr.Gonzalez. No, no, I understand that.
    Mr.Mishkin. The bigger players, we have to supervise them 
similarly to the way we have to look at smaller players.
    Mr.Gonzalez. Do you have any report that is forthcoming or 
any recent studies? I know Barney Frank, in Financial Services, 
was thinking of having a hearing on it. I don't know if that 
has transpired. Madam Chairwoman you may be more aware of that.
    ChairwomanVelazquez. No.
    Mr.Gonzalez. Are you doing anything on it?
    Mr.Mishkin. I'm not sure, but if we are doing something on 
it, I would be happy to get back to you on it.
    Mr.Gonzalez. If you would, I would really appreciate that.
    On free trade agreements, this came up the other day when 
we had the ambassador with the trade representative being here: 
Why is it important to include environmental and labor 
provisions in there as far as compliance, a regulatory scheme 
that we want to make sure is imposed on our trading partners?
    Mr.Mishkin. Well, again, I really don't want to comment on 
the details of free trade agreements. I have expressed that I 
am somebody who believes that the global trade is a positive 
influence on the American economy. And also, I think 
importantly, a positive influence on economies elsewhere in the 
world where very many poor people in the rest of the world in 
fact benefit by a global economy. In fact, one of the great 
things about our history is that the U.S. Actually encouraged 
this global economic system after World War II.
    Mr.Gonzalez. I understand the international implications 
and good policy; we need to be engaged and so on. The point I 
am always trying to make from a business perspective is, we 
need a level playing field for our domestic men and women. So 
if we have a regulatory scheme that actually imposes greater 
costs on the product or service that we actually provide and 
they don't, it is a tremendous disadvantage. A lot of people 
say, you are into the environment because you are a tree hugger 
or into labor because you are being pro-labor. Well, you know, 
you may be. But the other reasons are very practical and very 
important, and I am afraid that we just have never really 
emphasized that part of it.
    The last question I have is just the cost of energy and the 
potential economic impact. I mean, we are going to have $100 
barrel of oil. It hasn't translated yet to the pump, but it is 
going to, obviously, by Christmas, if not sooner. But look at 
the small business impact. They are on the margins all of the 
time. They don't absorb or don't get to really pass on as 
easily as, I think, some of the bigger outfits. Are you 
evaluating the rising costs of energy? I am not just talking 
about gasoline but natural gas and such. This is going to be 
huge this winter.
    Mr.Mishkin. We do actually look carefully about what is 
going on in terms of the energy markets and the impact both on 
businesses and households. So, clearly, there is an issue of, 
what is the relationship, for example, to what is happening in 
oil prices to gasoline prices? What impact does it have on 
natural gas prices? These prices actually do have an important 
impact on the economy. And in fact, it is something we have to 
monitor in order to think about what is going to happen to the 
economy in the future. We talked about we have to forecast in 
order to do policy well. And indeed, thinking about what the 
role of energy prices and the higher energy prices that we've 
experienced lately has on the economy is in fact a key element 
of what we have to do in thinking about how we conduct policy.
    Mr.Gonzalez. My concern is the disparate impact that it has 
on small businesses. They are just too close, as I always say 
operating on the margins. So when their operating costs go up, 
it really is--I am not sure if the Fed looks at the very 
distinct position that small business has, as opposed to in the 
overall economic picture and then we can say, gee, they are the 
economic engine of the United States and stuff, but the truth 
is we don't really look at specifically what relief will we try 
to provide them to confront and actually survive, because I 
don't think they survive very long, but again, thank four your 
testimony, and I yield back.
    ChairwomanVelazquez. Questions?
    Well, Governor, thank you so much for your contribution 
this morning.
    Mr.Mishkin. My pressure.
    ChairwomanVelazquez. Members will have 5 legislative days 
to submit statements for the record. Without objection this 
hearing is adjourned.
    [Whereupon, at 10:30 a.m., the committee was adjourned.]
    
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