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



                                                        S. Hrg. 110-350
 
                          THE ECONOMIC OUTLOOK

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


                                HEARING

                               before the

                        JOINT ECONOMIC COMMITTEE
                     CONGRESS OF THE UNITED STATES

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                               __________

                            NOVEMBER 8, 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 Cummings, Maryland
Jim Webb, Virginia                   Lloyd Doggett, Texas
Sam Brownback, Kansas                Jim Saxton, New Jersey, Ranking 
John Sununu, New Hampshire               Minority
Jim DeMint, South Carolina           Kevin Brady, Texas
Robert F. Bennett, Utah              Phil English, Pennsylvania
                                     Ron Paul, Texas

                  Michael Laskawy, Executive Director
             Christopher J. Frenze, Minority Staff Director


                            C O N T E N T S

                              ----------                              

                                Members

Hon. Charles E. Schumer, Chairman, a U.S. Senator from New York..     1
Hon. Jim Saxton, Ranking Minority, a U.S. Representative from New 
  Jersey.........................................................     4
Hon. Carolyn B. Maloney, Vice Chair, a U.S. Representative from 
  New York.......................................................     5
Hon. Sam Brownback, a U.S. Senator from Kansas...................     6

                                Witness

Statement of Hon. Ben S. Bernanke, Chairman, Board of Governors 
  of the Federal Reserve System, Washington, DC..................     7

                       Submissions for the Record

Prepared statement of Senator Charles E. Schumer, Chairman.......    40
Prepared statement of Representative Jim Saxton, Ranking Minority    43
Prepared statement of Representative Carolyn B. Maloney, Vice 
  Chair..........................................................    44
Prepared statement of Senator Sam Brownback......................    46
Prepared statement of Representative Elijah E. Cummings..........    47
Prepared statement of Representative Ron Paul....................    48
Prepared statement of Hon. Ben S. Bernanke, Chairman, Board of 
  Governors of the Federal Reserve System, Washington, DC........    49
Letter dated November 9, 2007 from Representative Loretta Sanchez 
  to Chairman Ben S. Bernanke with written questions for the 
  record.........................................................    53
Letter dated November 26, 2007 from Chairman Ben S. Bernanke to 
  Hon. Loretta Sanchez re: questions for the record..............    55
    Chairman Bernanke's response to written questions submitted 
      by Representative Sanchez..................................    56
Chart entitled, ``Projected Economic Costs of the Subprime 
  Mortgage Crisis State-by-State''...............................    58
Chart entitled, ``The Bush Economy: Employee Compensation Has 
  Lagged Far Behind Productivity''...............................    59


                          THE ECONOMIC OUTLOOK

                              ----------                              


                       THURSDAY, NOVEMBER 8, 2007

             Congress of the United States,
                          Joint Economic Committee,
                                                    Washington, DC.
    The Committee met at 10 a.m. in room 216 of the Hart Senate 
Office Building, The Honorable Charles E. Schumer (Chairman of 
the Committee) presiding.
    Senators present. Bennett, Bingaman, Brownback, Casey, 
Klobuchar, Schumer, and Sununu.
    Representatives present. Brady, Cummings, Doggett, English, 
Hinchey, Maloney, Paul, Sanchez, and Saxton.
    Staff present: Christina Baumgardner, Ted Boll, Heather 
Boushey, Chris Frenze, Stephanie Dreyer, Nan Gibson, Colleen 
Healy, Marc Jarsulic, Aaron Kabaker, Israel Klein, Tyler Kurtz, 
Michael Laskawy, Zachary Luck, Kimberly Magee, Robert O'Quinn, 
Jeff Schlagenhauf, Robert Weingart, Adam Wilson, Jeff Wrase, 
and Adam Yoffie.

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

    Senator 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. We're always pleased 
when the Federal Reserve Chairman comes to share his views on 
the state of our economy.
    Chairman Bernanke, when you came before this Committee last 
March, one of the major topics discussed, was the potential for 
fallout from the subprime lending crisis. It's something this 
Committee has been very concerned with for quite some time, and 
I think you'd be the first to admit that the subprime mess has 
not been contained, but, instead, has proved to be a contagion 
that has spread in dangerous ways throughout not just the 
housing market, but our economy, and even into the global 
financial system.
    The seizing up of credit markets this summer, was the 
clearest indication of the unanticipated, potentially 
disastrous risks that out-of-control subprime lending poses to 
the financial markets.
    There is now a lack of confidence in creditworthiness 
throughout the markets, and, at the core, there is a lack of 
confidence in the subprime market. Until we correct that, we 
will not solve our broader problems.
    I want to applaud you and the Federal Reserve Board for 
your aggressive, and, I believe, appropriate response to this 
summer's liquidity crisis. It's vital that we maintain the 
health of our financial markets and ensure that they function 
smoothly.
    You deserve credit for your prompt actions. However, while 
we did weather that summer storm, I am worried that there may 
be a bigger storm on the horizon.
    Quite frankly, I think we are at a moment of economic 
crisis, stemming from four key areas: Falling housing prices, 
lack of confidence in creditworthiness, the weak dollar, and 
high oil prices.
    Each of these problems, alone, would be enough of a threat 
to our economic well being, but taken together, they are 
essentially the four horsemen of economic crisis.
    First, as we have warned, and as you acknowledge in your 
testimony, we face a wave of foreclosures in the next years, 
that threaten millions of American homeowners and the 
neighbors.
    The housing boom has busted, and we see trillions of 
dollars in lost home values across the Nation.
    Second, the credit markets remain in crisis. It's just 
simply a lack of confidence. The dollar has dropped 
dramatically against most of the major currencies of the world, 
and it seems to hit lows not seen in decades, nearly every day.
    Finally, oil prices keep reaching near record highs, 
driving up energy costs in all sectors of the economy.
    Even our bedrock assumptions are being put into doubt. As 
housing prices decline, there are real fears that we won't be 
able to depend on consumers, the engine of our economy over the 
past few years, to keep spending.
    We now hear that foreign investors may no longer be 
confident in the dollar as the global currency of choice.
    I'm not surprised to hear experts such as your predecessor, 
Alan Greenspan, warn about the threat of recession. I've begun 
to worry about it, too.
    In particular, as I watch bank after bank write down bad 
investments tied to baroque financial instruments that even 
sophisticated investors don't understand, I fear for the 
stability and ultimate confidence in our financial system.
    I've talked about the Wild West of subprime mortgage 
brokers, and I'm beginning to wonder if we have a Wild West of 
unregulated financial instruments, of SIVs and mis-rated CDOs 
and other complicated investments, whose values are not marked-
to-market, or even marked-to-model, but, to quote one Wall 
Street strategist, are marked-to-make believe.
    To quote you, Mr. Chairman, the markets want to know how 
much these damn things are worth, and I want to know what all 
of us--the Federal Reserve, the Congress, and this 
Administration can do, if anything, to assuage those fears.
    I'm very concerned, Mr. Chairman, that none of the 
regulators are acting quickly or boldly enough to deal with the 
risks we're facing. A laissez faire, hands-off attitude, might 
be appropriate, if we had one of these crises, but confronting 
all of these problems at once, should be a call to action, 
because the danger we face is so much greater.
    I know that Secretary Paulson has organized a ``super 
conduit'' to deal with the liquidity crunch faced by SIVs and 
the threat they pose to broader financial markets.
    To be direct, I'm worried that this may just be a shell 
game, an attempt to move bad investments around, and keep them 
from landing back on the books.
    I'd be curious to hear your opinion today, Mr. Chairman, 
about the Secretary's plan, as well as your view about the 
risks these complex and opaque pools of capital now present to 
our financial system, and how you intend to deal with them.
    If you don't feel you have the tools at your disposal to 
address these problems, then I hope you'll share your views on 
what we in Congress ought to do.
    I am glad to see that much of your statement is given over 
to the importance of helping distressed subprime borrowers. You 
mention some of the efforts my colleagues and I have made--and 
I won't spend more time on that right now, but I will say that 
it would really be nice if the Administration would join us in 
our attempts to protect families from the fallout of the 
subprime lending disaster.
    The policy responses from the Administration have not come 
close to matching the magnitude of the crisis. There is a lack 
of confidence that anyone is in charge.
    Mr. Chairman if you feel that, in your position, you cannot 
speak publicly about the changes that are needed, I urge you to 
speak privately to members of the Administration, use your 
position to jawbone them into action.
    Your predecessor was not shy about putting his prestige and 
credibility to work behind the scenes. I encourage you to do 
the same.
    One of the great legacies of the American economy, has been 
its ability to make everyone better off. Throughout most of our 
history, when our economic pie has gotten bigger, everyone has 
shared and the Nation has prospered and everyone got along.
    But over the 7 years of this Administration, that has not 
been the case. Even in the recovery of the past few years, the 
benefits have gone mainly to those at the top.
    Now, as we face an economic slowdown, or worse, I'm very 
worried that it's those Americans who haven't shared in our 
recent growth, who will bear the brunt of economic decline, and 
the policies of this Administration, will only further 
exacerbate their difficulties.
    I don't pretend that there are easy solutions to troubling 
challenges facing our economy. The oil crisis, the falling 
dollar, they took years in the making and will not be solved 
with the snap of a finger, but we cannot shy away from those 
challenges.
    We cannot, for another day or month, avoid these problems 
any longer because the chickens seem to be coming home to 
roost.
    We need your voice, either publicly or privately, to help 
move us in that direction. I look forward to your testimony on 
the economic outlook, and to an interesting discussion of how 
we best meet these and other economic challenges we face.
    Senator Schumer. Normally, I encourage all of our Members 
to make opening statements, but because we only have a limited 
time with Chair Bernanke, I'm going to ask your Vice Chairman 
and the Senate and House Ranking Members to make opening 
statements. Other Members may submit their full opening 
statements for the record.
    Now, I turn to the Committee's Ranking Republican, my 
colleague on the House side, Mr. Saxton.
    [The prepared statement of the Senator Schumer appears in 
the Submissions for the Record on page 40.]

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

    Representative Saxton. Mr. Chairman, thank you very much. 
Chairman Bernanke, I'm pleased to join in welcoming you again 
here to testify before the Joint Economic Committee.
    I appreciate your testimony in the past and look forward to 
your views on the economic outlook today.
    According to the standard measures of performance, such as 
economic growth and the unemployment rate, the U.S. economy, on 
the one hand, seems to be doing quite well.
    Real economic growth was 3.9 percent in the third quarter, 
while the unemployment rate remains relatively low at 4.7 
percent in October.
    Exports and consumer spending continue to advance, 
reflecting the resilience of the U.S. economy. The recent pace 
of economic growth is all the more remarkable, given the 
challenges facing the economy.
    Residential real estate investment declined at a 20-percent 
rate in the third quarter, continuing a longer trend. Housing 
prices are falling in many areas of the country, and housing 
inventory levels are on the rise.
    Oil prices, as we all know, are nearing $100 a barrel, and 
the dollar is falling. In recent months, it has also become 
clear that a number of large financial institutions have 
invested in mortgage securities of dubious quality.
    Huge writedowns of assets by Citigroup and Merrill Lynch, 
are recent validations of the serious concerns about the value 
of mortgage-backed securities. Uncertainty about the extent of 
bad investments related to the subprime and other mortgages has 
spread, resulting in sharp declines in the valuation of bank 
stocks.
    The financial markets have become very volatile, as we have 
seen, particularly in the last several days. Even though recent 
economic growth appears to be strong, the combination of the 
decline in homebuilding, falling housing prices, spiking oil 
prices, and financial turmoil risks to the continuation of 
healthy economic growth.
    The Fed has acted to reduce the strains on the financial 
sector, to head off a slowdown in the economy. According to 
leadership consensus and Federal Reserve forecasts, the economy 
will continue to expand through 2008.
    Thank you, Mr. Chairman. I look forward to the testimony.
    [The prepared statement of Representative Saxton appears in 
the Submissions for the Record on page 43.]
    Senator Schumer. Vice Chair Maloney.

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

    Representative Maloney. Thank you very much, Mr. Chairman, 
for holding the hearing, and welcome to Chairman Bernanke. We 
are all eager to hear your remarks on the economic outlook and 
what that may mean for monetary policy during these troubling 
times.
    Tremendous uncertainty remains about how the subprime 
fallout and the housing slowdown will infect the broader 
economy. Calling it a subprime crisis is no longer adequate, as 
the breadth and depth of this escalating credit crisis roils 
our major financial institutions, almost daily.
    The seeming inability of our most sophisticated and 
respected institutions to measure their exposure to these 
assets, and more importantly, to manage the risks associated 
with them, poses a serious threat to our financial markets.
    The chairman of General Motors' recent admission, 
yesterday, that he could not tell with any accuracy what the 
Company's exposure is to subprime losses at GMAC is both 
stunning and frightening. Investors did not understand what 
they were buying when they held CDOs and SIVs.
    Now we're seeing billions of dollars in losses on these 
investments. Risk is coming home to roost with a vengeance. We 
have yet to see the full impact of these losses, on the economy 
or on the labor market.
    In the near term, forecasters expect the economy to slow, 
as high energy prices and falling home values squeeze 
consumers, all of which points to a gathering storm that could 
drag down the economy, taking American jobs with it.
    The Federal Reserve has worked to prevent the economy from 
derailing and has eased the credit crunch by lowering its key 
interest rates, but at their last meeting, the Fed signalled a 
wait-and-see approach for further action.
    With crude oil edging toward $100 a barrel and the dollar 
sinking like a stone, inflation is certainly a concern for the 
Fed. The dollar fell sharply again yesterday, as the Chinese 
government signalled a shift away from the purchases of dollars 
in favor of Euros.
    I think we would all like to hear more from Chairman 
Bernanke about any contingency plans the Fed has, should 
economic forces move toward a free-fall of the dollar. Our 
tremendous fiscal imbalances, including our record $9-trillion 
debt, further complicate the Fed's job of setting the right 
course for monetary policy, but for the moment, core inflation 
has remained unchecked, and there is little evidence that the 
labor market poses any real inflationary risks.
    Wages have barely kept pace with rising prices, and they 
have lagged far behind productivity.
    I hope the Chairman will agree, that how American families 
are faring, should not take a back seat to fighting inflation.
    By all accounts, we haven't felt the worst of the housing 
market slump.
    Millions of Americans are worried that they can't afford to 
keep their homes, let alone to heat them this winter.
    Congress is working very hard to keep people in their 
homes, and to prevent another crisis like this one from 
happening again. In the House of Representatives, we have 
passed reform legislation to shore up the FHA and the GSEs.
    Just this week, we passed sweeping mortgage and anti-
predatory lending legislation through the Financial Services 
Committee, which will head to the floor next week.
    These are important first steps. There is a great deal more 
to do to help restore the American dream of many hardworking 
families.
    Mr. Chairman, we look forward to gaining some insights into 
how the Fed will balance various risks to the economy with 
monetary policy. Again, we welcome you to the Committee.
    [The prepared statement of Representative Maloney appears 
in the Submissions for the Record on page 44.]
    Senator Schumer. Thank you, Vice Chair Maloney.
    Ranking Member Brownback.

 OPENING STATEMENT OF HON. SAM BROWNBACK, A U.S. SENATOR FROM 
                             KANSAS

    Senator Brownback. Thank you, Mr. Chairman. Mr. Chairman 
we're pleased to have you here.
    The American economy has demonstrated, I believe, amazing 
resilience in the face of a variety of challenges. Witness 24 
consecutive quarters of positive, real economic growth--24 
consecutive quarters; 50 consecutive months of payroll 
employment growth. That's the longest on record.
    And there has been significant expansion in our exports, 
yet my perception, and, I think, that of my colleagues up here, 
is that our economy is at a crossroads. That's why I think 
we're all so interested in your testimony here today and why 
the markets are so interested in your testimony.
    We have had a nice long run, but it looks as if there are 
some really troubling signs out there. We've all talked about 
oil prices; we've all talked about the subprime market. I know 
you're going to address those.
    One thing that certainly seems clear to me, on our part as 
legislators, is that the idea of raising taxes at this point in 
time would be a terrible idea and a terrible thing for the 
economy. If we were either to raise them purposefully, or to 
allow them to be raised because we didn't vote to extend the 
tax cuts that have been put in place, that would be the exact 
wrong signal, the exact wrong thing to do in an economy that is 
at a crossroads.
    So, from our stance of fiscal policy and what we can do for 
economic growth on our side, I would certainly hope we would 
set aside all sorts of ideas about raising taxes, and say no, 
we're going cut taxes and we're going to keep them low to try 
to keep the economy going.
    On your side of it, I look forward to your comments and 
what your thoughts are on what we should do with subprime 
mortgages, also on the impact of high oil prices on consumer 
spending.
    I do hope the Fed is considering a further cut in rates to 
help the economy, to help the American consumer, who accounts 
for 70 percent of the economy.
    Going into the important Christmas buying season, it seems 
to me now is the time--and I know you're weighing this--but I 
would certainly put my two cents worth in, that rate cuts at 
this point in time, when the consumer is seeing so much direct 
pressure on their pocketbook--those gas prices get up to $3 a 
gallon--it seems to hit some sort of psychological point in the 
consumer's mind.
    They have less to spend, and that's a reality for them. I'm 
going to spend less in other areas. That reverberates further 
on through the economy.
    So, a rate cut could be something very valuable, a signal 
to send into this economy--to the economy and to the consumer.
    Much is at stake on our part and on your part. We look 
forward to your thoughts and wisdom that you can share with us 
on what we need to do to navigate through these troubled 
waters. I'm delighted you're here, delighted that you're in 
that job and I'm not.
    [The prepared statement of Senator Brownback appears in the 
Submissions for the Record on page 46.]
    Senator Schumer. Mr. Chairman, proceed.

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

    Chairman Bernanke. Thank you, Chairman Schumer, Vice Chair 
Maloney, Representative Saxton and other Members of the 
Committee. Thank you for inviting me here this morning to 
present an update on the economic situation and outlook.
    Since I last appeared before this Committee in March, the 
U.S. economy has performed reasonably well. On preliminary 
estimates, real gross domestic product grew at an average pace 
of nearly 4 percent over the second and third quarters, despite 
the ongoing correction in the housing market.
    Core inflation has improved modestly, although recent 
increases in energy prices, will likely lead overall inflation 
to rise for a time.
    However, the economic outlook has been importantly affected 
by recent developments in financial markets, which have come 
under significant pressure over the past few months. The 
financial turmoil was triggered by investor concerns about the 
credit quality of mortgages, especially subprime mortgages with 
adjustable interest rates.
    The continuing increase in the rate of serious 
delinquencies in such mortgages, reflects, in part, a decline 
in underwriting standards in recent years, as well as a 
softening of house prices.
    Delinquencies on these mortgages are likely to rise further 
in coming quarters, as a sizable number of recent vintage 
subprime loans experience their first interest rate resets. I 
will have more to say about this problem and its implications 
for homeowners, later in my testimony.
    At one time, most mortgages were originated and held by 
depository institutions. Today, however, mortgages are commonly 
bundled together into mortgage-backed securities or structured 
credit products, rated by credit-rating agencies, and then sold 
to investors.
    As mortgage losses have mounted, investors have questioned 
the reliability of credit ratings, especially those of 
structured products.
    Because many investors had not developed the capacity to 
perform independent evaluations of these often complex 
instruments, the loss of confidence in the credit ratings, 
together with uncertainty about developments in the housing 
market, led to a sharp decline in the demand for these 
products. Since July, few securities backed by subprime 
mortgages have been issued.
    Although the problems with subprime mortgages initiated the 
financial turmoil, credit concerns quickly spilled over into a 
number of other areas. Importantly, the secondary market for 
securities backed by prime, jumbo mortgages, also contracted, 
and the issuance of such securities has declined significantly.
    Prime jumbo loans are still being made to prospective home 
purchasers, but they are at higher spreads and have more 
restrictive terms.
    Concerns about mortgage-backed securities and structured 
credit products, even those unrelated to mortgages, also 
greatly reduced investor appetite for asset-backed commercial 
paper, although that market has improved somewhat recently.
    In the area of business credit, investors shied away from 
financing leveraged buyouts and from purchasing speculative-
grade corporate bonds, and some larger banks, concerned about 
potentially large and difficult-to-predict draws on their 
liquidity and balance sheet capacity, became less willing to 
provide funding to their customers and to each other.
    To be sure, the recent developments may well lead to a 
healthier financial system in the medium to long term. 
Increased investor scrutiny of structured credit products is 
likely to lead, ultimately, to greater transparency in these 
products and to better differentiate among assets of varying 
quality.
    Investors have also become more cautious and are demanding 
greater compensation for bearing risk. In the short term, 
however, the events do imply a greater measure of financial 
restraint on economic growth, as credit becomes more expensive 
and difficult to obtain.
    At the height of the recent financial turmoil, the Federal 
Reserve took a number of steps to help markets return to more 
orderly functioning. The Fed increased liquidity in short-term 
money markets in early August through larger-than-normal open 
market operations, and on August 17, the Federal Reserve Board 
cut the discount rate, the rate at which it lends directly to 
banks, 50 basis points, or \1/2\ percentage point, and, 
subsequently, took several additional measures.
    These efforts to provide liquidity, appear to have been 
helpful, on the whole, but the functioning of a number of 
important markets remained impaired.
    The turmoil in financial markets, significantly affected 
the Federal Reserve's outlook for the broader economy. Indeed, 
in a statement issued simultaneously with the Board's August 17 
announcement of the cut in the discount rate, the Federal Open 
Market Committee noted that the downside risk to economic 
growth had increased appreciably.
    The Committee took further action at its next scheduled 
meeting on September 18th, when it cut its target for the 
Federal Funds Rate by 50 basis points.
    This action was intended as a counterbalance to the 
tightening of credit conditions and to address, in a preemptive 
fashion, some of the risks that financial developments pose to 
the broader economy.
    The Committee met most recently on October 30 and 31. The 
data reviewed at that meeting, suggested that growth in the 
third quarter had been solid at a 3.9 percent rate, according 
to the initial estimate by the Bureau of Economic Analysis.
    Residential construction declined sharply during the 
quarter, as expected, subtracting about 1 percentage point from 
overall growth. However, the GDP report provided scant evidence 
of spillovers from housing to other components of final demand.
    Strong growth in consumer spending was supported by gains 
in employment and income, and businesses increased their 
capital spending at a solid pace.
    A strong global economy stimulated foreign demand for U.S.-
produced goods and services, as foreign trade contributed 
nearly 1 percentage point to the growth of real output last 
quarter.
    Looking forward, however, the Committee did not see the 
recent growth performance as likely to be sustained in the near 
term. Financial conditions had improved somewhat after the 
September FOMC action, but the market for nonconforming 
mortgages remained significantly impaired and survey 
information suggested that banks had tightened terms and 
standards for a range of credit products over recent months.
    In part because of the reduced availability of mortgage 
credit, the contraction in housing-related activity seemed 
likely to intensify. Indicators of overall consumer sentiment 
suggested that household spending would grow more slowly, a 
reading consistent with the expected effects of higher energy 
prices, tighter credit, and continuing weakness in housing.
    Most businesses appear to enjoy relative good access to 
credit, but heightened uncertainty about economic prospects 
could lead business spending to decelerate, as well.
    Overall, the Committee expected that the growth of economic 
activity would slow noticeably in the fourth quarter, from its 
third quarter rate.
    Growth was seen as remaining sluggish through the first 
part of next year, then strengthening as the effects of tighter 
credit and the housing correction began to wane.
    The Committee also saw downside risks to this projection. 
One such risk was that financial market conditions would fail 
to improve, or even worsen, causing credit conditions to become 
even more restrictive than expected.
    Another risk was that in light of the problems in mortgage 
markets and the large inventories of unsold homes, house prices 
might weaken more than expected, which could further reduce 
consumers' willingness to spend and increase investors' 
concerns about mortgage credit.
    The Committee projected overall core inflation to be in a 
range consistent with price stability next year.
    Supporting this view were modest improvements in core 
inflation over the course of the year, inflation expectations 
that appeared reasonably well anchored, and futures quotes 
suggesting that investors saw food and energy prices coming off 
their recent peaks next year.
    But the inflation outlook was also seen as subject to 
important upside risks. In particular, prices of crude oil and 
other commodities had increased sharply in recent weeks and the 
foreign exchange value of the dollar, had weakened.
    These factors were likely to increase overall inflation in 
the short run and should inflation expectations become umoored, 
have the potential to boost inflation in the longer run, as 
well.
    Weighing its projections for growth and inflation, as well 
as the risk to those projections, the FOMC, on October 31, 
reduced its target for the Federal Funds Rate an additional 25 
basis points to 4.5 percent.
    In the Committee's judgment, the cumulative easing of 
policy over the past 2 months, should help forestall some of 
the adverse effects on the broader economy that might otherwise 
arise from the disruptions in financial markets, and promote 
moderate growth over time.
    Nonetheless, the Committee recognized that risk remained to 
both of its statutory objectives of maximum employment and 
price stability. All told, it was the judgment of the FOMC that 
after its action of October 31, the stance of monetary policy 
roughly balanced the upside risk to inflation and the downside 
risk to growth.
    In the days since the October FOMC meeting, the few data 
releases that have become available have continued to suggest 
that overall economic activity, the overall economy, remain 
resilient in recent months; however, financial market 
volatility and strains have persisted.
    Incoming information on the performance of mortgage-related 
assets, has intensified investors' concerns about credit market 
developments and the implications of the downturn in the 
housing market for economic growth.
    In addition, further sharp increases in crude oil prices 
have put renewed upward pressure on inflation, and it may 
impose further restraint on economic activity.
    The FOMC will continue to carefully assess the implications 
for the outlook of the incoming economic data and financial 
market developments and will act as needed to foster price 
stability and sustainable economic growth.
    I would like to say a few words about actions being taken 
to help homeowners who have fallen behind on their mortgage 
payments, or seem likely to do so.
    As I mentioned, delinquencies will probably rise further 
for borrowers who have a subprime mortgage with an adjustable 
interest rate, as many of these mortgages will soon see their 
rates reset at significantly higher levels.
    Indeed on average, from now until the end of next year, 
nearly 450,000 subprime mortgages per quarter are scheduled to 
undergo their first interest rate reset. Relative to past 
years, avoiding the payment shock of an interest reset by 
refinancing the mortgage will be much more difficult, as home 
prices have flattened out or declined, thereby reducing 
homeowners' equity, and lending terms have tightened.
    Should the rate of foreclosure rise proportionately, 
communities, as well as individual borrowers, would be hurt 
because concentrations of foreclosures tend to reduce property 
values in surrounding areas.
    A sharp increase in foreclosed properties for sale could 
also weaken the already struggling housing market, and thus 
potentially, the broader economy.
    Home losses through foreclosure can be reduced if financial 
institutions work with borrowers who are having difficulty 
meeting their mortgage payment obligations. In recent months, 
the Federal Reserve and other banking agencies have issued 
statements calling on mortgage lenders and mortgage servicers 
to pursue prudent loan workouts.
    Our contacts with the mortgage industry suggest that 
servicers have recently stepped up their efforts to work with 
borrowers facing financial difficulties or an imminent rate 
reset.
    Some servicers have been proactive about contacting 
borrowers who have missed payments or face resets, as 
experiences shows that addressing the problem early increases 
the odds of a successful outcome.
    Foreclosure cannot always be avoided, but in many cases, 
loss mitigation techniques that preserve home ownership are 
less costly than foreclosure.
    To help keep borrowers in their homes, servicers have been 
offering assistance through repayment plans, temporary 
forbearance, and loan modifications.
    Comprehensive data on the success of these efforts to avert 
foreclosures are not available, but my sense is that there is 
scope for services to further increase their loss mitigation 
efforts.
    The development of standardized approaches to workouts and 
the sharing of best practices can help increase the scale of 
the effort, even if ultimately, workouts must be undertaken 
loan-by-loan.
    Although workouts are to be encouraged, regulators must be 
alert to ensure that they are done in ways that protect 
consumers' interests and do not disguise lenders' losses or 
impair safety and soundness.
    The Federal Reserve has been participating in efforts by 
community groups to homeowners avoid foreclosure. For example, 
Governor Kroszner of the Federal Reserve Board serves as a 
director of NeighborWorks America, a nonprofit organization 
that has been helping thousands of borrowers facing current or 
potential distress to obtain assistance from their lenders, 
their servicers, or trusted counselors through a hotline.
    The Federal Reserve Board staff has been working with 
consumer and community affairs groups through the Federal 
Reserve System, to help identify localities that are most at 
risk of high foreclosures, with the intent to help local groups 
better focus their outreach efforts to borrowers.
    Other contributions include foreclosure prevention programs 
such as the Home Ownership Preservation Initiative which the 
Federal Reserve Bank of Chicago helped to initiate, and efforts 
by Reserve Banks to convene workshops for stakeholders, to 
develop community-based solutions to mortgage delinquencies in 
their areas.
    The Federal Reserve System is also engaged in research and 
analysis that should involve policy responses to these issues.
    The Congress is also focused on reducing homeowners' risks 
of foreclosure. One statutory change that could help is the 
modernization of programs administered by the Federal Housing 
Administration.
    The FHA has considerable experience helping low- and 
moderate-income households obtain home financing, but it has 
lost market share in recent years, partly because borrowers 
have moved toward nontraditional products with more flexible 
and quicker underwriting and processing, and partly because of 
a cap on the maximum loan value that can be insured.
    In modernizing the FHA, the Congress might encourage joint 
efforts with the private sector that expedite the refinancing 
of subprime loans held by creditworthy borrowers facing resets.
    It might also consider granting the Agency the flexibility 
to design products that improve affordability through such 
features as variable maturities or shared appreciation.
    Also, the FHA could provide more refinancing options for 
riskier households, if it could tailor the premiums it charges 
for mortgage insurance to the risk profile of the borrower.
    As I have discussed in earlier testimony, the Federal 
Reserve is taking steps to avoid subprime lending problems from 
recurring, while preserving responsible subprime lending. In 
coordination with other Federal supervisory agencies and the 
Conference of State Banking Supervisors, we have issued 
principles-based underwriting guidelines on subprime mortgages 
to help ensure that borrowers obtain loans that they can afford 
to repay and have the opportunity to refinance, without 
prepayment penalty for a reasonable period before the first 
interest rate reset.
    In addition, together with the Office of Thrift 
Supervision, the Federal Trade Commission, the CSBS, and the 
American Association of Residential Mortgage Regulators, we 
have launched a pilot program aimed at strengthening reviews of 
consumer protection compliance at selected non-depository 
lenders with significant subprime mortgage operations.
    Finally, using the authority granted to us by the Congress 
under the Home Ownership and Equity Protection Act, we are on 
schedule to propose rules by the end of this year to address 
unfair or deceptive mortgage lending practices. These rules 
would apply to subprime loans offered by any mortgage lender.
    We are looking closely at practices such as prepayment 
penalties, failure to escrow for taxes and insurance, stated 
income and low-documentation lending, and failure to give 
adequate consideration to a borrower's ability to repay.
    Using our authority under the Truth in Lending Act, or 
TILA, we expect that we will soon propose rules to curtail 
abuses in mortgage advertising and to ensure that consumers 
receive mortgage disclosures at a time when the information is 
likely to be the most useful to them.
    We are also engaged in a rigorous broader review of the 
TILA rules for mortgage loans which will make use of extensive 
consumer testing of disclosures. Thank you. I'd be pleased to 
answer your questions.
    [The prepared statement of Chairman Bernanke appears in the 
Submissions for the Record on page 49.]
    Senator Schumer. Thank you, Mr. Chairman. We very much 
appreciate your comprehensive testimony.
    You noted in your statement, that you thought there would 
be slow growth in the next few quarters, but not a recession. 
You also noted that there are downsides that one would have to 
take into account, and they would be, again, what I call the 
four horsemen of our economic problems: Lower housing prices, 
higher oil prices, dropping dollar, and lack of confidence in 
the credit markets.
    So, let me ask you a question: Is a recession out of the 
question? What is the likelihood that we might go into a 
recession? If I could make it simple, on a scale of 1 to 10, 10 
being most likely, how likely is a recession?
    Chairman Bernanke. Mr. Chairman, as you noted, our forecast 
is for moderate, but positive growth going forward through the 
next few quarters. Economists are extremely bad at predicting 
turning points, and we don't pretend to be any better.
    We have not calculated a probability of recession, and I 
wouldn't want to offer that today. Again, our assessment is for 
slower growth, but positive growth going into next year. We 
think that by the spring or early next year, that as these 
credit problems resolve and as we hope the housing market 
begins to find a bottom, that the broader resiliency of the 
economy, which we are seeing in other areas outside of housing 
will take control and will help the economy recover to a more 
reasonable growth pace.
    Senator Schumer. Thank you. Next, yesterday, there was 
mention by a Chinese official--and some gave it more credence 
than others--that the Chinese might start investing more of 
their assets, even switching over some of their assets to those 
in stronger currencies than the dollar.
    How worried are you about that? How likely is it to occur? 
How much credibility do you give this statement that was made 
yesterday?
    Chairman Bernanke. There is no official Government 
statement in this regard, and I'm not particularly concerned 
about any major change in the holdings of China or any other 
country.
    There is, on the margin, sovereign wealth funds and 
portions of reserve accumulations that are being devoted to 
higher returns which means spreading across instruments, as 
well as across currencies.
    But, again, I don't see any significant change in the broad 
holdings of dollars around the world. dollars remain the 
dominant reserve asset, and I expect that to continue to be the 
case.
    We would like to add, though, that the strength of the 
dollar, in the medium term, will ultimately depend not on those 
portfolio choices, so much as on the strength of the U.S. 
economy, our trade situation, and on the openness of our 
financial markets to foreign capital. I'm optimistic on those 
fronts, and I do believe that that will lead to a sound dollar 
in the medium term.
    Senator Schumer. Wouldn't it be in the interest of some of 
these foreign countries, in the longer term, not in the 
immediate term, if the dollar continues to show the weakness 
that it has shown so far, to diversify?
    Chairman Bernanke. Well, if they're pegging their exchange 
rate to the dollar, then there's a certain need, but to hold 
dollars, of course. But I think, more broadly, that the 
financial markets in the United States are still the deepest, 
the most liquid, and offer the most range of investment 
opportunities; and in that respect, you often see, for example, 
trade between third countries, still being invoiced in dollars, 
because it remains a standard of value around the world, and I 
expect that to continue.
    Senator Schumer. One of the engines of our economic growth, 
the main engine, has been consumer spending. It's been 
estimated that a significantly high percentage of that consumer 
spending was fueled by refinancings of homes which gave the 
consumer more money to spend for other things.
    The decline in housing prices, both because refinancings 
would decline and because people felt they had less in terms of 
assets, present a problem for consumer spending. How much do 
you expect the decline in housing prices to affect consumer 
spending? And again, if home prices decline further than you 
expect, would that create a real danger for our economy?
    Chairman Bernanke. Certainly, as homeowners see their 
wealth declining in terms of their house value, that will 
affect their thinking about long-term spending opportunities 
and affect their spending.
    We do not take an alarmist view of this, however. There are 
some who feel that consumers react extremely strongly, for 
example, to changes in home equity line availability.
    Our sense is that the relationship between home wealth and 
consumer spending is governed primarily by what's called the 
wealth effect, which suggests that for each dollar that a house 
value falls, there's a net effect on consumer spending of 
somewhere between 4 and 9 cents, something like that.
    That may be an effect that's maybe spread over a period of 
time, so there will be an effect, but we see it as relatively 
moderate. But as you point out correctly, there are a number of 
factors at play right now, including high oil prices, for 
example, that would be negatives for consumer spending.
    On the other hand, to the extent the labor market has 
remained reasonably strong and employment income has continued 
to grow, that is a positive to help sustain consumers.
    Senator Schumer. One final question: Federal Reserve 
Governor Kroszner recently suggested that mortgage investors 
and servicers modify subprime mortgages en masse rather than on 
a case by case basis because it's just so hard. There are so 
few people on the ground. These are complicated instruments 
these days.
    What is your view of doing that? I know the Federal Reserve 
has said you were going to issue some guidance to lenders on 
these standardized loan modifications. Could you comment on how 
seriously the Fed would take Governor Kroszner's idea and what 
you're doing about it?
    Chairman Bernanke. We take it seriously. I mentioned in my 
testimony the need to scale up these efforts as resets become 
eminent. We are looking, for example, we are already talking 
with servicers who are developing either computer programs or 
templates or procedures that allow them, at least as a first 
cut, to categorize mortgages in terms of how they are to be 
treated.
    That, on the one hand, will help them scale up their 
efforts. We believe that is beginning to happen. We encourage 
that to happen.
    In addition, by providing a systematic approach to 
addressing these mortgages they actually protect themselves 
against claims by investors or others who feel that they are 
arbitrarily changing or modifying the loans.
    We do support scaling up these efforts. And the best way to 
do that is to create some more systematic approaches to doing 
so.
    Senator Schumer. Thank you.
    Congressman Saxton.
    Representative Saxton. Thank you, Mr. Chairman.
    Let me ask: I sat here this morning observing the 
information flow back and forth. We talked about a number of 
issues, some of which are positive and some of which are not so 
positive.
    For example, on the positive side, it is good news that 
core inflation--the numbers that we look at to study core 
inflation--lead us to think that inflation, at least core 
inflation, seems to be pretty much in check.
    On the other hand, we have talked about construction, 
particularly housing construction, being in not such good 
shape.
    You just mentioned that the house price decline has a 
wealth effect which has implications going forward. The 
financial condition of large banks has been discussed here at 
some length this morning, and that is cause for some concern 
relative to economic growth.
    And of course, the potential effect of hundred-dollar-a-
barrel oil has implications going forward as well.
    I noted from the FOMC statement last week, it suggested at 
least to some that some in the markets said the Fed monetary 
policy stance was becoming, quote, ``more neutral.''
    Given that core inflation seems to be in check, and given 
that there are concerns going forward with the economy, could 
you give us your view of what perhaps ``more neutral monetary 
policy'' means?
    Chairman Bernanke. Yes, Congressman.
    As we said in our statement, we feel that the risks in 
terms of what could go wrong in both directions have become 
more balanced since we have taken 75 basis points of cuts in 
the last two meetings to try to offset the tightening of credit 
that we see.
    On the inflation side, it is true that there are some 
positives. Core inflation has been lower. We believe that 
inflation expectations remain reasonably stabilized.
    That being said, Congresswoman Maloney mentioned oil prices 
and the declining dollar which may have some effects on import 
prices. Those are effects we cannot ignore.
    Should inflation expectations begin to move up and 
inflation begin to rise, it would be very costly for us to have 
to bring that back down. And so that is a concern we have, and 
we need to pay attention to inflation. It is very important 
that we do so.
    On the output side, again, we do expect some slowing 
relating to a variety of factors including tightening credit 
conditions and the slowing in the housing market. But as you 
mentioned yourself, the broader economy outside of housing has 
been remarkably resilient over the last couple of years.
    We had 4 percent growth in the third quarter even with the 
percentage point subtracted for housing, and the numbers we 
have seen in the last week or two have not really changed the 
view that, so far at least, the spillovers from housing to the 
broader economy have been limited.
    Having said all that, there are a lot of uncertainties. The 
financial market turmoil creates a good deal of uncertainty on 
how that is going to evolve. The housing market creates 
uncertainty. The dollar and oil prices are sources of 
uncertainty.
    So our view is that we have a mandate to fulfill. That 
mandate is to ensure price stability and maximum employment, 
and we will be very dependent on the data. We will be observing 
what data comes in. We will be looking at conditions of the 
financial markets, and we will be trying to continuously update 
our views on how the economy is likely to evolve and respond as 
we see those risks change in one direction or another.
    We certainly want to be able to respond as needed to meet 
our mandate.
    Representative Saxton. Thank you. On the housing spillover, 
I have been curious about this because I have been watching the 
same, or many of the same numbers that you have.
    You would think that with construction being down, other 
sectors of the economy would be directly affected: major 
appliances, hardware of various kinds, the lumber industry 
obviously, and other sectors of the economy that provide 
products that are used in the home construction business, as 
well as other related sectors of the economy.
    Do you have any idea why it is that the spillover effect 
does not seem to be more evident?
    Chairman Bernanke. Congressman, we do see the spillover in 
the areas that you mentioned. For example, the Detroit auto 
makers are showing declines in their sales of pickup trucks 
because of the declines in construction activity.
    And certainly companies making appliances and home 
furnishings and so on have seen activities decline, and in 
general manufacturing activity has slowed and looks at this 
point to be growing very, very slowly. That in part reflects 
the relationship between manufacturing and housing, which is 
only partly offset by exports.
    But in general I think there are two factors that have kept 
the economy growing. One is that the labor market has remained 
reasonably strong, and with reasonably good availability of 
jobs and income growth consumers have money to spend.
    The second factor which is going to support the economy 
going forward is that the global economy is also very strong, 
and demand for U.S. production and exports has helped buoy our 
economy.
    For the first time in this last year, in a year-and-a-half 
or so, for the first time in many years the trade sector has 
been a positive contribution to the U.S. growth as opposed to a 
negative contribution. And I think going forward we will see 
additional strength coming from foreign trade.
    Representative Saxton. Thank you, Mr. Chairman.
    Senator Schumer. Vice Chair Maloney.
    Representative Maloney. Thank you very much for your 
testimony today. I am really stunned by the lack of 
understanding by investors in major sophisticated institutions 
in SIVs and CDOs. They seem not to have understood the risk.
    We are seeing major losses at major institutions. My 
question is: Does the Fed--I certainly hope the Fed has a 
better understanding, or sense of what is in these CDOs and 
SIVs than the investors.
    Chairman Bernanke. The problems emerged some time ago when 
the subprime losses began to appear. Some of these mortgage-
backed securities and other types of instruments that had 
mortgages, even though they were technically rated AAA began to 
show losses.
    Suddenly the confidence was lost, and investors became 
unwilling to buy these instruments. In retrospect, it is 
surprising and disappointing that, as you say, sophisticated 
investors essentially looked at the credit rating and that is 
all they did. They did not do due diligence. They did not 
investigate what was in the CDOs, for example, in any detail.
    Representative Maloney. Has the Fed investigated?
    Chairman Bernanke. The Fed of course is working with the 
other regulators: the SEC, the Accounting Board, and so on, to 
make sure that these off-balance-sheet instruments and the bank 
balance sheets themselves are being written down appropriately 
so they reflect the actual values.
    We are working with the banks and the ones who sponsor 
these off-balance-sheet instruments to make sure they are 
getting true valuations.
    It is a little bit of a moving target, because as time 
passes, we see ratings downgrades, for example, and some of the 
assets have to be re-valued again.
    But it is very much in the interest of the banks to 
disclose as much as possible and to write down their losses. 
We, along with the other regulators, are paying close attention 
to that marking process.
    Representative Maloney. It seems that the CDOs are so 
opaque in their risk and composition that trade in them only 
works in a rising market.
    I have seen your actions in this area and I wonder why 
hasn't the Fed been more insistent on a major improvement in 
transparency as a condition of the Government's willingness to 
participate in basically propping up these markets.
    As you know, when Government came in and worked with long-
term capital markets in 1998, we demanded risk management. Best 
practices came out of it. Treasury demanded basic improvement 
in the bailout in Mexico.
    Why isn't the Fed coming out with specific, really best 
practices or goals to force the transparency in this area that 
everyone seems to not understand basically what they're buying 
or the value?
    Chairman Bernanke. First, Congresswoman, we are not bailing 
out anybody. We did not put a penny of our money or Federal 
money into the banks, or into the CDOs. What we are doing is 
exercising our responsibility to make sure that the banks 
disclose the information, and that they value these things 
properly.
    It is not our practice in the broad financial world to 
protect investors, particularly sophisticated investors who 
should be able to make their own evaluations, from buying 
individual instruments.
    Our responsibility is to make sure that the banks are safe 
and sound, and they are appropriately valuing their balance 
sheets and their exposures to these off-balance-sheet 
instruments are appropriately measured and accounted for, 
particularly with respect to capital. That is what we are 
focused on.
    We have been focused on it for some time. As we move 
forward into Basel II and other changes we are making, it is 
certainly going to be something we are looking at very closely.
    Representative Maloney. Last week former Secretary Rubin 
said that a weak dollar is bad for the U.S. economy. Do you 
agree with him that a strong dollar increases Americans' 
standard of living and keeps inflation low?
    Or do you think, as some economists argue, that we can 
devalue our way to prosperity, allow the dollar to weaken to 
boost exports, help close the trade deficit, and create better 
jobs?
    Chairman Bernanke. Again, the Secretary of the Treasury is 
the spokesperson for official policy. We are looking at the 
dollar primarily as it affects the U.S. economy.
    Representative Maloney. Let me say this a different way. Do 
you think that the dollar, the decline of the dollar, will lead 
to inflation and higher long-term interest rates?
    Chairman Bernanke. The decline of the dollar has the 
potential to raise import prices and contribute to inflation. 
Therefore, we are very attentive to that risk.
    In all but the shortest of terms, the Federal Reserve's 
policy determines how much inflation there is, and we are going 
to make sure that the inflationary impact that may come from 
the weakening dollar is not passed into broader prices and 
becomes part of the underlying inflation rate.
    Representative Maloney. Thank you. My time is up.
    Senator Schumer. Senator Brownback.
    Senator Brownback. Thank you, Mr. Chairman.
    Mr. Bernanke, on page 6 of your testimony you indicated you 
were going to continue to talk about the need to foster price 
stability and sustainable economic growth.
    I want to make sure I am clear with you on this. Do you 
consider either of these as the greater threat at this point in 
time? Or that these are roughly kind of equal threats, price 
stability, or inflation and economic growth?
    Chairman Bernanke. We assess the risk to those objectives 
as being roughly balanced at this time. There are risks on both 
sides of the mandate.
    As we go forward, however, we are not dogmatic. As we go 
forward we are going to follow the data. We are going to see 
what happens in the financial markets, and we are going to try 
to make judgments over time as we get the information.
    Senator Brownback. Even as oil prices go to $100 a barrel, 
$3 at the gas pump? You look at those as particularly equal?
    I look at gas prices and that is directly out of the 
consumers' pocketbooks. That is a direct hit. Then as we are 
going into the Christmas season, I am having to pay a lot more 
at the pump. I think you really begin to affect the mentality 
when you get to that $3-a-gallon gas or above, as it is in many 
places around the country.
    Chairman Bernanke. Senator, you are absolutely right. This 
is a big burden for the U.S. economy. Although we have been 
pretty resilient so far in dealing with higher oil prices, I 
would point out that while it has its effects on consumer 
spending it is also obviously an inflation risk both because of 
oil prices and gasoline prices are part of the consumer's 
basket and therefore part of inflation, and even more 
concerning would be if those gas prices were to feed through 
into other costs and lead to a broader rise in prices.
    So we have to be very vigilant to make sure that higher oil 
prices do not translate into broader inflation in the economy.
    Senator Brownback. Not as the Fed Chairman, but as an 
economist, raising taxes at this point in time, not dealing 
with the Alternative Minimum Tax problem that is grabbing more 
people, or allowing a raising of taxes on dividends or capital, 
what sort of impact would that have on the economy at this 
point in time?
    Chairman Bernanke. Senator, I am not going to comment on 
specific individual proposals. I do think that a net gain, a 
net increase in taxes that was substantial would probably not 
be advisable because of its effect on aggregate demand.
    But it is a complex issue, each of these tax areas that you 
are mentioning, to talk about the pros and the cons. We can 
pursue that if you like, but I prefer not to take a position on 
one side or the other of these individual tax proposals.
    Senator Brownback. Still, as an overall item in the economy 
at this point in time where you have an economy that is 
concerning, to raise taxes now would not be advisable for its 
impact on the long-term economic growth in the economy.
    Chairman Bernanke. A large increase in net taxes would tend 
to be a drag on consumer spending and on the economy through a 
number of different channels, I should say. That would be an 
issue, I think, if that were to be the case, given what we 
expect to be a slower growth economy for the next couple of 
quarters.
    Senator Brownback. I want to look at the impact of China on 
the U.S. economy. You must be watching that very closely. Their 
purchasing, or their use of dollar denominations, inflationary 
impact coming from consumer products coming out of China into 
the U.S. economy, or the concern we have of consumer products 
coming from China, what are the lead factors you are watching 
in the Chinese economy as far as its impact in the United 
States?
    Chairman Bernanke. The main thing we would like to see in 
China is a rebalancing of the economy away from this very 
strong dependence on exports which contributes to global 
imbalances and to the U.S. external deficit toward a more 
domestically driven economy.
    So, particularly, in China this is a rather remarkable 
statistic. But the average national savings rate in China is 
close to 50 percent, as poor a country as it is. Which means 
that in order--even though they have very high capital 
investment--in order to sustain growth they have to export. 
They have a current account surplus now on the order of 9 to 10 
percent of GDP.
    They need to re-orient their growth toward domestic needs. 
They do need to do that by strengthening consumer spending and 
by reducing the emphasis on exports.
    I gave a speech some time ago talking about some of the 
ways they could do that, by strengthening the social safety net 
so people did not have to save so much in anticipation of being 
sick or retiring.
    In addition, as we have talked often--and Senator Schumer 
has often emphasized--they need to increase the flexibility of 
their exchange rate in order to allow for the natural process 
of demand to shift away from a totally export-oriented economy 
and more toward a balanced domestically oriented economy.
    Senator Brownback. Thank you, Mr. Chairman.
    Senator Schumer. Senator Bingaman.
    Senator Bingaman. Thank you very much, Mr. Chairman, for 
being here.
    Let me ask about the secondary market for mortgages. My 
impression is that the ability of an individual to borrow from 
a bank ultimately depends upon the ability of that bank to turn 
around and sell that mortgage into a secondary market of some 
kind.
    That seems to me to be the place where the system is 
breaking down or has broken down; and over the next 6 months or 
so, that's the place where the greatest danger lies.
    If banks are not able to sell into a secondary market, 
credit continues to get restricted and limited. Would you have 
any thoughts as to how to fix that problem?
    Chairman Bernanke. I agree with you that one of the largest 
factors that leads us to think the economy is going to slow 
somewhat, is precisely that issue. Mortgage availability has 
declined significantly. That's affecting demand for housing and 
the housing sector and seeping over to the broader economy.
    Some of this is probably inevitable, in the sense that 
we've seen a significant tightening of lending standards in the 
subprime area, which is understandable given the problems in 
that area. But we're also seeing, for example, problems of 
banks securitizing prime jumbo mortgage loans, that is, 
mortgage loans that are greater than $417,000.
    That doesn't mean those loans aren't being made. Many banks 
are making them and keeping them on their balance sheets, and 
there is some securitization going on that's limited.
    The result is that those mortgages are still available, but 
at somewhat tighter terms and higher prices than otherwise.
    I think, over time, that market is going to improve. I'm 
not sure what an immediate fix would be. There's been some 
discussion of raising the conforming loan limit on GSEs.
    If we do that, I think it ought to be a very temporary 
measure and be done in a way that assures us that doing so 
doesn't risk the underlying safety and soundness of those 
institutions.
    Senator Bingaman. Would you think a temporary increase of 
that $417,000 limit would make some sense?
    Chairman Bernanke. One suggestion I would have--again, it's 
very important that we not override the regulators' view that 
the safety and soundness of these institutions must be 
protected.
    So, one possibility would be if the Federal Government were 
willing to act as guarantor. For example, suppose the GSEs were 
to pay their usual mortgage insurance credit fee to the Federal 
Government which then acted as guarantor, so to take away the 
credit risk from the GSEs.
    They could then process these jumbo loans and sell them in 
the secondary market, and that would, I think, be of some 
assistance to the mortgage market.
    From the Federal Government's point of view, that would be 
taking on some credit risk which you may or may not be willing 
to do. I think that if you did that, it would be a good idea to 
make the GSEs ultimately responsible for any excess losses, or 
some part of excess losses relative to the premiums that are 
paid, and leave it to the regulator to determine when the 
safety and soundness was adequate that the GSEs could make that 
repayment.
    So I think there might be some mechanisms that involve 
Federal interaction, but I think it's extremely important, as 
we look at these options, that we don't take actions that will 
endanger the safety and soundness of the underlying 
institutions.
    Senator Bingaman. Just to follow up on that suggestion that 
you made there about the Federal Government taking on this 
risk, would we have to legislate to do that?
    Chairman Bernanke. Yes.
    Senator Bingaman. Is the legislation that is pending in the 
House--have you reviewed that as to whether that accomplishes 
what you're suggesting?
    Chairman Bernanke. I'm not aware that it does. The 
legislation in the House, is mostly about dealing with those 
who are in trouble, borrowers already in trouble, and, 
prospectively, the rules for avoiding future abuses.
    There is not, to my knowledge--perhaps Senator Schumer can 
correct me--there has not been, to my knowledge, a lot of 
effort devoted toward the secondary market.
    Senator Bingaman. Thank you.
    Senator Schumer. Senator Sununu.
    Senator Sununu. Thank you, Mr. Chairman. I think I'll begin 
my questioning with an issue related to the one Senator 
Bingaman was talking about, but it is, frankly, a little bit 
more negative in its perspective.
    Yesterday, the Dow dropped 360 points, and a number of 
analysts in the financial press blamed a lot of that drop on 
the New York Attorney General and his press release that 
alleged, in his words, quote, ``systemic fraud,'' and, quote, 
``a pattern of collusion in the mortgage industry.''
    The Attorney General made those allegations with specific 
reference to transactions between Fannie Mae, Freddie Mac, and 
Washington Mutual for which he issued subpoenas. My question to 
you, is, in this environment where we see big problems with 
credit in the mortgage industry, is this kind of a press 
release really helpful to solving the problems in front of us.
    Chairman Bernanke. Senator, I don't want to intervene in 
the Attorney General's decisions about what cases to pursue, 
and I would add that the Federal Reserve has, obviously, no 
regulatory authority over any of those institutions.
    I think what's upsetting the stock market is that it's 
primarily financial stocks that have been falling, and the 
concern is that financial firms have not, in the view of the 
stock market, perhaps completely written down the losses that 
they've suffered.
    Senator Sununu. I will be happy to address transparency, 
and I'm not asking you to comment on whether or not someone is 
guilty or not guilty, but I'm trying to identify whether or not 
this will help us address the problems that exist in the 
industry.
    Chairman Bernanke. I don't want to intervene in the 
Attorney General's decisions.
    Senator Sununu. If you don't want to comment on it, that's 
fine. Obviously, again, I want to understand what is helpful 
and what isn't.
    You mentioned transparency in the marking-to-market. This 
is something else that I'd like to talk about, and apparently, 
you'd like to talk about it more than my first question, so 
I'll be happy to move there.
    The Treasury announced a super SIV, a large, enhanced 
liquidity vehicle to try to deal with liquidity issues in 
structured investment vehicles. There are 30 of them, mostly 
held by very large institutions.
    You point out that transparency is essential. The process 
of price discovery is essential to working through these 
problems.
    What, in your opinion, is the purpose of this enhanced 
liquidity vehicle, and what will its impact on price discovery 
be?
    There is a Federal official quoted in the Wall Street 
Journal, that said that this proposal, quote, ``has the 
potential to contribute, rather than to impair these markets in 
the process of price discovery.''
    I would maintain that it's just as true to say this vehicle 
has the potential to impair, rather than to contribute to the 
markets in the process of price discovery. What's the purpose 
of the vehicle and what impact do you think it will have on 
price discovery?
    Chairman Bernanke. Senator, it all depends on the 
execution, as I'm sure you would agree. My understanding of the 
idea behind it is that a consortium of banks, together with 
investors--major investors--would oversee the process of 
purchasing high-quality assets from these unwinding SIVs and 
create a new vehicle which would then be financed by commercial 
paper purchased by, for example, large mutual funds.
    My understanding of the process is that because investors, 
as well as a number of banks would be involved, essentially as 
gatekeepers in bringing assets into this new vehicle, that the 
valuations--there will be an incentive, particularly on the 
part of the investors, but also on the part of banks who didn't 
have direct disclosures.
    There would be an incentive to create accurate market 
pricing if that is the way it works. Again, it depends on the 
execution, but if that's the way it works, it would remove some 
overhang from the market; it would create a stable financing 
source for those assets, and it ought not to be inconsistent 
with the price discovery process.
    Senator Sununu. I would only observe the operative phrase 
you used regarding participation of investment firms that don't 
have exposure in these areas. If you look at the list of firms 
that were most excited about participating, they all have 
significant exposure in these investment areas.
    When you were here last, which was 7 months ago, I 
explained if you looked at the aggregate down payment available 
in our economy from consumers on homes and looked at changes in 
credit underwriting standards, it was very likely that this 
year, home inventories, inventories of unsold homes, would 
increase from the level back in March of--approximately 6 
months, to 8 to 10 months. I asked you, what do you think the 
impact on demand or the economic level of activity would be, if 
housing inventories were at 8 to 10 months, as opposed to 
today's 6 months?
    And you responded, if they were at that level--and I do not 
expect that they will be, construction will fall further. I'm 
sure we'll never have the opportunity to say at any other time, 
that I was right and you were wrong, and granted, maybe it was 
just a lucky guess, but I think we've looked at changes in 
credit and we've looked at what was available for down payment. 
It's highly likely that inventories would go at least to those 
levels.
    I think, without going into detailed explanation, that 
there's a very good chance, over the next 12 months, that 
inventories will go to at least 12 months and probably to 14 
months. What would be the impact on the economy and, in 
specific terms, of an increase in housing inventories to 14 
months, and what is the best estimate or the best forecast of 
those at the Fed looking at the housing industry today?
    Chairman Bernanke. Senator, you were right and I was wrong.
    Senator Sununu. I didn't ask you to say that by any means.
    Chairman Bernanke. Inventories have risen, and they've 
produced a great deal of downward pressure on construction. And 
to get to where you're describing would require further 
declines in demand, slower responses by homebuilders, and it 
would suggest even a greater disequilibrium and a longer period 
of workout that would subtract directly from economic growth, 
and increase the hazard of spillovers into other parts of the 
economy. That's a concern.
    Again, our anticipation--and it depends very much on both 
the homebuilders' response and the buyers' response--is that 
those inventories are not going to go much further from here, 
but in 6 months, you can tell me, you know, that I was wrong 
again.
    Senator Sununu. I will not look forward to that.
    Chairman Bernanke. We believe that this process, although 
we're now under a million single-family homes, from a peak of 
1.7 million--we've really greatly reduced the rate of home 
construction, so, in some sense, we think there's a minimum 
because there is a certain amount of family formation and so on 
that's going to support a certain amount of building.
    So we don't expect it to get to the point you suggest, but 
perhaps you're a better forecaster.
    Senator Schumer. Congressman Cummings.
    Representative Cummings. Thank you very much, Mr. Chairman. 
Mr. Chairman, thank you for meeting with us.
    Many Members of Congress are now holding forums in their 
districts, as I will be doing very shortly to help people who 
are coming to our doors, literally with tears in their eyes, 
trying to figure out how they're going to manage a foreclosure 
that's right around the corner. Unfortunately, they have been 
harmed by what they thought was going to be a dream, now 
turning into a nightmare.
    You know, as I sat here and I listened to you, it seems 
like you have painted a very rosy picture of the foreclosure 
situation, but if you came and walked through my district, Mr. 
Chairman, I think people would be surprised that you seem so 
calm.
    Let me ask you a broad question on how we make economic 
decisions. Why did anyone think that the housing market would 
not suffer tremendous losses, particularly given the extent of 
subprime lending extending to those with poor credit, and also 
given the obvious risks associated with the increases, which 
could certainly be expected due to adjustable-rate mortgages 
and certain nontraditional loan packages?
    Given the extent of the declines that have occurred, do you 
think that our markets are adequately regulated?
    Chairman Bernanke. Congressman, first, I don't know how you 
got the impression that I was unconcerned about foreclosures.
    Representative Cummings. I didn't say you were not 
concerned. I just said you seem to be pretty calm about it, and 
I guess what I'm trying to make sure of is that there's a 
connection. I note so often that what happens is that when we 
make a decision in the suites, we forget about the people who 
actually have to go through this, but I will not forget those 
indivuduals, especially as a Member that lives in the inner 
city of Baltimore.
    I look at my constituents who are losing their homes, who 
are seeing their values go down. Baltimore appreciated, I 
think, something like 1200 foreclosures in January, now 7,000 
just recently, in a month. I mean, things--they're becoming 
alarming, and I guess I'm just trying to figure out exactly 
how. You talked a little bit earlier about efforts on the part 
of the companies to fix mortgages in order to help people get 
fixed rates.
    I just want to know, I want from you every single thing 
that you can possibly do to help us help our constituents.
    I was just telling Representative Hinchey on the way over, 
when a person loses their home, it's not just their loss; it's 
the family's loss and their dream. The dream that they thought 
they had captured suddenly disappears out of their hands. 
Children look at them and they say, well, gee, I don't know 
whether I'm going to try to buy a house. That's the problem.
    Many of them, I'm sure, will go a lifetime and never be 
able to buy a house. Again, we're talking about this economy 
that we want to keep strong, but what we're failing to examine, 
are the people who are literally being taken out of the market 
due to a foreclosure.
    Chairman Bernanke. Congressman, I spent about half my 
testimony talking about this problem. It's a very serious 
problem. I think it hurts people; I think it hurts communities.
    I discussed a number of the actions that companies are 
taking, and I would urge, first of all, that people in trouble 
get in contact very early with their servicer or their lender 
because the earlier you get in touch, the better chance there 
is to work something out.
    I urge the lenders and the servicers to expand their 
efforts to try to restructure mortgages and help people stay in 
their homes. I think it's very important.
    I talked about the Federal Reserve's efforts to try to work 
with community groups to try to assist that process, and I also 
talked about regulatory actions that we're taking to try to 
ensure that it doesn't happen again.
    So, it is a very important problem, and we spend a lot of 
time--we've been meeting with people. I met a few days ago with 
Reverend Jesse Jackson to talk about some of these issues.
    We have been spending a lot of time on this issue, and we 
think it's a very, very important issue for which we're going 
to do everything we can.
    Representative Cummings. Those companies that are 
participating are pretty much voluntary?
    Chairman Bernanke. We have to try to give them guidance, to 
show them how best to approach this problem. We think it's in 
their interest. It's in nobody's interest if a creditworthy 
borrower loses their home. It's not in anybody's interests.
    We want to try to make sure that they have the flexibility 
and the leeway needed to restructure loans for people who 
should be in the home, have the credit to be in the home.
    Representative Cummings. A little earlier, you said that 
the patchwork nature of enforcement authority and subprime 
lending poses a special challenge. Can you discuss what should 
be done to improve enforcement of provisions intended to 
protect consumers in the subprime markets?
    Chairman Bernanke. Enforcement is an issue. We are working, 
as I mentioned, on a set of regulations that would apply to all 
lenders, so that would be a new set of rules that would apply 
to all lenders, including those outside of the Federal safety 
net.
    The question is enforcement. The States are typically in 
charge of overseeing the non-federally regulated lenders. Some 
of them are very, very good at doing that, but we think there's 
probably more that we can do at the Federal Reserve to work 
with them, to coordinate with them.
    We have right now going on, a pilot program where we are 
working with other agencies and with the States to try to 
compare our approaches to supervision and oversight for 
mortgage lenders, to see what we can learn from each other, and 
to try to increase our coordination with them, to try to make 
them as effective as possible, and try to get as close a 
relationship with them as possible.
    Representative Cummings. Thank you, Mr. Chairman.
    Senator Schumer. Congressman Paul.
    Representative Paul. Thank you, Mr. Chairman. The best way 
I could describe the problems that we face here in this 
country, as well as the problem the Federal Reserve faces, is 
that we are, indeed, between a rock and a hard place.
    We have a serious problem that we don't talk about much, 
how we got here. We talk about how we're going to patch it up.
    The bubble has been burst. We saw what happened after the 
NASDAQ bubble burst. We don't ask how it was created, and now 
we have a housing bubble that's deflating and spreading. Nobody 
says, where does it come from?
    What is the advice that you generally get? That is, inflate 
the currency. They don't say inflate the currency; they don't 
say debase the currency; they don't say devalue the currency; 
they don't say cheat the people who are safe; they say, lower 
the interest rates, but they never ask you--and I don't hear 
you say too often--the only way I can lower interest rates is, 
I have to create more money. I have to lower the discount rate; 
I have to make it generous; I have to increase reserves; I have 
to lower the interest rate, fix the interest rate, the 
overnight rate.
    The only way you can do this is by increasing the money 
supply. I see this as the problem that we don't want to talk 
about.
    Currently, of course, we can't follow the money supply with 
M3, but we can follow one of your statistics, the MZM, the 
rating caps available, and we see that inflation is alive and 
well.
    That money supply figure is going up at about 20 percent, 
annualized. This just means the dollar gets weaker. Everybody 
says, well, that's great, the dollar is weaker and we're going 
to have exports. And that is a fallacy. It may be for a month 
or 2, but it just invites inflation.
    Unless we get down to the bottom of it and define what 
inflation is, and not look only at prices--this was taught by 
the free market economists all through the 20th century. They 
said, beware, they will increase the money supply, but they 
will make you concentrate on prices, and we'll give you CPIs 
and PPIs and they'll fudge those figures, and they'll talk 
about wage and price controls to solve our problems.
    And we ignore the fundamental flaw which is, not only have 
we had a subprime market in housing, but the whole economic 
system is subprime, and we have artificially low interest 
rates.
    It was not under your tenure in office. It has been going 
on for 10 years or longer. Now we are bearing the fruits of 
that policy of 1 percent interest rates, overnight rates, and 
that is not a distortion? Instead of looking at the prices, the 
consumer prices which nobody in this country really believes, 
we need to talk about the distortion, the malinvestment, the 
misdirection, the bad information that has been gotten from 
artificially low interest rates.
    In many ways some people refer to you as a price fixer, you 
know, because you fix interest rates. The market is powerful, 
and usually overwhelms and does come into play, but when the 
Fed fixes an interest rate at 1 percent, that is price fixing.
    At the end of your testimony you suggested that we should 
address this housing crisis and we should have rules that would 
address deceptive lending practices.
    I just think that is not the answer at all. The real 
deception is when we distort the value of money when we create 
money out of thin air. We have no savings. Yet there is so-
called ``capital.'' There is money available, but it comes from 
what you have to do when the pressure is put on you.
    So I think we have to get back to the very fundamentals of 
where this problem comes from. The bubbles occur when we have 
this malinvestment and the creation of new money.
    So my question boils down to this: How in the world can we 
expect to solve the problems of inflation--that is, the 
increase in the supply of money--with more inflation?
    Chairman Bernanke. Congressman, first as a small technical 
point on the growth in money, money growth has been pretty 
moderate over the last 2 years.
    The decrease in MZM is probably related to the financial 
turmoil. People have been taking their savings out of risky 
assets and putting them into the bank, and that makes the money 
data show faster growth.
    I am not sure that is indicative of a policy necessarily. 
What we tried to do is follow the mandate that Congress gave 
us. The mandate that Congress gave us is to look at employment 
and inflation as measured by domestic price growth, as I talked 
about today, and I think you would agree we do see risks to 
inflation and we are taking those into account and want to make 
sure that prices remain as stable as possible in the United 
States.
    Representative Paul. How can you do this and pursue this 
policy you have without further weakening the dollar? There is 
a dollar crisis out there, and people's money is being stolen. 
People who have saved are being robbed.
    If you have devaluation of the dollar by 10 percent, people 
are being robbed of 10 percent. But how can you pursue this 
policy without addressing the subject that somebody is losing 
their wealth because of a weaker dollar? And it is going to 
lead to higher interest rates and a weaker economy.
    Chairman Bernanke. If somebody has their wealth in dollars 
and they are going to buy consumer goods in dollars who is a 
typical American, then the decline in the dollar, the only 
effect it has on their buying power is it makes imported goods 
more expensive.
    Representative Paul. But not if you're retired and elderly 
and you have CDs; their cost of living is going up no matter 
what your CPI says. Their cost of living is going up. They are 
hurting. That is why the people in this country are very upset.
    Thank you.
    Representative Hinchey [presiding]. We have a certain level 
of anxiety up here, Mr. Chairman, because there are votes 
pending shortly in both Houses. I am going to go briefly, and 
then we will try to keep it as fast as possible.
    First of all, let me express my appreciation to you for all 
the good work you do, and of course for being here with us 
today.
    The Federal Reserve has a dual mandate from the Congress. 
One is to hold down inflation and make sure it doesn't impede 
upon the economy, and the other is to promote economic growth 
and to maintain and sustain strong employment figures--good 
jobs for people as much as possible.
    It seems to me that right now you are facing a very complex 
set of conflicting circumstances on both ends. It is going to 
be a real challenge to deal with this not just from your point 
of view, but from our point of view.
    I think in a variety of ways obviously we are all limited 
in what we can do, and I think that the mandate of the Federal 
Reserve is specific.
    I think that you have done just about all you can do. There 
will probably be some pressure to lower interest rates again, 
but the fact is, if those interest rates continue to go down, 
then the inflation issue is going to continue to be jacked up.
    We are right now facing an inflationary situation which is 
increasing. Estimates are that it could go up as high as 2 
percent over the course of the next year, maybe even higher 
than that.
    And in that context, I think we have to realize that in 
that core inflation we are not including the two most 
inflationary aspects of this economy: the cost of energy, 
particularly oil, and the price of food, both of which are 
rising dramatically. If that continues, then the pressure on 
inflation obviously is going to be much, much higher.
    We are also confronting a situation of a declining economy. 
This economy is not doing well. The example of the mortgage 
foreclosures on 2 million people--and it may be a lot more than 
that as time goes on--is really not the cause of the problem we 
are facing, but just a factor of it. It is a factor of the 
weakness of this economy.
    The question we are facing is: How are we going to deal 
with this?
    You have got a dollar which is now depressed to record 
lows. There is every indication that that is likely to continue 
unless something is done to try to address it. The major 
problem with the dollar being driven to record lows, the major 
factor of that is the deep debt that this economy is in both, 
from the Federal point of view and from people's personal 
points of view.
    Federal debt now is up above $9 trillion. It has risen by 
more than $4 trillion over the course of this Administration. 
And all across the country people are spending nearly 10 
percent more, month by month by month, more than what they are 
making.
    So the increase in personal debt is going up rapidly. 
Obviously, that cannot be sustained. And that is in fact what 
is sustaining whatever growth we are experiencing in this 
economy.
    Then people talk about the job rate is good. But as a 
matter of fact, the job rate is not good. One of the things 
that is not being considered, in the context of the 
unemployment rate, is the number of people who have dropped out 
of the economy altogether, dropped out of the job market. They 
are not seeking jobs. The unemployment rate is not 4.7 if you 
bring those people in. It brings it up well above 5 percent and 
maybe as high as 5.5 percent.
    All of these factors are crunching in on us. It reminds me 
of a period that we faced a couple of decades ago which was 
phrased ``stagflation'' when you had increasing inflation and a 
downturn in the economy, which is essentially what we are 
confronting today.
    We have low job growth rate in America today over the 
course of the last 6 years, the lowest job growth that we have 
seen since the Depression. I think that we deeply depend upon 
you to give us some advice.
    What is Congress going to do to try to deal with this 
economy when we look at the Federal Reserve struggling with it 
and we see that there is a limitation on what you can do with 
regard to interest rates, which is your primary factor in 
trying to drive the economy?
    Chairman Bernanke. You are certainly correct that there is 
a delicate balance on both sides of the mandate, which is 
difficult to assess.
    I think the area where the Congress has the most influence 
is fiscal policy, obviously, and making wise decisions about 
spending that will promote growth, that will support and 
structure education and those sorts of things. That is as 
important as is having a rational, sensible tax policy.
    I would like to be more specific than that, but I think 
that is really the area where Congress can be most effective.
    In addition, I suggested today that there might be steps 
Congress could take to try to ameliorate the disclosure issue 
you mentioned. The Federal Housing Administration is one 
potential vehicle, but there may be others.
    I do think there are things that can be done. I guess I 
should also say that while we do expect slower growth, 
fortunately, we do not see anything approaching a period of the 
1970s. We think growth will be more moderate, and inflation has 
some risks to it, but we do think that the performance should 
be much better than that, period.
    Representative Hinchey. I hope your optimism on that has 
some validity. I would hate to see it go in the opposite 
direction. We are teetering right now in a very, very difficult 
set of circumstances.
    I am very pleased to hear you talk about how this Congress 
should be focusing more and more attention and resources on 
things like education and health care and building up the basic 
infrastructure.
    We are now spending $2 billion a month in Iraq on a war 
which was justified under completely falsified premises. So 
this Congress--you are right, Mr. Chairman--has got to refocus 
its attention and begin to deal with the basic aspects of this 
economy and deal with the situation in the Middle East much 
more constructively than we have.
    Because I think what you have done with the interest rate 
situation has sustained things for a longer period of time than 
it would have, but I think that that time is just about on the 
edge of running out.
    I am really concerned about what is going to happen now 
over the course of the next few years.
    Thank you very much.
    Representative Maloney [presiding]. Mr. Bennett.
    Senator Bennett. Thank you very much, Madam Chair.
    First, just a personal observation. When I first came to 
the Senate 15 years ago and attended these meetings, the drum 
beat that I heard over and over again was: We are not making 
enough credit available to the poor.
    We were coming out of the savings and loan crisis. And in 
response to that crisis, financial institutions were bringing 
down the basis on which they would make loans in order to keep 
themselves from the bankruptcies that occurred with the savings 
and loan crisis.
    The argument from Congress was: You were far too 
restrictive in your requirements as to who can get money, and 
you should loosen up; you should make credit available to the 
poor; you are failing your social responsibility for not making 
credit available to the poor.
    Now I find it interesting that we find that the new cry is: 
You have made too much credit available to the poor. It is your 
responsibility, you financial institutions.
    I do not in any way condone those financial institutions 
that have played fast and loose with the rules. They are the 
ones that are paying the biggest price with this meltdown, and 
they should.
    But we should remember that in the circumstance, many 
people have acquired homes that would not otherwise have homes, 
and the better off they will be. Many of those borrowers who 
were getting hurt falsified their income statements. Others 
were speculators who were flipping properties and had not 
intention of living in them.
    They were participating in the bubble and betting on tulip 
time, betting that some greater fool would come buy the house 
at a higher price than they paid, and they lost their bet, and 
they deserve what they got.
    The fundamental question, picking up a little bit on what 
Senator Sununu was saying, we have heard forecasts as to how 
long it will take for this to work itself out, and it will work 
itself out.
    Markets make better decisions than governments do. And the 
market will punish; the market will reward, and the market will 
ultimately stabilize.
    I remember forecasts that it would work itself out in about 
6 to 8 months. Give me your forecast now. That clearly is not 
right, and I do not know whether you made it, or whether I made 
it, or whatever; and that does not matter. Look into your 
crystal ball. Is it going to take a year? Is it going to be the 
end of 2008 before the market has sorted this all out?
    Do you think that is too pessimistic, or too optimistic? 
What is your sense?
    Chairman Bernanke. Senator, first the reason that many 
forecasters, including the Federal Reserve, have understated 
the amount of time it would take for this to resolve has been 
because we have continued to get bad news on subprime lending 
and the implications of that for housing demand.
    We saw that in the spring. We have seen it now more 
recently. And these things have led us to extend the period of 
adjustment.
    From our perspective, what we are asking ourselves is: When 
will housing construction stabilize, even at a low level, so 
that it no longer subtracts from growth percentage point as it 
has been?
    That does not mean that it is going to be recovered to 
where it was or anything like that. At the risk of being proved 
wrong again and having a new credit crunch and other factors 
delaying it even further, our current calculation is that 
things will begin to flatten out in the second quarter of next 
year. So it is still I guess 6 months, but that is of course 
very provisional.
    One of the things we look at very carefully, as the data 
come, in are what is happening to permits and starts and 
mortgage applications and the like. We continue to adjust our 
forecasts according to that.
    Senator Bennett. You are more optimistic than some of the 
other economists I have talked to. That is helpful.
    Let me switch topics entirely now that we have you here 
with your background and address a question that I think is 
long term--very serious for the American economy. The short-
term label on it is called ``Sovereign Wealth Funds.''
    As we see countries by virtue of the oil prices become 
very, very wealthy, we think of the Middle East countries, but 
we also have to include Russia in this category. We see a 
change in the underlying economic structure. Instead of wealth 
being held in the hands of shareholders who have an agenda to 
increase the wealth, we see wealth held in the hands of 
governments who have political agendas as to how they will use 
the wealth.
    If I may draw a comparison to two competing examples: 
ExxonMobil when it makes money off of oil, uses that money to 
try to find more oil; Hugo Chavez, when he makes money off that 
oil, uses it to try to destabilize South America and become the 
next Fidel Castro.
    We are seeing foreign governments making purchases that 
have political implications. This is not the Japanese buying 
Rockefeller Center. I remember everybody being all upset in the 
1980s: The Japanese have bought Rockefeller Center. And I said, 
yes, and what are they going to do about it.
    Are they going to jackhammer it up and take it to Tokyo? 
They are stuck with it. It is in New York. And as it turned 
out, they sustained a fairly significant loss on the value of 
Rockefeller Center after they bought it.
    But in today's world, you can buy a company. You can 
dominate an industry that is worldwide. Then, inject into that 
the geopolitical agenda rather than an investor's agenda and 
that could make your job significantly more difficult.
    I am sure you had some thoughts on this down at the Fed. I 
would appreciate it if you would share some of those with us.
    Chairman Bernanke. Certainly, Senator, this is a topic of 
discussion at the G7 recent meetings, Sovereign Wealth Funds. 
There are quite a variety of them. Norway has one, for example. 
But of course, many of them are based on oil revenues or 
foreign exchange currency revenues.
    The view of the G7--collectively we asked the IMF and other 
institutions to work with us on this--that Sovereign Wealth 
Funds need to have a code of conduct that describes how they go 
about investing in other countries.
    The code of conduct includes transparency, so we know what 
they are doing; governance, so we know how they are controlled 
and to what purpose; and importantly, to the issue you are 
referring to, that their investments be economically oriented 
and economically motivated in order to make a profit or a 
return, as opposed to gaining control of an important company 
or industry.
    So I believe it is very important that Sovereign Wealth 
Funds follow that type of behavior. In return for that, I think 
we need to keep our markets open. And when they are investing 
as good investors and good citizens, that we should allow them 
access to Rockefeller Center, if that happens to be what they 
want to buy next.
    But it is an important issue because they are now larger 
than hedge funds collectively, and the way they conduct their 
investments will be very important as we go forward.
    But again, I understand your issue. The reform of CFIUS 
that recently took place tries to address the national security 
aspects of this. So I think the combination of the code of 
conduct by the Sovereign Wealth Funds, national security 
protections along the lines of CFIUS, but open financial and 
capital markets of the United States that will attract foreign 
investment I think are the elements that will allow this to 
work.
    Senator Bennett. Thank you. My time is up. I will just make 
this one quick comment:
    Of the oil companies that dominate the world now, those 
that are owned by shareholders like ExxonMobil represent a 
small percentage. The dominant oil companies are Gazprom, 
Pemex, and companies of that kind. And as we beat up on 
American oil companies as if they really control the market, we 
should understand that the market is being controlled by 
foreign governments.
    Senator Casey [presiding]. Congresswoman Sanchez.
    Representative Sanchez. Thank you, Mr. Chairman. To some 
extent I would like to associate myself with the remarks of 
Congressman Paul earlier about some of the things that have 
been going on structurally. I think that is really where the 
problem is.
    I represent Orange County, which is headquarters to 
probably all of the major builders, even in the United States. 
We export construction of new homes, in particular, from Orange 
County.
    I am also the home of four mortgage originators: 
Ameriquest, 21st Century, and so many others. And I represent 
Anaheim and Santa Ana, California, which 1 out of every 3 homes 
up for sale right now in those two cities, or 33 percent, are 
from foreclosure. This is really, really hitting home.
    By the way, I was just out to purchase a home in the last 
10 days. I have an 800+ credit score. I have no debt, 
basically. I have a lot of assets. And I went to the one 
institution where I carry a small loan with them, a home loan, 
and they quoted me a price of 100 basis points over what is 
quoted in what we are talking about as far as rates in the 
paper, in the newspapers.
    If there is a credit crunch on for somebody like me, there 
is really a credit crunch on for people trying to work out of 
their homes and trying to save their credit, or trying to save 
their home.
    I think it is a very, very big problem for us. And of 
course Bill Gross, a big Republican and CEO of PIMCO, on 
Monday, basically told us that he thought he would foresee this 
for another 2 or 3 years. We are really not anywhere close to 
the bad part of this.
    As well as some of the homebuilders, the new builders who 
told me, ``I was selling product at a million dollars, new 
product at a million dollars. And today, Loretta, you can go 
down and the same product I am selling for $700,000 5 miles out 
of your District in Orange County near the Coast,'' not one of 
those places where you are out in the middle of nowhere. They 
are really having problems.
    So I think we have really got a problem on our hands. But 
this generates, I think, from really bad policy, fiscal policy 
coming out of Washington, DC, in particular over the last 6 
years. I really have to say that.
    And Mr. Chairman, you are at the Federal Reserve, but you 
were the advisor to the President on this. I think we have some 
real problems here, structural problems.
    I think the decline of the dollar is only beginning. And I 
would ask you, I have lots of questions, but I don't have time 
because we have a vote on the floor, but I would ask you that 
in your private meetings you get this Administration to 
understand they need to invest in their people's health. They 
need to invest in their people's education. We need to invest 
in transportation, in communication, and things that make our 
people more productive. And we need to stop wasting our money.
    Mr. Hinchey said $2 billion a month in Iraq. It is $3 
billion a week of operating expenses in Iraq. That is not even 
going to my defense contractors for future systems weapons in 
California. No. That is operating, and it does not come back to 
the United States.
    Please, in your private meetings, you have a different role 
now, but in your private meetings, we need to get this 
Administration to understand we cannot continue to spend and 
not invest in our people and in our country.
    That is what I would like to tell you this morning.
    Senator Casey. In the interest of getting everyone to vote, 
the House is now having a vote, I would ask that we take a 
brief recess. I know the Senate has one vote. I think I can get 
back here rather quickly, as can other Members.
    Mr. Chairman, I know you have other engagements. You are 
able to stay here until 12:20? That is my understanding.
    We will take a brief recess and resume.
    [Recess.]
    Representative Maloney [presiding]. I apologize for having 
these votes and running back and forth.
    Mr. Brady.
    Representative Brady. Thank you, Madam Chairwoman.
    Mr. Chairman, thank you for being here. So far about $50 
billion of losses have been identified in the subprime loans at 
this point. Some estimates say the final amount may be equal to 
the savings and loan default with a total of about $150 
billion.
    Is that in the ballpark of what you estimate to be 
eventually declared?
    Chairman Bernanke. Yes, that is in the ballpark. Although I 
would emphasize that there is no reason to think that would all 
be in financial institutions. It would be spread around to a 
lot of investors of different types.
    Representative Brady. Do you see that impact working 
through our economy until the second quarter of next year?
    Chairman Bernanke. It is not the financial losses, per se, 
but rather the weakness in the housing market that will keep 
construction on the downtrend probably through at least early 
next year.
    Representative Brady. Do you see there being a maturing 
market for these mortgage assets that are basically illiquid at 
this point? I know Secretary Paulson is working to work with 
the master liquidity enhancement conduit. Does the Fed see a 
way to accelerate the mature market where we will see the true 
value of assets that are being held?
    Chairman Bernanke. First I should say the markets are 
working hard to achieve that. The commercial paper market, for 
example, has stabilized and a lot of the bad paper, or weaker 
conduits, have unraveled and the stronger of the conduits are 
now stabilizing and are being funded.
    With respect to Federal Reserve's role, we along with other 
bank regulators--the SEC and so on--whose job it is essentially 
to look at it from the perspective of the banks and the other 
financial institutions to make sure that they both have their 
own balance sheets, and through the conduits in which they have 
interests, or which they sponsor are appropriately marking down 
assets according to the best available prices or measures of 
value.
    Representative Brady. How long do you think it will be 
before we see the true value of those assets? Do you expect 
that to be occurring within the next quarter? Obviously they 
have appreciated significantly.
    Chairman Bernanke. Again, speaking from the point of view 
of financial institutions, I think they are being aggressive in 
marking down their assets. Based on what they can see, they 
have in most cases disclosed the losses that they have.
    The possibility remains that assets, individual assets, 
will continue to be marked down as they get downgraded for 
example, which requires rethinking.
    I do believe financial institutions are being aggressive, 
and it is certainly very much in their interests to get that 
information out as fast as possible.
    Representative Brady. Like a Master Liquidity Enhancement 
Conduit (MLEC), I am trying to understand the creation of it. 
Do you think that accelerates the true value of these assets, 
or delays them a bit?
    Chairman Bernanke. As I discussed earlier, I think it 
depends on the execution. If it does involve the oversight of 
investors and a range of financial institutions, then ideally 
the assets go into the MLEC at a fair value at a market value.
    So if it works properly, I think it would speed up the 
recognition of values in part because it would remove some of 
the risks of fire sales and a rapid drawing down of assets in 
some of these vehicles and allow the market to stabilize and 
begin to make a better long-term valuation of what is in these 
assets.
    Representative Brady. A final thought on the subprime. I 
know that you have given it both thought and action. I, like 
most Members of this body, am a big believer in home ownership 
for all the many benefits of it.
    It seems to me Congress's policy is encouraging regulation 
and tax incentives. We have encouraged home loans and business 
loans to borrowers who do not have a strong credit history, all 
with the worthy goal of increasing lending to those 
constituencies.
    But given the weakness that this crisis has revealed from 
income verification to lax underwriting, to suspect credit 
ratings, to what extent have congressional policies such as the 
Community Reinvestment Act--or truthfully any other policy--to 
what extent have Congressional policies played a role in the 
subprime crisis?
    Chairman Bernanke. That would be very difficult for me to 
judge. I think what I would like to say is that lending to 
people without long, well-established credit histories can be 
both profitable and socially beneficial, and we have seen that.
    We have seen responsible subprime lending, and we have seen 
subprime credit extended in other areas as well. We have also 
seen at least the reduction of red lining and those similar 
issues that were a problem in the past.
    I think, again, it depends on execution. Banks can lend to 
under-served populations, but the rules of credit worthiness 
and underwriting still obviously apply. We have learned that 
lesson in the last couple of years.
    Representative Brady. I asked that only because when we 
have taken the approach of sort of going after the market on 
this, and there is substantial merit to that, but I just wonder 
if it is time for Congress to reassess our policies. Is it time 
to require a down payment?
    Do we have more substantial asset tests when you take out a 
variable rate mortgage? Because there you are, not only open to 
the economy, but you risk the interest rate fluctuations as 
well.
    Is it time for Congress to take a look at back to basics, 
as to how we can both encourage home ownership but lessen the 
risk of bad loans?
    Chairman Bernanke. Two comments. One goes back to the CRA 
issue. A lot of the subprime lending was done by nonbank 
lenders who have no CRA obligations. In that case, obviously 
there was no CRA effect.
    As far as underwriting is concerned, you cannot really 
legislate good underwriting. But you can require, for example, 
that lenders take appropriate account of ability to repay and 
so on. That is in some of the bills that are there, but it is 
also something we are looking at in the Federal Reserve in our 
regulatory process that we expect to have next month to release 
some rules.
    Representative Brady. Thank you. Will there be any 
recommendation for Congress, Mr. Chairman?
    Chairman Bernanke. No, just a rules change.
    Representative Brady. Thank you, Mr. Chairman.
    Senator Schumer [presiding]. Senator Casey.
    Senator Casey. Thank you, Mr. Chairman.
    I appreciate the opportunity to participate in this 
hearing. Chairman Bernanke, we appreciate your patience with us 
voting and having a brief recess.
    I just have two areas to cover. One of course is on the 
subprime crisis. And I have a second area to cover. I wanted to 
first of all highlight some of your testimony.
    On page 6 of your testimony, in the section that deals with 
subprime borrowers, you say at the end of that first full 
paragraph and I quote:

    Should the rate of foreclosure rise proportionately, communities as 
well as individual borrowers would be hurt because concentrations of 
foreclosures tend to reduce property values in surrounding areas. A 
sharp increase in foreclosed properties for sale could weaken the 
already struggling housing market and thus potentially the broader 
economy.

Unquote.
    Which is what your testimony was. I thought that was a good 
summation of what this crisis means for individual families and 
their communities, but also a larger impact on the economy.
    I just wanted to direct your attention to two charts. The 
first is a map developed by this Committee: ``Projected 
Economic Costs of the Subprime Mortgage Crisis State by 
State.''
    [The chart referenced above appears in the Submissions for 
the Record on page 58.]
    I note that Pennsylvania is around $2.5 billion. Other 
States are higher than that. The overall numbers--for those who 
cannot see it--for the third quarter of 2007 to the third 
quarter of 2009, loss of home value, loss in neighboring 
property value, loss in property tax value,the overall number 
based upon this research can be summarized this way: Seventy-
one billion dollars in housing wealth directly destroyed 
because of the foreclosures reducing the value of the home. 
Thirty-two billion dollars in housing wealth indirectly 
destroyed. We know these numbers. I thought this was a graphic 
presentation of what it means State by State and nationally, 
and you know that as well, Mr. Chairman.
    I do note in your testimony, and I was grateful that you 
highlighted a lot of the strategies that are being employed 
now, on pages 7, 8, and 9, loan workouts, loss mitigation 
techniques, repayment plans, temporary forbearance, loan 
applications, work with community groups.
    I note that Senator Schumer, Senator Brown, and I have 
worked on legislation. But in addition to that, we pushed to 
have $100 million--we actually wanted $300 million in the 
budget, but we came out with $100 million--to help fund these 
community groups that are trusted by home owners and people 
within that community, but also have some certifiable 
expertise.
    So you highlight a lot of the strategies that banks and 
financial institutions are employing, the work the Fed has 
done, the work the Congress could do, especially with the 
Federal Housing Administration, and I say all that just as a 
preliminary backdrop to the question:
    If someone in Pennsylvania or any other State is watching 
your testimony today, even though you have covered this broadly 
and specifically, I would ask you just to restate what you can 
tell them that you are trying to do, the Fed is trying to do, 
to deal with the immediate impact. A lot of what we talked 
about here will prevent this from happening again, we hope. We 
are working on that. But what can you tell them now that the 
Fed is doing in the immediate or near term to help those who 
have already been the victims of not just the crisis, but the 
impact of the reset on their bottom line families?
    Chairman Bernanke. If I were speaking to someone in that 
situation, the first thing I would say to them is, ``Get in 
touch with your lender.''
    Experience shows that the earlier you get in touch, the 
more quickly and more likely it is that you can resolve the 
issue. Indeed, the banks tell us that one of their big problems 
is that nobody will respond to their calls, and they find it 
very difficult.
    So I would give that piece of advice to your constituents.
    With respect to what the Fed is doing, obviously our first 
responsibility is to try to maintain a healthy economy, which 
will help reduce the costs that you allude to. But in addition, 
as I have discussed in my testimony, we are quite active.
    As you know, we have Reserve Banks around the country, in 
the different regions of the country, and we have been quite 
active in working with those community groups that you 
mentioned, trying to help them identify strategies, help them 
identify communities where the problems are most severe and 
where their efforts should be concentrated trying to help with 
their training.
    We have convened groups at the Fed and other places--I've 
spoken myself to many, many different people--about the 
barriers to refinancing, for example, the accounting and other 
barriers.
    The Fed was one of the first to bring forward this issue of 
FAS-140 which is an accounting provision that can impede 
refinancing. So in all these dimensions, we are doing what we 
can as a central bank to assist in resolving this problem.
    Your characterization--I read the JEC report and it 
properly characterizes this as a very, very important problem 
that has implications not just for individuals, but for the 
broader economy as well.
    Senator Casey. Do you see any further interventions that 
the Fed is planning or at least contemplated or seriously 
considered?
    Chairman Bernanke. We hope that our actions to stabilize 
financial markets and the economy, will help the credit crunch 
situation we see now.
    We still have to see that improve over time. It will be 
very nice to see the secondary markets for prime jumbo loans, 
for example, jump up again. We get to see more activity.
    One of the problems right now is that creditworthy 
borrowers who would like to refinance out of the subprime ARM 
are finding it very difficult to do so, because of tightened 
credit terms.
    Credit terms should be tight and underwriting should be 
good, but to the extent that there's an artificial reduction in 
supply of credit associated with the financial market 
situation, we hope that our policies would lead, over time, to 
a more normal, better functioning financial system.
    Senator Casey. I have one more question. I want to turn to 
a second chart. The staff of this Committee makes great charts, 
and I want to make sure we use them.
    [The chart referenced above appears in the Submissions for 
the Record on page 59.]
    This one is very simple, but profound in its impact. The 
gap--and anyone who can differentiate between red and blue on 
this chart, can see it--the gap between productivity, which has 
been rising, as we see, since the late 1990s, compensation per 
hour rising, but not nearly as significantly.
    That gap between the blue, the higher line, the blue line, 
and the red line, I think, is an academic way of expressing 
profound frustration and anxiety that a lot of families feel. 
They feel that they are working harder than ever before and the 
data supports that, the productivity and output numbers support 
that, but their bottom line is not growing.
    And on top of the wage stagnation or failure to grow, they 
have higher healthcare costs, even though they've leveled off; 
higher costs in tuition and stories about an increase in fuel 
for the average family, paying maybe 11 percent more this year 
that I saw in a report yesterday.
    I ask you--and this is a tough question to answer briefly, 
but I'd ask you to choose one of two options, because I know 
you have some limitations on what you can say, but in the 
context of what either Congress can and should be doing to 
reduce that gap between productivity and wage growth, or if you 
cannot make such a recommendation, or don't feel comfortable 
with doing that, just a general philosophical statement about 
what can we do as a society and as a government, to try to 
bring those two lines together, to have higher wage growth in 
the context of higher output.
    Chairman Bernanke. I was asked a little earlier about what 
Congress could do to address these problems. You pointed to 
some of the issues that are hurting middle class living 
standards.
    One, of course, is energy. That has been a big problem 
throughout this period. Certainly, I know that Congress is 
working on energy policies and trying to find ways to provide 
alternative sources of energy that would be more economical in 
the long run.
    You mentioned healthcare, where the costs continue to rise. 
That's part of our inflation issue, and we measure those costs 
in our inflation index.
    Certainly, there are numerous reforms that can be 
undertaken. It is far too much to try to address in 15 seconds, 
to address that very important problem. I've spoken on a number 
of occasions, and this doesn't directly address your issue, but 
certainly there's a lot of concern about the rise in inequality 
in our society, and part of that, at least, is the result of 
the increasing return to high education and skills that we see 
in our modern technological, mobilized economy.
    And although it's a medium- to long-term solution, I do 
think that education and training and skill creation is 
critical for creating a broad base for prosperity in this 
country.
    Senator Casey. Thank you very much, Mr. Chairman.
    Senator Schumer. We want to thank you. I know you have to 
leave at 12:20 p.m., but I just have a quick, quick question 
here.
    In your testimony, you suggested that GSEs might be allowed 
to securitize jumbo loans with the Federal Government acting as 
guarantor. I think that's a very good idea.
    In fact, legislatively, it is something that I would try to 
introduce and get passed. Do you have any idea of how high that 
ought to go? For all loans, even two- or three-million-dollar 
loans?
    Chairman Bernanke. That's up to Congress, but, certainly--
--
    Senator Schumer. What would be your thought?
    Chairman Bernanke [continuing]. A million dollars.
    Senator Schumer. Thank you, Mr. Chairman, for your 
patience. We had a series of votes. We very much appreciate 
your being here.
    [Whereupon, at 12:20 p.m., the hearing was adjourned.]
                       Submissions for the Record


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        Prepared Statement of Representative Elijah E. Cummings

    Welcome Federal Reserve Chairman Ben Bernanke to this 
important hearing on the U.S. Economic Outlook. As you know, 
this Committee has a broad mandate that includes the duty to 
make recommendations about economic policy that affects each 
and every American. It is with great anticipation that I 
welcome your testimony and look forward to hearing your views 
about the state of our economy and how to prevent what 
tentatively looks like a forthcoming recession.
    As you know, Mr. Chairman, you testified in our last 
hearing on the U.S. economy in March of 2007 that you foresaw 
an upward swing in the U.S. market and you believed that the 
potential fall out from subprime lending--or rather 
``predatory'' lending--could be ``contained'' instead of 
spilling over to other industries, such as the financial 
services and construction industries, amongst others.
    However, despite your high hopes, the exact opposite has 
happened. The housing and mortgage crisis has only worsened--
with housing prices falling nationally for the first time since 
the Great Depression. Making matters worse, the American people 
continue to suffer under a market where loosing ones home has 
become the nightmare of 1 out of 5 homeowners with subprime 
loans, costing 2.2 million families their homes.
    The stark reality is that we as Members of Congress see the 
results in the devastating experiences of our constituents. 
Anyone who walks through my district will see family after 
hard-working family losing their homes because they were 
victimized by predatory subprime lenders. In fact, Maryland is 
currently ranked 22nd nationally in home foreclosures--compared 
to last year's ranking of 40th adding to this crisis the city 
of Baltimore has experienced a loss of $1.8 billion over the 
past 2 years in reduced property value.
    The effects of the subprime lending crisis are rippling 
throughout the economy, reflected in everything from the 
accelerating slump in housing markets across the country to the 
summer's global financial crises driven almost entirely by 
fears about the collapsing subprime mortgage market. While 
continuing to jeopardize the overall economy, the subprime 
crisis also continues to drive tens of thousands of families 
out of their homes, constricting the flow of credit to millions 
of Americans and directly and indirectly affecting our 
financial services sector.
    Investors in the financial sector have suffered from 
extreme losses that appear to only be worsening. Morgan Stanley 
recently declared a $3.7 billion loss on subprime mortgage-
linked investments resulting in an expected $2.5 billion hit to 
its overall net income. Even financial stocks have declined due 
in part to the effect of the subprime lending crisis.
    Although I applaud the Federal Reserve for their efforts to 
alleviate the negative effects of the subprime crisis by 
issuing guidelines to be followed by lenders and participating 
in programs like NeighborWorks America, a nonprofit 
organization that helps thousands of borrowers who are facing 
current or potential distress in obtaining assistance from 
their lenders, more needs to be done.
    Therefore, I have a difficult time buying the picture of 
potential economic growth being painted when I see people who 
may have lost their only chance in a lifetime at home 
ownership.
    All the while, Mr. Chairman, this Administration and 
President have continued to spend U.S. taxpayer dollars 
unwisely. As you are aware, on Monday, October 22, 2007, 
President Bush requested an additional $46 billion for U.S. 
military operations in Iraq and Afghanistan. This is on top of 
the original $150.5 billion requested at the beginning of 
Fiscal Year 2008, bringing the total amount requested to $196.4 
billion--more than 10 times the original $50 to $60 billion 
cost estimated by the White House in 2002. Meanwhile, the 
Administration is satisfied with continuing our military 
operations in Iraq--functioning on borrowed time and largely 
borrowed money, costing an astounding 70 percent of an 
estimated 2.4 trillion in taxpayer dollars over the course of 
the next decade according to the Congressional Budgetary 
Office. The result is a limited budget to advance our 
priorities at home--like aiding the increasingly unstable real 
estate market, advancing U.S. trade and safeguarding a 
continued decline in the value of the U.S. dollar.
    In fact, Mr. Chairman the dollar has declined 6 percent 
against the Euro since August. However, the Euro is not the 
only currency rising against a falling U.S. dollar: the 
Australian dollar, the Japanese Yen, and the Canadian dollar 
are following the same trend. Even in an address by the 
President of France, Nicolas Sarkozy in a joint session to 
Members of Congress and the Senate made a striking warning that 
``the dollar cannot remain solely the problem of others'' and 
that if ``we are not careful, monetary disarray could indeed 
morph into economic war, and we would all--all of us--be its 
victims.'' And sadly--it appears that President Sarkozy's 
warning has increasingly becoming our reality. Countries that 
hold large amounts of U.S. dollars are already changing their 
currency reserves in favor of the Euro: Russia, Switzerland, 
the United Arab Emirates and Venezuela are just few examples.
    It is time that we focus on individuals--and on those who 
are being left behind in our economy. According to data 
recently released by the Internal Revenue Service, Americans' 
average income in 2005 was less than in 2000, the fifth 
consecutive year in which this was the case--and the first 
period since World War II during which incomes have not grown. 
We also see that income and wealth are becoming increasingly 
concentrated in the hands of a very few. Thus, those making 
more than $1 million received just under 50 percent of all the 
income gain that occurred in 2005. We need to focus on ensuring 
that we do not leave increasing numbers of our fellow citizens 
behind as we work to move ahead.
    Chairman Bernanke, I appreciate you appearing before us 
today. I look forward to your testimony and learning what steps 
we can take to improve our dire economic situation.
                              ----------                              


             Prepared Statement of Representative Ron Paul

    Our economy finds itself in a precarious state. Oil prices 
are rising, gold is nearing all-time highs, and the dollar is 
nearing all-time lows. The root of this crisis, as with past 
financial and economic crises, results from Federal Government 
intervention into the economy, not to anything endemic to the 
market, nor to the actions of market participants.
    The collapse of the housing market has served as a catalyst 
for the economy's latest bust. For years the Federal Government 
has made it one of its prime aims to encourage homeownership 
among people who otherwise would not be able to afford homes. 
Various Federal mortgage programs through the FHA, Fannie Mae, 
and Freddie Mac have distorted the normal workings of the 
housing market.
    The implicit government backing of Fannie Mae and Freddie 
Mac provides investors an incentive to provide funds to Fannie 
and Freddie that otherwise would have been put to use in other, 
more productive sectors of the economy. It was this flood of 
investor capital that helped to fuel the housing bubble.
    Legislation such as the Zero Downpayment Act and the 
misnamed American Dream Downpayment Act made it possible for 
people who could not afford down payments on houses to receive 
assistance from the Federal Government, or even to pay no down 
payment at all, courtesy of the taxpayers. The requirement of a 
down payment has always helped to ascertain the ability of a 
buyer to pay off a mortgage. It requires the buyer to show hard 
work and thrift, the ability to delay present consumption in 
order to make a larger acquisition in the future.
    When this requirement is minimized or eliminated, you 
introduce a new class of homebuyers, people who are unable to 
budget and save for the purchase of a home, or who should wait 
for a few years until they have saved enough to purchase a 
home. Federal policies have encouraged investors, lenders, and 
brokers to cater to these people, so it is no surprise that 
market actors came up with ever more sophisticated means of 
bringing these people into the real estate market.
    Finally, the Federal Reserve's loose monetary policy and 
lowering of interest rates were a major spur to the housing 
boom. Low interest rates influence marginal buyers, those who 
are sitting on the fence, and encourage them to take on a 
mortgage that they otherwise would not. Even when interest 
rates are raised, no one expects them to stay high for long, as 
there is always pressure from politicians and investors to keep 
rates low, as no one wants the cheap credit to end.
    Thinking that interest rates will cycle from low to higher, 
back to low, lenders begin to offer adjustable rate mortgages, 
2/28's, 3/27's, and other sophisticated mortgages that may trap 
many unsavvy buyers. Buyers go short, lenders go long, and many 
people have been burned as a result.
    It is time that the Federal Government get out of the 
housing business. Through our interventionist legislation we 
have caused the boom and bust, and any attempts at reform that 
fail to address the causes of our current problem will only sow 
the seeds for the next bubble.

    Prepared Statement of Hon. Ben S. Bernanke, Chairman, Board of 
        Governors of the Federal Reserve System, Washington, DC

    Chairman Schumer, Vice Chairman Maloney, Representative 
Saxton, and other members of the Committee, thank you for 
inviting me here this morning to present an update on the 
economic situation and outlook.

                   DEVELOPMENTS IN FINANCIAL MARKETS

    Since I last appeared before this Committee in March, the 
U.S. economy has performed reasonably well. On preliminary 
estimates, real gross domestic product (GDP) grew at an average 
pace of nearly 4 percent over the second and third quarters 
despite the ongoing correction in the housing market. Core 
inflation has improved modestly, although recent increases in 
energy prices will likely lead overall inflation to rise for a 
time.
    However, the economic outlook has been importantly affected 
by recent developments in financial markets, which have come 
under significant pressure in the past few months. The 
financial turmoil was triggered by investor concerns about the 
credit quality of mortgages, especially subprime mortgages with 
adjustable interest rates. The continuing increase in the rate 
of serious delinquencies for such mortgages reflects in part a 
decline in underwriting standards in recent years as well as 
softening house prices. Delinquencies on these mortgages are 
likely to rise further in coming quarters as a sizable number 
of recent-vintage subprime loans experience their first 
interest rate resets. I will have more to say about this 
problem and its implications for homeowners later in my 
testimony.
    At one time, most mortgages were originated and held by 
depository institutions. Today, however, mortgages are commonly 
bundled together into mortgage-backed securities or structured 
credit products, rated by credit-rating agencies, and then sold 
to investors. As mortgage losses have mounted, investors have 
questioned the reliability of credit ratings, especially those 
of structured products. Because many investors had not 
developed the capacity to perform independent evaluations of 
these often-complex instruments, the loss of confidence in the 
credit ratings, together with uncertainty about developments in 
the housing market, led to a sharp decline in demand for these 
products. Since July, few securities backed by subprime 
mortgages have been issued.
    Although the problems with subprime mortgages initiated the 
financial turmoil, credit concerns quickly spilled over into a 
number of other areas. Importantly, the secondary market for 
securities backed by prime jumbo mortgages also contracted, and 
the issuance of such securities has declined significantly. 
Prime jumbo loans are still being made to prospective home 
purchasers, but they are at higher spreads and have more-
restrictive terms. Concerns about mortgage-backed securities 
and structured credit products (even those unrelated to 
mortgages) also greatly reduced investor appetite for asset-
backed commercial paper, although that market has improved 
somewhat recently. In the area of business credit, investors 
shied away from financing leveraged buyouts and from purchasing 
speculative-grade corporate bonds. And some larger banks, 
concerned about potentially large and difficult-to-predict 
draws on their liquidity and balance sheet capacity, became 
less willing to provide funding to their customers or to each 
other.
    To be sure, the recent developments may well lead to a 
healthier financial system in the medium to long term: 
Increased investor scrutiny of structured credit products is 
likely to lead ultimately to greater transparency in these 
products and to better differentiation among assets of varying 
quality. Investors have also become more cautious and are 
demanding greater compensation for bearing risk. In the short 
term, however, these events do imply a greater measure of 
financial restraint on economic growth as credit becomes more 
expensive and difficult to obtain.

                     FEDERAL RESERVE POLICY ACTIONS

    At the height of the recent financial turmoil, the Federal 
Reserve took a number of steps to help markets return to more 
orderly functioning. The Fed increased liquidity in short-term 
money markets in early August through larger-than-normal open 
market operations. And on August 17, the Federal Reserve Board 
cut the discount rate--the rate at which it lends directly to 
banks--50 basis points, or \1/2\ percentage point, and 
subsequently took several additional measures. These efforts to 
provide liquidity appear to have been helpful on the whole, but 
the functioning of a number of important markets remained 
impaired.
    The turmoil in financial markets significantly affected the 
Federal Reserve's outlook for the broader economy. Indeed, in a 
statement issued simultaneously with the Board's August 17 
announcement of the cut in the discount rate, the Federal Open 
Market Committee (FOMC) noted that the downside risks to 
economic growth had increased appreciably.
    The Committee took further action at its next scheduled 
meeting, on September 18, when it cut its target for the 
Federal funds rate 50 basis points. This action was intended as 
a counterbalance to the tightening of credit conditions and to 
address in a preemptive fashion some of the risks that 
financial developments posed to the broader economy.
    The Committee met most recently on October 30-31. The data 
reviewed at that meeting suggested that growth in the third 
quarter had been solid--at a 3.9 percent rate, according to the 
initial estimate by the Bureau of Economic Analysis. 
Residential construction declined sharply during the quarter, 
as expected, subtracting about 1 percentage point from overall 
growth. However, the GDP report provided scant evidence of 
spillovers from housing to other components of final demand: 
Strong growth in consumer spending was supported by gains in 
employment and income, and businesses increased their capital 
spending at a solid pace. A strong global economy stimulated 
foreign demand for U.S.-produced goods and services, as foreign 
trade contributed nearly 1 percentage point to the growth of 
real output last quarter.
    Looking forward, however, the Committee did not see the 
recent growth performance as likely to be sustained in the near 
term. Financial conditions had improved somewhat after the 
September FOMC action, but the market for nonconforming 
mortgages remained significantly impaired, and survey 
information suggested that banks had tightened terms and 
standards for a range of credit products over recent months. In 
part because of the reduced availability of mortgage credit, 
the contraction in housing-related activity seemed likely to 
intensify. Indicators of overall consumer sentiment suggested 
that household spending would grow more slowly, a reading 
consistent with the expected effects of higher energy prices, 
tighter credit, and continuing weakness in housing. Most 
businesses appeared to enjoy relatively good access to credit, 
but heightened uncertainty about economic prospects could lead 
business spending to decelerate as well. Overall, the Committee 
expected that the growth of economic activity would slow 
noticeably in the fourth quarter from its third-quarter rate. 
Growth was seen as remaining sluggish during the first part of 
next year, then strengthening as the effects of tighter credit 
and the housing correction began to wane.
    The Committee also saw downside risks to this projection: 
One such risk was that financial market conditions would fail 
to improve or even worsen, causing credit conditions to become 
even more restrictive than expected. Another risk was that, in 
light of the problems in mortgage markets and the large 
inventories of unsold homes, house prices might weaken more 
than expected, which could further reduce consumers' 
willingness to spend and increase investors' concerns about 
mortgage credit.
    The Committee projected overall and core inflation to be in 
a range consistent with price stability next year. Supporting 
this view were modest improvements in core inflation over the 
course of the year, inflation expectations that appeared 
reasonably well anchored, and futures quotes suggesting that 
investors saw food and energy prices coming off their recent 
peaks next year. But the inflation outlook was also seen as 
subject to important upside risks. In particular, prices of 
crude oil and other commodities had increased sharply in recent 
weeks, and the foreign exchange value of the dollar had 
weakened. These factors were likely to increase overall 
inflation in the short run and, should inflation expectations 
become unmoored, had the potential to boost inflation in the 
longer run as well.
    Weighing its projections for growth and inflation, as well 
as the risks to those projections, the FOMC on October 31 
reduced its target for the Federal funds rate an additional 25 
basis points, to \41/2\ percent. In the Committee's judgment, 
the cumulative easing of policy over the past 2 months should 
help forestall some of the adverse effects on the broader 
economy that might otherwise arise from the disruptions in 
financial markets and promote moderate growth over time. 
Nonetheless, the Committee recognized that risks remained to 
both of its statutory objectives of maximum employment and 
price stability. All told, it was the judgment of the FOMC 
that, after its action on October 31, the stance of monetary 
policy roughly balanced the upside risks to inflation and the 
downside risks to growth.
    In the days since the October FOMC meeting, the few data 
releases that have become available have continued to suggest 
that the overall economy remained resilient in recent months. 
However, financial market volatility and strains have 
persisted. Incoming information on the performance of mortgage-
related assets has intensified investors' concerns about credit 
market developments and the implications of the downturn in the 
housing market for economic growth. In addition, further sharp 
increases in crude oil prices have put renewed upward pressure 
on inflation and may impose further restraint on economic 
activity. The FOMC will continue to carefully assess the 
implications for the outlook of the incoming economic data and 
financial market developments and will act as needed to foster 
price stability and sustainable economic growth.

                 HELPING DISTRESSED SUBPRIME BORROWERS

    I would like to say a few words about actions being taken 
to help homeowners who have fallen behind on their mortgage 
payments or seem likely to do so. As I mentioned, delinquencies 
will probably rise further for borrowers who have a subprime 
mortgage with an adjustable interest rate, as many of these 
mortgages will soon see their rates reset at significantly 
higher levels. Indeed, on average from now until the end of 
next year, nearly 450,000 subprime mortgages per quarter are 
scheduled to undergo their first interest rate reset. Relative 
to past years, avoiding the payment shock of an interest rate 
reset by refinancing the mortgage will be much more difficult, 
as home prices have flattened out or declined, thereby reducing 
homeowners' equity, and lending terms have tightened. Should 
the rate of foreclosure rise proportionately, communities as 
well as individual borrowers would be hurt because 
concentrations of foreclosures tend to reduce property values 
in surrounding areas. A sharp increase in foreclosed properties 
for sale could also weaken the already struggling housing 
market and thus, potentially, the broader economy.
    Home losses through foreclosure can be reduced if financial 
institutions work with borrowers who are having difficulty 
meeting their mortgage payment obligations. In recent months, 
the Federal Reserve and other banking agencies have issued 
statements calling on mortgage lenders and mortgage servicers 
to pursue prudent loan workouts.\1\ Our contacts with the 
mortgage industry suggest that servicers recently have stepped 
up their efforts to work with borrowers facing financial 
difficulties or an imminent rate reset. Some servicers have 
been proactive about contacting borrowers who have missed 
payments or face resets, as experience shows that addressing 
the problem early increases the odds of a successful outcome. 
Foreclosure cannot always be avoided, but in many cases loss-
mitigation techniques that preserve homeownership are less 
costly than foreclosure. To help keep borrowers in their homes, 
servicers have been offering assistance with repayment plans, 
temporary forbearance, and loan modifications. Comprehensive 
data on the success of these efforts to avert foreclosures are 
not available, but my sense is that there is scope for 
servicers to further increase their loss-mitigation efforts. 
The development of standardized approaches to workouts and the 
sharing of best practices can help increase the scale of the 
effort, even if, ultimately, workouts must be undertaken loan 
by loan. Although workouts are to be encouraged, regulators 
must be alert to ensure that they are done in ways that protect 
consumers' interests and do not disguise lenders' losses or 
impair safety and soundness.
---------------------------------------------------------------------------
    \1\ Board of Governors of the Federal Reserve System (2007), 
``Working with Mortgage Borrowers,'' Division of Banking Supervision 
and Regulation, Supervision and Regulation Letter SR 07-6 (April 17); 
and ``Statement on Loss Mitigation Strategies for Servicers of 
Residential Mortgages,'' Supervision and Regulation Letter SR 07-16 
(September 5).
---------------------------------------------------------------------------
    The Federal Reserve has been participating in efforts by 
community groups to help homeowners avoid foreclosure. For 
example, Governor Kroszner of the Federal Reserve Board serves 
as a director of NeighborWorks America, a nonprofit 
organization that has been helping thousands of borrowers 
facing current or potential distress to obtain assistance from 
their lenders, their servicers, or trusted counselors through a 
hotline. The Federal Reserve Board's staff has been working 
with consumer and community affairs groups throughout the 
Federal Reserve System to help identify localities that are 
most at risk of high foreclosures, with the intent to help 
local groups better focus their outreach efforts to borrowers. 
Other contributions include foreclosure prevention programs, 
such as the Home Ownership Preservation Initiative, which the 
Federal Reserve Bank of Chicago helped to initiate, and efforts 
by Reserve Banks to convene workshops for stakeholders to 
develop community-based solutions to mortgage delinquencies in 
their areas. The Federal Reserve System is also engaged in 
research and analysis that should help inform policy responses 
to these issues.
    The Congress is also focused on reducing homeowners' risk 
of foreclosure. One statutory change that could help is the 
modernization of programs administered by the Federal Housing 
Administration (FHA). The FHA has considerable experience 
helping low- and moderate-income households obtain home 
financing, but it has lost market share in recent years, partly 
because borrowers have moved toward nontraditional products 
with more-flexible and quicker underwriting and processing and 
partly because of a cap on the maximum loan value that can be 
insured. In modernizing the FHA, the Congress might encourage 
joint efforts with the private sector that expedite the 
refinancing of subprime loans held by creditworthy borrowers 
facing resets. It might also consider granting the agency the 
flexibility to design products that improve affordability 
through such features as variable maturities or shared 
appreciation. Also, the FHA could provide more refinancing 
options for riskier households if it could tailor the premiums 
it charges for mortgage insurance to the risk profile of the 
borrower.
    As I have discussed in earlier testimony, the Federal 
Reserve is taking steps to avoid subprime lending problems from 
recurring while preserving responsible subprime lending. In 
coordination with other Federal supervisory agencies and the 
Conference of State Banking Supervisors (CSBS), we have issued 
principles-based underwriting guidance on subprime mortgages to 
help ensure that borrowers obtain loans that they can afford to 
repay and have the opportunity to refinance without prepayment 
penalty for a reasonable period before the first interest rate 
reset. In addition, together with the Office of Thrift 
Supervision, the Federal Trade Commission, the CSBS, and the 
American Association of Residential Mortgage Regulators, we 
have launched a pilot program aimed at strengthening reviews of 
consumer protection compliance at selected nondepository 
lenders with significant subprime mortgage operations.
    Finally, using the authority granted us by the Congress 
under the Home Ownership and Equity Protection Act, we are on 
schedule to propose rules by the end of this year to address 
unfair or deceptive mortgage lending practices. These rules 
would apply to subprime loans offered by any mortgage lender. 
We are looking closely at practices such as prepayment 
penalties, failure to escrow for taxes and insurance, stated-
income and low-documentation lending, and failure to give 
adequate consideration to a borrower's ability to repay. Using 
our authority under the Truth in Lending Act (TILA), we expect 
that we will soon propose rules to curtail abuses in mortgage 
advertising and to ensure that consumers receive mortgage 
disclosures at a time when the information is likely to be the 
most useful to them. We are also engaged in a rigorous, broader 
review of the TILA rules for mortgage loans, which will make 
use of extensive consumer testing of disclosures.
    Thank you. I would be pleased to answer your questions.
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    [GRAPHIC] [TIFF OMITTED] 40283.009
    
    [GRAPHIC] [TIFF OMITTED] 40283.010
    
Response from Chairmain Ben Bernanke to Written Questions Submitted by 
                     Congresswoman Loretta Sanchez

    Q.1. Mr. Chairman, in your testimony you discussed specific 
Federal Reserve policy actions due to the recent financial 
turmoil. You mention increasing liquidity through larger-than-
normal open market operations, cutting the discount rate by 50 
basis points, and several additional measures. What were the 
additional measures taken?

    A.1. The chronology below shows the principal monetary 
policy actions and other measures in financial markets that the 
Federal Reserve has taken over the past several months.
    August 10: Federal Reserve issued a statement reaffirming 
its commitment to provide liquidity to facilitate financial 
market functioning and added $38 billion in reserves through 
three open-market operations largely collateralized by agency-
issued or agency-guaranteed mortgage-backed securities.
    August 17: The Federal Open Market Committee (FOMC) issued 
a statement observing that the downside risks to growth have 
increased appreciably; the Federal Reserve Board approved a 50 
basis point reduction in the primary credit rate and announced 
that term financing will be provided for up to 30 days 
renewable by the borrower.
    August 20: The Federal Reserve announced that it will 
redeem $5 billion in Treasury bill holdings from its System's 
Open Market Account (SOMA) portfolio.
    August 21: The Federal Reserve reduced the minimum fee rate 
for the SOMA Securities Lending Program.
    August 23: The Federal Reserve clarified the eligibility 
and haircuts for collateral that can be used to back discount 
window loans.
    August 20 to October 23: The Federal Reserve approved the 
requests of several large commercial banks for exemptions from 
Section 23A of the Federal Reserve Act in order to enable the 
banks to lend to their securities affiliates to fund loans to 
customers that hold substantial mortgage-related assets. The 
exemptions are available for the duration of the period that 
the special discount window term lending arrangements announced 
on August 17 remains available.
    September 18: FOMC reduced the target Federal funds rate by 
50 basis points to 4.75 percent. The Board approved a further 
50 basis point reduction in the primary credit rate.
    October 31: The FOMC lowered the Federal funds rate by 25 
basis points to 4.5 percent. The Board approved a further 25 
basis point reduction in the primary credit rate.

    Q.2. You mentioned that you hope that policy responses to 
the credit crisis will not lead to an artificial tightening of 
credit. However, how concerned are you about artificially low 
interest rates?

    A.2. The Federal Reserve recognizes that costs and risks 
can arise both from a stance of monetary policy that is too 
tight and one that is too easy. Interest rates that are too 
high given anticipated economic and financial conditions can 
lead to subpar expansion in output and employment; interest 
rates that are too low can add to inflationary pressures. The 
objective of the Federal Reserve in conducting monetary policy 
is to foster achievement of our statutory dual mandate of 
maximum employment and stable prices.

    Q.3. Mr. Chairman, you declared that the Fed had not 
calculated the chances of the economy moving in a recession. If 
you had to, what would you say the odds are? We all know that 
the economy is going to slow as the housing situation will 
continue for 2 years or more. What probable event or events 
could take the economy over the edge into a recession?

    A.3. Over the years, economists and statisticians have made 
a number of formal efforts to predict recessions, and, hence, 
to assign odds to the likelihood of a recession occurring over 
a given time period. Unfortunately, these efforts have fared 
poorly. In part, the difficulty arises from the fact that all 
recessions are different. Although all recessions are 
characterized by declines in economic activity across a broad 
set of indicators, each individual recession seems to stem from 
different causes. Because economic conditions are different 
prior to and during each recession, it is difficult to find 
reliable indicators that help predict the next recession. 
Moreover, the structure of the economy continually evolves, 
which adds to the challenge of predicting recessions. In 
particular, changes in technology, domestic and international 
market structures, demographics, and economic policy over time 
result in shifts in the relationships between economic 
indicators and economic outcomes.
    Even though one cannot predict with reasonable confidence 
the probability of a recession occurring over, say, the next 
twelve months, it is possible to identify some of the possible 
events that could pose downside risks to the performance of the 
economy. In that regard, I would point to the potential for a 
more severe contraction in the housing sector as an important 
risk. In addition, it is possible that financial market 
conditions could deteriorate significantly or that current 
tighter credit conditions could exert unexpectedly large 
restraint on household and business spending. Nevertheless, it 
is important to keep in mind that during recent decades, the 
U.S. economy had proved quite resilient to episodes of economic 
and financial distress. Accordingly, although a good deal of 
uncertainty surrounds the economic outlook, the pace of 
economic expansion seems likely slow in the near term and then 
should return to a moderate rate over the course of the next 
year.

    Q.4. With the markets reacting with so much volatility when 
only one, albeit large, sector of the economy takes a downturn, 
it appears that you are exhibiting a confidence in the overall 
economy that is not entirely justified. How long do you 
envision the housing sector to remain in recession? In your 
calculations, what percentage of the overall economy is made up 
by the housing sector?

    A.4. Conditions in the housing sector are likely to be weak 
into 2008. This assessment reflects a number of factors. On the 
demand side, tightened terms and reduced availability of sub-
prime and jumbo mortgages has impaired the ability of some 
prospective buyers to obtain financing. In addition, some 
prospective purchasers apparently are reluctant to buy when 
they think that house prices will be weak or falling for a 
while. On the supply side, the inventory of unsold homes is 
quite high relative to sales. The overhang is likely to weigh 
heavily on construction activity as well as the prices of both 
newly built and existing homes.
    Moreover, as I mentioned in my prepared statement, on 
average from now until the end of next year, nearly 450,000 
subprime mortgages per quarter are scheduled to undergo their 
first interest rate reset. Relative to past years, avoiding the 
payment shock of an interest rate reset by refinancing the 
mortgage will be much more difficult, as home prices have 
flattened out or declined, thereby reducing homeowners' equity, 
and lending terms have tightened. Should the rate of 
foreclosure rise proportionately, communities as well as 
individual borrowers would be hurt because concentrations of 
foreclosures tend to reduce property values in surrounding 
areas. A sharp increase in foreclosed properties for sale could 
also weaken the already struggling housing market and thus, 
potentially, the broader economy.
    Finally, the housing sector typically is more cyclical than 
many other parts of the economy; its share of overall activity 
tends fluctuate a fair amount over time. Over the past quarter 
century, the nominal value of spending for residential 
investment has varied between \31/4\ and \61/4\ percent of GDP, 
with an average of \41/2\ percent.
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[GRAPHIC] [TIFF OMITTED] 40283.011

  

                                  
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