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


                                                        S. Hrg. 110-111
 
                          THE ECONOMIC OUTLOOK

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

                                HEARING

                               before the

                        JOINT ECONOMIC COMMITTEE
                     CONGRESS OF THE UNITED STATES

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                               __________

                             MARCH 28, 2007

                               __________

          Printed for the use of the Joint Economic Committee

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                        JOINT ECONOMIC COMMITTEE

    [Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]

SENATE                               HOUSE OF REPRESENTATIVES
Charles E. Schumer, New York,        Carolyn B. Maloney, New York, Vice 
    Chairman                             Chair
Edward M. Kennedy, Massachusetts     Maurice D. Hinchey, New York
Jeff Bingaman, New Mexico            Baron P. Hill, Indiana
Amy Klobuchar, Minnesota             Loretta Sanchez, California
Robert P. Casey, Jr., Pennsylvania   Elijah E. Cummings, Maryland
Jim Webb, Virginia                   Lloyd Doggett, Texas
Sam Brownback, Kansas                Jim Saxton, New Jersey
John E. Sununu, New Hampshire        Kevin Brady, Texas
Jim DeMint, South Carolina           Phil English, Pennsylvania
Robert F. Bennett, Utah              Ron Paul, Texas

                Chad Stone, Executive Director (Acting)
             Christopher J. Frenze, Minority Staff Director















                            C O N T E N T S

                              ----------                              

                      Opening Statement of Members

Statement of Hon. Charles E. Schumer, Chairman, a U.S. Senator 
  from New York..................................................     1
Statement of Hon. Jim Saxton, Ranking Minority, a U.S. 
  Representative from New Jersey.................................     3
Statement of Hon. Carolyn B. Maloney, Vice Chair, a U.S. 
  Representative from New York...................................     4

                               Witnesses

Statement of Hon. Ben S. Bernanke, Chairman, Board of Govenors of 
  the Federal Reserve System.....................................     5

                       Submissions for the Record

Prepared statement of Senator Charles E. Schumer, Chairman.......    33
Prepared statement of Representative Jim Saxton, Ranking Minority    34
Prepared statement of Representative Carolyn B. Maloney, Vice 
  Chair..........................................................    35
Prepared statement of Hon. Ben S. Bernanke, Chairman, Board of 
  Governors of the Federal Reserve System........................    36
Prepared statement of Senator Sam Brownback......................    38


                          THE ECONOMIC OUTLOOK

                              ----------                              


                       WEDNESDAY, MARCH 28, 2007

             Congress of the United States,
                          Joint Economic Committee,
                                                     Washington, DC
    The Committee met at 10:30 a.m., in room 216 of the Hart 
Senate Office Building, the Honorable Charles E. Schumer, 
Chairman of the Joint Economic Committee, presiding.
    Senators present: Bennett, Brownback, Casey, DeMint, 
Klobuchar, Schumer, Sununu, and Webb.
    Representatives present: Brady, Hinchey, Maloney, Paul, and 
Saxton.
    Staff present: Katie Berne, Chris Frenze, Nan Gibson, 
Colleen Healy, Robert Keteher, Israel Klein, Jeff Schlagenhauf, 
Chad Stone, Robert Weingart, and Adam Wilson.

OPENING STATEMENT OF HON. CHARLES E. SCHUMER, CHAIRMAN, A U.S. 
                     SENATOR FROM NEW YORK

    Chairman Schumer. The hearing will come to order. I want to 
welcome Federal Reserve Chairman Ben Bernanke to this hearing 
of the Joint Economic Committee on the Economic Outlook.
    This Committee has a broad mandate to study and make 
recommendations about economic policy, and we frequently seek 
the views of the Federal Reserve Chairman as we carry out that 
mandate.
    Chairman Bernanke, we live in interesting times, and you 
face a number of important challenges in setting a course for 
monetary policy that will achieve the multiple goals of high 
employment, balanced economic growth, and reasonable price 
stability.
    Those challenges are all the more complicated by what's 
turning out to be an emerging crisis for homeowners all over 
the country, the subprime market fallout.
    Today is the first time that we will hear Chairman Bernanke 
say that the wave of defaults we are witnessing in the subprime 
market, quote, ``Casts serious doubt on the adequacy of 
underwriting standards for these loans.''
    And today, we will take his words as a further indication 
that there must be a response on the Federal level. When so 
many mortgage brokers are able to deceive our most vulnerable 
families into loans that they could never afford without anyone 
batting an eye, that part of the housing finance system is 
broken.
    I will be introducing a bill that would establish a 
national regulatory system for all mortgage brokers, including 
those at non-bank companies. To me, it makes very little sense 
that there should be one standard for banks and another 
standard for non-banks.
    We will also establish a suitability standard for 
borrowers, so that they will never issue a loan that the 
borrower can't afford.
    The wave of subprime foreclosures that we've seen so far 
could well be the tip of the iceberg, and we all know what 
these foreclosures do to families that fall victim to them. 
It's on the front page of our national papers every day.
    Here's a story about Newark, in the New York Times, and the 
number of foreclosures, just in Newark, is astounding and 
troubling. Now, the question, of course, that is--you have two 
hats here as Federal Reserve Chairman: One is what the Federal 
Reserve should do to deal with the subprime market, and we're 
going to ask you some questions about that. You mention, again, 
a little bit about it in your statement which I welcome.
    Second, of course, is the systemic risk that this might 
cause. They are two separate issues, and you make clear that we 
need to do something in the former, but the verdict is out on 
how much the latter is going to create systemic risk.
    What I worry about is the layering-on of the risk that the 
subprime market reflects in our broader economy. In other 
words, if it were just one issue and everything else were 
hunky-dory, you would not worry much about systemic risk.
    But there is a very low personal savings rate, record high 
debt levels, trade imbalances, and vulnerability to sharp 
currency depreciation if the rest of the world forecloses on 
us.
    And you add the subprime problems here that, who knows, 
might spread to the prime market--might not--it creates some 
problems.
    Just as families, teased into unsuitable subprime loans, 
are signing over their economic security, the Nation is at risk 
of mortgaging away our economic future if we don't deal with 
these problems and start investing in our own future growth.
    There are times when the direction of monetary policy is 
clear. This does not appear to be one of those times.
    It looks like the Fed has become more neutral about the 
Federal direction of monetary policy, and I think this is 
prudent for a number of reasons: First, the typical American 
family has been left behind so far in the recovery from the 
2001 recession.
    Productivity growth has been strong, but workers' earnings 
haven't kept up with the growth. Profits have risen sharply--so 
have the salaries and bonuses of top management--but middle-
class families have not seen their paychecks keep up with 
rising healthcare premiums, college costs, gas prices, just to 
name a few expenses squeezing families today.
    It would be cruel injustice if this recovery were to be cut 
short before workers' earnings began to reflect their 
productivity and before families' real incomes more closely 
followed the trajectory of economic growth.
    Another reason to be open to an easing of monetary policy 
is the concern that the housing market adjustment is far from 
over. Recent housing data have offered little encouragement 
that the market might be stabilizing, so it is still too early 
to tell if the worst is over for the housing market.
    I, personally, don't think the worst is over for the 
housing market because of all of the problems we are reading 
about in the subprime market--and those will clearly get worse, 
at least in terms of their effects on average families.
    Just to mention a few statistics here: 52,000 families 
foreclosed on their homes last year in New York alone, so this 
is a serious problem. It's a terrible instance where lack of 
oversight has led to a Wild-West mentality among unscrupulous 
lenders, and frankly, the exploitation of large numbers of 
financially unsophisticated borrowers.
    It's bad that entire corporations built on this faulty 
business plan and investors who funded those schemes will be 
out of business or out of money, and those failures will lead 
to some adjustment in the market.
    But the real tragedy here is that 2.2 million homeowners 
face the real possibility of losing their homes because they 
were misled or just plain swindled by modern-day bandits. This 
Committee will be very interested in your testimony, Chairman 
Bernanke, and in your answers to our questions about the causes 
and consequences of the trouble in the subprime market and 
their effects on the overall economy.
    Problems in the housing market are at the forefront of my 
concerns about overall economic outlook but, as I mentioned, 
there are other issues that we are also focused upon.
    The new Congress is beginning to take real steps to get the 
budget deficit under the control, in the wake of the budget 
excesses of the last 6 years but those excesses have brought us 
or helped bring about a large trade deficit, low national 
savings, and a mounting debt to the rest of the world.
    I hope, Chairman Bernanke, that you agree with me that the 
current trade deficit is unsustainably large. It's critically 
important that we take steps to bring it down. I look forward 
to your testimony on the Economic Outlook and to a discussion 
of how we can best meet the economic challenges we face, and 
finally, how we can better protect millions of American 
families from being robbed in this lawless Wild West of exotic 
home loans sometimes called ``Liar Loans.''
    Normally, I encourage all of our members to make opening 
statements, but we're going to have votes on the floor. I think 
the last time they said was 11:30, so I'm going to ask our Vice 
Chairman and the Senate and House Ranking Members to make 
opening remarks, and would ask the indulgence of others, if we 
could submit statements to the record.
    With that, let me call on my colleague, Jim Saxton.
    [The prepared statement of Senator Schumer appears in the 
Submissions for the Record on page 33.]

    STATEMENT OF HON. JIM SAXTON, RANKING MINORITY, A U.S. 
                 REPRESENTATIVE FROM NEW JERSEY

    Representative Saxton. Mr. Chairman, thank you very much. 
Chairman Bernanke, it's a pleasure to be here to welcome a 
fellow New Jerseyian, a Princetonian, to the Committee this 
morning.
    As the Federal Reserve has noted, the U.S. economy has 
performed well in recent years. Economic growth has been 
strong, unemployment stands at about 4.5 percent, and 7.6 
million jobs have been created since August of 2003.
    Further, long-term inflation pressures are under control 
and long-term interest rates remain at low levels. According to 
the Federal Reserve's Monetary Policy Report submitted to 
Congress last month, the economic outlook for this year and 
next appears favorable.
    The report notes that the drag on the economy from the 
decline in homebuilding may lessen during 2007; real wage and 
job gains should continue to boost consumer spending; and 
financial conditions for business, appear to be quite good.
    In addition, U.S. exports are expected to make a positive 
contribution to growth. The risks to the economy going forward 
include the potential impact of unsound prime lending, 
continued weakness in housing, and slower growth of business 
investment.
    Nevertheless, taking these and other factors into account, 
the Federal Reserve Board has projected that U.S. economic 
growth will range somewhere between 2.5 and 3 percent during 
the year 2007.
    The economic growth projected by the Fed in 2007 is in line 
with that of the Blue Chip consensus of economic forecasters. 
Although the prospects for economic expansion are good, I 
continue to be concerned about the prospect of much higher 
taxes in the future, under policies currently being considered 
in Congress.
    Although the economy has proven to be extremely resilient 
in recent years, the possibility of a policy mistake 
undermining economic growth cannot be dismissed lightly. If we 
can avoid such mistakes, the prospects of economic expansion 
will continue to be favorable over the next several years.
    So once again, Mr. Chairman, let me thank you for being 
here with us this morning, and we look forward to hearing from 
you.
    [The prepared statement of Representative Saxton appears in 
the Submissions for the Record on page 34.]
    Chairman Schumer. Vice Chairperson Maloney.

  OPENING STATEMENT OF HON. CAROLYN B. MALONEY, VICE CHAIR, A 
               U.S. REPRESENTATIVE FROM NEW YORK

    Vice Chair Maloney. Thank you, Chairman Schumer from the 
great State of New York. I welcome Chairman Bernanke and thank 
you for testifying today.
    This hearing comes at an important time because monetary 
policy is at a critical juncture. With new risks in the housing 
markets and weak business investment, the Fed last week 
essentially acknowledged that economic conditions may be 
deteriorating more than expected.
    Evidence of a slowing economy is building, and the concern 
is that the unemployment rate will begin to rise, if slow 
growth continues which argues for easing rates.
    At the same time, inflation has been higher than the Fed is 
comfortable with over the long term which seems to have 
prevented the Fed from lowering interest rates. To ease or not 
to ease which way will the arrow go?
    How the Fed will answer that question is what we will all 
try to divine today. I look forward to gaining some insights 
into how the Fed will balance the various risks to the economy.
    How American families are faring should be part of the 
Fed's equation because the economy is weakening even before 
many have shared in the gains from the economic growth we have 
seen so far.
    Income is growing the most for executives and highly-
compensated individuals but ordinary working Americans are only 
just beginning to see their paychecks rise above inflation.
    The ability of American consumers to keep spending, may be 
flagging with the cooling housing market and recent stock 
market volatility. We are facing, by all accounts, a tsunami of 
defaults and foreclosures in the subprime market.
    In each of our districts, our constituents are encountering 
payment shock as their subprime loans reset to much higher 
rates. By some estimates, 2.2 million homeowners with subprime 
loans made through 2006 are at risk of losing their homes.
    Rising delinquencies on subprime home loans, while 
devastating to the many families who have fallen prey to these 
vehicles, could also have broader implications for the economy. 
Some economists have already started to compare the subprime 
market meltdown to the dot-com bubble.
    Chairman Bernanke, I hope you will provide some reassurance 
that this is not the case. In the House, we are working on 
comprehensive subprime lending legislation to fix this problem. 
One question before us today is whether the Fed will act under 
its Home Ownership and Equity Protection Act powers to regulate 
unfair and deceptive practices to extend the proposed 
guidelines, the joint guidelines that came out to non-bank 
lenders, or whether Congress should legislate to achieve that 
result.
    Setting the right course for monetary policy is complicated 
by our current fiscal and international imbalances. The 
challenge for this Congress is to return to the fiscal 
discipline that has been squandered by the President and 
Congress over the past 6 years.
    Today in the House of Representatives, we are debating a 
realistic budget plan that adheres to pay-go principles for 
controlling the deficit and bringing revenues into line with 
what we need to spend to defend the country and take care of 
the needs of our citizens.
    Mr. Chairman, thank you for holding this important hearing, 
and I look very, very much forward to Chairman Bernanke's 
testimony. Thank you for being here.
    [The prepared statement of Representative Maloney appears 
in the Submissions for the Record on page 35.]
    Chairman Schumer. Thank you. I see that my colleague, 
Senator Brownback, is not here but we'll afford him the 
opportunity to do an opening statement in addition to his 
question period.
    Chairman Bernanke, the floor is yours.

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

    Chairman Bernanke. Thank you, Chairman Schumer, Vice 
Chairman Maloney, Representative Saxton, and other members of 
the Committee, for inviting me here this morning to present an 
update on the outlook for the U.S. economy.
    I will begin with a discussion of real economic activity, 
and then turn to inflation.
    Economic growth in the United States has slowed in recent 
quarters, reflecting, in part, the economy's transition from 
the rapid rate of expansion experienced over the preceding 
years, to a more sustainable pace of growth.
    Real gross domestic product rose at an annual rate of 
roughly 2 percent in the second half of 2006 and appears to be 
expanding at a similar rate early this year.
    The principal source of the slowdown in economic growth 
that began last spring has been the substantial correction in 
the housing market. Following an extended boom in housing, the 
demand for homes began to weaken in mid-2005.
    By the middle of 2006, sales of both new and existing homes 
had fallen about 15 percent below their peak levels. 
Homebuilders responded to this fall in demand by sharply 
curtailing construction.
    Even so, the inventory of unsold homes has risen to levels 
well above historical norms. Because of the decline in housing 
demand, the pace of house price appreciation has slowed 
markedly, with some markets experiencing outright price 
declines.
    The near-term prospects for the housing market remain 
uncertain. Sales of new and existing homes were about flat, on 
balance, during the second half of last year. So far this year, 
sales of existing homes have held up, as have other indicators 
of demand, such as mortgage applications for home purchase, and 
mortgage rates remain relatively low.
    However, sales of new homes have fallen, and continuing 
declines in starts have not yet led to meaningful reductions in 
the inventory of homes for sale.
    Even if the demand for housing falls no further, weakness 
in residential construction is likely to remain a drag on 
economic growth for a time as homebuilders try to reduce their 
inventories of unsold homes to more normal levels.
    Developments in subprime mortgage markets raise some 
additional questions about the housing sector. Delinquency 
rates on variable-interest-rate loans to subprime borrowers 
which account for a bit less than 10 percent of all mortgages 
outstanding, have climbed sharply in recent months.
    The flattening of home prices has contributed to the 
increase in delinquencies, by making refinancing more difficult 
for borrowers with little home equity. In addition, a large 
increase in early defaults on recently-originated subprime 
variable-rate mortgages casts serious doubt on the adequacy of 
the underwriting standards for these products, especially those 
originated over the past year or so.
    As a result of this deterioration in loan performance, 
investors have increased their scrutiny of the credit quality 
of securitized mortgages, and lenders, in turn, are evidently 
tightening the terms and standards applied in the subprime 
mortgage market.
    Although the turmoil in the subprime mortgage market has 
created severe financial problems for many individuals and 
families, the implication of these developments for the housing 
market, as a whole, is less clear.
    The ongoing tightening of lending standards, although an 
appropriate market response, will reduce somewhat the effective 
demand for housing, and foreclosed properties will add to the 
inventories of unsold homes.
    At this juncture, however, the impact on the broader 
economy and financial markets of the problems in the subprime 
market seems likely to be contained. In particular, mortgages 
to prime borrowers and fixed-rate mortgages to all classes of 
borrowers continue to perform well, with low rates of 
delinquency. We will continue to monitor this situation 
closely.
    Business spending has also slowed recently. Expenditures on 
capital equipment declined in the fourth quarter of 2006 and 
early this year.
    Much of the weakness in recent months has been in types of 
capital goods used heavily by the construction and motor 
vehicle industries, but we have seen some softening in the 
demand for other types of capital goods as well.
    Although some of this pullback can be explained by the 
recent moderation in the growth of output, the magnitude of the 
slowdown has been somewhat greater than would be expected, 
given the normal evolution of the business cycle.
    In addition, inventory levels in some industries, again, 
most notably in industries linked to construction and motor 
vehicle production, rose over the course of last year, leading 
some firms to cut production to better align inventories with 
sales.
    Recent indicators suggest that the inventory adjustment 
process may have largely run its course in the motor vehicle 
sector but remaining imbalances in some other industries may 
continue to impose some restraint on industrial production for 
a time.
    Despite the recent weak readings, we expect business 
investment in equipment and software to grow at a moderate pace 
this year, supported by high rates of profitability, strong 
business balance sheets, relatively low interest rates and 
credit spreads, and continued expansion of output and sales.
    Investment in nonresidential structures such as office 
buildings, factories, and retail space, should also continue to 
expand, although not at the unusually rapid pace of 2006.
    Thus far, the weakness in housing and in some parts of 
manufacturing does not appear to have spilled over to any 
significant extent to other sectors of the economy.
    Employment has continued to expand as job losses in 
manufacturing and residential construction have been more than 
offset by gains in other sectors, notably healthcare, leisure 
and hospitality, and professional and technical services. And, 
unemployment remains low by historical standards.
    The continuing increases in employment, together with some 
pickup in real wages, have helped sustain consumer spending 
which increased at a brisk pace during the second half of last 
year and has continued to be well-maintained so far this year.
    Growth in consumer spending should continue to support the 
economic expansion in coming quarters. In addition, fiscal 
policy at both the Federal, State and local levels should 
impart a small stimulus to economic activity this year.
    Outside the United States, economic activity in our major 
trading partners has continued to grow briskly. The strength of 
demand abroad has helped to spur strong growth in U.S. real 
exports which rose about 9 percent last year, and a robust 
world economy should continue to provide opportunities for U.S. 
exporters this year.
    Growth in U.S. real imports slowed to about 3 percent in 
2006, in part reflecting a drop, in real terms, in imports of 
crude oil and petroleum products.
    Despite the improvements in trade performance, the U.S. 
current account deficit remains large, averaging 6.5 percent of 
nominal GDP during 2006.
    Overall, the economy appears likely to continue to expand 
at a moderate pace over coming quarters. As the inventory of 
new homes is worked off, the drag from residential investment 
should wane.
    Consumer spending appears solid, and business investment 
seems like to post-moderate gains.
    This forecast is subject to a number of risks. To the 
downside, the correction in the housing market could turn out 
to be more severe than we currently expect, perhaps exacerbated 
by problems in the subprime sector.
    Moreover, we could see yet greater spillover from the 
weakness in housing to employment and consumer spending than 
has occurred thus far.
    The possibility that the recent weakness in business 
investment will persist is an additional downside risk.
    To the upside, consumer spending, which has proved quite 
resilient despite the housing downturn and increases in energy 
prices, might continue to grow at a brisk pace, stimulating a 
more rapid economic expansion than we currently anticipate.
    Let me now turn to the inflation situation. Overall, 
consumer price inflation has come down since last year, 
primarily as the result of the deceleration of consumers' 
energy costs.
    The Consumer Price Index, or CPI, increased 2.4 percent 
over the 12 months ending in February, down from 3.6 percent a 
year earlier.
    Core inflation slowed modestly in the second half of last 
year, but recent readings have been somewhat elevated, and the 
level of core inflation remains uncomfortably high.
    For example, core CPI inflation over the 12 months ending 
in February was 2.7 percent, up from 2.1 percent a year 
earlier. Another measure of core inflation that we monitor 
closely, based on the price index or personal consumption 
expenditures, excluding food and energy, shows a similar 
pattern.
    Core inflation, which is a better measure of the underlying 
inflation trend than overall inflation, seems likely to 
moderate gradually over time. Despite recent increases in the 
price of crude oil, energy prices are below last year's peak, 
although I might add that in the last few days that has become 
less true.
    If energy prices remain near current levels, greater 
stability in the cost of producing non-energy goods and 
services will reduce pressure on core inflation over time.
    Of course, the prices of oil and other commodities are very 
difficult to predict, and they remain a source of considerable 
uncertainty in the inflation outlook.
    Increases in rents--both market rents and owner's 
equivalent rent--account for a substantial part of the increase 
in core inflation over the past year. The acceleration in rents 
may have resulted, in part, from a shift in demand toward 
rental housing, as families found home ownership less 
financially attractive.
    Rents should begin to decelerate as the demand for owner-
occupied housing stabilizes and as the supply of rental units 
increases. However, the extent and timing of that expected 
slowing is not yet clear.
    Another significant factor influencing medium-term trends 
in inflation is the public's expectations of inflation. These 
expectations have an important bearing on whether transitory 
influences on prices--such as changes in energy costs--become 
embedded in wage and price decisions and so leave a lasting 
imprint on the rate of inflation. It is encouraging that 
inflation expectations appear to be contained.
    Although core inflation seems likely to moderate gradually 
over time, the risks to this forecast are to the upside. In 
particular, upward pressure on inflation could materialize if 
final demand were to exceed the underlying productive capacity 
of the economy for a sustained period.
    The rate of resource-utilization is high, as can be seen 
most clearly in the tightness of the labor market. Indeed, 
anecdotal reports suggest that businesses are having difficulty 
recruiting well-qualified workers in a range of occupations.
    Measures of labor compensation, though still growing at a 
moderate pace, have shown some signs of acceleration over the 
past year likely, in part, a result of the tight labor market 
conditions.
    To be sure, faster growth in nominal labor compensation 
does not necessarily portend higher inflation. Increases in 
compensation may be offset by higher labor productivity or 
absorbed, at least for a time, by a narrowing of firm's profit 
margins, rather than passed on to consumers in the form of 
higher prices.
    In these circumstances, gains in nominal compensation would 
translate into gains in real compensation as well.
    Underlying productivity trends appear generally favorable 
despite the recent slowing in some measures, and the markup of 
prices over unit labor costs is high by historical standards so 
such an outcome is certainly possible.
    Moreover, if the economy grows at a moderate pace for a 
time, as seems most likely, pressures on resource-utilization 
should ease.
    However, a less benign possibility is that tight product 
markets might allow firms to pass some or all of their higher 
labor costs through to prices. In this case, increases in 
nominal compensation would not translate into increased 
purchasing power for workers but would add to inflation 
pressures.
    Thus, the high level of resource-utilization remains an 
important upside risk to continued progress in reducing 
inflation.
    In regard to monetary policy, the Federal Open Market 
Committee has left its target for the Federal Funds Rate 
unchanged at 5.25 percent since last June.
    To date, the incoming data have supported the view that the 
current stance of policy is likely to foster sustainable 
economic growth and a gradual ebbing in core inflation.
    Because core inflation is above the levels most conducive 
to the achievement of sustainable growth and price stability, 
the Committee indicated in a statement following its recent 
meeting that its predominant policy concern remains the concern 
that inflation will fail to moderate as expected.
    However, the uncertainties around the outlook have 
increased somewhat in recent weeks. Consequently, the Committee 
also indicated that future policy decisions will depend on the 
evolution of the outlook for both inflation and economic 
growth, as implied by incoming information.
    Thank you. I would be happy to take your questions.
    [The prepared statement of Hon. Ben Bernanke appears in the 
Submissions for the Record on page 36.]
    Chairman Schumer. Thank you, Mr. Chairman, for your, as 
usual, erudite testimony.
    I want to focus my questions, as I mentioned, on the 
subprime market. Last week, there was a lot of discussion about 
the failure of regulators to act as problems started to unfold.
    In December I wrote this letter to you with several of my 
colleagues on the Banking Committee that asked why your October 
guidance, outlining the need to underwrite loans at their 
fully-indexed rate in order to truly assess the borrower's 
ability to pay, did not pertain to subprime mortgages, 
especially to the increasingly popular exploding ARMs.
    I'm aware that the Fed is preparing new guidance related to 
mortgage underwriting--including subprime loans--this summer, 
and that this guidance is in the comment phase.
    Today I could not help but notice in your testimony--and I 
think this is for the first time--that you acknowledge that 
faulty underwriting standards--such as the ones we wrote you 
about in the letter--could have contributed to this subprime 
crisis that is devastating for hundreds of thousands of 
families.
    So I have two questions: First, will your new guidance be 
enough? Considering that you don't even regulate non-bank 
lenders who have issued the vast majority of subprime loans in 
the past 2 years, should non-bank mortgage lenders be subject 
to Federal regulations that banks are now forced to comply 
with, like HMDA, HOPA, and your new nontraditional mortgage 
guidance?
    The second question is: Why has it taken till 2007 to come 
up with underwriting standards for the mortgage lending 
industry in general, let alone the more risky subprime aspect 
of the lending in particular?
    The writing has been on the wall for some time now that all 
too many mortgage lenders have been tricking borrowers into 
loans they could never mathematically afford.
    Chairman Bernanke. Thank you, Mr. Chairman. First, the 
nontraditional mortgage guidance, to which you allude, does 
apply to subprime mortgages.
    It was specifically targeted at so-called exotic mortgages, 
interest-only, option arms, those types of not-amortizing-types 
of mortgages.
    We began discussion of that guidance with our colleagues in 
2004. We went out for guidance after that, so this guidance has 
been in the air, so to speak, for some time.
    And in particular, the principles that that guidance 
enunciated were three: First, that underwriting has to be good, 
has to be, indeed, consistent with the fully-indexed rate; 
secondly, that disclosures must be adequate; and thirdly, that 
risk management by the lenders must be appropriate.
    The more recent subprime guidance to which you allude 
really closes a technical loophole, which is that the 
nontraditional mortgage guidance did not apply to fully-
amortizing mortgages such as 2/28s and 3/27s.
    Chairman Schumer. Right.
    Chairman Bernanke. We are closing that loophole with this 
new guidance, but I would say that the basic principles of good 
lending that were enunciated in the nontraditional mortgage 
guidance, I hope, were understood to apply more broadly.
    With respect to non-bank mortgage lenders, the HMDA and 
HOPA regulations do, in fact, apply to them in terms of the 
regulation, but the Federal Reserve has no authority to enforce 
those regulations.
    Chairman Schumer. Right.
    Chairman Bernanke. Therefore, it falls to the States or to 
other agencies to do that enforcement.
    With respect to our subprime and other guidances, that also 
does not apply to non-bank lenders.
    Chairman Schumer. Right.
    Chairman Bernanke. However, we have tried to coordinate, to 
some extent, with the State banking supervisors in the hope 
that they, in many cases------
    Chairman Schumer. Is your advice to us to include non-bank 
lenders who have issued these subprimes and give you the 
ability to regulate them or some other Federal agency?
    Chairman Bernanke. I think--more generally, first, from the 
Federal Reserve's point of view, I think that where we need 
more clarity is on our authority to regulate non-bank 
subsidiaries of banks or bank holding companies.
    There was some uncertainty about our authorities there, 
particularly with respect to consumer issues.
    And I have asked our staff to do a complete review of our 
powers and practices with respect to those.
    The broader issue of non-bank lenders is a difficult issue. 
I think it bears on the question of whether you want to go to a 
Federal predatory lending law. I think it's worth looking at 
that.
    There are a number of questions that would have to be 
answered. One would be: Would it be a preemptive law or would 
it be a base law? And, the second question to which you allude 
is: Who would enforce it?
    Chairman Schumer. Right.
    Chairman Bernanke. Frankly, that's a very difficult 
question. Currently, it's the states, and I think the question 
arises------
    Chairman Schumer. They haven't done a very good job, have 
they?
    Chairman Bernanke. The question arises as to whether 
Federal requirements or funding would allow the oversight, 
which is uneven--in some places it's good; in some places it's 
not so good.
    Chairman Schumer. You don't rule out of hand, expanding 
Federal regulation and jurisdiction to these non-bank lenders, 
because if you close down the bank lenders or regulate them, 
the non-bank lenders will just move in, and they're much worse.
    They account for the worst of the loans, the worst of the 
excesses, and it seems to me that it makes no sense to say 
we're regulating the bank subprime area when it will just shift 
over to the non-bank. Don't you agree with that?
    Chairman Bernanke. I agree with that, and I think that 
looking at alternative ways of enforcing the rules is 
worthwhile.
    Chairman Schumer. Final question--and this relates more to 
the systemic aspect. And I was glad to hear what you said in 
answer to the first question. We have to do something here, and 
we will. As I mentioned, I'll be introducing legislation on 
this area very shortly.
    The second is systemic. If the perfect storm of lower home 
values and higher mortgage rates, along with shakier paychecks 
and unsuitable loans, does lead to a dramatic increase in 
foreclosures that many are predicting, how will the dumping of 
empty homes on the market affect overall housing supply and 
housing prices in the near term? And second, many of my friends 
in New York working in the financial sector are warning me that 
they're already beginning to see the subprime default problem 
creep into the prime market.
    To what extent do you think this is happening, and what are 
the chances that the prime market will be impacted as well?
    Chairman Bernanke. Mr. Chairman, we're certainly watching 
that very carefully--we've been monitoring the markets. We're 
looking at not only the other portions of the mortgage market, 
but also other types of credit like automobile credit and so 
on, and so far, we don't see any significant indications that 
this problem has spilled over into those other markets.
    We're certainly going to follow that and watch it 
carefully. We've also spent a lot of energy and thought in 
trying to determine what implications the subprime situation 
might have for the overall housing market. We're very 
uncertain, as I said in my testimony.
    Our best guess, based on the size of that market and its 
contribution to overall demand for housing--the fact that 
subprime issuance, particularly some of the worst subprime 
issuance, seems to have come down already--is that the effects 
on the housing market will be moderate, and therefore, that the 
effects on the economy overall should be relatively small.
    However, as I said, there's a risk there and we're 
certainly going to watch it very carefully.
    Chairman Schumer. But, thus far, you see none of this 
spreading into the prime market?
    Chairman Bernanke. We have not.
    Chairman Schumer. Okay, thank you, Mr. Chairman. I'm now 
going to call on the Senate Ranking Member, Senator Brownback. 
I mentioned, while you were out, Sam, that if you want to do an 
opening statement in addition to your questions, feel free.
    Senator Brownback. Thank you very much, Mr. Chairman. I 
apologize for being here late, and I will not deliver my 
opening statement, although I would like to if I could have a 
little more time on a question.
    [The prepared statement of Senator Brownback appears in the 
Submissions for the Record on page 38.]
    Chairman Schumer. That's fine.
    Senator Brownback. Mr. Chairman, thank you very much for 
being here. I appreciate your discussion and your statement.
    If I could go right directly to comments by your 
predecessor suggesting that there are factors existing now that 
we're leaning towards a recession or--I don't know if he would 
put quite that careful of a term, knowing that he picks his 
terms carefully.
    It got quite a stir. But you, in your testimony, don't 
point towards that I take it. Are there factors that you're 
looking at, or that he doesn't know about, that would cause the 
situation to lean towards a recession or--I would just like to 
hear your comment on that very public discussion that took 
place and give you a chance to comment about it, because I 
think it's on a lot of people's minds. It certainly is when I 
get questioned by the media.
    Chairman Bernanke. Well, Senator, as I have indicated, we 
continue to expect the economy to grow at a moderate pace, so 
we expect continued growth. There are risks to the outlook in 
both directions, as I indicated, so we'll have to watch to see 
if those risks materialize, and if so, how serious they are.
    But again, our expectation is for moderate growth. I would 
make a point, I think, which is important, which is there seems 
to be a sense that expansions die of old age; that after they 
reach a certain point, then they naturally begin to end.
    I don't think the evidence really supports that. If we look 
at history, we see that the periods of expansions have varied 
considerably. Some have been quite long, and the evidence that 
expansions must ultimately come to an end, essentially of old 
age, does not seem to be there.
    So, our basic forecast remains for moderate growth, and 
that's our expectation.
    Senator Brownback. With all the factors that you are 
looking at, even though the housing market and the subprime 
issue is out there, you don't see that leading towards a 
recession at this point in time?
    Chairman Bernanke. We do not, but we do note that there are 
risks to the central forecast.
    Senator Brownback. Let me go specifically at a couple of 
areas that you said that there were notable expansions in. And 
I think these actually pose some real questions and potential 
problems.
    You note the expansion in employment in the healthcare 
sector, which, as I've been looking at that, that sector of the 
economy--healthcare as a percentage of GDP--has been growing 
substantially, if not unsustainably fast.
    If I'm remembering my numbers correctly, some are 
projecting it to be up to 20 percent of the economy within the 
next 10 years. Is that an area of concern that you look at, or 
do you look at that as saying, well, this is just a key area of 
growth for us as a country, and this does not represent any 
particular concern or issue area?
    Chairman Bernanke. Senator, the point I was making in the 
short-term context is that our economy is now more than 80 
percent service-oriented, including healthcare, but many other 
things as well.
    And so the weakness we're seeing in housing and in certain 
parts of manufacturing, 100 years ago that would have been most 
of the economy. Today it's a relatively small part of the 
economy, and much of the rest of the economy is growing pretty 
strongly, which is the point I was making in the testimony.
    Your question, though, is a good one. Our healthcare system 
is very strong; it's technologically very advanced, but it's 
not very efficient. And, it's growing; the costs of healthcare 
are growing rapidly, and that raises very serious questions for 
us, both in terms of competitiveness and in terms of, in 
particular, the long-term fiscal situation, because Medicare 
and the costs of providing healthcare for seniors is the single 
largest long-term concern from the point of view of the Federal 
budget.
    So, I think it is very important that we begin to try to 
address the question of healthcare costs. I'm not sure this is 
the appropriate forum to talk about this large issue, but we 
can certainly do that.
    But I think this is a serious question, and we do need to 
take measures that will keep healthcare costs from growing 
faster than the economy. They have been growing much faster 
than the economy as a whole, and as you point out, they 
therefore become a bigger share of total GDP. I think that, in 
the long run, is a concern.
    Senator Brownback. One other question that I want to look 
at as far as the overall impact on the economy, and it's a big 
policy issue that we're wrestling with and going to wrestle 
with--that is immigration and immigration reform. You note 
labor market and anecdotal data about shortages in labor market 
area. Do you have particular concerns of what we're looking at 
on immigration reform or areas that we should, vis-a-vis the 
shortages in labor market areas that you cite in here?
    Chairman Bernanke. Well, not necessarily in the context of 
what I've been talking about. It's generally more difficult 
finding qualified workers at higher skill levels. Many 
immigrants are lower skill levels.
    Nevertheless, the lower-skilled workers are heavily 
integrated into various aspects of our economy, ranging from 
agriculture to construction to other areas as well, and I would 
hope that whatever decisions the Congress makes about this, 
attention be paid to the possibility of short-term disruptions 
to the existing labor force and to the existing pattern of 
employment.
    Senator Brownback. Do you have concerns that that is 
happening now?
    Chairman Bernanke. I haven't seen too much happening now, 
no.
    Senator Brownback. I raise the issue because it is going to 
be a key debate that we're going to have.
    Mr. Chairman, thank you very much for being here and 
addressing some of these key questions.
    Chairman Schumer. Thank you. Congresswoman Maloney, Vice 
Chair Maloney.
    Vice Chair Maloney. Thank you very much, Mr. Chairman.
    Chairman Bernanke, as you know, the Federal Reserve has 
authority under HOPA to prevent unfair and deceptive practices, 
and a Fed rulemaking would apply to all lenders, not just to 
the Federally-regulated depository institutions.
    And to me, this authority offers a simple avenue to extend 
to all parts of the market, the principles that were set out in 
the Federal guidance that you issued on March 2nd, especially 
the notion that lenders must assess the borrower's ability to 
repay the loan at the fully-indexed rate.
    Do you agree that the Fed could use this authority to 
extend the principles of the guidance to the whole market?
    Chairman Bernanke. Vice Chairman, first of all, let me just 
make a comment that there's been some impression that we have 
not used this authority, which is incorrect. We have, in fact, 
used it on three separate occasions to prevent loan-flipping, 
demand mortgages and some practices with respect to open-end 
versus closed-end debt, so we do use it.
    Vice Chair Maloney. Well, I congratulate you for using it 
and for coming out with the guidance that I think is very 
useful and very helpful, and I applaud the regulators for 
coming out with this guidance.
    But you do agree--you mentioned earlier that you need to 
have control over the non-bank subsidiaries. Couldn't we just 
extend HOPA to cover the non-bank subsidiaries?
    Chairman Bernanke. It does cover them so you are correct 
that by setting rules under the HOPA unfair, deceptive acts and 
practices provision, the Federal Reserve could set rules for 
all mortgage lenders. You are correct about that.
    There are a couple of questions that I would just raise for 
your attention.
    Vice Chair Maloney. But do you plan to do that?
    Chairman Bernanke. We are going to review and look at it 
very carefully. The concerns we have are two. The first is that 
this is enforceable by private right of action, that is, by 
lawsuit. Therefore, we have to make the rules extremely 
precise.
    If we simply try to implement a guidance which is a general 
set of principles, through this rulemaking, we would be setting 
up lenders for the uncertainties associated with these general 
principles, and we would probably be killing the market, 
because there would be so much legal uncertainty associated 
with lending in this market.
    So we are reviewing our powers, and we are going to try to 
determine whether there are steps we can take under this 
authority that will be useful in applying to all lenders in the 
economy.
    The other point I would make, which I also discussed with 
Chairman Schumer, was that although we have the authority to 
pass these rules, we still have the enforcement issue. Our 
enforcement powers do not extend beyond the banking system.
    Vice Chair Maloney. Do you think the guidance should be 
extended to the secondary market? Obviously, lenders would not 
be making these risky loans if people were not buying them. 
Freddie Mac has, by their own initiative, announced that they 
will follow the Federal guidance now and will no longer buy 
these risky loans, but do you think it should be extended to 
the secondary market?
    Chairman Bernanke. That's an interesting question, and I 
don't have a final answer to that, but I do think we do need to 
be somewhat careful. I believe that the State of Georgia did 
so-called assignee liability, which meant that anyone who 
bought the loan had the same liability as the originator of the 
loan.
    And I believe I'm correct that that had some significant 
effects on the ability of lenders in Georgia to securitize 
those loans to ultimate investors. So, the balance is between 
maintaining a healthy access to capital in this market versus 
making sure that these rules are obeyed.
    I think the best place to apply these rules would be at the 
level of the originator. I'm open to discussion on assignment 
liability, but I do think we have to go very carefully in that 
direction.
    Vice Chair Maloney. What about the rating agencies? Were 
they asleep at the switch? They were rating everything as an 
AAA when they were risky-risky-risky subprime. And what are 
your comments on the rating agencies' role in this?
    Chairman Bernanke. Well, ratings do sometimes lag behind 
reality, and that seems to have happened at least in some cases 
here.
    Vice Chair Maloney. And I just want to ask about the 
markets. Do you think that there is too much liquidity in the 
markets with the rising debt, the high yield, the bonds, the 
security loans? Is there too much liquidity? And I have also 
been told that China is coming forward with a trillion-dollar 
hedge fund. What impact will that have on the markets? There 
seems to be a tremendous amount of liquidity and--your 
comments?
    Chairman Bernanke. Well, ``liquidity'' has a number of 
different meanings, and I think they tend to get confused 
sometimes.
    I think there is liquidity in the sense that outside the 
United States there is a lot of excess savings, and that is 
flowing into the United States and looking for return.
    In that sense there is a lot of ``money,'' quote/unquote, 
looking for opportunities. That search for opportunities, in 
turn, has triggered a great deal of market activity such as 
hedge funds and private pools of capital, which make the 
markets quite liquid in another sense, in the sense that there 
is lots and lots of trading.
    So markets are liquid in that sense. But I do not think 
that is necessarily a problem, although I do think that people 
have to be aware not to get carried away as perhaps they did in 
the subprime lending situation.
    With respect to the Chinese, what they have set up, I 
believe, is about a $200 billion fund to try to increase 
returns on their overall investments. They are doing that on a 
gradual basis. I think it is mostly diversification across 
instruments as opposed to across currencies, and I do not 
really see any problem with that.
    I do not think that is going to generate any particular 
problems for our financial markets or for our economy.
    Vice Chair Maloney. Thank you. My time is up. Thank you, 
Mr. Chairman.
    Chairman Schumer. Congressman Saxton.
    Representative Saxton. Mr. Chairman, thank you.
    Chairman Bernanke, I would like to return to the subject of 
monetary policy and the state of the economy. The Federal Open 
Market Committee's statement of last week suggested to some in 
the markets that Fed monetary policy stance was becoming, 
quote, ``more neutral.''
    The statement is perhaps still having an impact on markets. 
There still is some controversy about the exact meaning of the 
statement, and what the exact meaning of a move toward 
``neutral policy'' means.
    If that is in fact your understanding, could you within 
this context give us your definition of ``neutral policy''?
    Chairman Bernanke. Neutral policy would be one where there 
is a sense that the risks are weighted equally on both sides of 
the dual mandate, and therefore, policy is essentially 
unpredictable. It depends on events as they come forward.
    In our statement we said that our view was that the 
inflation risk was still predominant. And so our policy is 
still oriented towards control of inflation, which we consider 
at this time to be the greater risk.
    Nevertheless, as I mentioned in my testimony, the 
uncertainties have risen and therefore a little more 
flexibility might be desirable. Nevertheless, I do want to 
emphasize that we have not shifted away from an inflation bias.
    Representative Saxton. So the bias continues to be toward 
inflation, but I think you just said that there is a movement 
toward, or in the direction of, a more neutral policy? Is that 
fair?
    Chairman Bernanke. I would say it would be more accurate to 
say we are looking for a bit more flexibility, given the 
uncertainties that we are facing and the risks that are 
occurring on both sides of our outlook.
    An additional point, we in general prefer not to give 
advance rate guidance; that is, not to tell the market we're 
going to do this, that and the other. Rather, it is better for 
the FOMC to describe our outlook and the risks we see to the 
outlook, and let the markets make their own determination about 
how to price assets.
    So one aspect of this change has been to move away from 
forward-rate guidance, which we view as something that should 
be undertaken mostly under unusual circumstances.
    Representative Saxton. Does the policy statement suggest 
that economic conditions were weaker as of that statement, 
which was March 21st, than at the January meeting? Or that real 
estate adjustments have a good way to go before they're 
concluded? Or that, as you just mentioned, inflation is more 
persistent than expected?
    Chairman Bernanke. Our statement included a description 
both of a situation on the real side of the economy and on the 
inflation side, and our sense that the risks had increased on 
both sides--that the outlook for output was a bit weaker as we 
indicated in our statement--but that the inflation situation 
had become slightly riskier as well. And so, both sides of the 
mandate are facing somewhat greater risks.
    Representative Saxton. And with regard to real estate 
adjustments, is there a concern, a continuing concern with 
regard to that subject?
    Chairman Bernanke. We believe that the housing market does 
present a potential downside risk to our baseline forecast. We 
are watching it very carefully. Our baseline forecast is that 
this housing correction will work itself out, and that sometime 
later this year, as the inventory of unsold homes comes down, 
construction will stabilize, and the economy will consequently 
strengthen somewhat.
    Representative Saxton. Certainly the Blue Chip Consensus 
has been revised down almost every month recently. Can you give 
us any idea how the forecast in February the Fed made in 
January might be revised as we go forward? Will it follow the 
Consensus?
    Chairman Bernanke. Congressman, the forecast we present is 
a Committee product. It is the entire FOMC's collective wisdom. 
So we have not revisited that, and I cannot really give you new 
numbers at this juncture.
    Our general outlook, the contour of how we expect the 
economy to evolve, is very much unchanged--at least it has not 
materially changed. In particular, we expect the economy to 
continue to grow at a moderate pace. We expect to see some 
strengthening later on as the housing market returns to 
something closer to equilibrium. And we expect inflation to 
moderate gradually. But as I discussed this morning, we do see 
risks to all of those forecasts.
    Representative Saxton. Finally, the Fed policy statement 
does appear to be somewhat more straightforward than earlier 
was the case. In that sense we welcome this tiny step, I guess, 
toward more transparency.
    Could you comment on any progress the Fed is making in 
becoming more transparent?
    Chairman Bernanke. Congressman, as I think you know, we 
have been discussing a whole range of issues to try to improve 
our transparency and our accountability for monetary policy to 
the Congress.
    Because we meet only every 6 weeks or so, it has been a 
slow process, and it has been a deliberative process. But we 
have made considerable progress. We have looked at a number of 
possible ways of increasing our transparency, though we have 
not yet come to any decisions.
    I am and will be consulting with Congress on any matters 
that need to be brought forward, but we have not yet reached a 
point where I can report that we have made specific decisions 
on this.
    Representative Saxton. Thank you very much.
    Thank you, Madam Chairlady.
    Vice Chair Maloney [presiding]. Thank you, sir. And I yield 
to Mr. Hinchey.
    Representative Hinchey. Thank you, Madam Chairman.
    Chairman Bernanke, it is a pleasure to be with you, and I 
very much appreciate your service. The work that you do is very 
important to our country, and I think that you do a very good 
job in doing it.
    Recently you gave testimony before the House Budget 
Committee on an issue that was raised here briefly a moment ago 
where you focused a lot of attention on the rising cost of 
health care.
    You said, I think correctly, that it is not the best issue 
to bring up at this particular moment, but it is something that 
is really haunting for all of us. Because it is an issue that 
we are going to have to address in the context of this economy. 
Failure to do so is going to provide some very substantial 
problems, as you pointed out very clearly in that testimony 
before the Budget Committee.
    There are other aspects of the economic circumstances that 
we are confronting that I am beginning to become somewhat 
pessimistic about.
    They relate to a number of things, one of which is the fall 
in housing, a drop that was expected to be somewhat in the 
neighborhood of 100 million, and it dropped to something over 
800,000, I think, last year.
    So that has been one of the driving forces of this economy, 
and it is part of the driving force based upon debt. We have an 
economy here that is increasingly driven by debt. Even though 
the budget deficits have fallen somewhat--the deficit last year 
was just about $250 billion and that is less but it is a very 
substantial budget deficit nevertheless--and the national debt 
is now up over $8.8 trillion.
    So we have an economy at the public level that is driven 
largely by debt, but that is also true with the average person 
across the country, spending somewhere in the neighborhood of 
almost 110 percent of what they earn.
    Now it is pretty obvious, I think, that this is a situation 
that really cannot be sustained. And it cannot be sustained as 
we also confront other issues like the loss of jobs and the 
loss of meaningful jobs.
    The income of households across the country is dropping. I 
think it has dropped by more than 4 percent, I think something 
in the neighborhood of 4.5 percent over the course of the last 
several years.
    And we are exporting more jobs each year. As you pointed 
out in your testimony, the economy here is driven increasingly 
not by manufacturing but by service sector jobs. And the major 
service sector jobs, including the best paying service sector 
jobs, are being exported very dramatically more and more.
    So, these are the things that I think ought to be very 
troubling to us as we try to confront what we should do as a 
Congress to keep this economy moving. The economy has been 
growing, but most of that growth has been reflected in 
corporate profits. Very little of it is being transferred to 
the average person across the country.
    Wages have continued to decline, although the decline is 
less steep than it had been previously over the previous 
several years.
    What do you think we should be doing? And how serious do 
you think this situation is? We have an economy that is based 
upon debt, one that has a Current Account Deficit of $856.7 
billion, 6.5 percent of GDP, and continues to rise. And with 
that Current Account Deficit going up, the exportation of jobs 
is increasing.
    How do you think we should be dealing with this?
    Chairman Bernanke. The central theme of the remarks you are 
making has to do with savings and debt. It is true that the 
U.S. is a low-saving country, and that has a number of 
implications.
    One of them, of course, is the Current Account Deficit. 
Because we invest more here in terms of capital goods and 
housing than we save domestically, we have to borrow the 
difference from abroad, and that is in fact the Current Account 
Deficit.
    We also have the concern that our country is going through 
a demographic transition: we are becoming an older society with 
more people of retirement age with fewer workers for each 
retiree. And so, it is important that the U.S. increase its 
savings to better prepare for the future.
    There are essentially two ways to do that:
    One is through fiscal policy, by trying to run smaller 
deficits or even surpluses at both the Federal and the sub-
Federal levels. That is very challenging, I understand, and 
particularly challenging given the entitlement costs that are 
going to be coming down the pike, but it is certainly something 
to be looked at.
    The other is to try to encourage more saving among the 
private sector. Corporations do a good bit of our savings. 
Retained earnings, for instance, are a good bit of the savings 
of the U.S. economy. But households, as you point out, do not 
directly save very much.
    Unfortunately, we do not have a set of policies which we 
know are time-tested to increase saving. Just one small step 
that I think the Congress took that was useful was the pension 
reform.
    The Congress made it possible for employers to offer 401K 
plans that have an opt-out provision rather than an opt-in. And 
when people are automatically put into the 401K and they have 
to actively seek to be taken out, that they tend to save more. 
So, these sorts of insights can help us improve saving.
    Another thing which relates very much to the subprime 
lending issues that Congresswoman Maloney and others have 
mentioned has to do with financial literacy and training people 
to understand better not only mortgage terms, but also 
budgeting and issues like retirement planning, so that they 
will better appreciate the need to put aside some of their 
income for the future.
    Vice Chair Maloney. The gentleman's time has expired.
    Representative Paul. We are under the 5-minute rule.
    Mr. Paul.
    Representative Paul. Thank you, Madam Chairman, and welcome 
Chairman Bernanke.
    It seems to me too often that we run into our financial 
problems, and then there is the wringing of the hands, and yet 
many have predicted that we are going to get into these 
problems.
    For instance, in the 1990s it was not a total surprise to a 
lot of people that things were out of whack when it came to the 
NASDAQ, and yet the NASDAQ bubble collapses, and people panic, 
and people get hurt, and then there is an outcry.
    Well, what we have to do is craft more regulations again. 
And there has been fraud. Of course all the penalties necessary 
to take care of Enron were taken care of without new 
regulations, and the market sort of handled the distortions 
that were there, but nobody asked the questions: Why was there 
such distortion?
    The same way in the housing bubble. The same predictions 
have been going on for years and years, and yet everybody gets 
reassured, and everybody knows that we have to spread home 
ownership to those who do not really qualify, and yet the same 
bubble is being built, and nobody said: Well, where does all 
this credit come from?
    I think we fail to ask the question of what the cause is, 
and then when the problem hits, then we treat the symptoms, and 
we say, well, what we need are more regulations. If we would 
only regulate the lenders we could have prevented these 
problems from occurring.
    And I do not buy into that. I do not think it is that 
simple. And I think we fail too often even to look to the 
fundamental monetary policy, because easy credit does allow 
people to do things they would not ordinarily do.
    When you have interest rates down to 1 percent, and then 
you subsidize Fannie Mae and Freddie Mac with a line of credit, 
and then you encourage these loans, I do not see why anybody 
should be surprised this should happen.
    But my concern is that we do not look to the cause, which 
is easy credit. I mean, we have no savings rates, so this 
credit has to come from somewhere. It usually comes out of thin 
air. And we end up with these problems.
    But one measurement that we used to have to sort of 
indicate what is going on monetarily was the M3 numbers, which 
I think is an important number. And there is a private source 
now that reports M3 numbers. And I think, most likely, they are 
pretty accurate compared to the old M3, and they report that M3 
is growing at an over-11 percent rate, which I would think 
would, you know, get people's attention if it was an official 
report from the Federal Reserve.
    So, it seems like there is almost a distraction from the 
real cause.
    Then again, we look at our CPI, and we say, oh, the CPI is 
not going up so badly, we have no inflation. And yet you look 
at the cost of housing, the prices of houses are soaring. But 
they are excluded from the CPI.
    It just seems like we do not have everything on the table, 
and that we should be more concerned about monetary policy, per 
se, rather than saying, well, we have problems; all we need to 
do here in Congress is if we just wrote more regulations we're 
going to solve all our problems.
    But I have one specific question dealing with the recent 
crisis coming up and the recent changes in the stock market. 
And that was on the February 27th was a sudden change in the 
market, and ours went down over 400 points.
    On days like that, does the Presidential Working Group on 
Financial Markets? Do you have meetings to talk about sudden 
changes in the marketplace like that?
    Chairman Bernanke. We did not have a meeting on February 
27th. It is a usual practice whenever there is some stress in 
financial markets for the senior staff deputies to be in touch 
with each other gather information to see if anything is going 
on.
    In this particular case there was no indication, other than 
the computer problem at the New York Stock Exchange, of any 
kind of breakdown of markets or anything like that. And so, no 
further action was taken and no meeting of the principals 
occurred.
    Representative Paul. So, the Working Group has not taken 
any precise action in the last several months, would you say? 
Or have you taken some action of some sort? And why is that 
information not readily available to us and to the markets? 
Because it would have profound significance if we knew that 
group was interfering in the marketplace.
    Chairman Bernanke. We took no action with respect to the 
stock market. We released, as you know, a set of principles 
describing how we believe that oversight of hedge funds and 
private pools of capital ought to be conducted--principally 
through a market discipline approach, as we discussed in that 
document.
    Representative Paul. Is there any chance that we would ever 
get minutes of meetings for the Working Group that the Congress 
would know more about how the Working Group operates, and how 
often? I understand it's more active, and you meet more often 
than you used to.
    Chairman Bernanke. I don't know what the information 
gathering is. We meet and discuss broad issues of general 
importance in the financial area in terms of financial 
regulation, financial markets.
    And then if we have findings, we present them to the public 
in the form of the principles, for example.
    Representative Paul. My time has expired. Thank you.
    Chairman Schumer [presiding]. Thank you.
    Senator Casey.
    Senator Casey. Mr. Chairman, thank you for chairing this 
hearing and having us to get together to have Chairman Bernanke 
here, and thank you, Mr. Chairman, for your public service.
    I am going to try to get in, if I can, three questions. The 
first one centers on the issue of workforce. We have had over 
many years, as far back as a decade ago, an attempt by the 
Federal Government to have a positive impact on workforce 
development in training a workforce for this country.
    We know the impact it has on economic growth and the impact 
on competitiveness, and so I think in so many ways we could 
spend a hearing just on that. It is a transcendent economic 
issue.
    I was struck in your testimony on page 6 by something that 
kind of jumped off the page at me. It was in the second full 
paragraph on page 6. I will just read one sentence. It says: 
``Indeed, anecdotal reports suggest that businesses are having 
difficulty recruiting well-qualified workers in a range of 
occupations.''
    It is a profound statement in and of itself, and I know it 
is a tremendous challenge we have as a country. I really have 
two questions:
    What is your source or the underpinning for that statement 
and the challenge that it creates? If you can comment on that.
    And second, what do you think this government needs to do 
not just in this budget year but in terms of a long-term 
strategy on workforce development?
    Chairman Bernanke. Thank you, Senator. We have many, many 
contacts throughout the business community around the country, 
some of them through the user bank branches that are around the 
country, many by contacts that we have with CEOs and leaders of 
various corporations and various businesses.
    We hear that in the labor market there is something of a 
divide--that low-skilled workers can be found but for people 
with substantial skills, whether they be nursing, or banking, 
or welding, it is very difficult to find appropriately 
qualified people. And this is a theme we hear over and over 
again from businesses and from all types of temporary help 
agencies from all types of employers.
    As I have talked about in some recent speeches, I do think 
that improving the level of skills and training is the critical 
issue for addressing, for example, the rise in income 
inequality; to give people the opportunities to succeed in our 
economy, and particularly in an economy which is becoming more 
and more technologically advanced.
    The main theme I would leave you with is that there are 
many different ways to accomplish that. And while it is very 
important to try to improve our K-12 system, there are many 
other ways in which people learn. There are junior colleges, 
community colleges, online colleges, on-the-job training, life-
long learning, early childhood education, many different ways. 
I think it would very helpful for Congress to continue to look 
at these different approaches and try to encourage good, 
innovative ways of increasing the skill level of our workforce. 
It is a critical issue.
    Senator Casey. I think we agree on that priority.
    Let me just ask you one follow-up with regard to that. Is 
there one area that you--and you have listed a number of them, 
whether they are nursing or welding or manufacturing skill, as 
well as technological skill--that you have most concern about 
in the labor sector or that has, in your judgment, or would 
have, if we do not invest or we do not have a strategy that 
would have the most adverse impact on our competitiveness 
around the world?
    Chairman Bernanke. No, I think it is very broad-based. 
People often point to those with advanced degrees--engineers 
and so on--and those people are important of course. But again, 
in manufacturing, for example--where there has been over the 
years a general decline in employment--there has actually been 
an increase in the demand for highly skilled workers.
    So that need for skills really cuts across a wide variety 
of sectors and levels.
    Senator Casey. And just following up on what you said as 
well with regard to workforce. I believe you mentioned income 
inequality. Wage stagnation is something we have all discussed 
before, and it is interesting.
    Chairman Schumer and his team do a great job of preparing 
for this hearing, and one of the things they did, and I wish I 
had the chart itself--it is hard to see--but it is a chart that 
really shows the gap between productivity when productivity has 
been rising or output per hour; that's been going up. 
Obviously, we are happy about that, and our workers deserve a 
lot of credit. And our economy is reflective of that.
    But there is a gap, according to the chart we have used 
here, starting in 2001, between productivity and compensation. 
And that is a significant gap, and it is a real nightmare for 
workers.
    I just wanted to have you comment on this statement. This 
is not mine, but I think it reflects my thinking: Most of the 
gains from growth--there it is [the chart], I'm sorry. This is 
a good team we have got here.
    You can see where the gap begins starting in 2001, and I 
think it is pretty clear. And one thing that the commentary 
with the chart said is: Real compensation of workers, their 
wages and benefits, tends to track productivity growth as they 
did in the 1990s, but starting in 2001 that has not happened.
    What is your sense of that? And what do you think we need 
to do to close that gap? And I realize it will not happen in 1 
year, but we need a strategy to do that.
    Chairman Bernanke. Well, there are a lot of factors 
involved, but part of it is a lag that does occur. When 
productivity picks up, generally that shows up first in 
profits, and only after a period you begin to see the real wage 
response.
    If your picture went back to the mid-1990s, you would see 
the same thing in the mid-1990s in the long recovery at that 
period. In this case, it has been the case that productivity 
has outstripped compensation for a while. More recently we have 
seen some gains in real wages.
    Last year, for example, we saw some improvements in that 
respect. So I think there is a lot of evidence in the long run 
that compensation per hour and productivity per hour do line 
up, but there are periods when it lags. And the most recent 
period, as often happens during slow growth periods like 2001 
and then during the initial recovery, there has been a lag.
    Senator Casey. Thank you. I am out of time.
    Thank you, Mr. Chairman.
    Chairman Schumer. Thank you.
    Senator Sununu.
    Senator Sununu. Thank you.
    Mr. Chairman, in general, I think members of this Committee 
and Members of Congress would support, very much support, 
sensible, reasonable, appropriate standards for credit. That 
benefits consumers because with good disclosure and standards 
for credit, consumers get access to appropriate levels of 
credit which help them improve their quality of life and do the 
things that they wish to do for their families.
    And, it is good for lenders. Because lenders want to make 
appropriate loans in whatever sectors of our market they are 
lending because that is how they make money. Lenders do not 
make money, they lose money when they lend inappropriately and 
as a result see default, whether it is in housing or any other 
area of the economy.
    So it makes sense to have good standards for credit. But it 
is important that we understand what effect an inappropriate 
dramatic tightening of credit might have on the economy and in 
the housing area in particular, and I would like to talk a 
little bit about that this morning.
    It is my understanding that the average down payment on 
homes in America is in the 15 to 16 percent range. And that is 
probably divided among a lot that are in the conforming area, 
20 percent down payment, and those that are nonconforming. I 
think about 40 percent of the mortgages outstanding fit into 
that nonconforming area. The average down payment there is 9 
percent.
    Now, if we have a significant tightening of credit, whether 
it is through regulation and subprime or any other area, it 
seems to me that the most likely result would be a movement in 
the industry toward that 20 percent limit, toward that 20 
percent conforming down payment standard.
    What effect would that have on the activity in the market 
and on demand?
    Chairman Bernanke. Well, you raise a good point. Our sense 
is that outside of the subprime mortgage area--that is in prime 
mortgages and in other types of credit--we have not seen much 
effect from the subprime developments, and so we have not seen 
a significant tightening of credit in those areas.
    There has been a tightening of credit in subprime 
mortgages. Certainly some of that is desirable because 
excessively lax underwriting was one of the problems that led 
to the situation we have.
    We have to hope that it will not overshoot in some sense, 
and that credit will still be available. In particular, those 
people who are facing difficulties and possible foreclosure, 
one way to solve that problem is to refinance. So if 
refinancing funds are not available or are not on terms that 
are affordable, that is going to in some sense exacerbate the 
problem.
    So, while the improper or inappropriate lending has ended, 
we would hope that the standards do not revert to such a level 
that reasonable, sensible lending cannot continue. And that is 
an issue we have to follow.
    Senator Sununu. There was about $320 billion put toward 
down payment last year. Is it reasonable to assume that 
consumers are not going to step forward with more down payment 
money this year?
    Chairman Bernanke. Well, as you pointed out, the down 
payments are typically higher the prime market. And the prime 
market does not seem to be changing very much.
    Senator Sununu. I'm sorry, higher as a percentage of value. 
If consumers in last year's economy, in last year's market, 
allocated $320 billion in aggregate down payments, I just do 
not think it is likely that in this market they are going to 
suddenly step up with $380- or $400 billion in down payment. 
The amount available for down payment in the aggregate will 
probably be the same or slightly less? Is that reasonable?
    Chairman Bernanke. In the prime market, I am not sure. I do 
not think the problem in terms of demand----
    Senator Sununu. I am talking about economy-wide. I am not 
making a distinction between prime and subprime. I am saying: 
In the economy as a whole, I think there were about $2 trillion 
in purchases, home purchases last year, $320 billion in down 
payment. How will the economy as a whole react, consumers 
react, in allocating money toward down payment this year?
    Chairman Bernanke. And I am trying to say that I think, in 
the prime market, people will still be able to do that and the 
down payments will not change very much.
    The real issue for buyers in that market is the uncertainty 
about what is happening to house prices and to housing demand, 
and trying to make a decision about when is the right time to 
get back in the market.
    In the subprime market where there have been a lot of very 
low down payment loans, I think those will be less available 
and that will prove a constraint for some people who will not 
be able to afford mortgages.
    Senator Sununu. My point is that it is unlikely that the 
consumers will allocate significantly more than $320 billion 
for down payments in the coming year. But as we tighten 
standards, if we move them toward, everyone toward, a 20 
percent conforming standard arbitrarily, that means that the 
down payment that is available will support a dramatically 
lower volume of purchases. And that, in turn, will drive the 
inventories even higher.
    So, I am trying to get from you a reasonable estimate of 
what the magnitude of that effect might be. If you assume that 
the same amount of down payment will be available, and you 
assume a movement toward that 20 percent, then instead of 
seeing inventories at 6 or 7 months which is where they are 
today, and the inventory level is going to be between 8 and 10 
months.
    So now you do not have to agree with those assumptions or 
the likelihood, but I would like to know what you think the 
impact on demand or on the economic level of activity would be 
if housing inventories were at an 8- to 10-month inventory as 
opposed to a 6-month inventory.
    Chairman Bernanke. If they were at that level, and I do not 
expect that they will be, but if they were at that level, then 
construction would fall even further, and it would be an 
additional source of contraction in the economy.
    Chairman Schumer. Senator Bennett.
    Senator Bennett. Thank you very much, Mr. Chairman, and 
Chairman Bernanke, welcome again to the Congress.
    You talked in your testimony about the strength of the 
international economy helping the American economy, and I would 
like to focus on that for a bit.
    Our headline writers get consumed with China, and they talk 
about the rate of growth in the Chinese GDP. I like to point 
out to them at the amount of growth in the American GDP from 
2001 till now has been greater than the total Chinese GDP is. 
That is, our GDP has grown in that period close to $3 trillion, 
and their total GDP is less than 2.5. So, I focus a little less 
on China than on our main trading partner and investment 
partner which is the European Union.
    There is more investment across the Atlantic than with any 
other partner by far. There are trillions of American dollars 
invested in Europe and trillions of European dollars, or euros, 
converted into dollars invested in America.
    And one of the problems that is being identified as we talk 
about our relationship between the European Union or the 
European economic community, define it as you will, and America 
is that we are seeing more and more American companies moving 
activities into Europe by virtue of the regulatory burden in 
America.
    The Chairman, along with the Mayor of New York City, held a 
press conference and talked about this--where New York is 
ceasing to be the dominant financial center of the world, it is 
shifting to London. And the two primary drivers of that shift 
that I found when I was in Europe talking to people about it 
are--not necessarily in this order, they come up in this order 
but they are not necessarily in this order in their impact--
Sarbanes-Oxley and the Tort system in the United States, with 
companies saying we just cannot expose ourselves to the kinds 
of class action lawsuits and other activities that are 
available in the United States that are not available to people 
in Europe.
    Do you see any signs, other than the concern of New York 
which I share although it is a provincial concern, the world 
economy will not fail if London replaces New York as the 
primary source? But do you see any economic concerns of an 
impact if, indeed, more and more barriers exist in the United 
States to other companies in other countries investing here and 
building plants here and so on?
    Toyota has just announced a major, major investment in 
Mississippi, and Senator Lott is all excited. They offered him 
one of their SUVs, and he said, no, that is an import. I will 
wait until the plant is built and I will buy the Toyota from 
Mississippi.
    And I tried to chide Senator Alexander. I said, you are 
driving a Nissan. He said, yes, it is a great Tennessee 
product. And Senator Voinovich saw my wife's Honda Accord and 
approvingly said, yes, that is built in Ohio.
    So, do you see in this whole circumstance American 
regulatory barriers showing signs of discouraging other 
countries for making these kinds of investments in the United 
States?
    Chairman Bernanke. Senator, there are different issues that 
I think you correctly point out. Foreign direct investment in 
the United States is still healthy. We receive a lot of foreign 
direct investment, and it is good for our economy. We get jobs 
from that. We get technological transfers and productivity 
gains from that, and that is still going on.
    The issue that Senator Schumer and others have raised has 
to do with, in particular, the competitiveness of our financial 
markets, our exchanges.
    Senator Bennett. As we move more and more into a service 
economy, that becomes more and more important.
    Chairman Bernanke. Yes. And it is important. To some 
extent, it is to be expected that New York would not dominate 
the world the way it had earlier in the last century as other 
centers grow and develop and become more sophisticated.
    At the same time, it is important for us to decide and 
investigate whether specific rules and regulations that we have 
in the United States are more burdensome than necessary to 
achieve their regulatory objectives.
    And the two that you mentioned have come up a lot. With 
respect to Sarbanes-Oxley, there has been, of course, 
considerable concern about the costs of implementing it and 
concerns particularly about Section 404, as you know.
    I think some progress is being made on that particular 
issue in that the Public Company Accounting Oversight Board and 
the SEC together are proposing new audit standards that would 
be more flexible and risk-focused for smaller companies. I 
think that is a good step, and we ought to see whether that 
reduces the costs of Sarbanes-Oxley sufficiently and makes them 
more commensurate with the benefits of that legislation.
    I agree also that the issues of securities litigation is 
one we need to take a look at. We do have a great deal more of 
that than other countries, and we should take a look at that to 
see whether it can be reduced somehow or at least made more 
commensurate with the benefits of that activity.
    Chairman Schumer. Thank you.
    Congressman Brady.
    Representative Brady. Thank you, Chairman.
    Thank you, Chairman, for being here with us again today. 
Two questions: One budget policy, one trade. We are in a 
serious discussion on Capital Hill about how to balance the 
budget which is good. As Republicans we should have spent more 
time doing that ourselves.
    But there are two competing approaches, one of which is to 
balance the budget in 5 years with increased spending and 
allowing President Bush's tax cuts to expire which increases 
marginal tax rates, capital gains, and dividends rates. For a 
family of four in Texas it is an average increase of about 
$2700 on the family budget.
    The competing proposal, Republican proposal, is to balance 
it in the same period of time but to not let those tax rates 
expire, and to begin to attempt to restrict spending at least 
to the point of trying to prepare ourselves for the massive 
expenditures when our baby boomers start to hit.
    I am not trying to draw you into this debate, but from an 
economic standpoint, which approach is the preferred method in 
your view?
    Chairman Bernanke. There are inevitably questions of values 
in that decision. Clearly, low tax regimes, if they are 
properly structured, will provide better incentives and tend to 
be more efficient and, therefore, are beneficial in that 
respect.
    On the other hand, government spending has value as well. 
We talked about training and education programs for example. So 
I think the law that I would support would be the law of 
arithmetic which says that whatever you spend and whatever you 
take in needs to be commensurate.
    So, if you propose low taxes, that is good. That has 
benefits for the economy. But it is important to find the 
spending cuts on the other side to balance those tax cuts.
    If, on the other hand, you want to increase government 
spending programs, you need to find revenues from some source 
to balance it.
    The tradeoff between those two things is not 
inconsequential. It makes a difference to the economy but the 
tradeoff depends ultimately on the values you attach to these 
different outcomes. And Congress is the elected body that 
embodies the values of the American People and is ultimately 
responsible for making that decision.
    Representative Brady. In a choice between balancing the 
budget with lower tax rates and balancing the budget with 
higher tax rates which is the preferred method?
    Chairman Bernanke. If you have lower tax rates you will 
tend to have better incentives and lower dead-weight loss which 
is what economists refer to as the distortions that are created 
by high tax rates that affect behavior.
    But one might be willing to accept those distortions and 
losses if one thinks that the spending that is being done has 
sufficiently high social value. That is the kind of balance 
that Congress has to come to.
    Representative Brady. My final question. You make the point 
in your testimony that trade is an important part of the U.S. 
economy. America is the world's largest seller of products and 
goods. We are also the largest buyer. And you make the note 
that the growth rate in our sales is actually about three times 
larger than the growth rate in what we are purchasing.
    Since 2002, with the President's ability to trade 
promotional authority to go out and negotiate trade agreements, 
we have seen increased sales to those countries. I think the 
markets for those 13 nations only equal about 7 percent of the 
global market, yet they represent almost half of what we are 
selling abroad.
    So while we are very open, we find other countries are 
often closed. These trade agreements open up these markets with 
new customers for us.
    How important--as trade promotion authority is set to 
expire later this year, as the clock is running on trade 
agreements with Peru, and Colombia, Panama, perhaps Korea, how 
important, from an economic standpoint, is it that we continue 
to have the ability to open up those markets?
    How important is it that Republicans and Democrats try to 
find some common ground to allow us to go out there and set 
those rules for us to compete?
    Chairman Bernanke. There is considerable evidence that open 
markets and free trade promote growth and strengthen an 
economy. And I hope that we will continue to try to open 
markets and do so in a more comprehensive way.
    I think it would be better if we could do it through a DOHA 
process instead of country-by-country. We have to address some 
of the implications of trade. We may have to deal with issues 
of helping workers who are dislocated and so on.
    But I hope the United States will not turn away from trade 
because it has been a tremendous source of growth and 
prosperity for us over the last couple hundred years.
    Representative Brady. Thank you.
    And Chairman, I would point out we have a trade surplus of 
$5.5 billion with our trading partners and most of our trade 
deficit, overall 80 percent, is with those we do not have trade 
agreements with. So, it is important we address this issue.
    Thank you.
    Chairman Schumer. Thank you, Congressman.
    They have just called the vote. My colleague, Congressman 
Hinchey, wishes to ask a question. Then if we have time, we 
will let Congresswoman Maloney ask a question, and then we will 
break.
    Congressman Hinchey.
    Representative Hinchey. Thank you very much, Mr. Chairman.
    I just wanted to return to the situation of the economy and 
its impact on people broadly. The discussion of Toyota and 
Nissan reminded me of a comment made by the Chairman of General 
Motors many, many years ago in testimony before the Congress: 
What's good for General Motors is good for the Nation.
    Now it seems: What's good for Toyota and good for Nissan is 
good for the Nation. Although it really isn't. Because, 
although there are jobs, the profit is being exported out of 
the country. And so we are not just exporting jobs, we are 
exporting profits to other corporations that are coming here to 
bring in jobs because our ability to do it seems to be greatly 
impaired.
    And that is an interesting question that I think this 
Congress has to deal with. We are ostensibly going through an 
economic recovery, but the fact of the matter is it is not the 
same kind of economic recovery we have experienced in the past.
    Ever since the Second World War, every economic recovery 
has seen a rise in wages and salaries averaging 3.7 percent. 
This economy since November of 2001, the increase in wages and 
salaries have only been 1.7 percent. We are seeing a greater 
and greater concentration in the hands of the economic elite of 
this country and a reduction in the economic capacity of the 
middle class. And in fact, a shrinking of the middle class.
    That is not just bad for the economy, it is bad for the 
Democratic Republic. You cannot have a country like ours 
without a strong middle class.
    So my question, Mr. Chairman, is: What are we going to do? 
How are we going to change this thing around? I do not think we 
can continue to move in this same direction without having this 
country change completely. Not just economically but also in 
terms of its democratic processes as well.
    Chairman Bernanke. Let us first address the issue of 
foreign direct investment.
    Like free trade, free flows of foreign direct investment 
can be quite beneficial. When we invest abroad other countries 
invest here. In the case of Nissan, as you mentioned, it 
creates jobs here but not all of the profits leave because, of 
course, there are American shareholders of those companies as 
well.
    So I hope that we will not throw up barriers to investment 
in the same way we will not throw up barriers to trade in goods 
and services.
    Now, we do not want to poormouth America. We have enormous 
strengths, very flexible markets, innovative culture, lots of 
entrepreneurship, very deep capital markets. So we are a very 
strong economy.
    We are the wealthiest economy in the world.
    Representative Hinchey. But the benefits of that economy 
are not being experienced by all the people. We have seen the 
chart that was up here a little while ago talking about 
productivity growth that was very interesting.
    One of the factors of productivity growth is based upon 
technology rather than on the fact that people are being able 
to produce more through working. And because it is based on 
technology, the profits from that productivity growth are going 
to fewer and fewer people.
    So, if you have an economy where wages and salaries are 
only going up by 1.7 when they traditionally have gone up by 
3.7 in recoveries, there is something wrong.
    Chairman Bernanke. Congressman, I was going to say that we 
have these strengths, and we should recognize these strengths. 
But we have some things we need to work on as well.
    With respect to the specific issue about the recent growth 
in real wages, I do think we are going to see some improvement 
as real wages tend to catch up with productivity.
    But more broadly, as I already indicated--and I think when 
we discussed this a moment ago--there are two areas where we do 
need to improve. One is in the skills of our workforce and we 
need to take that very seriously.
    And the other is in saving, to create more resources for 
capital investment and for foreign investment.
    I think those are the two weaknesses that we need to 
address if we want to compete effectively in this open 
globalized economy we live in.
    Chairman Schumer. I am going to call on Congresswoman 
Maloney for a short question with a short answer.
    Vice Chair Maloney. Thank you.
    Is it reasonable to expect that business investment and net 
exports can grow to offset the loss of housing investment and 
possible slowing of consumption? And, could you walk us through 
the kinds of likely incoming news that would increase the 
chances that the Fed would lower rates, and what kind of news 
would discourage such a move?
    Chairman Bernanke. Well, as we say, given the current 
housing situation, we think growth is going to be moderate. It 
is probably going to stay moderate until the housing situation 
turns around and we begin to see greater construction.
    At that point, if nothing else changes we will begin to see 
a more rapid expansion. I cannot tell you specifically what 
policy is going to do but we are obviously going to be paying 
attention to both parts of the dual mandate--sustainable 
employment and price stability--and using our collective 
judgment to make the best decisions we can to get the best 
outcome for the American people.
    Chairman Schumer. Thank you, Mr. Chairman.
    Vice Chair Maloney. Thank you.
    Chairman Schumer. And thank you. I want to thank my 
colleagues here, and I want to thank the Chairman.
    Just one little final comment in reference to some of 
Senator Sununu's comments. One of the problems with the 
mortgage market these days is: the accountability does not 
occur until you get way to the top.
    The person who offers the mortgage gets a fee. The mortgage 
company, particularly if they are not a bank, gets a fee. Even 
the first issuer of securities gets a fee. And then it is 
divided up and somebody buys, as the securities are sliced up, 
the riskiest ones.
    And that, I would just say, means that your standard 
practice of, well, just let the market adjust to all these 
things, it takes awhile because there is no immediate 
accountability.
    It creates a lot of bumps in the road, and sometimes it is 
a lot less perfect than a perfect market ought to be. Hence, 
the need for some kind of regulation at the lower levels where 
there is no accountability at all.
    I do not know if you agree or disagree with that, but you 
are shaking your head and I will let the record show--I do not 
know if he was just shaking his head because it is a good 
question or he agrees with the answer.
    [Laughter.]
    Chairman Bernanke. It was an excellent question, Senator.
    [Laughter.]
    Chairman Schumer. An excellent question. On that happy 
note, we will conclude. Thank you, Mr. Chairman.
    [Whereupon, at 12:09 p.m., Tuesday, March 28, 2007, the 
hearing of the Joint Economic Committee was adjourned.]
                       Submissions for the Record

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       Prepared Statement of Senator Charles E. Schumer, Chairman
    I want to welcome Federal Reserve Chairman Ben Bernanke to this 
hearing of the Joint Economic Committee on ``The Economic Outlook.'' 
This Committee has a broad mandate to study and make recommendations 
about economic policy, and we frequently seek the views of the Federal 
Reserve Chairman as we carry out that mandate.
    Chairman Bernanke, we live in interesting times and you face a 
number of important challenges in setting a course for monetary policy 
that will achieve the multiple goals of high employment, balanced 
economic growth, and reasonable price stability.
    Those challenges are all the more complicated by what is turning 
out to be an emerging crisis for homeowners all over the country--the 
sub-prime mortgage market fallout.
    Today is the first time we will hear Chairman Bernanke say that the 
wave of defaults we are witnessing in the sub-prime market ``casts 
serious doubt on the adequacy of the underwriting standards'' for these 
loans.
    Today, we will take his words as a further indication that we must 
respond on the Federal level. When so many mortgage brokers are able to 
deceive our most vulnerable families into loans that they could never 
afford, without anyone batting an eye--the system is broken.
    I'm planning on introducing a bill that would establish a national 
regulatory system for all mortgage brokers, including those at non-bank 
companies; and establish a suitability standard for borrowers so that 
they will never issue a loan that the borrower cannot afford.
    The wave of sub-prime foreclosures that we have seen so far is just 
the ``tip of the iceberg''--and we all know what these foreclosures do 
to the families that fall victim to them. It's on the front page of our 
major national newspapers every day.
    What is less clear--and what we hope to examine today--is how the 
sub-prime crisis will impede our broader economic growth.
    In many ways, I believe that the layering on of the risk in the 
sub-prime market reflects the layering on of risk in our broader 
economy. From our negative personal savings rate, record-high debt 
levels, trade imbalances, and vulnerability to sharp currency 
depreciation if the rest of the world starts to foreclose on us--we 
must figure out how to get out of this mess. Just as families teased 
into unsuitable subprime loans are signing over their economic 
security, the nation is at risk of mortgaging away our economic future 
if we don't change course and start investing in our own future growth.
    There are times when the direction for monetary policy is clear but 
this does not appear to be one of those times. It looks like the Fed 
has become more neutral about the future direction of monetary policy 
and I think that is prudent for a number of reasons.
    First, the typical American family has been left behind so far in 
the recovery from the 2001 recession. Productivity growth has been 
strong but workers' earnings have not kept up with that growth. Profits 
have risen sharply and so have the salaries and bonuses of top 
management.
    But middle class families have not seen their paychecks keep up 
with gas prices, health care premiums, and college costs, just to name 
a few expenses squeezing families today. It would be a cruel injustice 
if this recovery were to be cut short before workers' earnings began to 
reflect their productivity and families' real incomes more closely 
followed the trajectory of our economic growth.
    Another reason to be open to an easing of monetary policy is the 
concern that the housing market adjustment is far from over. Recent 
housing data has offered little encouragement that the market might be 
stabilizing; so it is still too early to tell if the worst is over for 
the housing market.
    I personally don't think the worst IS over for the housing market 
because everyday on the front page of major newspapers, I read of 
families all over the country who are now in a financial tailspin 
because they were deceived into unsuitable loans.
    As the New York Times reports today, just across the river from my 
home state, in Newark, New Jersey, a majority of the foreclosures were 
in areas with concentrated minority populations and a majority of those 
borrowers had bad credit.
    52,000 families foreclosed on their homes last year in New York 
State alone, so I am particularly concerned with what is happening in 
the sub-prime market. This is a terrible instance where a lack of 
oversight has led to a wild-west mentality among unscrupulous lenders 
and, frankly, the exploitation of large numbers of financially 
unsophisticated borrowers.
    It is bad that entire corporations built on this faulty business 
plan and investors who funded those schemes will be out of business or 
out of money. Those failures will surely lead to some adjustment in the 
financial markets.
    But the real tragedy here is that 2.2 million homeowners face the 
real possibility of losing their homes because they were misled, or 
just plain swindled by modern day bandits. This Committee will be very 
interested in your testimony, Chairman Bernanke, about the causes and 
consequences of the troubles in the sub-prime market and their effects 
on the overall economy.
    Problems in the housing market are at the forefront of my concerns 
about the overall economic outlook but there are other issues as well 
that we are keenly focused on. The new Congress is beginning to take 
real steps to get the budget deficit under control in the wake of 
budget excesses of the past 6 years. But those excesses have brought us 
a large trade deficit, low national saving, and a mounting debt to the 
rest of the world.
    I hope, Chairman Bernanke that you agree with me that the current 
trade deficit is unsustainably large and that it is critically 
important that we take concrete steps to bring it down. I look forward 
to your testimony on the economic outlook and to a discussion of how we 
can best meet the economic challenges we face, and finally how we can 
better protect millions of American families from being robbed in this 
lawless, wild west of exotic home loans.
    Normally I encourage all of our members to make opening statements. 
But because we have votes expected on the floor and in order to stay 
within our limited time with Chairman Bernanke, I am going to ask only 
our Vice Chairman and the Senate and House Ranking members to make 
opening remarks. Other members may submit their full opening statements 
into the record.
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   Prepared Statement of Representative Jim Saxton, Ranking Minority
    It is a pleasure to join in welcoming Federal Reserve Chairman Ben 
Bernanke before the Committee this morning.
    As the Federal Reserve has noted, the U.S. economy has performed 
well in recent years. Economic growth has been strong, unemployment 
stands at 4.5 percent, and 7.6 million jobs have been created since 
August of 2003. Furthermore, long-term inflation pressures are under 
control, and long-term interest rates remain low.
    According to the Federal Reserve's Monetary Policy Report submitted 
to Congress last month, ``the economic outlook for this year and next 
appears favorable.'' This report notes that the drag on the economy 
from the decline in homebuilding may lessen during 2007, real wage and 
job gains should continue to boost consumer spending, and financial 
conditions for businesses are good. In addition, U.S. exports are 
expected to make a positive contribution to growth.
    The risks to the economy going forward include the potential impact 
of unsound subprime lending, continued weakness in housing, and slower 
growth of business investment. Nonetheless, taking these and other 
factors into account, the Federal Reserve Board has projected that U.S. 
economic growth will range between 2.5 and 3.0 percent in 2007.
    The economic growth projected by the Fed in 2007 is in line with 
that of the Blue Chip consensus of economic forecasters. Although the 
prospects for economic expansion are good, I continue to be concerned 
about the prospect of much higher taxes in the future under policies 
currently being debated in Congress.
    Although the economy has proven to be extremely resilient in recent 
years, the possibility of policy mistakes undermining economic growth 
cannot be dismissed lightly. If we can avoid such mistakes, the 
prospects for economic expansion will continue to be favorable over the 
next several years.
                               __________
  Prepared Statement of Representative Carolyn B. Maloney, Vice Chair
    Thank you, Chairman Schumer. I want to welcome Chairman Bernanke 
and thank him for testifying here today.
    This hearing comes at an important time because monetary policy is 
at a critical juncture. With new risks in the housing market and weak 
business investment, the Fed last week essentially acknowledged that 
economic conditions may be deteriorating more than expected.
    Evidence of a slowing economy is building and the concern is that 
the unemployment rate will begin to rise if slow growth continues, 
which argues for easing rates. At the same time, inflation has been 
higher than the Fed is comfortable with over the longer-term, which 
seems to have prevented the Fed from lowering interest rates.
    To ease or not to ease rates? How the Fed will answer that question 
is what we will all try to divine today. I look forward to gaining some 
insights into how the Fed will balance the various risks to the 
economy.
    How American families are faring should be part of the Fed's 
equation because the economy is weakening even before many have shared 
in the gains from the economic growth we have seen so far. Income is 
growing the most for executives and highly compensated individuals but 
ordinary workers are only just beginning to see their paychecks rise 
above inflation. The ability of American consumers to keep spending may 
be flagging with the cooling housing market and recent stock market 
volatility.
    We are facing, by all accounts, a tsunami of defaults and 
foreclosures in the primary subprime market. In each of our districts, 
our constituents are encountering payment shock as their subprime loans 
reset to much higher rates. By some estimates, 2.2 million homeowners 
with subprime loans made through 2006 are at risk of losing their home.
    Rising delinquencies on subprime home loans, while devastating to 
the many families who have fallen prey to these vehicles, could also 
have broader implications for the economy. Some economists have already 
started to compare the subprime market meltdown to the dot-com bubble. 
Chairman Bernanke, I hope you will provide some reassurance that this 
is not the case.
    In the House, we are working on comprehensive subprime lending 
legislation to fix this broken system. One question before us today is 
whether the Fed will act under its Home Ownership and Equity Protection 
Act powers to regulate unfair and deceptive practices to extend the 
proposed guidelines to non-bank lenders or whether Congress should 
legislate to achieve that result.
    Setting the right course for monetary policy is complicated by our 
current fiscal and international imbalances. The challenge for this 
Congress is to return to the fiscal discipline that has been squandered 
by the President and Congress over the past 6 years. Today in the 
House, we are debating a realistic budget plan that adheres to pay-go 
principles for controlling the deficit and bringing revenues into line 
with what we need to spend to defend the country and take care of the 
needs of our citizens.
    Mr. Chairman, thank you for holding this important hearing and I 
look forward to our discussion about the economic outlook.
    Prepared Statement of Hon. Ben S. Bernanke, Chairman, Board of 
                Governors of the Federal Reserve System
    Chairman Schumer, Representative Saxton, and other members of the 
Committee, thank you for inviting me here this morning to present an 
update on the outlook for the U.S. economy. I will begin with a 
discussion of real economic activity and then turn to inflation.
    Economic growth in the United States has slowed in recent quarters, 
reflecting in part the economy's transition from the rapid rate of 
expansion experienced over the preceding years to a more sustainable 
pace of growth. Real gross domestic product (GDP) rose at an annual 
rate of roughly 2 percent in the second half of 2006 and appears to be 
expanding at a similar rate early this year.
    The principal source of the slowdown in economic growth that began 
last spring has been the substantial correction in the housing market. 
Following an extended boom in housing, the demand for homes began to 
weaken in mid-2005. By the middle of 2006, sales of both new and 
existing homes had fallen about 15 percent below their peak levels. 
Homebuilders responded to the fall in demand by sharply curtailing 
construction. Even so, the inventory of unsold homes has risen to 
levels well above recent historical norms. Because of the decline in 
housing demand, the pace of house-price appreciation has slowed 
markedly, with some markets experiencing outright price declines.
    The near-term prospects for the housing market remain uncertain. 
Sales of new and existing homes were about flat, on balance, during the 
second half of last year. So far this year, sales of existing homes 
have held up, as have other indicators of demand such as mortgage 
applications for home purchase, and mortgage rates remain relatively 
low. However, sales of new homes have fallen, and continuing declines 
in starts have not yet led to meaningful reductions in the inventory of 
homes for sale. Even if the demand for housing falls no further, 
weakness in residential construction is likely to remain a drag on 
economic growth for a time as homebuilders try to reduce their 
inventories of unsold homes to more normal levels.
    Developments in subprime mortgage markets raise some additional 
questions about the housing sector. Delinquency rates on variable-
interest-rate loans to subprime borrowers, which account for a bit less 
than 10 percent of all mortgages outstanding, have climbed sharply in 
recent months. The flattening in home prices has contributed to the 
increase in delinquencies by making refinancing more difficult for 
borrowers with little home equity. In addition, a large increase in 
early defaults on recently originated subprime variable-rate mortgages 
casts serious doubt on the adequacy of the underwriting standards for 
these products, especially those originated over the past year or so. 
As a result of this deterioration in loan performance, investors have 
increased their scrutiny of the credit quality of securitized 
mortgages, and lenders in turn are evidently tightening the terms and 
standards applied in the subprime mortgage market.
    Although the turmoil in the subprime mortgage market has created 
severe financial problems for many individuals and families, the 
implications of these developments for the housing market as a whole 
are less clear. The ongoing tightening of lending standards, although 
an appropriate market response, will reduce somewhat the effective 
demand for housing, and foreclosed properties will add to the 
inventories of unsold homes. At this juncture, however, the impact on 
the broader economy and financial markets of the problems in the 
subprime market seems likely to be contained. In particular, mortgages 
to prime borrowers and fixed-rate mortgages to all classes of borrowers 
continue to perform well, with low rates of delinquency. We will 
continue to monitor this situation closely.
    Business spending has also slowed recently. Expenditures on capital 
equipment declined in the fourth quarter of 2006 and early this year. 
Much of the weakness in recent months has been in types of capital 
goods used heavily by the construction and motor vehicle industries but 
we have seen some softening in the demand for other types of capital 
goods as well. Although some of this pullback can be explained by the 
recent moderation in the growth of output, the magnitude of the 
slowdown has been somewhat greater than would be expected given the 
normal evolution of the business cycle. In addition, inventory levels 
in some industries--again, most notably in industries linked to 
construction and motor vehicle production--rose over the course of last 
year, leading some firms to cut production to better align inventories 
with sales. Recent indicators suggest that the inventory adjustment 
process may have largely run its course in the motor vehicle sector but 
remaining imbalances in some other industries may continue to impose 
some restraint on industrial production for a time.
    Despite the recent weak readings, we expect business investment in 
equipment and software to grow at a moderate pace this year, supported 
by high rates of profitability, strong business balance sheets, 
relatively low interest rates and credit spreads, and continued 
expansion of output and sales. Investment in nonresidential structures 
(such as office buildings, factories, and retail space) should also 
continue to expand, although not at the unusually rapid pace of 2006.
    Thus far, the weakness in housing and in some parts of 
manufacturing does not appear to have spilled over to any significant 
extent to other sectors of the economy. Employment has continued to 
expand as job losses in manufacturing and residential construction have 
been more than offset by gains in other sectors, notably health care, 
leisure and hospitality, and professional and technical services, and 
unemployment remains low by historical standards. The continuing 
increases in employment, together with some pickup in real wages, have 
helped sustain consumer spending, which increased at a brisk pace 
during the second half of last year and has continued to be well 
maintained so far this year. Growth in consumer spending should 
continue to support the economic expansion in coming quarters. In 
addition, fiscal policy at both the Federal and the state and local 
levels should impart a small stimulus to economic activity this year.
    Outside the United States, economic activity in our major trading 
partners has continued to grow briskly. The strength of demand abroad 
has helped to spur strong growth in U.S. real exports, which rose about 
9 percent last year, and a robust world economy should continue to 
provide opportunities for U.S. exporters this year. Growth in U.S. real 
imports slowed to about 3 percent in 2006, in part reflecting a drop in 
real terms in imports of crude oil and petroleum products. Despite the 
improvements in trade performance, the U.S. current account deficit 
remains large, averaging 6\1/2\ percent of nominal GDP during 2006.
    Overall, the economy appears likely to continue to expand at a 
moderate pace over coming quarters. As the inventory of unsold new 
homes is worked off, the drag from residential investment should wane. 
Consumer spending appears solid, and business investment seems likely 
to post moderate gains.
    This forecast is subject to a number of risks. To the downside, the 
correction in the housing market could turn out to be more severe than 
we currently expect, perhaps exacerbated by problems in the subprime 
sector. Moreover, we could yet see greater spillover from the weakness 
in housing to employment and consumer spending than has occurred thus 
far. The possibility that the recent weakness in business investment 
will persist is an additional downside risk. To the upside, consumer 
spending--which has proved quite resilient despite the housing downturn 
and increases in energy prices--might continue to grow at a brisk pace, 
stimulating a more-rapid economic expansion than we currently 
anticipate.
    Let me now turn to the inflation situation. Overall consumer price 
inflation has come down since last year, primarily as a result of the 
deceleration of consumers' energy costs. The consumer price index (CPI) 
increased 2.4 percent over the twelve months ending in February, down 
from 3.6 percent a year earlier.
    Core inflation slowed modestly in the second half of last year but 
recent readings have been somewhat elevated and the level of core 
inflation remains uncomfortably high. For example, core CPI inflation 
over the twelve months ending in February was 2.7 percent, up from 2.1 
percent a year earlier. Another measure of core inflation that we 
monitor closely, based on the price index for personal consumption 
expenditures excluding food and energy, shows a similar pattern.
    Core inflation, which is a better measure of the underlying 
inflation trend than overall inflation, seems likely to moderate 
gradually over time. Despite recent increases in the price of crude 
oil, energy prices are below last year's peak. If energy prices remain 
near current levels, greater stability in the costs of producing non-
energy goods and services will reduce pressure on core inflation over 
time. Of course, the prices of oil and other commodities are very 
difficult to predict, and they remain a source of considerable 
uncertainty in the inflation outlook.
    Increases in rents--both market rent and owner's equivalent rent--
account for a substantial part of the increase in core inflation over 
the past year. The acceleration in rents may have resulted in part from 
a shift in demand toward rental housing as families found homeownership 
less financially attractive. Rents should begin to decelerate as the 
demand for owner-occupied housing stabilizes and the supply of rental 
units increases. However, the extent and timing of that expected 
slowing is not yet clear.
    Another significant factor influencing medium-term trends in 
inflation is the public's expectations of inflation. These expectations 
have an important bearing on whether transitory influences on prices, 
such as changes in energy costs, become embedded in wage and price 
decisions and so leave a lasting imprint on the rate of inflation. It 
is encouraging that inflation expectations appear to be contained.
    Although core inflation seems likely to moderate gradually over 
time, the risks to this forecast are to the upside. In particular, 
upward pressure on inflation could materialize if final demand were to 
exceed the underlying productive capacity of the economy for a 
sustained period. The rate of resource utilization is high, as can be 
seen most clearly in the tightness of the labor market. Indeed, 
anecdotal reports suggest that businesses are having difficulty 
recruiting well-qualified workers in a range of occupations. Measures 
of labor compensation, though still growing at a moderate pace, have 
shown some signs of acceleration over the past year, likely in part the 
result of tight labor market conditions.
    To be sure, faster growth in nominal labor compensation does not 
necessarily portend higher inflation. Increases in compensation may be 
offset by higher labor productivity or absorbed--at least for a time--
by a narrowing of firms' profit margins rather than passed on to 
consumers in the form of higher prices. In these circumstances, gains 
in nominal compensation would translate into gains in real compensation 
as well. Underlying productivity trends appear generally favorable, 
despite the recent slowing in some measures, and the markup of prices 
over unit labor costs is high by historical standards, so such an 
outcome is certainly possible. Moreover, if the economy grows at a 
moderate pace for a time, as seems most likely, pressures on resource 
utilization should ease.
    However, a less benign possibility is that tight product markets 
might allow firms to pass some or all of their higher labor costs 
through to prices. In this case, increases in nominal compensation 
would not translate into increased purchasing power for workers but 
would add to inflation pressures. Thus, the high level of resource 
utilization remains an important upside risk to continued progress in 
reducing inflation.
    In regard to monetary policy, the Federal Open Market Committee has 
left its target for the Federal funds rate unchanged, at 5\1/4\ 
percent, since last June. To date, the incoming data have supported the 
view that the current stance of policy is likely to foster sustainable 
economic growth and a gradual ebbing in core inflation. Because core 
inflation is above the levels most conducive to the achievement of 
sustainable growth and price stability, the Committee indicated in the 
statement following its recent meeting that its predominant policy 
concern remains the risk that inflation will fail to moderate as 
expected. However, the uncertainties around the outlook have increased 
somewhat in recent weeks. Consequently, the Committee also indicated 
that future policy decisions will depend on the evolution of the 
outlook for both inflation and economic growth, as implied by incoming 
information.
    Thank you. I would be happy to take your questions.
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              Prepared Statement of Senator Sam Brownback
    Thank you Chairman Schumer for scheduling today's hearing. And 
thank you Chairman Bernanke for taking the time to share your views on 
the outlook for the American economy with us this morning.
    The U.S. economy seems to be in a transition from the rapid rate of 
expansion we have experienced over the past several years to a more 
sustainable average pace of growth.
    The main source of the recent moderation has been a substantial 
cooling in the housing market, which has led to a noticeable slowdown 
in the pace of residential construction. However, the slowdown in 
housing market activity and the slower appreciation of house prices do 
not seem to have spilled over to any significant extent to other parts 
of the economy. The exception, of course, lies in the subprime mortgage 
market where delinquency rates and defaults have increased and a number 
of large lenders have closed shop. It remains to be seen whether or to 
what extent difficulties in the subprime mortgage market spill over to 
more general credit availability, and we look forward to your comments 
on that issue.
    Consumer spending, which accounts for the vast majority of our 
Nation's gross domestic product, has continued to expand at a solid 
rate, supported by continued healthy gains in incomes and employment. 
On average, about 162,000 new payroll jobs have been added each month 
over the past 6 months, and the unemployment rate, at 4.5 percent in 
February, remains very low by historical standards. In fact, Chairman 
Bernanke, in testimony that you delivered before Congress in February, 
you referred to ``tightness'' in the labor market and identified 
anecdotal reports suggesting that businesses are having difficulty 
recruiting well-qualified workers in certain occupations. To the extent 
that the ``tight'' labor market makes it easier for Americans who want 
jobs to get jobs, I am delighted by labor market tightness.
    In addition to healthy household finances, outside of subprime 
mortgages with variable interest rates, the business sector also seems 
to be in sound financial condition. And, outside the United States, 
economic growth of our major trading partners has continued to rise. 
Strong demand from abroad has helped generate a strong expansion in 
U.S. real exports, which grew about 9 percent last year. However, 
despite improvements in our trade performance, the U.S. current account 
deficit remains large and grew to nearly 6.5 percent of our Nation's 
gross domestic product last year.
    Inflation, inflation expectations, and long-term interest rates 
remain low by historical standards. It will be interesting to hear your 
thoughts on the outlook for inflation and interest rates as we move 
forward.
    There are, of course, uncertainties associated with the outlook for 
the U.S. economy. Probably the biggest uncertainty today involves what 
will be the ultimate outcomes of the housing market correction and the 
fallout in subprime mortgage lending.
    In terms of the long-term outlook for the economy, I would say that 
we know one thing with certainty: we know that we will soon observe the 
retirement of the baby boomers and we know that promises made under our 
Social Security and Medicare systems are unsustainable. With that 
certainty, Congress must act now to reform our entitlement programs and 
avoid a fiscal train wreck. Failure to do so will threaten the health 
of our economy.
    While our focus today is on a macroeconomic overview of the state 
of the economy, I believe that there are some powerful social and 
cultural trends that play a significant role in determining a family's 
economic well being. Unfortunately, these factors are often overlooked 
in our discussions. This is particularly the case when we look at the 
widening income inequality that has been occurring for decades. From 
the evidence I have reviewed, it appears that factors such as family 
structure and education level have a significant impact on where 
households find themselves on the income scale.
    When you look at the makeup and educational levels in households at 
the top and bottom 20 percent of the income distribution, the numbers 
are striking in terms of married versus single parent families. In the 
top 20 percent almost 90 percent of households are married. In the 
bottom 20 percent, only 25 percent of households are married. If 
marriage rates continue to decline and if the size of the education 
premium continues to rise, the existing income gap will likely widen 
further. I believe that we have to be aggressive in implementing 
policies that serve to strengthen the traditional family if we are 
going to reverse this trend.
    I have made it a priority to work toward reducing disincentives 
toward marriage that are built into our tax code and our government 
programs. Stable families, low taxes, a growing economy, and education 
are what will promote economic opportunity and success.
    I look forward to your testimony and the question and answer 
session to follow.
  

                                  
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