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



 
                        MONETARY POLICY AND THE


                      STATE OF THE ECONOMY, PART I

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

                                HEARING

                               BEFORE THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                               __________

                           FEBRUARY 26, 2007

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 110-92



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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            DEBORAH PRYCE, Ohio
CAROLYN B. MALONEY, New York         MICHAEL N. CASTLE, Delaware
LUIS V. GUTIERREZ, Illinois          PETER T. KING, New York
NYDIA M. VELAZQUEZ, New York         EDWARD R. ROYCE, California
MELVIN L. WATT, North Carolina       FRANK D. LUCAS, Oklahoma
GARY L. ACKERMAN, New York           RON PAUL, Texas
BRAD SHERMAN, California             STEVEN C. LaTOURETTE, Ohio
GREGORY W. MEEKS, New York           DONALD A. MANZULLO, Illinois
DENNIS MOORE, Kansas                 WALTER B. JONES, Jr., North 
MICHAEL E. CAPUANO, Massachusetts        Carolina
RUBEN HINOJOSA, Texas                JUDY BIGGERT, Illinois
WM. LACY CLAY, Missouri              CHRISTOPHER SHAYS, Connecticut
CAROLYN McCARTHY, New York           GARY G. MILLER, California
JOE BACA, California                 SHELLEY MOORE CAPITO, West 
STEPHEN F. LYNCH, Massachusetts          Virginia
BRAD MILLER, North Carolina          TOM FEENEY, Florida
DAVID SCOTT, Georgia                 JEB HENSARLING, Texas
AL GREEN, Texas                      SCOTT GARRETT, New Jersey
EMANUEL CLEAVER, Missouri            GINNY BROWN-WAITE, Florida
MELISSA L. BEAN, Illinois            J. GRESHAM BARRETT, South Carolina
GWEN MOORE, Wisconsin,               JIM GERLACH, Pennsylvania
LINCOLN DAVIS, Tennessee             STEVAN PEARCE, New Mexico
PAUL W. HODES, New Hampshire         RANDY NEUGEBAUER, Texas
KEITH ELLISON, Minnesota             TOM PRICE, Georgia
RON KLEIN, Florida                   GEOFF DAVIS, Kentucky
TIM MAHONEY, Florida                 PATRICK T. McHENRY, North Carolina
CHARLES WILSON, Ohio                 JOHN CAMPBELL, California
ED PERLMUTTER, Colorado              ADAM PUTNAM, Florida
CHRISTOPHER S. MURPHY, Connecticut   MICHELE BACHMANN, Minnesota
JOE DONNELLY, Indiana                PETER J. ROSKAM, Illinois
ROBERT WEXLER, Florida               KENNY MARCHANT, Texas
JIM MARSHALL, Georgia                THADDEUS G. McCOTTER, Michigan
DAN BOREN, Oklahoma                  KEVIN McCARTHY, California
                                     DEAN HELLER, Nevada

        Jeanne M. Roslanowick, Staff Director and Chief Counsel


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    February 26, 2008............................................     1
Appendix:
    February 26, 2008............................................    53

                               WITNESSES
                       Tuesday, February 26, 2008

Reinhart, Carmen M., Ph.D., Professor, School of Public Policy, 
  Department of Economics, University of Maryland................    13
Rivlin, Alice M., Ph.D., Senior Fellow, Brookings Institution....     6
Roubini, Nouriel, Ph.D., Professor of Economics, Stern School of 
  Business, New York University, and Chairman, RGE Monitor.......    15
Taylor, John B., Ph.D., Mary and Robert Raymond Professor of 
  Economics, Stanford University.................................     9
Zandi, Mark, Ph.D., Chief Economist and Founder, Moody's 
  Economy.com....................................................    11

                                APPENDIX

Prepared statements:
    Paul, Hon. Ron...............................................    54
    Reinhart, Carmen M...........................................    55
    Rivlin, Alice M..............................................    59
    Roubini, Nouriel.............................................    66
    Taylor, John B...............................................    87
    Zandi, Mark..................................................    91


                        MONETARY POLICY AND THE



                      STATE OF THE ECONOMY, PART I

                              ----------                              


                       Tuesday, February 26, 2008

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 10:05 a.m., in 
room 2128, Rayburn House Office Building, Hon. Barney Frank 
[chairman of the committee] presiding.
    Members present: Representatives Frank, Waters, Maloney, 
Capuano, Hinojosa, Clay, Miller of North Carolina, Scott, 
Green, Cleaver, Sires, Klein; Bachus, Castle, Paul, Manzullo, 
Jones, Shays, Feeney, Garrett, Pearce, Price, and Campbell.
    The Chairman. This is the second in a series of hearings 
this committee has had and will have while I chair it, around 
the state of the economy. We have under the Humphrey-Hawkins 
Act, and I should note I think--well, I guess I have before, 
but I'm not sure if this is the first or the second Humphrey-
Hawkins hearing we have had since Gus Hawkins passed away at 
the age of 100, a really great man. And the value of the Act 
becomes all the clearer. As I look at the European Central Bank 
with its mandate only to deal with inflation and our Central 
Bank with its dual mandate to deal with inflation and high 
employment mandated by the Humphrey-Hawkins Act, I am again 
reminded, I think, of the wisdom of Gus Hawkins and Hubert 
Humphrey, because I think we are well served by the duality of 
that mandate compared to what the ECB does.
    But it was my view that in addition to hearing from the 
Chairman of the Federal Reserve Board, we ought to hear from 
other voices as well on the economy, and that is the purpose of 
this hearing. Tomorrow, Chairman Bernanke will testify before 
this committee, and Thursday he'll testify before the Senate. 
But this is part of a process by which we solicit other views.
    I think the Federal Reserve is a very well-run institution. 
We have a former member here, of the Board. But I also believe 
that it gets in general more intellectual and political 
deference than is healthy in a democracy. It is often 
considered to be the case that it is legitimate for us in the 
democratic fora to debate war and peace and the physical future 
of the universe and the most intimate questions of human 
conduct, but if any politician dare talk about 25 basis points 
on the interest rate, that is somehow a great breach of the 
rules and could cause terrible consequences. That is nonsense; 
monetary policy is a legitimate subject for debate as well as 
any other as long as it is conducted in a sensible way.
    It is particularly the case in this particular period, 
because what we are seeing are, I think, the limits and 
constraints that the Federal Reserve faces in monetary policy. 
And I think--let me announce a change of mind. Some time ago 
when we talked about the multiplicity of Federal regulators in 
the banking area, a common subject, one question I raised was, 
well, why does the Federal Reserve need to be a bank regulator? 
We have all these other bank regulators. Why can't they just be 
the monetary authority, as is the case in other places? And 
Alan Greenspan said at the time--and I was skeptical, but I now 
acknowledge that he was right--that being the regulator informs 
the Fed's judgment about the economy in ways that help in the 
formulation of monetary policy.
    The problem I must say is that I do not think Chairman 
Greenspan fully followed through on this, because I think what 
we have is a disconnect between the Fed's authority as a 
regulator and its role in monetary policy essentially for 
ideological reasons under Chairman Greenspan, the Federal 
Reserve consciously decided not to exercise a great deal of its 
regulatory authority. That is now changing under Mr. Bernanke. 
I don't think that has been adequately addressed.
    For example, in 1994, Congress passed the Homeowners Equity 
Protection Act to give the Federal Reserve regulatory authority 
over all mortgages, not just those issued by depository 
institutions. Chairman Greenspan consciously and deliberately 
decided not to enforce that, not to use that authority. When 
the Comptroller of the Currency and the Office of Thrift 
Supervision issued their Federal preemption of a lot of State 
consumer protection laws, including some in the mortgage area, 
one response was to beef up what the Comptroller of the 
Currency could do with regard to consumer protection.
    I spoke at that point to the late Ned Gramlich, who was the 
Federal Reserve Governor with that responsibility. He said, 
``Well, here is what you need to do. Under the Federal Trade 
Act, the Federal Reserve system has the authority to promulgate 
a code of unfair and deceptive practices for the banks. That 
would be a replacement for some of the State consumer laws that 
were knocked out.'' I said, ``Well, that's good. Why are we not 
doing that?'' And he said that Chairman Greenspan is opposed to 
that. He thinks that is too much regulation. We wrote, some of 
us, to the Chairman, and he said, no, he wasn't going to do 
that.
    Mr. Bernanke, I think, is again going to reverse that 
decision, and I believe under Chairman Bernanke you are going 
to see an exercise of authority to promulgate that code that we 
didn't have before. The relevance of that is this: I think 
there has been a tendency to look at monetary policy as the 
macro sector of the economy and financial regulation was micro, 
but the micro has decisively influenced the macro. We have a 
macroeconomic crisis today.
    Clearly, at least the worst financial crisis in the world 
since 1998, and its impact in the United States is conceivably 
worse than 1998, and the single greatest cause--obviously, all 
phenomena in a complex world have multiple causes--but the 
single greatest cause is regulatory failure. The single 
greatest cause of the current economic crisis is the failure of 
Federal regulators, in particular in the United States, to use 
regulatory authority. The result has been not just the subprime 
crisis, but the infection of the entire credit system by the 
subprime crisis. And both the fact that mortgage loans were 
made that should not have been made and the absence of any 
sensible regulation, and the fact that those loans were then 
allowed to spread in various ways that were obviously not fully 
understood throughout the system, is the single biggest cause 
of why we are here.
    So what we are talking about today--and in consequence, as 
a number of people have noted, monetary policy is somewhat 
constrained. I do note Chairman Greenspan generally, both 
during the dot.com issue and the irrationally exuberant stock 
market, to quote the Chairman at the time, and today, Chairman 
Greenspan's inclination was to pose this choice. Either I 
deflate the entire economy or I allow these phenomena to 
continue.
    And, of course, the answer to that dilemma is sensible 
regulation. If you have inadequate regulation of abuses, yes, 
then you do get to a situation where your choice is deflation 
of the entire economy or allowing the abuses to flourish. And 
that's why in the current context in particular, sensible 
consideration of monetary policy requires looking at the role 
of regulation. Because in the absence of regulation, you give 
monetary policy too heavy a lift, one that it conceptually and 
intellectually cannot make.
    And that is what I believe we will inevitably be talking 
about. I have reviewed much of the testimony, and not 
surprisingly, many of the witnesses in fact make that point, 
that the problem we face today is a problem of inadequate 
regulation of--and innovation, securitization, a good thing, 
because innovations that don't serve some positive role die of 
their own lack of merit. But innovation that outstripped that 
any regulation, and the consequent problems that we have had 
have led us to where we are today.
    So I said, in this case, whether we are talking about 
monetary policy under the Humphrey-Hawkins Act, or the economy 
in general, we are talking about, in my judgment, the role that 
inadequate regulation has played in causing a dilemma for the 
monetary policymakers. And that is what we will be talking 
about today, and we will be talking about with the Chairman 
tomorrow.
    The gentleman from Alabama.
    Mr. Bachus. I thank the chairman. Congressman Paul is going 
to deliver our opening statement, but I would like to comment 
on one thing. On this committee, it is difficult for us to 
assess exactly how much stress there is on the financial sector 
because, I think, of a lack of transparency, and in certain 
cases a lack of accountability. So as with the markets, there 
is a lot of uncertainty out there as to where this economy 
stands.
    You add to that economic conditions that in some cases are 
soft and in other cases are really not. The economy in many 
ways is doing quite well. And you add to that what is the 
proper response in light of what I would say is troublingly 
high inflation. This morning the PPI came out, and I'm sure 
Members know, it was very high, which obviously should be a 
concern to the Fed and should be a concern to us. When you have 
a slowing economy and a high inflation rate, it makes it 
particularly difficult to know what to do or what not to do. So 
we would be very interested in your advice in that regard, but 
I will say the inflation numbers this morning were not good 
news.
    The Chairman. Representative Paul, the gentleman from 
Texas.
    Dr. Paul. Thank you, Mr. Chairman. I appreciate this. I 
would like unanimous consent to submit a written statement.
    The Chairman. Without objection, any written statements any 
of the witnesses or members would like to include will be 
included as part of the record.
    Dr. Paul. I want to thank the chairman for holding these 
hearings, and especially for the title of the hearing. The 
title is very appropriate, ``Monetary Policy and the State of 
the Economy,'' because indeed they are related. Sometimes we in 
the Congress and for other reasons, economic problems are 
created, and we look to the Federal Reserve to solve the 
problems. From my viewpoint, we should look at the Federal 
Reserve a little earlier, because I see so many of our problems 
that we have coming from monetary policy.
    The Austrian economists, led by Mises and Hayek--Hayek, of 
course, won the Nobel Prize--talk significantly about monetary 
policy and how inflation of the money supply is the real 
culprit because it distorts interest rates and causes the 
malinvestment and the excessive debt. And it is for this reason 
that most economists accept the notion that inflation is always 
a monetary policy, and yet today we still talk about, well, the 
price of oil is going up, so therefore it might lead to 
inflation, rather than saying, what is happening to the money 
supply?
    Well, currently, we don't get all the statistics on the 
money supply anymore; M3 was an important number, total money 
supply, and that hasn't been looked at for a couple of years, 
and yet private sources report that is growing at about 16 
percent a year. Now the significance of this is the distortion 
that causes in the marketplace. The Austrian economists 
predicted well before the collapse of socialism at the end of 
the 20th Century that it would collapse because they eliminated 
the pricing structure. If you don't have free market pricing, 
you can't determine what to produce, and at what quality and 
what quantity, and only the market can do that. But likewise, 
they were every bit as critical about the manipulation of 
interest rates, and that is what the Federal Reserve is doing, 
always making interest rates go up or down. And they generally 
get it wrong both times. They either have them too high or too 
low, and they will get criticism from both sides.
    But we as a nation who champion the marketplace have 
totally rejected the idea that the market can determine 
interest rates, and that is why I think we get into trouble 
like this. In the 1960's, we faced a similar problem, because 
we were pretending that we could have guns and butter and it 
wouldn't really cost us. Well, anybody who knows about the 
1970's knows that it cost us a lot.
    Right now, what we are looking forward to is a cost much 
greater than what we witnessed in the 1970's, because we are 
much deeper in debt. Our foreign indebtedness is overwhelming. 
Our productive jobs are overseas and inflation is roaring 
again. Government statistics always lag reality, but even in 
government statistics today, as Congressman Bachus points out, 
inflation is over 12 percent a year. I mean, this is serious 
business. We are in stagflation. I don't think there is a 
question about: are we in a recession? We are in a recession. 
The numbers will catch up, no matter what the government 
statistics say, just talk to the American people. They are 
having a tough time. Ask middle-class Americans what they are 
doing. They are being wiped out, because their cost of living 
is going up much faster than their wages can keep up. Same way 
with Social Security beneficiaries.
    This is all a consequence of monetary policy, the fact that 
we allow ourselves to resort to the creation of money. If we 
had to pay for this war and for the welfare programs we have 
here at home by taxes, this would all end quickly. But instead, 
you know, we tax to the hilt, then we borrow as much as we can. 
Then there is a limit on that because interest rates might go 
up, and we fear that. So then we resort to the creation of new 
money out of thin air, which is another tax, because the value 
of that dollar goes down, prices go up, and who gets hit the 
most? The middle-class Americans. This is why middle-class 
Americans are really suffering.
    So there are a lot of things that I believe could be done, 
but once the Fed causes this distortion, we can't resort to the 
fact of saying, well, we need more regulations by the 
government. We need more regulations, but I would like to see 
the regulations come from the marketplace to make the 
adjustments necessary. But it is inevitable to have a recession 
once you create an artificial boom with the inflationary policy 
of the Fed, and that is what we are facing today.
    We are in the early stages of a recession, and 
unfortunately, many who have studied Austrian economics predict 
that this one is going to be long and tough and a lot worse 
than the problems we faced in 1979 and 1980. Hopefully, we can 
do the right things, but it would involve the Congress cutting 
back and not putting the pressure on the Fed to monetize this.
    And it is an inevitable myth we have lived with that war is 
an economic stimulus. That is absolutely false, and yet we live 
by that. We think, well, if we just spend money and the war 
spending participates in our GDP growth, and pretend that we're 
growing by building bombs that are blown up--this is an 
absolute myth, and therefore, this economy, I think, is on 
shaky ground, and we need to go back to look at what sound 
economic policies are as well as sound monetary policy. I thank 
you, Mr. Chairman.
    The Chairman. I thank the gentleman, and we will now 
proceed with our witness panel.
    Mr. Bachus. Mr. Chairman?
    The Chairman. Yes?
    Mr. Bachus. I'd like to just briefly say that our witness 
is John Taylor, who is a distinguished professor at both 
Stanford and before that at Princeton, and I think at Columbia. 
He has a distinguished record at the Treasury Department, is 
considered an authority on monetary policy and currency, and we 
are proud to have him, as well as our other witnesses.
    The Chairman. I thank the gentleman. Let me add that I have 
good memories of the work we did together on debt relief and 
generally trying to show some flexibility with regard to aid to 
the poorest countries in the world through the international 
financial institutions which fell under Professor Taylor's 
jurisdiction.
    Our first witness now is Dr. Alice Rivlin, who is a 
visiting professor at the Public Policy Institute of 
Georgetown, a senior fellow in the Economic Studies Program at 
Brookings, and was Vice Chair of the Federal Reserve System 
from 1996 to 1999. Dr. Rivlin.

 STATEMENT OF ALICE M. RIVLIN, PH.D., SENIOR FELLOW, BROOKINGS 
                          INSTITUTION

    Ms. Rivlin. Thank you, Mr. Chairman. I, too, am glad you 
are having this hearing, and I am happy to be here to share my 
views. I agree with you that monetary policy is a very 
legitimate subject of debate, as is regulation. I do think you 
should separate them in your head, though. And I will use the 
term ``monetary policy'' as it is conventionally used by 
economists to mean what the Fed is doing to regulate the 
macroeconomy.
    Now I know you want to focus on monetary policy today 
because you have Chairman Bernanke coming tomorrow. But I 
actually think monetary policy, as I am defining it, should be 
pretty far down your list of worries. The Federal Reserve has 
used the tools of its monetary policy arsenal quite 
aggressively and imaginatively in the last few months, and 
clearly indicated its intention to do more if necessary, so it 
seems to me that they are doing a good job.
    I think you should also be extremely pleased with the swift 
bipartisan action of the Congress and the Administration on the 
stimulus package. You may need to take further action, but the 
initial package was well-designed for maximum effect, and it 
passed with remarkable alacrity. Our policy process doesn't 
always function that well.
    Now if the consensus forecast is roughly right, and we have 
some on the panel who differ with the consensus, we will have 
slow growth for the next couple of quarters but will avoid 
recession and see growth resuming by the end of the year. But 
the situation, as you point out, is precarious. In housing, a 
spreading wave of foreclosures could undermine consumer 
confidence and increase the probability of recession.
    Continued risk aversion of investors and unwillingness to 
lend on the part of financial institutions could raise the 
probability even higher. The hardest challenges now are to 
minimize housing foreclosures and get the credit markets 
functioning more normally, both without spending excessive 
public resources or rewarding people who made dumb and 
irresponsible decisions. That is a tall order. It is a hard 
thing for the committee to be facing.
    The slowdown in the economic growth and job creation in the 
last quarter of 2007 was clearly the result of the decline in 
residential construction and housing prices, and the crisis in 
the subprime market. Nobody should have been surprised by that. 
We created a bubble, and bubbles burst.
    We shouldn't forget that a lot of good came from the 
housing boom. Millions of people moved into new or better 
housing, and most of them, including most subprime borrowers, 
are living in those houses and making their mortgage payments 
on time. I think the downside was that many people came to 
believe that housing prices would go on rising forever. Lenders 
became lax. Borrowers became over-extended. Speculation took 
hold, and we simply built too many houses. It will take time 
for demand to catch up with supply.
    The explosion of subprime lending was a clear regulatory 
failure. My former Federal Reserve colleague, Ned Gramlich, to 
whom you referred, warned repeatedly that lax standards and 
predatory practices in the subprime market deserved urgent 
regulatory attention. But the problem is that we have a very 
fragmented regulatory system. Most of the questionable 
practices were not being perpetrated by federally regulated 
banks, and the Washington regulators, as you pointed out, just 
did not get on the case.
    The worldwide fallout from the subprime crisis is just an 
example of how complex and interrelated our international 
markets have become. It was also a black eye for market 
capitalism. It was an embarrassing moment for those who boast 
about the intelligence and sophistication of financial markets. 
How come so few people asked the simple question, what happens 
to the value of these mortgage-backed securities when the music 
stops? When housing prices level off or decline, adjustable 
rates reset, and people with not-so-great credit histories 
can't make their monthly payments? Financial market 
participants now say they underpriced the risk. That is code 
for failing to ask some pretty obvious questions.
    A lot of financial institutions and funds found themselves 
owning securities worth less than they thought or whose values 
could not be easily determined. The result was some pretty big 
losses and a panicky flight from risk. Uncertainty about the 
future tightness of credit markets makes forecasting the real 
economy unusually difficult. A scenario in which the crunch 
gradually resolves and credit flows return to some semblance of 
normality produces a far rosier economic outlook than a 
scenario in which financial institutions suffer additional 
large losses and the crunch gets worse, and we just don't know.
    But meanwhile, back in the real economy, activity looks 
slow but actually not disastrous. The consensus of forecasters 
is that the underlying resilience of the American economy, 
aided by surging exports reflecting the weak dollar, and buoyed 
by the monetary and fiscal stimulus, will keep the economy from 
spiraling into recession. And my guess, for what it's worth, 
which is not a lot, is that the consensus will prove about 
right.
    But the uncertainty is very great, and you have to worry 
about the downside. As I said, I think the Federal Reserve has 
been using its tools aggressively and inventing new ones on the 
run. Most of the Federal Reserve's action has been aimed at 
pumping liquidity into the credit system in hopes of getting 
the banks lending again. The Fed lowered the discount rate and 
encouraged borrowing at the discount window. That didn't work 
very well. So they invented a new tool, the ``term auction 
facility,'' a mechanism to enable banks to borrow large, fixed 
amounts of credit from the Fed, and this was coordinated with 
other central banks.
    I think these actions have been appropriate and creative. I 
know there are those who think the Fed is behind the curve. I 
suspect that these critics have in their heads, for whatever 
reason, a forecast like Congressman Paul's--a forecast of deep 
recession to come, and they don't think the Fed is acting on 
that forecast. However, the consensus forecast and the Fed's 
does not anticipate recession.
    Moreover, there are ample reasons for concern about 
bringing the short-term interest rate down too far and too 
fast. Fear of aggravating inflation is clearly one, and the 
other is apprehension about making monetary policy so 
accommodating that it fuels the next bubble in whatever asset 
class might catch the investors' fancy.
    One way to take part of the onus off the Fed and avoid 
excessive easing of monetary policy is swift action on fiscal 
stimulus, and you have done that--a very great accomplishment. 
I was among those who urged several additions to the package, 
including an extension of unemployment compensation for an 
additional 13 or 26 weeks, a temporary increase in food stamp 
payments, and some relief to the States in the form of an 
increase in the Medicaid match.
    The States are always hard hit in an economic slowdown, and 
tend, as they have to balance their budgets, to cut spending, 
often on Medicaid and other benefits to low-income people, and 
to raise taxes. These actions tend to make the economic 
situation worse and Federal relief can help forestall them.
    I would urge the Congress, however, not to load a second 
stimulus package with slow-spending projects, however worthy, 
such as infrastructure, that do little to stimulate the economy 
in the short term, and add to the growing Federal debt. I also 
believe that the stimulus ought to be paid for. This is just a 
plea to remember that PAYGO is important and it should not be 
set aside--exceptions can become a very dangerous habit.
    But the difficult challenge, it seems to me now, is 
designing a workable way of minimizing foreclosures and keeping 
families who are able to pay their mortgages in their homes. 
Foreclosures are in nobody's best interest; they are expensive 
for lenders and servicers, painful for families, and 
destructive of property values in the surrounding neighborhood 
and beyond.
    The Treasury has been working energetically to pull the 
servicers and the borrowers together, and many States are doing 
this. This effort will help, but by itself, it is very unlikely 
to be sufficient to prevent a wave of foreclosures in the next 
couple of years.
    Legislating in this area is very tricky, both legally and 
morally. Rescuing individuals and institutions from the 
consequences of imprudent decisions smacks of condoning those 
decisions. However, it may be worth some moral hazard to avoid 
the spreading contagion of foreclosures that is likely to 
damage the prudent along with the imprudent.
    There are a great many proposals before the Congress on 
avoiding foreclosures, and I will not go into those here. Many 
groups more knowledgeable than I are eager to inform you on 
their views on this subject.
    But in conclusion, so far I think the policy response to 
the current macro situation is on the right track, both from 
the monetary authorities and from the stimulus. But the 
difficult tasks still lie ahead, that of crafting a set of 
policies that will be successful in containing the spreading 
contagion of foreclosures.
    Thank you, Mr. Chairman.
    [The prepared statement of Dr. Rivlin can be found on page 
59 of the appendix.]
    The Chairman. Next, Professor Taylor, who has already been 
introduced.

  STATEMENT OF JOHN B. TAYLOR, PH.D., MARY AND ROBERT RAYMOND 
          PROFESSOR OF ECONOMICS, STANFORD UNIVERSITY

    Mr. Taylor. Thank you, Mr. Chairman, and Mr. Bachus for 
inviting me.
    I would like to begin my testimony with just a brief review 
of the broader span of time in the role of monetary policy that 
has led us to where we are; in fact, I would like to go back 25 
years. It seems to me if you look at the span of time since the 
early 1980's, you see a remarkably improved economy compared to 
what we saw in the late 1960's and 1970's.
    We have had, since the early 1980's, three of the longest 
expansions in American history. We have had recessions, of 
course, but they have been much shorter, much less frequent, 
and much milder than in the past, especially in this period in 
the 1970's where we had recessions every 3 or 4 years. This is 
a much better situation than in the past.
    If you go back just a decade, you see the trend growth, 
even more impressive. I think this is important to note. 
Starting in the mid- to late 1990's, the productivity growth 
rate in the United States picked up by substantial amount the 
way economists measure, by about one percentage point. That 
alone has produced, believe it or not, another $9 trillion of 
goods and services that would not otherwise have been produced 
in the United States; $9 trillion--that is a lot of money that 
has gone to good use.
    If you now think about even more recently, you have seen 
this remarkably good performance spread around the world. Since 
2002, there has not been the emerging market financial crises 
that we saw so much of in the 1990's. The 1990's, one crisis 
after another in emerging markets, and since 2002, it has been 
much quieter. That growth and global expansion, if you like, 
global long boom, has also produced enormous amount of good 
things around the world.
    Economist magazine just wrote last month that between 1999 
and 2004, 135 million people have come out of poverty around 
the world. That is the benefits of this strong economy that we 
have been experiencing until recently. So I think there has 
been a lot here to note. Now what am I mentioning this for now? 
It is because I believe; and, I think economists who have 
studied this carefully--monetary economists in particular--
think that monetary policy played a great role in this 
stability in this unusual period of infrequent recessions and 
long expansions. And you can see that when you look carefully 
at the monetary policy decisions. They indeed have been more 
aggressive, more timely in responding to both increases in 
inflation and downturns in the economy--much more aggressive 
and timely--more flexible, if you like, than in the past, 
especially than in the 1970's when we had this terrible problem 
with inflation.
    So in my view, and I think in the view of many monetary 
economists, monetary policy, not just in the United States, but 
even more recently in other countries deserves substantial 
credit for this unusual period. I think monetary policymakers 
at our Federal Reserve and other central banks around the world 
deserve praise and credit for this remarkable situation.
    I start here, because it seems to me that one of the risks 
we face in deciding how to adjust to the current situation is 
the risk of overdoing it if you look, providing an excess of 
these, we could very well bring this back to those bad, old 
days of higher inflation and--listen to this--frequent 
recessions, deep recessions.
    That's the most important thing that we could risk here and 
how it would respond to this crisis to bring us back to those 
days, which no one wants to go back to. So I would say this is 
especially a concern now as Mr. Bachus pointed out with the 
inflation data that are coming in. The CPI last week (4.3 
percent over the year), that's not just a 1-month number.
    If you try to look more carefully and take out some of the 
special factors, you always have to be wary about doing that. 
It's still pretty high, over the comfort range that the Federal 
Reserve has mentioned. And when I go around the country and 
speak, I'm sure the members of this committee get this too. 
There is mention of inflation--frequently--just as there is the 
downside risks.
    So most of our focus here, rightly so, has been about the 
downside risks, and those are real. Growth much lower in the 
last quarter than in the third quarter of last year, it's going 
to be slow this quarter too. Even if it's not negative, it's 
going to be slow. So there are these substantial risks; and, my 
written testimony I go through explanation of how we got here, 
and Alice Rivlin has already mentioned those.
    I think the financial sector is in a particularly difficult 
situation now. Starting last August, you saw the interest rates 
rising substantially in the money markets and the so-called 
LIBOR market. That has raised credit costs above what it 
otherwise would be, so the question to me for this committee 
and for the Federal Reserve is how to balance these risks. How 
do we balance the risks of down-side and the risks of 
inflation?
    There are benchmarks around that economists have used to 
try to balance out these two or three factors. One of them, by 
the way, is called the Taylor rule. If you look at things like 
that, it seems to me it gives you a way to balance. And if I 
look at the inflation rate and the degree of slow-down in the 
economy at this point, even adjusting for the turbulence in the 
money markets, I still get an interest rate which is somewhat 
above the current interest rate already.
    That suggests to me that when you balance the risk 
properly, the additional easing would be questioned, given the 
circumstances both on inflation, both on the risks in the 
economy, and in the financial markets. So that would be my main 
point to make in these opening remarks.
    I would just say briefly, in terms of the money markets, in 
assessing whether the term auction facility is working, I would 
say that additional transparency from the Federal Reserve would 
be useful. In particular, what the balance sheet of the Fed 
looks like, what the Fed balances are from the commercial 
banks, additional transparency would be useful.
    Thank you, Mr. Chairman.
    [The prepared statement of Dr. Taylor can be found on page 
87 of the appendix.]
    Mr. Miller of North Carolina. [presiding] Thank you.
    Dr. Zandi?

 STATEMENT OF MARK ZANDI, PH.D., CHIEF ECONOMIST AND FOUNDER, 
                      MOODY'S ECONOMY.COM

    Mr. Zandi. I want to thank the committee for the 
opportunity to present today.
    I would like to make three points in my remarks. First, I 
think the economy is in the midst of a recession. I think the 
economy contracted in December, January, and it feels like it 
is contracting in February. And if we string another several 
months of declines together, that will be considered a 
recession.
    I think there are some parts of the country that are 
already clearly in recession: California, Arizona, Nevada, 
Florida, and Michigan are, in my view, in recession. They 
account for one-fourth of the Nation's GDP. And then there are 
15 other States scattered across the country that if you total 
up their gross product, it is another fourth of GDP. So in 
total, we are close to half of the regional economies in 
recession or close.
    I also think the big metropolitan areas in the Northeast 
are struggling quite significantly, and particularly New York, 
because of the problems on Wall Street, and in Washington, D.C. 
If you total all that up, we're well over half the Nation's 
GDP, so I think we're in the midst of an economic downturn.
    My second point is that obviously the problem is in the 
housing and mortgage markets, the securities markets. The 
housing market continues to literally evaporate. New and 
existing home sales are down 35 percent, and that overstates 
the strength of the market, because that includes foreclosure 
sales, which in the case of California accounts for half of all 
current sales in California.
    Housing starts are down over 60 percent, which is the 
steepest decline in the post-World War II period in terms of 
construction; and, house prices now are down 10 percent from 
their peak. The peak was just about 2 years ago in the spring 
of 2006, and the intensity of the price declines are very 
significant and quite severe. And over three-fourths of the 
Nation's metropolitan areas are now experiencing significant, 
persistent price declines, year over year price declines.
    This of course along with the subprime armory setting, the 
lack of credit and the weakening job market is resulting in a 
surge in mortgage foreclosures and defaults. We collect very 
high quality data based on credit files from credit bureau 
Equifax. As of the last week of January, there were 
approximately 550,000 first mortgage loans in default; that 
translates into an annualized pace of $2.2 million defaults. 
That is the first step in the foreclosure process.
    Just to give you context, in 2005 which was a good year, 
foreclosure defaults were under 800,000, so we're almost 3 
times that and rising very rapidly. Delinquency rates: 30, 60, 
90, 120, 143 all jumping very rapidly; and that suggests that 
the foreclosures are going to continue to rise significantly at 
least to the spring and into the early summer.
    Obviously, one of the key problems here is the shut-down of 
the mortgage securities market. The residential mortgage 
securities market is in the non-conforming market, outside of 
what Fannie Mae, Freddie Mac, and the FHA do, which by the way 
was half the origination volume in 2006. It has completely shut 
down--literally shut down. There were zero bonds issued for 
Alt-A loans in the month of January and total subprime Alt-A, 
and jumbo loans issuance in January totaled at an annualized 
pace, less than $50 billion.
    And to give you context there, in 2006, there was over a 
trillion dollars in issuance in those sectors. There was no 
credit flowing. So the problem in the housing and mortgage 
market, which go to the root of the economic problems that we 
face are not getting any better. They are at this point still 
getting worse.
    Point three goes to policy. I think policymakers are very 
slow to respond to events in the wake of the subprime shock 
last summer. I think the Federal Reserve misjudged the severity 
of the downturn and the breadth of the downturn and was slow. I 
do think they have caught up. I think a 3 percent fund rate 
target is appropriate at this point in time, and the futures 
market expect a 2 percent funds rate by the summer.
    That seems perfectly reasonable to me in the context of a 
recessionary economy. Fiscal policymakers also deserve 
plaudits. The fiscal stimulus package was a good one, 
particular the pace at which everyone got it together. Tax 
rebate, I think, is particularly efficacious, so I think that 
is helpful. I think the steps towards alleviating the problems 
in the housing mortgage markets are good steps, but they are 
baby steps.
    They are not enough. Hope Now, Project Lifeline, expanding 
the loan caps on Fannie, Freddie, and FHA will be helpful, 
particularly for California, Washington, D.C., New York, and 
South Florida, allowing States to issue more bonds to help 
refinancing efforts. All these steps though are not going to, 
you know, solve the problem. They are very, very small steps. I 
think we are coming to the point where policymakers need to be 
much more aggressive with respect to what is going on in the 
mortgage securities market. There are some good ideas that are 
now being formulated, and I just mentioned one.
    I do think it's now time to think about a tax pair-financed 
fund to purchase mortgage loans and mortgage securities. I 
think this could be done through an option process. Set up a 
bidding process for sellers to come in with mortgage 
securities, loans, even pools of loans if possible. Make a bid.
    That bid certainly would be not at full value. They would 
take a big cut, but I think they would find that a way to 
restart the market. Once the market has restarted, once we have 
a price, I think credit will start to flow; and, more 
importantly, we have a price that all the other institutions 
with bad credit on their balance sheets could mark to; they 
could write that down quickly and get on with business.
    Moreover, the Federal Government would then be the owner of 
these mortgages, if they bought home mortgages in the auction 
process, and they could take their time and figure out exactly 
what to do with these mortgages and stem some of the 
foreclosures and the deleterious impact it's having on the 
broader economy.
    So that's a big step. That's something that requires a big, 
philosophical jump, but I do think we're getting to the point 
where the cost to taxpayers or something like that will be 
measurably less than the cost of doing nothing and watching the 
economy continue to slip away and undermine tax revenue 
increase spending to help support the people who are losing 
their jobs.
    Thank you.
    [The prepared statement of Dr. Zandi can be found on page 
91 of the appendix.]
    The Chairman. Next is Professor Carmen Reinhart, who is 
professor of economics in the School of Public Policy, 
Department of Economics, University of Maryland. And also 
relevant, she is a research associate at the National Bureau of 
Economic Research.
    Professor Reinhart?

 STATEMENT OF CARMEN M. REINHART, PH.D., PROFESSOR, SCHOOL OF 
 PUBLIC POLICY, DEPARTMENT OF ECONOMICS, UNIVERSITY OF MARYLAND

    Ms. Reinhart. Let me begin.
    The Chairman. Is your microphone on?
    Ms. Reinhart. Thank you. This is my first hearing, so 
please bear with me if I fumble a little. I'm not sure what the 
procedures are, but let me divide--
    The Chairman. I guess the procedure is, you talk.
    [Laughter]
    The Chairman. Then, when you are through, we will ask you 
questions and you answer. Let me just say, of all the places in 
this building, I hope we are tied for last in protocol. So 
please go ahead.
    Ms. Reinhart. So let me divide my remarks into four parts. 
First, I defer to everyone here on the very short-term issues 
of whether the employment numbers or the housing numbers, I'm 
going to talk first about a big issue which has to do with the 
stuff that I know, which is financial crises, which is what 
we're in.
    And, then, I'm going to talk about three issues, and I'm 
going to take issue with you on policy response. And then I'm 
going to talk about regulation. And then I'm going to say 
something--lastly, where I'm relatively more ignorant about 
whether we can reverse these things. But let me start with the 
big picture of where I think we are.
    The Chairman. Dr. Reinhart, it may be rude not to look at 
people, but when you turn your head, you lose the microphone, 
so please look straight ahead.
    Ms. Reinhart. Okay. So first, on the issue of where we are, 
if the past is any resemblance on the future, and we always 
like to think we're different, but we're not. We have been 
through several financial crises, including the most severe 
financial crises. Believe me, I have looked at all of them in 
the industrial countries in the post-war, and then I have also 
looked at emerging markets. I am not even going to touch 
emerging markets, but on the big financial crises and the 
advanced economies, they are associated with recessions, full 
stop.
    So, if you are lucky, it is a slow-down, and that is like 
in 1995 when we had the Barings crisis, but that is a different 
order of magnitude. So the big crises are associated with 
recessions, full-stop. The recessions could be milder, or they 
could be softer. I think the Federal Reserve has been excellent 
in moving quickly; however, if we want to beat Japan, which had 
a crisis that lasted 10 years, then we should tell the Federal 
Reserve to start worrying about inflation, John. They shouldn't 
worry about inflation now. They should worry about the 
recession.
    The second point is, if you don't act quickly, then it is 
too little, too late. We are having a credit crunch, as you 
describe, believe me. I believe Dr. Zandi described the credit 
crunch to the tee. You know, this is a classic. I don't study 
high frequency events. But I can tell you, I have looked at 
every, single banking crisis in the post-war, and credit 
crunches are a problem.
    And they are a problem that doesn't go away in 1 month or 6 
months. It takes a while. This is not something that is easily 
reversed. Asset prices are falling as we speak--housing 
prices--equity prices. This creates a loss in wealth that is 
not easily undone and has serious consequences for consumption.
    You know, in industrial countries over the past 30 years on 
average, housing prices fell about 25 percent from their peak. 
That is non-trivial. So, the first part of my presentation is 
just on the magnitude of where we are at a broad brush. My 
second part is on the policy response of the Federal Reserve.
    The Chairman. I wanted to get to the second part. You are 
going to run out of time, so I wanted to get to each part, if 
you can, rather than get to the second part.
    Ms. Reinhart. All right. Very quickly, I think we need more 
easing. Okay? I do think we need more easing. I do think that 
what we have to work on is the very quick reversal, if 
inflation, which I believe and I share completely.
    The Chairman. Dr. Reinhart, please address your remarks to 
the panel. I'm sorry, but I do have more time to take. But, 
just talk to us.
    Ms. Reinhart. One last point. Regulation in the United 
States is more akin to Banana Republic than we would like to 
think. And in that regard, in the Federal Reserve's actions, 
but also the delegation to the States, and I will end my 
remarks right there. The consolidation of regulation is an 
important issue.
    The Chairman. You have more time. You can get to your third 
point. I just wanted to move it on.
    Ms. Reinhart. No. No, because I really do think the 
regulation issue is critical. You know, I have looked at 
Venezuela, and then there is somebody who says, oh, this guy 
did it and then this guy did it. No. We have to consolidate 
regulation. I want to make this point, because I think we have 
to consolidate. But, I also want to say we don't want to be 
like Japan.
    We have to act quickly and decisively, because this is a 
financial crisis and, you know, too little too late is a 
problem. And I leave my remarks there.
    [The prepared statement of Dr. Reinhart can be found on 
page 55 of the appendix.]
    The Chairman. Thank you.
    And, finally, Professor Roubini, who is a professor of 
economics at New York University's Stern School of Business, 
and the co-founder and chairman of RGE Monitor.

 STATEMENT OF NOURIEL ROUBINI, PH.D., PROFESSOR OF ECONOMICS, 
 STERN SCHOOL OF BUSINESS, NEW YORK UNIVERSITY, AND CHAIRMAN, 
                          RGE MONITOR

    Mr. Roubini. Thank you, Mr. Chairman, and members of the 
committee, for this opportunity to present my views. There are 
three questions I think that are in the minds of everybody 
about the economy. The first one is, of course, whether we're 
going to have a soft landing or a hard landing, meaning a 
recession. The second is how much more severe this credit 
crunch and problem in the financial market is going to get; are 
they going to improve? And third, what can the Fed do? Can the 
Fed avoid this kind of hard landing in the economy?
    In my view, on the first one at this point, the debate is 
not anymore whether we're going to have a hard landing or a 
soft landing, but rather on how hard the hard landing is going 
to be. I agree with Mr. Zandi, we're already in a recession, 
when you look at the variety of macro-economic indicators, the 
economy starts to contract some time in December. And a rising 
number of economists now are suggesting that actually this 
recession is going to relatively shallow, two quarters, Q1 and 
then Q2, and then a recovery of economy growth.
    My view of it is actually that this recession is going go 
be much more severe, longer, and protracted than just two 
quarters. I expect that this recession might last at least 4 
quarters, and possibly even more than that.
    If you look at the last two recessions in 1990 and 1991, 
and 2001, they lasted almost 3 quarters, 8 months each. And in 
my view, the conditions in the financial market and the 
economy, compared to the last two recessions, are worse. And 
that's why I believe this recession is going to be much longer, 
at least 4 quarters, if not 6 quarters.
    There are at least three dimensions in which I think that 
the condition and the macro-economy and financial markets that 
are worse today than they were in the previous two recessions 
in the United States. And that's why I believe this recession 
is going to be more severe and more protracted.
    The first reason is that we're experiencing right now the 
worst housing recession since the Great Depression. Housing 
starts have fallen sharply, but unfortunately new home sales 
have fallen even more, and therefore the gap between supply and 
demand, the stock of unsold homes, is at an unprecedented high. 
Home prices have already fallen by 10 percent and they might 
fall at least 20 percent from peak, and some people say all the 
way to 30 percent.
    If they fall 20 percent, that's a wiping out of $4 trillion 
of housing wealth in housing. If it's 30 percent, it's going to 
be $6 trillion. If there is a 20 percent fall in home prices, 
the number of houses that are going to be underwater with the 
value of their homes below the value of their mortgage is going 
to be something like $15 million.
    If home prices fall by 30 percent, that number is going to 
be over $20 million, and we have no recourse loans. There is a 
huge incentive when you are in negative equity or underwater to 
essentially do jingle mail, put your keys in an envelope, send 
it to the banker, and walk away.
    So we're facing a systematic problem in the housing market. 
This housing recession is getting worse, has not bottomed out. 
The consequences are going to be massive and severe like you 
haven't seen since the Great Depression. First observation.
    Second observation is that the conditions for the housing 
sector are much worse today then were in 2001. In 2001, the 
problems were the corporate sector. Today we have a U.S. 
consumer that is shopped out, is saving less, and is debt-
burdened, and the U.S. consumer is being buffeted by a whole 
series of negative shocks.
    Home prices are falling, home equity withdrawal is 
collapsing. Oil is at $100 and gasoline prices are very high. 
There is a slack in the labor market that's starting. Consumer 
confidence is falling. Debt ratios for consumers are 136 
percent of income. Debt servicing ratios are going up because 
of resetting of ARMs. There is a credit crunch in financial 
markets.
    All these shocks are buffeting the U.S. consumer, who has 
now started to retrench. And with consumption being 70 percent 
of aggregate demand, retrenchment of the U.S. consumer means a 
severe recession.
    Third observation of why this crisis is going to be worse 
and this recession is going to be worse. People talk about the 
subprime crisis and subprime meltdown. The problem is that we 
have a systematic problem in the financial system that goes 
well beyond the subprime problem. Now the problem in terms of 
the fault and so on are spreading from subprime to near-prime, 
to Alt-A to prime mortgages, to jumbo loans, default rates 
across the board for all sorts of mortgages are going up.
    Secondly, it's not just a problem of residential real 
estate. The entire commercial real estate market is also 
frozen, and there is going to be a collapse of commercial real 
estate activity. Who would like to build shopping centers, 
stores, offices, as ghost towns in the West. Of course, we will 
lag, the collapse of housing is going to lead to collapsing of 
commercial real estate.
    It's not just a problem of real estate. You're seeing now a 
rise in the fault rates all across unsecured consumer debt, 
auto loads, credit cards, and student loans. There is going to 
be a sharp increase in these default rates.
    You have massive problems in the leverage loan market with 
these LVOs that were done in a reckless way, and now leverage 
loans are being priced 80 cents on the dollar. You have the 
problem with the monolines, and I don't believe they're going 
be able to rescue a downgrade of these monolines, and if that 
downgrade is going to occur, it will have severe effects, as 
we've seen in the money market, and a downgrade of other assets 
that were being ensured by the monolines, as backed securities.
    And finally people say the corporate sector is doing better 
today than in 2001. Yes, that's true, on average. There is a 
fat tail of corporates that are actually highly distressed, 
with lots of that and not much profits. On an average in the 
United States, corporate default rates in the last 30 years has 
been something like 3.8 percent. For the last 2 years, that 
rate of default on corporate bonds was only 0.6 percent, \1/6\ 
of what is normal.
    In a typical recession, corporate default rates go up as 
high as 10 to 15 percent and recovery rates given default fall 
sharply. In a normal year, you recover 70 cents on the dollar, 
in a recession, you recover only 30 cents on the dollar. So you 
have a double whammy in a recession. Default rates are much 
higher and recovery rates are much lower.
    So there are going to be significant massive increases 
we've seen already in the data, in corporate default. In the 
last 2 years, there was slash of liquidity, credit spreads were 
very low, and they were bottomed out at 260 over Treasury's 
last June; now they're over 700 basis points over Treasury on 
junk bonds.
    There is going to be a massive increase in corporate 
defaults. And once that happens, about $50 trillion of credit 
default swaps that are ensuring something like $5 trillion of 
corporate bonds are going to also get in trouble, because at 
that point those who sold the insurance, some of them might go 
belly-up. Might be some hedge funds, might be some investment 
banks, might be some monolines. And those who bought insurance 
might discover that they were not hedged, and you're going to 
have another massive loss.
    So the problem we're facing right now in the U.S. economy 
is not a subprime mortgage problem but the subprime financial 
system that has severe stress like we have not seen in the last 
30 years. This is a severe financial crisis, and that's why the 
recession is going to be more severe.
    A final point about Fed policy: In my view, whatever the 
Fed at this point does is too little, too late. Of course, the 
Fed is going to ease more aggressively, and that's going to put 
the floor on how deep and how severe this recession is going to 
be, but it's not going to prevent it, because the recession has 
already started.
    And monetary policy is ineffective in a number of ways. 
First of all, today we have a glut, a glut of housing, a glut 
of automobiles, a glut of consumer goods. And when you have a 
glut of these things, it takes time to work out the glut, and 
monetary policy becomes less effective. It's like pushing on a 
string. In 2001, we had a glut of tech capital goods. The Fed 
slashed rates all the way from 6\1/2\ percent to 1 percent. We 
still had the recession and real investment on tech capital 
goods fell by 4 percent of the GDP. It took years to work out 
this glut.
    That's why when you have a glut the demand for these 
capital goods becomes interest rate insensitive. Therefore, we 
are not going to resolve the problem of housing or auto or 
consumer durables with easy money.
    Second observation: Monetary problems can deal with 
problems of illiquidity, but today we don't have just problems 
of illiquidity in the U.S. economy; we have problems of 
insolvency. We have millions of households that are bankrupt. 
We have had 200 subprime lenders already going out of business. 
We have dozens of home builders that are going to go out of 
business, or already have gone out of business. You've had 
dozens of financial institutions where highly leveraged got in 
trouble and lost money and shut down. And soon enough, as I 
argued, there is going to be a massive increase in corporate 
default rates. These are problems of insolvency of credit that 
you cannot resolve with money only.
    The third point is that right now we have a shoddy 
financial system that is not affected very much by the monetary 
policy. You have non-bank financial institutions, that like 
banks borrow short and illiquid ways and lend long or invest in 
illiquid ways, as savings, conduits, money market funds, hedge 
funds, investment banks. And unlike banks that have access to 
the lender-of-last-resort support of the fed, these non-bank 
financial institutions that have subject to this liquidity risk 
of a rollover of their claims that might lead to a crush 
because of illiquidity don't have access to the lender-of-last-
resort support of the fed.
    Final point: We have systematic problem in the financial 
system. The lack of transparency, the great opacity that exists 
of all these instruments that are hard to price, that are 
highly liquid, and therefore monetary policy cannot affect 
them.
    So, final observation: We are in a recession, and this is 
going to be a severe recession, and we are in the middle of 
systematic and systemic financial crisis that is becoming 
extremely dangerous.
    [The prepared statement of Dr. Roubini can be found on page 
66 of the appendix.]
    The Chairman. Thank you. Dr. Rivlin, let me just clarify 
one thing. Usually when people leave things out, and they have 
written statements, I am happy because we move quicker. But you 
left out one phrase for speed that I hope you'll repeat. You 
talk about the importance of paying for the stimulus that we 
just did. In your written testimony, you said over 5 years. I 
assume you omitted to say that orally.
    Ms. Rivlin. Sorry about that. Yes, I meant over 5 years.
    The Chairman. Right. Because there would be no point in 
doing the stimulus that immediately--
    Ms. Rivlin. You certainly don't want to pay for the 
stimulus in the year that you do it.
    The Chairman. No. And that would have been the speaker's 
position, and it is within the PAYGO rules to have the 5-year 
payback period.
    Ms. Rivlin. Yes. I'm just a fan of the PAYGO rules, and I 
don't like--
    The Chairman. I understand. But I--now I do want to get 
back, and I also agree, as you pointed out, obviously monetary 
policy and regulatory policy are not the same. I understand 
that. I do think that what is happening here is that ordinarily 
when we do Humphrey-Hawkins hearings, both the hearings 
themselves and previously the focus is on the macro-economy. 
But it does again seem to be today--and many of the witnesses 
have said this--that it is a failure in what has been the 
micro, the particular subprime lending, a fairly specific 
sector, that's the single biggest cause of the current macro 
problem. And you can't solve the problem without getting back 
to it.
    Let me just--this is kind of a sequence--as I was reading 
the testimony this morning I was struck, and I have handed this 
out to people. Dr. Rivlin: ``The exposure to subprime lending 
was a clear regulatory failure. So that regulatory failure 
cause of exposure in the subprime lending.'' Then Dr. Zandi: 
``The fundamental source of the economy's problems is the 
housing downturn and surge in mortgage loan defaults and 
foreclosures.'' That is, it was a regulatory failure that led 
to the subprime crisis, and it's the subprime crisis that's led 
to the border crisis. Professor Reinhart talks about multiple 
regulatory failures, which have led to this.
    And now let me turn to Professor Roubini, because we have 
already heard today the argument that ``Well, yes, but if the 
government rushes in, you'll just make it worse, leave the 
market to itself.''
    And let me just quote, and I'd ask you to expand on and ask 
others to comment on this. In your testimony, you say, ``Policy 
makers''--the executive branch I assume you're talking about--
``stress that their preferred approach would be one of `self-
regulation' and reforms undertaken by private financial 
institutions rather than new rules and regulations imposed by 
authorities. While the right balance between principles and 
rules and regulations and supervision is open to discussion, 
the recent experience suggests that excessive reliance on 
principles not backed by appropriate rules, the delusional hope 
that internal models of risk management will provide the right 
amount of risk-taking, the wishful thinking that self-
regulation will work, the hope that financial institutions will 
self-reform the system of compensation of bankers, are all 
mistaken views. A more robust set of rules, regulations, and 
supervisions will be necessary, as excessive reliance on self-
regulation and market discipline has shown its failure.''
    I would ask any of the members to comment: I think that is 
absolutely the case. We used to have someone here who was a 
monetary economist, who was in the House: ``Markets are smart 
and government is dumb.'' I guess if you still wanted to hold 
to the question of ``Government is dumb,'' we would have a 
remake of the movie, ``Dumb and Dumber.''
    [Laughter]
    The Chairman. So, Dr. Roubini, do you want to expand on 
that? And then I would ask the others, if they want to comment.
    Mr. Roubini. Yes. I present more detail in my written 
testimony, my points of view on the issue of regulation. And as 
I said, right now we're facing a significant problem that goes 
well beyond subprime. Of course, many of the regulatory 
mistakes were done in the last years by allowing these reckless 
lending practices to occur. Things like zero down payment, no 
verification of income assets, and jobs, interest rate only, 
negative amortization, and TISA rates.
    And by the way, all this kind of stuff was occurring not 
only in subprime but in subprime, near prime, and prime, jumbo 
loans, piggyback loans, home equity loans. About 2/3 of all 
mortgage origination since 2005 had these reckless 
characteristics.
    But as I said, right now what the financial stability-- 
401--7 are discussing are these broader problems of the 
stability of the Anglo-Saxon financial system. You have issues 
of internal models of risk management, whether they work or 
not, whether liquidity risk is stress enough, what is the role 
of credit rating agencies and their conflicts of interest, what 
is the system of compensation of bankers, whether the system of 
originate and distribution of credit risk transfer 
securitization is working, or how can we reform it? Whether 
Basel II should be reformed because its weakness is by relying 
too much on internal models, on rating agencies, not assessing 
correctly liquidity risk, having countercyclic--procyclical 
capital-- ratio.
    So there is a whole set of things that are right now on the 
table, and if you want a financial system that works and 
everybody is in favor of financial innovation, but we know a 
financial system works only if there is a set of rules and 
regulations. Because otherwise we are in a financial market 
that is--
    The Chairman. Let me--because we are running out of time. 
But is it fair to summarize your view? Is it that these things 
that you are describing were all decisions made in the private 
sector, and you believe that in dealing with them and 
preventing repetitions, etc., some public sector decisions are 
going to have to be made setting up the rules, is that correct?
    Mr. Roubini. Yes. I mean there's this debate on how much 
you want to rely on principles as opposed to rules, because of 
course there is a risk the financial innovations are--
    The Chairman. But in either case, they are promulgated--
    Mr. Roubini. --in the light of regulation, but I think the 
pendulum swung too much in the direction of relying only on 
principle and self-regulation--
    The Chairman. But in both cases, in principles and rules--
and I agree with you that we need more rules--you are talking 
about binding legally promulgated restrictions on what the 
private sector does?
    Mr. Roubini. Yes, I do. I think that--
    The Chairman. All right--
    Mr. Roubini. --I think that a certain reliance on stronger 
rules--of course, you have to be cautious--
    The Chairman. Thank you. I have to move on. Dr. Reinhart?
    Ms. Reinhart. The decentralization of governance, if you 
will, of regulation, is a problem. One of the things that if 
you look at the big picture, at the BIS, is that you try to get 
common rules. If you have every State having their own rules on 
what is deemed a worthy loan, we're really steering away from 
actually the big picture that we're pushing.
    The Chairman. Thank you. Dr. Zandi.
    Mr. Zandi. Well, let me say that I think there's plenty of 
blame to go around, a lot of actors that were involved in this 
and many mistakes made, not just the regulators. But I do think 
regulatory oversight was lacking in this period, and I think 
most fundamentally that's because of the Byzantine nature of 
our regulatory structure. There are half a dozen regulatory 
bodies that oversee the mortgage and housing markets, and in 
fact the mortgage industry worked hard to find the cracks in 
the regulatory structure. In fact, some of the most egregious 
lending was done by institutions that were regulated by the 
FDIC, the OTS, the OCC, and the Federal Reserve. They--
    The Chairman. But could have been under the Homeowner's 
Equity Protection Act if the Federal Reserve had promulgated 
rules.
    Mr. Zandi. Yes, although this was a period that was fast 
moving, big changes. It was hard to see that the restructure 
was creating the kind of problems it was. But I sympathize with 
what you're saying, and I do think if the regulatory agencies 
were more rationalized, if there was some way to centralize the 
process, although this is a big problem--
    The Chairman. I have to disagree there. With regard to the 
non-bank lender, originators, mortgage brokers, there wasn't 
any split, there was the Federal Reserve. They had pretty 
primary jurisdiction. There was potentially some State things, 
but frankly the problem here was that the Comptroller of the 
Currency and the Office of Thrift Supervision pre-empted State 
authority in many areas. So I mean it's not as if somebody 
tried to do something, and somebody else checked them. The 
Federal Reserve had authority and they decided not to use it.
    Mr. Zandi. Yes. I think though, that you know, think back 
to the period of 2005 and 2006. These new institutions 
reforming very rapidly, they were literally under the radar 
screen. I mean, restructures I think weren't really under their 
purview--thinking about it.
    The Chairman. I miss Ned Gramlich. He was a great man. I 
hope he left his radar screen to somebody, because they weren't 
under his radar screen. Dr. Taylor?
    Mr. Taylor. Mr. Chairman, I think these are good points. I 
would say that, however, the problems were caused, as we know, 
by financial institutions making decisions in retrospect 
certainly they shouldn't have had individuals making decisions 
like this. So, I think the first thing to say is the problems, 
the responsibility for dealing with them are with those 
individuals, are with the private investors, the private 
institutions.
    The role of policy right now, we discussed this, monetary 
policy in particular is to prevent spillovers of that to the 
rest of the economy. That's--
    The Chairman. But can monetary policy prevent the 
spillover? I think that is the frustration that absent 
regulation--
    Mr. Taylor. Yes, I believe it can.
    The Chairman. You think monetary policy by itself can deal 
with the foreclosures?
    Mr. Taylor. I believe it's having an effect already. You 
know, for example, some of these resets are going to be smaller 
with--
    The Chairman. You think that the only policy response we 
need for the current situation is to continue to have lower 
interest rates?
    Mr. Taylor. I think it's part of the response. I think it 
prevents some of the--
    The Chairman. What would the rest be?
    Mr. Taylor. But you can overdo it, and that's why I've said 
the inflation issues are important too.
    I think with respect to looking at changes, you need to be 
very specific about what the problems were. The off-balance 
sheet operations at the banks, the so-called structured 
investment vehicles, those should have been monitored.
    The Chairman. Can we mandate that they'll be on the balance 
sheet?
    Mr. Taylor. --monitored in the future. You look at what the 
Fed--
    The Chairman. Should we mandate that they would be on the 
balance sheets, the regulators?
    Mr. Taylor. I think you need to see what the Fed comes up 
with in that--
    The Chairman. Well, it could be that the Fed is not out in 
Patagonia somewhere. This is a public policy question.
    Mr. Taylor. --think about what you're mandating. Let me put 
it that way. So define what the structure investment vehicle 
is. If you think the regulators are not doing it right, then of 
course you need to change the law. But I'd say be specific, 
what's the problem, address the problem, and then take some 
actions.
    But there is a concern about overdoing it, and try to 
change--reform the whole system when there--
    The Chairman. My last question. Do you think regulation has 
been overdone in the last 5 years in this area?
    Mr. Taylor. No, I don't think regulation has been overdone.
    The Chairman. Thank you. Dr. Rivlin?
    Ms. Rivlin. Two points. I think you have to be careful not 
to overdo it. You do have a regulatory failure here. However, 
if everything that we can now think of with hindsight had been 
done, you might still have had a housing bubble. There's not 
much that regulation can do to keep people from making dumb 
decisions. And what we know about market economies is that 
every once in a while they get really irrational, and it is 
very hard to stop people who think that housing prices are 
going to go up forever.
    But that said, I think now you need to look at who 
regulates what and make the system more rational and stronger, 
so that we don't have a repeat of this particular set of 
issues.
    The Chairman. But you acknowledge that Ned Gramlich did say 
that we should step in and do something?
    Ms. Rivlin. Yes, and I think he was right. We should have 
done something. But your problem is, ``What do we do now?''
    The Chairman. No. Well, that is true, but in order to 
figure out what to do now, you have to figure out what went 
wrong. And assessing the role that regulation played in the 
past is part is part of what you do going forward. Ignoring 
history is not a good way to make policy prescriptions.
    Ms. Rivlin. Right. And I think clearly we should have 
regulated--I don't know who exactly ``we'' is--``we'' the 
government should have regulated all of the people who were 
making predatory loans.
    The Chairman. And I will close with one last point--and I 
didn't get a chance to talk to Dr. Roubini--but we ought to be 
clear, we aren't just talking about subprime. Subprime is where 
it started. But in fact, the absence of good decisionmaking in 
the private sector and the absence of any regulation allowed it 
to spread, and mechanisms in the private sector that we were 
told might be confining this, various forms of diversification 
and risk management, appeared to have exported it. But it does 
appear that among the major exports in the America these past 
years have been bad mortgages, and with negative consequences 
elsewhere in the world.
    So it started as a subprime crisis and then spread through 
the system and systemic aspects that we were told a couple of 
years ago were going to confine this seemed to have spread it. 
Mr. Bachus?
    [No response]
    The Chairman. Mr. Paul.
    Dr. Paul. Thank you very much. My question is directed to 
Dr. Roubini, but first off I want to say once again that I have 
a little trouble with this assumption that if we have poor 
information sent out to us in the marketplace from the Federal 
Reserve with distortion of interest rates that regulation is 
all that we need that will solve all these problems, because 
mistakes are made by investors and savers, mainly because 
they're getting bad information.
    But I wanted to address a subject with Dr. Roubini. In his 
written comments, he says the perception by markets that the 
Fed is trying to avoid necessary economic correction and the 
necessary adjustment in asset prices is something that I think 
is what's going on right now and so important, because when 
there is a distortion, the market says correct.
    But because of the emotional and political aspect of people 
losing a house, you know, it's virtually impossible. Nobody 
wants to take that position because it looks like you're being 
cold-hearted. Yet at the same time when the pretense is that 
we're going to save everybody's home, frequently when we're 
demanding lower interest rates, we know that behind the scenes 
what we're really doing is propping up Wall Street.
    Every time there's an announcement of significance with 
interest rates, the stock market pops up, and that seems to me 
to be the real goal is to bail out Wall Street because the 
people continue to lose their homes.
    But my question is related to a later statement that you 
said here. The Fed has now altogether ignored concern about 
moral hazard and concerns about future inflation and now 
starting to undermine the credibility of the Fed. And I think 
that is also true, but what I'd like to ask about is, when 
should we be concerned about that? After we have this crisis 
develop and the bubble seems to be unwinding? Where in your 
estimation does the bubble come from?
    And when was your concern about the housing market? Was it 
after we saw 2 years ago or so that this thing was collapsing, 
or was this something that you were able to predict? And were 
you concerned about it when overnight rates were 1 percent and 
we could get mortgages once again down at 4 percent in this age 
of fiat money where there's zero amount of savings? This is 
astounding.
    You know, in capitalism, capital comes from savings, but we 
have no savings. And yet, you could go out and get a mortgage, 
a $500,000 or a $100 million mortgage and pay under 5 percent 
for this. Was your--did you have concern at that time about 
what the Fed was doing? And would you accept the premise that 
much of the mischief and the bubbles come from the Federal 
Reserve? If not, where do the bubbles come from?
    Mr. Roubini. You're asking a set of very important and 
interesting questions. If I have to try to explain how we got 
into this housing bubble, I think there are a variety of 
factors. I think there is a consensus now that the Fed cut 
rates and kept them too low for too long. If you're using, for 
example, the Taylor rule that Professor Taylor has developed, 
you probably should have started raising rates much faster than 
they did after the 2001 recession. So certainly, easy money was 
part of the story.
    Part of it was also global conditions that kept, you know, 
long-term interest rates low, this bull market conundrum that 
Chairman Greenspan was referring to that depends on global 
conditions like the relative supply of savings grow relative to 
investment. So that was a factor that kept the loan rates low 
in normal and real terms.
    But in my view, even more so the monetary policy was a 
failure of regulatory policy. Because if you're expecting home 
prices to go up by, say, 20 or 30 percent per year, having a 
Fed fund at 100 basis points higher is not going to make much 
of a difference. And that's where the regulatory failure came, 
because literally, allowing things like zero downpayments, like 
not verifying the income and the assets and the loans, having 
interest rate-only loans. Having negative amortization where 
you're paying even less than the interest and then the mortgage 
value is going up over time. Introducing teaser rates.
    These were forms of financial innovation that were 
dangerous and were reckless, and Governor Gramlich and others 
early on suggested these things were things they should have 
avoided. And unfortunately, Chairman Greenspan was the biggest 
cheerleader for these forms of financial innovation that led us 
into trouble.
    So the Fed made mistakes, but in terms of monetary policy 
and in terms of regulatory policy, it was not just the Fed. It 
was the entire attitude, I fear, in Washington the last few 
years which essentially wanted to emphasize any form of 
regulation, was this kind of laissez faire ideology that 
markets know better. But we know in financial markets, people 
are greedy. And greed is good in some sense, at least 
entrepreneurship, but it has to be controlled by institutions, 
rules and regulation. Otherwise, financial markets become a 
jungle where you have asset bubbles and credit bubbles and when 
this occurs, and they go bust, the economic consequences are 
severe.
    Dr. Paul. May I have one short question?
    Ms. Waters. [presiding] Yes, you may.
    Dr. Paul. This is a short question for Dr. Taylor. You talk 
about the Taylor rule and how to figure out the proper Federal 
funds rate. Of course, from my viewpoint of the market, nobody 
is capable of doing this. But what would your estimate be if we 
allowed the market--what would happen if the market determined 
the Fed fund's rate? And why would it be so bad?
    Mr. Taylor. Well, the only way the market could determine 
the Federal funds rate is if the Fed set money supply or the 
reserves and then the market could respond. So the system we 
work in now tries to come close to that, Mr. Paul, but it 
doesn't do it exactly.
    Instead what the Fed does is sets the interest rates to be 
consistent, I believe, with these low inflation goals. And if 
they stick on that, we should be fine. I think if, again, to my 
opening, the last 25 years, you have to recognize are 
remarkably stable and long expansions, relatively infrequent 
recessions, shallow recessions. That is much better than how it 
used to be, and it spread around the world. I think that's a 
signal that monetary policy in these dimensions has done well.
    It's made--it's not always been that way. I think the ease 
in 2002-2003, as I wrote before, did go too far. And that's one 
of the reasons now why I would be concerned about going too far 
again. If you stick these basics--inflation, you're right to 
point out concerns about inflation, but you consider that along 
with balancing the risks to the downside, I think we should be 
okay.
    Ms. Waters. Thank you. I will recognize myself for 5 
minutes. Let me just quickly ask this panel, do you believe 
that the recently passed economic stimulus package is the right 
kind of fiscal policy to stimulate spending in the economy? 
Just--you don't have to expound on it, just yes or no. Starting 
with you, Mr. Roubini.
    Mr. Roubini. Yes. I do believe it's a step in the right 
direction.
    Ms. Waters. Yes?
    Mr. Roubini. Yes.
    Ms. Waters. Thank you.
    Ms. Reinhart. I concur.
    Mr. Zandi. I think it was a laudable package, yes.
    Mr. Taylor. I would like to just add, I think some effort 
to worry about the tax increases that are coming down the line 
is important right now. If there's not legislation introduced 
to prevent the tax increases in 2011, 2012, etc., then we could 
be actually undoing any stimulus that comes from what you've 
already passed.
    Ms. Waters. Yes, Ms. Rivlin?
    Ms. Rivlin. I think the package was a very good one and 
speedily enacted. I suggested in my written statement that 
there were some things you might have added and may still have 
to add.
    Ms. Waters. Thank you. It appears that in this discussion 
this morning, there is a lot of attention on the subprime 
crisis, which appears to be at the center of this economic 
downturn. And I'd just like to ask Mr. Roubini, Mr. Frank was 
reading, I guess, part of your statement where you talk about 
self-regulation and you believe that public policymakers I 
think it is said here, would prefer self-regulation to 
regulation that's developed by the public policymakers here. Do 
you really believe that there's any chance for over-regulation 
by this Congress in the financial services market in any shape, 
form, or fashion? Does anyone believe that, Mr. Roubini?
    Mr. Roubini. Certainly you have to be careful about, you 
know, not overregulating. I think that--
    Ms. Waters. Who do you think would overregulate? Who do you 
think--how much power do you think the financial institutions 
have in this Congress?
    Mr. Roubini. I don't know that. What I'm saying is that in 
this debate about regulation of the financial system, there is 
a long discussion on how much you should rely on market 
incentives, on principles on self-regulation, and also you 
should have also the stakes of actual rules. And I think that 
there has to be a fine balance between the two, and 
unfortunately in the last few years we have gone too much in 
the direction of essentially relying only on market discipline, 
on self-regulation and on internal incentive the financial 
system for a variety of reasons, and I'm not going to spell 
them now. They don't work. So I think that the balance has to 
be brought back to a set of rules and regulations that are 
binding, together with reliance on these principles.
    Ms. Waters. The financial institutions basically 
responsible for the subprime crisis are involved in a coalition 
of financial groups that are talking about self-regulation in 
dealing with the subprime crisis--Hope Now. Are any of you 
familiar with Hope Now? Dr. Rivlin, is it working?
    Ms. Rivlin. I think it's a good idea. As I said in my 
testimony, I don't think it will solve the problem, but it may 
help.
    Ms. Waters. Does anyone know what it has been doing or what 
it has accomplished since they got together and decided they 
were going to correct some of the problems and do some of the 
workouts and make sure that people stay in their homes? Has it 
been working? Does anyone know? Has it worked at all?
    Mr. Zandi. They have put out information with regard to the 
amount of contacts they've made with distressed homeowners. 
They have put out information with regard to how many 
modifications have occurred to loan contracts and repayment 
plans. I think in a broad sense, it has helped only on the 
margin, and it has not helped in a significant way. Most of 
what the coalition of lenders and investors in Hope Now have 
done is put people on repayment plans, which simply says, you 
haven't paid me in the past, but I'll allow you the opportunity 
to pay me in the future. But by the way, I'm going to roll in 
penalties and fees on what you didn't pay me before. So 
prospects are that these folks aren't going to stay in their 
homes for very much longer. It's just delaying the inevitable.
    So I think in general it's fair to say that there has been 
some positives from it, but they have been very, very small and 
very minor. And I think fundamentally the problem is that the 
investor groups that own these mortgages are very conflicted 
with respect to what should and what they want done. And until 
they're on the same page, we're not going to see many 
modifications. And that may never happen without some pressure.
    Ms. Waters. Would you suggest, Ms. Reinhart, that there 
should be public policy that would help these institutions 
really get in the modifications business?
    Ms. Reinhart. Consolidation of regulation. I think part of 
the problem that we're seeing is that nobody is held 
accountable, that, you know, it's you blame that person and you 
blame that person.
    Ms. Waters. Is there anyone here who thinks that the 
servicers should be given protection from liability in order to 
do modifications because they have said that they are afraid of 
having to--of being sued by the investors if they do 
modifications that would lose money or would not realize the 
profits that were anticipated? Do you think servicers should be 
given protection from liability?
    Mr. Zandi. I don't think--there's legislation to do that. I 
think even if you passed it, it would be ineffective. I think 
servicers would still be nervous that they would get sued, 
because you could not write the legislation in a way that would 
satisfy them. They're going to have to get the green light from 
the investor groups themselves before they engage in 
significant modification. And by the time you get this all 
together and in place and everyone figures it all out, you 
know, we're past--we're going to be deep into 2008, and we're 
going to have a lot more foreclosures and a lot more problems.
    So, it's not a bad road to go down, but I am very skeptical 
it will result in any substantive improvement in the market 
anytime in the near future. There's other legislation for cram-
downs in bankruptcy in Chapter 13. I think that's a better 
idea. I think that's a stick. I understand there are problems 
with it and I sympathize with those issues, but I do think that 
is a more--that could be more efficacious.
    Ms. Waters. Does anyone here have a better idea of how to 
do this?
    Mr. Zandi. Yes. My view is instead of doing it 
legislatively, you set up a taxpayer-based fund that would go 
in through an auction process and buy mortgage loans and 
mortgage securities in a bidding auction context. And in that 
kind of context, the sellers of these mortgages would take a 
loss. They would sell, but they would sell at a big discount, 
so they would get hurt.
    And you would start the securities market. You would revive 
the market because you know the Treasury is the buyer. Let's 
say it's the Treasury that's conducting the auction. You would 
have a market. They say I'm buying. I'm going to get the best 
price. As soon as there's a price, there's a market. Credit 
will start to flow.
    Moreover, once you have a price, then all the other 
institutions with mortgage holdings can mark to that price. One 
of the problems we're having right now is they don't know what 
to mark to, therefore, they can't clean off their balance sheet 
all their bad loans, and therefore they're unwilling and unable 
to extend credit. This would allow them to do that.
    And then third, if you're buying mortgage loans, the 
government is buying mortgage loans, they take possession of 
those loans. They are now the owner, and that gives the 
government significant latitude with respect to how to treat 
those mortgages. You could, you know, you could lower the 
mortgage amount to the value of the home and then refinance 
into an FHA loan. There are many things you could do. But that 
would be a process that would restart the securities market, 
get credit flowing, and also help some of these very hard-
pressed homeowners. And no one's getting a bailout.
    Ms. Waters. Thank you. Very interesting. All right. We're 
going to move on to Mr. Shays. Who is next? Oh, you're back.
    The Chairman. I am glad to delegate to the gentleman from 
Connecticut. The gentleman from California is recognized.
    Mr. Campbell. Thank you, Mr. Chairman. Let me preface my 
questions by saying I agree with Dr. Roubini and Dr. Zandi that 
I think we are in a period of negative GDP growth which is very 
likely, almost certain to be 6 months or longer, and therefore 
be the technical definition of a recession, and very likely to 
be longer than that. So I'm going to use the term 
``recession,'' because I think we are in one, and that to deny 
that is just ignoring what is likely, what is almost certainly 
the truth.
    So my first question is to Dr. Taylor and Dr. Roubini. If 
this--this was not a consumer-led downturn. This was a credit 
and capital downturn. Consumers, it would seem to me therefore, 
can't lead us out of it, and that what we have to do is figure 
out ways to get capital moving again, get people to take risks 
again, to change risk premiums, etc., to get capital moving. Am 
I wrong on that? And if so--or if I'm right, what should we be 
doing to do that?
    Mr. Taylor. I think that's certainly part of it. But 
remember, consumption and actually net exports has held up the 
economy for almost 2 years. You have 2 years of a housing 
decline. It's really in some sense to me amazing as you look 
back on that we had two full years of recordbreaking declines 
in starts and construction. And for most of that period, this 
economy just kept going. That's because of the strength of the 
consumer. Also, foreign trade and exports. So it is important 
to make sure that--in fact the biggest risk in my view is that 
you have some weakening on the consumer side.
    With that said, efforts to bolster investment, that's where 
some of the interest rates effects come into play that the Fed 
has already taken, is very important. And I would say that's--
it has to be a balanced thing. You know, the best kind of 
recovery, which I think we should be thinking about now, by the 
way, because you're right. Whether you call it a recession or a 
slowdown, we're in it. So the thing to me to thinking about is 
how we--what's this next expansion going to look like? I don't 
think it's going to be as deep as Dr. Roubini indicates.
    Mr. Campbell. Dr. Roubini, your thoughts?
    Mr. Roubini. Yes. I mean, the problems, of course, started 
with housing, but in some sense the sector of the economy that 
has the most financial trouble and vulnerability is the housing 
sector. In the 1990's, of course, it was the corporate sector 
that over-expanded, over-invested, and borrowed too much. And 
then you had the bust of the tech bubble, and the consumer was 
actually in much better shape. That's why you didn't have a 
contraction of private consumption during the last recession.
    But the last few years have been years in which there has 
been a massive increase in consumer debt. A lot of it was 
mortgages, but a lot of it was not just mortgages. It was, you 
know, auto loans, credit cards, student loans, you name it. And 
the total stock of that, of the housing sector's share of their 
income went from 100 percent to 136 percent, and the savings 
rate of the housing sector that was already low to begin with 
in the 1990's fell further and went all the way into negative 
territory.
    So the worry that I have right now is that we have 
essentially the largest part of the economy, this private 
consumption and the housing sector, that is under severe 
financial distress, that has never had so much debt, and now we 
have this severe credit crunch, and you are also buffeted by 
slack in labor market, high oil prices and everything else. 
That's why I worry about--
    Mr. Campbell. So what brings us out?
    Mr. Roubini. Excuse me?
    Mr. Campbell. What brings us out of this?
    Mr. Roubini. I think that you need fiscal stimulus, as you 
have done already. I don't think it's going to be enough, what 
you've already done. Last time around we started from a surplus 
of 2.5 percent of GDP. In 2000, it went to a deficit of 3.5. 
There was a 6 percent in fiscal policy. This package is 1 
percent, first of all, and we've squandered the surplus that we 
had a few years ago. That's why now we structure a budget 
that--
    Mr. Campbell. But I guess--and I'm sorry to just--because I 
have several more questions. Is it capital? Is it capital that 
will bring us out of it, or will the consumer bring us out?
    Mr. Roubini. It will be capital, but I think that actually 
in the United States for the last few years, we have invested 
too much in unproductive capital, essentially the stock of 
housing capital, and we didn't invest enough into the 
productive capital. Traditionally in the United States, housing 
is subsidized in a dozen of different ways. And then went this 
bubble. So, part of the adjustment is unavoidable. There was 
too much investment in residential real estate. That has to 
fall. And hopefully, the right economic policy is going to lead 
to a recovery of real investment in the true capital stock of 
the economy.
    Mr. Campbell. Okay. Let me--because I'm actually already 
running out of time. Let me fire off two questions and then 
I'll ask. One will be to you, Dr. Zandi.
    The Chairman. We're being a little lax on time, so don't--
you don't have to rush that much. Go ahead.
    Mr. Campbell. Oh, okay. All right. Then, Dr. Zandi, let me 
ask you. Talking about your proposal of an auction of MBSes and 
so forth, I guess I don't understand how if the Treasury--if 
there's an auction, Treasury goes in and buys it, they're by 
definition offering the highest price, or a higher price than 
anybody else, how that is not the Treasury thereby providing or 
essentially bailing out to some degree the investors and people 
who made some bad decisions, and in my view ought to lose money 
for having made those bad decisions.
    Mr. Zandi. Right. Well, they're making a market. And the 
market will determine the value, the appropriate value, the 
price, the appropriate price, because they're going to take 
bids from multiple sellers who are going to be bidding against 
each other and know it, and determine the appropriate price for 
those securities.
    Mr. Campbell. So you're saying that if you have some MBSes 
now there is nobody--you can't--even 20 cents on the dollar, 
you couldn't sell it to anybody?
    Mr. Zandi. Well, you will find somebody who will buy it for 
10 cents on the dollar or 20 cents on the dollar, but no one is 
going to sell it, because they know that's not the appropriate 
value. And therefore there is no trading, and therefore there 
is no market.
    Mr. Campbell. Well, then why does the Treasury need to buy 
these? If the idea is that all you need to do is create a 
market with some liquidity, why can't a market be created 
without Treasury?
    Mr. Zandi. What you need is a buyer who is willing to pay 
fair value, and says--and I can find that fair value because 
I'm big enough and I can set up an auction that's deep enough 
and broad enough and have enough sellers in it that I can find 
the appropriate price.
    Mr. Campbell. Okay.
    Mr. Zandi. Right now, there is no price.
    Mr. Campbell. Okay.
    Mr. Zandi. There is no market. And there is no credit.
    Mr. Campbell. All right. One more question for you, and 
then I have one question for the panel generally. Is--if we 
talk--you mentioned that the Alt-A, subprime, and largely the 
secondary market is kind of totally missing, dried up, gone as 
of January I think you said, out there. If we do additional 
regulation, don't we have to be careful that we don't 
perpetuate that situation? Don't we want that market to come 
back, not like it was, but at least to some degree?
    Mr. Zandi. Yes. Absolutely. And, you know, this discussion 
about regulation and what should be done about the regulatory 
process is an issue for the long run. This is a complicated 
issue. I would not jump in and make big decisions fast, because 
this is a can of worms that has been in the making since the 
Great Depression. It just can't be fixed quickly.
    What needs to be fixed quickly is what you began with in 
your questioning, and that is the securities markets need to be 
restarted. Because if credit doesn't flow, you can help 
homeowners today with problems, but you're going to have 
hundreds of thousands behind them. So it's key to get the 
credit flowing. And my point is, we're coming to the 
realization, I'm coming to the realization that the markets 
aren't going to do it on their own. Ninety-five percent of the 
time, they figure it out, and markets should be left to their 
own devices and do it. Five percent of the time they can't, and 
this seems to me like it may be one of those times, 5 percent.
    Mr. Campbell. Okay. Then the last question I have. We have 
all talked about the economy. I share Dr. Taylor's concern 
about inflation, by the way. But the one thing I didn't hear 
anybody mention was the value of the dollar. And I guess this 
is for the whole panel, and then I'll close, Mr. Chairman. Is 
anyone concerned about--that if the value of the dollar falls 
further from where it is that that is good, dangerous, or bad 
for United States economic policy long-term? Thank you.
    Ms. Rivlin. I would be concerned if the dollar plummeted 
and added to disarray in the world markets, but an orderly 
decline in the dollar, which is what we have seen, seems to me 
what we need to stimulate exports--to reduce our very large 
deficit in the balance of payments.
    It's getting better. We have a long way to go. And part of 
the self-corrective mechanism is the dollar falling and making 
it much more attractive for other people to buy from us, and 
less attractive for us to buy from them.
    Mr. Taylor. I certainly think we should be concerned about 
precipitous movements, but I also think we should be concerned 
about the strength of the dollar per se. It's a very important 
part of policy for confidence in America to have what I used to 
call at the Treasury the strong dollar policy.
    I do think that there are potential inflationary 
consequences of the dollar depreciating, and that's one of the 
concerns certainly that would be part of my thinking. I think 
with respect to the improvement in the trade deficit that we've 
seen, which we have, the current account has come down, I 
actually believe that's largely due to in some sense the same 
thing we're worried about here, is the housing. Because it 
means that the gap between saving and housing--saving and 
investment, excuse me--has come down, and that's just what 
would cause the improvement in the current accounts. It's one 
of the silver linings that we always try to think about for any 
event like this. But the trade deficit improvement is I think 
mainly related to the investment issue.
    Ms. Reinhart. Add that can we take it one step at a time. 
Right now, the process that we are in, and I agree with 
Nouriel, is a recession or about to be in one. A weakening 
dollar helps the current account deficit. We can worry about 
the inflation consequences; but for the time being, let's worry 
about the economic downturn, because it's not likely to go away 
in a month or two.
    The Chairman. The gentlewoman from New York.
    Mrs. Maloney. Thank you.
    Dr. Zandi, you mentioned that we need to get credit flowing 
in our country, but how do we get that credit flowing? How do 
we get that credit access moving? What can we in government do 
to stimulate or help that direction?
    Dr. Zandi. Well, I think the root of the problem in the 
securities markets in the financial system obviously goes to 
the residential, mortgage securities market. That has been 
effectively shut down. So I think if you focus on that market, 
try to revive that market, that the rest of the financial 
system will follow, just as it followed down into the credit 
crunch or credit squeeze, it will follow it out. And I do think 
we are at a point where we shouldn't wait for the markets to 
figure it out themselves, because it is affecting the broader 
economies resulting in a recession-like, if not a full-blown, 
recession.
    So my proposal is that the Federal Government become more 
actively involved in that process. I've described that to you. 
I could describe it again, but I think that would be the most 
efficacious way of reviving, restarting quickly, something that 
could be done very quickly. We have experience with auction 
processes.
    The Federal Reserve very ingeniously put together the Taft 
process, which has worked, I think in everyone's view, quite 
well. I think we can do that quite easily. There's obviously 
missing, complicated issues, but I think that's the best 
approach.
    Mrs. Maloney. Some of the candidates for President are 
saying that our tax credit system is skewed in this country and 
that what we need to do is be giving tax advantages, tax 
credits to those companies and corporations that create jobs in 
America. And some allege that our system now really rewards 
companies that go overseas and move their headquarters and jobs 
overseas. Could you comment on that Dr. Zandi? And do you think 
that is a direction we should be considering?
    Mr. Zandi. Yes, I mean I think the Tax Code plays obviously 
a key role in the location and expansion decisions of 
businesses here in the United States and globally, and, because 
we are clearly a very globally-oriented economy in every 
aspect, that is important. We are competing with other 
countries with respect to our Tax Code and how attractive our 
Tax Code is.
    But let me say, I think this isn't an issue for 2008 or 
2009. That would be more of a longer-term issue for the next 
President. It's not something I think I would be focusing on 
this year.
    Mrs. Maloney. Now, many of you have testified that we are 
headed towards a downturn in our economy. Would you like to 
comment on whether you think this downturn will be short and 
shallow, or long and deep? And how limited might the Fed be in 
their capacity to act due to the rising inflation?
    Dr. Rivlin, and anyone else who would like to comment?
    Ms. Rivlin. Frankly, I don't think we know. What we can do 
is take out insurance to increase the probability that it will 
be short and shallow. I think you've already done that with the 
stimulus package. I think the Fed has done that by cutting 
rates. And now you need to take steps that will get the credit 
flowing again. I like Dr. Zandi's proposal.
    There are others, but you need to work both on the credit 
markets, and, I think, on the ground where the foreclosures 
are. And I would consider in addition to his proposal, or that 
family of proposals, some direct grants either to States or to 
nonprofit organizations that can help keep people in 
communities in their houses, buy the foreclosed houses if 
necessary, and rent them back.
    Mrs. Maloney. Well, we have taken steps. In fact, roughly 
300,000,000 RFPs are out now to community groups. In my home 
State and city, we are having meetings with homeowners with 
people on the ground, government sponsored, to try to help 
them.
    But in that vein, what additional measures give us, if you 
believe according to Dr. Zandi's testimony where we are facing 
prices of $4 a gallon that this would be the equivalent tax of 
$100 billion on our households? This burden on top of the 
losses and wealth to the home prices falling and higher heating 
oil and gases, what additional measures in addition to revenue 
sharing helped localities and the steps that we have taken in 
Congress would give us the biggest bang for the buck to help 
families the most during this challenging time?
    Dr. Rivlin, and anyone else who would like to comment?
    Ms. Rivlin. I think we may need additional stimulus and I 
would do it through either increasing the Food Stamp Program, 
certainly lengthening the time for unemployment insurance, and 
some form of revenue-sharing with the States, which could be 
the Medicaid match. We've done that before. It works, and we 
know how to do it.
    Mrs. Maloney. Some of us, including our chairman, tried to 
get that in our stimulus package.
    Mr. Taylor. Ms. Rivlin, just briefly I think what you're 
doing in the communities is very important, and more of that 
needs to be done. I think at the higher levels, if you like 
what's done, are the Treasury--and actually my Governor in 
California did the same thing--was to bring the servicers and 
the investors together, because there is a lot of commonality.
    I think they had a lot of mutual interest here. If they 
could figure out a way to get over this, I think that's very 
important. I must say though, with respect to further action, I 
am beginning to worry about the psychology of tax increases 
coming down the line. Right now, unless there is a change in 
the law, we are going to get a tax increase, a big one, coming 
in 2010.
    And it's going to be a tax increase on capital as well as 
labor. I think that's beginning to be a concern for people and 
I think the next step, whatever it is, has to recognize that 
and take some actions, in my view, to prevent it.
    Mrs. Maloney. Anyone else? My time is up if anyone else 
would to comment.
    The Chairman. That's all right. We'll move on to the 
gentleman from Florida.
    Mr. Feeney. Well, thank you, Mr. Chairman, and thanks for 
holding this hearing.
    If we were hoping that consumer confidence was going to 
pull us out of this potential recession, anybody listening in 
today, you know, will be less likely to come to our rescue. 
Now, I think we are pretty much agreed that this is going to be 
something more significant than a soft landing and the question 
is what to do about it.
    Very briefly, with respect to fiscal policy, nobody has 
actually mentioned Milton Friedman's concept of permanent 
income. The fact is that investors long term don't change their 
behavior unless there is some positive change in permanent 
income and one-time stimulus packages, while they may or may 
not do very much harm, do very little long-term good.
    As Dr. Taylor pointed out, it is productivity that leads to 
prosperity for a society and that has always and everywhere 
been true. I view a stimulus package a little bit like a rain 
dance. The thing about a rain dance is that if you dance long 
enough, it will rain, but probably not because you were 
dancing, and it may not do a lot of harm.
    I will say that, you know, Dr. Zandi, your comments about 
the fact that we just don't have a credit crisis, there simply 
is no credit, I think was one of the extemporaneous positions 
you took. Even borrowers with good credit are having a devil of 
a time getting access to mortgage loans. Obviously, this is 
starting to spill over into business loans, etc.
    Housing prices are declining. There are no buyers out there 
because buyers cannot get access to credit, and the correction 
in the easy credit has already occurred. No new regulation has 
to occur from this Congress, because investors simply are not 
willing to enter this mortgage lending market.
    Dr. Zandi, investors buying securitized loans, where was 
that, say, 2 or 3 years ago versus where it is today? The 
amount of total capital investors are putting into securitized 
mortgage loans, do you happen to know?
    Mr. Zandi. At the peak in 2005, 2006, and the first half of 
2007, annualized issuances were running at just about a 
trillion dollars. And that was per annum.
    Mr. Feeney. Per annum?
    Mr. Zandi. Per annum. That's a non-conforming market, 
everything that Fannie, Freddie, and the FHA don't do.
    Mr. Feeney. And where is it now?
    Mr. Zandi. In January, annualized, per annum, less than $50 
billion.
    Mr. Feeney. So roughly 95 percent of the market is gone?
    Mr. Zandi. I would say it is effectively nothing.
    Mr. Feeney. And with respect to encouraging the re-
establishment or the resurrection, I guess we need a 
``Lazarus'' act here. It's dead.
    With respect to doing that, is it true that to the extent 
that you further impair security, that it will take longer for 
the investors to come back?
    Mr. Zandi. I think I started to say yes.
    Mr. Feeney. I spoke to a Realtor recently. She said the 
biggest problem she has on a daily basis is that appraisers are 
terrified to establish a price, because they are going to be 
held civilly responsible, etc., so she can't get even today's 
market value, because appraisers are worried about what the 
market will be 6 months or a year from now.
    But along with that, I'm very interested, because I also 
serve on the Judiciary Committee, and you testified recently in 
front of that committee about your cram-down proposal. To the 
extent that residential mortgages are subject to the arbitrary 
decision of a judge, either to reduce the interest rate, to 
reduce the value of the security, or to lengthen payments, is 
that a factor as we try to pull a Lazarus with the credit 
market that will prolong the return of investors to start 
providing credit again to borrowers?
    Mr. Zandi. No. I don't believe so, because the legislation 
is for mortgages that have already been originated and not 
mortgages going forward, and, so, I don't think it will have 
any material impact on the securities market.
    Mr. Feeney. Well, presumably, number one, is that the 
opinion of Moody's, whom you represent?
    Mr. Zandi. That is my own personal opinion.
    Mr. Feeney. Okay. Well, presumably, moral hazard, which is 
a concept the economists talk about, consumers, investors, 
etc., presumably even Congress can be subject to the theory of 
moral hazard, and if we do it once and like it, get patted on 
the back by news editorial boards and the few borrowers that 
will be helped, isn't there a potential we will do it again, 
or, even more importantly, won't there be a potential in the 
minds of the investors that have left the market? Maybe Dr. 
Taylor could answer that question.
    Mr. Taylor. Well, it's the idea of moral hazard applies to 
government as well as to private individuals. Its incentives 
are really important. So if you are going to give the 
indication that is the problem with the so-called bail-out 
worries, that if you just make it easy for people to get out of 
mistakes that they made themselves, then you are going to 
perpetuate future mistakes in the future.
    And the ideal with respect to the subject of this hearing, 
monetary policy, as long as the focus is on the overall 
economy, interest rates coming down, looking at growth 
inflation issues, and not focus particularly on especially 
parts of the financial sector, that should be fine with respect 
to the moral hazard. So it's a way to focus on the macro things 
in terms of the broad instruments we have, like interest rates, 
and as it said bail out particular sectors.
    Mr. Feeney. I am happy to go on, but we have other 
questions.
    The Chairman. I appreciate it, and that you have come to an 
appropriate segue here, the gentleman from North Carolina, the 
author of the bankruptcy bill.
    Mr. Miller of North Carolina. Thank you, Mr. Chairman.
    Quickly, before we turn to the bankruptcy bill, I want to 
disagree with the members of the panel or others who suggested 
what happened, that the calls of foreclosure prices was that 
lenders or financial institutions generally were not 
sufficiently cautious in making loans without making sure that 
people could repay the loans.
    Pretty much everyone involved in mortgage lending in 2005 
and 2006 knew perfectly well the people they were lending money 
to could not repay the loans according to the terms of the 
loans. They were loans that were designed to become unpayable, 
unaffordable.
    The absolute intention was that people would be in a 
position of being trapped and having to refinance again. And 
every time they refinanced again, they'd have to pay a 
prepayment penalty, maybe 5 percent of the mortgage; to get out 
of the last mortgage, they would have to pay points and fees to 
get into the new mortgage. And every time they did that as 
housing appreciated, the middle-class families who owned the 
homes had less of the house, less of the equity. And everybody 
involved in mortgage lending, they're the ones who ended up 
with it. It ended up in their pocket, not in the pockets of the 
middle-class families, and that was the exact intention.
    What went wrong? Dr. Rivlin used the phrase, ``the music 
stopped.'' Is the value housing stopped appreciating? And when 
that stopped happening, it didn't work. Seventy percent of the 
subprime loans in 2005 and 2006 had prepayment penalties; 90 
percent had a quick reset of interest rates that might increase 
after 2 or 3 years, so there are 2/28s and 3/27s.
    The monthly payments would typically go up 30 to 50 
percent. Everyone knew that those could not be repaid, and the 
volume of subprime loans went from 8 percent of all mortgage 
lending in 2003 to 28 percent of all mortgage lending, and 55 
percent wasn't to people with poor credit; 55 percent of the 
people who got subprime loans qualified for prime loans. They 
had their trust betrayed by the people they were dealing with.
    Dr. Zandi, you did testify before the Judiciary 
Subcommittee on what is being called the ``cram-down'' bill, 
the bill that would allow bankruptcy courts to modify home 
mortgages on the same terms, the same basis they would modify 
any other form of secured debt. And you did say then that you 
thought that would have a very modest, if any, effect.
    You did suggest that it be time-limited. There would be 
some said. The bill in the House now has been. You were by 
teleconference or you were by video, and after you left us, 
there were other witnesses. And one of those, actually, was Mr. 
Feeney, who asked one of the other witnesses or said, well, you 
know, I am sure that there are other economists who take a 
different point of view, and the witness for the mortgage 
bankers was nodding his head vigorously, as if to say, yes, 
that's right. Yes, we do have economists who say that.
    Mr. Zandi. I am sure you could find on any subject multiple 
economists, I understand.
    Mr. Miller of North Carolina. Well, my question is, have 
you seen it published? Because I haven't seen an analysis. My 
understanding of the way academics do things is that they 
publish their analysis. They set forth what their facts are. 
They take you through their analysis and give you their 
conclusions. In the 8th grade, we called it ``show your work.''
    Showing your work in 8th grade math class is exactly the 
same. Peer review is exactly the same concept. Now I have 
heard--one Member who has been on the fence about this bill has 
told me that someone, an opponent of the bill, said that they 
were willing to show him, privately, their analysis, but it was 
privately. It was sort of, ``Psst, want to see our economic 
analysis?''
    While the analysis that supports the conclusion that you 
reached has been published, there was a Georgetown study just a 
week or two ago of 40 some pages long; it had footnotes and 
charts and graphs and all the stuff that you think serious, 
academic work would have.
    Mr. Zandi. No. Academic work doesn't have charts.
    Mr. Miller of North Carolina. What's that?
    Mr. Zandi. They don't have charts.
    Mr. Miller of North Carolina. Okay. I have yet to see 
anything.
    Mr. Zandi. No. No charts. Yes.
    Mr. Miller of North Carolina. By the opponents that really 
sets out their analysis for why interest rates are going to 
leap. Are you familiar with any published analysis?
    Mr. Zandi. No, sir. I am not, and I am following this very 
carefully. And I have not seen any. No.
    Mr. Miller of North Carolina. Okay, I have asked the 
Congressional Research Service. It seems that there are several 
comparisons that are apt here. In 1978, the law changed. It is 
one of the major re-writes of the bankruptcy law. Before that, 
as I understand it, with the exception of a few rare times in 
American history, secured debts could not be modified in 
bankruptcy.
    After 1978, everything but home mortgages for individuals 
could be modified in bankruptcy. I asked the Congressional 
Research Service to look at and compare investment properties, 
the availability of lending, the availability of credit, the 
terms of credit, the interest rates for investment property and 
for primary residence to see if they could see anything 
different coming out of 1978. They said, ``No. Nothing.''
    The Georgetown study looked at the different places in the 
country where the courts were applying the law differently 
between 1978 and 1994 said they could see no difference. Is 
that a valid analysis, to see if the law is different one place 
than it is somewhere else, to see if the terms of availability 
credit are different in the two places?
    Mr. Zandi. Yes, I think the Georgetown study that you are 
referring to is a well-done study. It's the best study I have 
seen and I think it provides strong evidence that there is no 
difference in interest rates, or no significant difference--
nothing they can tease out of the data.
    Mr. Miller of North Carolina. Well, there's that. There's 
the difference in different parts of the country based on what 
the courts decided--the split in the circuits, lawyers say. The 
mortgage lending industry says one of the big differences that 
the bankruptcy bill would mean that they couldn't collect 
deficiencies beyond for the indebtedness beyond the buy of the 
home. But, in fact, a good many States now have anti-deficiency 
statutes, including the world's 5th largest economy, 
California.
    Mr. Zandi. Sure.
    Mr. Miller of North Carolina. I am not aware of any 
difference in the terms of availability credit between States 
who have anti-deficiency statutes and those that do not. Are 
you aware of any difference?
    Mr. Zandi. No, sir. I am not.
    Mr. Miller of North Carolina. Okay, in 1986, the same 
thing, family farms, chapter 12 of the bankruptcy laws allowed 
exactly the same thing with respect to family farms.
    Are you aware of any?
    Mr. Zandi. No.
    Mr. Miller of North Carolina. Okay. Are those the kinds of 
things that you would expect to look to to see if there would 
be a difference in terms of availability of credit?
    Mr. Zandi. I can't think of a better approach than exactly 
that.
    Mr. Miller of North Carolina. Okay, and you were aware of 
the Georgetown study. You reviewed it.
    Mr. Zandi. And I have heard the arguments from the Mortgage 
Banker's Association. I have heard the numbers. I think the 
added interest cost was 250 basis points. I think more recently 
they are saying 150, but I have not seen any research or work. 
I have tried to see it, but I have not seen it. No.
    Mr. Miller of North Carolina. Okay, thank you, Mr. 
Chairman.
    The Chairman. The gentleman from New Jersey, the gentleman 
from Connecticut, the gentleman from North Carolina, and the 
gentleman from Illinois are on the list that the minority gave 
to me. So, the gentleman from New Jersey.
    Mr. Garrett. Thank you, Mr. Chairman. And thank you 
gentlemen and ladies of the panel, as well.
    I appreciate you coming and your testimony. You know, 
taking a line from the gentleman from Florida who has raised 
questions with regard to doing the rain dance, the suggestion 
there of course is that you can do the rain dance, and keep on 
doing it, and it will do no harm. Of course, what we do in 
Congress is a little bit different than that. What we do may 
have negative implications.
    Mr. Taylor was referencing the idea that with stimulus 
today, there may be potential tax hikes down the road, and that 
could be doing some harm. And regulating in certain areas may 
be creating moral hazards in other areas, potentially, and that 
could be doing some harm. So, as light as the rain dance 
analogy might work in some cases, it may not work exactly as to 
what Congressmen do.
    I do appreciate all your testimony today. Let me just ask 
sort of a candid question as we sit here trying to figure out 
whether we should be regulating more or less or to what degree 
and what action should be taken and what the predictions are 
for the future.
    Can any of you comment on this? Back in 2005, when Congress 
was here discussing some other legislation and what have you, 
and the housing market was going pretty well--strong--what have 
you. I know we heard a recitation to the late Ned Gramlich, who 
was making his predictions.
    Can any of you reference us to your comments or papers 
predicting in 2007 that the market would be where it is today, 
that the balloon would have burst as it did, and that we would 
be in this significant credit problem we find ourselves in 
today?
    Who predicted this on the panel?
    Mr. Roubini. In July and August of 2006, I wrote a series 
of articles arguing that we will experience the worst U.S. 
housing recession in the last 50 years, that home prices would 
fall from pig to trough by at least 20 percent, and, that these 
housing recessions were going to lead to a severe credit crunch 
and eventually a recession. And it was not just me. There were 
seven other people in academia and otherwise that predicted 
that this was just a housing bubble like we've never seen in 
U.S. history.
    If you look at the second edition of the book by Bob 
Shiller, ``Irrational Exuberance,'' there is a chart showing 
the real home prices for the United States for the last 120 
years. It has like a flat chart with some booms and busts, 20 
percent. Since 1997, this chart shows that the real prices go 
up 100 percent. This was not a bubble; I don't know what's a 
bubble. It was about to go bust.
    Mr. Garrett. Thank you. Anyone else?
    Ms. Reinhart. If I may say so, I wrote the twin crisis 
paper, which was about banking crises and currency crises in 
1996 before the Asian crisis erupted.
    Mr. Garrett. And anyone else?
    Ms. Reinhart. Well, let me just make one quick point.
    Mr. Garrett. Thank you. Thank you. Anyone else, because I 
have other questions.
    Ms. Rivlin. I think quite a few people thought that this 
was a housing bubble--what was not really anticipated was how 
it would affect the credit markets through the mortgage-backed 
securities. I think that was the big surprise.
    Mr. Garrett. Okay. And I have some other questions unless 
you want to chime in now. And I appreciate that, because I 
asked Alan Greenspan that question when he was here. Because to 
put the question this way, I want to get into the housing 
market as soon as this bubble bursts timing wise, and he could 
never answer that question for me, so I appreciate those of you 
who were out in front of it.
    One of the issues, of course, besides the housing market as 
you just mentioned, is the credit market. And part of that goes 
to the issue, first tied to it, is the bond market today and 
the problems that we are seeing with some of the big bond 
insurers that they are in trouble.
    Do any of you want to comment on this? What would happen to 
our overall economy if some of those insurers go belly-up? And, 
secondly, what would the effect of a downgrade on the GSEs? We 
have already seen the beginning of that, I guess, on Monday--a 
downgrade of Fannie Mae by Goldman Sachs.
    Is a ripple effect there and what is that effect on the 
economy as well?
    Ms. Reinhart. Ratings are pro-cyclical, so do not look for 
help from that end, meaning that when you know, like Nouriel 
talks about things being bad, ratings are not going to help in 
that front, they are very pro-cyclical. They are pro-cyclical 
at the corporate level and at the sovereign level.
    Mr. Garret. Thanks, I appreciate that.
    Mr. Taylor. So one thing, one of the certainly issues if 
you go back and look at what went wrong is the rating agencies 
themselves. I mean this is ridiculous, what they were calling 
high-quality paper. In retrospect, it seems to me as healthy to 
go back and now and try to get this right, and look into the 
future.
    So yes, it will have some negative impacts, absolutely. And 
hope to minimize the spillover of those, as I have tried to 
indicate. But I think now you don't want to do anything to 
really question as best possible analysis from the rating 
agencies we can get, because it was terrible.
    Mr. Garrett. Well there is talk that there may be 
downgrades of MBIA and AMBEC of an additional $40 to $70 
billion in write-downs, a phenomenal number. Can the financial 
market basically absorb that large of a figure?
    Mr. Zandi. Well, I think your focus on the monolines and on 
potential downgrade of the GSE's highlights how significant the 
risks are, and that if in fact there are downgrades of the 
monolines, they will be out of business and there will be 
significant problems in the municipal bond market, which will 
affect many households.
    And it will also induce greater substantive write-downs, 
tens of billions if not hundreds of billions of dollars in the 
mortgage security markets, because there is insurance in those 
bonds as well. The GSE got downgraded, then of course the cost 
of--right now the only part of the mortgage market that is 
prior and current to the households is through Fannie, Freddie 
and the FHA.
    Fannie and Freddie are not as creditworthy, their cost of 
capital rises, therefore mortgage rates are going to rise, they 
are going to be less willing and able to extend out credit.
    So this highlights the very significant risks that exist 
and are playing out, and highlight the importance of 
policymakers to continue to be very aggressive and try to work 
on policies that are going to help the securities markets, I 
think that is what's important here.
    The Chairman. Quickly, could--we are going to have a vote, 
so one more quick question, yes.
    Mr. Garrett. Just one quick question. To the credit of the 
chairman, I know the chairman has been trying to move 
legislation with regard to the GSE's for reform in that area, 
and we haven't gotten that done. Is that a problem that we just 
expanded there, without doing what the chairman is trying to do 
as far as putting some reins on it as the chairman is trying to 
do?
    Mr. Zandi. No. I don't--because what you did was a 
temporary increase in their loan cap, and I think that is 
entirely appropriate in the context of the problems we are 
having. And the help that this will provide will be very 
significant to California, South Florida, New York, and 
Washington, D.C. Those are the markets where many of the 
securities are based; those are where the loans are.
    The Chairman. And the Secretary of the Treasury has my word 
that this committee will not consider a bill to extend that 
beyond the December 31st expiration.
    Mr. Garrett. And I appreciate the chairman for that.
    The Chairman. Unless it is in the context of the broader 
reform, including, because some have been concerned, Mr. 
Roubini raised it about the upper-end bias. Money that would be 
using some of the money they would make off that for lower 
income, affordable housing.
    Well I just can't resist. When I listen to the rating 
agencies, I do want to use a quote, if I may, that I have 
applied in other contexts. It says--I look at the role of the 
rating agencies in this, and it was triggered by Dr. Reinhart 
saying they were pro-cyclical, which is a polite way of saying 
that they come in after the fact and tell us what they should 
have told us before.
    The great editorial writer for the New York Post, Murray 
Kempton, once said that, ``The function of editorial writers is 
to come down from the hills after the battle is over and shoot 
the wounded.'' That does appear to be what the rating agencies 
have done in the current situation. The gentleman from Georgia.
    Mr. Scott. Thank you Mr. Chairman, and again welcome all of 
you to our committee. I would like to get your reaction to a 
couple of points. The first one deals with the housing crisis, 
and the other deals with what is happening with many of our 
companies going into bankruptcy with these two things.
    First, let's deal with the housing crisis, and what a 
program that has been put forward is, do you think, is enough? 
And that is the Bush Administration's new plan for homeowners 
facing foreclosure, which is Project Lifeline, I think you all 
are familiar with that. I would like to ask you if you think, 
if you truly believe that this plan will go far enough to keep 
these families in their homes.
    And that is particularly true, because as we look at banks 
who are continuing to restrict access to credit seems to me 
continues to acerbate the problem. In addition, property values 
are declining, making it difficult for an increasing amount of 
homeowners to refinance in the first place. By the end of the 
year, it is estimated that 15 million households will actually 
owe more on their mortgages than their homes are worth.
    This has to be a major concern, and in fact there are 
hundreds of thousands of homeowners who, even if they wanted to 
refinance, just cannot do so because they are locked out. Do 
you believe that what the Administration is putting forward in 
Project Lifeline is enough to get the job done, given the 
complexes and the inter-reactions that are happening as a 
result of the banks number one, restricting access to credit 
and the derivatives of the problem as I outlined earlier.
    Ms. Rivlin. No, I don't. I think it will help some people, 
but probably not very many, and I think you need a two-pronged 
approach. One is the one that Dr. Zandi has discussed--some 
kind of a taxpayer fund, buying mortgages or mortgage pools at 
a considerable discount. The discount ensures that sellers are 
not making much money. And I think you also need to work at the 
community level. It will not be easy to design that; you might 
let the States do it. But you need to get people on the ground 
thinking about how to keep people in their homes and having 
some resources to do it.
    Mr. Scott. Yes, Dr. Taylor.
    Mr. Taylor. I think what the Treasury is doing, and what I 
said earlier Governor Schwarzenegger did in California to bring 
the servicers and the investors together, it is focused on the 
problem right now, which is to try to get some adjustments in 
the payments so people can stay in their houses and have the 
okay of that basically from the people who will benefit from 
that, the investors themselves.
    I think that is very good. I think Mrs. Maloney's comment 
about the community organizations and doing this at the ground 
level, and Dr. Rivlin mentioned this too, is very important as 
well. My sense is those are the things we should be doing. The 
risk here is the housing prices falling even further it seems 
to me. And we don't know what is going to happen with that, 
there is certainly a risk of that.
    But at the current levels, especially with the interest 
rates being lower, that reduces the reset issue significantly, 
the fact that you have a lot of the indexes that are used to 
reset the mortgages have come down, even the LIBOR index has 
come down substantially, a couple hundred basis points.
    Mr. Zandi. Can I say in regard to Hope Now and Project 
Lifeline?
    Mr. Scott. Yes, you may.
    Mr. Zandi. They are, I think, laudable efforts, but they 
will ultimately fail, at least to a degree that matters. And 
there are three reasons, because there are three different 
groups that have a significant problem with making it work. 
First are the investors that own highly rated traunches of 
these securities. They have no interest, financial interest in 
allowing modification to occur.
    Second, the servicers themselves, they are very nervous 
about being sued by the investors even though they are under 
tremendous pressure by you to do so. So they are going to be 
very reluctant to it. And third, just operationally, this is a 
very, very difficult thing for them to implement effectively, 
quickly and that is mucking it up.
    Mr. Scott. But let me get your thoughts on this, because I 
think there is one proposal that certainly needs to be put on 
the table I think, and I would like to get your response to it. 
And that is would not it make sense for us to put a moratorium, 
a type of moratorium on all foreclosures and put a time limit 
on it, maybe it's for 6 months? But to give an opportunity to 
stop the bleeding and allow a refinancing to take place that 
would be patterned on that, a person's ability to pay at that 
particular point. The moratorium on the mortgages, is that a 
real possibility that we should be looking at?
    Mr. Taylor. I think a government-mandated moratorium would 
be troublesome at this point.
    Mr. Scott. I didn't hear you sir.
    Mr. Taylor. I think a government-mandated moratorium would 
be quite troublesome at this point. I think the lifeline idea 
of a month, a pause if you like, which is basically agreed to 
from the private sector is, it makes sense to me at this point. 
But if you are going to just go in and affect private contracts 
on a massive basis, it seems to me it could cause more problems 
in the future than you are trying to solve.
    Mr. Scott. But the point is that I would say I am getting 
at is that unfortunately throughout this country, the rate of 
foreclosures and the timeframe to enact the foreclosures 
varies. Some months if you are--in some States, if you are 
behind in your payments a month or 2 months, your property is 
on the courthouse being dealt with, and in other States, the 
timeframe stretches.
    And I think that is a fundamental flaw that we are not 
dealing with this disparity, and the lengths of time and the 
range of numbered payments that the individual consumer gets 
behind before his house is foreclosed, I think we need to 
address that.
    Mr. Taylor. It just seems to me that the plans that are in 
place now do try to narrow in on the people that can deal with 
this problem and the ones that should be fine, or they are not 
affected by it. So it is a pretty big section in the middle 
there that it's focused on and it seems to me that's what we 
should try to do in the meantime. In the meantime you know, if 
it could get worse, risks are there for further housing price 
to decline.
    Mr. Nouriel. Can I add a point. I think that the severity 
of the problem is that there are essentially two types of 
solutions. One is one in which essentially you do the auction 
and the government essentially nationalizes a good chunk of the 
mortgages, hundreds of billions of dollars. So that is 
socialization on a certain of these loses.
    The alternative is that in a market solution, eventually 
millions of people are going to go out, walk out of their 
homes, because as you have suggested millions, and many more 
are going to have a value of their homes that is below the 
mortgage, so they can walk out. In that case, you wipe out the 
capital of the banking, your systemic banking crisis and you 
nationalize the banking system.
    So either way you nationalize the mortgages or you 
nationalize the banks, that is what we are facing now.
    Ms. Reinhart. Forgive my ignorance on this topic, but one 
of the chronic problems with commodity stabilization schemes is 
treating permanent shocks as temporary. And so that you try to 
treat it as temporary and patch it, but that it lasts. I think 
we are facing some of that here.
    The Chairman. We will now move on with that tearful close, 
and we will go to Mr. Shays.
    Mr. Shays. Thank you, I am going to make a few 
observations. First, I love this panel, and I read all your 
statements. So I wasn't hearing some of the answers, but great 
statements, great panel. I am struck by the last questioner and 
it is like he is trying to, in my judgement, with no 
disrespect, repeal the law of gravity.
    The reason you have foreclosures is that people are 
stopping paying their mortgages and the people who own the 
properties have to pay someone else. And it would be like, it 
seems to me, saying if someone can't quit a job, even if the 
employer isn't paying them. Well you have to just keep working. 
Your employer isn't paying you, but you have to keep working. 
In this case, someone isn't making payment on property that 
someone else owns that owes money to someone else.
    And how are they going to pay that someone else if you just 
say the people can stop paying, but you can't foreclose on 
them. I am getting from this that consumers, there is a them 
that they are shopped-out, saving less and debt-burdened, that 
is a pretty scary thing. And Ms. Rivlin, your comment that we 
built more houses than there was a demand for, and that is 
amazing in a way when you think about it, because what it says 
to me is as we were building more houses, we had to find people 
to buy them, and the people we found to buy them were people 
who couldn't afford them.
    And so we were having more risky schemes to get them to buy 
them. But what it says to me is that there is no easy fix, 
which leads me to a second point. There are three CEO's, all 
brothers of Fortune 500 companies, and they said, ``What made 
you all successful?'' And they said, ``We faced up to reality 
and we dealt with reality.''
    And it strikes me that we are trying to ignore reality. 
Reality is we have more houses than there is a demand for right 
now, and that is one of the challenges. Another challenge is 
that we have a bond market where the bond companies, the 
insurance companies need about $15 billion.
    Another reality, it seems to me, is that credit agencies 
have destroyed their franchise. They--I don't trust them. And 
now I am concerned that the credit agencies, to try to win back 
favor, and I would like you to comment on this are going to now 
really clamp down and then depreciate the value of what is on 
the market, of what people hold as having some value and 
further deteriorated. And I am concerned that the rating 
agencies, to try to win back favor, are going to 
overcompensate. I would like you to quickly, each of you, tell 
me about what role the credit agencies have in making things 
get worse or better.
    Mr. Taylor. I think it seems that a lot of the investors 
should look elsewhere than the credit agencies to get their 
information. That would keep them on their toes. And you know, 
the investors I know, they don't even need these credit rating 
agencies. So the more we can find, if you like, substitutes, 
new ones, competitions for this business, the better off we 
will be.
    Mr. Shays. Others?
    Ms. Reinhart. The literature on both on the corporate level 
and on the sovereign level, rating agencies are pro-cyclical. 
They do not help in economic downturns.
    Mr. Shays. Mr. Chairman, I would just like to say we have 
had some hearings on credit agencies, and I would love us to 
revisit this issue.
    The Chairman. Yes, I would say that the gentleman from 
Pennsylvania, Mr. Kanjorski, has been significantly engaged 
with that and we will return to that.
    Mr. Shays. Could I ask about--the first package was a 
stimulus package, you know we gave folks some money to spend, 
we allowed businesses to write off their capital and new 
planting equipment, and we raised the housing limits for Fannie 
Mae, Freddie Mac, and FHA. And that all seemed to make sense. 
It strikes me that the second package has to shore up the 
credit market in the sense of we have to somehow, should we be 
providing money to the bond market. And I mean you have 
mentioned it, but I would like to know if there is consensus.
    It strikes me that if we basically are not telling people 
whether or not their taxes are going to go up, the wise 
investor is going to hold back because of not knowing what is 
going to happen, or are they, because the capital gains may go 
up try to sell property even more quickly to take a lower price 
but pay a lower tax?
    Could you speak to that, and then I am done.
    Mr. Taylor. I briefly mentioned this before--I think 
anything that is in the future should deal with this tax 
increase that is coming down the line unless legislation is 
passed. I don't think you can separate it out anymore; that was 
part of the way this moved so quickly.
    Mr. Shays. Now you were the request of the Republican 
members as a witness. I would like to know what some of our 
other members say. No, I mean, and I happen to agree with you. 
I am just curious if others agree with you, Dr. Taylor.
    Mr. Roubini. I don't agree, I think that those tax cuts 
were things we couldn't afford. And unfortunately, whoever is 
going to be in power in the next Administration will have to 
reverse some of these tax cuts.
    Mr. Shays. So--if dividends go up?
    Mr. Roubini. And income taxes for the higher-income 
individuals as well, absolutely. You have a fiscal time bomb. I 
mean your fiscal debt is already going from 150 to 410, and 
that doesn't include Iraq and Afghanistan. And on top of it--
    Mr. Shays. And that will have no impact on slowing the 
growth of the economy?
    Mr. Roubini. No, but on top of it you are going to have 
another fiscal stimulus at the end of the year with a 
recession. The recession is going to make the deficit even 
bigger. And now people are talking about the government buying 
hundreds of billions of dollars worth of mortgages. So there 
are people saying we are going to have a budget deficit of $800 
billion a year from now.
    That is the problem we are facing, so you want to make also 
the tax cuts permanent, another trillion dollars of losses of 
revenues? I think it is just kind of fiction.
    Mr. Shays. Doctor, do you believe that tax cuts stimulate 
any economic growth, or do you just think that is some kind of 
made-up story?
    Mr. Roubini. If you cannot afford them, they don't 
stimulate economic growth; there is a budget constraint you 
have to finance.
    Mr. Shays. Dr. Zandi?
    Mr. Zandi. Well I think this is a debate for the next 
president and the next Congress. I think if you try to tackle 
that one now, you will not get anywhere and you will not make 
any progress on things that you should. Secondly, I am all for 
lower tax rates, I think they are stimulatory, I think they are 
very helpful. The lower the tax rates we can have, the better. 
But I also think our most significant long-term economic 
problem is those very large, looming budget deficits. The 
budget math is very disconcerting, and if you have the lower 
tax rates great, but we have to figure out how to pay for them.
    Ms. Reinhart. In a nutshell, short run gain, long-term 
pain. That is basically--meaning--
    Mr. Shays. I understand.
    Ms. Rivlin. The reason the tax cuts were not made permanent 
was that we couldn't afford them, and we knew that at the time, 
you all knew that at the time, and that is why they were made 
temporary. And it is still true, on a long-term basis, that we 
are going to need either to cut spending drastically or to 
raise revenues, and you have to face up to that.
    Mr. Shays. Okay, thank you. Thank you all very, very much.
    The Chairman. The gentleman from Texas.
    Mr. Green. Thank you, Mr. Chairman. Thank you and the 
ranking member for hosting this hearing, and I thank the 
witnesses for appearing today. Let me start with a question 
with reference to regulation. Are you of the opinion that 
regulation could have prevented this current crisis? And 
because I have not been here, I have not heard much of what you 
have answered. And by the way, I have had another hearing that 
I have been attending for the benefit of those who want to know 
why I wasn't here.
    If you think that regulation could have prevented this 
crisis, could you just kindly extend a hand into the air, this 
way I can get through it quickly, if you think regulation could 
have prevented it. The current subprime crisis as it's called, 
the current crisis in financial markets, could regulation have 
helped prevent it?
    Ms. Rivlin. I think it could have mitigated it. If we had 
stronger regulation of predatory lending, we would have not had 
as much capital flowing into the housing markets, but I don't 
think it would have solved the whole problem. The very low 
interest rates also exacerbated the housing bubble.
    Mr. Green. If we would have had regulations in place to 
prevent making loans at a teaser rate, but not having the 
purchaser qualified for the adjusted rate, would that have been 
helpful, anyone differ? If we had in place a regulation that 
required documentation showing that you had income, would that 
have been helpful?
    The Chairman. Could I just let you note that the recorder 
is very good at his job, but his ability to record head nods, 
eyebrow raises--we probably want to give some indication of 
people as to what they--
    Mr. Green. Yes, sir, thank you, Mr. Chairman.
    Ms. Reinhart. I just want to make one observation. You know 
that I have studied crisis everywhere, banking crisis, and the 
problem is that regulation usually lags behind financial 
innovation. That is a chronic problem.
    Mr. Green. I concur with you. I right now am not going to 
challenge anyone on the notion of whether we could 
prognosticate what was going to happen as such as we could have 
had the regulations in place. I think there was some evidence 
to indicate that there was some regulations that we could have, 
based on empirical evidence, put in place.
    But be that as it may, I would like to go back to where I 
was with reference to undocumented loans, loans where you don't 
have document to support, income. If you are of the opinion 
that would not have been helpful, raise your hand. For the 
record, all persons seem to agree that it would have been 
helpful, with one exception, Mr. Taylor.
    Mr. Taylor. What specifically is your question, sir?
    Mr. Green. My question is a basic statement. We had many 
loans made to persons who did not document income, commonly 
known as no-doc loans. If we had regulations, some regulation 
that would require some documentation of your income, would 
that have been helpful?
    Mr. Taylor. Now I am going to have to see what 
documentation you mentioned, but let me be more specific. I 
think that a lot of the loans given to people were based on 
statistics that they were paying, and the same quality of 
people who continue to pay. And that is because housing prices 
were rising so rapidly that people had an enormous incentive to 
keep up their payments. And so those data were used by the 
underwriters, by the automatic underwriting programs, and I 
think that was a big part of the problem.
    Mr. Green. So if I may, would I put you on the side of 
those who would contend that no-doc loans were not helpful?
    Mr. Taylor. I see specifically what you mean, but--
    Mr. Green. No-doc loans, a person gets a loan and does not 
produce evidence of income.
    Mr. Taylor. Basically you have to have evidence of the 
borrower's capability of paying to get a loan.
    Mr. Green. So you would agree that making no-doc loans then 
does provide some degree or problem for an industry that 
depends on payback.
    Mr. Taylor. Yes.
    Mr. Green. Okay. For fear that I may not get this in, I 
probably will come back to my questions. But Dr. Zandi, are you 
familiar with the term ``traunche warfare?''
    Mr. Zandi. Yes, I think so.
    Mr. Green. You mentioned the persons who are at the higher 
traunches.
    Mr. Zandi. Yes.
    Mr. Green. And you have persons who are at lower traunches. 
The statement has been made that no one benefits from what is 
occurring now. You said earlier however that the persons who 
are at these higher traunches, they don't have the same risk if 
you will. You didn't use that term, but that is the term that I 
would add.
    Mr. Zandi. Incentives.
    Mr. Green. Yes, incentives as those in the lower traunches.
    Mr. Zandi. Right.
    Mr. Green. Could you explain to us why the persons at the 
higher traunches, as briefly as you can, would not have the 
same incentives, please?
    Mr. Zandi. The folks who are at the highest traunches, the 
triple A, double A traunches will get their money back unless 
70 or 80 percent failure rate, default rate, net loss rate 
occurs on the security. And in a modification, what they are 
worried about--let me back up.
    In most of these securities, what happens is you have a 
pool of money out there that is distributed to all the 
investors. This pool gets distributed based on how the 
underlying mortgages perform. So if the mortgages are 
performing well, then over time that pool of money gets 
distributed to all off the investors, the highly rated 
traunches, the lower rated traunches.
    What the highly rated traunche owners are worried about 
that in the modification that money will get distributed and 
then the modification will ultimately go bad and they will 
suffer a loss and there won't be that pool of money to protect 
them and they will ultimately lose money. So they are much more 
interested in allowing these loans to go all the way through 
the process and wiping out the lower rated traunches.
    And what they have left are the homeowners who are going to 
pay and who are going to pay reliably and they are going to get 
their money back. So in the modification they are very nervous 
that they are not going to get their money, and in a 
foreclosure, they are more likely to get their money back.
    Mr. Green. Just a final comment, if I may, Mr. Chairman, 
and by the way the people who have these higher traunches, they 
paid more to occupy the positions that they occupy.
    Mr. Zandi. Yes, they got a lower return because they took 
less risk. It is the guys at the bottom end who took a lot of 
risk got very high returns. And their view is, you know, why 
should I help them out, when this was the deal? If things got 
bad, the lower rated were going to suffer more than me.
    Mr. Green. Thank you, Mr. Chairman. I yield back.
    Mr. Jones. Mr. Chairman, thank you very much, and I want to 
thank the panel. I've been in and out like most members of 
other committees, and one major committee, military personnel 
talking about the needs of the active duty, the needs of our 
military--
    The Chairman. Well, we probably ought to stick with this 
subject, since we're going to have a vote soon.
    Mr. Jones. I'm coming right to it. The book, ``The Day of 
Reckoning,'' by Pat Buchanan, says that any great nation that 
has to borrow money from foreign governments to pay its bills 
will not long be a great nation. America is borrowing money 
from other countries to pay our bills. Dr. Zandi, this will 
probably go to you, but if anybody else wants to join in, that 
will be great.
    My concern is--and I realize that debt is part of living--
the issue when you can pay your debt each month, but you're 
going to borrow money from another bank to pay your bills, 
which America is doing, by putting all these Treasury notes out 
for sale, then you can live within the debt.
    My question is this: At what point does America lose its 
financial credit with other countries? If the debt is growing 
at $1.61 billion a day, we're borrowing money to fight the war 
in Iraq and Afghanistan, we're borrowing money to pay for the 
surplus--I mean the stimulus package--at what point, Dr. Zandi, 
do we get to a point of no return?
    It happened to the Soviet Union during the Ronald Reagan 
days in the presidency. There was an arms race that they tried 
to compete with America. America was strong then, and therefore 
they couldn't compete. They fought a 10-year war in 
Afghanistan. So we're in a situation where now we're having to 
borrow money to pay our national bill. At what point does this 
get beyond the point of no return?
    Mr. Zandi. I think once we get into the next President's 
term, when we start to grapple with the question of what do we 
do about the tax cuts, and how do we address Social Security, 
Medicare, and Medicaid, if you are not successful in addressing 
that issue, I think we will have a significant problem.
    Mr. Jones. Okay. Will you explain your point of a 
significant problem? The American people--
    Mr. Zandi. I think what it would manifest itself in is that 
interest rates would rise measurably, long-term interest rates 
would rise measurably, and of course that would be a 
significant weight on the economy--and that would certainly 
exacerbate conditions--that you will need to solve that long-
term budget problem; otherwise, we're going to face high long-
term rates, much slower investment and productivity growth, and 
ultimately it feeds on itself.
    Mr. Jones. Would you say that the next President--he or 
she--the next President would have 8 years to try to get a 
handle on this problem, or less or more?
    Mr. Zandi. I think it's in their term, because we are going 
to be faced with the question of: What are we going to do about 
those tax cuts? How are we going to pay for them, or not? And 
just how are we going to address Social Security or Medicare?
    The Baby Boomers are right there, and they are now sucking 
down Social Security, Medicare, and given the high cost of 
health care and the escalating cost of health care, we're 
there. It's going to be in this term.
    Mr. Jones. I have a couple more minutes. Would anyone else 
like to respond?
    Ms. Rivlin. I don't think we know the exact moment at which 
the reckoning comes, but I agree with everything Dr. Zandi has 
said. We've been taking chances for a long time. We need to fix 
this problem of the long-run budget deficit. That doesn't mean 
we have a crisis in the budget right now. It's a relatively 
small amount in relation to our economy, but our long-term 
problem is very serious.
    Mr. Jones. Anyone else?
    Mr. Reinhart. Britain once dominated the world. It no 
longer does. Things happen. And the 1967 sterling crisis was a 
good end to that reign. So we have to be very careful.
    Mr. Jones. Mr. Chairman, thank you very much. I'll yield 
back at this time.
    The Chairman. Clearly, Dr. Reinhart, Britain's reign over 
the world did end some time before the sterling crisis of 1967.
    Ms. Reinhart. But that finished the sterling zone.
    The Chairman. The gentleman from Illinois?
    Mr. Manzullo. Well, thank you. I'm intrigued with the 
testimony, and if I could just make a few observations: 
Everybody on the panel agreed that the present stimulus package 
was good to put $600 to $1,800 in the hands of the American 
consumers so they could spend it, but only one agreed that the 
tax cuts should continue.
    I just find it totally contradictory that you could be in 
favor of this stimulus, and then sit back and look at the 
average family of 4 having to pay about $2,700 more in taxes, 
when in fact Wall Street is already reacting to that. But that 
is more of a commentary.
    Second, Dr. Rivlin had mentioned in her testimony the fact 
that--and perhaps I read it wrong--residential construction is 
not a big part of the economy, even with its linkage to 
consumer durables and other real estate services. I would 
disagree with that entirely.
    If you take a look at what goes in home lumber, wire and 
electrical fixtures, plumbing, pipes, fixtures, appliances, 
windows, glass, flooring, wood, linoleum, paint, caulk, 
hardware, locks, hinges, nails, indirectly loggers, truck 
sales, for pick-up trucks, for construction sites, tires--I 
have a tire factory in my district--other construction tools 
and trucks and equipment, sales of these items have huge hits 
on manufacturing, whenever that happens in residential housing, 
and when you don't have residential housing going up, you don't 
have commercial housing going up, because one drives the other.
    And this is backed up into all aspects of the economy. You 
can sit here, we can sit here and solve the housing crisis 
today, but when people are losing their jobs because of the 
smack from the collapse of the residential construction 
industry, then all of us are the tiger chasing each other 
around the tree, trying to figure out what's going on.
    But also services related to residential housing are 
Realtors, brokers, telecompany, mortgage brokers, then the 
people who build the office buildings for the people in these 
professions. And so I think we have to sit back and take a 
reality check as to the impact of construction and the impact 
of manufacturing.
    Dr. Greenspan did a great job of keeping down inflation, 
but he did not understand manufacturing. Chairman Bernanke 
does. Dr. Greenspan said that what jobs you lose in 
manufacturing, you more than compensate for in high-end, white-
collar jobs, but on three different occasions, when I examined 
him before this committee, he couldn't give me an example of 
one of those.
    But the real question I want to ask here is this: Lisa 
Madigan, who is the attorney general for the State of Illinois, 
put out her report as to what happened in the housing market, 
and she said this housing market collapsed even before the 
resetting of ARMs because people bought homes they could not 
afford in the first place.
    That is what is going on in Illinois. And my question to 
you is whether you have a federalism hat on or federalism hat 
off, whose job is it to govern these instruments of debt? The 
2/28s, the 3/27s, the no-principal payments, the ARMs, the fact 
that people took out these layered loans. I mean, who has the 
jurisdiction over that? The States? And if not the States, then 
the Federal Government? And what agency? I'm trying to attach 
responsibility, if any, as to who would be in the position to 
get rid of these types of loans that cause the problem.
    Ms. Rivlin. Part of the problem was that the answer to that 
question wasn't clear. The States had jurisdiction over many of 
these loans. The chairman has pointed out that arguably, the 
Federal Reserve could have asserted its authority to regulate 
these loans, and certainly to pull the other regulators 
together and say, ``Let's all do it together,'' which they 
eventually did do.
    But it was a very unclear situation, and that's what I 
think you as legislators have to straighten out.
    Mr. Manzullo. Okay. Would everybody agree with that 
analysis?
    Mr. Zandi. Yes. I think the problem is you had the Federal 
Reserve, the OCC, the OTS, the FDIC, the FCC, and every State 
regulatory agency having some part of the process, and it was 
only until--I believe it was November of 2006 that they 
collectively issued their first guidance with respect to 
interest-only neg-am jumbo loans. They didn't even get to 
subprime loans. They didn't issue collective guidance on 
subprime loans until I believe it was April/May of 2007, well 
after the fact.
    And that goes to the Byzantine nature of the--
    Mr. Manzullo. Now the guidance on it is in terms of words 
of guidance or actual saying that you can't have these 
documents, or governing the documents.
    Mr. Zandi. No, it was strongly--it was worded guidancing--
you know, you can't make teaser rates to these types of loans.
    Mr. Manzullo. But I guess my question is--and maybe we all 
scratch our heads--why would a bank or lending agency get 
involved in having somebody buy a house when you don't even 
know if that person can make the first payment? I mean what--
something happened that--
    The Chairman. Would the gentleman yield?
    Mr. Manzullo. Of course.
    The Chairman. What happened was securitization.
    Mr. Zandi. Yes.
    The Chairman. What happened was that you no longer had to 
worry about whether that individual could pay you back, because 
you made the loan and sold it, and then other people bought it, 
and packaged it, and sliced it, and they said, ``We have all 
these techniques.'' And what they did was take these loans that 
never should been made in the first place, and sent them all 
over the world.
    Mr. Manzullo. But isn't there something--I don't want to 
use the word ``dishonest,'' but I just, I mean you're a 
business person, and you're sitting across the table from a 
person you know cannot make that first payment.
    The Chairman. Yes.
    Mr. Manzullo. And there's a problem there.
    Mr. Roubini. As the chairman suggested, you had essentially 
a securitization food chain, in which every step of the way 
somebody was making an income from a fee and not told in the 
credit risk. You started with the mortgage broker that wanted 
to maximize his or her own income by maximizing the number of 
mortgages that are being approved. Then there was the 
originating bank, that was essentially putting these things 
together into RMBS's and sending them somebody else and getting 
a fee. It was the mortgage appraiser, who had an incentive to--
    The Chairman. But--
    Mr. Roubini. --over-appraise the value of the mortgages. 
Then the investment bank was repackage--
    The Chairman. Everybody at--
    Mr. Roubini. --into CDO's, and the rating agency was making 
a fee and profit out of mis-rating this thing. So at every step 
of the way, somebody was making a fee and transferring--
    Mr. Manzullo. I understand. Mr. Chairman, I do have one 
question.
    The Chairman. Yes, go ahead.
    Mr. Manzullo. I didn't mean to cut you off. If there is 
going to be a regulation here, and I'm just--we're all thinking 
out loud, and that's the purpose of the hearing--wouldn't the 
regulation be at the level where you could say unless these 
certain underwriting criteria are met, that there can be no 
securitization?
    The Chairman. Will the gentleman yield?
    Mr. Manzullo. Of course.
    The Chairman. We passed a bill that does a lot of that. The 
bill that came out of this committee that passed the House says 
that nobody in the country, including your broker, can make 
certain loans. And we then require that the securitizer do due 
diligence before packaging the loans, and we hold the 
securitizer liable if a loan has been sold without the due 
diligence, the borrower can then cancel out the loan, and the 
securitizer is on the hook. So much of what the gentleman--
    Mr. Manzullo. There were some infirmities in that bill that 
compelled me to vote against it, but there's--
    The Chairman. Well, I gather. But the gentleman is--
    Mr. Manzullo. I understand. I understand.
    The Chairman. But what the gentleman is asking for, we have 
already passed in this House.
    Mr. Manzullo. I understand that. I understand that. And 
thank you. I'm going to yield back to--
    The Chairman. Well, I'm going to take some time out, 
because I have to say, with all due respect, that I now know 
more about regulation, and Dr. Roubini, you got it wrong. And 
Mr. Zandi and Dr. Reinhart. No, it was not a multiplicity of 
regulators; it was an absence of regulators.
    First of all, under the Homeowner's Equity Protection Act 
passed in 1994 out of this committee--not by me--John LaFalce, 
my predecessor, a senior Democrat, was the major advocate, and 
it is not an accident that was the last time the Democrats, 
frankly, were in control of the House--the Federal Reserve was 
given authority to promulgate rules for all mortgages, not just 
for depository institutions. Dr. Roubini, as you noted 
correctly in your written statement--frankly, you should have 
stuck with it--you say that there was a clear regulatory 
failure. Ned Gramlich started that; this is on your page 3. And 
then you note: ``Most of the questionable practices were not 
perpetrated by federally regulated banks, and the Washington 
regulator didn't know the case.''
    So there wasn't much the OCC and the OTS could have done. 
Under Chairman Greenspan, as an ideological matter, he flatly 
refused to use the authority given to him by the Homeowner's 
Equity Protection Act despite Ned Gramlich asking him to do it. 
He said that was the kind of intervention that would do more 
harm than good.
    We then had, frankly, a further problem because it was then 
up to the States, and the States had the right to do it or not 
do it. But Dr. Reinhart, I'd have to disagree with you on this 
one point.
    Some States were trying to do things. And then the 
Comptroller of the Currency and the Office of Thrift 
Supervision promulgated rules that significantly preempted 
rules not only concerning national banks, nationally--banks, 
but their affiliates, and their operating subsidiaries and 
their affiliates were a problem.
    So there were State laws. For example, we just had a 
lawsuit going through. Ohio had a law about mortgage brokers. 
State Farm had a bank, and they required mortgage brokers to be 
contractors, not employees of the bank. And Ohio had some rules 
about the mortgage brokers, and the Office of Thrift 
Supervision said, ``No, no, we preempt that, they're a national 
thrift.''
    What we have since done in the bill that this committee 
passed was in fact to not wait for the Fed anymore, but to pass 
a set of laws, as Dr. Roubini says in his written statement, 
where you had depository institutions making mortgages with 
insured deposit funds, there was regulation. And a very small 
percentage of the problem happened there.
    The problem came when pools of money not from depositors, 
liquidity that became available not subject to regulation, 
originated by non-regulated institutions, they weren't subject 
to those national rules, they were subject to some State rules. 
Some of them got preempted.
    What we have now done is to pass this set of national 
rules, including--we were told oh, don't interfere with the 
securitizers--we have given some liability to that 
securitizers.
    Chairman Bernanke takes credit, and I think he has a 
dilemma, because he doesn't want to repudiate Alan Greenspan, 
so he's been a little slower, but he is in fact taking 
different views with regard to this, with regard to the 
authority the Federal Reserve has under the Federal Trade Act 
to promulgate unfair and deceptive practice codes for banks. 
He's moving.
    So the Fed now has begun the process of adopting rules on 
OPA. But the Fed did have some power. There were enforcement 
problems, I will concede. The statute didn't give them an 
enforcement problem, although in the past when the Fed has 
wanted to do something and it didn't have enough enforcement 
power, it found its way here pretty quickly and asked for it.
    So we should be very clear that it was not a tangle of 
regulators; it was the deregulatory theory of the time. It's 
the philosophy that Dr. Roubini talked about: ``We'll handle it 
ourselves. You stay out of it. Don't mess us up.'' That was the 
philosophy that ruled the Congress, that markets are smart and 
government is dumb.
    And there was a conscious decision by people for 
ideological reasons to restrain themselves. We are now saying, 
``No, we do need to get into regulation,'' and it's a point Dr. 
Reinhart made. Innovation outstrips regulation. And innovation 
is a good thing. And innovation that produces no value, you 
don't have to worry about. It will die, and no one will support 
it.
    But you do have to make sure that regulation catches up to 
innovation and to some extent allows the benefit without the 
harm. But this is a clear case of ideological preference for 
deregulation, leading to this problem.
    The panel is excused, and I thank you.
    Ms. Rivlin. I don't disagree with that.
    [Whereupon, at 12:58 p.m., the hearing was adjourned.]
                            A P P E N D I X



                           February 26, 2008
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