[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
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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.
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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.