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


 
                ECONOMIC RECOVERY OPTIONS AND CHALLENGES

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

                                HEARING

                               before the

                        COMMITTEE ON THE BUDGET
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                               __________

            HEARING HELD IN WASHINGTON, DC, OCTOBER 20, 2008

                               __________

                           Serial No. 110-43

                               __________

           Printed for the use of the Committee on the Budget


                       Available on the Internet:
       http://www.gpoaccess.gov/congress/house/budget/index.html


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                        COMMITTEE ON THE BUDGET

             JOHN M. SPRATT, Jr., South Carolina, Chairman
ROSA L. DeLAURO, Connecticut,        PAUL RYAN, Wisconsin,
CHET EDWARDS, Texas                    Ranking Minority Member
JIM COOPER, Tennessee                J. GRESHAM BARRETT, South Carolina
THOMAS H. ALLEN, Maine               JO BONNER, Alabama
ALLYSON Y. SCHWARTZ, Pennsylvania    SCOTT GARRETT, New Jersey
MARCY KAPTUR, Ohio                   MARIO DIAZ-BALART, Florida
XAVIER BECERRA, California           JEB HENSARLING, Texas
LLOYD DOGGETT, Texas                 DANIEL E. LUNGREN, California
EARL BLUMENAUER, Oregon              MICHAEL K. SIMPSON, Idaho
MARION BERRY, Arkansas               PATRICK T. McHENRY, North Carolina
ALLEN BOYD, Florida                  CONNIE MACK, Florida
JAMES P. McGOVERN, Massachusetts     K. MICHAEL CONAWAY, Texas
NIKI TSONGAS, Massachusetts          JOHN CAMPBELL, California
ROBERT E. ANDREWS, New Jersey        PATRICK J. TIBERI, Ohio
ROBERT C. ``BOBBY'' SCOTT, Virginia  JON C. PORTER, Nevada
BOB ETHERIDGE, North Carolina        RODNEY ALEXANDER, Louisiana
DARLENE HOOLEY, Oregon               ADRIAN SMITH, Nebraska
BRIAN BAIRD, Washington              JIM JORDAN, Ohio
DENNIS MOORE, Kansas
TIMOTHY H. BISHOP, New York
GWEN MOORE, Wisconsin

                           Professional Staff

            Thomas S. Kahn, Staff Director and Chief Counsel
                 Austin Smythe, Minority Staff Director


                            C O N T E N T S

                                                                   Page
Hearing held in Washington, DC, October 20, 2008.................     1

Statement of:
    Hon. John M. Spratt, Jr., Chairman, House Committee on the 
      Budget.....................................................     1
    Hon. Paul Ryan, ranking minority member, House Committee on 
      the Budget.................................................     1
        Prepared statement of....................................     3
    Hon. Ben S. Bernanke, Chairman, Federal Reserve Board........     4
        Prepared statement of....................................     9
        Speech given at the Economic Club of New York, October 
          15, 2008...............................................    13
        Responses to Mr. Etheridge's questions for the record....    87
    Martin Neil Baily, the Brookings Institution.................    36
        Prepared statement of....................................    39
    Iris J. Lav, deputy director, Center on Budget and Policy 
      Priorities.................................................    44
        Prepared statement of....................................    48
    William W. Beach, director, Center for Data Analysis, the 
      Heritage Foundation........................................    55
        Prepared statement of....................................    57
    Hon. Bob Etheridge, a Representative in Congress from the 
      State of North Carolina, questions for the record..........    86
    Hon. Jon C. Porter, a Representative in Congress from the 
      State of Nevada, prepared statement of.....................    88


                           ECONOMIC RECOVERY
                         OPTIONS AND CHALLENGES

                              ----------                              


                        MONDAY, OCTOBER 20, 2008

                          House of Representatives,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to call, at 10:00 a.m. in Room 
210, Cannon House Office Building, Hon. John Spratt [chairman 
of the committee] presiding.
    Present: Representatives Spratt, DeLauro, Schwartz, Kaptur, 
Becerra, Doggett, Blumenauer, McGovern, Tsongas, Scott, Baird, 
Moore of Kansas, Moore of Wisconsin, Ryan, Garrett, Simpson, 
and Tiberi.
    Chairman Spratt. In the interest of time, it is important 
that we stick by the clock today, and, therefore, I call the 
hearing to order.
    We will begin with some few short comments. We began this 
year wary of a recession. And to mitigate if not avoid it, we 
passed a countercyclical bill with rebates and business tax 
concessions, totaling about $150 billion in revenues foregone.
    Before adjourning, Congress acted again. At the Bush 
administration's request, we passed recovery measures which 
included budget authority of $700 billion, a new kit of tools 
for Treasury and the Federal Reserve. The House also passed a 
$61 billion bill to shore up the economy, but faced with a veto 
threat, the Senate did not follow through.
    We called this hearing to know Chairman Bernanke's 
assessment of the economy and ask whether you, sir, believe 
that further action is needed to boost the economy and turn it 
around. Our second panel will deal with specific fiscal actions 
that the Congress might take to counteract current economic 
conditions.
    I would say to all the members here that the chairman is 
committed to leaving at 11 o'clock, and we have agreed with 
that understanding. And we want to proceed as expeditiously as 
possible. And therefore, I am holding my statement to this 
length and turn now to Mr. Ryan for any opening statement he 
has.
    Mr. Ryan. All right. Thank you, Chairman. I guess I will 
take the cue off that, and I will ask unanimous consent that my 
opening statement be included in the record.
    Thank you for having this hearing.
    We are all concerned about a weak economy and the impacts 
on our families. My own hometown of Janesville, Wisconsin, is 
suffering particularly from the consequences of this downturn. 
That is why I voted for the extension of unemployment 
insurance. But I also want to pursue policies to ensure 
sustained economic growth.
    The topic of today's hearing, options for economic 
recovery, the Democrats have already come out with their 
preferred option, a bloated $300 billion spending stimulus 
package. The advertised intent of this package is to get the 
economy back on track. We all want that. Yet we should not be 
under any illusion that this stimulus package will address the 
core problems of our current financial crisis and our economic 
weakness.
    The major problem, which Chairman Bernanke is about to 
describe, has been that our credit markets have virtually 
frozen up and nearly stopped functioning. Left unaddressed, 
this situation poses a real threat of a financial meltdown, 
followed by a deep and prolonged recession.
    Well, the Fed has acted preemptively and promptly to 
address this crisis. It has taken extraordinary and 
unprecedented measures to inject liquidity into these frozen 
credit markets and to preserve the integrity and the 
functioning of our financial system. We in Congress have also 
taken actions on a bipartisan basis, passing legislation 
designed to stabilize the financial markets. We have also 
extended unemployment insurance to soften this blow from the 
downturn to those individuals who are losing their jobs in 
this.
    Now, in the interest of time, I will be brief only to say 
that this is the Budget Committee, and the CBO director has 
already told us that the deficit this year could well climb to 
above $750 billion. That is before this kind of a stimulus 
package, which, with more government spending being shoveled 
out the door, at best would probably give us a little pop in 
GDP statistics, manipulating the economic statistics, but not 
addressing the core problem, which is, how do we grow the 
economy? What are the policies we put in place to give us long-
run, sustained economic growth?
    I would simply close by saying this: The doctrine that is 
giving us this stimulus idea of spending more money here this 
year is a Keynesian principle, it is a Keynesian doctrine. It 
is well-founded and held by many people. But that same economic 
doctrine which is bringing this bill to this hearing says you 
don't raise taxes when the economy is in trouble.
    Yet this Democratic majority passed just this year the 
largest tax increase in American history. They are already 
proposing tax rates on capital, tax rates on investment, tax 
rate increases on small businesses. In fact, the chairman of my 
own committee, the Ways and Means Committee, is saying we want 
a 45 percent top tax rate for small businesses. Seven out of 10 
jobs in this country come from small businesses. The last thing 
Congress ought to be doing under any economic doctrine is 
raising taxes in a recession, yet that is precisely what this 
majority is proposing to do.
    So shoveling $300 billion out the door, bringing our 
deficit up to a trillion dollars, will only serve to actually 
weaken the dollar, increase our borrowing costs, and not 
address the fundamental problems in our economy. We need 
policies that grow the economic pie, that grow opportunity. 
Raising taxes on opportunity is not the answer.
    With that, Chairman, I will yield the balance of my time. 
And I thank Chairman Bernanke for coming here to join us today.
    [The information follows:]

     Prepared Statement of Hon. Paul Ryan, Ranking Minority Member,
                        Committee on the Budget

                                 PART I

    Thank you, Chairman Spratt. Welcome, Chairman Bernanke.
    We're all concerned about a weak economy and the impact on American 
families. My own hometown is suffering from the consequences of this 
downturn. That's why I've voted for the extension of unemployment 
insurance, but I also want to pursue policies to ensure sustained 
economic growth.
    The topic of today's hearing is ``Options for Economic Recovery.'' 
The Democrats have already come out with their preferred option: a 
bloated $300 billion stimulus package.
    The advertised intent of this package is to ``get the economy back 
on track.'' Yet, we should not be under any illusion that this stimulus 
package will address the core problems of our current financial crisis 
and economic weakness.
    The major problem, which Chairman Bernanke is about to describe, 
has been that our credit markets have virtually frozen up and nearly 
stopped functioning. Left unaddressed, the situation posed the very 
real threat of a financial meltdown followed by a deep and prolonged 
recession.
    The Fed has acted preemptively and promptly to address this crisis. 
It is taking extraordinary and unprecedented measures to inject 
liquidity into these frozen credit markets and preserve the integrity 
and functioning of our financial system.
    We in Congress have also taken action by passing bipartisan 
legislation designed to stabilize financial markets.
    These actions, combined with weakness in our economy, obviously 
entail costs. The CBO has just warned us that even without a stimulus 
package, this year's budget deficit could reach $750 billion. Adding 
the Democratic stimulus package would take the budget deficit to $1 
trillion. That tells me that we are simply not serious about our fiscal 
situation.
    A much higher level of government spending and increased deficits 
is going to sharply raise our debt service costs and weaken the dollar.
    Although the long-run costs of the proposed stimulus are real, the 
long-run benefits are highly suspect. In fact, we have seen time and 
time again that these temporary fiscal spending packages simply provide 
one or two quarters of ``pop'' before the economy simply reverts back 
to its pre-stimulus trend. That is because they do nothing to change 
the main factors driving our long-term growth trajectory.
    If higher government spending led to robust economic growth, our 
economy would be soaring along right now instead of entering a 
recession.
    If Congress is going to take action, it should be through fast-
acting tax policy that boosts incentives to invest and create jobs. 
That is the growth dynamic that leads to a bigger economic pie. Short-
term actions like stimulus do not grow the economic pie; they simply 
transfer funds from one part of the economy to another.

                                PART II

    The Democratic $300 billion stimulus proposal raises serious 
concerns about how Washington will respond to the financial crisis.
    I'm afraid that this is only the beginning, and that we are going 
to see a lot more government intervention in the economy that will be 
detrimental to jobs, wages, and the financial security of the American 
people.
    My fear is that this financial crisis, and the policy reactions it 
has forced us to take, could send us down a path toward a fundamentally 
different economic model--one of bigger government, higher spending and 
taxes, and heavy-handed government controls--rather than a reliance on 
private markets.
    This would be a serious mistake. When I look back at the root 
causes of our current financial crisis, I don't see an indictment of 
our capitalist system, but rather a distortion of private markets 
through some of the Federal Government's actions.
    First, earlier this decade the Federal Reserve set the stage for a 
wave of mortgage borrowing by keeping credit conditions too loose for 
too long. Low interest rates encouraged both homeowners and financial 
institutions to borrow too much and become highly leveraged, which is 
accentuating the pain of the massive de-leveraging we are witnessing 
today.
    Second, the Federal government encouraged, mandated, and subsidized 
both lenders and borrowers to extend and accept mortgage credit to 
people who simply were not in a financial position to repay these 
loans.
    Third, I've been warning for a decade that Fannie Mae and Freddie 
Mac posed a huge risk to taxpayers. During that period, Fannie and 
Freddie, at the urging of members of Congress and others, were creating 
and securitizing more risky loans. In addition, Fannie Mae and Freddie 
Mac became the largest holders of mortgage-backed securities. In fact, 
by the time the government was forced to take these companies over, 
their combined mortgage investment portfolios had reached $1.5 
trillion, which exceeds the entire GDP of countries like Canada, 
Mexico, and Spain.
    Clearly, a variety of private actors were also at fault, but Fannie 
and Freddie's large purchases of mortgage-related securities, many of 
which were near-prime or subprime, put the government stamp of approval 
on a fundamentally flawed system--a system of cheap money, low risk, 
and ever-rising home prices.
    Looking ahead, we need to modernize our antiquated regulatory 
system, improve transparency, and make sure those that take risks are 
fully accountable for the consequences.
    But we should also be careful to guard against a regulatory over-
reaction formulated in the heat of the current crisis that may have 
unintended consequences down the road.
    Also, we should not mistake the urgent action we are undertaking 
now in reaction to the crisis as a template for a viable, long-term 
economic model.
    Though it may be obscured by recent events, the unprecedented 
economic growth and prosperity we have witnessed in this country over 
its history has been driven by free markets--by entrepreneurship, 
innovation, and private risk and reward.
    Government did not create this prosperity and my concern is that we 
will take actions that will hurt Americans ability and opportunities to 
secure renewed prosperity in the future.

    Chairman Spratt. I would say to Mr. Ryan, the farthest away 
of our intentions with this hearing today is to talk about a 
tax increase. And I am a little bit lost as to what he is 
referring to. But in the interest of time, let's proceed.
    Mr. Chairman, thank you, sir, for coming. We know that your 
time is at a premium, that there are many demanding your 
attention, but we also represent the people of this country, 
435 different districts. And as we have learned with the $700 
billion bailout package, so-called, we need to communicate with 
the American people to help them understand what is being done 
and what purposes it serves. And I think that your coming here 
will enhance the public's understanding of where we stand.
    The floor is yours. You can read your testimony, which will 
be made part of the record.
    I would also ask unanimous consent at this point that all 
members, the chairman included, be allowed to include their 
opening statements.
    And your statement will be included in its entirety in the 
record. Mr. Bernanke, again, thank you for coming. We 
appreciate you being here.

 STATEMENT OF BEN S. BERNANKE, CHAIRMAN, BOARD OF GOVERNORS OF 
                   THE FEDERAL RESERVE SYSTEM

    Mr. Bernanke. Thank you.
    Chairman Spratt, Representative Ryan and other members of 
the committee, I appreciate this opportunity to discuss recent 
developments in financial markets, the near-term economic 
outlook, and issues surrounding the possibility of a second 
package of fiscal measures.
    As you know, financial markets in the United States and 
some other industrialized countries have been under severe 
stress for more than a year. The proximate cause of the 
financial turmoil was the steep increase and subsequent decline 
of house prices nationwide, which, together with poor lending 
practices, have led to large losses on mortgages and mortgage-
related instruments by a wide range of institutions.
    More fundamentally, the turmoil is the aftermath of a 
credit boom characterized by underpricing of risk, excessive 
leverage, and an increasing reliance on complex and opaque 
financial instruments that have proved to be fragile under 
stress. A consequence of the unwinding of this boom and the 
resulting financial strains has been a broad-based tightening 
in credit conditions that has restrained economic growth.
    The financial turmoil intensified in recent weeks as 
investors' confidence in banks and other financial institutions 
eroded and risk aversion heightened. Conditions in the 
interbank lending market have worsened, with term funding 
essentially unavailable. Withdrawals from prime money market 
mutual funds, which are important suppliers of credit to the 
commercial paper market, severely disrupted that market. And 
short-term credit, when available, has become much more costly 
for virtually all firms. Households and State and local 
governments have also experienced a notable reduction in credit 
availability.
    Financial conditions deteriorated in other countries as 
well, putting severe pressure on both industrial and emerging 
market economies. As confidence in the financial markets has 
declined and concerns about the U.S. and global economies has 
increased, equity prices have been volatile, falling sharply on 
net.
    In collaboration with governments and central banks in 
other countries, the Treasury and the Federal Reserve have 
taken a range of actions to ameliorate these financial 
problems. To address ongoing pressures in interbank funding 
markets, the Federal Reserve significantly increased the 
quantity of term funds it auctions to banks and accommodated 
heightened demands for funding from banks and primary dealers.
    We have also greatly expanded our currency swap lines with 
foreign central banks. These swap lines allow cooperating 
central banks to supply dollar liquidity in their own 
jurisdictions, helping to reduce strains in global money 
markets and, in turn, in our own markets.
    To address illiquidity and impaired functioning in the 
market for commercial paper, the Treasury implemented a 
temporary guarantee program for balances held in money market 
mutual funds, helping to stem the outflows from these funds.
    The Federal Reserve put in place a temporary lending 
facility that provides financing for banks to purchase high-
quality, asset-backed commercial paper from money markets 
funds, thus providing some relief for money market funds that 
have needed to sell their holdings to meet redemptions.
    Moreover, we will soon be implementing a new commercial 
paper funding facility that will provide a backstop to 
commercial paper markets by purchasing highly rated commercial 
paper from issuers at a term of 3 months.
    The recently enacted Emergency Economic Stabilization Act 
provided critically important new tools to address the 
dysfunction in financial markets, and thus reduce the 
accompanying risks to the economy. The Troubled Asset Relief 
Program, or TARP, authorized by the legislation, will allow the 
Treasury to undertake two highly complementary activities.
    First, the Treasury will use TARP funds to provide capital 
to financial institutions. Indeed, last week, nine of the 
Nation's largest financial institutions indicated their 
willingness to accept capital from the program, and many other 
institutions, large and small, are expected to follow suit in 
coming weeks.
    Second, the Treasury will purchase or guarantee troubled 
mortgage-related and possibly other assets held by banks and 
other financial institutions. Taken together, these measures 
should help rebuild confidence in the financial system, 
increase the liquidity of financial markets, and improve the 
ability of financial institutions to raise capital from private 
sources.
    As another measure to improve confidence, the act also 
temporarily raised the limit on the deposit insurance coverage 
provided by the Federal Deposit Insurance Corporation and the 
National Credit Union Administration from $100,000 to $250,000 
per account, effective immediately.
    Unfortunately, the loss of confidence in financial 
institutions became so severe in recent weeks that additional 
steps in this direction proved necessary. The FDIC, the Federal 
Reserve Board, and the Secretary of the Treasury, in 
consultation with the President, determined that significant 
risks to the stability of the financial system were present. 
With this determination, the FDIC was able to use its authority 
to provide, for a specified period, unlimited insurance 
coverage of funds held in non-interest-bearing transactions 
accounts, such as payroll accounts. In addition, the FDIC 
announced that it would guarantee the senior unsecured debt of 
FDIC-insured depository institutions and their associated 
holding companies.
    In taking the dramatic steps of providing capital to the 
banking system and expanding guarantees, the United States 
consulted with other countries, many of whom have announced 
similar actions. Given the global nature of the financial 
system, international consultation and cooperation on actions 
to address the crisis are important for restoring confidence 
and stability.
    These measures were announced less than a week ago, and 
although there have been some encouraging signs, it is too 
early to assess their full effects. However, I am confident 
that these initiatives, together with other actions by the 
Treasury, the Federal Reserve and other regulators, will help 
restore trust in our financial system and allow the resumption 
of more normal flows of credit to households and firms.
    I would like to reiterate the critical importance of the 
recent legislation passed by the Congress. Without that action, 
tools essential for stabilizing the financial system, and 
thereby containing the damage to the broader economy, would not 
have been available. That said, the stabilization of the 
financial system, though an essential first step, will not 
quickly eliminate the challenges still faced by the broader 
economy.
    Even before the recent intensification of the financial 
crisis, economic activity had shown considerable signs of 
weakening. In the labor market, private employers shed 168,000 
jobs in September, bringing the total job loss in the private 
sector since January to nearly 900,000. Meanwhile, the 
unemployment rate, at 6.1 percent in September, has risen 1.2 
percentage points since January. Incoming data on consumer 
spending, housing, and business investment have all showed 
significant slowing over the past few months, and some key 
determinants of spending have worsened. Equity and house prices 
have fallen, foreign economic growth has slowed, and credit 
conditions have tightened.
    One brighter note is that the declines in the prices of oil 
and other commodities will have favorable implications for the 
purchasing power of households. Nonetheless, the pace of 
economic activity is likely to be below that of its longer-run 
potential for several quarters.
    As I noted, the slowing in spending and activity spans most 
major sectors. Real personal consumption expenditures for goods 
and services declined over the summer and apparently fell 
further in September. Although the weakness in household 
spending has been widespread, the drop-off in purchases of 
motor vehicles recently has been particularly sharp. Increased 
difficulty in obtaining auto loans appears to have contributed 
to the decline in auto sales. Consumer sentiment has been quite 
low, reflecting concerns about jobs, gasoline prices, the state 
of the housing market, and stock prices.
    In the business sector, orders and shipments for nondefense 
capital goods have generally slowed, and forward-looking 
indicators suggest further declines in business investment in 
coming months. Outlays for construction of nonresidential 
buildings, which had posted robust gains over the first half of 
the year, also appear to have decelerated in the third quarter. 
Although the less favorable outlook for sales has undoubtedly 
played a role, the softening in business investment also 
appears to reflect reduced credit availability from banks and 
other lenders.
    As has been the case for some time, the housing market 
remains depressed, with sales and construction of new homes 
continuing to decline. Indeed, single-family housing starts 
fell 12 percent in September, and permit issuance also dropped 
sharply. With demand for new homes remaining at a low level and 
the backlog of unsold homes still sizable, residential 
construction is likely to continue to contract into next year.
    International trade provided considerable support for the 
U.S. economy over the first half of the year. Domestic output 
was buoyed by strong foreign demand for a wide range of U.S. 
exports, including agricultural products, capital goods and 
industrial supplies. Although trade should continue to be a 
positive factor for the U.S. economy, its contribution to U.S. 
growth is likely to be less dramatic as global growth slows.
    The prices of the goods and services purchased by consumers 
rose rapidly earlier this year, as steep increases in the 
prices of oil and other commodities led to higher retail prices 
for fuel and food, and as firms were able to pass through a 
portion of their higher costs of production. These effects are 
now reversing in the wake of the substantial declines in 
commodity prices since the summer.
    Moreover, the prices of imports now appear to be 
decelerating, and consumer surveys and yields on inflation-
indexed Treasury securities suggest that expected inflation has 
held steady or eased. If not reversed, these developments, 
together with the likelihood that economic activity will fall 
short of potential for a time, should bring inflation down to a 
level consistent with price stability.
    Over time, a number of factors will likely promote the 
return of solid gains in economic activity and employment in 
the context of low and stable inflation. Among those factors 
are the stimulus provided by monetary policy; the eventual 
stabilization in housing markets that will occur as the 
correction runs its course; improvements in our credit markets 
as the new programs take effect and market participants work 
through remaining problems; and the underlying strength and 
recuperative powers of our economy.
    The time needed for economic recovery, however, will depend 
greatly on the pace at which financial and credit markets 
return to more normal functioning. Because the time that will 
be needed for financial normalization and the effects of 
ongoing credit problems in the broader economy are difficult to 
judge, the uncertainty currently surrounding the economic 
outlook is unusually large.
    I understand that the Congress is evaluating the 
desirability of a second fiscal package. Any fiscal action 
inevitably involves trade-offs, not only among current needs 
and objectives but also because commitments of resources today 
can burden future generations and constrain future policy 
options between the present and the future. Such trade-offs 
inevitably involve value judgments that can be properly made 
only by our elected officials. Moreover, with the outlook 
exceptionally uncertain, the optimal timing, scale and 
composition of any fiscal package are unclear.
    All that being said, with the economy likely to be weak for 
several quarters and with some risk of a protracted slowdown, 
consideration of a fiscal package by the Congress at this 
juncture seems appropriate. Should the Congress choose to 
undertake fiscal actions, certain design principles may be 
helpful. To best achieve its goals, any fiscal package should 
be structured so that its peak effects on aggregate spending 
and economic activity are felt when they are most needed, 
namely during the period in which economic activity would 
otherwise be expected to be weak.
    Any fiscal package should be well-targeted, in the sense of 
attempting to maximize the beneficial effects on spending and 
activity per dollar of increased Federal expenditure or lost 
revenue. At the same time, it should go without saying that the 
Congress must be vigilant in ensuring that any allocated funds 
are used effectively and responsibly. Any program should be 
designed, to the extent possible, to limit longer-term effects 
on the Federal Government's structural budget deficit.
    Finally, in the ideal case, a fiscal package would not only 
boost overall spending and economic activity, but would also be 
aimed at redressing specific factors that have the potential to 
extend or deepen the economic slowdown. As I discussed earlier, 
the extraordinary tightening in credit conditions has played a 
central role in the slowdown thus far and could be an important 
factor delaying the recovery. If the Congress proceeds with a 
fiscal package, it should consider including measures to help 
improve access to credit by consumers, home buyers, businesses 
and other borrowers. Such actions might be particularly 
effective at promoting economic growth and job creation.
    Thank you. I would be pleased to take your questions.
    [The prepared statement of Ben Bernanke follows:]

         Prepared Statement of Hon. Ben S. Bernanke, Chairman,
                         Federal Reserve Board

    Chairman Spratt, Representative Ryan, and other members of the 
Committee, I appreciate this opportunity to discuss recent developments 
in financial markets, the near-term economic outlook, and issues 
surrounding the possibility of a second package of fiscal measures.

                         FINANCIAL DEVELOPMENTS

    As you know, financial markets in the United States and some other 
industrialized countries have been under severe stress for more than a 
year. The proximate cause of the financial turmoil was the steep 
increase and subsequent decline of house prices nationwide, which, 
together with poor lending practices, have led to large losses on 
mortgages and mortgage-related instruments by a wide range of 
institutions. More fundamentally, the turmoil is the aftermath of a 
credit boom characterized by underpricing of risk, excessive leverage, 
and an increasing reliance on complex and opaque financial instruments 
that have proved to be fragile under stress. A consequence of the 
unwinding of this boom and the resulting financial strains has been a 
broad-based tightening in credit conditions that has restrained 
economic growth.
    The financial turmoil intensified in recent weeks, as investors' 
confidence in banks and other financial institutions eroded and risk 
aversion heightened. Conditions in the interbank lending market have 
worsened, with term funding essentially unavailable. Withdrawals from 
prime money market mutual funds, which are important suppliers of 
credit to the commercial paper market, severely disrupted that market; 
and short-term credit, when available, has become much more costly for 
virtually all firms. Households and state and local governments have 
also experienced a notable reduction in credit availability. Financial 
conditions deteriorated in other countries as well, putting severe 
pressure on both industrial and emerging-market economies. As 
confidence in the financial markets has declined and concerns about the 
U.S. and global economies have increased, equity prices have been 
volatile, falling sharply on net.
    In collaboration with governments and central banks in other 
countries, the Treasury and the Federal Reserve have taken a range of 
actions to ameliorate these financial problems. To address ongoing 
pressures in interbank funding markets, the Federal Reserve 
significantly increased the quantity of term funds it auctions to banks 
and accommodated heightened demands for funding from banks and primary 
dealers. We have also greatly expanded our currency swap lines with 
foreign central banks. These swap lines allow the cooperating central 
banks to supply dollar liquidity in their own jurisdictions, helping to 
reduce strains in global money markets and, in turn, in our own 
markets. To address illiquidity and impaired functioning in the market 
for commercial paper, the Treasury implemented a temporary guarantee 
program for balances held in money market mutual funds, helping to stem 
the outflows from these funds. The Federal Reserve put in place a 
temporary lending facility that provides financing for banks to 
purchase high-quality asset-backed commercial paper from money market 
funds, thus providing some relief for money market funds that have 
needed to sell their holdings to meet redemptions. Moreover, we soon 
will be implementing a new Commercial Paper Funding Facility that will 
provide a backstop to commercial paper markets by purchasing highly 
rated commercial paper from issuers at a term of three months.
    The recently enacted Emergency Economic Stabilization Act provided 
critically important new tools to address the dysfunction in financial 
markets and thus reduce the accompanying risks to the economy. The 
Troubled Asset Relief Program (TARP) authorized by the legislation will 
allow the Treasury to undertake two highly complementary activities. 
First, the Treasury will use TARP funds to provide capital to financial 
institutions. Indeed, last week, nine of the nation's largest financial 
institutions indicated their willingness to accept capital from the 
program, and many other institutions, large and small, are expected to 
follow suit in coming weeks. Second, the Treasury will purchase or 
guarantee troubled mortgage-related and possibly other assets held by 
banks and other financial institutions. Taken together, these measures 
should help rebuild confidence in the financial system, increase the 
liquidity of financial markets, and improve the ability of financial 
institutions to raise capital from private sources.
    As another measure to improve confidence, the act also temporarily 
raised the limit on the deposit insurance coverage provided by the 
Federal Deposit Insurance Corporation (FDIC) and the National Credit 
Union Administration from $100,000 to $250,000 per account, effective 
immediately. Unfortunately, the loss of confidence in financial 
institutions became so severe in recent weeks that additional steps in 
this direction proved necessary. The FDIC, the Federal Reserve Board, 
and the Secretary of the Treasury in consultation with the President 
determined that significant risks to the stability of the financial 
system were present. With this determination, the FDIC was able to use 
its authority to provide, for a specified period, unlimited insurance 
coverage of funds held in non-interest-bearing transactions accounts, 
such as payroll accounts. In addition, the FDIC announced that it would 
guarantee the senior unsecured debt of FDIC-insured depository 
institutions and their associated holding companies. In taking the 
dramatic steps of providing capital to the banking system and expanding 
guarantees, the United States consulted with other countries, many of 
whom have announced similar actions. Given the global nature of the 
financial system, international consultation and cooperation on actions 
to address the crisis are important for restoring confidence and 
stability.
    These measures were announced less than a week ago, and, although 
there have been some encouraging signs, it is too early to assess their 
full effects. However, I am confident that these initiatives, together 
with other actions by the Treasury, the Federal Reserve, and other 
regulators, will help restore trust in our financial system and allow 
the resumption of more-normal flows of credit to households and firms. 
I would like to reiterate the critical importance of the recent 
legislation passed by the Congress; without that action, tools 
essential for stabilizing the financial system and thereby containing 
the damage to the broader economy would not have been available. That 
said, the stabilization of the financial system, though an essential 
first step, will not quickly eliminate the challenges still faced by 
the broader economy.

                            ECONOMIC OUTLOOK

    Even before the recent intensification of the financial crisis, 
economic activity had shown considerable signs of weakening. In the 
labor market, private employers shed 168,000 jobs in September, 
bringing the total job loss in the private sector since January to 
nearly 900,000. Meanwhile, the unemployment rate, at 6.1 percent in 
September, has risen 1.2 percentage points since January. Incoming data 
on consumer spending, housing, and business investment have all showed 
significant slowing over the past few months, and some key determinants 
of spending have worsened: Equity and house prices have fallen, foreign 
economic growth has slowed, and credit conditions have tightened. One 
brighter note is that the declines in the prices of oil and other 
commodities will have favorable implications for the purchasing power 
of households. Nonetheless, the pace of economic activity is likely to 
be below that of its longer-run potential for several quarters.
    As I noted, the slowing in spending and activity spans most major 
sectors. Real personal consumption expenditures for goods and services 
declined over the summer and apparently fell further in September. 
Although the weakness in household spending has been widespread, the 
drop-off in purchases of motor vehicles recently has been particularly 
sharp. Increased difficulty in obtaining auto loans appears to have 
contributed to the decline in auto sales. Consumer sentiment has been 
quite low, reflecting concerns about jobs, gasoline prices, the state 
of the housing market, and stock prices.
    In the business sector, orders and shipments for nondefense capital 
goods have generally slowed, and forward-looking indicators suggest 
further declines in business investment in coming months. Outlays for 
construction of nonresidential buildings, which had posted robust gains 
over the first half of the year, also appear to have decelerated in the 
third quarter. Although the less favorable outlook for sales has 
undoubtedly played a role, the softening in business investment also 
appears to reflect reduced credit availability from banks and other 
lenders.
    As has been the case for some time, the housing market remains 
depressed, with sales and construction of new homes continuing to 
decline. Indeed, single-family housing starts fell 12 percent in 
September, and permit issuance also dropped sharply. With demand for 
new homes remaining at a low level and the backlog of unsold homes 
still sizable, residential construction is likely to continue to 
contract into next year.
    International trade provided considerable support for the U.S. 
economy over the first half of the year. Domestic output was buoyed by 
strong foreign demand for a wide range of U.S. exports, including 
agricultural products, capital goods, and industrial supplies. Although 
trade should continue to be a positive factor for the U.S. economy, its 
contribution to U.S. growth is likely to be less dramatic as global 
growth slows.
    The prices of the goods and services purchased by consumers rose 
rapidly earlier this year, as steep increases in the prices of oil and 
other commodities led to higher retail prices for fuel and food, and as 
firms were able to pass through a portion of their higher costs of 
production. These effects are now reversing in the wake of the 
substantial declines in commodity prices since the summer. Moreover, 
the prices of imports now appear to be decelerating, and consumer 
surveys and yields on inflation-indexed Treasury securities suggest 
that expected inflation has held steady or eased. If not reversed, 
these developments, together with the likelihood that economic activity 
will fall short of potential for a time, should bring inflation down to 
levels consistent with price stability.
    Over time, a number of factors are likely to promote the return of 
solid gains in economic activity and employment in the context of low 
and stable inflation. Among those factors are the stimulus provided by 
monetary policy, the eventual stabilization in housing markets that 
will occur as the correction runs its course, improvements in our 
credit markets as the new programs take effect and market participants 
work through remaining problems, and the underlying strengths and 
recuperative powers of our economy. The time needed for economic 
recovery, however, will depend greatly on the pace at which financial 
and credit markets return to more-normal functioning. Because the time 
that will be needed for financial normalization and the effects of 
ongoing credit problems on the broader economy are difficult to judge, 
the uncertainty currently surrounding the economic outlook is unusually 
large.

                             FISCAL POLICY

    I understand that the Congress is evaluating the desirability of a 
second fiscal package. Any fiscal action inevitably involves tradeoffs, 
not only among current needs and objectives but also--because 
commitments of resources today can burden future generations and 
constrain future policy options--between the present and the future. 
Such tradeoffs inevitably involve value judgments that can properly be 
made only by our elected officials. Moreover, with the outlook 
exceptionally uncertain, the optimal timing, scale, and composition of 
any fiscal package are unclear. All that being said, with the economy 
likely to be weak for several quarters, and with some risk of a 
protracted slowdown, consideration of a fiscal package by the Congress 
at this juncture seems appropriate.
    Should the Congress choose to undertake fiscal action, certain 
design principles may be helpful. To best achieve its goals, any fiscal 
package should be structured so that its peak effects on aggregate 
spending and economic activity are felt when they are most needed, 
namely, during the period in which economic activity would otherwise be 
expected to be weak. Any fiscal package should be well-targeted, in the 
sense of attempting to maximize the beneficial effects on spending and 
activity per dollar of increased federal expenditure or lost revenue; 
at the same time, it should go without saying that the Congress must be 
vigilant in ensuring that any allocated funds are used effectively and 
responsibly. Any program should be designed, to the extent possible, to 
limit longer-term effects on the federal government's structural budget 
deficit.
    Finally, in the ideal case, a fiscal package would not only boost 
overall spending and economic activity but would also be aimed at 
redressing specific factors that have the potential to extend or deepen 
the economic slowdown. As I discussed earlier, the extraordinary 
tightening in credit conditions has played a central role in the 
slowdown thus far and could be an important factor delaying the 
recovery. If the Congress proceeds with a fiscal package, it should 
consider including measures to help improve access to credit by 
consumers, homebuyers, businesses, and other borrowers. Such actions 
might be particularly effective at promoting economic growth and job 
creation.
    Thank you. I would be pleased to take your questions.

    Chairman Spratt. Thank you, Mr. Chairman. Thank you very 
much indeed.
    Mr. Chairman, in your speech to the Economic Club of New 
York recently, you noted that, ``In one respect we are''--and I 
am parsing and quoting--``better off than those who dealt with 
earlier financial crises. Generally, in past crises, broad-
based government intervention came too late. Waiting too long 
to respond has usually led to much greater costs of 
intervention and, more importantly, magnified the painful 
effects of financial turmoil on households and businesses. In 
this case, prompt and decisive action by political leaders,'' 
quoting from your statement, ``will restore more normal market 
functioning much more quickly and at a lower cost.'' You went 
on to warn, ``Even if markets stabilize, a broad economic 
recovery will not happen right away.''
    In a separate talk, your vice chair, Donald Kohn, said, 
``It is likely the economy will be subpar well into next 
year.'' One of our witnesses today, Dr. Martin Baily, has said, 
``I don't know if there is anything we can do in the short run 
to avoid a mild recession. The question is what we can do to 
avoid a very severe recession.''
    These are the concerns that caused us to call this hearing. 
They go to the heart of the hearing. The question is, if we are 
threatened with a recession, it could be deep and severe and 
last long after you have stabilized the financial markets. 
Wouldn't prompt and decisive action now be less than the costs 
of intervention and turmoil later?
    Mr. Bernanke. Mr. Chairman, as I indicated, I think given 
the uncertainties about the near term and the risks that still 
exist, I think that it is appropriate for Congress to be 
thinking about a fiscal program at this time. The size and the 
composition of that are obviously items for the Congress to 
determine in negotiation and discussion.
    And I would reiterate the point that there is an awful lot 
of uncertainty right now, arising in part from the fact that we 
don't know how quickly the credit markets will return to normal 
and how quickly credit extension will return to normal. So, in 
that respect also, I think we need to be flexible and continue 
to watch the situation as we go forward.
    Chairman Spratt. You also stated in your speech, and you 
have said elsewhere, that this problem began with the problem 
in the subprime mortgages but it has become much broader than 
that. Nevertheless, that is one of the primary causes. And the 
first steps being taken by the Fed and the Treasury go to 
recapitalizing the banks of this country. The first tranche of 
$250 billion will be spent for that purpose.
    How do we get money flowing back into the housing markets 
so we can both restart the housing markets and also deal with 
the huge number of foreclosures and mortgages in default?
    Mr. Bernanke. Well, Mr. Chairman, first of all, the steps 
being taken in the financial markets are directly intended to 
try to address the problems of credit availability not just for 
mortgages but more generally.
    By restoring the strength of the financial institutions, by 
restoring confidence in the financial markets, by taking 
troubled assets off of balance sheets, we will restart the flow 
of credit more generally, which is a very important step.
    Chairman Spratt. But there is no legal requirement, as I 
understand it, that the banks divert a certain portion of their 
recapitalized funds to housing or housing modification 
mortgages, things of that nature.
    Mr. Bernanke. There are requirements that the banks meet 
standards for renegotiating and restructuring troubled 
mortgages. But I was going to go on to say that I think that, 
beyond banks themselves, which are of course one important 
group of mortgage lenders, there are other things that are 
going on and can be done. In particular, Fannie and Freddie, 
the stabilization of those two companies, I think, despite some 
run-up in mortgage rates last week, I do think will provide 
more credit, more available credit for homeowners going 
forward.
    The Congress, of course, has just passed the Hope for 
Homeowners bill, which allows troubled mortgages to be written 
down in terms of principal and then renegotiated and refinanced 
into the Federal Housing Administration. Further steps could be 
taken along those lines if the Congress wished to.
    The Congress could also further support Fannie and 
Freddie's funding and address some of the costs that they face 
in order to make more credit available to the mortgage market.
    Chairman Spratt. Last question from me. You ended your 
testimony by saying, ``Any program should be designed, to the 
extent possible, to limit longer-term effects on the Federal 
Government's structural budget deficit.'' You also say that we 
should consider measures that would improve consumer credit 
access, business access to credit.
    Would you elaborate a little further on those, please, sir?
    Mr. Bernanke. Well, certainly.
    We are in a situation where the deficit is large. That is 
not totally inappropriate, given the nature of the emergency 
that we are facing, and not totally avoidable, given the loss 
of tax revenues associated with the decline in the economy. 
Nevertheless, it is important, obviously, to maintain careful 
and, you know, well-managed fiscal position in the longer term. 
Indeed, one of the reasons that economists argue for 
conservative fiscal management is that precisely when times 
like this come around you want to have the capacity and the 
scope necessary to deal with the problem.
    With respect to the credit markets, the Congress has a 
variety of tools that it might use to try to address some of 
the problem, which, as I said, is very central to the economic 
slowdown. Depending on the particular case, Congress might 
consider guarantees or partial guarantees. It might consider 
direct lending. It might consider tax credits. In the case of 
the housing market, it might consider things like paying the 
guarantee fees in Fannie and Freddie. There are other tax 
measures that could be taken to stimulate credit.
    There is just a variety of things that could be done. And I 
think the right way to think about it is to look at each 
situation, try to ascertain the extent to which credit markets 
are failing or not functioning properly, and to try to find 
methods that will restore credit to something closer to a more 
normal level.
    Obviously, these would have to be temporary and carefully 
designed. The Federal Reserve is more than happy to try to work 
with you on specific possibilities.
    Chairman Spratt. Thank you, sir.
    [The speech referred to follows:]

 Speech by Chairman Ben S. Bernanke at the Economic Club of New York, 
                            October 15, 2008

           STABILIZING THE FINANCIAL MARKETS AND THE ECONOMY

    Good afternoon. I am pleased once again to share a meal and some 
thoughts with the Economic Club of New York. I will focus today on the 
economic and financial challenges we face and why I believe we are well 
positioned to move forward. The problems now evident in the markets and 
in the economy are large and complex, but, in my judgment, our 
government now has the tools it needs to confront and solve them. Our 
strategy will continue to evolve and be refined as we adapt to new 
developments and the inevitable setbacks. But we will not stand down 
until we have achieved our goals of repairing and reforming our 
financial system and restoring prosperity.
    The crisis we face in the financial markets has many novel aspects, 
largely arising from the complexity and sophistication of today's 
financial institutions and instruments and the remarkable degree of 
global financial integration that allows financial shocks to be 
transmitted around the world at the speed of light. However, as a long-
time student of banking and financial crises, I can attest that the 
current situation also has much in common with past experiences. As in 
all past crises, at the root of the problem is a loss of confidence by 
investors and the public in the strength of key financial institutions 
and markets. The crisis will end when comprehensive responses by 
political and financial leaders restore that trust, bringing investors 
back into the market and allowing the normal business of extending 
credit to households and firms to resume. In that regard, we are, in 
one respect at least, better off than those who dealt with earlier 
financial crises: Generally, during past crises, broad-based government 
engagement came late, usually at a point at which most financial 
institutions were insolvent or nearly so. Waiting too long to respond 
has usually led to much greater direct costs of the intervention itself 
and, more importantly, magnified the painful effects of financial 
turmoil on households and businesses. That is not the situation we face 
today. Fortunately, the Congress and the Administration have acted at a 
time when the great majority of financial institutions, though stressed 
by highly volatile and difficult market conditions, remain strong and 
capable of fulfilling their critical function of providing new credit 
for our economy. This prompt and decisive action by our political 
leaders will allow us to restore more normal market functioning much 
more quickly and at lower ultimate cost than would otherwise have been 
the case. Moreover, we are seeing not just a national response but a 
global response to the crisis, commensurate with its global nature.
    This financial crisis has been with us for more than a year. It was 
sparked by the end of the U.S. housing boom, which revealed the 
weaknesses and excesses that had occurred in subprime mortgage lending. 
However, as subsequent events have demonstrated, the problem was much 
broader than subprime lending. Large inflows of capital into the United 
States and other countries stimulated a reaching for yield, an 
underpricing of risk, excessive leverage, and the development of 
complex and opaque financial instruments that seemed to work well 
during the credit boom but have been shown to be fragile under stress. 
The unwinding of these developments, including a sharp deleveraging and 
a headlong retreat from credit risk, led to highly strained conditions 
in financial markets and a tightening of credit that has hamstrung 
economic growth.
    The Federal Reserve responded to these developments in two broad 
ways. First, following classic tenets of central banking, the Fed has 
provided large amounts of liquidity to the financial system to cushion 
the effects of tight conditions in short-term funding markets. Second, 
to reduce the downside risks to growth emanating from the tightening of 
credit, the Fed, in a series of moves that began last September, has 
significantly lowered its target for the federal funds rate. Indeed, 
last week, in an unprecedented joint action with five other major 
central banks and in response to the adverse implications of the 
deepening crisis for the economic outlook, the Federal Reserve again 
eased the stance of monetary policy. We will continue to use all the 
tools at our disposal to improve market functioning and liquidity, to 
reduce pressures in key credit and funding markets, and to complement 
the steps the Treasury and foreign governments will be taking to 
strengthen the financial system.
    Notwithstanding our efforts and those of other policymakers, the 
financial crisis intensified over the summer as mortgage-related assets 
deteriorated further, economic growth slowed, and uncertainty about the 
financial and economic outlook increased. As investors and creditors 
lost confidence in the ability of certain firms to meet their 
obligations, their access to capital markets as well as to short-term 
funding markets became increasingly impaired, and their stock prices 
fell sharply. Prominent companies that experienced this dynamic most 
acutely included the government-sponsored enterprises (GSEs) Fannie Mae 
and Freddie Mac, the investment bank Lehman Brothers, and the insurance 
company American International Group (AIG).
    The Federal Reserve believes that, whenever possible, the 
difficulties experienced by firms in financial distress should be 
addressed through private-sector arrangements--for example, by raising 
new equity capital, as many firms have done; by negotiations leading to 
a merger or acquisition; or by an orderly wind-down. Government 
assistance should be provided with the greatest reluctance and only 
when the stability of the financial system, and thus the health of the 
broader economy, is at risk. In those cases when financial stability is 
broadly threatened, however, intervention to protect the public 
interest is not only justified but must be undertaken forcefully and 
without hesitation.
    Fannie Mae and Freddie Mac present cases in point. To avoid 
unacceptably large dislocations in the mortgage markets, the financial 
sector, and the economy as a whole, the Federal Housing Finance Agency 
put Fannie and Freddie into conservatorship, and the Treasury, drawing 
on authorities recently granted by the Congress, made financial support 
available. The government's actions appear to have stabilized the GSEs, 
although, like virtually all other firms, they are experiencing effects 
of the current crisis. We have already seen benefits of their 
stabilization in the form of lower mortgage rates, which will help the 
housing market.
    The difficulties at Lehman and AIG raised different issues. Like 
the GSEs, both companies were large, complex, and deeply embedded in 
our financial system. In both cases, the Treasury and the Federal 
Reserve sought private-sector solutions, but none was forthcoming. A 
public-sector solution for Lehman proved infeasible, as the firm could 
not post sufficient collateral to provide reasonable assurance that a 
loan from the Federal Reserve would be repaid, and the Treasury did not 
have the authority to absorb billions of dollars of expected losses to 
facilitate Lehman's acquisition by another firm. Consequently, little 
could be done except to attempt to ameliorate the effects of Lehman's 
failure on the financial system. Importantly, the financial rescue 
legislation, which I will discuss later, will give us better choices. 
In the future, the Treasury will have greater resources available to 
prevent the failure of a financial institution when such a failure 
would pose unacceptable risks to the financial system as a whole. The 
Federal Reserve will work closely and actively with the Treasury and 
other authorities to minimize systemic risk.
    In the case of AIG, the Federal Reserve and the Treasury judged 
that a disorderly failure would have severely threatened global 
financial stability and the performance of the U.S. economy. We also 
judged that emergency Federal Reserve credit to AIG would be adequately 
secured by AIG's assets. To protect U.S. taxpayers and to mitigate the 
possibility that lending to AIG would encourage inappropriate risk-
taking by financial firms in the future, the Federal Reserve ensured 
that the terms of the credit extended to AIG imposed significant costs 
and constraints on the firm's owners, managers, and creditors.
    AIG's difficulties and Lehman's failure, along with growing 
concerns about the U.S. economy and other economies, contributed to 
extraordinarily turbulent conditions in global financial markets in 
recent weeks. Equity prices fell sharply. Withdrawals from prime money 
market mutual funds led them to reduce their holdings of commercial 
paper--an important source of financing for the nation's nonfinancial 
businesses as well as for many financial firms. The cost of short-term 
credit, where such credit has been available, jumped for virtually all 
firms, and liquidity dried up in many markets. By restricting flows of 
credit to households, businesses, and state and local governments, the 
turmoil in financial markets and the funding pressures on financial 
firms pose a significant threat to economic growth.
    The Treasury and the Fed have taken a range of actions to address 
financial problems. To address illiquidity and impaired functioning in 
commercial paper markets, the Treasury implemented a temporary 
guarantee program for balances held in money market mutual funds to 
help stem the outflows from these funds. The Federal Reserve put in 
place a temporary lending facility that provides financing for banks to 
purchase high-quality asset-backed commercial paper from money market 
funds, thus reducing their need to sell the commercial paper into 
already distressed markets. Moreover, we soon will implement a new, 
temporary Commercial Paper Funding Facility that will provide a 
backstop to commercial paper markets by purchasing highly rated 
commercial paper directly from issuers at a term of three months when 
those markets are illiquid.
    To address ongoing problems in interbank funding markets, the 
Federal Reserve has significantly increased the quantity of term funds 
it auctions to banks and accommodated heightened demands for temporary 
funding from banks and primary dealers. Also, to try to mitigate dollar 
funding pressures worldwide, we have greatly expanded reciprocal 
currency arrangements (so-called swap agreements) with other central 
banks. Indeed, this week we agreed to extend unlimited dollar funding 
to the European Central Bank, the Bank of England, the Bank of Japan, 
and the Swiss National Bank. These agreements enable foreign central 
banks to provide dollars to financial institutions in their 
jurisdictions, which helps improve the functioning of dollar funding 
markets globally and relieve pressures on U.S. funding markets. It 
bears noting that these arrangements carry no risk to the U.S. 
taxpayer, as our loans are to the foreign central banks themselves, who 
take responsibility for the extension of dollar credit within their 
jurisdictions.
    The expansion of Federal Reserve lending is helping financial firms 
cope with reduced access to their usual sources of funding and thus is 
supporting their lending to nonfinancial firms and households. 
Nonetheless, the intensification of the financial crisis over the past 
month or so made clear that a more powerful, comprehensive approach 
involving the fiscal authorities was needed to address these problems 
more effectively. On that basis, the Administration, with the support 
of the Federal Reserve, asked the Congress for a new program aimed at 
stabilizing our financial markets. The resulting legislation, the 
Emergency Economic Stabilization Act, provides important new tools for 
addressing the distress in financial markets and thus mitigating the 
risks to the economy. The act allows Treasury to buy troubled assets, 
to provide guarantees, and to inject capital to strengthen the balance 
sheets of financial institutions. The act also raises the limit on 
deposit insurance from $100,000 to $250,000 per account, effectively 
immediately.
    The Troubled Asset Relief Program (TARP) authorized by the 
legislation will allow the Treasury, under the supervision of an 
oversight board that I will head, to undertake two highly complementary 
activities. First, the Treasury will use the TARP funds to help 
recapitalize our banking system by purchasing non-voting equity in 
financial institutions. Details of this program were announced 
yesterday. Initially, the Treasury will dedicate $250 billion toward 
purchases of preferred shares in banks and thrifts of all sizes. The 
program is voluntary and designed both to encourage participation by 
healthy institutions and to make it attractive for private capital to 
come in along with public capital. We look to strong institutions to 
participate in this capital program, because today even strong 
institutions are reluctant to expand their balance sheets to extend 
credit; with fresh capital, that constraint will be eased. The terms 
offered under the TARP include the acquisition by the Treasury of 
warrants to ensure that taxpayers receive a share of the upside as the 
financial system recovers. Moreover, as required by the legislation, 
institutions that receive capital will have to meet certain standards 
regarding executive compensation practices.
    Second, the Treasury will use some of the resources provided under 
the bill to purchase troubled assets from banks and other financial 
institutions, in most cases using market-based mechanisms. Mortgage-
related assets, including mortgage-backed securities and whole loans, 
will be the focus of the program, although the law permits flexibility 
in the types of assets purchased as needed to promote financial 
stability. Removing these assets from private balance sheets should 
increase liquidity and promote price discovery in the markets for these 
assets, thereby reducing investor uncertainty about the current value 
and prospects of financial institutions. Unclogging the markets for 
mortgage-related assets should put banks and other institutions in a 
better position to raise capital from the private sector and increase 
the willingness of counterparties to engage. With time, the provision 
of equity capital to the banking system and the purchase of troubled 
assets will help credit flow more freely, thus supporting economic 
growth.
    These measures will lead to a much stronger financial system over 
time, but steps are also necessary to address the immediate problem of 
lack of trust and confidence. Accordingly, also announced yesterday was 
a plan by the Federal Deposit Insurance Corporation (FDIC) to provide a 
broad range of guarantees of the liabilities of FDIC-insured depository 
institutions, including their associated holding companies. The 
guarantee covers all newly issued senior unsecured debt, including 
commercial paper and interbank funding, and it will also cover all 
funds held in non-interest-bearing transactions accounts, such as 
payroll accounts. This broad guarantee will be effectively immediately, 
and fees for coverage will be waived for 30 days. After the 30-day 
grace period, banks may continue to participate in the guarantee 
program by paying reasonable fees.
    I would like to stress once again that the taxpayers' interests 
were very much in our minds and those of the Congress when these 
programs were designed. The costs of the FDIC guarantee are expected to 
be covered by fees and assessments on the banking system, not by the 
taxpayer. In the case of the TARP program, the funds allocated are not 
simple expenditures, but rather acquisitions of assets or equity 
positions, which the Treasury will be able to sell or redeem down the 
road. Indeed, it is possible that taxpayers could turn a profit from 
the program, although, given the great uncertainties, no assurances can 
be provided. Moreover, the program is subject to extensive controls and 
to oversight by several bodies. The larger point, though, is that the 
economic benefit of these programs to taxpayers will not be determined 
primarily by the financial return to TARP funds, but rather by the 
impact of the program on the financial markets and the economy. If the 
TARP, together with the other measures that have been taken, is 
successful in promoting financial stability and, consequently, in 
supporting stronger economic growth and job creation, it will have 
proved itself a very good investment indeed, to everyone's benefit.
    Stabilization of the financial markets is a critical first step, 
but even if they stabilize as we hope they will, broader economic 
recovery will not happen right away. Economic activity had been 
decelerating even before the recent intensification of the crisis. The 
housing market continues to be a primary source of weakness in the real 
economy as well as in the financial markets, and we have seen marked 
slowdowns in consumer spending, business investment, and the labor 
market. Credit markets will take some time to unfreeze. And with the 
economies of our trading partners slowing, our export sales, which have 
been a source of strength, very probably will slow as well. These 
restraining influences on economic activity, however, will be offset 
somewhat by the favorable effects of lower prices for oil and other 
commodities on household purchasing power. Ultimately, the trajectory 
of economic activity beyond the next few quarters will depend greatly 
on the extent to which financial and credit markets return to more 
normal functioning.
    Inflation has been elevated recently, reflecting the steep 
increases in the prices of oil, other commodities, and imports that 
occurred earlier this year, as well as some pass-through by firms of 
their higher costs of production. However, expected inflation, as 
measured by consumer surveys and inflation-indexed Treasury securities, 
has held steady or eased, and prices of imports now appear to be 
decelerating. These developments, together with the recent declines in 
prices of oil and other commodities as well as the likelihood that 
economic activity will fall short of potential for a time, should lead 
to rates of inflation more consistent with price stability.
    This past weekend, the finance ministers and central bank governors 
of the Group of Seven industrialized countries met in Washington. We 
committed to work together to stabilize financial markets and restore 
the flow of credit to support global economic growth. We agreed to use 
all available tools to prevent failures that pose systemic risk. We 
affirmed we will ensure our deposit insurance programs instill 
confidence in the safety of savings. We agreed to ensure that our banks 
and other major financial intermediaries, as needed, can raise capital 
from public as well as private sources. We further agreed that we would 
take all necessary steps to unfreeze interbank and money markets, and 
that we will act to restart the secondary markets for mortgages and 
other securitized assets. Finally, we recognized that we should take 
these actions in ways that protect taxpayers and avoid potentially 
damaging effects on other countries. I believe that these are the right 
principles for action, and I see the steps announced by our government 
yesterday as fully consistent with them.
    I have laid out for you today an extraordinary series of actions 
taken by policymakers throughout our government and around the globe. 
Americans can be confident that every resource is being brought to bear 
to address the current crisis: historical understanding, technical 
expertise, economic analysis, financial insight, and political 
leadership. I am not suggesting the way forward will be easy, but I 
strongly believe that we now have the tools we need to respond with the 
necessary force to these challenges. Although much work remains and 
more difficulties surely lie ahead, I remain confident that the 
American economy, with its great intrinsic vitality and aided by the 
measures now available, will emerge from this period with renewed 
vigor.

    Mr. Ryan?
    Mr. Ryan. Thank you, Chairman.
    I enjoyed your speech at the Economic Club in New York last 
week. And I am also comforted by the fact that you are one of 
our Nation's leading scholars on what went wrong during the 
Great Depression. And particularly your work on adverse 
feedback loops I find very telling.
    You suggested that fiscal policy was not a significant 
factor in addressing the problems during the Depression; 
instead, that monetary policy and stabilizing the banking 
sector were the key factors.
    Don't we face a similar situation today, where our economic 
ills are due to problems in our financial services sector and 
the response of monetary authorities or lack thereof?
    Mr. Bernanke. Well, as I indicated, I thought the two 
critical lessons learned from the 1930s were, first, to have an 
appropriate monetary policy. In the 1930s, the Federal Reserve 
allowed prices to fall at 10 percent a year, which is 
obviously, you know, not appropriate. Secondly, the second 
lesson is to try to stabilize the financial system, not allow 
the credit system to break down. And, again, the authorities 
failed to do that from 1929 to 1933.
    Some of the steps that were most effective early in 
President Roosevelt's first term were reversing those problems. 
So I think those are very important. I think that is an 
important reason why, you know, why we are going to control and 
manage the situation. We won't be making those mistakes.
    Again, as I said, a fiscal package is potentially helpful 
and worthwhile to be considered. But the composition and size 
of that, there are many different ways you could go on that. I 
think that is up to Congress to try to figure out.
    Mr. Ryan. But the core component of our efforts to prevent 
a prolonged downturn is monetary, is what I am taking from 
that, and that there might be a fiscal complement to that.
    Let me ask you this question. The next session of Congress, 
at the end of it, we have very large tax rate increases that 
will occur. And it is already embedded in the current law.
    And if our goal and effort is to redeploy private capital, 
to bring savings and investment off the sidelines and redeploy 
them in the economy to create growth and get out of the 
recession, is it a good idea at the end of the next session to 
dramatically increase the after-tax rate of return on 
investment by increasing the tax on investment?
    Dividends taxes, capital gains taxes, marginal income tax 
rates, all are scheduled to increase substantially by the end 
of the next session. In fact, this majority here passed a 
budget resolution which all but guarantees those things will 
happen. We are looking at legislation moving through here 
possibly as early as next March that might bring the top rate, 
which is the one that the passive entities, small businesses, 
subchapter S's pay, up to as high as 45 percent.
    In this time of a recession, of a downturn, is it a good 
idea to dramatically raise the tax on investment, the tax on 
entrepreneurship, risk-taking, and on small businesses?
    Mr. Bernanke. Congressman, you are addressing two issues, 
both of which are relevant.
    Mr. Ryan. But that is fiscal, and since we are here to talk 
about fiscal policy, there is spending and taxing components to 
fiscal policy.
    Mr. Bernanke. Absolutely, absolutely. But you are alluding 
to two different issues, both of which I think you are making 
good points.
    You know, first, as you noted earlier, there is the 
Keynesian, or demand, effects of tax and spending policies. 
From that perspective, generally speaking, you would not want 
to have a net tax increase in the middle of a slowdown, and 
just from a demand perspective. And so that is certainly 
something you want to look at.
    More generally, I think that--and this is the other issue--
I think everyone would agree probably on the committee that our 
tax system needs improvement, it needs to be made more 
consistent with growth, more efficient. To the extent that 
improvements in the tax code could be part of this program, if 
you do undertake one, that is only a good thing.
    So both aspects of that, I think, are relevant as you think 
about these issues.
    Mr. Ryan. Okay.
    Let me ask you just one last question about your balance 
sheet. The Fed's balance sheet has grown considerably during 
this time, from I think about $900 billion pre-crisis to about 
$1.8 trillion today, as it established a number of these credit 
facilities to extend loans to private companies.
    Does the expansion of the Fed's balance sheet present any 
difficulties for you in terms of your conduct of monetary 
policy? And are there any limitations on expanding your balance 
sheet further?
    Mr. Bernanke. First, Congressman, a good bit of that 
expansion is these swaps we have done with other central banks, 
which allows them to make dollar liquidity available in their 
own economies. And I would just note that there is no credit 
risk to us because their counterparties are those other central 
banks, and they are responsible for the lending and the credit 
risk.
    The increase in the size of the balance sheet creates 
operational difficulties, obviously, managing all that. 
Generally speaking, however, it does not have a significant 
effect on monetary policy or inflation risk.
    And one very important contribution there is what the 
Congress did in the recent emergency act, which gave the 
Federal Reserve the ability to pay interest on reserves. By 
paying interest on reserves, we are able to keep the short-term 
interest rate close to the committee's target and, therefore, 
maintain our monetary policy at the same time that we provide 
this extra liquidity to the system.
    I would also just note for clarity that providing this 
liquidity does not increase the money supply. The money supply 
has grown slowly, and there is no inflationary impact.
    Mr. Ryan. You are sterilizing this as you move----
    Mr. Bernanke. We are sterilizing, meaning that we are 
undoing the effects of the money supply, so there is no net 
effect on the money supply.
    Mr. Ryan. Right. So just for laymen, as you pump money 
through the system to these facilities over here, you are 
mopping up excess money over there to make sure that there is a 
net no increase in the money supply, correct?
    Mr. Bernanke. Exactly.
    Mr. Ryan. Thank you.
    Chairman Spratt. Mr. Doggett. Three minutes, Mr. Doggett.
    Mr. Doggett. Thank you, Mr. Chairman.
    While sincerely applauding your personal commitment to 
right our economy, I continue to have the same concerns about 
the effectiveness of the bailout and its fairness to taxpayers.
    As of this morning, are you personally aware of any Federal 
employee at any relevant Federal regulatory entity who has been 
fired or demoted or disciplined in any way as a result of this 
debacle?
    And since Congress approved this $700 billion bailout, are 
you personally aware of any request that has been made to 
anyone in the private sector responsible, whether they are on 
Wall Street or somewhere else, for this debacle that they be 
replaced or just asked to take a pay cut?
    Mr. Bernanke. Well, on Wall Street there have been quite a 
few high-profile firings of CEOs based on their performance in 
the recent period.
    Mr. Doggett. Since the bailout?
    Mr. Bernanke. The bailout was--you know, the capital 
injection was only last week. But there----
    Mr. Doggett. Well, I am talking about since it was signed 
into law. There really have not been any requests that Treasury 
has made that any of those people be replaced, have they?
    Mr. Bernanke. So, the Treasury's approach is twofold. 
First, we want to strengthen our financial system so that the 
counterparties who deal with our banks will not be worried 
about their insolvency and will be willing to deal with them.
    Mr. Doggett. I understand there may be a rationale for 
taking that course, but I just want to make it clear that there 
has been no removal of anyone from any Federal regulatory 
agency, or discipline, or any request that anyone since the 
bailout was signed into law be removed or asked not to take 
even a bonus on Wall Street.
    Mr. Bernanke. If the Treasury undertakes to deal with a 
mismanaged bank that is close to failure, then its terms will 
be much more Draconian and tough than the case where we are 
just trying to broaden the base of capital throughout our 
economy.
    In the case of the Federal Reserve, I would mention that 
when we made this large loan to AIG Insurance, we----
    Mr. Doggett. Yes, sir. That was before the bailout, and you 
did take some action there. But that has not been copied since 
then.
    How about just a request that the individuals not be 
rewarded with a bonus this year?
    As you know, when Deutsche Bank's CEO and many of its 
leading traders have pledged that they will waive millions in 
annual payouts, there is a recent report that six major U.S. 
banks have reserved a total of $70 billion for pay and bonuses 
this year, a substantial portion of which represents 
discretionary year-end bonuses.
    Isn't the American taxpayer in this bailout just being 
asked to subsidize those executive compensation schemes and 
maintaining dividend payments?
    And indeed, since the bailout bill, in the short period you 
described, hasn't Treasury actually weakened what I viewed as 
political pablum in the original bailout bill on golden 
parachutes by saying that you don't define a golden parachute 
as anything that is a mere three times normal pay and bonuses?
    Mr. Bernanke. Well, Congressman, my understanding--and you 
can follow up with Treasury--my understanding is that all of 
the provisions that Congress inserted with respect to executive 
compensation have been applied to every recipient of capital, 
which was not required by the bill. So there have been 
applications of what was in the bill. I don't think that 
Treasury has authority beyond what Congress gave it to insist 
on other restrictions.
    Mr. Doggett. It did define a golden parachute as three 
times anything these banks want to pay their executives, didn't 
it?
    Mr. Bernanke. Yes.
    Mr. Doggett. Thank you.
    Chairman Spratt. Mr. Garrett?
    Mr. Garrett. I thank the chairman and I thank the ranking 
member for holding this important meeting today.
    And I thank the chairman, as well, for your important work, 
as always, during these amazingly difficult times.
    You know, we are here primarily to discuss the idea of a 
new economic stimulus package. It was back earlier this past 
year, this year in February is when Congress passed 5140, which 
was the Economic Stimulus Act of 2008; $150 billion was said to 
be targeted, timely and temporary. And as I have said before, I 
am not sure how well it was targeted or timely, but the 
temporary aspect we can certainly attest to by the data that 
came after it.
    And I am all in favor of returning the proverbial tax 
dollars back to the taxpayer. In that case, what we basically 
did was send $600 checks to folks for them to spend. But the 
data seemed to show that what you saw after that was simply a 
spike in retail sales for a short period of time. That is why I 
would say you had a temporary effect but no real stimulating 
effect overall on the economy.
    And I am going to get back, if time remains, to ask you 
your comment on what really needs to be done to stimulate an 
economy. Is it just getting people to have a short period of 
time to be able to spend money, whether it is unemployment 
checks or some of the other ideas that are floating around now 
or the past ones, or whether you need some more what I would 
say is job creation-type things, encouraging assets that are 
sitting on the sidelines to get back into the mix?
    But before I get to that, let me just ask you a couple 
other questions with what is going on. It was in your 
testimony, and I think I know some of the answers on this, but 
I will ask you anyway.
    You said you are going to be buying, in the process of 
buying high-grade commercial paper. And I believe the answer 
will be, but I will ask you, the authority to do this--maybe 
you said this in your testimony--would be under section 13.3 of 
the Federal Reserve Act. Is that correct?
    Mr. Bernanke. Correct. That is correct.
    Mr. Garrett. Okay. I assume, but I will ask you, do you 
have the authority under that act, if exigent circumstances 
dictate and you see the need to, to go beyond high-grade paper 
to buy other things else to try to get the markets going again 
and what have you?
    Mr. Bernanke. The law requires that we be adequately 
secured. We are not allowed to make loans without security or 
some guarantee of repayment.
    Our plan for a repayment in this case is three-fold: first, 
collateral when available; secondly, endorsements, which 
basically is a second signature; and third, that we are 
charging fees and spreads on those commercial paper credit to 
provide a cushion for credit purposes.
    In principle, we could do further, but it would be much 
more difficult because we would need to have better--at a lower 
credit rating, we would have to find stronger guarantees to 
protect our lending.
    Mr. Garrett. I only have a few seconds here apparently. Do 
you have the authority to go out and actually buy mortgage-
backed securities as well?
    Mr. Bernanke. We have that authority. We also have the--
that is not even 13.3. We have the authority under just 
ordinary open market operations to buy--sorry--GSE-guaranteed 
only mortgage-backed securities.
    Mr. Garrett. Only GSEs. You don't have authority under 13.3 
to buy other mortgage-backed securities?
    Mr. Bernanke. No.
    Mr. Garrett. You don't.
    Chairman Spratt. Mr. McGovern?
    Mr. McGovern. Thank you, Mr. Chairman.
    Thank you very much for being here today. I have to tell 
you, in light of these difficult economic times, I wouldn't 
want to be you for anything in the world. But there are days I 
don't want to be me either, when I go home and talk to some of 
my constituents who are angry, who are frustrated and who are 
hurting.
    And so I want to say as clearly as I can that the 
frustration over the Federal response to the economy goes deep 
and wide. People are not just reading about the economy, they 
are seeing and feeling what this lousy economy means in their 
401(k)s, in their pensions and their mortgages and their jobs.
    I went along with the $700 billion proposal presented by 
the administration, by you and others, modified by the House 
and Senate. And we talk a lot about how that package helps 
people not only on Wall Street but on Main Street. But, quite 
frankly, we are not doing nearly enough for the people who live 
on Main Street or any of the side streets where economic 
security is growing more and more precarious.
    Now, we have given billions for banks, but very little for 
States and localities. And this financial crisis may be global, 
but all the cuts and the pain and the sacrifices seem to be 
local. Last week, my Governor from Massachusetts announced he 
is going to have to make huge spending cuts. And he is doing 
this because tax revenues are plunging, along with the stock 
and real estate market meltdowns.
    And behind every one of these dollars that we talk about 
here in Washington are real people. And I think we need 
desperately here in Washington to help our States. We need to 
provide them with direct support, especially for Medicaid, for 
food stamps, for unemployment benefits, and for infrastructure 
projects that are ready to get up and running, which provide 
jobs, income and revenue.
    So I guess, you know, you have kind of suggested that--
well, I am trying to make it clear, to be clear here. I think 
it would be helpful for us for you to be as emphatic in favor 
of an economic stimulus package that would invest in our States 
and our local communities as you were in terms of this rescue 
package that we passed.
    And one final question: How are you using your new 
authority under the Emergency Economic Stabilization Act to 
help State and local governments? Have you considered using any 
of the $700 billion to purchase State and municipal bonds from 
financial institutions? And would you consider making a direct 
investment into primary bond insurers?
    Mr. Bernanke. Let me just--first of all, I am very 
concerned about the average person. That is my only motivation 
for what we are doing. I was very emphatic about the financial 
rescue plan because I think if the financial system crashes the 
implications for everyone in the country would be quite severe. 
I understand the need of Congress to try and address the 
problems of their constituents, and I think you should do so. 
That is your job, that is what you have been elected to do.
    With respect to State and local--I should also remind you 
it is the Treasury that is, of course, running this program and 
their decisions. The bill suggests a focus on mortgage and 
mortgage-related securities, and I think that is where they are 
starting. But, you know, I suppose that alternatives would be 
possible.
    I mentioned earlier the importance of allowing credit to 
flow more freely. This might be an area where the Federal 
Government could assist the State and local governments at 
lower cost by simply helping them obtain credit at more normal 
rates, which is one of the problems that they are facing right 
now.
    Chairman Spratt. Mr. Simpson?
    Mr. Simpson. Thank you, Mr. Chairman.
    Thank you, Mr. Chairman, for being here. We appreciate it 
very much.
    Let me ask this question. It came to me a few weeks ago, or 
a few days ago, talking with the bankers and the home builders 
and the automobile dealers and the real estate agents in my 
State that have some concerns about the $250 billion we are 
putting into the financial markets.
    And then I read this article in the Wall Street Journal 
that I am certain that you have read, and let me preface it 
with these comments. It says here, Treasury essentially forced 
nine major U.S. banks to agree to $125 billion from the Federal 
Government. Mr. Yingling of the American Bankers Association 
said, ``Most banks are well-capitalized and do not need cash 
infusions.''
    And then it says, ``Analysts, investors and some bankers 
applauded the government's rescue. They said it would help 
rebuild confidence in the industry and could set the stage for 
a wave of consolidation in which stronger companies take over 
their weaker rivals.'' And Mr. Kansas, the former CEO of North 
Fork Bancorp, said, ``Banks are likely to use the government's 
capital to retire outstanding debt that pays a higher yield 
than the 5 percent on the government's preferred shares. They 
will reduce funding costs, boosting profits. Such moves will 
pad banks' profits without supporting the overall economy.''
    How do you respond to that? And do you think that is 
accurate? And is that what we are intending to do with the $250 
billion?
    Mr. Bernanke. Well, first of all, let me be just clear, we 
are not throwing $250 billion out the window. What we are doing 
is buying preferred shares in strong companies that will pay a 
return and will be repaid. So it is an acquisition of assets, 
not a spending program.
    Mr. Simpson. But isn't the purpose to get that money out 
into the market to free up capital?
    Mr. Bernanke. The purpose is to make those institutions 
stronger so that people will be willing to deal with them, 
which they were not previously. And that is why we were on the 
brink of a very serious banking crisis, which looks to be in 
better situation right now, looks to be having been averted.
    Most importantly, though, by making the banks stronger, 
giving them more capital, it frees up their balance sheet, 
gives them more capacity to lend. We need them, over and above 
just being well-capitalized in a regulatory sense, we need them 
to have the capacity to make new loans and extend credit to our 
economy. Otherwise, the economy is not going to be able to 
grow.
    Mr. Simpson. Is there anything that requires them to lend 
that money, that new capital that they get, rather than use it 
for mergers and acquisitions of less secure banks and so forth 
to grow, essentially?
    I noticed that you have said one of the problems that you 
have in this whole environment is that we have allowed some 
companies to become too large to fail. Are we creating more of 
that?
    Mr. Bernanke. I don't think so. The capital is being spread 
across the country, to small banks as well as large banks. When 
you have this capital and you no longer have these tough 
balance sheet constraints, if you have the capital you should 
go out and lend it, if you have good opportunities.
    Now, we can't force them to lend, because we don't want to 
force them to make bad loans. We want them to make good loans 
that are based on their assessment of credit quality. But that 
being said, a bank that has lots of extra capital is passing up 
profit opportunities if it doesn't make loans.
    Mr. Simpson. Thank you.
    Chairman Spratt. Mr. Scott?
    Mr. Scott. Thank you, Mr. Chairman.
    Mr. Chairman, you mentioned the need to take troubled 
assets off balance sheets. There is a difference between 
illiquid assets and worthless assets. And this is important, 
because lending authority is a function of the balance sheet of 
the bank and the capital accounts. You can get more money into 
the capital accounts if you mark to fair value rather than mark 
to market.
    What is the status of that?
    Mr. Bernanke. Well, mark-to-market accounting is the 
province of the SEC and the FASB and so on. There have been 
some clarifications that have been issued, in particular that 
banks need not blindly follow market prices in cases where 
there are very few transactions and very illiquid markets.
    Mr. Scott. So if you have a temporarily illiquid asset, you 
don't have to lose all of the value by marking to market.
    Mr. Bernanke. That has been a clarification in that 
direction, yes.
    Mr. Scott. In buying stock, you get value, as you have 
indicated. Can this be done without any significant cost to the 
taxpayer?
    Mr. Bernanke. Well, I believe that all the banks will pay 
us back with interest. And I would expect that there would be 
no cost on these capital programs, or very limited cost.
    Mr. Scott. And that would get capital into the banks' 
capital accounts so that they could have more lending 
authority.
    Mr. Bernanke. More lending capacity and greater confidence 
in terms of being able to deal with their counterparties.
    Mr. Scott. And is there any suggestion that overpaying for 
worthless assets from all over the world is better than the 
targeted purchase of preferred shares, as you are doing?
    Mr. Bernanke. The plan is not to overpay for anything. The 
plan is to use market mechanisms to try and determine the 
appropriate pricing for those assets; in doing so, to unfreeze 
markets which are not currently giving good assessments of what 
the longer term values of those assets are, and to create more 
liquidity in those markets.
    If that is successful, that will be an important 
contribution to try to get these markets going again and 
bringing private money in as well. But I do think that the 
capital program is valuable, and I supported that.
    Mr. Scott. Thank you. The idea that we are not going to 
overpay for assets was a little murky during the consideration 
of the bill. There was every indication that we would.
    Can I get chart number one?
    In the 1990s, we made the tough choices in our budget and 
balanced the budget, went into surplus, and were rewarded with 
great economic numbers. The Dow was the best in 75 years, great 
jobs, in stark contrast to what is going on now.
    What did we do right in the 1990s that we are not doing 
now?
    Mr. Bernanke. Well, part of what happened in the 1990s--you 
mentioned two things, the budget surplus and the Dow. I mean, 
those two things were connected. With the very high Dow, 
capital gains and other income was providing lots of revenue. 
So your view of the 1990s depends in part on whether you think 
the Dow was appropriately priced at the peak in the late 1990s. 
To the extent that it was a bubble, then part of that 
prosperity was not sustainable.
    Mr. Scott. Well, I guess the harder we work and the more 
responsible we are, the luckier we get.
    Thank you, Mr. Chairman.
    Chairman Spratt. Mr. Tiberi?
    Mr. Tiberi. Thank you, Mr. Chairman.
    Thank you, Chairman, for being here today. I know you have 
a very difficult job.
    Knocking on doors the last 2 days in two Columbus suburbs, 
I heard a lot of opinions, a lot of opinions from people who 
are pretty upset, upset with the $700 billion, the $250 billion 
infusion last week.
    And a common theme was the only thing we did is create a 
deeper hole for our children to dig out of, in terms of debt 
for the future. And I would like you to comment on that.
    But overall, if you could speak to this committee, but more 
importantly to the American people, on why that $250 billion 
infusion is a good thing for Main Street and side streets, as 
Mr. McGovern said, and why the overall package is important to 
Main Street and the side streets in our districts. Because 
people aren't feeling that that is helping with their problems.
    Mr. Bernanke. Congressman, I understand the communication 
problem that exists here. Let me just make a couple of 
comments.
    The first is, the $700 billion headline number is an 
enormous number. It does not reflect anything like what we 
would expect to be the actual ultimate cost of this program to 
taxpayers. As has been discussed, we are acquiring assets for 
that money. And, in particular, the capital that we have 
injected into these banks, as long as the banks remain healthy, 
they will pay that capital back with interest, and the taxpayer 
will not be out any money.
    In terms of why this is good for the person on Main Street, 
you know, I have studied these issues for many years as an 
academic. And what we have seen in the 1990s in East Asia, what 
we have seen in Japan, what we saw in Sweden, what we have seen 
in many other cases in the postwar period is that very severe 
financial crises lead inevitably to deep and protracted 
recessions. It is, therefore, essential to stabilize the 
financial system as soon as possible and to get credit flowing 
again.
    And I think that we are seeing that we have made progress, 
that we did address this question early rather than late. And 
that gives us much better prospects for getting the economy 
going again early.
    I think since the rescue package was passed, I suspect, 
evidently not from all your constituents, but I suspect more 
people are recognizing that the credit constraints really are 
hitting home. And the people can't get auto loans, that there 
are plenty of firms small and large that can't get ordinary 
credit, that housing mortgage credit is harder to get. These 
are direct consequences of our financial crisis. And things 
that stabilize the financial system and get credit flowing 
again will have direct and palpable benefits to people on Main 
Street and to the economy.
    Mr. Tiberi. Just one final point to emphasize what Chairman 
Spratt said earlier. There appears at least to be a disconnect 
right now, because there are people who are concerned who are 
still losing their home or in neighborhoods where homes have 
been lost. There doesn't appear to be anything, in terms of 
what they are feeling, to help with that home foreclosure 
situation. Just something to put on your radar screen.
    Thank you.
    Chairman Spratt. Mr. Baird?
    Mr. Baird. Mr. Chairman, thank you very much.
    Mr. Tiberi hit the nail on the head. The public doesn't yet 
get that we would have had a collapse. Now, you couldn't very 
well come to the public and say that, probably.
    But what would have happened, in your mind, had we not 
passed the bill we passed recently?
    Mr. Bernanke. If we had not passed that bill, we would have 
not had the authority to do the capital injections we did last 
week. The Federal Reserve would not have had the ability to 
expand its balance sheet, because we would not have had the 
interest on reserves provision.
    And the risk would have been, while all the other countries 
in the world, in Europe and elsewhere, were taking strong 
measures to protect their banks and protect their markets, that 
we would have had a very severe financial crisis in the United 
States that would have resulted in the failure of major 
institutions and would have led to a very severe and protracted 
recession in this country, and that actions to remedy that a 
few months from now would not have been sufficient to undo the 
damage.
    Mr. Baird. So if we translate that into the average guy, 
lost jobs, lost businesses, lost farms, lost homes, far more 
than we are seeing now.
    Mr. Bernanke. Absolutely.
    Mr. Baird. That is what we have to help people understand.
    Secondly, this issue of a fiscal stimulus. I favored the 
last time that we should have invested in infrastructure. We 
are talking now about investments in infrastructure, which 
could actually build things, tangible assets for a long time, 
and create jobs.
    Can you discuss briefly that issue, if we do this and put 
people to work and build things?
    Mr. Bernanke. So, first of all, infrastructure is a form of 
capital. It pays a return if it is well-invested. That is a 
very good thing for the economy. It is very constructive.
    Now, there is a somewhat separate issue here, though, which 
is, will it stimulate the economy in the relatively near term? 
And there the question really turns on, how much extra spending 
and employment will you get from infrastructure projects that 
you would not otherwise have had? And the concern usually has 
been that infrastructure projects take a long time to plan and 
develop, and once the project starts, it takes a number of 
years, so that the actual implications for near-term activity 
are limited.
    To the extent that that problem can be addressed--and I 
don't honestly know to what extent there are things on the 
shelf that can be pulled off or maintenance that could be not 
deferred or things of that sort; that is a question you have to 
determine----
    Mr. Baird. Let me interject on that.
    Mr. Bernanke [continuing]. That could be helpful.
    Mr. Baird. In my district, schools, roads, bridges, water 
treatment projects are waiting to be done--permitted, designed, 
ready to go. They lack the capital. And I think that is the 
case nationwide. And we have studied that on the Transportation 
and Infrastructure Committee. And to my way of thinking, if we 
are going to do this, I will tell you, much better than a tax 
cut.
    And the final thing I would say is, I find it just so 
intriguing that my friends on the other side would suggest that 
tax increases are somehow going to cripple the economy and then 
turn around and say we are passing more debt onto our children. 
We are passing debt onto our children largely because of the 
tax deficit that has been created and because of the costs of 
this conflict.
    Thank you, Mr. Chairman.
    Chairman Spratt. Ms. Kaptur?
    Ms. Kaptur. Thank you.
    Mr. Chairman, welcome. I know you are a voice of reason in 
these discussions. And in my very brief time, I would like to 
render some opinions, perhaps that some might be able to use.
    I view as most curious, uneven and incomplete the set of 
administration's actions being taken to address this meltdown. 
And what I see happening is a greater concentration toward the 
big banks, many of whom were wrongdoers in my opinion, 
rewarding the irresponsible, and new costs being imposed on 
community banks, for example, that very much were not a part of 
making the bad loans.
    Number two, I view the bursting of the housing bubble as 
the key element in the meltdown, yet nothing is being done now 
to address the rising foreclosure rates in places like Ohio. 
And if we don't do workouts now or get a moratorium for a brief 
period of time, we are going to see this problem being 
exacerbated into this last quarter and next year.
    Number three, the purchase by the government of bad loans 
made by bad lenders remains a bad idea. And I would urge you to 
use market discipline to help resolve the situation, as you 
well know was done in the 1930s and certainly in the 1980s.
    And I would ask you to look to the FDIC--though I know you 
are not directly involved, you are in administration meetings 
on this--look to get the FDIC to use its full emergency powers 
to protect all general creditors of those banks with the fraud 
exception. That has not been done. The administration is slowly 
getting there, but it isn't there yet. That is the most 
important thing that can be done to engender confidence in the 
system.
    Number two, urge the FDIC to employ the Net Worth 
Certificate Program we successfully used back in the 1980s, 
rather than the TARP program, which essentially rewards the bad 
actors.
    Number three, urge the SEC to mark housing loans from an 
accounting perspective to true market economic value, as 
opposed to an arbitrary index.
    Finally, I wanted to say that I think the Fed has an 
important role to play in sorting out the bad actors. What is 
surprising to me, though, through all of this, though 
Countrywide was a major mortgage lender, and the New York Times 
reported yesterday they were Fannie's biggest mortgage client, 
the September 2004 audit showed that in six of Countrywide's 
largest regions, one in eight of their loans was severely 
unsatisfactory because of shoddy underwriting, yet the Federal 
Reserve's New York office maintained them on their list of 
primary dealers, security dealers, for the Fed, until they were 
purchased by Bank of America this year.
    So in 1999, 2000, 2001, 2002, 2003, 2004, 2005, 2006, 2007, 
2008, the Fed was saying, Give them a green light. Frankly, I 
don't understand that and wonder if you could respond.
    Mr. Bernanke. Certainly.
    First of all, on Countrywide, the primary dealer is a 
totally separate company from the mortgage lender. The quality 
of that dealer and its operations is independent of what the 
other part is doing.
    On foreclosures, I agree with you that stopping preventable 
foreclosures is extraordinarily important. It will help the 
housing market, it will help communities, it will save us money 
in the long run; and I hope that we will look to continue ways 
to do that. I am very much in favor of that.
    On community banks, community banks did not make subprime 
loans, but they do have other commercial real estate and other 
loans which are problematic. Some of them do need capital. Some 
of them will be selling to the asset program. I think it is 
very important that whatever we do, that it not disfavor 
community banks, that it maintain the diversity and strength of 
our community banking system; and I support that very strongly.
    Ms. Kaptur. Mr. Chairman, could I just ask the Chairman of 
the Fed if he could provide for the record the difference 
between Countrywide and Countrywide.
    Mr. Bernanke. They are two separate companies, the primary 
dealer and the---
    Ms. Kaptur. There is no relationship between them at all?
    Mr. Bernanke. Not in terms of--the primary dealer doesn't 
make mortgage loans.
    Chairman Spratt. Ms. Tsongas.
    Ms. Tsongas. Thank you.
    Mr. Bernanke, thank you for your service, as you have heard 
from all of us, in this time of tremendous turmoil and 
uncertainty.
    I, too, like Mr. McGovern, just returned from Massachusetts 
this morning. As you know and as he indicated, our State has 
experienced tremendous fiscal stress with a shortfall in its 
budget of over a billion dollars. The governor and legislature 
are working to address it, but you can imagine it is a most 
difficult time.
    My question really is, as they work to make significant 
cuts that will reduce services both within State government 
across our communities and the many organizations--nonprofit 
and otherwise--that are affected, if this doesn't simply serve 
in the end to further weaken the broader economy, wouldn't we 
be wise to consider some relief in the next stimulus package?
    Mr. Bernanke. From a spending perspective, to the extent 
that relief leads the States and localities to restore 
services, to conduct greater maintenance and those sorts of 
things, it does contribute to demand and would be part of a 
stimulus package. You don't want to be in a situation where you 
are compensating them for past spending or putting money in the 
rainy-day fund, because that doesn't help the current situation 
in terms of spending and activity.
    I reiterate what I said before, which is: One way to 
approach this, one problem that they are facing now, as you 
well know, is that the municipal bond markets are not 
functioning well, and they are facing very high interest rates 
and finding it very difficult to obtain credit. Addressing that 
issue might be one way to be of assistance to States and 
localities.
    Ms. Tsongas. Well, it is my understanding, if we were to 
include some relief in a stimulus package, that it would 
address the--that there wouldn't be enough to really make up 
for the all the shortfall across the board, across the many 
State governments, so that it really would be more just a way 
of helping to avoid some of the really dramatic cuts that are 
going to have to take place.
    Mr. Bernanke. Thank you.
    Chairman Spratt. You yield back your time.
    Dr. Bernanke and Mr. Chairman, we are at the 11:00 hour. I 
have got six more questioners. I can reduce that to 2\1/2\ 
minutes, and we will get you out of here in 15 minutes, if that 
is agreeable.
    Mr. Bernanke. Thank you, sir.
    Chairman Spratt. Mr. Moore of Kansas.
    Mr. Mooree of Kansas. Thank you, Mr. Chairman, for being 
here. I think a lot of us would agree that one of the worst 
political blunders here was using the term ``bailout'' instead 
of ``economic rescue'' or ``economic recovery,'' because it was 
never, never my intention, and I think a lot of others' either, 
to bail out Wall Street, but to try to protect the people on 
Main Street, back around our homes and in our congressional 
districts, who are in retirement, are nearing retirement, who 
have 401(k)s or otherwise invested in the stock market, who 
took a terrible, terrible beating here.
    That is the only reason I voted for this package. Am I 
correct, or am I looking at this incorrectly?
    Mr. Bernanke. That is absolutely correct, and that is the 
only reason I supported the package.
    Mr. Moore of Kansas. Thank you. That answers my question. 
Thank you, sir.
    Chairman Spratt. Mr. Blumenauer of Oregon.
    Mr. Blumenauer. Thank you, Mr. Chairman.
    Mr. Chairman, I am curious, you referenced from the outset 
that part of what started this cascade appeared to be problems 
in the housing market, precipitous decline that led to a series 
of other things unraveling.
    I am curious if you see an opportunity in the short term to 
do something dramatic to change their status vis-a-vis 
bankruptcy law or other Federal intervention that could help 
stabilize it; and, second, if you are concerned at all about 
further unraveling on Wall Street due to hedge funds that are 
having massive claims, evidently made against them for cash 
that might continue the downward slide over the course of the 
next couple of months.
    Mr. Bernanke. On the first question, we have to keep in 
mind how big the housing sector is--I mean, an $18 trillion 
sector. It would be very difficult, even for the Federal 
Government, to put a floor under housing prices as a general 
matter. I think the two best ways to address the housing issue 
are, first----
    Mr. Blumenauer. May I just, if I may, we--in business and 
vacation homes, we allow, in bankruptcy, people to go directly 
to the market. The Federal Government doesn't have to do this. 
This is part of the bankruptcy provision, for example.
    Aren't there mechanisms that could be done similar to that 
that get us out of that box?
    Mr. Bernanke. Well, I was going to say, I think the two 
best ways to approach the housing market, one of them which 
relates to what you are saying, is to help prevent preventable 
foreclosures. Steps have been taken in that direction.
    I would support further steps to try to make sure that 
everyone who can afford to stay, who has sustained a mortgage 
and wants to stay in the home, is able to stay in the home. I 
think there are ways to address that.
    The second thing is, again, part of our problem is that the 
mortgage markets are not working properly. Taking steps to 
strengthen the mortgage markets and make mortgage credit more 
available to the public, I think would also be an important 
step to try to stabilize housing.
    On hedge funds: Hedge funds, a number of them have taken a 
lot of losses right now, but that is appropriate. They are risk 
takers, and as they have made bad guesses--or as many people 
have--of course they have lost and their investors have lost.
    Chairman Spratt. Ms. DeLauro.
    Ms. DeLauro. Thank you, Mr. Chairman.
    Dr. Bernanke, are we in a recession, your judgment, are we 
in a recession now? Yes or no.
    Mr. Bernanke. Well, I don't think it is a fair question for 
the following reason: A recession is a technical term that was 
created by academics for studying a certain pattern.
    Ms. DeLauro. We have got many economists, one coming this 
afternoon from Brookings, who says that there is a recession. 
Are we in a recession now?
    Mr. Bernanke. We are in a serious slowdown in the economy, 
which has very significant consequences for the public. Whether 
it is called a ``recession'' or not is of no consequence.
    Ms. DeLauro. Moving from there, then, to what a--in 
Friday's New York Times, Paul Krugman wrote the following, 
``There is not much Ben Bernanke can do for the economy. He can 
and should cut interest rates even more, but nobody expects 
this to be more than provide a slight economic boost.''
    Let's talk about the Federal Government. What size should 
an economic recovery package be? $150 billion? $300 billion?
    Dr. Bernanke, you are an economist. Besides being the head 
of the Fed, you have a Ph.D. from Harvard in economics. Give us 
your best judgment in terms of you are also a student of the 
Depression. Let us know what size this ought to be.
    I have got to move quickly because I have got just a few 
minutes. I want to talk about what should make up that in your 
view--not mine or my colleagues', you as an economist, Dr. 
Bernanke.
    Mr. Bernanke. Well, I am an economist. You will hear many 
other economists who will give their views.
    I think that this is partly--has to do with the composition 
and the debate that you all will have about what is appropriate 
to put into this.
    I cannot tell you, as Congress, what number you should 
pass. That is up to you.
    Ms. DeLauro. What would you suggest, 150?
    Mr. Bernanke. If you undertake a fiscal package, given the 
slowing of the economy, I think it should be significant, but I 
can't give you a number.
    Ms. DeLauro. Okay. The pieces of it, investing in 
maintaining roads, bridges, schools, alternative sources of 
energy, of projects as a way to create jobs and to put 
disposable income in the hands of a consumer. Yes? No?
    Mr. Bernanke. Those are very valuable things to do. But in 
terms of their short-term stimulus, as I mentioned to somebody 
earlier, it depends on what the timing is. Will you have these 
things up and running with people working in your term or not?
    Ms. DeLauro. We believe they can. Is it a good thing? The 
answer apparently is yes.
    Okay, helping States and localities to prevent cuts in 
services--health care, police services, construction jobs--yes 
or no?
    Mr. Bernanke. If it involves additional services and 
spending in the short term and if those are valuable services, 
then that would be constructive from the point of view of 
spending and growth.
    Ms. DeLauro. Extension of the UI benefits?
    Mr. Bernanke. I think you have done that already, right?
    Ms. DeLauro. No, no. We passed it in the House. It didn't 
pass in the Senate. The President says that, in fact, if we did 
that--quite frankly, he said that people would stop looking for 
jobs.
    Mr. Bernanke. I am quite sure that the UI benefits were 
extended. There is a temporary extension, emergency extension 
of unemployment compensation.
    Chairman Spratt. Goes from 39 weeks to 52.
    Ms. DeLauro. This is a new extension we are talking about. 
This is a new extension, because 800,000 people, as of the end 
of this month, are going to lose their benefits. We did that in 
the past. We are now talking now, which we did pass in the 
House before.
    Thank you, Mr. Chairman.
    Chairman Spratt. Ms. Moore.
    Ms. Moore of Wisconsin. Thank you, Mr. Chairman.
    You had said in your speech to the Economic Club of New 
York that the financial crisis was much broader than subprime 
lending, large inflows of capital in the United States and 
other countries stimulated reaching for yield and under-pricing 
of risk, excessive leverage under the development of complex 
and opaque financial instruments.
    My question is, is some of our economic stimulus money 
going to be used for what I hear, different numbers--$60 
trillion, perhaps--to secure these opaque financial 
instruments?
    Mr. Bernanke. Are you referring to the $700 billion?
    Ms. Moore of Wisconsin. Yes.
    Mr. Bernanke. Well, again, a good part of that is going to 
go into capital, as we have already seen; and then parts that 
go into buying assets will be done for the most part----
    Ms. Moore of Wisconsin. Mortgage-related assets with 
underlying houses, raggedy as they may be, versus these opaque 
instruments.
    Mr. Bernanke. Well, unfortunately, a lot of mortgages are 
held in these complex instruments.
    Ms. Moore of Wisconsin. Okay, let me ask a question before 
my time runs out.
    I see a lot of commercials talking about how Freddie and 
Fannie just have precipitated this entire financial downturn. 
Then I note that James Lockhart, the agency director of the 
Federal Housing Finance Agency, has said that of the $12 
trillion in outstanding mortgages, these troubled assets, the 2 
to 4 percent of them, are being held by Fannie and Freddie, 
versus nonbanking entities like Countrywide that were 
responsible for, like, 84 percent of these.
    Is that correct, that 2 to 4 percent of these troubled 
assets are being held by Fannie and Freddie?
    Mr. Bernanke. I had not heard that number. I know they have 
some bad assets.
    Ms. Moore of Wisconsin. This is a quote by James Lockhart.
    Mr. Bernanke. I would like to see the context of that 
number.
    I think the problem with Fannie and Freddie was, as the 
Federal Reserve pointed out for many years, they didn't have 
enough capital to bear against the amount of risk they were 
taking in their portfolio.
    Ms. Moore of Wisconsin. The risk for troubled assets or 
just their mortgages, period?
    Mr. Bernanke. They certainly have a lot of assets. A lot of 
mortgages have problems, and we discovered that when we went in 
and looked at the losses and evaluated their portfolios.
    Ms. Moore of Wisconsin. Is it a fair statement that some of 
these nonbanking internationals like Countrywide have been the 
precipitating factor in underwriting these troubled assets 
versus some sort of statement that Fannie and Freddie sort of 
led the charge into this economic crisis?
    Mr. Bernanke. I think the main contribution that Fannie and 
Freddie made was having insufficient capital. That was their 
main problem.
    Ms. Moore of Wisconsin. Insufficient capital versus the 
poor, criminal underwriting. Thank you.
    Chairman Spratt. Ms. Schwartz of Pennsylvania.
    Ms. Schwartz. Thank you very much.
    Thank you, Mr. Chairman. I think you are going to you can 
hear from many of us the frustration we are expressing on 
behalf of our constituents about, is this working, how is it 
going to work in both the short-term and long term.
    I wanted to follow up on the previous questions. We are 
certainly looking at what we can do in the short term, and we 
feel an obligation to take some action.
    We have done some already to give you and, of course, and 
Secretary some authority to get us out of the situation we are 
in right now, some economic stabilization and, hopefully, 
renewed investor confidence, some capital in the markets. But 
what I wanted to ask about is what we can do in both the short 
and long term, going forward, so I want to look at not just the 
short term but the long term.
    We have had years of failures of investments in innovation 
and new technologies--energy technologies, we have just done 
some of that. But what would you say, going forward, we ought 
to be doing as we look at both infrastructure in the short 
term, but long term--investments in education, investment in 
helping small businesses be able to do that innovation and new 
technology.
    If we don't start to grow new businesses, we are going to 
continue to talk about how do we just get out some recovery for 
Wall Street? I mean, what my constituents are saying to me is 
how are we going to create those new jobs that really matter to 
them in their district.
    It seems to me the only way we do that is to use some of 
our clout and, potentially, tax policy, as well as government 
funding, for investment encouragement incentives for 
innovation, cutting-edge technologies, new jobs of the future, 
educate our workforce for the future.
    Do you agree with that, or do you think that what we have 
done is enough for us to go forward when we leave the free 
market?
    Mr. Bernanke. Well, what we are doing right now is trying 
to stabilize our short-term financial crisis and the associated 
effects on the economy.
    But for the long term, we want to make all kinds of 
investments, human capital investments. Education is critically 
important, workforce skills. R&D technology is a critical part 
of our portfolio, other kinds of investments from energy to 
infrastructure to private capital. So all of these things are 
very important for long-term growth.
    Ms. Schwartz. Thank you very much.
    Do you want to give us some advice about how we deal with 
that, given the national debt that we are in and the increased 
national debt we are going to see this year.
    Mr. Bernanke. Well, a lot of private--a lot of capital 
investment takes place--can take place in the private sector.
    Ms. Schwartz. It should.
    Mr. Bernanke. But clearly there are going to have to be 
some very tough choices made.
    Part of the problem here is that we have an aging 
population, which is going to create additional needs through 
entitlements and so on. You have a very tough job ahead of you.
    Ms. Schwartz. But, nonetheless, you are recommending that 
we make some of those kinds of investments in order to be able 
to create the jobs----
    Mr. Bernanke. Our society as a whole needs to make 
investments in both people and in physical capital.
    Ms. Schwartz. Thank you, Mr. Chairman.
    Chairman Spratt. Last member, Mr. Becerra of California.
    Mr. Becerra. Thank you, Mr. Chairman.
    Mr. Chairman, thank you for staying the extra time. Perhaps 
on another occasion when you have the time, we will have an 
opportunity to flesh out the elements of what would make a good 
fiscal package to lead to further economic recovery. But I do 
appreciate the comments you have made to date with regard to 
the potential for a good stimulus or a fiscal and economic 
recovery package.
    I do want to make notes that I appreciate your words with 
regard to the Tax Code and how improvements to it could be a 
very good thing. So perhaps we could flesh that out with you 
later on in the future as well.
    I wanted to move towards this whole issue of the way the 
markets are reacting. It seems to me that everyone agrees that 
the markets always yearn for stability, some predictability. I 
think you would agree with that.
    One of the problems that we have seen with this crisis is 
that they have had little sense of predictability and stability 
about what might happen with the financing of the different 
markets. But to some degree, the markets always try to 
anticipate what is going to happen. Maybe they are not able to 
do it today because they always try to forecast, and to the 
degree possible, factor into their investment decisions what 
they see ahead or what might be around the corner.
    Would you agree with that?
    Mr. Bernanke. Of course, yes.
    Mr. Becerra. I know that they are constantly trying to 
forecast what you will do on interest rates. They certainly 
were forecasting what we would do with regard to this $700 
billion package, and I suspect they will continue to try to 
forecast and anticipate what we do.
    Would you agree with that?
    Mr. Bernanke. Yes.
    Mr. Becerra. When we come to this next administration, next 
Congress, we are going to be facing the Bush tax cuts which 
begin to expire at the end of 2010. The markets have known 
that, Wall Street has known that; we have known that in 2010 
the Bush tax cuts would be expiring.
    I would think that for the same reasons that the markets 
yearn for predictability and stability and always try to 
forecast and factor in what they will do with their investment 
decisions, given what they see ahead of them, that they must be 
factoring in and to some degree anticipating what might happen 
when 2010 arrives with regard to those Bush tax cuts.
    Would you agree with that?
    Mr. Bernanke. Yes. But there are a lot of other 
uncertainties and factors as well.
    Mr. Becerra. I understand that completely. Nothing is 
totally predictable.
    But to the degree that they see before them a law that is 
set to expire at the end of 2010, that affects much of what 
they do because of the taxes that are implicated, to some 
degree you would think that since 2001 and 2003 when the Bush 
tax cuts were first passed, they have had to be in the process 
of trying to forecast where we would head in fiscal policy here 
in Congress and the White House come the end of 2010.
    Mr. Bernanke. I would think so, yes.
    Mr. Becerra. I appreciate that.
    Thank you, Mr. Chairman.
    Chairman Spratt. Mr. Chairman, thank you very much for your 
testimony, for coming today, for your forthright answers, and 
not least for your forbearance. We very much appreciate it, and 
thank you for your input to our process.
    Mr. Bernanke. Thank you, Mr. Chairman.
    Chairman Spratt. Our next panel will explore more 
specifically the options before us, concrete measures that we 
might take.
    This panel consists of Martin Baily, who is now a Senior 
Fellow at The Brookings Institution, but was formerly the 
Chairman of the Council of Economic Advisers for President 
Clinton; Iris Lav, Deputy Director of the Center on Budget and 
Policy Priorities; and William Beach, Director of the Center 
for Data Analysis at The Heritage Foundation.

   STATEMENTS OF MARTIN N. BAILY, PH.D., SENIOR FELLOW, THE 
BROOKINGS INSTITUTION; IRIS J. LAV, DEPUTY DIRECTOR, CENTER ON 
 BUDGET AND POLICY PRIORITIES; AND WILLIAM W. BEACH, DIRECTOR, 
       CENTER FOR DATA ANALYSIS, THE HERITAGE FOUNDATION

    Chairman Spratt. Thank you all for coming. We look forward 
to your testimony.
    We have your testimony prefiled and as a matter of 
procedure make it a part of the record, if there is no 
objection, so that you can summarize it as you see fit.
    Let's begin with Mr. Baily.

              STATEMENT OF MARTIN N. BAILY, PH.D.

    Mr. Baily. Thank you very much, Chairman Spratt, 
Representative Ryan and other members of the committee. I 
appreciate the opportunity to speak.
    My own perception of the economy accords very closely with 
the one that Chairman Bernanke gave. I do think we are in a 
recession, which has declined GDP, and GDP has been declining 
since the middle of the year.
    Some forecasters are saying this will be a mild recession, 
and I think it may be. There is a good deal of uncertainty 
about that. But increasingly we are seeing forecasts of a more 
severe recession, and I think that is rather likely--I say here 
about a 25 percent probability of what I call a very severe 
recession, which would perhaps involve as much as a 4 percent 
decline in GDP in the last quarter of this year and again in 
the first quarter of next year and a continuing, perhaps 
smaller decline in the second quarter.
    I don't think that is inevitable. I think there are things 
that Congress could do, including the stimulus package that is 
the subject of this hearing to try to avert a more severe 
crisis. I think it is important that those things be done.
    Now, obviously, as many of you have said in this hearing 
and elsewhere, the housing market has been at the center of 
this recession and the likelihood of a more severe recession. 
So I think it is a priority to do something about the housing 
market.
    We have talked a lot already about the injection of 
capital, which I support, in the finance institutions. I 
disagree with the sentiments that have been expressed here that 
that injection and perhaps taking some of the distressed assets 
is a crucial part of reinvigorating the banking and financial 
system and is essential to the recovery of the Main Street 
economy. I do think it would be helpful to do something more 
direct on the housing side also.
    I am a little unsure myself exactly how that $700 billion 
is going to be allocated to different uses. Of course, there 
was money that was put into Fannie and Freddie that can expand 
their mortgage lending. So whether this particular package you 
are considering now should include money for housing or not, I 
am not certain of that.
    I think there need to be additional funds put into housing. 
If it is not available in the money that has already been 
appropriated, then I think some additional should be put there.
    I won't go over some of the issues around exports, 
commodity prices; Chairman Bernanke mentioned that already, and 
I agree with the things that he said.
    Let me go--turn my attention more to how large I think the 
package should be, a stimulus package and what it should 
contain.
    I have a little sympathy with Chairman Bernanke, as you 
were pressing him, having been in an official position myself, 
I think he naturally wants to avoid trying to have a dominant 
role in fiscal policy; he feels monetary policy, his view. But 
since I am not in his shoes, I will be more specific.
    I just sort of look at a kind of rule of thumb, although I 
am fairly familiar with the forecasting models that do this 
more professionally. It looks to me that a package--that 
Congress is looking at about the right range, $150-300 billion. 
The 150, I think if the mild recession scenario is true--and, 
of course, a lot of dynamics of that are already unfolding--if 
that scenario were to be true, then I think 150 would get us 
back--would avoid at least a severe recession and would get us 
back growing again in 2009.
    Since I think that mild scenario recession is a little too 
optimistic, I think we probably will need a package that is 
somewhat larger than that.
    At the same time, like many of the members of this 
committee, I am very concerned about the amounts that we are 
adding to the budget deficit and the effect that will have on 
future generations and their ability to service that debt and 
repay that debt. So I would not like to see this go over the 
$300 billion mark and not have too many Christmas tree 
ornaments on it, but to keep it under that.
    In fact, I proposed that perhaps there will be a package in 
two tranches of $200 billion that would be made now, and an 
additional $100 billion that would be agreed upon, but that 
would not actually take place unless the unemployment rate went 
over 7.5. I don't know exactly what the right trigger is, but I 
wanted to put some number out there. I think we are quite 
likely to see an unemployment rate over 7.5.
    Now, what should be the elements in it? I have already 
mentioned the need for stabilizing the housing market. As I 
say, I find it attractive to, perhaps through Fannie and 
Freddie, make available mortgages at somewhere between 5 and 6 
percent. That has gotten a proposal from Glenn Hubbard, who was 
the Chairman of the Council in the beginning of the Bush 
administration. I am supporting it.
    Some of my colleagues at Brookings support that, making--
allowing people to roll into a mortgage at roughly what we 
think would be a market rate if we didn't have a crisis. Glenn 
Hubbard said 5.25; maybe it is that, maybe it is 5.5, but 
somewhere in that range, so as to avoid some of the effects of 
interest rate resets that would take place.
    Now, some of those mortgages that are currently held would 
involve prepayment penalties, that people have been given a low 
teaser rate at the beginning. So if they try to repay that 
mortgage, there are some penalty provisions within it.
    I don't want to try to bail out people who have made bad 
decisions all around, but I think there were some loans that 
were made, that were originated, where the people did not know 
what they were getting into; and I think there is a case for 
helping them. So I do think there is a case for readjusting 
some of those penalties downwards, or perhaps rolling them into 
the next mortgage so that those prepayment penalties did not 
become an obstacle to acquiring a more affordable mortgage.
    I do think that the tax rebates that we had last time were 
a good move, and I think we should do them again. One of 
reasons I think that is attractive is that the IRS could use 
the same list they used before. We could get this money out of 
the door very quickly. Since we are in, I think, a recession, 
and threatening by the fourth quarter of this year that we may 
be in a severe recession, I think there is a lot to be said for 
getting some money out as tax rebates as we did earlier.
    Those tax rebates, people argue about how effective they 
were. I think they meant the consumption was higher than it 
would have been without the tax rebates. I don't think every 
dollar will get spent, but I do think most of it will get spent 
over the space of three or four quarters.
    There has been some discussion here about unemployment 
insurance. I do think we should try to make sure that people 
are not losing their unemployment benefits. There is a danger 
with unemployment insurance where people remain unemployed, but 
I think in the current situation it would be a mistake to have 
people lose their unemployment benefits.
    I am also concerned about the fact that the number, the 
fraction of unemployed covered by unemployment insurance, is 
not very high and is down compared to what it was historically. 
It has been low for a while, but--so I propose here that 
perhaps we should look at extending unemployment insurance to 
people who are not currently getting it.
    I think part-time workers, who are often women, miss out on 
unemployment benefits; and I mention what was done in 1975. 
Some of my colleagues, I would say, say to me, we don't want to 
try a new program now, we have got to do this quickly. But I 
think I want to leave this on the table as something that 
should be considered.
    On infrastructure, there has been a lot of mention of 
infrastructure. I share the concern that Chairman Bernanke had 
that we don't want stuff that is going to roll out very slowly. 
But I do think there are some maintenance expenditures and some 
stuff that is ready to go that is being described here that 
could be preserved, that would go right into preserving jobs 
and increasing the benefits of the Nation's infrastructure.
    I mentioned a couple of other things, State aid and 
business tax changes, but I think I am going to go quickly to 
the two items that I think might stand in the way of a fiscal 
stimulus package. One is, would a fiscal stimulus package cause 
a run on treasuries or a run on the dollar? I don't believe so. 
I think it is reasonable to worry about that; we are escalating 
the deficit and the debt, and we certainly don't want to 
undermine the full faith and credit of the United States, but 
there is certainly no sign in markets that that is an issue 
right now. In fact, Treasury interest rates have been low. 
There has been a flight to quality and, actually, the dollar.
    I actually welcomed the decline in the dollar that took 
place after 2002, because I think it made our manufacturing 
sector more competitive. I don't want to see the dollar go back 
up to where it was, but it has actually been stronger in the 
last few weeks than at its low point. I think it was well over 
1.50 to the Euro, 1.56 or something, and know it is 
substantially higher than that. So we are not seeing a run on 
the dollar.
    Then, finally, on inflation, I have a lot of confidence on 
the Federal Reserve that they are going to keep inflation under 
control. We have a weak economy, commodity prices are falling, 
as Bernanke mentioned, inflation expectations are easing.
    So, again, while I don't like the inflationary consequences 
of escalating the deficit and the debt, I don't think inflation 
is our biggest concern right now.
    Thank you.
    Chairman Spratt. Thank you, Dr. Baily.
    [The statement of Mr. Baily follows:]

   Prepared Statement of Martin Neil Baily, the Brookings Institution

    The author is a Senior Fellow and Director of the Initiative on 
Business and Public Policy at The Brookings Institution in Washington 
DC. He was previously the Chairman of the Council of Economic Advisers 
and a member of President Clinton's cabinet (1999-2001). He also served 
as a Member of the Council (1994-96). He would like to thank Barry 
Bosworth, William Gale, Robert Litan, Ezra Greenberg and Charles 
Schultze for very helpful comments, but the views expressed here are 
those of the author only.

                      KEY POINTS IN THIS TESTIMONY

     The steps now being taken to ease the financial crisis are 
the right ones and I expect to see credit conditions easing gradually.
     The Main Street economy of jobs and production is now very 
weak and the housing market has not yet stabilized. We are in a 
recession and the only question is how deep it will be.
     Policymakers are debating a fiscal stimulus package of 
between $150 billion and $300 billion and that is the right range to be 
thinking about.
     According to the Blue Chip forecast, GDP declined in the 
third quarter and there will be a mild recession with a further decline 
in the fourth quarter. With a mild recession scenario like this, a 
stimulus package of $150 billion would be enough to get the economy 
back on a growth path.
     The Blue Chip is too optimistic, however, and the chances 
for a severe recession are pretty high, in which GDP would decline at a 
4 percent annual rate in both the fourth quarter of 2008 and the first 
quarter of 2009, with continuing but smaller declines until late in 
2009. Under this scenario a stimulus package of $300 billion would be 
enough to ameliorate the recession substantially, although it would not 
eliminate it.
     Given the uncertainty involved, I recommend an immediate 
stimulus package of $200 billion and the preparation of an additional 
stimulus of $100 billion that is triggered if unemployment goes over 
7.5 percent.
     It is vital to stabilize the housing market. Some of the 
funds in the financial rescue package should be used to help households 
directly. If more funds are needed, a portion of the stimulus package 
should be used for this purpose. Enabling families to move into 30-year 
fixed rate mortgages through Fannie and Freddie at a rate of interest 
between 5 and 6 percent is an attractive approach to providing this 
assistance.
     It is vital that a stimulus work quickly and provide as 
much boost to spending as possible. A further round of tax rebates to 
be distributed this fall would get help to the economy quickly.
     Other possible approaches include assistance for 
unemployment insurance, and aid to states and localities. The latter 
could include funds for infrastructure, provided this does not slow 
down disbursement. Increased maintenance of our existing infrastructure 
is vital and would add to jobs quickly.
     The explosion of federal debt is very troubling and must 
be addressed by Congress once the crisis is past. Concerns about the 
marketability of Treasury securities and about inflation are real but 
not great enough to counter the urgent need for a new fiscal stimulus.

                  THE OUTLOOK FOR THE U.S. ECONOMY \1\

    The U.S. and global economies have been severely stressed by the 
crisis in financial markets. The drying up of lending has adversely 
impacted both the business and consumer sectors. Many economists at 
Brookings, along with others, have advocated the use of direct capital 
injection into financial institutions to recapitalize them and allow 
the resumption of bank lending and thanks to the actions of Congress, 
the Treasury has both the funds and the authority to accomplish this 
and has now started the process of recapitalization. It would have been 
better had this process started earlier, but I am cautiously optimistic 
that the steps now being taken here in the United States as well as by 
other countries will be enough to stabilize the financial sector. Given 
that this crisis has repeatedly turned out to be worse than expected, 
however, that may not be the case and Congress and the Administration 
must stand ready to do whatever is needed to restore an effective 
financial sector. A strong financial sector is essential to overall 
economic growth and the recovery of Main Street. It is reasonable to 
expect that taxpayers be protected as far as possible and share in any 
future capital gains that result from the rescue, but it would be a 
terrible mistake to let this sector go under, even though Wall Street 
has caused many of its own problems.
---------------------------------------------------------------------------
    \1\ The discussion in this section has benefitted from my work as 
an advisor to the McKinsey Global Institute. I have also benefited from 
the analysis of Macroeconomic Advisers and other forecasters. The views 
are the author's own.
---------------------------------------------------------------------------
    Even though the financial sector is likely on the right track, the 
housing market remains very depressed and home prices are still 
falling. The most important factor determining whether homeowners 
default is whether or not they are under water, with outstanding 
mortgage debt exceeding the value of the house. However, with a 
recession underway, families that face unemployment or loss of income 
for other reasons will find that it is impossible for them to pay their 
mortgages or credit card bills and they lose their homes. Policies have 
been put in place already to help homeowners, but they may not be 
enough. If the American economy is to move to a sustainable recovery, 
the housing market has to stabilize.
    The economy of Main Street is headed in the wrong direction, with 
employment falling, unemployment rising and monthly data that suggest 
that GDP has been declining since mid year. GDP growth will likely turn 
negative when the data for the third quarter are tabulated, and the 
decline will be much larger in the fourth quarter of this year. GDP can 
be expected to fall for one or two more quarters in 2009. The biggest 
weight pulling the economy down has been the residential housing sector 
and, so far, there is no clear evidence that this has turned a corner. 
The data on housing starts released October 17 continue to show a pace 
of rapid decline and I expect to see further reductions in residential 
construction for the rest of this year and perhaps into 2009. The 
numbers on retail sales released last week were very weak especially 
since the figures for earlier months were revised down, auto sales are 
low, and industrial production is falling. Consumption is being 
adversely affected by the huge loss of wealth from the decline in home 
prices and equity prices and can be expected to decline at about a 3 
percent annual rate in the second half of this year. Business 
investment held up well in the early stages of the crisis, but is now 
falling also. The U.S. economy is in a recession and the only question 
is how deep it will be. Unemployment tends to lag behind the business 
cycle and often continues to rise even after a recovery is underway. 
Based on the economic trends now at work, it is very probable that 
unemployment will hit the range of 7 to 8 percent and a deeper 
recession is quite possible. Unemployment hit 10 percent in the 1982 
recession and, while I do not think we will reach that level in this 
recession, we cannot rule it out. It takes GDP growth at a rate between 
2\1/2\ and 2\3/4\ percent to keep unemployment from rising, and a 
higher growth rate to bring unemployment down. We may see a solid 
bounce back in growth in the second half of 2009, but it is more likely 
that it will take until 2010 before unemployment declines again.
    One of the bright spots this year has been the performance of U.S. 
exports. After adjusting for inflation, exports grew at over 12 percent 
at an annual rate in the second quarter and are likely to match that 
pace or more in the third. In addition, inflation-adjusted imports are 
weak as a result of the fall in the dollar that began in 2002 and the 
weakening U.S. economy. Domestic demand actually remained flat in the 
second quarter and all of the GDP growth was accounted for by the 
improvement in net exports. Exports have been keeping us out of the 
graveyard. Looking ahead, I expect that exports will remain a positive 
and that imports will still be weak, but the effects of trade will not 
be large enough to offset falling consumption and investment. 
Currently, both Europe and Japan are weakening and likely will head 
into their own recessions, making for a slowing of U.S. export growth. 
The dollar has recovered some ground against the euro also, which will 
trim U.S. export gains.
    One economic factor that is clearly helping and is likely to remain 
a positive is commodity prices. The price of oil fell below $70 a 
barrel on October 16th, less than half of the peak price it hit earlier 
this year. Commodity prices fluctuate greatly and it is hard to tell 
exactly where they are headed, but a weakening global economy can be 
expected to depress commodity prices, so it is unlikely that they will 
return to anything close to their peak levels. The United States, of 
course, is a producer of commodities as well as a consumer, so there 
are companies and workers that are hurt when commodity prices fall. On 
balance, however, U.S. economic growth benefits from a fall in 
commodity prices, especially oil and food prices which very quickly 
affect the wallets of consumers. There is nothing like seeing oil at 
$140 a barrel to make oil at $70 a barrel look good.
    In the early stages of the financial crisis it was notable that 
jobs and GDP were holding up rather well; in fact there was 2.8 percent 
growth in the second quarter. That good news about growth was 
deceptive, however. The financial crisis has set in motion the dynamics 
of an economic downturn. Even though the financial sector is probably 
on the road to recovery, its negative impact on growth will remain with 
us for a while yet.
    This recession was not inevitable. Almost everyone was caught up in 
the belief that housing prices would keep rising and this encouraged 
speculation and over-borrowing by households, lax lending standards by 
mortgage providers and a failure to supervise and regulate banks 
effectively. Wall Street banks as well as foreign banks became 
overleveraged and took on excessive risks, credit rating agencies 
failed to do their job.\2\ There is plenty of blame to go around. 
Congress, the Administration and the Federal Reserve should have done 
more to help and so should the economics profession. Given what has 
happened, there is nothing that Congress can do now that will allow us 
to avoid a recession, and so the goal now is damage control, avoiding a 
deep recession and putting in place the basis for a solid recovery.
---------------------------------------------------------------------------
    \2\ See the Brookings website for links to recent papers on the 
financial crisis and what to do about it.
---------------------------------------------------------------------------
         WHAT CAN POLICYMAKERS DO TO AMELIORATE THE RECESSION?

    Given the economic weakness, there is a strong case for a new 
fiscal stimulus package that would boost spending and offset the chain 
reaction of declining spending and employment. Historically, the use of 
fiscal policy to smooth the business cycle has had a mixed record. It 
is hard to assess where the economy stands, so that fiscal stimulus can 
sometimes have an impact when the economy is already recovering and 
does not need the help. That problem does not apply to the current 
situation. It is clear that the economy is trending down and needs help 
to sustain aggregate demand and private sector employment. The more 
serious objection to a stimulus package is that it will contribute to 
the budget deficit and that is indeed a valid argument, but it does not 
carry the day. If the economy goes into a severe recession, tax 
revenues will fall sharply and the impact on the budget deficit will 
likely be even worse than the impact of the fiscal stimulus. Even if a 
stimulus package creates a net cost to the deficit, that cost is 
worthwhile to avoid the damage of a severe recession.
    How large should the stimulus package be? Assume that there is a 
stimulus passed this fall that injects $100 billion into the economy in 
the first quarter of 2009, and that around 80 percent of this amount is 
spent over the first three quarters of 2009--$40 billion in the first 
quarter and $20 billion in each of the subsequent two quarters. (I have 
used $100 billion as a round number to make the arithmetic easier to 
follow. There is a good case for a larger stimulus package than this.) 
Such a package would add about 1.1 percent to GDP growth in that 
quarter about O.75 percent to the GDP growth rate in the second and 
third quarters of 2009. The overall, the increment to GDP growth in 
2009 would be a little under 0.7 to the growth rate for the year 
(averaging the quarterly effects of 1.1, 0.75, 0.75 and 0.15). A larger 
stimulus package, I assume, would scale up the impact proportionately, 
with a package of $150 billion being 50 percent larger and a package of 
$300 billion having three times the impact.\3\
---------------------------------------------------------------------------
    \3\ The U.S. economy produces and spends about $14 trillion a year 
or $3.5 trillion in each quarter. The first round effect of an 
additional $40 billion in spending, therefore, is to add 1.1 percentage 
points to the GDP growth rate in the first quarter of 2009. That 
increment to growth would drop to 0.55 percentage points in the second 
and third quarters. In a slack economy, a positive increment to 
consumer spending is likely to have a second round effect, as the 
increase in retail sales or other spending puts more money into the 
hands of the workers and businesses that provide the goods and 
services. I assume there would be the equivalent of about another $50 
billion as a secondary effect for each $100 billion of initial 
stimulus. It is hard to know the timing of this secondary effect--it 
would likely be spread over 12 to 18 months after the passage of the 
stimulus package. To get a rough magnitude, I assume that the secondary 
impact would add 0.2 percent to growth in the second quarter of 2009, 
another 0.2 percent in the third quarter, 0.15 in the fourth quarter 
and the rest spread further into the future.
---------------------------------------------------------------------------
    The current Blue Chip consensus forecast says that GDP declined 0.3 
percent in the third quarter of this year and will decline 1.1 percent 
in the fourth quarter. The Blue Chip then says that GDP will decline by 
only 0.1 percent in the first quarter of 2009 and will resume positive 
growth after that. If this Blue Chip forecast is correct, a package of 
$150 billion would boost growth to 1 percent in the first quarter of 
2009, and as high as 2.9 percent in the second quarter. Under this 
scenario, a stimulus of $150 billion seems plenty.
    The Blue Chip consensus is too optimistic and many of the 
forecasters who contribute to this consensus have been revising down 
their forecasts. Consider a pessimistic scenario where there is about a 
4 percent GDP decline in the fourth quarter of this year, about the 
same in the first quarter of 2009, about a 1.5 percent decline in the 
second quarter of 2009, about a 1 percent decline in the third quarter 
and a small positive growth rate in the fourth quarter. I do not think 
we will see a recession quite that bad, but that scenario is not out of 
the bounds of possibility. There is about a 25 percent probability that 
we will see a recession of this severity in the absence of offsetting 
policy actions. Suppose Congress were to enact a stimulus package of 
$300 billion--a number that is around the high end of the current 
debate. This would boost growth but even so there would be a GDP 
decline of 0.7 percent in the first quarter of 2009, followed by 
positive growth of about 0.75 in the second quarter and growth of just 
over 2 percent in the third quarter. The fourth quarter of 2009 would 
remain sluggish unless the stimulus had succeeded in reviving 
consumption. Under this scenario, a $300 billion stimulus would not 
result in buoyant growth in 2009, but it would substantially offset the 
severe recession.
    What are the uncertainties around these estimates? I have assumed 
that 40 cents of each dollar of stimulus is spent in the quarter in 
which the money is received by families and 80 cents is spent over 
three quarters. Some economists will judge these numbers are too high 
and point to the impact of the first stimulus package in 2008 where 
consumption fell in the second quarter and is expected to fall in the 
third, despite the rebate checks. The difficulty with that view is that 
we do not know the counterfactual, what the situation would have been 
without the tax rebates. Very likely, consumption would have been 
significantly lower. Given that American consumers on average have been 
spending nearly all of their disposable income for many years, I find 
it hard to believe that they will save a huge fraction of any 
additional income from a new stimulus package for more than a few 
quarters. Initially, the 2008 tax rebates went into savings accounts or 
to pay off debts, but this strengthening of consumer balance sheets is 
allowing them to weather the economic conditions of today with smaller 
cutbacks in spending.
    It is quite possible, however, that the lags will be longer than 
specified in this example. A stimulus package passed this fall might 
not get money into people's hands until the second quarter of next year 
and the impact of that on spending might be lagged into the latter half 
of 2009 or into 2010. If the Blue Chip forecast turned out to be 
correct and, in addition, it took a while for the stimulus to work, we 
could find that the policy had over-stimulated an economy that was 
already well into recovery. My own judgment is that this recession is 
likely to be prolonged, so I am not too worried about that possibility. 
In addition, monetary policy could act to slow the economy if it turns 
out that it is overheating.
    Given the dangers the economy is facing, I view $150 billion as 
being about the minimum amount that will have a serious impact on 
economic growth in 2009. Given the concerns about the budget deficit 
that I articulate shortly in this testimony, I would not exceed a $300 
billion package. My specific proposal within this range of numbers is 
therefore to prepare a stimulus package in two tranches. The first to 
be enacted immediately would be for $200 billion. The second tranche 
for an additional $100 billion would be ready to go and would be 
enacted on the basis of a trigger. One possible trigger would be that 
if the unemployment rate moves over 7.5 percent, the second tranche is 
released.

              WHAT FORM SHOULD THE STIMULUS PACKAGE TAKE?

    The important factors to consider are well-known to this committee 
and I recommend the analysis of stimulus design provided this spring by 
the Congressional Budget Office. In order to alleviate a recession that 
is already underway, it is important to get the money into the hands of 
Americans quickly and that this addition to income translates into 
additional spending as close to dollar for dollar as possible. Given 
the problem of the exploding budget deficit, it is important that the 
changes be temporary and do not contribute unduly to the worsening of 
the deficit in the long run.
     Stabilizing the Housing Market. The economy will not 
return to sustained economic growth while the housing market continues 
to fall. And there is a two-way interaction between these two factors 
because supporting economic growth will help stabilize the housing 
market. Congress has already agreed to a substantial investment of 
capital into the GSEs to support the mortgage market. And the terms of 
the $700 rescue package allow for the purchase of mortgages as well as 
mortgage-backed assets. Since I do not know how much money it will take 
to recapitalize the banking system, so I am not sure how much is 
available for direct support of the housing market. If there is not 
enough money already approved, then I would urge the Committee to 
support additional funds for families facing default. It is very hard 
to do this without rewarding past misbehavior by either lenders or 
borrowers, but I find attractive the proposal from both Republican and 
Democratic economists to allow households to roll existing mortgages 
into new 30-year fixed rate mortgages available through Fannie and 
Freddie at an interest rate between 5 and 6 percent. These would 
particularly be valuable to families caught in interest rate re-sets to 
high levels, and the pre-payment penalties could be adjusted and rolled 
into the new mortgage, or eliminated altogether. The program would be 
restricted to owner-occupied properties.
     Tax rebates. I urge the committee to pass quickly a new 
tax rebate package. If this were done very quickly, the IRS could use 
the same taxpayer list that was used earlier this year and the money 
would be released this fall. Having the rebates be refundable ensures 
that low and moderate income families get a benefit. The IRS got the 
rebate checks out quickly earlier this year and using this approach is 
simple and quick.
     Unemployment Insurance. This program has traditionally 
been a backstop for the economy, serving as an important automatic 
stabilizer. With the job situation deteriorating there are many workers 
reaching the point where benefits are exhausted and it would make sense 
to extend the duration. Over the years, the fraction of the unemployed 
receiving benefits has declined and women seem particularly 
disadvantaged because they often work part-time. In 1975 Special 
Unemployment Assistance was enacted by a Democratic Congress and signed 
by President Ford to help persons that were not eligible under the 
usual rules. I would support such a program again now, particularly to 
help single mothers or fathers who have lost jobs but are not eligible 
for standard UI benefits and who will find it difficult to qualify for 
welfare. This program should be funded by the federal government and 
not by the states (the program was federally funded in 1975).
     Infrastructure. Many House members are concerned about the 
deplorable state of the nation's infrastructure and would like to 
devote some fraction of the stimulus package to infrastructure 
investment. I share the concerns about the state of our roads and 
bridges, but I am also aware of the objection to using infrastructure 
investment as a stabilization policy because it can be too slow to 
work. There are two ways in which this problem could be overcome: 
First, there is great need for improved maintenance of the 
infrastructure, including crumbling roads that need repair and bridges 
that may age prematurely or even collapse because they have not been 
looked after. Looking after the existing infrastructure is not as 
exciting as cutting ribbons on new projects, but it could generate jobs 
quickly and meet an important need. Second, there are state and local 
projects that are being cancelled because of the short term budget 
pressures. Sustaining such projects would avoid layoffs that would 
otherwise take place.
     Aid for States and Localities. There are many states and 
localities that are feeling tremendous budget pressures because of the 
weak economy and the decline in property tax revenue. Providing 
assistance to them would prevent or ameliorate the cutbacks in spending 
that would otherwise occur.
     General budget assistance, targeted perhaps to states with 
high unemployment and mortgage default rates
     Assistance to sustain Medicaid spending. Some states are 
finding it difficult or impossible to sustain support for health care 
because of budget pressures.
     Business Tax Changes. The marginal rate of corporate tax 
is higher in the United States than in many other countries with whom 
we compete internationally. At the same time, corporations do not pay a 
lot of tax--the average rate of taxation is pretty low. As part of a 
long run package of tax reforms I support the idea of broadening the 
base of corporate tax and lowering the rate. In my judgment, however, 
adjusting business taxes now is not attractive as a response to the 
recession. Capital gains taxes are already low. Investors are staying 
on the sidelines of the stock market because they are concerned about 
market risk and volatility, not because of concerns about the taxes 
they might pay on capital gains. In the past several years, non-
financial corporations have improved their balance sheets and added to 
their cash holdings. It is much more important to get the balance 
sheets of the financial sector into better shape and free up lending to 
businesses and consumers. The fiscal stimulus package is sufficiently 
important, however, that if business tax changes are necessary to 
obtain bipartisan support for the package, I would support them on that 
basis.

 THE THREAT OF INFLATION AND THE FISCAL CHALLENGE: $700 BILLION HERE, 
   $300 BILLION THERE AND PRETTY SOON WE ARE TALKING ABOUT REAL MONEY

    A year or so ago, when the economy was still growing it was clear 
that the problem of chronic budget deficits was real and urgent. We 
have known for years that the population is aging and living longer and 
that Medicare, Medicaid and, to a lesser extent, Social Security were 
going put pressure on the budget for years to come. I support fiscal 
discipline and believe that the federal budget should be balanced on 
average over a period of years. Can we really afford to pay for a 
fiscal stimulus package over and above the $700 billion for the rescue 
package together with the funds for Fannie, Freddie, AIG, and Bear 
Stearns? There are two possible economic arguments for why we might 
find it unwise to expand the deficit for a stimulus package. The first 
would be that it caused a flight from U.S. Treasury securities and 
perhaps a run on the dollar. The second is that it would result in 
inflation. It would take more space than is available to go into these 
issues in depth, but the simple answer is that neither concern is large 
enough to prevent passage of a fiscal stimulus.
    Investors here in the U.S. and around the globe know the fiscal 
situation of the federal government and anticipate the likely expansion 
of the national debt. Despite that, there is no shortage of buyers for 
U.S. Treasuries. The interest rate on 10-year notes is under 4 percent 
and the U.S. dollar has appreciated against the euro in the past year 
and stands now at about $1.34. There has been a ``flight to quality'' 
recently as a result of the crisis and the benchmark of quality remains 
U.S. Treasury securities. I am deeply troubled by the persistence of 
federal deficits, the over dependence on foreign borrowing and the lack 
of a national debate about how to pay for federal spending and how to 
moderate its growth. But letting the economy go into a deep recession 
is not going to solve the long run fiscal challenge facing America. 
Global financial markets will let us borrow to pay for the stimulus 
package and we should go ahead and do that.
    There is a working model of inflation that has guided policymakers 
over the years and its first ingredient is that inflation will increase 
when commodity prices go up and will decrease when these prices 
decline. Commodity prices are set in global markets and are only partly 
under the influence of the state of our own economy or our monetary 
policy. The second ingredient is that inflation will increase when 
there is excess demand in the economy, production capacity is strained 
and labor is in short supply. It will fall when there is slack in the 
economy. The third ingredient is linked by most economists to inflation 
expectations, so that when higher inflation is expected it can actually 
cause higher actual inflation. Of these three ingredients, the first 
two are pointing to an easing of inflationary pressures: commodity 
prices have come down and seem likely to stay well below their peak. 
The U.S. economy already has slack capacity and will have much more in 
the year ahead. For the third ingredient, there have been signs of an 
upward adjustment of inflation expectations, something that has 
troubled the FED in the past year. That seems to be fading, however, as 
the other drivers of inflation ease off. Adding huge amounts to federal 
borrowing is not a good thing for inflation, but that concern is not 
enough to change the case for the stimulus. I am old-fashioned enough 
to think about wage-price spirals as much as expectations, and on this 
score, there is little sign of the kind of wage price spiral that was 
so difficult to deal with in the 1970s. With good productivity growth, 
businesses are not facing an upward push of labor costs.

                               CONCLUSION

    The American economy is in trouble and the balance of risks 
strongly favor a substantial fiscal stimulus. I urge Congress to act on 
this proposal as soon as possible.

    Chairman Spratt. Now, Iris Lav from the Center on Budget 
and Policy Priorities.

                    STATEMENT OF IRIS J. LAV

    Ms. Lav. Thank you for the opportunity to be here today.
    My testimony is focused on why Federal fiscal relief for 
the States is particularly necessary and an effective part of 
the stimulus plan at this time. Now, it doesn't mean that I 
don't think any other things should be part of a stimulus plan 
or would be effective--and I could discuss those in the Q&A. 
But I think the issue of the States is particularly critical, 
and I would like to explore that fairly fully with you, if I 
may.
    So State finances are in pretty dire straits. There are 
about 36 States at this moment that are experiencing fiscal 
stress. If I could have my first slide, please.
    So the stress comes in a couple of pieces. There are 29 
States that, when they enacted their fiscal year 2009 budgets, 
which started on July 1 in most States, they closed gaps, 
deficits of $48 billion that were about 9 percent of these 
States' budgets, huge. Those are the light blue and the orange 
States there.
    But the budgets have soon fallen apart. The revenue 
estimates they used in enacting those budgets turned out to be 
much more optimistic than what is actually happening with the 
economy. So we have 22 States that are again in trouble with 
midyear deficits that most of them have to do something about. 
Those are another $11 billion. Those are the orange and the 
dark blue States, the orange being the ones that have both 
initial and midyear deficits.
    We also have been tracking collection numbers for some of 
the larger States. We have new collection numbers. If I could 
have the next slide, please.
    They are really pretty bad. These are adjusted for 
inflation. You can see that sales tax revenues in particular, 
as consumption has fallen off, have dropped in a lot of 
States--you know, in the 8 and 9 percent range. Florida has had 
a 12 percent drop in sales tax collections. Income tax revenues 
are also down in a large number of States.
    I think most of the States, even though I said there are 22 
States with midyear gaps, these are numbers that have really 
just come out. The September numbers are the ones that really 
drove those down, and they have not taken them into account. So 
further down, those revisions are pretty much inevitable.
    Now, of course, that is this year, and we are not going to 
be done with this problem, with the economic problems, at the 
end of this year. Pretty soon, we get to--governors are right 
now putting together their fiscal year 2010 budgets, and they 
will begin to be debated in January and February. That 
situation looks very bleak. I think that there are 16 States 
that have already announced 2010 deficits, but that number is 
low because most States don't--you know, aren't talking about 
it yet or haven't projected yet.
    If we want to try and think of what is going to happen next 
year, one thing we can do is look what happened in the 
recession in the early part of this decade--if I could have the 
next slide, please.
    Deficits started at about $40 billion in fiscal year 2002, 
but rose to $75 billion in fiscal year 2003 and $80 billion in 
fiscal year 2004.
    Now, in this downturn, economic conditions are worse than 
they were then. That was a relatively mild recession; for 
unemployment, then, peaked at 6.3 percent. It is already 6.1 
percent; pretty much, most forecasters are talking about it 
trending toward 8 percent at this point in time.
    When unemployment goes up, it obviously reduces State 
income taxes. People also lose their health insurance, they 
also come on to Medicaid. They need other services, and that is 
likely to be even greater than in the past. Although, you know, 
there were 6 million new people that came on to the Medicaid 
rolls in the earlier recession, I would anticipate a lot more 
than that now.
    Second, the decline in the stock market this time has 
matched the decline in the last recession by some of the 
measures of markets. It is unclear where the bottom of the 
market is, whether we have reached it, whether we have not. Of 
course, no one knows, and that affects income taxes as well 
through capital gains taxes.
    Third, and very important, is that in the last recession 
consumers used home equity loans--the housing market was 
strong--and other sources of credit to bolster their 
consumption. That is not available to consumers now, to say the 
least. So consumption expenditures and sales taxes are likely 
to fall more steeply. I just showed you how steeply they are 
falling right now.
    So I would estimate--I had made an estimate that, given 
deterioration of revenue and given the history of the last 
recession, that we are looking, going forward, at about $100 
billion in deficits, something in that neighborhood for 2010, 
the upcoming fiscal year.
    Now, those deficits are particularly problematic, because 
unlike a Federal deficit, when a State has a deficit, it leads 
directly to spending cuts and tax increases, which leads to 
reduced demand which further harms the economy. You know, all 
States but one have a requirement to balance their budget, so 
they have to take action. When these revenues go down and the 
demand for services go up, they have very few choices. Under 
the balanced budget requirement, they can do one of three 
things, they can draw down reserves, they can cut spending, or 
they can raise taxes.
    Now, States have been pretty prudent on reserves. They 
entered this, this economic weakness, with the largest reserves 
they had ever had, $69 billion, or 10.5 percent of their 
general fund budgets. They have used down quite a lot of that, 
and they are on the road to being depleted, given this year's 
actions for the purposes of budget balancing.
    Of course, all the reserves are not matched, necessarily, 
in all the States. There is a big chunk of that in Alaska which 
isn't going to have a problem.
    But the other two options States have to balance their 
budgets are cutting spending and raising taxes. As I said, both 
of those intensify the economic downturn. They lay off 
employees, they cancel contracts, they eliminate payments to 
businesses and to nonprofits that provide direct services, cut 
benefits to individuals. Then those people who, in turn, lose 
their jobs have less money to spend on consumption; and you get 
a decline in the economy greater than the budget cut in the 
first place.
    Tax increases, of course, also remove demand from the 
economy, because people in businesses have less to spend.
    Obviously, the Federal Government doesn't have this 
constraint, so it makes great sense, in our federalist system, 
for the Federal Government to try and prevent these 
economically damaging actions. So you will recall, of course, 
that in May of 2003, just before the beginning of State fiscal 
year 2004 there, you enacted a $20 billion fiscal relief 
package. It provided two types of assistance to the States; 
half of it was in the form of an increase in the Federal share 
of Medicaid, technically known as the FMAP, and the other part 
was general grants to States, $10 billion of each kind.
    That was very important in the last recession, but it was 
not enacted until a million people had already lost eligibility 
for Medicaid as States cut back, and States had already made 
deep cuts in K-12 education, raised tuition in public 
universities and community colleges and done a lot of other 
damaging things. In the best of all worlds, it would have been 
enacted before some of those demand reducing cuts were enacted. 
It was criticized by the GAO primarily because it was too late.
    So States have already begun cutting their budgets now. 
About half the States have made budget cuts in public health 
insurance programs, services for the elderly and the disabled, 
K-12 education, et cetera. Eighteen States have cut their 
workforce, and States are poised to make far more drastic cuts 
as they deal with their midyear deficits and enact their 2010 
budget. This is about one of the best forms of stimulus you can 
do, preventing these procyclical cuts.
    I would think this time around that more than $20 billion 
in relief will be necessary. In fact, I would suggest that 
about $50 billion is the right number to be thinking of right 
now. It would be about half the expected deficits for 2010, or 
you can think of it as a third of the combined 2009-2010 
deficits--however, less than a third, however you want to look 
at it. And I would say the majority, perhaps about two-thirds 
of it, should be in the form of increased FMAP, increasing the 
Federal share of Medicaid. That can be used right away. It is 
immediately put to work. We know there are going to be people 
coming rapidly onto the Medicaid rolls. It is the new spending 
that Chairman Bernanke was talking about.
    If you don't do that, and people lose their private health 
insurance, it looks like we might trend to a somewhat shameful 
50 million people uninsured in this country.
    I think the other piece of it should be available, again as 
a block grant, both to prevent cuts in education and programs 
like that; but also one of the things that States cut is aid to 
localities. Local governments also have been having problems, 
and we really don't want the States to be cutting aid to 
localities at this time.
    So people often--when I say this, or when people say this, 
people often raise the question, aren't we creating a moral 
hazard? If the Federal Government goes ahead and helps the 
States, doesn't that give the States license to be less 
responsible with their own fiscal house in good times, knowing 
that the Federal Government might bail them out? I think the 
answer is a very clear no, that is not true.
    The evidence of what has happened before and the evidence 
of what States have done is pretty clear. Between 2001 and the 
today, or even before this downturn started, the beginning of 
this downturn, States have reduced expenditures as a share of 
the economy. States are not bulking up their expenditures in 
any way. They also--you know, their taxes are about the same, 
and States did build up these very substantial rainy-day funds 
that I mentioned.
    So I think that States have a lot of reasons to themselves 
be responsible. We are not talking about the Federal Government 
giving the States everything they need. They are still going to 
have to make very painful cuts.
    I mean, $100 billion is like $1 in every seven States' 
pay--spent from their operating budgets. So it is a huge 
amount, and that is if it was evenly distributed, which--you 
know, it will be more than that in some States.
    I would suggest that this, of course, be temporary, that 
States should be allowed to use the fiscal relief over a 15-to-
18-month period to make sure it is coming in immediately as 
stimulus.
    Finally, I would just say the hallmark of a good stimulus 
is that it is well targeted, temporary and timely. That is sort 
of the same thing I think that Chairman Bernanke said at the 
end, that you really have to make sure it is being spent right 
away and that it is getting where it needs to be and that it is 
temporary.
    Federal fiscal relief fits perfectly into those criteria. 
For this reason, any number of economists have called for 
fiscal relief to the States as the key part of the stimulus 
package, and they include people such as Mark Zandi, Paul 
Krugman, Larry Summers, Jared Bernstein, Alan Blinder and many 
others.
    So I thank you for your consideration.
    Chairman Spratt. Thank you very much.
    [The statement of Ms. Lav follows:]

          Prepared Statement of Iris J. Lav, Deputy Director,
                 Center on Budget and Policy Priorities

    Thank you for the opportunity to discuss with you today why federal 
fiscal relief for states is a particularly necessary and effective part 
of a stimulus plan at this time.
    State finances are in dire straits. At least 36 states are 
experiencing fiscal stress.\1\
---------------------------------------------------------------------------
    \1\ This includes states with deficits that were closed in enacting 
their fiscal year 2009 budgets, states with mid-year gaps, and three 
states (Kansas, Oregon, and Washington) that did not have fiscal year 
2009 deficits but are projecting deficits for fiscal year 2010.
---------------------------------------------------------------------------
     There are 29 states that closed shortfalls of $48 billion 
in enacting their fiscal year 2009 budgets (for the year beginning July 
1, 2008 in most states). The shortfalls equaled 9 percent of these 
states' general fund (operating) budgets.
     Since fiscal year 2009 budgets were enacted, budgets have 
fallen out of balance producing new, mid-year deficits in 22 states and 
the District of Columbia that total more than $11 billion or 4 percent 
of budgets.
     The latest revenue collection numbers suggest that the 
situation is rapidly worsening. Third quarter 2008 sales tax and income 
tax revenue are coming in well below prior year levels and well below 
states' initial projections in most of the states that have released 
figures. These latest figures have not yet been taken into account in 
most states' budget forecasts.
     At least 16 states have announced that they are expecting 
deficits for state fiscal year 2010 that so far total $18 billion, but 
that number is very low because it is very early in the year for most 
states to make such a projection and because revenue collections 
continue to weaken. Deficits during the downturn in the early part of 
the decade reached $75 billion and $80 billion in the second and third 
year of that fiscal crisis, and economic conditions are now projected 
to be significantly worse than they were then. Judging from the rate at 
which revenue is deteriorating and the history of prior recessions, the 
2010 gaps are likely to be in the $100 billion range.
    These state deficits are particularly problematic because, unlike 
the federal deficit, they lead directly to spending cuts and tax 
increases that reduce demand, which further harms the economy.
    Whenever the national economy stagnates or falls into recession, 
state revenues also stagnate or decline. This happens just at the very 
time that states face upward pressure on their budgets as residents 
lose jobs and income and health insurance and become eligible for 
Medicaid or other safety net programs. This produces deficits.
    These state deficits are not like the increase in the federal 
deficit that typically also occurs during a recession. This is because 
all states but one have a requirement to balance their general fund 
(operating) budgets. States with flagging revenues cannot provide even 
the normal level of services--let alone meet the increased demand for 
services and supports.
    Under balanced budget requirements, states have three primary 
actions they can take during a fiscal crisis: they can draw down 
available reserves, they can cut expenditures, or they can raise taxes.
    Most states do keep ``rainy day funds'' and other reserves to try 
to anticipate this problem. States entered this period of economic 
weakness with the largest reserves they have ever had, totaling $69 
billion or 10.5 percent of their general fund budgets at the end of 
fiscal year 2007. But those funds are on the road to being depleted for 
the purpose of budget balancing--and that was before the events of the 
last four weeks that undoubtedly have weakened fiscal conditions in the 
states.
    The other two options states have to meet their balanced budget 
requirements are tax increases and budget cuts. These options both are 
pro-cyclical. That is, they intensify the economic downturn rather than 
help the economy recover.
    The spending cuts and tax increases states make when they must 
balance their budgets under conditions of falling revenue can further 
slow a state's economy during a downturn and contribute to the further 
slowing of the national economy, as well. When states cut spending, 
they lay off employees, cancel contracts with vendors, eliminate or 
reduce payments to businesses and nonprofit organizations that provide 
direct services, and cut benefit payments to individuals. In all of 
these circumstances, the companies and organizations that would have 
received government payments have less money to spend on salaries and 
supplies, and individuals who would have received salaries or benefits 
have less money for consumption. This directly removes demand from the 
economy.
    Tax increases also remove demand from the economy by reducing the 
amount of money people and businesses have to spend.
    In contrast to the states, the federal government can run a 
deficit, and it does not have to take the actions damaging to the 
economy (and to low- and middle-income families needing state services) 
that state balanced budget requirements force on states during 
recessions. Thus, one of the best ways to stimulate the economy in a 
downturn is for the federal government to provide short-term, 
additional funding to states.
    You will recall that in 2003, you enacted a $20 billion fiscal 
relief package for states. It provided two types of assistance to 
states: 1) a temporary increase in the federal share of the Medicaid 
program; and 2) general grants to states, based on population. Each 
part was for $10 billion.
    While extremely important, the 2003 fiscal relief package was not 
enacted until after 1 million people lost eligibility for Medicaid 
because of state cutbacks, and deep cuts had been made in K-12 
education, child care, state workforces, and a variety of other areas. 
In the best of all worlds, it would have been enacted before those 
demand-reducing cuts were made.
    States already have begun cutting their budgets; about half of the 
states have made cuts in public health programs, services for the 
elderly and disabled, K-12 education, or universities and colleges. At 
least 18 states have cut their workforce. And states are on the verge 
of making far more drastic cuts as they deal with their mid-year 
deficits and begin to enact fiscal year 2010 budgets.
    There is the opportunity to prevent many of these damaging actions 
through providing fiscal relief. Preventing these pro-cyclical state 
actions is among the best forms of stimulus you could provide, because 
it both prevents budget cuts to programs that are needed by people who 
are losing jobs and incomes in this recession, and prevents state 
actions from worsening the economy.
    This time around, however, it seems that much more than $20 billion 
in relief will be necessary.
     To stop the most damaging of the budget cuts, fiscal 
relief of approximately $50 billion would be needed. This would be 
about one-half of the expected deficit for state fiscal year 2010 (or 
less than one-third the combined deficits for state fiscal years 2009 
and 2010).
     The majority of the fiscal relief ($30 billion to $35 
billion) would be most effective as an increase in the federal share of 
the Medicaid program (FMAP), accompanied by a ban on states reducing 
eligibility in that program and thereby driving up the ranks of the 
uninsured. Without such assistance, the number of uninsured in this 
country could rise to 50 million.
     The remainder of the relief could be made available to 
prevent cuts in education and other critical state programs, as well as 
to lower the likelihood that states will cut aid to localities.
    Federal fiscal relief of $50 billion would provide a substantial 
stimulus by averting that amount of pro-cyclical actions by states that 
otherwise would be inevitable. It would be sufficient to prevent many 
of the state budget cuts that would be most harmful to low- and 
moderate-income households, including the newly unemployed. But, 
relative to the size of the deficits, it would not create a ``moral 
hazard'' that could in any way induce states to be less responsible 
with their own finances. The need to amass substantial ``rainy day 
funds'' and other reserves during strong economic times would remain.
    I would stress that the payments to states would be temporary. 
States should be allowed to use fiscal relief over a 15 month or 18 
month period after enactment.
    The hallmark of a good stimulus is that it is well-targeted, 
temporary, and timely. Federal fiscal relief to the states fits well on 
all of those dimensions. For these reasons, a number of economists have 
called for fiscal relief to the states to be a key part of a stimulus 
package, including Mark Zandi, Paul Krugman, Laurence Summers, Jered 
Bernstein, and Alan Blinder, among others.
    The following reviews some of the details of the current situation 
and the case for fiscal relief.

                        STATE FISCAL CONDITIONS

    When states project deficits--gaps between projected revenue and 
projected spending--for an upcoming fiscal year, they have to take 
action to close those deficits. As noted above, 36 states are already 
experiencing fiscal stress. Twenty-nine states closed shortfalls of $48 
billion in enacting their fiscal year 2009 budgets. In many states, 
however, the revenue estimates used to project their budget shortfalls 
were still far too optimistic; the economy has seriously deteriorated 
since those budgets were enacted. As a result, budgets have fallen out 
of balance producing new, mid-year deficits in 22 states and the 
District of Columbia that total more than $11 billion or another 4 
percent of budgets\2\ (See Figure 1.) And that is a snapshot of the 
situation last week. Virtually every day, additional states are 
announcing shortfalls or increasing their estimate of the size of their 
shortfalls.
---------------------------------------------------------------------------
    \2\ The gaps are 4 percent of the budgets of the 20 states that 
have provided specific estimates. There are no estimates for California 
and Illinois.



    States are just beginning to release revenue collection data for 
the 3rd quarter of 2008 (which is the first quarter of fiscal year 2009 
in most states). The sales tax data certainly reflects the slump in 
retail sales and consumption, while the income tax data reflects, among 
other factors, the increase in the unemployment rate.
    There are revenue declines in most of the states that have released 
data. For example, sales tax revenues for the third quarter 2008 
compared to the third quarter 2007 are down 8.8 percent in California, 
12.1 percent in Florida, 8.0 percent in Georgia, 7.3 percent in 
Massachusetts, and 8.5 percent in Missouri, after adjustment for 
inflation. (See Table 1.)



    Looking ahead to 2010, it is difficult to overstate the fiscal 
problems states will face. It seems increasingly likely that this 
recession will be more severe than the last recession, and thus state 
fiscal problems are highly likely to be worse than they were in 2003 
when fiscal relief was last enacted.
    This is true for at least three reasons:
     Unemployment, which peaked after the last recession at 6.3 
percent, has already reached 6.1 percent, and many economists expect it 
to rise to 7 percent or even 8 percent. This would reduce state income 
taxes, and increase participation in Medicaid and other services, to a 
greater degree than in the past.
     The decline in the stock market now has matched the 
decline in the last recession by some measures and may yet fall 
further. This affects states' capital gains taxes, which in many states 
are a major component of income taxes.
     Consumers' access to home equity loans and other sources 
of credit is far less than it was in the last recession, so consumption 
expenditures and therefore sales taxes are likely to fall more steeply 
than in the past.
    Even though this recession and fiscal crisis is likely to be 
considerably deeper than the one at the beginning of the decade, it is 
still instructive to look at what happened in that prior recession. 
That recession was relatively short and mild, yet created large state 
fiscal deficits over a four-year period. The fiscal year 2002 deficit 
was $40 billion, but it rose to $75 billion in 2003 and $80 billion in 
2004.
    This year, the deficit for the first year of the fiscal crisis, 
fiscal year 2009, is $59 billion and still growing.\3\ (See Figure 2)
---------------------------------------------------------------------------
    \3\ This includes the deficits states closed in enacting their 2009 
budgets and the mid-year deficits for which there are estimates.



    Some 16 states have already announced that they face deficits they 
will have to close in enacting their fiscal year 2010 budgets.\4\ Ten 
of those states have estimated the size of those gaps for a total of 
$18.2 billion. As additional states announce gaps, and the size of the 
gaps are reevaluated for deteriorating economic conditions, the size of 
the 2010 gap will grow substantially. The 2010 gap is likely to be in 
the range of $100 billion--or even more if the economy experiences 
additional deterioration between now and then.
---------------------------------------------------------------------------
    \4\ They are Alabama, Arizona, California, Connecticut, Florida, 
Hawaii, Kansas, Maine, Maryland, Minnesota, New York, Oregon, Vermont, 
Virginia, Washington, and Wisconsin.
---------------------------------------------------------------------------
    Under state balanced budget constraints, deficits of this size 
inevitably mean very large cuts in Medicaid, education, and other vital 
programs. If the deficits were evenly spread over the states, $100 
billion would represent about 14 percent of state general fund 
expenditures.

                              BUDGET CUTS

    In the last recession, 1 million people lost health insurance 
because of cutbacks in Medicaid and SCHIP in 34 states. In addition, 
one-third of the states cut child care subsidies or otherwise limited 
access to child care, two-thirds cut per-pupil expenditures for K-12 
education, and most raised tuition at public colleges and universities. 
Aid to local governments for functions other than education also was 
cut in many states, which led local governments to scale back services 
on which low- and middle-income people rely.
    The worst of the budget cuts generally come in the second or third 
year of a state fiscal crisis, and that pattern is likely to hold this 
time around. That is because in the first year of an economic slowdown, 
states can draw down rainy day funds and reserves. They also can take 
actions such as instituting hiring and travel freezes, as well as 
finding items in their budget that are more marginal to their core 
functions.
    So far this year, about half the states have enacted budget cuts 
that affect low- and moderate-income people--reductions in funding and 
services in public health programs, services for the elderly and 
disabled, K-12 education, or universities and colleges. While these 
reductions are quite serious to anyone who is hit by them, they are not 
yet at the devastating level seen in the last recession or the even 
deeper cuts in some previous recessions.
    For example, in enacting its fiscal year 2009 budget, Rhode Island 
eliminated health coverage for 1,000 parents and will require 7,800 
low-income families to pay higher monthly premiums for public insurance 
(which is likely to result in some who cannot afford the premiums 
becoming uninsured). States such as Arizona and California are reducing 
their Medicaid rolls by increasing the frequency with which some 
recipients must reapply for benefits, which research suggests will 
cause eligible people to become uninsured. On another front, tuition at 
state universities and community colleges has been increased in at 
least 11 states, with increases ranging from 4 percent to 15 percent. 
Rhode Island, for example, hiked community college tuition by 14.3 
percent. Tuition increases such as these affect the ability of students 
with limited means to attend college.
    As states cope with the reality that the economic assumptions they 
used in enacting their fiscal year 2009 budgets were too optimistic, 
they are poised to make another round of budget cuts for the current 
fiscal year. Cuts are in the process of being made in Maryland, 
Massachusetts, Virginia, Utah, and Georgia. Another set of states are 
getting ready to consider cuts, including South Carolina, New Jersey, 
Connecticut, New York, New Hampshire, Florida, Nevada, Arizona, and 
California. These states either have scheduled special legislative 
sessions after the elections to make additional cuts, or will be doing 
so through executive powers.
    It will not be long, however, before states will begin to 
deliberate their fiscal year 2010 budgets in early 2010. It is in those 
budgets--as states cope with what is likely to be $100 billion in 
deficits after they have already taken all of the ``easier'' actions--
that the most damaging cuts will occur. Since portions of state 
budgets, such as courts, corrections, public safety and homeland 
security, and others cannot be cut or cut much, states budget cuts 
typically fall on health care, education, and aid to local governments.
    Some of the deepest cuts are likely to occur in state health 
programs, particularly Medicaid and SCHIP, as they did in the last 
recession. Medicaid is often high on the list when states need to make 
budget cuts. Unlike aid to schools, for example, which generally is 
committed at the beginning of the school year, Medicaid is a program 
that is spent monthly. A change in Medicaid in any month will affect 
expenditures for the remainder of the fiscal year. And since Medicaid 
costs generally rise rapidly as enrollment is boosted by people losing 
jobs and income, it becomes a target for cuts. With the number of 
uninsured already 46 million in 2007, the combination of people losing 
jobs and some businesses dropping health insurance to try to stay 
afloat, the number of uninsured could reach 50 million if public 
program cut eligibility or cannot finance insurance for those newly 
eligible for Medicaid and SCHIP.
    Education is also a major concern. In the last recession, we saw 
new or higher fees for textbooks and courses, shorter school days, 
reduced personnel, and reduced transportation. States or school 
districts took actions that resulted in teacher layoffs and larger 
classroom sizes, or eliminated offerings such as music, enrichment 
programs and the like--all of which arguably affect the quality of the 
education children receive. And, as noted above, when tuition at 
universities and community colleges are increased, it reduces the 
ability of students from low- and moderate income families to access 
higher education.

                            SIZE OF STIMULUS

    We estimate that federal fiscal relief to states should total about 
$50 billion. This would be about one-half of the expected deficit for 
state fiscal year 2010 (or less than one-third the combined deficits 
for state fiscal years 2009 and 2010 and probably an even smaller 
fraction of total deficits states will face, since fiscal problems are 
likely to continue into sates fiscal year 2010).
    The number $50 billion sounds like a lot, particularly compared to 
the $20 billion provided in the last downturn. This downturn is likely 
to be considerably deeper than the one in the early part of the decade, 
with higher unemployment, greater drops in consumption, and the 
additional factor of the housing sector weakness. Deficits will be 
larger, and more aid is needed.
    Some people raise the issue of whether a large federal payment to 
the states raises the specter of ``moral hazard.'' Some may ask 
whether, if the federal government provides aid to states in a 
recession, this will create a moral hazard problem in which states 
overspend, cut taxes too much, and/or fail to build up ``rainy day'' 
funds during periods of economic growth because they expect the federal 
government to bail them out when an economic downturn comes.
    It is highly unlikely that the $50 billion would create a moral 
hazard, because it would be far from the total amount of deficit states 
have to close. They still will have to take actions that negatively 
affect their residents--actions most policymakers are quite loathe to 
take. The need for such actions provides a significant incentive to 
states to be prudent and save funds during the next economic expansion.
    Moreover, the evidence suggests that the federal fiscal relief 
provided in the past did not have this effect. The federal government 
provided such relief in the last downturn, and states have not 
overspent or slashed taxes since then in the expectation that they 
would be bailed out during future downturns. On average, state 
expenditures as a share of the economy at the beginning of the current 
downturn were lower than they were in state fiscal year 2001, while 
state taxes as a share of the economy were at about the same level. In 
addition, states built up substantial ``rainy day'' reserve funds to 
draw upon in a downturn; at the end of 2006, those reserves were 
actually a little larger, as a share of annual state expenditures, than 
before the recession at the start of this decade.
    The problem is that recessions can have such large effects on state 
budgets that they tend to wipe out rainy day reserves and produce 
sizeable shortfalls. For example, states began this decade with 
reserves equaling 10.4 percent of annual expenditures, a quite 
substantial amount. But these reserves closed only about one-quarter of 
the state budget gaps that opened up through state fiscal year 2003. 
Rainy day fund and other reserve balances in the current economic 
crisis are no where near enough to plug the deficits.

                            FORM OF STIMULUS

    The majority of the fiscal relief would be most effective as an 
increase in the federal share of the Medicaid program (FMAP), together 
with a ban on states from reducing eligibility in that program.
    Cuts in Medicaid not only hurt people who become uninsured, but 
also generally result in reductions in payments to providers--which in 
turn can lead to reduced staffing and reductions in demand for goods 
and services in the state. An increase in the FMAP tied to maintenance 
of effort provision can avert the most damaging of such cuts.
    An increase in the FMAP also provides particularly timely and 
effective stimulus. States, most of which will have rising Medicaid 
costs as people losing jobs and income come onto the rolls, can 
immediately use the funds from an increased FMAP to pay those costs. 
There is no need to develop projects, go through an appropriation 
process, or even have the legislature in session. This makes the FMAP a 
particularly good vehicle for stimulus.
    Going forward, states could probably absorb $30 billion to $35 
billion in enhanced FMAP. $30 billion would represent approximately 20 
percent of state Medicaid spending.\5\ In the last recession, Medicaid 
enrollment increased by 17 percent and arguably would have increased by 
about 20 percent if states had not drastically cut enrollment prior to 
receiving federal fiscal assistance.\6\ Since this recession is likely 
to be deeper and more prolonged than the one at the beginning of the 
decade, $30 billion to $35 billion seems like a reasonable number to 
assist states in handling increased caseloads and costs, to prevent 
large-scale increases in the number of uninsured, and to avoid the 
fiscal drag on the economy.\7\
---------------------------------------------------------------------------
    \5\ State Medicaid spending in federal fiscal year 2008 is 
estimated to be roughly $156 billion in fiscal year 2008. $30 billion 
is just under 20 percent of state spending. CBPP calculations based on 
CBO March 2008 Medicaid baseline.
    \6\ Enrollment was 35.7 million in December 2001 and 41.8 million 
in December 2004--a 17 percent increase. If one adds back the 
approximately 1 million people who lost eligibility for Medicaid prior 
to enactment of the fiscal relief, the increase would be 20 percent. 
Data from Kaiser State Health Facts.
    \7\ Two factors cause Medicaid to increase during a downturn. As 
unemployment rises, more people need Medicaid. The Urban Institute 
estimates 1 percent point increase in the unemployment rate equals 1 
million additional Medicaid enrollees. Jon Gruber estimates it at 1.2 
million enrollees. In addition, the increase in health care costs 
continues to erode employer-based insurance, especially when businesses 
have low profitability or losses, which adds to the Medicaid rolls.
---------------------------------------------------------------------------
    The other $20 billion (or $15 billion) should be provided as a 
flexible block grant. This could prevent cuts in education and social 
services--which lead to reductions in employment in the government and 
nonprofit sectors and create a drag on the economy. It also could 
lessen the tendency of states to cut their aid to local governments in 
recession. A number of local governments also have revenue problems or 
soon will because of declining housing values and property taxes and 
are likely to impose cuts on public services.
    Earlier this year, when fewer states were facing fiscal stress, the 
Center has released reports suggesting that fiscal relief might be 
targeted on states that are experiencing the most economic stress, as 
measured by changes in employment, foreclosures, and food stamp rolls 
(as a proxy for changes in poverty).\8\ In particular, it was clear 
that energy- and commodity-rich states were benefiting from 
extraordinarily high prices for those goods and were not experiencing 
fiscal problems. These states included West Virginia, Louisiana, Texas, 
New Mexico, North Dakota, Montana, Wyoming, and Alaska. As U.S. and 
world demand has weakened in the last month, however, it appears that 
those high prices will be declining; the price of oil has already 
dropped from a peak of $145 a barrel to the $70 range. As a result, it 
is likely that fiscal distress will ultimately reach most states if 
present trends continue. It may no longer be necessary to use the type 
of targeting we had earlier suggested, or it may make sense to target 
one type of the assistance but not the other.
---------------------------------------------------------------------------
    \8\ See, for example, Iris Lav, Jason Levitis, and Edwin Park, 
House Stimulus Plan Effectively Targets Fiscal Relief to States, Center 
on Budget and Policy Priorities, September 26, 2008. http://
www.cbpp.org/9-26-08sfp.htm
---------------------------------------------------------------------------
                                 TIMING

    In the last recession, federal fiscal relief for states was enacted 
at the end of May, 2003, just before the beginning of state fiscal year 
2004. As the year-by-year deficit chart shows, states had already been 
coping with deficits and enacting budget cuts for two years before the 
federal fiscal relief was enacted. By the time federal relief was 
enacted, for example, 1 million people had already lost eligibility for 
public health insurance programs. The relief specified that no further 
eligibility reductions could be made, so it undoubtedly prevented 
additional deterioration.
    It would be far better to enact fiscal relief now, before states 
make the deep cuts that otherwise will be inevitable as they enact cope 
with mid-year deficits and particularly as they enact their state 
fiscal year 2010 budgets (for the year beginning July 1, 2009 in most 
states) in the first part of 2009.

    Chairman Spratt. Dr. Beach. Thank you for coming.

                 STATEMENT OF WILLIAM W. BEACH

    Mr. Beach. Thank you very much, Mr. Chairman, Mr. Ryan, 
members of the committee, it is a pleasure to be with you this 
morning.
    My name is Bill Beach, and I am the Director of the Center 
for Data Analysis at The Heritage Foundation.
    We are at an odd moment in the evolution of these economic 
challenges. There is great hope, but little evidence, that the 
credit market fixes will work. There is increasing concern, but 
again, little evidence to date that the financial crisis will 
push the general economy into a severe recession.
    My own sense is that we have passed into a recession that 
could become significantly worse and long lived if Congress and 
other governments make wrong or ineffective policy moves. 
Recessions that start in credit markets last longer than those 
that stem from shocks to aggregate demand or supply. This one 
looks like it could be with us for a long while unless we do 
highly effective things to reduce its impact.
    The question now is, what should Congress do. Congress 
obviously should do nothing to harm the economy. I always say 
that in my testimony.
    It should let the Federal Reserve lead the effort to 
stabilize economic activity. It should keep its focus on 
crafting long-term, pro-growth economic policy. Most 
importantly, Congress should make no change to basic policies 
that would signal increases in risk either through raising 
taxes or through increasing burdensome regulations.
    It also should be extremely wary of any legislation that 
could in any way be interpreted as America withdrawing from 
international product or capital markets. Congress can ill 
afford to repeat the awesome errors of its predecessor in the 
early days of the Great Depression and retreat from the world 
economic stage.
    I recommend that Congress address economic policies in 
three interrelated areas, all of which affect near- and long-
term economic performance. I will speak about the first two of 
these three--tax policy, energy policy and long-term spending.
    There are areas of economic policy where congressional 
action can be timely and targeted, though it may not intend to 
be short range in focus at all. Those areas involve the 
reduction of investment risk.
    What can increase risk? Many factors, of course, but public 
policy commonly looms large. Tax increases, especially if they 
land on capital, increase the cost of capital and lower 
investment returns. When investors are uncertain about whether 
taxes will go up or stay the same, they still can act as though 
taxes have risen if they judge the risk of an increase to be 
nearly equal to an actual increase. Rising uncertainty can have 
the effect of driving down investments in riskier takings.
    So here is what I recommend on the tax side, and I know 
that this is something that can be timely and targeted, but I 
don't know temporary. Make the tax reductions of 2003, 2001 and 
2003, permanent. Thus, among the first things that Congress can 
do to address the current slowdown is to pronounce definitively 
on the tax increases scheduled for 2009 and 2011.
    There are projects, new businesses, expansions of existing 
businesses that would be undertaken today if Congress signaled 
that taxes would be lower in 3 years. Since nearly all major 
capital undertakings last beyond this 3-year period, it is 
likely that making all or more of the Bush tax deductions 
permanent would stimulate economic activity today, as well as 
in 2011.
    Accelerated depreciation: In addition, we know from past 
experience that accelerating the tax depreciation of capital 
equipment and buildings for--or 1-year expensing of business 
purchases that otherwise would be depreciated over a longer 
period of time is a good way to stimulate the economy. This was 
certainly the record in the last slump. Democrats and 
Republicans have commonly supported this approach.
    Look at taxes on capital gains and dividends: We also have 
recent experience with reducing the tax rate on long-term 
capital gains and dividend income. If Congress were to reduce 
these tax rates by 50 percent or more in the next 2 years, the 
cost of capital to businesses would fall and investment 
stability would be enhanced. Indeed, if Congress were to 
approve a temporary zero capital gains tax rate on new stock 
issues, troubled banks could raise more of the capital they 
desperately need without having to go every day to the Treasury 
Department.
    Lower the corporate profits tax: In one area of fundamental 
public policy there is now universal agreement that our Federal 
business taxes are far too high. The tax rate on corporate 
profits is the second highest in the world.
    Why is it not the firm policy of this committee and this 
government and this country to make certain that the corporate 
profits tax is always below the average corporate income tax of 
other industrialized companies. Such a policy would enhance our 
competitive standing worldwide and significantly reduce the 
incentive for U.S. firms to relocate to lower countries--lower-
tax countries.
    If Congress were to make the tax reductions of 2001 and 
2003 permanent and lower the corporate profits tax from 35 to 
25 percent, I estimate the following economic effects would 
ensue. This is done from a model of the U.S. economy which is 
in widespread use throughout the government and the private 
sector.
    More jobs: By making the 2001 and 2003 tax deductions 
permanent and reducing the corporate profits tax by 1,000 basis 
points, an annual average of 2.1 million more jobs would be 
created. Indeed, over the 10-year period for which these 
forecasts apply, 3.4 million more jobs would be created above 
baseline--current-law baseline in 2018.
    These tax moves would dramatically increase the level of 
national output. The growth rate of the economy would increase 
by a full half percentage point in 2011 and 2012 when taxes 
will otherwise increase under current law. The annualized 
growth rate jumps by three-tenths of 1 percent, and, on 
average, gross domestic product averages $284 billion more over 
the forecast window.
    These tax changes dramatically improve household income, 
partly because the economy is so much better and partly because 
the average tax burden falls. The average household would have 
an additional $5,138 to spend or save after paying taxes. By 
2018, that amount rises to $9,700 additional after-tax dollars.
    Let me just say something quickly about energy policy 
because it is also related to getting the economy moving. 
Rapidly increasing prices for gasoline and petroleum-based 
energy generally slowed the economy and made the economy more 
vulnerable to the economic setbacks that we are having today. 
If Congress acts to expand energy supplies, looking--the 
forward-looking prices will fall and economic activity will 
shed off the drag that stems from that sector.
    Let me illustrate in closing. Economists working with me in 
my Center for Data Analysis at Heritage estimated the economic 
effects of a $2 increase in retail unleaded gasoline. We have 
just experienced such an increase over the past 14 months. We 
found that total employment falls by 586,000 jobs, after-tax 
personal income falls by $532 billion, personal expenditures 
consumption fall by $430 billion, and significant personal 
savings are spent to pay for the increased cost of gasoline. 
Those are the damages that were done when the gasoline prices 
were rising rapidly upward.
    A resumption of world economic growth might again fuel 
those increases. So look to the energy policy as one handle 
that you can use in stimulating the economy.
    Thank you very much.
    Chairman Spratt. Thank you very much.
    [The statement of Mr. Beach follows:]

           Prepared Statement of William W. Beach, Director,
           Center for Data Analysis, the Heritage Foundation

    The stock market turmoil that has captured everyone's attention is 
rooted in the ongoing crisis in credit markets and aggravated by the 
slowdown in general economic activity that stems from the ills of the 
financial sector. It is all the more spectacular by the extraordinary 
highs and lows that equity markets are recording. It almost seems that 
the only thing truly predictable about today's investment markets is 
just how unpredictable they have become.
    Yet, the current situation on Wall Street and in bourses all around 
the world is not altogether new territory. We have seen amazing changes 
in stock market indexes before, and we have seen recovery in each 
instance. What is new to everyone except the very few who can remember 
market activity during the early 1930s is the high level of risk 
aversion that surrounds virtually every transaction. The LIBOR/Fed 
funds spread, a reliable measure of risk, has reached record levels in 
the past four weeks; and the Federal Reserve lost all control of their 
Fed funds target rate in the middle of September and has failed so far 
to recapture it. (See Figures 1, 2 and 3 attached). Despite some of the 
boldest moves ever made by the government of the United States to tame 
these fears, a high intolerance to risk continues.



    We're at an odd moment in the evolution of these economic 
challenges: there is great hope but little evidence that the credit 
market fixes will work; and there is increasing concern but, again, 
little evidence that the financial crisis will push the general economy 
into a severe recession. My own sense is that we have passed into a 
mild recession that could become significantly worse and long-lived if 
Congress and other governments make wrong or ineffective policy moves. 
Recessions that start in credit markets last longer than those that 
stem from shocks to aggregate demand or supply. This one looks like it 
could be with us for a long while unless we do highly effective things 
to reduce its impact.
    There also is an increasing awareness that the roots of the current 
crisis are firmly planted in public policy mistakes, which includes 
excessive liquidity produced by decisions by the Federal Reserve. The 
engaged public appears to understand that staunching the current flow 
of bad economic news requires that the root causes of this crisis be 
dealt with. Congress and the past two administrations bear 
responsibility for expanding the spectrum of home mortgages into 
segments of the population that were not ready for the financial 
responsibilities of mortgage credit. The Fed bears responsibility for 
fueling the feverish pace of speculation surrounding mortgages, and 
regulatory bodies must own up to their failure to rein in these market 
excesses.
    Congress also finds itself at the center of debate over how best to 
respond to the deepening economic slowdown. Indeed, there is widespread 
expectation that the House and Senate will send the President 
legislation very soon to stimulate the economy. Many who find 
themselves out of work or have seen their incomes or businesses decline 
doubtless look forward to congressional action. The question now is, 
what should Congress do?
    As I will argue later in my testimony, Congress obviously should do 
nothing to harm the economy; it should let the Federal Reserve lead the 
effort to stabilize economic activity; and it should keep its focus on 
crafting long-term, pro-growth economic policy. Most importantly, 
Congress should make no change to basic policies that would signal 
increases in risk either through raising taxes or through increasing 
burdensome regulations. It also should be extremely wary of any 
legislation that could in any way be interpreted as America withdrawing 
from international product or capital markets. Congress can ill afford 
to repeat the awesome errors of its predecessor in the early days of 
the Great Depression and retreat from the world economic stage.
    Congress should take this moment of slow growth to do what it does 
best: set broad economic policy. In this instance, Congress should 
concentrate on signaling to investors and workers alike that its 
principal focus will be on improving pro-growth economic policy, mainly 
in the areas of tax, regulatory, and spending policies. Serious work by 
the Congress in these areas will create greater predictability for 
investors and business owners and assure workers that they will have a 
better chance of improving their wages through increased productivity. 
Efforts to enhance the long run may very well have immediate, short-run 
benefits as economic decision makers reduce the risk premium they place 
on starting new businesses or expanding existing enterprises.



    I recommend that Congress address economic policies in three 
interrelated areas, all of which affect near- and long-term economic 
performance: (1) tax policy, (2) energy policy, and (3) long-term 
spending.
    Nearly every significant general slowdown in economic activity is a 
good time for congressional policymakers to ask: Are we doing 
everything we can to support long-term economic growth? That is, 
slowdowns are good times to get back to policy fundamentals and make 
certain that everything Congress can do to allow the economy to grow 
has been done.
    I am convinced the Congress is not the best policymaking body for 
addressing the short-run challenges of the economy. That role is better 
played by the Federal Reserve System. So much of what Congress does is 
tied to the budget and appropriation processes, which take time to 
reach legislative results. Moreover, Members of Congress frequently do 
not have the time or background for keeping up with financial markets, 
the ebb and flow of economic data, and the actions of economic 
institutions the way the Fed does, or even as the economic agencies of 
federal and state governments do. These institutional factors explain 
why congressional action often occurs after the need for action has 
expired and why the actions it takes often are not as targeted as they 
need to be.
    However, there are areas of economic policy where congressional 
action can be timely and targeted, though it may not intend to be 
short-range in focus at all. Those areas involve the reduction of 
investment risk.
    Investors are driven, in general, by comparative rates of return 
when making investment decisions between various opportunities. If two 
business opportunities are possible but one has a better rate of return 
than the other, then the investor will go with the superior 
opportunity--the one with the higher rate of return. Suppose, though, 
that outside factors intervene (a flood, war, regulatory changes) and 
this otherwise superior investment now carries more risk than the 
inferior one. The investor discounts the rates of return for the 
greater amount of risk, and if the rate of return on the first 
opportunity is still superior, the investor goes with that same 
opportunity. If, on the other hand, the risk is too great to go with 
the otherwise superior opportunity, the investor may take the more 
cautious approach of avoiding risk and placing funds in the opportunity 
with the otherwise lower rate of return.

                           TAX POLICY CHANGES

    What can increase risk? Many factors, of course, but public policy 
commonly looms large. Tax increases, especially if they land on 
capital, increase the cost of capital and lower investment returns. 
When investors are uncertain about whether taxes will go up or stay the 
same, they still can act as though taxes have risen if they judge the 
risk of an increase to be nearly equal to an actual increase. And 
rising uncertainty can have the effect of driving down investments in 
riskier undertakings.
    Make the tax reductions of 2001 and 2003 permanent: Thus, among the 
first things Congress can do to address the current slowdown is to 
pronounce definitively on the tax increases scheduled for 2009 and 
2011. There are projects, new businesses, and expansions of existing 
businesses that would be undertaken today if Congress signaled that 
taxes would be lower in three years. Since nearly all major capital 
undertakings last beyond this three-year period, it is likely that 
making all or most of the Bush tax reductions permanent would stimulate 
economic activity today as well as in 2011.



    I am probably not the only one here today who knows of businesses 
that are preparing now for higher taxes in 20ll. They are preparing 
themselves by reducing their riskier projects and providing for 
stronger cash flows in 2010. It is altogether possible that there are 
projects being cancelled today that would otherwise go forward if taxes 
were not scheduled to rise in 2011. At times like the present, the 
speech of policymakers is as important as the policy actions they take. 
The decision makers in business and investment are watching Washington 
closely to discern the direction Congress will take in responding to 
this crisis. If that direction includes tax increases, then investors 
will find more favorable economies to support and business owners will, 
as much as they can, locate their expanded activities in places with 
more favorable tax regimes.
    Thus, Congress should signal today what it plans to do on taxes in 
two or three years. For my part, I urge the Congress to make permanent 
the key provisions of the 2001 and 2003 tax law changes. Maintaining 
lower tax rates on labor and capital income will encourage both labor 
and capital to work harder now when we need that greater activity.
    Accelerated depreciation: In addition, we know from past experience 
that accelerating the tax depreciation of capital equipment and 
buildings or one-year expensing of business purchases that otherwise 
would be depreciated over a longer period of time for tax purposes can 
help during periods of slow growth. This was certainly the record in 
the last slump.\1\
---------------------------------------------------------------------------
    \1\ Matthew Knittel, ``Corporate Response to Accelerated Tax 
Depreciation: Bonus Depreciation for Tax Years 2002--2004,'' U.S. 
Department of the Treasury, Office of Tax Analysis, Working Paper No. 
98, May 2007, Office of Tax Analysis, U.S. Department of Treasury.
---------------------------------------------------------------------------
    Taxes on capital gains and dividends: We also have recent 
experience with reducing the tax rate on long-term capital gains and on 
dividend income. If Congress were to reduce these tax rates by 50 
percent for the next two years, the cost of capital to businesses would 
fall and investment stability would be enhanced. Indeed, if Congress 
were to approve a temporary zero capital gains tax rate on new stock 
issues, troubled banks could raise the more of the capital they 
desperately need without having to go to the Treasury Department.
    Lower the corporate profits tax: In one area of fundamental tax 
policy there now is nearly universal agreement: our federal business 
taxes are far too high. The tax rate on corporate profits is the second 
highest in the world. Why is it not the firm policy of the government 
of this country to make certain that the corporate profits tax is 
always below the average corporate income tax of other industrialized 
countries? Such a policy would enhance our competitive standing world 
wide and significantly reduce the incentive for U.S. firms to relocate 
to lower tax countries.
    The current high rate affects the location decisions of businesses 
that end each tax year with taxable income and every business decision 
by taxable and non-taxable corporations who estimate the costs of 
buying new equipment and expanding operations. Congress should follow 
the lead of its Ways and Means Chairman and decrease the income tax on 
corporations. In fact, it should dramatically drop that rate.
    If Congress were to make the tax reductions of 2001 and 2003 
permanent and lower the corporate profits tax from 35 to 25 percent, I 
estimate the following economic effects would ensure:
     More jobs: By making the 2001 and 2003 tax reductions 
permanent and reducing the corporate profits tax by 1000 basis point, 
an annual average of 2.1 million more jobs are created. Indeed, 3.4 
million jobs above a current law baseline are created in 2018 by newly 
energetic businesses.
     Overall economic activity more vigorous: These tax moves 
dramatically increase the level of national output. The growth rate of 
the economy increases a full half percentage point in 2011 and 2012, 
when taxes will otherwise increase under current law. The annualized 
growth rate jumps by .3 of a percent, and Gross Domestic Product 
averages $284 billion more over a 10-year forecast window than would 
prevail under current law. By 2018, GDP is $321 billion higher.
     More after-tax household spending: These tax changes 
dramatically improve household income, partly because the economy is so 
much better and partly because the average tax burden falls. The 
average household would have $5,138 dollars more to spend or save after 
paying their taxes. By 2018, this amount is $9,750 (after subtracting 
inflation).
    Do not depend on demand-side stimulus: Demand-side stimulus (tax 
rebates, the child tax credit, and the 10 percent tax bracket) do 
little to change the course of the sluggish economy. Certainly for tax 
rebates, we have just passed through a laboratory experiment of sorts. 
President Bush signed legislation earlier this year that gave each 
taxpayer a $600 tax rebate ($1,200 for married taxpayers). Congress 
hoped that these rebates would stimulate consumption and prevent the 
economy from falling into a recession. While the jury is still out on 
this experiment, initial and supporting evidence for this view looks 
very thin.
    More than likely, the tax rebate of 2008 will join those of 2001 in 
falling well below expectations as a way to stimulate the economy or 
move it from a prolonged sluggish growth trend. Indeed, the contraction 
in investment and thus job creation did not begin to improve until 
after the 30 percent partial expensing in the 2002 act and the 50 
percent partial expensing in the 2003 act, which also cut the tax rates 
on dividend and capital gain income. Congress has enacted depreciation 
and expensing stimulus plans under Republican and Democrat majorities.

                             ENERGY POLICY

    Rapidly increasing prices for gasoline and petroleum based energy 
generally slowed the economy, helped bring on our current recession, 
and their effects continue to impede job and income growth. If Congress 
acts to expand energy supplies, forward looking prices will fall and 
economic activity will shed off the drag that stems from this sector.
    Let me illustrate. Economists working with me in the Center for 
Data Analysis at Heritage estimated the economic effects of a $2.00 
increase in retail unleaded gasoline.\2\ We have just experienced such 
an increase over the past 14 months. We found that
---------------------------------------------------------------------------
    \2\ See Karen A. Campbell, ``How Rising Gas Prices Hurt American 
Households,'' Heritage Foundation Backgrounder, No. 2162, July 14, 
2008. A copy of this report is attached to this testimony as Appendix 
1.
---------------------------------------------------------------------------
     Total employment falls by 586,000 jobs.
     After-tax personal income falls by $532 billion.
     Personal consumption expenditures fall by $400 billion, 
and
     Significant personal savings would be spent to pay for the 
increased cost of gasoline.
    These national level results reflect the economic effects of price 
changes. That is, disposable income falls because the economy slows 
below its potential. In addition, households have to spend more in 
gasoline.
    We looked at the economic effects on three types of households. Let 
me describe the effects on one of these: a married household with two 
children under the age of 17. For this household, disposable income 
falls by $1,085; purchases of goods and services falls by $719; and 
$792 is taken out of personal savings just to pay the gasoline bill.
    Some analysts argue that gasoline consumers can adapt to higher 
prices by changing their driving patterns and their automobiles. 
However, new research by Jonathan Hughes, Christopher Knittel, and 
Daniel Sperling (all from the University of California-Davis) shows 
that families today have little opportunity to quickly adapt to higher 
prices. Most working families have two income earners who commute by 
automobile to work. They live in suburbs away from mass transit 
opportunities. Their children have extensive after-school activities to 
which they are transported more often than not in an SUV. Today's 
short-term price and income elasticities are a full ten times smaller 
than those estimated using data from 20 years ago.\3\
---------------------------------------------------------------------------
    \3\ See Johanthan E. Hughes, Christopher r. Knittel, and Daniel 
Sperling, ``Evidence of a shift in the Short-Run elasticity of Gasoline 
Demand,'' National Bureau of Economic Research Working Paper, w12530 
(September, 2006).
---------------------------------------------------------------------------
    These lower elasticities mean that consumers have a much harder 
time adapting to gasoline price shocks today than two decades ago. 
Pretty much all they can do is reduce their consumption on other items 
and take funds out of savings to pay for the higher priced gas. Doing 
so, of course, slows the economy and makes everyone else worse off.
    There are many economic problems facing Congress, from slowing 
global economic activity to persistently bad news from our financial 
sector. Congress can act on some of the economic fronts before it, but 
its ability to affect the nation's economic future is limited. On 
energy, however, its actions to increase supplies in the short and long 
run could do some good, particularly for workers looking for jobs and 
families hoping to keep their children in violin lessons and little 
league baseball.
    I am a free trader who believes imports are central to our economic 
vitality and future economic strength. However, our heavy reliance on 
foreign oil producers (imported oil now constitutes over 60 percent of 
our daily petroleum demand) has made us subject to price variations due 
to supply disruptions, supply extortion, and booming world demand. I 
believe that increasing the domestic production of petroleum and 
refined oil products would have a positive effect on our domestic 
economy, largely through more jobs and income.
    In another study prepared by economists in my Center, we asked what 
would be the economic effects of increasing domestic production of 
petroleum by 10 percent. The U.S. currently consumes 20 million barrels 
per day, of which around 65 percent come from foreign sources. If 
domestically sourced petroleum increased by 2 million barrels per day, 
what would be the economic effects.
    Our analysis indicates that such an increase would
     Expand the nation's output as measured by the Gross 
Domestic Product by $164 billion.
     Increase employment by 270,000 jobs.
    Congress exercises enormous authority over petroleum mining, 
largely through its regulation of off-shore and federal land oil 
reserves. Authorizing more oil mining in these reserves today would 
begin to wean the U.S. from the economically harmful reliance on so 
much foreign petroleum.
    One of the more tragic features of recent energy policy actions by 
Congress is how often it has failed to increase access to energy 
resources on the grounds that doing so would not have any effect on 
supply or price for years. While possibly correct from an engineering 
standpoint, this excuse for inaction makes no sense economically. If 
Congress were to announce greater access to proved reserves, mining 
activity would immediately begin, capital and talent would leave other 
parts of the world and travel to the United States, forward pricing 
markets would feel the downward pressure on prices that impending 
supply increases make, and ordinary Americans would not discount their 
own economic futures as much as they do today.

                            SPENDING POLICY

    Increase confidence in the U.S. economy by addressing long-term 
spending challenges. While the attention of most policymakers will be 
on immediate responses to the current slowdown, everyone should attend 
to a factor that's increasingly important to confidence in the U.S. 
economy: the seeming unwillingness of Congress to seriously address the 
enormous financial challenges from entitlement spending. Many investors 
and organizations that play key roles in the future of the U.S. economy 
are worried about long-term growth given the fiscal challenges posed by 
Social Security's and Medicare's unfunded liabilities. The Financial 
Times recently reported that the lead analyst for the U.S. at Moody's 
warned that the credit rating agency would downgrade U.S. treasury 
government debt if action was not soon taken to fix entitlements.
    Thus, at a time when the economy is slowing and the speech as well 
as the actions of Congress can affect economic activity, policymakers 
should take concrete steps that will announce their intention to 
address unfunded liabilities in these important programs. While reforms 
in these programs may be beyond what this Congress can do, it is 
possible to signal change by reforming the budget rules.
    Currently, the federal budget functions as a pay-as-you-go system, 
with a very limited forecast of obligations and supporting revenues. We 
just do not see in the official budget what may happen over the next 30 
years. The five and ten-year budget windows do not permit Members or 
the general public to sense the obligations that are coming beyond that 
ten-year time horizon.
    A good first step in addressing the long-term entitlement 
obligations of the United States would be to show these obligations in 
the annual budget. This could be done by amending the budget process 
rules to include a present-value measure of long-term entitlements. 
Such a measure would express in the annual budget the current dollar 
amount needed today to fund future obligations. Such a measure has been 
endorsed by a number of accounting professionals, including the Federal 
Accounting Standards Advisory Board.
    A solid second step would be to convert retirement entitlements 
into 30-year budgeted discretionary programs. Such a move recognizes 
that mandatory retirement funding programs for millionaires that crowd 
out discretionary spending programs for homeless war veterans make no 
sense at all. If we are to contain entitlement spending and reform the 
programs driving those outlays, then a paradigm shift likely will be 
required. Recognizing Social Security and Medicare as discretionary 
programs helps to force attention on changes that will assure their 
survival well into the 21st century.\4\
---------------------------------------------------------------------------
    \4\ See Stuart M. Butler, ``Solutions to Our Long-Term Fiscal 
Challenges,'' Testimony before the Committee on the Budget, United 
States Senate, January 31, 2007.

    Chairman Spratt. Mr. Ryan, would you like to lead off?
    Mr. Ryan. Sure. Can you bring up chart 14, please.
    About 5 months ago we passed a stimulus package, a demand-
side stimulus package. If you take a look at chart 14, if you 
look at personal consumption expenditures, that is about 17 
percent of GDP, gross domestic product. Look at what happens. 
We basically got a one-quarter pop in GDP statistics. Then we 
gravitated back towards the pre-stimulus trend.
    So the concern I think some of us have in doing this fast, 
demand-side stimulus is they might give you a pop in a quarter 
in which they take place, but then you go right back down. The 
question is, what is it we can we do to build in the long-term, 
sustainable growth, grow the economic pie so that we might 
create new and lasting job growth and permanently reduce 
unemployment. That is point one.
    Point two is, look at our fiscal situation we are in right 
now. We are looking at easily a $750 billion deficit next year 
alone. You throw a stimulus thing on this, $300, we are over a 
$1 trillion, a $1 trillion budget deficit.
    Now the question is--I think you can have good 
disagreements about this--what does that do to the value of our 
dollar? What does that do to our borrowing costs? More to the 
point, what does that do to the signals we send to the markets, 
to the global markets, on America's ability to borrow and our 
borrowing costs? All of these borrowing costs put an enormous 
tax rate increase on future generations. It speaks to the 
ability of our economy to grow in the future or not.
    The one thing I think we often forget here is global 
competitiveness. You know, we used to just take it for granted 
that the American economy is always going to be the fastest 
growing economy, the marvel of the world. We are number one, we 
always will be.
    Well, the oceans don't separate our economies anymore. With 
technology today, with globalization, it is just so integrated. 
That is why our relative economic and tax policy relative to 
our competitors matters so much more than it ever did before.
    So going into the next session of Congress with this notion 
that we are going to dramatically increase tax rates on 
investment, on capital, on small businesses, especially 
relative to our foreign competitors, to me, is just like the 
economic equivalent of shooting yourself in the foot.
    So I will just start with you, Dr. Beach, because you focus 
on econometrics and modeling. Give us your sense of modeling--I 
know you cut your testimony short--on what kind of job increase 
would we have using a model on this, just if we actually 
produce some more of our own energy, say 2 billion barrels of 
oil produced in America versus overseas?
    What kind of job increases would we see if we lowered the 
after-tax rate of return on capital by doing some of the tax 
things you mentioned? What are the job implications of lowering 
the corporate income tax versus keeping it where it is, which, 
as you mentioned, is the second highest in the world?
    So, what are the job implications for these kinds of fiscal 
decisions that we are about to make?
    Mr. Beach. Well, all of those things you just mentioned in 
isolation have a positive effect on unemployment, particularly 
private sector employment. Of course, that should be the 
objective that you should be looking at this point.
    I was at one time, Congressman, I guess, one of the 
principal revenue planners for the State of Missouri back when 
I was young. That happened to be in the early 1980s when we 
were facing significant contractions in our revenue sources, 
almost identical to those, but multiplied by twice, that Iris 
Lav put up for you.
    At that time, we thought the best thing that we could do 
and what the Federal Government could do would be to look at 
their fundamental tax policy. There are ways we could cut 
bridges, we could close operations which were no longer needed; 
and because we had shortfalls of revenue, we did all of that.
    But we also spent a lot of time looking at our business 
taxes, both short-term business taxes, like having a zero tax 
rate on small business income for a period of 18 months that 
would then lead to a little higher rate when they fully 
recovered. That is not a bad idea at the State level, not a bad 
idea at the Federal level.
    Looking at fundamental tax reform: The corporate business 
tax rate matters a great deal on location. The State of 
Missouri was trying to get people to move from Iowa and 
Illinois, Kansas, Mr. Moore, into Missouri. I think all of the 
things that you have mentioned are significant.
    A lot of people think energy production won't produce jobs. 
It is just, you know, energy production in Saudi Arabia, now it 
is in the United States. But we were amazed to learn in our 
models that that was actually a very positive thing to do. We 
were looking at half a million jobs to 800,000 jobs over about 
a 5-year period, just from increasing energy production by 10 
percent in the United States.
    So you can do that as part of the stimulus package. You can 
do that as part of your long-term growth.
    Mr. Ryan. I appreciate the indulgence, we don't have a 
clock in these two positions here, chairman or ranking, but I 
will just ask one more question for each of you. This is 
something, I think, we on each side of our aisle are concerned 
about, have to be concerned about.
    Are we building the seeds of too many too-big-to-fail 
institutions in this country? We are getting through this 
crisis, and we are doing it by seeing mergers, by seeing 
financial institutions grow, in order to take the balance sheet 
problems. But what is it we ought to do after we get through 
this crisis to assure that we don't have too many too-big-to-
fail institutions which, down the road, if we do not manage 
risk properly, do not supervise and regulate effectively, what 
kind of seeds are we planting for ourselves and how do we best 
prevent that from really being a problem down the road?
    I will just start with each of you. Thank you.
    Mr. Baily. Thank you.
    We are creating too many institutions that are too big to 
fail. I am not sure what we can do about it over the next short 
period of time.
    There are advantages to having large financial 
institutions. They operate in global markets. The problem is 
that when they get into trouble, we have to go rescue them.
    I am not enjoying this rescue package. I am sure you are 
not. It is putting money into companies that have made bad 
decisions. I think we have to do it to preserve the financial 
sector.
    I think, going forward, we need to take a hard look at our 
regulatory system and supervisory system, which I think failed, 
to make sure that those institutions that are large--because we 
are going to continue to have large financial institutions--are 
being regulated in a way that is effective.
    I don't think that necessarily means more regulation. There 
were rooms full of regulators in some of these large banks. We 
need to be more effective in our regulation to make sure that 
they don't fail.
    I share your concern. We are creating some moral hazards.
    I would make one more quick comment, and that is the one-
quarter pop; I wish it had been more of a two- or three-quarter 
pop. But given that we are expecting GDP to decline in the 
fourth quarter and probably in the first quarter of next year, 
I think getting a short-term stimulus out there, even if it 
only gives us a two- to three-quarter pop, would be worthwhile.
    Ms. Lav. I mean, I am not an expert on these financial 
institutions, but I think the answer is to let--worry a little 
bit less about size and a little more about how do we make sure 
they don't fail; how do we make sure that these institutions 
are responsible to people, they are responsible to the laws, 
and that the regulations are right, to make sure they can't 
have these kinds of excesses.
    I mean, lots of people could see that there was something 
wrong going on in the mortgage market, for example. It wasn't 
that nobody saw it. It is just that it wasn't--you know, 
nothing moved forward to try to fix it. So I think that is the 
answer, you know, to be proactive.
    Mr. Beach. Congressman, I think moral hazard is going to be 
harder to manage that than the money supply. I think that is 
going to be on your desk for a long, long time.
    I supported the bailout--excuse me, the rescue plan like 
you did. I did so with my eyes open, that we are creating 
policies now, which will be in the boardroom as business 
parameters. Well, we can make that investment. We can do those 
things because, after all, a few years ago, the Federal 
Government spent an enormous amount of money to make sure that 
we didn't fail.
    You have got to do something in public law that will 
reverse that tendency; otherwise, we are going to be here, I 
would guess, in a few years with the health care industry, 
because we are probably going to create another bubble out of 
this that will move into another part of our economy.
    Just let me also say that bailouts, rescue plans, 
oftentimes result in the revaluation of a country's sovereign 
debt; and that is reflected by a downward pattern in the 
valuation of their currency. That won't happen right away, but 
the sooner, the closer we get to the generation, my generation 
retiring--and that is just a few years, of course--we are going 
to be looking at debt revaluation issues. I think they will be 
related to the policies which are being worked out now.
    Chairman Spratt. Just to engage in our battle of the charts 
here, let me put two up as a historic reminder, something that 
we as Democrats are proud of, namely, the real economic growth 
rate of the Clinton administration, 1993 to 2000, versus the 
Bush administration, 3.7 percent versus 2.4 percent of the 
policies that you have just been discussing.
    In addition, with respect to jobs, if we could have that 
chart, the average number of jobs created during the Clinton 
administration was 237,000, the Bush administration, 52,700.
    Mr. Ryan. Does that include the recession that President 
Bush inherited as it came into office?
    Chairman Spratt. That includes the entire period of time. 
That is just for the record.
    Now, Mr. Doggett.
    Mr. Doggett. Thank you, Mr. Chairman. I don't believe it is 
reasonable to launch a large new expenditure without 
considering how the last $700 billion that Congress approved is 
being used. With nobody taking personal responsibility for any 
part of this financial system fiasco either in Washington or on 
Wall Street, and with some of the people who contributed to the 
crisis actually getting rewards instead of penalties, we don't 
have a formula for preventing a reoccurrence of these excesses.
    Going forward, we have essentially the same Federal 
regulatory personnel, the same Wall Street directors, the same 
executives running the same show as they were running before 
the Bush administration made its urgent plea of bailout or 
bust. And I believe the American people would be better served 
by our seeking more accountability, more transparency and a 
better return on their investment.
    While I am very pleased that direct investment in banks, an 
approach that so very recently Secretary Paulson was in this 
Congress condemning as what he called an admission of failure, 
that that was used as the first choice of the Treasury. I don't 
believe that there is adequate public understanding of the 
terms of that investment.
    Treasury acted not as the lender of last resort, but as the 
lender of best resort, offering banks a far sweeter deal than 
the terms Warren Buffet required, a far sweeter deal than the 
British banks got. Indeed, about the same similarity with the 
Buffet deal and the Treasury deal is the name applied to the 
stock, which in Treasury's purchase amounts to essentially a 
below-market 5 percent loan.
    Mr. Buffet got twice as much in dividends as taxpayers are 
to receive, and he got more than 85 percent more common stock 
rights than taxpayers will get. And now, according to Chairman 
Bernanke's speech last week in New York, the Treasury will 
return to the purchase of toxic securities--what Nobel Prize-
winning economist, Joseph Stiglitz, has called the ``cash-for-
trash plan.''
    Most folks, seeing so much money being spent now out of the 
$700 billion, have good reason to wonder how much of it will be 
available when the new President is sworn in in January. And 
all of this comes with an understanding, I think by everyone, 
that this $700 billion is not about stimulating our economy out 
of the current economic recession. It is only the necessary and 
expensive medicine for preventing a financial system shutdown.
    Against that backdrop and recognizing that the Bush 
administration is responsible for adding literally trillions of 
dollars of additional national debt and recognizing, as several 
of you said, that sooner stimulus is better than later 
stimulus, isn't the more prudent approach for us immediately 
for when the Senate reconvenes on November 17th to simply 
approve in its current form, or something very similar, the 
bill that the House has already approved to provide $60 
billion, approximately $61 billion, in immediate stimulus to 
try to get this economy moving again without prejudging what 
action may be necessary when we reconvene in January?
    Dr. Baily, if you would lead off.
    Mr. Baily. Thank you. I appreciate your concern about what 
has happened. I think it has been a rather sad episode in 
history.
    Mr. Doggett. Indeed.
    Mr. Baily. There are a lot of people to blame I think on 
this. I think there will be some accountability; we do have a 
legal system which is going to hold some people accountable. 
There are a lot of people who have lost money.
    But this is certainly a sad episode. And I think we are 
doing this rescue package because we really need to do this 
rescue package, not because we like it----
    Mr. Doggett. Sir, I wouldn't disagree that action was 
needed; it was a question of responsible action.
    But as my time dwindles, let me just ask you specifically, 
isn't the most responsible thing to do now, as far as a 
stimulus for our economy, to have the Senate approve the bill 
the House has already approved in about 3 or 4 weeks, and then 
consider what addition is needed when we reconvene next year?
    Mr. Baily. Well, as an economist, I would like to see a 
stimulus get out there as quickly as possible. So I don't want 
to comment on all the specifics and details, but to get a 
stimulus that, as Iris said, was quick and temporary and had 
the most effect on the economy.
    Mr. Doggett. Is there any element of the stimulus that we 
approved, which included some increase in the Medicare matching 
right, an increase in food stamp benefits, an extension of 
unemployment benefits and some modest infrastructure 
investments, that you would be opposed to, in what we have 
already passed?
    Mr. Baily. No, I support those measures. As I said in my 
testimony, I would like to see a round of tax rebates done 
quickly.
    Mr. Doggett. And, Ms. Lav, my time is up, but do you agree 
with the package Congress has already approved as at least a 
first step to trying to get our economy righted?
    Ms. Lav. I think it has all the right elements in it. It is 
good for that.
    I think I would like to see it be bigger. And so that the 
politics this year is about how you can best get to there. But 
I think the time is now for something bigger if it is 
politically possible to do that.
    Mr. Doggett. Thank you, Mr. Chairman.
    Chairman Spratt. Mr. McGovern. Mr. Scott.
    Oh, I beg your pardon. Mr. Garrett, I beg your pardon. I 
almost got away with it.
    Mr. Garrett.
    Mr. Garrett. Thank you.
    Dr. Baily, if I heard you right--and correct me if I heard 
you wrong--you said that where we are now with a weak dollar is 
a good thing. I would always think just the opposite, that we 
should be trying to strive with the monetary and fiscal policy 
to get a strong dollar.
    And at the same time you made that comment, you were also 
making the comment part of the rationale there is because of 
the low cost of borrowing and the flight to treasuries. But 
isn't that just because we are in a tight credit market right 
now, and that is just the market where they are going to go 
into? And if everything goes through with this $700 billion 
bailout, which I did not support, but if it all goes through, 
as we hope that it will, that that credit situation will 
change, liquidity will flow again and the interest rates on 
those treasuries will not be these historic low numbers, and we 
will be in a worse situation than we are now?
    Mr. Baily. I think we need a dollar that is appropriate, 
that makes our manufacturing sector competitive. I don't want 
to see a weak dollar. There are costs to us for a weak dollar, 
so I wouldn't use that word at all.
    I don't think we should have an overvalued dollar; and I 
think the dollar had become overvalued by 2002, and that is why 
I think some adjustment of the dollar is appropriate.
    I actually think the China currency should be adjusted up 
against the dollar because I don't think they are at the market 
equilibrium. I want to see markets work right in terms of 
making our economy more competitive.
    Mr. Garrett. Thank you.
    And, Ms. Lav, you made the comment--I just went back to 
your notes--your comment says three ways that a State can deal 
with a situation. It seems to me, at least in my own State, in 
the State of New Jersey, we have found a fourth way to deal 
with our economic problems, and that is the same as what the 
Federal Government does, and that is called borrowing.
    We don't raise taxes, we don't cut--well, actually New 
Jersey does. We raise a lot of taxes in New Jersey; and cut 
spending--well, we never do that. But we borrow despite the 
fact the constitution doesn't allow it. So isn't that really 
the fourth category? Isn't that what sort of skews some of the 
numbers out there?
    Ms. Lav. Most States absolutely can't borrow. Although some 
of them can do things like borrowing from the future in the 
sense that they can sort of sell a future stream of earnings, 
which is a sort of borrowing from the future, but it is 
actually a sale, like when they securitize their tobacco 
settlement revenue and that sort of thing.
    So New Jersey has kind of a large overhang of debt that it 
has acquired for various purposes in the past.
    States balance their operating budget and then they borrow 
for other things. They certainly borrow, that is what--they 
would sell bonds, they borrow for infrastructure. 
Infrastructure in States has nothing to do with their operating 
budget; by and large, that is a separate part of the budget 
that is not covered by balanced budget requirements, and they 
borrow to do those things. And that is a lot of the way that 
New Jersey has--you know, it has floated bonds. And it has got 
a larger debt than most other States, there is no question 
about that; and the interest rate comes onto the general fund 
budget and is a problem for it.
    But most States are not entirely in the same situation as 
New Jersey.
    Mr. Garrett. And I don't know--I have to delve into it 
more--some would argue that New Jersey at least--not to pick on 
New Jersey, but they have used it more just for infrastructure, 
but they also actually have used it in the past for operating 
expenses.
    Ms. Lav. They have through switching around. There are a 
couple of States that do that--New Jersey, Illinois and 
California, but very few others.
    Mr. Garrett. Mr. Beach, you made the comment you supported 
the bailout, and you worry about the moral hazard in the 
boardroom that they sort of put that out there and they said, 
now we can anticipate the Federal Government stepping in and 
relieving us of some responsibilities, I guess--your words, not 
mine. But what we need to do now is have the Federal Government 
step in to rectify that.
    You have been around here for a while and looked at how the 
Federal Government works. You have seen how we have come up 
with solutions to problems before, such as in Sarbanes-Oxley, 
which basically was supposed to provide us with all the 
transparency in the world with absolutely no cost to the 
economy or the business system. Of course, we know it did have 
a tremendous cost, and it may have actually made our Wall 
Street market move overseas in a lot of ways because of that.
    I understand what you are saying, what needs to be done, 
but knowing the history of the way the Federal Government 
operates, do you have any pleasant view that that is actually 
what is going to occur now, that we are going to come up with a 
proverbial world-class regulator, which we obviously could not 
get in place prior to the demise--almost demise of Fannie and 
Freddie, that actually solves these problems?
    Mr. Beach. Now that I am the old hand here, let me just say 
that usually the policy-making bodies of the Congress don't get 
it quite right the first time. And that is because of the way 
that you operate with your elections and with your committee 
structures and so forth. That is not a criticism, because what 
is great about the system is that you do return to the same 
issues time and time again.
    Once the regulatory bodies have settled on their rules, one 
of the things you notice is, they rarely return to take a look 
at the rules. They wait for you to push them. So I am hopeful 
on the second go-round of this--and I am confident in the next 
Congress you will have second and third go-rounds--that you 
will find ways of putting strictures, rules in place that will 
make it extremely difficult for this moral hazard thing to 
propagate into yet another real problem that you have to solve.
    Mr. Garrett. I am sure there are going to be a lot of 
strict rules.
    Mr. Beach. I agree. Regulation is probably going to be the 
least of the problems you have.
    Mr. Garrett. Thank you.
    Chairman Spratt. Mr. Scott.
    Mr. Scott. Thank you, Mr. Chairman.
    Dr. Baily, you mentioned the troubled assets on the banks' 
books. And I was actually surprised to hear Chairman Bernanke 
talk about not overpaying for assets, because in discussions--
there is nothing in the bill to restrict buying worthless 
assets at overpriced--overpriced; and in my discussions with 
people before the bill is that is exactly what was intended.
    If the intention now is to purchase these so-called 
``troubled assets'' at a good-faith estimate of fair value, 
even when there is technically no market, they are temporarily 
illiquid, but at a good-faith estimate of fair value, what does 
the government purchase of the asset do that marking to fair 
value wouldn't have done for free?
    Mr. Baily. I was puzzled by the top when it first came out. 
It seemed to me, the need was to recapitalize the banks. And my 
understanding was that they would probably overpay for the 
assets relative to what those assets could command in the 
marketplace, and the difference would then be used to 
recapitalize the banks.
    I think it is much better what they are doing now, which is 
to inject capital directly into the banks.
    Mr. Scott. Rather than buy worthless assets from all over 
the world, a small percentage of which would actually land in 
the capital account of banks that we are aiming at?
    Mr. Baily. Right. So I think that is a better plan.
    I do think there was a rationale towards creating more of a 
market for some of these assets. So I actually think that using 
some of the $700 billion to buy some of these assets, using 
this reverse-auction technique, might allow greater liquidity 
in those markets for assets that hopefully are not worthless, 
but that do have some value when held to maturity, and we can 
create greater liquidity in that market.
    I understand the dangers of overpaying. But I think that is 
a legitimate part of this rescue package.
    Mr. Scott. But if it is at fair value, you could have 
accomplished most of what we are aiming at just allowing mark 
to fair value rather than marking to market?
    Mr. Baily. Well, the idea, I think, is that if you can 
create an effective market for these assets, that it improves 
the liquidity of the banks and allows them to sell assets, but 
I understand the concern.
    Mr. Scott. Is there any thought that we might actually buy 
enough of these assets to create a market?
    Mr. Baily. Well----
    Mr. Scott. I mean, there are tens of trillions of dollars 
out there, and we are talking about $700 billion.
    Mr. Baily. I think it could help. I think it could help. I 
recognize your concerns, Congressman.
    Mr. Scott. Helping home owners, now that we essentially own 
Fannie Mae and Freddie Mac, what would be the ultimate cost of 
doing one of these loans at a commercial rate 5.25, 5.75, for 
those that can actually pay?
    Mr. Baily. Well, if you are issuing the mortgage at what 
will be--once this crisis is passed, will be a fair market or a 
commercial rate, then the cost to taxpayers--there wouldn't be 
a cost to taxpayers.
    Mr. Scott. You can essentially help the taxpayer at no cost 
to the taxpayer?
    Mr. Baily. Well----
    Mr. Scott. Excuse me, the homeowner at no cost to--at 
probably no cost to the--there is no guarantee here?
    Mr. Baily. There is no guarantee.
    Mr. Scott. But you would----
    Mr. Baily. There may be some cost to the taxpayer, but I 
think you can minimize that cost while maximizing the help to 
the home owner.
    Mr. Scott. You also mentioned a prepayment issue.
    What would your reaction be to legislation to prohibit 
prepayment penalties as inherently unfair, especially when some 
of these mortgages can reset at draconian rates?
    Mr. Baily. I think we would have been better off without 
these mortgages that started at the low interest rates and then 
were pushed up, because I think they ended up being deceptive.
    If you do offer a homeowner a mortgage with a very low rate 
of interest, that is not a market rate. You are losing money in 
the first few years. And so that is why they put in some of 
these prepayment penalties.
    But I do think that the Federal Reserve has put out 
guidelines for mortgages that are more stringent than the ones 
that were in place.
    Mr. Scott. What would your reaction be to a prohibition 
against prepayment penalties?
    Mr. Baily. I think at this point it is probably a good 
thing. I think it is a good thing.
    Mr. Scott. Bang for the buck on the kinds of things you can 
do for a stimulus: Capital gains tax cuts, what kind of bang 
for the buck do you get on government expenditure resulting in 
actual stimulus to the economy if it is capital gains tax cuts 
versus extending unemployment benefits, food stamps or direct 
aid to States?
    Mr. Baily. I believe you would get more bang from the buck 
from the other things than you would from a capital gains tax 
cut.
    Mr. Scott. Thank you, Mr. Chairman.
    Chairman Spratt. Mr. Simpson.
    Mr. Simpson. Thank you, Mr. Chairman.
    Do you believe that too, Mr. Beach?
    Mr. Beach. No. That is actually not what the literature 
shows. When you reduce the taxes on capital, you get a much 
faster reaction in productive markets than when you reduce the 
taxes on labor.
    What you should do is, you should look after the needs of 
people who are hungry and unemployed because it is the right 
thing to do. And there will be plenty of those people and will 
be plenty of opportunity for you to pass that kind of 
legislation.
    If you want to get the economy moving again, then focus 
like a laser beam on what causes the economy to move; and it 
usually, in the short run, is capital costs. So that is why the 
Chairman was looking at any way that you could unfreeze credit 
from your side--he has his side--but from the legislative side. 
Look at accelerated depreciation, bonus depreciation, full 
expensing as a short-term stimulus for 2 or 3 years.
    But the literature clearly indicates that it is just the 
opposite. You go after capital first and labor second if you 
are going to look at growing the economy out of an immediate 
problem. Do the right thing for people and then be hardheaded 
about the economy.
    Mr. Simpson. My study of the Depression of 1932--I hate to 
call it the Great Depression, because I hate to use the word 
``great'' with ``depression''--was if there were two mistakes 
that they made, and they did many things right trying to 
address it and stuff--this isn't a criticism. But if they did 
two things wrong, it was that they raised taxes and, two, that 
they became more protectionist and isolationist.
    Is that a fear that we have, that we are going to do the 
same thing? I mean, we have got some free trade agreements 
before Congress now that should pass, I think.
    Mr. Beach. You certainly don't want to do the opposite. And 
the literature, the history of that period, does assign three 
public policy mistakes, one of which was a tax increase to 
balance the budget because at that time even Franklin Delano 
Roosevelt, prior to his election as President, believed in 
balancing budgets at the State and the Federal level.
    We kind of know a little bit differently now. Ultimately, 
it is the right thing to do in the short run. It may not be the 
right thing to do.
    Secondly, a protectionist attitude that led to the passage, 
prior to the Democrats taking over, of a very bad international 
trade law.
    And thirdly, what the Chairman was talking about this 
morning from this side of the table what the Federal Reserve 
failed to do in terms of its own responsibilities.
    Those three things have generally been figured out as the 
three triggers that made a recession into a very serious and, 
hopefully, unprecedentedly bad and never-to-be-repeated 
depression.
    Mr. Simpson. Mr. Baily, I will tell you, just for your 
purposes, information, I agree with Mr. Baird. I will tell you, 
I have talked to my transportation departments. Both local, 
State, and everyone else, they have projects that have been 
engineered and ready to go that are on the board.
    I voted against the economic stimulus package because I 
didn't think it was an economic stimulus to give people $600 
checks so they could buy TVs made in China. I thought we could 
actually employ people and we would get something out of that 
in the end, and that would be an improvement in our 
infrastructure, and there would be a value there.
    To the extent that we do that, that makes sense to me. And 
it is not slow; there are things out there ready to go. So I 
just thought I would throw that out.
    But last, Ms. Lav, when I read your testimony and I heard 
your testimony, I kind of get the impression that you feel the 
purpose of State government is to employ people.
    The purpose of State government is to deliver services. To 
the extent we employ people to do that, that is a good thing. 
But when I read that we ought to be bailing out States, and 
that it doesn't present a moral hazard to those States that we 
are going to be bailing out--we have got States that do a good 
job. We do things differently. We administer our services 
differently. Some States do it more efficiently than other 
States.
    I was in the State legislature in 1987 when we went through 
some very difficult times. We had to make tough choices. And 
now we are going to prevent some States from making difficult 
choices by doing that.
    The governor of Idaho just a couple months ago, or a month 
ago, ordered a 1 percent holdback across the board, told them 
to be prepared for a 2 percent; and when he talked about it, he 
said, As we create this new budget, we are going to have to 
make priority decisions. What is wrong with that?
    I read in your thing that States take action such as 
instituting hiring freezes and travel freezes, as well as 
finding items in their budget that are more marginal to the 
core function. Isn't that a good thing?
    Ms. Lav. I said in my testimony that what they have done up 
until now, that those things are mild and that that is nothing 
against what is coming. So I characterized the things you just 
said as ``mild.''
    And most States can find a 1 percent or a 2 percent cut. I 
mean, during good times things tend to expand maybe, you know, 
or be a little less efficient than they have to be. So 1 
percent, 2 percent, 3 percent usually is a possibility. But 
what I am talking about is, on average, 14 percent, which will 
be 20 percent in some States. And that is--and of course, the 
purpose of States is to provide services. That is why I am 
talking about putting the majority of the fiscal relief through 
Medicaid.
    In the last recession there were 6 million additional 
people who needed Medicaid. There would have been more if 
States hadn't--at least another million if States hadn't cut 
eligibility.
    Mr. Simpson. But in your testimony one of the things is, 
you say that you don't believe States ought to be able to 
adjust their requirements for Medicaid if you give this relief. 
Isn't that what the States do? They make decisions, different 
States, based on different needs in their State or what the 
State legislature perceives? Some States are much more 
generous.
    In SCHIP, you saw some States giving up to 400 percent of 
income poverty levels; other States chose not to do that. In 
Idaho, it was 185 percent. Are we saying that 400 percent is 
the appropriate level? And I voted for the SCHIP improvement.
    Ms. Lav. I am not saying any level at this point is 
appropriate. I mean, a lot of States have prioritized health 
care as private employers have dropped, and so they have made 
those choices.
    But what I am saying is, while you are giving the Federal 
money, you don't want the States simply to substitute the money 
you give them for some other expenditures because that is not 
stimulus basically. You want it to be additional stimulus; and 
so, therefore, you don't want them to reduce eligibility, back 
out the money and use it for something else. You want them to 
use it for Medicaid, which is why there is that--for new people 
coming onto the rolls, which makes it forward-looking stimulus.
    And in answer to your question, you get about, according to 
Moody's Economy.com you get about $1.36 in stimulus for every 
dollar you spend in State fiscal relief.
    Mr. Simpson. Let me tell you what my State will--and I have 
not talked to them yet, but I will guarantee you what my 
governor and what my State legislature will tell me.
    If you are going to bail out the States for whatever, the 
problems that they currently face, whether it was through their 
own inactions or wasteful spending or whatever, and that Idaho 
is going to get somebody that says, Keep it, we will solve our 
own problems; you have got a big enough problem of your own in 
Washington with a $450 or $1 trillion deficit.
    Thank you.
    Chairman Spratt. Mr. Baird.
    Mr. Baird. I thank the Chair. I thank our witnesses.
    As I listened to the debates over the last few weeks and 
today I think about how we have labeled generations these days. 
There is the Greatest Generation and there is Generation X and 
there is a new generation. I have got two 3\1/2\-year-old boys, 
and they are part of Generation M; and the reason I say ``M'' 
is, I am thinking of Mercutio in Romeo and Juliet whose dying 
words were ``A plague on both your houses.''
    And sometimes I listen to the Dems and Republicans, and I 
have got to tell you, we are passing onto these kids 
unconscionable, unconscionable, crushing levels of debt and 
deficit. And there are good ideas on both sides, Dems and 
Republicans, and there are really bad ideas on both sides. But 
this level of deficit is not sustainable, and this level of 
debt is not.
    We talk about targeted and temporary and whatever--timely. 
Man, I would be much better with prompt and paid for and 
permanent. I would rather see us do things that we pay for that 
leave us a permanent asset.
    And hence, when Mr. Simpson--I appreciate his 
acknowledgement. We share this agreement about the last 
stimulus; we got nothing tangible out of that. We didn't get a 
road, a bridge, a water treatment infrastructure. We got 
nothing that we could point out to our kids and say, Look, this 
not only put people to work, it gave you cleaner water, more 
efficient roads, safer bridges, improved schools, et cetera. So 
if we are going to do something on this, I hope we will do 
something that is paid for and leaves us something lasting.
    The other thing that strikes me is, we have to streamline 
the economy as well. Just throwing more money at it is like 
putting more fuel in a very boxy automobile. We have all kinds 
of regulatory structures, requirements, et cetera. It takes 10 
years from inception to construction for highway projects now, 
10 years.
    We are translating documents into multiple languages, we 
are doing multiple levels of EIS, we have got umpteen Federal 
agencies. That costs money in the financial sector.
    Do you want to help our banks? Tell us they don't have to 
send us those lousy privacy notices every month that nobody 
reads, or every year. There are all sorts of things that we 
ought to be looking at, top to bottom, to say, Where is their 
drag-wind resistance on an economy that has to get going? And 
we haven't talked about it at all today, but that is a 
structural issue.
    I worry, Mr. Beach, about the permanency of the tax cuts. 
Because I don't doubt that you can create all the jobs, et 
cetera. I could create a lot of jobs today by taking my credit 
card out and buying all kinds of stuff, but there are deficit 
implications to that.
    And I worry, Ms. Lav, about the issue of bailing our States 
out. I think there is moral hazard. Some States step up to the 
plate, maintain their infrastructure, care for their kids' 
health care. We have seen it in our State. We have much higher 
coverage of our kids. SCHIP comes along, we don't get the 
benefit; the States that did lag get the benefit.
    Mr. Baily, I appreciate your acknowledging infrastructure, 
but I am really concerned about this one more helicopter drop 
of money having lasting impact. So I put that out there.
    Mr. Beach, are you concerned about the deficit? And I will 
put that in the context that Doug Holtz-Eakin testified almost 
exactly 2 years ago before this very committee, maybe exactly 2 
years ago, that the so-called ``stimulus effect'' of tax cuts 
doesn't generate revenue to exceed the cost of the tax cuts. He 
modeled it eight or nine different ways.
    Now, are you concerned about that at all?
    Mr. Beach. I am very concerned about it. I have been 
testifying for years for a balanced budget amendment to the 
Constitution. I think it is extremely important. But now I am 
on another jihad, and that is that, take your $700 billion 
rescue plan and imagine it as a bucket--I know we are not 
talking about a bailout today, but just imagine it that way--
and then imagine what it is going to take you just to rescue 
Social Security when your children are 25. And--that will be 
about 56 of those buckets, and that will be money you are going 
to have to raise.
    As far as taxes are concerned, I came today to talk to you 
about making the Bush tax cuts or those reductions permanent. 
That is one idea. I would much prefer you to take the entire 
Tax Code apart and make it more efficient. If you decide that 
you need to have more revenue, fine, or less revenue, fine; but 
a more efficient Tax Code, regardless of whichever way you go, 
will do wonders for the economy. I don't know that you have 
time to do it now, but whatever you do on taxes, make that your 
objective.
    Mr. Baird. So the efficiency and streamlining argument 
could be vastly superior to just throw more money at it?
    Mr. Beach. It is vastly more superior. And the deficits we 
are talking about now, Congressman, from this or from anything 
that you are going to do in the next Congress are simply minor 
tiny little pebbles compared to what we are looking at in the 
tsunami debt coming our way.
    Ms. Lav. We have looked very carefully at whether it is 
State policy or the economy that is causing these deficits. And 
the States that have the deficits, we looked at three factors; 
we have got a lot of research on this.
    The States that are having problems, the States that are 
having the highest foreclosure rates, we looked at three 
factors. There is nothing the States did wrong; it is not the 
States' fault. The States that are having the highest increases 
in poverty measured by food stamp rolls, that is nothing the 
States did, that is what is happening in the national economy.
    And the States that are having the greatest declines in 
employment. That matches almost exactly with the States that 
are having deficits now.
    So I think that whatever the differences in State policies, 
they are swamped by what the economy is doing to the States 
now.
    Mr. Baily. Can I make a quick comment?
    First of all, I agree with you entirely about the need to 
do something about the deficit in the long run. I don't have 
young children anymore, but I do have a grandchild now, and I 
am quite concerned about what we are passing on to her.
    I think it is just unrealistic, the discussion, the debate 
we are having about taxes and spending. I mean, we need to make 
reforms on Medicare. Social security is not so much of a 
problem. But we need to make some of these reforms, and then we 
need to think about how we are going to pay for all that 
spending.
    In terms of a helicopter drop, I understand why you have 
some concern about that. I am more concerned about making sure 
we get enough money out there quickly that we turn this economy 
around, because things are looking very ugly right now.
    Mr. Baird. Thank you.
    Chairman Spratt. Ms. Kaptur.
    Ms. Kaptur. Thank you, Mr. Chairman, for this hearing. And 
I thank the witnesses for coming.
    I am one of the Members that voted ``no'' on both bills 
before Congress. I would do so again. I feel that the Congress 
passed something that would not be effective, but would be 
fast.
    And I believe that criminal prosecutions need to proceed--
the FBI is underfunded to do that--to show that in the decade 
of the 1990s and in this decade there was willful intent by 
very powerful financial institutions in this country to create 
money where there was no underlying asset. And people knew 
exactly what they were doing.
    I would like to place on the record, and I will read these 
very quickly, the list of the primary government securities 
dealers that the Federal Reserve maintains in New York:
    As of October 1, 2008, Bank of America, which just bought 
Countrywide; BNP Paribas Securities Corporation; Barclays 
Capital; Cantor Fitzgerald; Citigroup; another one of the 
troubled institutions, Credit Suisse Securities; Daiwa 
Securities; Deutsche Bank Securities; Dresdner Kleinwort 
Securities; Goldman Sachs, another company that just came under 
the bank holding--a company that--for which they paid nothing 
for the FDIC insurance that they are now eligible to use; HSBC 
Securities; J.P. Morgan Securities; Merrill Lynch Securities; 
Mizuho Securities; Morgan Stanley, another company that just 
came under the umbrella of the FDIC; and UBS Securities, LLC.
    The Congress gave the administration the green light, and 
now they behave like Wrong Way Corrigan. Rather than bringing 
to task some discipline inside this market, we have essentially 
allowed the administration to reward the irresponsible 
financial institutions. Why haven't the people in the 
administration used the full powers of the Federal Deposit 
Insurance Corporation to resolve this situation, as we have in 
the past, including the use of the net worth certificate 
program?
    I disagree with Dr. Baily. I don't think that we should be 
taking taxpayer money and placing it in these institutions. I 
think we should be using the net worth certificate program and 
the tried and true mechanisms of market discipline to work out, 
bank by bank, what needs to be done to make the consumer as 
whole as we can make them.
    We can do the mortgage workouts there as well. We don't 
have to do it in this backward way. In fact, back in August 
when the Congress passed that housing legislation, it was 
supposed to stem, give some help to do workouts at the local 
level so we wouldn't exacerbate the foreclosure situation.
    We are exacerbating it. In places like Ohio foreclosures 
are getting worse, not better. And there is nothing happening 
now immediately to not make it worse and to precipitate a much 
deeper and longer recession.
    So if anyone from the administration is listening, I hope 
they will look to the FDIC to use its full powers, to look to 
the net worth certificate program, to look to the fair value 
accounting and to using the true value of the asset rather than 
arbitrary indexed value through SEC accounting standards, use 
the market discipline that we need to use rather than taking 
more money from the taxpayers.
    The question I really have of you is--and frankly, I am 
somewhat in shock in what the Chairman of the Federal Reserve 
said to me, there was no relationship between the Countrywide 
that sits on the Federal Reserve's board of primary security 
dealers up in New York and the Countrywide institution which 
made most of the loans, subprime loans, that got us into all 
this trouble to begin with. And I want to place some 
information about Countrywide on the record here today.
    I would like to ask you, which businesses benefit from 
debt? As America becomes deeper and deeper in debt, which 
businesses broker in that debt and earn money off the debt, the 
growing debt of the American people?
    Mr. Baily. You are opposed to the rescue package. I 
respectfully disagree. I think when the ship hits the iceberg, 
you can go back and say, as they have apparently done, that 
there were defective rivets and defective steel.
    Ms. Kaptur. But the ship is headed in the wrong direction, 
Doctor; the ship is headed in the wrong direction. They have 
injected some capital into some of the biggest institutions in 
this country, but it hasn't stopped the hemorrhage.
    What they have done is one way of going about this problem. 
A better way would have been to use the FDIC's full emergency 
powers, much better way to go about this.
    Mr. Baily. Well, Sheila Bair and the FDIC, I think, are 
doing an outstanding job now.
    Ms. Kaptur. They could do better. They could do better. 
They could use their full powers.
    Mr. Baily. Well, that is probably true. I think they are 
doing the right thing at this point.
    Ms. Kaptur. But who benefits from debt?
    Mr. Baily. The U.S. Treasury debt?
    Ms. Kaptur. The American people's debt.
    Mr. Baily. The American people's debt?
    Ms. Kaptur. As brokered through the Treasury. Who benefits 
from debt? Who is making money off the American people's debt?
    Mr. Baily. Well, we have spent more than we have received 
in revenue. And many Americans that have received the benefits 
of that spending, whether it is Medicare spending or Social 
Security spending--and Social Security has actually been sold, 
I shouldn't put them on the table--but other kinds of spending 
that we haven't paid for. So in some sense we, the American 
people, are having to pay the passing on the bill, but we have 
actually benefited in the short term. Other institutions use 
U.S. debt.
    I don't think anybody is making excessive returns on 
holding government debt.
    Ms. Kaptur. Who makes money off the U.S. debt, sir? This is 
not a complicated question. Aren't they the very institutions 
that are benefiting from the capital infusion by the American 
taxpayers?
    Mr. Baily. Yes. They earn an interest return on holding 
that money, yes.
    Ms. Kaptur. And what is their interest return that you 
estimate?
    Anyone on the panel, how much money do they make in a year? 
How much money will----
    Mr. Baily. Well, the total interest on the debt, I don't 
have that number at my fingertips, but it is certainly very 
large.
    Ms. Kaptur. It is billions of dollars?
    Mr. Baily. Yes.
    Ms. Kaptur. Yes. Thank you.
    And I wonder if any of your organizations could provide for 
the record which institutions are benefiting from the growing 
debt of the American people? Do any of you have that?
    Mr. Beach. I would be happy to supply some information to 
you on that, Congresswoman.
    Ms. Kaptur. I thank you. We will make it a part of the 
record, Dr. Beach. Thank you.
    Chairman Spratt. Ms. Moore.
    Ms. Moore of Wisconsin. Thank you so much. I would like to 
pursue some questions that have already been raised, and I 
raised earlier with Chairman Bernanke.
    I am very concerned about the $700 billion investments. And 
I think as long as we are trying to make capital infusions in 
banks or trying to strategically purchase troubled assets where 
there is an underlying mortgage, I think perhaps we are heading 
in some direction where we can recover taxpayers' dollars.
    I am really, really concerned about these tranches and 
about these CDOs and other kinds of products--I think Ms. 
Kaptur just referred to it--where we have foreign investors and 
overleveraged dollars.
    What strategy do we have to just abandon the purchase of 
those troubled assets and let the markets work? I mean, let 
investors belly up, let them--you know, the market forces work 
here. To what extent do we have--do you think we will be able 
to accomplish that public policy imperative?
    Maybe I will ask Mr. Beach that.
    Mr. Beach. Congresswoman, that is a great question.
    Let's suppose that all public policy responses fail. You 
know, the evidence is not completely there that this is going 
to work, okay? So one of your contingency plans should be that 
everything fails, everything the Congress does fails. Then what 
markets will do, they will clear; and they will ruin companies, 
and they will wipe out debt, and the market mechanisms will 
work. And what will happen is that on the other side a smaller, 
but very efficient market will be present.
    I think what the Treasury Secretary and the Chairman of the 
Federal Reserve were thinking a couple of weeks ago was that 
that was too great a price to bear, and you had to buy these 
weights inside the portfolios that were not performing, the 
troubled assets. You had to make the infusions because the 
ruthlessness of market clearing would be a bloody thing to 
watch.
    So I have no doubt that the market will be very efficient 
and ruthless in getting its house in order. And maybe that is 
what we have to have. But on the other hand--you know, right 
now the jury is out on that.
    Ms. Moore of Wisconsin. Mr. Beach, let me ask you another 
question. You made a compelling argument for making the tax 
reductions of 2001 and 2003 permanent, accelerate depreciation, 
reducing the tax rate on long-term capital gains and dividend 
income.
    Are you concerned at all in terms of our recovery about the 
lack of revenue that is coming in? You say that we shouldn't 
really position ourselves to worrying about the demand side, 
consumer side. You don't seem to have much sympathy for 
consumer spending as being an answer.
    Mr. Beach. That is very important. Right.
    Ms. Moore of Wisconsin. Do you worry about the lack of 
revenue?
    Mr. Beach. As a former revenue planner, I can see that your 
revenues are going to be way short, based on the current tax 
system that you have in place. So what I am suggesting is that 
now you can make moves to essentially increase revenues or to 
decrease the rate of fall in revenues. And the actions which I 
have laid out are actions which I believe would be effective.
    If you do nothing, your revenues are going to fall and they 
are going to fall precipitously because of the contraction 
which is going on. So you should join your fellow Democrats and 
Republicans who have in the past said, accelerated 
depreciation, 1-year expensing, corporate rate reductions. 
Those are good things to do to increase revenues.
    Ms. Moore of Wisconsin. I have only 45 seconds left, and I 
am very intrigued with this line of questioning.
    You know, timeliness is one of the three parts of the 
three-legged stool: targeted, timely and temporary. So 
certainly extending the tax cuts permanently would not meet the 
temporary thing.
    What about timely? How fast would increasing these tax 
reductions, making them permanent, have an impact on Main 
Street?
    Mr. Beach. I just love that question. And the reason why 
this is the fastest thing you can do, it is the moment you 
begin to hold hearings and markets begin to judge that the Ways 
and Means and finance committees are going to do this, they 
actually begin to price it in.
    So it has an effect even before you pass the legislation, 
whereas spending is something that requires the dollars to get 
into the hands of governments or of businesses or of 
individuals in order for it to have that effect.
    So the fastest thing you can do by far, light speed, is on 
the tax side.
    Ms. Moore of Wisconsin. Okay.
    Can I just follow up tolerance?
    Chairman Spratt. One more question.
    Ms. Moore of Wisconsin. If, in fact, this has been a great 
strategy, these tax cuts are in place now and they have been in 
place since 2001, why aren't they working?
    Mr. Beach. That is a great question, and that is one--that 
is an absolutely great question.
    First off, the tax reductions of 2001 were intended to 
react to a recession which we stemmed over between 
administrations. In my view, the 2001 tax reductions were far 
too demand-side oriented to actually do any good, they did a 
little bit of good. But in the end, by 2002 and 2003, this 
Congress had done what I said it does oftentimes, go back at it 
and do it again; and you passed some really fine tax reductions 
that moved this economy forward.
    And then I think we have had a number of things that have 
buffeted public policy. We have not had several policies 
competently executed by both Congress and the administration. 
On top of that, we have had this building bubble.
    So I honestly think, if you take a look at the tax cuts 
that are pro-growth tax cuts, those have performed well and you 
would be in pretty hot water right now had they not been in 
place.
    Chairman Spratt. Ms. DeLauro.
    Ms. DeLauro. Thank you, Mr. Chairman.
    My understanding is, Dr. Beach, you talked about an 
economic recovery program a size between $150 billion to $300 
billion, depending on circumstances.
    Mr. Baily. I am Dr. Baily.
    Ms. DeLauro. Ms. Lav, what is your sense of an economic 
recovery package as we begin to think about putting this 
together? Just give me size.
    I have three other questions so I want to just kind of move 
quickly.
    Ms. Lav. It depends on what the pieces are.
    Ms. DeLauro. Well, you said $50 billion?
    Ms. Lav. $50 billion. And I think that I would associate 
myself with Mr. Baily.
    Ms. DeLauro. And my understanding from you, Mr. Beach, is, 
you don't believe in having an economic recovery package?
    Mr. Beach. Oh, contrary. No.
    I have laid one out for you. It is just different than the 
one you have been talking about.
    Ms. DeLauro. Right. It is my understanding with regard to 
the capital gains that while this improves cash flow--people 
can spend it on salaries, they can spend it--it doesn't 
necessarily stimulate the economy.
    Bonus depreciation can do that at the outset; it is a 
question of timing. But that was probably stuff that was going 
to be done already so it is not an increase in stimulus.
    Ms. Lav, let me go back to you for a second. I read your 
report very, very carefully, particularly because the 
shortfalls have opened up in the budgets of at least 21 States, 
including my own State of Connecticut. So clearly, in my view, 
an economic recovery package can help prevent cuts to health 
care coverage, public safety, education resulting from a State 
budget crisis. And I am there and will be supportive of those 
kinds of efforts.
    I want to ask you a question with regard to the 
infrastructure projects, and it adds capital budgeting, and I 
understand that with regard to States. But to what degree do 
you believe the economic and fiscal situation in these States 
is having on their ability to move forward with infrastructure 
projects?
    Ms. Lav. I think what is holding up the infrastructure 
projects is the bond, the liquidity issue, the ability to sell 
their bonds, because that is how it is that they, the States 
and localities, fund infrastructure.
    I would like to say--I think it is probably appropriate, 
just as the Federal Government is moving in to buy commercial 
paper--that bonds are a great investment. They are fine; State 
and local bonds are great.
    There are two kinds of bonds: the ones that are just cash 
flow bonds, like California, like Governor Schwarzenegger made 
a big fuss about and ultimately sold on the private market; but 
the infrastructure bonds, they are having to pay a lot of 
interest and so forth.
    So that would be one of the better things you could do to 
move infrastructure along.
    Ms. DeLauro. And do you believe--how helpful do you believe 
infrastructure funding will be in any economic recovery? How 
can it be helpful to States recover through job creation? Do 
you think there is a link?
    Ms. Lav. Yes, as long as you can do it fast enough. And I 
think if they are ready to sell their bonds, it is ready to go, 
so that is good.
    Ms. DeLauro. Rising interest rates on bonds for these 
investments limiting investor interest, if you can believe 
issuing Federal bonds--you just answered that--at low interest 
rates for these projects could significantly help the States?
    Ms. Lav. Right. And that is a good way to target.
    Ms. DeLauro. I have another question which I would like to 
ask, if I can just throw this out there.
    As part of a financial recovery package we passed last 
month, we lowered the child tax credit threshold to $8,500 
benefiting 13 million children, 2.9 million who would become 
newly eligible for a benefit, 10.1 who would see their credit 
increase due to this provision. That is according to the Tax 
Policy Center, something I have advocated for for a very, very 
long time.
    In fact, I believe the threshold should be dropped to zero, 
and something which we set the stage for with $300 child tax 
credit, including in the stimulus package that we passed with 
other tax rebates earlier in the year.
    As we try to get a grasp on what would be most effective in 
stimulating the economy, providing long-term growth, what, if 
any, additional tax relief do you believe should be provided 
for the middle class? Do you think we should continue with an 
$8,500 threshold for the child tax credit or, in fact, expand 
it further in 2009? Should we, as well, expand the earned 
income tax credit, offer income tax rate cuts and rebates and 
so on?
    Ms. Lav, let me have you start.
    Ms. Lav. I think that--you know, I am a little unclear 
whether tax rebates or something are the best thing to do right 
now. But I suspect that if you do them, they should be not only 
for the middle class, but they should go, as the last ones did, 
all the way down. Because you want to put the money in the 
hands of the people that are going to spend it the fastest, and 
those are the people who need it the most and who you are sure 
are not going to put it in their savings account, which is not 
going to help the economy right now, or pay down a credit card. 
Well, they might do that.
    So I think that money put into the hands of the people who 
need it right now, that is a good thing. That was great with 
the child tax credit. We are very happy. It could go down a 
little lower. I am not sure about zero; as you know, we don't 
think that.
    So I think there are things that need to be done with the 
EITC improvements, expansion. That also would be very good, 
particularly for people who don't have children living with 
them. I mean, that is a sort of a forgotten group of people who 
really would also be quite stimulative to give them additional 
funds.
    Mr. Baily. I think the EITC is a great program. It was 
started many years ago.
    Ms. DeLauro. By Ronald Reagan, I might add, who said that 
the best way to lift people out of poverty was through the 
EITC.
    Mr. Baily. It was greatly expanded in the Clinton 
administration, which I was a part of, and I think we were very 
proud of that. I think it is a great program.
    I do think some of these issues need to be addressed in 
sort of long-term tax policy which addresses the issue of 
revenue and all of that. I don't know that all of these things 
can be addressed in the short-run stimulus package.
    Ms. DeLauro. On the infrastructure question that I asked 
Ms. Lav about, it leading to job creation increase, albeit we 
can posit that these things all need to be done, they have to 
be ready to go; we are there on that issue.
    But just your view as to that link between the 
infrastructure piece and job creation and quickly putting money 
into the hands of consumers.
    Mr. Baily. If we can get that done quickly--and it is 
really incremental spending, not just displacing other 
spending--it certainly would add to jobs. It would be a very 
immediate stimulus to jobs under those circumstances.
    And I did mention in my testimony, also, the need for 
maintenance. I remember in the 1975 recession an economist from 
Pittsburgh saying, we could use all the unemployed filling in 
the potholes in Pittsburgh. I think there are some maintenance 
things that could be done.
    Ms. DeLauro. Oh, schools, without question. Maintenance is 
a very, very big part of that, and I appreciate your saying 
that.
    Mr. Beach. Let me just add one thing to the comments of my 
fellow panelists that I am very pleased to be with.
    A lot of the middle class, broadly defined, is involved in 
small businesses, millions upon millions of small businesses. 
We can't forget those. In all of our discussion I think we need 
to keep them in our focus.
    And so what I threw out this morning in just oral 
testimony--and I will throw it out again--what is wrong with a 
temporary tax rate for small businesses? It is targeted. You 
could do it on a timely basis. Those that have a corporate form 
could get a 25 percent rate; those 25.2 million small 
businesses that file through the 1040 as a personal, the sole 
proprietors, partnerships and sub-Ss, LLCs could see a 
temporary reduction in their tax rate as well.
    That is middle class, par excellence. It also is directly 
related to job creation, and it could be done in an extremely 
rapid way.
    Ms. DeLauro. I would say to you, Mr. Beach, that I am pro 
doing something for small businesses. And I like them to be 
defined and determined as small businesses and not what 
normally happens in this institution where it emanates up the 
chain to the very, very big corporations and the very 
wealthiest, both with individuals and corporations.
    Quick last question, Ms. Lav: Should the Medicaid funds be 
targeted to particular States versus the across-the-board 
percentage increase to all the States?
    Ms. Lav. Well, we had been advocating targeting until, I 
think, very recently when we are now seeing a plunge in the--
you know, it was really the energy States and the commodity 
States, and everybody else was in trouble.
    As I said, 36 States are in trouble, so there are about a 
dozen that aren't. And now that the price of oil has dropped 
and we are going to see demand weakening around the world, I am 
not so sure that we need to do the targeting anymore. I think 
it is right on the cusp of whether we should or not right now. 
If we do block grants, maybe we should target because that has 
been a criticism in the past.
    If I could just make one quick comment, I think the best 
thing we can do for small businesses is to stimulate demand 
because they are not going to pay taxes if they don't have any 
profits, and if there is no demand, they cannot make a profit.
    Ms. DeLauro. Thank you.
    Mr. Chairman, thank you.
    Chairman Spratt. One last question from me, if you will--
Dr. Baily in particular.
    This doesn't strike me as your garden variety business 
cycle recession. It started with the phenomenon of subprime 
mortgages, but as Dr. Bernanke pointed out today, it has 
broadened considerably beyond that.
    As I look at the proposals that are in place for addressing 
the primary source of the problem, namely, distress in the 
housing market, reverse-wealth effect as values plummet, I 
don't really see the pathway by which these billions of dollars 
flow from the major banks to individual borrowers, particularly 
those who are in default.
    I can see them using this to make new loans, but I wonder 
how the money gets to defaulted mortgagors.
    And secondly, having been in the business before, I know it 
is very individualized. There is no debtor who has exactly the 
same problem as his neighbor. So there is no cookie-cutter 
solution, no wholesale solution. It is going to have to be 
retail banking. And that is going to take a lot of people 
across this country. And I just don't see it coming together.
    First of all, the $250 billion is going to the 
capitalization, recapitalization of banks. The $100 billion 
that follows that won't come for some time, because they will 
have to come back and there will be a comment period before the 
money is approved by the Congress. We could be months away 
before real money is available for the homeowners who are in 
distress, and by that time they may be beyond help.
    Have you given any thought to how this will work with the 
structure we have in place with the Economic Stabilization Act? 
Any other ideas about how it could be made to work?
    Mr. Baily. This is not a garden-variety recession, I agree. 
The 1982 is the worst one we have had since World War II. This 
one is of a different character and is certainly, in its effect 
on housing and household wealth, is probably more severe than 
that one, or certainly comparable to that one. So I agree with 
you on that point.
    Second, I agree that what is being done on the banks is 
indirect. You are trying to rescue the banking system; you are 
not putting money directly into homeowners or families. And I 
think that is one of the reasons we are here today, is to think 
about what is the right way to get money directly into the 
hands of Americans and stimulate demand.
    I think we do have to recapitalize the banking system. I 
don't think there is any choice. You can look across countries, 
you can look in U.S. history, and we have to recapitalize the 
banks.
    I think it is also important that we devote some of this 
money to working out the mortgage problem. I mentioned in my 
testimony the suggestion of allowing people to roll into 30-
year, fixed-rate mortgages in order to reduce the number of 
foreclosures. We have obviously had other legislation and other 
programs that have helped homeowners. But I agree with you 
completely, we need to target some of these funds back to the 
homeowners.
    Chairman Spratt. Not the least of our problems is that the 
Federal Government or any other creditor can't really move in 
until they have sued to judgment their claim against the 
mortgage-backed security. Then they have to dis-assemble it and 
take out the individual mortgages. That assumes that they are 
buying the whole package, because I understand these packages 
have been sold in slivers, and that could be a problem too. So 
it is a Byzantine, bramble-bush legal nightmare.
    Mr. Baily. It is. It is. And that is why it is so hard to 
unravel this thing. I do think the suggestion of allowing 
homeowners to roll into new mortgages would help resolve it. 
But I agree with you, it is a bramble bush.
    Chairman Spratt. Well, let me just say what has happened. 
So you have to close a new mortgage. In the meantime, these 
folks haven't made their house payment. By definition, they 
almost will not have made other payments as well, because the 
house payment comes first and the car payment comes next.
    When you go to search the title in order to take a clear 
first lien on the property, guess what? The hospital has a 
judgmental lien against them; the other creditors as well, 
credit cards. Then you have a bigger problem than just the 
mortgage debt, with all of the accumulated administrative costs 
and legal fees. You have these other liens that have to be 
cleared off the record.
    Mr. Baily. That is right. In my home State of Maryland, 
they have had a program to try to help mortgage owners that are 
distressed. And it has been fairly expensive, and they haven't 
helped a lot of mortgage owners. So it is a difficult problem 
to solve, precisely because of these legal structures that you 
describe.
    I don't have a--I don't have a full answer for you, 
Congressman. I think it is going to take a while to play that 
out, and that is why we need to try to keep the rest of the 
economy going.
    Chairman Spratt. I think there is a fair amount of 
improvisation in what they are doing right now.
    Mr. Baily. Absolutely.
    Chairman Spratt. And this has yet to be improvised.
    Iris Lav or Bill Beach, do you have any further comments?
    Ms. Lav. No.
    Chairman Spratt. Okay.
    Mr. Beach. Thank you very much, Chairman. I think they are 
improvising.
    Chairman Spratt. Thank you all of you for coming.
    Mr. Beach. Thank you.
    Chairman Spratt. I very much appreciate it. Your answers 
have been extremely helpful to us, and we are grateful to you 
for your contribution.
    Mr. Baily. Thank you for having me, sir.
    Chairman Spratt. I ask unanimous consent that those members 
who did not have the opportunity to ask questions of the 
witnesses be given 7 days to submit questions for the record.
    We don't have any legal process by which we can compel 
answers, so don't worry. [Laughter.]
    Thank you very much.
    The meeting is hereby adjourned.
    [Questions for the record submitted by Mr. Etheridge 
follow:]

          Questions for the Record Submitted by Mr. Etheridge

    I would like to thank Chairman Spratt for holding this important 
and timely hearing. I regret that due to previously scheduled meetings 
in my district, I was unable to attend. Like everyone, I am concerned 
with the deteriorating state of our financial industry and our economy 
as a whole. We are continuing to see negative economic indicators 
throughout the economy, like rising unemployment and decreased 
quarterly growth, at the same time, the effects of the crisis on Wall 
Street are beginning to be felt on Main Street. I look forward to a 
continued discussion of possible stimulus measures that can get our 
economy back on track, and I thank you for the opportunity to have 
Federal Reserve Board Chairman Bernanke address my questions.
    1. Chairman Bernanke, I have heard from several small business 
owners throughout my district who are concerned by the continued 
decrease in small business lending. As you know, Congress passed the 
Emergency Economic Stabilization Act earlier this month to increase 
liquidity in the lending industry, and last week Secretary Paulson 
announced a plan to use $250 billion of that authority to provide 
capital to banks by purchasing equity in those that choose to 
participate. Outside of the nine major banks that have already 
announced participation in this plan, how many banks do you expect to 
participate in this program? In addition, if regional and local banks 
choose to participate in this program, what guarantees are there that 
they will use this money to make more loans for small businesses? How 
long will it take for local businesses to feel the effect of Treasury's 
actions?
    2. In addition, I am concerned that the Small Business 
Administration (SBA) has mistakenly been awarding small business 
contracts to large firms as reported in the Washington Post. This is 
precisely the time that SBA could be picking up the slack in lending to 
small businesses, and using their government backed guarantee to 
provide confidence in the marketplace. Are there any provisions to 
increase capital for SBA or to give them an increased role during this 
financial crisis?
    3. Beyond the steps that have already been taking, what action can 
the Federal Reserve, Treasury Department, or Congress take to improve 
liquidity so that small business can grow and qualified consumers can 
get credit to keep our economy on track?

    [Responses to Mr. Etheridge's questions follow:]

    
    
    
    
    [The statement of Mr. Porter follows:]

 Prepared Statement of Hon. Jon C. Porter, a Representative in Congress
                        From the State of Nevada

    On Monday October 20, 2008 the House Budget Committee held a 
hearing on the options and challenges involved with our economic 
recovery efforts. While I was unable to attend due to previous 
engagements, I would like to commend my colleagues on the Budget 
Committee for holding a hearing on this matter.
    In the State of Nevada, my constituents have been particularly hit 
hard by our current financial crisis. Economic events of the past 
several months have shaken the foundations of our financial systems and 
have led to the failure of a number of banks and lending institutions, 
three in Nevada alone. Furthermore, my constituency is suffering from 
one of the nation's highest foreclosure rates as well as an escalating 
unemployment rate. The matters under discussion today before the Budget 
Committee are of vital interest to me and my constituents, and I look 
forward to additional conversations with the panelists as we continue 
to navigate through this trying time and ensure that our recovery 
efforts are done in a timely and appropriate manner.
    At this critical moment in our financial future, while we are 
working as cautiously and expeditiously as we can to help stabilize the 
economy in a manner that protects taxpayers and homeowners, we also 
need to learn from this situation to protect us in the future. With 
this in mind, I introduced legislation calling for a special commission 
of inquiry into this crisis that would investigate the origins of the 
crisis as well as provide recommendation to guard against future 
crisis.
    We must have a full understanding of what led to this crisis in 
order to prevent it in the future. I remain committed to working with 
my colleagues on both sides of the aisle, and in the administration, to 
ensure that the public does not face the same situation in the future.

    [Whereupon, at 1:01 p.m., the committee was adjourned.]

                                  
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