[Joint House and Senate Hearing, 110 Congress]
[From the U.S. Government Publishing Office]
S. Hrg. 110-845
THE ECONOMIC OUTLOOK
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HEARING
before the
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
__________
SEPTEMBER 24, 2008
__________
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
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Members
Hon. Charles E. Schumer, Chairman, a U.S. Senator from New York.. 1
Hon. Jim Saxton, a U.S. Representative from New Jersey........... 5
Hon. Carolyn B. Maloney, Vice Chair, a U.S. Representative from
New York....................................................... 6
Hon. Sam Brownback, a U.S. Senator from Kansas................... 8
Witnesses
Statement of The Honorable Ben Bernanke, Chairman, Board of
Governors of the Federal Reserve System........................ 9
Submissions for the Record
Prepared statement of Hon. Charles E. Schumer, Chairman, a U.S.
Senator from New York.......................................... 50
Prepared statement of Hon. Jim Saxton, a U.S. Representative from
New Jersey..................................................... 52
Report entitled ``Government Policy Blunders Largely Caused
the Global Financial Crisis''.............................. 53
Report entitled ``The U.S. Housing Bubble and the Global
Financial Crisis: Housing and Housing-Related Finance''.... 59
Prepared statement of Hon. Carolyn B. Maloney, Vice Chair, a U.S.
Representative from New York................................... 88
Prepared Statement of Hon. Ron Paul, a U.S. Representative from
Texas.......................................................... 89
Prepared statement of Hon. Sam Brownback, a U.S. Senator from
Kansas......................................................... 90
Prepared Statement of Hon. Ben S. Bernanke, Chairman, Board of
Governors, Federal Reserve System.............................. 92
THE ECONOMIC OUTLOOK
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WEDNESDAY, SEPTEMBER 24, 2008
Congress of the United States,
Joint Economic Committee,
Washington, DC.
The committee met at 10:00 a.m. in room SD-106 of the
Dirksen Senate Office Building, The Honorable Charles E.
Schumer (Chairman) presiding.
Senators Present. Bingaman, Klobuchar, Casey, Webb,
Brownback, Sununu, DeMint, and Bennett.
Representatives Present. Maloney, Hinchey, Hill, Cummings,
Doggett, Saxton, English, Brady, and Paul.
Staff Present: Christina Baumgardner, Heather Boushey, Nate
Brustein, Gail Cohen, Nan Gibson, Colleen Healy, Marc Jarsulic,
Aaron Kabaker, Michael Laskawy, David Min, Aaron Rottenstein,
Justin Ungson, Ted Boll, Connie Foster, Chris Frenze, Bob
Keleher, Tyler Kurtz, Robert O'Quinn, Jeff Schlagenhauf,
Christina Valentine, Colm Willis, and Jeff Wrase.
OPENING STATEMENT OF THE HONORABLE CHARLES E. SCHUMER,
CHAIRMAN, A U.S. SENATOR FROM NEW YORK
Chairman Schumer. Let's clear out. Okay, good morning. Our
hearing will open.
First, let me just make a little housekeeping note here.
Because of the time constraints on Chairman Bernanke's
schedule, he has to testify in front of House Financial
Services this afternoon and must be gone by 12:30.
We're going to limit opening statements today to the Chair,
Vice Chair, Ranking Member and the Senior Senate Minority
Member. I generally like to give everyone a chance to do
opening statements, but, instead, what we've done, is given
seven minutes of question period, instead of five, and we
encourage members, if they wish to make--use part of that time
to make a statement, to feel free to do so.
We'll also, without objection, enter all other members'
opening statements into the record.
[The prepared statement of other members appears in the
Submissions for the Record on page 89.]
Chairman Schumer. Before I get into my statement, I'd like
to acknowledge the service of one of our colleagues on this
Committee, Congressman Jim Saxton. He's retiring at the end of
this Congress.
Jimmy and I have been friends since he came to the House.
He's been a distinguished Member of this Committee for 15
years; he's been chair of this Committee three times; Vice
Chair three times.
Jim, thanks for your service, and we'll miss you.
Mr. Saxton. Thank you very much. [Applause.]
Chairman Schumer. Okay, to begin, of course, I'd like to
welcome you to this hearing, Mr. Chairman, and I'd like to
thank you for appearing before this and the two other
Committees you're testifying in front of.
I think we all know how grueling this can be, but it's an
important part of the process, and, frankly, sunlight is a
great cleanser and disinfectant.
If the Administration's plan can't withstand public
scrutiny, we cannot make our case to the American taxpayers we
represent, and I think hearings like those that began in the
Senate Banking Committee, under the leadership of Chairman
Dodd, and continuing in Financial Services this afternoon, have
been important.
Over the last 24 hours, I've seen greater signs of
cooperation among my colleagues in the Congress, who, despite
many of their well-founded reservations, recognize the
magnitude of the problems we face and the importance of getting
something done.
So the hearings are part of this process, the so-called
sausage-making. We're doing them under speedy circumstances
this time, because of the worries we all have about the
financial markets, but they're a necessary and important part
of the process, and they help move things along.
As I said, I think we're better off today in terms of
getting this bill done, than we were yesterday, because of your
and your colleagues' testimony.
Now, when you were last before this Committee, Mr.
Chairman, in April--and this was a regularly scheduled hearing
of the Committee, where you always appear before us twice a
year, and this was scheduled long before the crisis--the crisis
we were facing then was the collapse of Bear Stearns.
And I can say that most of us thought that we had just
witnessed an event that we were never likely to see again in
our lifetimes, and yet here we are, six months later, and we're
discussing a crisis many orders of magnitude greater.
Mr. Chairman, I believe you have been eloquent and
impassioned in your warnings of the dangers we face, and that
we must try to do all we can to resolve the threat to our
financial system.
And I will reiterate what I said yesterday at the Banking
Committee: I do believe we must act and we must act soon.
But let us be clear. Americans are furious. I am sure that
every single one of my colleagues on both sides of the aisle
has heard what I have heard from my constituents: Amazement,
astonishment, and intense anger.
And they are right to be astonished and very angry. Over
the last eight years, we were told that markets knew best, that
financial alchemy had reduced risk to an afterthought, and that
we were entering a new world of global growth and prosperity.
Instead, what we have learned, is that we now have to pay
for the greed and recklessness of those who should have far
known better.
Unfortunately, that truth doesn't solve the crisis that
confronts us, and while Wall Street may have caused these
problems, if we do nothing, Main Street will also pay a severe
price.
Pension funds, money market mutual funds, and 401(k) plans
will be negatively impacted. Credit is already tightening,
which impacts households, as well as businesses large and small
throughout the country.
The lock down in lending has widespread consequences. I've
heard from car manufacturers that it's virtually impossible to
get an auto loan right now, unless you have a very high credit
score.
This year alone, they are likely to sell six million fewer
cars than they otherwise would, if credit remains as tight as
it is today.
So, even though the workers in Buffalo and Detroit and St.
Louis are blameless, they will suffer. It's not fair; it's not
right, but, unfortunately, that's the world we live in today,
and, to put our heads in the sand like ostriches and ignore it
will not serve the interest of those workers very well.
It's the reality we face and I think we, on both sides of
the aisle here in Congress, recognize it.
I want to assure the markets once again--and I think I
speak for all of us--that we will no be dilatory and we will
not add extraneous amendments; we will not Christmas-tree this
bill, and we will work in a bipartisan way to act and act soon.
In the last day, it has become clear to me that with the
exception of a few outliers on either side, there is clear
recognition among members of both parties, that we must act and
act soon.
And it has been good to hear from both Senators Obama and
McCain, that they believe we must act, though, like us, they
believe changes must be made in the Administration plan.
Still, as I said yesterday, as well, we must beware that in
taking actions, we do not choose a bad solution. The markets
want action; we understand that, but if we act so quickly that
we create an ineffective solution without adequate safeguards,
then we risk the plan failing, which would be an even worse
outcome for the markets, for the economy, and for our country.
Even on Wall Street, $700 billion is a lot of money, and
none of the thousands of money managers would invest that sum
without appropriate due diligence. These hearings and the
discussions that are happening as we speak, are our
Congressional due diligence, and we take that responsibility
seriously and we will make intelligent and relevant
improvements to the Administration plan.
We owe nothing less than that to the taxpayers who have put
us in office to safeguard their economic well being. It is a
sacred trust and I can say that it's a responsibility that all
my colleagues, both Democrats and Republicans, whatever our
philosophical differences, hold very dear.
As I have said, I believe there are three essential
components that must be part of this plan: THO, taxpayers,
homeowners, and oversight.
There can be no question--and this nonnegotiable--that we
must put taxpayers first. They must come ahead of bondholders,
shareholders, and executives, and we need to add to the
Administration's legislation those types of protections.
I think we must consider seriously, putting this program in
place, in tranches or installments, so that we do not limit the
Secretary's ability to act, as necessary, but are able to
evaluate the effectiveness of these expenditures over time.
If the program is working, Congress will certainly ratify
continuing expenditures by the Treasury, but if it's not
working, then we will need to review it before we once again
find ourselves on the brink.
I look forward to hearing your thoughts on that
possibility, Mr. Chairman.
Another idea I've proposed, is an insurance fund, modeled
on the FDIC and paid for by the financial industry, that can
defray some of the long-term costs of the Administration plan.
It clearly cannot cover the entire cost, but it seems only
fair that the industry that will receive the vast benefit of
this taxpayer-funded program, pay for some share of it
themselves.
Both Secretary Paulson and you seemed positively disposed
to that idea yesterday, and, again, I look forward to hearing
further from you today, as well.
Finally, on the taxpayer side, I remain puzzled by the
resistance you and Secretary Paulson have offered to proposals
that Senator Jack Reed and many of my colleagues have made
about the need for equity being part of the process we are
discussing.
My constituents are asking me about it, as do many of the
business people and many of your fellow economists who I've
spoken to about this.
This morning, Warren Buffett got an equity share in Goldman
Sachs and it didn't stop Goldman Sachs from making the deal
with Warren Buffett. It seems only fair that we reward
taxpayers, if, as we hope, this plan succeeds.
We also must do something to help homeowners. Chairman
Bernanke, you, yourself, have repeatedly stated that until we
find a floor in the housing markets--and foreclosures are
directly related to finding this floor--we will not solve the
problem.
And that affects not just those who made bad mortgages and
not just those who will lose their homes through no fault of
their own--the second group should be protected, the first
should not--but it affects every homeowner. The number of
foreclosures and the price of the average American's home, are
intrinsically related to one another and can't be separated.
As we've seen the complications of securitization, where
mortgages are placed into pools and then broken up into a large
number of securities, has created an enormous problem, it seems
to me that any voluntary program does not work, and the only
mandatory program that's available, is bankruptcy, and I would
also like to discuss that with you, as well.
Finally, this is the last of what I call the three THO
principles: There must be greater oversight as part of this
plan. The Administration is simply asking for trust. However
much we may like Secretary Paulson or you, Mr. Chairman, no
sane person would put $700 billion in your hands on trust
alone.
I cannot in good faith, tell my constituents that ``it's
fine; we know they'll do the right thing.'' Strict oversight is
a sine qua non, and I think that this will be the easiest part
of the three, taxpayers, homeowners, oversight, to accomplish.
To close, I'd like to add a few words about something I
worry has gotten lost in our focus on this crisis. As I have
said, I do believe that we will fix the financial crisis we
face, but that will not, in and of itself, fix many of the
other problems that continue to bedevil American families.
The economy of the past eight years, has hammered the
American middle class; their incomes have declined, their
healthcare coverage has weakened, the price of their gas and
food has skyrocketed, the value of their homes has plummeted,
and now many of them find their jobs threatened.
The plan the Administration has put forward, with certain
modifications, will, I hope, resolve this current mess, but
many other obstacles remain ahead of us. It is not enough to
maintain the status quo. We must find a way once again to make
the American economy the engine of prosperity it once was for
all Americans, and not a casino where we let some earn extreme
rewards by taking excessive risks while the rest of us get
stuck with the bill.
[The prepared statement of Senator Schumer appears in the
Submissions for the Record on page 50.]
Chairman Schumer. Congressman Saxton?
OPENING STATEMENT OF THE HONORABLE JIM SAXTON, A U.S.
REPRESENTATIVE FROM NEW JERSEY
Mr. Saxton. Mr. Chairman, I'd like to join in welcoming
Chairman Bernanke, and before I begin my statement, I would
like to thank you for the kind words at the outset.
I've enjoyed very much being a Member, Chairman and Vice
Chairman of the Joint Economic Committee. It's been a pleasure,
and I hope that Members of Congress in both parties have
benefitted from the discussions that we've had with the
Administration, with regulators, and with representatives of
the financial community, as well.
I would like to say also that, little did I know, in all
the years that I've been a Member and Chairman of this
committee that my tenure would end on such a serious note.
This is a serious problem for our economy and it's a
serious problem for Wall Street. But, most of all, my
heartstrings tug when I get telephone calls from my
constituents, and from people all across the country, for that
matter who call and ask, what's going to happen to their nest
egg, what's going to happen to their savings, what's going to
happen to their money market, what's going to happen to their
hometown bank? Those are questions that are certainly important
for them to ask and for us to help solve.
The main cause of the financial turmoil in the market, as I
see it, is the collapse of the housing bubble, inflated by
various government policies over many years.
Government policies supported in Congress, encouraged the
expansion of the subprime and other risky mortgages that fueled
the housing bubble. I've been a student of housing prices over
the years, and it was clear to me over the past three years or
so, that as we saw the housing bubble escalate, that there was
sure to be a correction and here it is.
In exchange, despite warnings for many years that both
Fannie and Freddie were excessively leveraged to a degree that
was dangerous, they continued to inflate the housing bubble,
undeterred by accounting scandals.
Now the country will have to pay a very high price for
lending policies highly influenced by political and not
economic objectives. Given their financial problems, created by
politicization of decision making, Fannie and Freddie have
essentially been taken over by the Federal Government.
In another startling development over the last several
weeks, a distinct investment banking industry, established by
the provisions of the well-meaning Glass-Steagall Act, has
essentially ceased to exist.
The independent investment banking business model proved
unable to withstand the stress in the financial markets,
wracking the entire financial structure of our economy.
These investment banks were highly leveraged and relied on
short-term funds to finance longer-term investments.
Unfortunately, many of these investments were mortgaged-backed
securities whose value has plunged over the last year.
The fact that the investment banking industry, created by
government regulation, has proven unsound, is a reminder that
government policies do not always provide effective solutions,
but can, in fact, create problems.
As a result, many investors are rightly concerned about the
safety of their savings and their investments, and I'm not
talking about big investors; I'm talking about mom and dad, who
go to work every day and put some of their earnings in a
savings account and that are now scared to death about what's
going to happen to those nest eggs.
Some action by government is now needed to recapitalize the
banks and other financial institutions, either by injections of
equity or removal of toxic investments.
In this financial meltdown, there is plenty of blame to go
around, but, ultimately, the American people expect action to
deal with this crisis. One good place to start would be
guaranteeing the safety of transaction accounts, checking
accounts, and money market accounts, that is, to assure savers
and small businesses, that their basic financial needs can be
met without disruption.
Thank you again, Mr. Chairman, and I yield back.
[The prepared statement of Representative Saxton appears in
the Submissions for the Record on page 52.]
Chairman Schumer. Thank you, Congressman Saxton. Vice Chair
Maloney?
OPENING STATEMENT OF THE HONORABLE CAROLYN B. MALONEY, VICE
CHAIR, A U.S. REPRESENTATIVE FROM NEW YORK
Vice Chair Maloney. Good morning. I'd first like to thank
Chairman Schumer for holding this timely hearing to examine the
economic outlook, especially in light of these sobering
developments in our financial markets in recent days and
months, and I want to welcome Chairman Bernanke.
What started out as a subprime crisis last summer, has
completely changed the face of Wall Street and created a
tinderbox that poses a significant threat to our financial
system.
Treasury Secretary Paulson's $700 billion proposal for the
Federal Government to buy toxic assets, is the equivalent of
one-quarter of the entire federal budget in 2008, more than the
total amount we spent this year on either the defense of our
country--and we are in two wars--or the entire Social Security
system.
American taxpayers are being asked to pour more of their
good money after bad, while not being provided with any
alternatives. Your Senate testimony yesterday, made the
distinction between the market price, the fire sale price, and
the higher, hold-to-maturity value, which is the price the
government would pay under your plan.
Your critics have called this a multi-billion-dollar
subsidy, and I would like you to clarify it further. Just a
fraction of this money could be used to help millions of
Americans avoid losing their homes.
I am confused by the fact that the Paulson Plan prefers
government intervention instead of the private sector acquiring
these assets. Yesterday, it was announced that Berkshire
Hathaway intends to invest $5 billion in Goldman Sachs. Morgan
Stanley sold a portion of their firm to the private sector over
the weekend.
One could say this is in response to government actions and
a backstop to the markets, but also it was reported that AIG
had private offers, as did Lehman.
The idea that the private sector does not want to buy these
assets, and, instead, our government should pay a premium and
that this is somehow good for the taxpayer, seems dubious.
Upon receiving this taxpayer money, large multinational
firms have three choices: They can provide credit in America,
they could invest in other countries, or they could conserve it
to replenish their capital, which is what happened in the
Japanese banking crisis.
Some critics have said that we are taking a big chance in
not knowing where this money will end up.
The other issue that has been repeatedly raised, is the
daisy-chain reaction of one firm bringing down the system. One
solution that has been proposed, would be to allow government
to seize the assets and do an orderly sale, before default and
the ensuing need for taxpayer-funded bailout.
Perhaps you can explain why this alternative is not
addressed in the Paulson program.
When management of so-called too-big-to-fail firms, have a
liquidity crisis that could be avoided, if they'd just accept a
buyout offer, wouldn't it serve the public interest, if the Fed
briefly guaranteed such firms' short-term obligations,
eliminating systemic risk and then force the auction of the
firm to the highest bidder? Isn't that better than effectively
nationalizing the firm, as in the AIG case; letting it fail and
damage the system, like Lehman; or worse, having the taxpayers
buy only the very worst assets, as the plan proposes to do?
These are questions that our constituents deserve to have
answered. We all recognize the need to do what is best for the
American economy, as a whole. We all recognize that the time
will come for an investigation of how we came to this crisis,
but any plan to use taxpayer funds, must require that the
businesses using the plan, make sacrifices, just as we are
asking current and future generations of Americans to do.
I look forward to your testimony.
[The prepared statement of Vice Chair Maloney appears in
the Submissions for the Record on page 88.]
Chairman Schumer. Senator Brownback?
OPENING STATEMENT OF THE HONORABLE SAM BROWNBACK, A U.S.
SENATOR FROM KANSAS
Senator Brownback. Thank you very much, Mr. Chairman.
Mr. Chairman, we're at a crossroads. We face the most
monumental economic decisions in modern times. This is not the
time to posture in pursuit of political advantage.
Two things, I believe, are certain: Inaction is not an
option, and we have to get this right.
To date, we've dealt with symptoms of the crisis and we now
deal with the cancer itself. The American people are angry and
they certainly have every right to be.
To most, this looks like just one more example of the
government making them pay for someone else's failures, and to
paraphrase President Reagan, they want the government to walk
by their side and stop riding on their back.
This is, at its core, I believe, about the interaction of
Wall Street and Main Street. Absent action, there's a prolonged
period in which credit stops flowing, there is a severe adverse
threat to the financial conditions of every household, every
American family, every American business, small and large.
This is certainly not an abstract fear. I'm sure that
everybody on this Committee has heard real-world examples of
how this crisis is hitting the real economy of their
constituents.
For example, a major automobile seller was unable to obtain
funding at workable rates to finance sales of its automobiles.
Since August 2007, 87 lenders have exited or temporarily
stopped making student loans backed by the Federal Government.
If your child is counting on a student loan for next
semester's education, it could be tough, if this continues,
tough to find.
Sixty-seven percent of our small business owners, who are
the engines of job creation in our economy, report that their
businesses have been affected by the credit crunch. If we have
a prolonged period in which credit flows virtually dry up, we
can count on failures of businesses to be able to make
payrolls, to employ workers, and to continue operations.
Failure to act can result in severely depressed economic
conditions. So I believe that it would be irresponsible to not
act.
But I also believe that we must act responsibly. Acting
responsibly includes looking out for taxpayers as we consider
devoting large amounts of taxpayer funds to resolve matters in
credit markets.
First, Chairman Bernanke, I would like you to explain in
your testimony, what you feel would happen, if we did not act
and credit flows remain frozen for a protracted period of time.
Second, I'd like you to explain how you think Treasury's
proposal would find true hold-to-maturity prices of the
distressed assets that are now being valued in illiquid or
nonexistent markets at fire sale prices, at best.
If Treasury pays too much for the assets, taxpayers lose.
If it doesn't pay enough, then banks end up taking severe
write-downs and must seek more capital and moving toward
selling more assets at fire sale prices.
Third, I'd like you to help me understand why it would not
be prudent to protect taxpayers by inserting into Treasury's
plan, requirements that those who sell troubled assets, provide
the taxpayers with preferred stock warrants.
Why, for example, could we not have Treasury buy troubled
assets at fire sale prices, inject capital into troubled
institutions, and obtain preferred stock warrants? We used
warrants when the Federal Government backed the Chrysler debt.
Fourth, I'd like you to help me understand why we should
consider Treasury's proposal of up to $700 billion of value.
Would there not be merit in considering an initial set of
purchases of certain classes of troubled assets, in the amount
of, say, $100 billion?
Then we could evaluate results and move on with $100
billion of purchases of other classes of troubled assets. It
seems to me that's only prudent, that an investor wouldn't just
say, well, here's $700 billion, but, rather, let's work at this
in tranches, and I'd like to understand why we couldn't go at
it that way, as a prudent investor would go at this.
Fifth, I'd like to know whether you believe that Treasury's
proposed plan has any room for loan modifications by the
Treasury, on troubled mortgages.
We have a crisis in confidence in financial markets and we
have a crisis of confidence of the American people in their
government.
When an American family seeks to borrow money to improve
their home or start a business, or when a small business looks
to borrow to expand operations, they have to explain in detail,
what they are going to do with the money, what the collateral
is, and how they are going to pay it back.
I don't think the American people are unreasonable in
asking the same questions of this proposal.
I appreciate the help that I anticipate that you will give
us and the country, in understanding how best to resolve the
stresses in the financial markets that pose a very real adverse
threat to our overall economy.
Again, I believe it would be irresponsible not to act, but
I also believe that we must act responsibly and get this right,
including protecting the taxpayers. Thank you, Mr. Chairman.
[The prepared statement of Senator Brownback appears in the
Submissions for the Record on page 90.]
Chairman Schumer. Thank you, Senator Brownback.
Chairman Bernanke, the podium is yours.
STATEMENT OF THE HONORABLE BEN S. BERNANKE, CHAIRMAN, BOARD OF
GOVERNORS, FEDERAL RESERVE SYSTEM; WASHINGTON, DC
Chairman Bernanke. Thank you. Chairman Schumer, Vice Chair
Maloney, Representative Saxton and other Members of the
Committee, I appreciate this opportunity to discuss recent
developments in financial markets, and to present an update on
the economic situation.
As you know, the U.S. economy continues to confront
substantial challenges, including a weakening labor market and
elevated inflation. Notably, stresses in financial markets have
been high and have recently intensified significantly.
If financial conditions fail to improve for a protracted
period, the implications for the broader economy could be quite
adverse.
The downturn in the housing market has been a key factor
underlying both the strained condition of financial markets and
the slowdown of the broader economy.
In the financial sphere, falling home prices and rising
mortgage delinquencies have led to major losses at many
financial institutions, losses only partially replaced by the
raising of new capital.
Investor concerns about financial institutions increased
over the summer, as mortgage-related assets deteriorated
further, and economic activity weakened. Among the firms under
the greatest pressure were Fannie Mae and Freddie Mac, Lehman
Brothers, and, more recently, the American International Group
(or AIG).
As investors lost confidence in them, these companies saw
their access to liquidity and capital markets increasingly
impaired and their stock prices drop sharply.
The Federal Reserve believes that, whenever possible, such
difficulties should be addressed through private-sector
arrangements, for example, by raising new equity capital, by
negotiations leading to a merger or acquisition, or by an
orderly wind-down.
Government assistance should be given with the greatest of
reluctance and only when the stability of the financial system,
and, consequently, the health of the broader economy, are at
risk.
In the cases of Fannie Mae and Freddie Mac, however,
capital raises of sufficient size appeared infeasible, and the
size and government-sponsored status of the two companies
precluded a merger with or acquisition by another company.
To avoid unacceptably large dislocations in the financial
sector, the housing market, and the economy as a whole, the
Federal Housing Finance Agency placed Fannie Mae and Freddie
Mac into conservatorship and the Treasury used its authority
granted by the Congress in July to make available financial
support to the two firms.
The Federal Reserve, with which FHFA consulted on the
conservatorship decision, as specified in the July legislation,
supported these steps as necessary and appropriate.
We have seen benefits of this action in the form of lower
mortgage rates, which should help the housing market.
The Federal Reserve and the Treasury attempted to identify
private-sector solutions for AIG and Lehman Brothers, but none
was forthcoming. In the case of AIG, the Federal Reserve, with
the support of the Treasury, provided an emergency credit line
to facilitate an orderly resolution.
The Federal Reserve took this action because it judged
that, in light of the prevailing market conditions and the size
and composition of AIG's obligations, a disorderly failure of
AIG would have severely threatened global financial stability,
and, consequently, the performance of the U.S. economy.
To mitigate concerns that this action would exacerbate
moral hazard and encourage inappropriate risk-taking in the
future, the Federal Reserve ensured that the terms of the
credit extended to AIG imposed significant costs and
constraints on the firm's owners, managers, and creditors.
The Chief Executive Officer has been replaced. The
collateral for the loan is the company itself, together with
its subsidiaries.
Insurance policyholders and holders of AIG investment
products are, however, fully protected.
Interest will accrue on the outstanding balance of the
loan, at a rate of three-month LIBOR plus 850 basis points,
implying a current interest rate over 11 percent.
In addition, the U.S. Government will receive equity
participation rights corresponding to a 79.9 percent equity
interest in AIG, and has the right to veto the payment of
dividends to common and preferred shareholders, among other
things.
In the case of Lehman Brothers, a major investment bank,
the Federal Reserve and Treasury declined to commit public
funds to support the institutions. The failure of Lehman posed
risks, but the troubles at Lehman had been well known for some
time, and investors clearly recognized--as evidenced, for
example, by the high cost of insuring Lehman's debt in the
market for credit default swaps--that the failure of the firm
was a significant possibility. Thus, we judged that investors
and counterparties had had time to take precautionary measures.
While perhaps manageable in itself, Lehman's default was
combined with the unexpectedly rapid collapse of AIG, which,
together, contributed to the development last week of
extraordinarily turbulent conditions in global financial
markets.
These conditions caused equity prices to fall sharply, the
cost of short-term credit, where available, to spike upward,
and liquidity to dry up in many markets.
Losses at a large money market mutual fund sparked
extensive withdrawals from a number of such funds. A marked
increase in the demand for safe assets, a flight to quality,
sent the yield on Treasury bills down to a few hundredths of a
percent.
By further reducing asset values and potentially
restricting the flow of credit to households and businesses,
these developments pose a direct threat to economic growth.
The Federal Reserve took a number of actions to increase
liquidity and stabilize markets. Notably, to address Dollar
funding pressures worldwide, we announced a significant
expansion of reciprocal currency arrangements with foreign
central banks, including an approximate doubling of the
existing swap lines with the European Central Bank and the
Swiss National Bank, and the authorization of new swap
facilities with the Bank of Japan, the Bank of England, and the
Bank of Canada, among others.
We will continue to work closely with colleagues at other
Central Banks to address ongoing liquidity pressures.
The Federal Reserve also announced initiatives to assist
money market mutual funds facing heavy redemptions, and to
increase liquidity in short-term credit markets.
Despite the efforts of the Federal Reserve, the Treasury,
and other agencies, global financial markets remain under
extraordinary stress. Action by the Congress is urgently
required to stabilize the situation and avert what otherwise
could be very serious consequences for our financial markets
and for our economy.
In this regard, the Federal Reserve supports the Treasury's
proposal to buy illiquid assets from financial institutions.
Purchasing impaired assets will create liquidity and promote
price discovery in the markets for these assets, while reducing
investor uncertainty about the current value and prospects of
financial institutions.
More generally, removing these assets from institutions'
balance sheets will help to restore confidence in our financial
markets and enable banks and other institutions to raise
capital and to expand credit to support economic growth.
I will now turn to a brief update on the economic
situation. Ongoing developments in financial markets are
directly affecting the broader economy through several
channels, most notably, by restricting the availability of
credit.
Mortgage credit terms have tightened significantly and fees
have risen, especially for potential borrowers who lack
substantial down payments or who have blemished credit
histories. Mortgages that are ineligible for credit guarantees
by Fannie Mae or Freddie Mac, for example, non-conforming jumbo
mortgages, cannot be securitized and thus carry much higher
interest rates than conforming mortgages.
Some lenders have reduced borrowing limits on home equity
lines of credit. Households also appear to be having more
difficulty of late in obtaining non-mortgage credit. For
example, the Federal Reserve's Senior Loan Officer Opinion
Survey reported that, as of July, an increasing proportion of
banks had tightened standards for credit card and for other
consumer loans.
In the business sector, through August, the financially
strongest firms remained able to issue bonds, but bond issuance
by speculative-grade firms remain very light.
More recently, however, deteriorating financial market
conditions have disrupted the commercial paper market and other
forms of financing for a wide range of firms, including
investment-grade firms.
Financing for commercial real estate projects, has also
tightened very significantly.
When worried lenders tighten credit, then spending,
production, and job creation slow. Real economic activity in
the second quarter, appears to have been surprisingly
resilient, but, more recently, economic activity appears to
have decelerated broadly.
In the labor market, private payrolls shed another 100,000
jobs in August, bringing the cumulative drop since November to
770,000. New claims for unemployment insurance are at elevated
levels and the civilian unemployment rate rose to 6.1 percent
in August.
Households' real disposable income was boosted
significantly in the Spring by the tax rebate payments, but,
excluding those payments, real after-tax income has fallen this
year, which partly reflects increases in the prices of energy
and food.
In recent months, the weakness in real income, together
with the restraining effects of reduced credit flows and
declining financial and housing wealth, have begun to show
through more clearly to consumer spending.
Real personal consumption expenditures for goods and
services declined in June and July, and the retail sales report
for August suggested outlays for consumer goods fell noticeably
further last month.
Although the retrenchment in household spending has been
widespread, purchases of motor vehicles have dropped off
particularly sharply.
On a more positive note, oil and gasoline prices, while
still at high levels, in part reflecting the effects of
Hurricane Ike, have come down substantially from the peaks they
reached earlier this summer, contributing to a recent
improvement in consumer confidence.
However, the weakness in the fundamentals underlying
consumer spending suggest that household expenditures will be
sluggish, at best, in the near term.
The recent indicators of the demand for new and existing
homes hint at some stabilization of sales, and lower mortgage
rates are likely to provide some support for demand in coming
months. Moreover, although expectations that house prices will
continue to fall, have probably dissuaded some potential buyers
from entering the market, lower house prices and mortgage
interest rates are making housing increasingly affordable over
time.
Still, home builders retain large backlogs of unsold homes,
which continue to restrain the pace of new home construction.
Indeed, single-family housing starts and new permit issuance
dropped further in August.
At the same time, the continuing decline in house prices
reduces homeowners' equity and puts continuing pressure on the
balance sheets of financial institutions, as I have already
noted.
As of midyear, business investment was holding up
reasonably well, with investment in nonresidential structures
particularly robust. However, a range of factors, including
weakening fundamentals and constraints on credit, are likely to
result in a considerable slowdown in the construction of
commercial and office buildings in coming quarters.
Business outlays for equipment and software also appeared
poised to slow in the second half of this year, assuming that
production and sales slow as anticipated.
International trade provided considerable support for the
U.S. economy over the first half of the year. Economic activity
has been buoyed by strong foreign demand for a wide range of
U.S. exports, including agricultural products, capital goods,
and industrial supplies, even as imports declined.
However, in recent months, the outlook for foreign economic
activity has deteriorated amid unsettled conditions in
financial markets, troubled housing sectors, and softening
sentiment.
As a consequence, in coming quarters, the contribution of
net exports to U.S. production is not likely to be as sizeable
as it was in the first half of the year.
All told, real gross domestic product is likely to expand
at a pace appreciably below its potential rate in the second
half of this year, and then to gradually pick up as the
financial markets return to more normal functioning and the
housing contraction runs its course.
Given the extraordinary circumstances, greater than normal
uncertainty surrounds any forecast of the pace of activity. In
particular, the intensification of financial stress in recent
weeks, which will make lenders still more cautious about
extending credit to households and business, could prove a
significant further drag on growth.
The downside risks to the outlook thus remain a significant
concern.
Inflation rose sharply over the period from May to July,
reflecting rapid increases in energy and food prices. During
the same period, price inflation for goods and services other
than food and energy also moved up from low rates seen in the
Spring, as the higher costs of energy, other commodities, and
imported goods were partially passed through to consumers.
Recently, however, the news on inflation has been more
favorable. The prices of oil and other commodities, while
remaining quite volatile, have fallen, on net, from their
recent peaks, and the Dollar is up from mid-summer lows.
The declines in energy prices, have also led to some easing
of inflation expectations, as measured, for example, by
consumer surveys and the pricing of inflation-indexed Treasury
securities.
If not reversed, these developments, together with the pace
of growth that is likely to fall short of potential for a time,
should lead inflation to moderate later this year and next
year.
Nevertheless, the inflation outlook remains highly
uncertain. Indeed, the fluctuations in oil prices in the past
few days illustrate the difficulty of predicting the future
course of commodity prices. Consequently, the upside risks to
inflation, remain a significant concern, as well.
Over time, a number of factors should promote the return of
our economy to higher levels of employment and sustainable
growth with price stability, including the stimulus being
provided by monetary policy, lower oil and commodity prices,
increasing stability in the mortgage and housing markets, and
the natural recuperative powers of our economy.
However, stabilization of our financial system is an
essential precondition for economic recovery.
I urge the Congress to act quickly to address the grave
threats to financial stability that we currently face. For its
part, the Federal Open Market Committee will monitor economic
and financial developments carefully, and will act as needed to
promote sustainable economic growth and price stability.
Thank you, Mr. Chairman.
[The prepared statement of Hon. Ben S. Bernanke appears in
the Submissions for the Record on page 92.]
Chairman Schumer. Thank you, Mr. Chairman. I appreciate,
once again, your erudite testimony.
All right, now, as you know, yesterday, because you were
sitting there, I asked Secretary Paulson why this entire plan
needed to be implemented at once, why we couldn't provide the
authority for some portion of that, say, $150 billion now, and
authorize the rest later.
He said he was strongly opposed, but he didn't really give
the reasons why. Authorizing this money in installments will
give the Secretary the ability he needs to deal with this
financial crisis, and $150 billion, is a lot of money, still.
Who would have thought we would think of it as a very low
amount, a couple of weeks ago?
But it would also ensure that taxpayers' interests are
being protected, and allow us in Congress to evaluate the
effectiveness of these expenditures over time.
Clearly, we have a financial crisis, but if the program is
working, Congress can certainly continue ratifying expenditures
by the Treasury, and if it's not working, then we'll need to
review it before, once again, we find ourselves on the brink.
So I want to ask you, Mr. Chairman, what are your thoughts
on this idea, and I want to stress that this is just an idea,
one of many that we in Congress are considering, as we try to
responsibly respond to this dire situation, of providing this
money in tranches or installments--some money now, some money
later.
In your estimation, do you need all of this money now, how
much do you need right now, can you explain why, if you
disagree with this idea, why $700 billion is needed
immediately?
And just let me say that I called up some people with
knowledge of the markets, and most of them thought--they said
to me, well, there might be greater confidence with $700
billion, but they didn't see--the consensus--and I only spoke
to a handful of people--was, it wasn't essential, in other
words, providing $150 billion with Congress's commitment to
come back and continue this, if the program is working, would
deal with the problem, certainly more than adequately.
Chairman Bernanke. Mr. Chairman, first--and this would
apply to the whole hearing--as you know, I'm neither part of
the Executive Branch nor the Legislative Branch, and so I have
no standing to negotiate this proposal----
Chairman Schumer. Correct. I'm just asking your opinion.
Chairman Bernanke [continuing]. And, therefore, I'm just
giving views.
I think the concern is that the markets need to have
confidence that this problem will be attacked with sufficient
force and addressed. Insufficient measures could be perceived
as drips and drabs and may not have the sufficient force to
address the confidence issue.
That being said, I think this is an issue you should take
up with Secretary Paulson. One alternative, of course, would be
to have close and continuous oversight of what's happening,
and, of course, if things are not working well, then, the
Congress can always intervene at an intermediate junction, if
it's really felt that things are not working.
Chairman Schumer. But just from your knowledge as an
economist, you're not going to use the full $700 billion in the
first three months or six months, and, by definition, if the
President's proposal passes, there certainly is Congress's
agreement, acquiescence, maybe, to go along with it, we're not
going to pull it back for no reason.
But I think it would assure the American people and we, as
their representatives, that there would be a constant eye on
this, that there wasn't such a huge outlay at once, which is a
huge pill for people to swallow.
So let me ask you the question just one other way: Even if
$700 billion would be advisable and probably a trillion would
be better than $700 billion, do you think that $150 billion is
insufficient to assure the markets that Congress is serious and
the government is serious about addressing this problem?
It certainly gives you what you need in the first several
months.
Chairman Bernanke. Senator, you ask me my opinion as an
economist, but, unfortunately, this a matter for psychology.
Chairman Schumer. Right.
Chairman Bernanke. And the question is, what signal, what
information would the market get about the government's
commitment to addressing this problem, and the details of what
the commitment really was. Therefore, I would urge you to
discuss that with Secretary Paulson.
This is a very big problem. As I mentioned yesterday, just
to take one metric, the outstanding U.S. mortgages in
commercial real estate and residential, is about $14 trillion.
Chairman Schumer. Right.
Chairman Bernanke. Therefore, $700 billion, which is, of
course, an enormous amount of money, is about five percent of
that amount outstanding, and so it is a very big problem and we
don't want to undershoot.
Chairman Schumer. Understood, and let me just say,
obviously, if we're convinced it's not sufficient, this
proposal will not stand. I would say this, that $550 billion is
an awful lot for psychological reassurance, when $150 billion
is a pretty good amount.
Let me go to my second, and, I guess, my last question: At
yesterday's hearing, I also brought up the idea of a fund.
These are all aimed with trying to limit the involvement of the
taxpayers, at least protect the taxpayers as much as we can.
This would be a fund like the FDIC's Deposit Insurance
Fund. It would collect, over time, fees, from large financial
institutions, those maybe that might be too big to fail, across
the board, not just banks, but all of them. They are all going
to benefit from this, being financial institutions, and it
would offset some of the costs.
That would serve the purpose of assuring the taxpayer that
the financial institutions, which are at the eye of the storm
here, are shouldering some of the burden, and it's not, hey, we
make the mistakes, you pay the bill.
So, let me--yesterday, both you and the Secretary thought
this would be a good idea. We are beginning to explore it with
the Banking Committees here, both sides of the aisle, and
Treasury. You've had a little time to sleep on it. Can you
elaborate on your thoughts on whether this might make some
sense?
Chairman Bernanke. Well, again, I think it should be on the
list of things that are discussed with the Administration and
with the Congress. Let me make a couple of comments about it,
in two contexts:
The first is--and I recognize that this doesn't address
your problem--we don't want to impair, in the near term, the
earnings and capital of financial institutions, to the extent
that it affects their lending and capacity to support the
economy. So, perhaps doing something with a longer horizon,
might be worth considering.
The other--and, again, I'm not negotiating for the
Secretary.
Chairman Schumer. Understood. I just want your opinions.
Chairman Bernanke. The second point, I think, is something
which I really would like the Committee to take away, which is
that the Federal Reserve and the Treasury have engaged in a
number of extraordinary activities over the last year, with
Bear Stearns and AIG and so on, and this takes us very far, of
course, as you know, from the Federal Reserve's main mission,
and was done with great reluctance.
The reason we undertook these events was because we felt
that the institutions involved were too big to fail, in the
sense that their failure would have significant implications
for the world economy.
The problem is that, unlike banks, for these non-bank
institutions, there was no clear set of resolution rules,
regimes, and so on, to address this problem.
I think, going forward, there are a lot of ways to address
it. First, it's important to have a resolution regime that we
can use in non-bank situations.
Secondly, that resolution regime needs financing, and that
might involve some kind of deposit insurance type payments.
But, thirdly, we also--and I think this is very important--
we were shocked, given the context of this financial stress,
that too-big-to-fail widened. The number of firms in that net
widened more than we would have anticipated, and we need to
take a number of steps--and I have suggested some in other
contexts--to reduce the number of firms in that category and to
make it possible for a large firm to fail without huge adverse
consequences to the whole system.
Chairman Schumer. Right. Well, thank you for that, and I'm
glad that you're open to this idea. I think this could help a
great deal in gaining passage of the legislation.
Congressman Saxton?
Mr. Saxton. Thank you, Mr. Chairman. Mr. Chairman, asking
Congress to authorize the expenditure of $700 billion, is, I
think, by anyone's account, a heavy lift.
It's almost five percent of GDP to bail out financial
institutions, to use this money to bail out financial
institutions, is controversial, to say the least.
It would be nice if we could go down to Treasury and there
was a big safe down there with $700 billion in it and we could
take the money and use it for this worthwhile plan. However,
Treasury doesn't have $700 billion in a big old safe, and we
have to go borrow it, and that has raised concerns on the part
of many lawmakers in both houses.
But relieved of the burden, financial institutions would be
able to get back in business, and if Treasury were to acquire
the impaired financial assets that are a result of subprime
mortgages, based on what is called mark-to-market accounting,
which means these assets are discounted, the Treasury may be
able to repay this debt and perhaps even earn a profit for the
taxpayers as we dispose of these assets down the road.
On the other hand, if we reject the Administration's plan,
the Treasury will not borrow $700 billion, not immediately,
anyway, because, if we don't do something to solve this
problem, it will intensify the probability of triggering a deep
and perhaps long recession.
If a recession were to occur, countercyclical outlays and
lower tax receipts would boost the federal budget deficits and
Treasury would have to borrow money to meet those needs. So, my
question is, would you walk us through your assessment of the
costs and risks we face, if we approve the plan, and could you
talk to us also about the likely consequences, if we disapprove
it?
Chairman Bernanke. Yes, Congressman, thank you.
First, let me address the question of prices. Vice Chair
Maloney asked me about this, as well, and I think my comments
yesterday might have been slightly misunderstood. Let me try to
address that:
Many of these assets are now currently being sold only
under distressed circumstances to illiquid markets, and that
leads to very low pricing, pricing which I refer to as fire-
sale pricing. It's that fire-sale pricing and the markdowns it
creates for banks that is one of the sources of why capital is
being reduced and why banks are unable to expand credit.
A big part of the program that the Treasury is proposing
would involve the Federal Government going out, and, through
various market-based mechanisms, buying some of these assets
from various financial institutions.
Now, the presence of a large buyer would obviously raise
prices above the fire-sale level. However, I am not advocating
that the government intentionally overpay for these assets;
rather, it's possible for the government to buy these assets,
to raise prices, to benefit the system, to reduce the
complexity, to introduce liquidity and transparency into these
markets, and still acquire assets which are not being overpaid
for in the sense that under more normal market conditions and
if the economy does well, most all of the value could be
recouped by the taxpayer.
So, again, I do think that the program will involve
increases in the prices from the current fire-sale values, but
not necessarily increases above levels which would be
sustainable in a more normal market and economic environment.
With respect to the fiscal implications, you're absolutely
right that $700 billion is an enormous amount of money, but
it's not an expenditure; it is an acquisition of assets that
does expose the taxpayer to significant risk.
We don't know exactly what the long-term cost or benefit
may be, but it is certain, to my mind, that if there is a loss,
it will be much, much less than $700 billion; it will be some
percentage of that.
And with respect to the fiscal effects, again, you're
exactly right, that people have been concerned of what about
the effects on the government budget, and I think those
concerns are very serious.
But it's really a question of alternatives. If we don't act
and we have a more severe and protracted downturn in the
economy, that will obviously affect tax revenues and increase
government expenditures to address the problems that that will
bring.
And so both approaches have fiscal implications, and my
view is that to protect the economy from what otherwise might
be a much more severe episode, that it's important that we take
steps to significantly address this financial situation.
Mr. Saxton. Thank you. Mr. Chairman, over last weekend,
Secretary Paulson announced two changes to the initial plan:
One is that foreign-based financial institutions with
substantial U.S. operations, would be eligible to participate,
and, second, the Treasury would be authorized to purchase other
impaired financial assets, not just impaired mortgages and
mortgage-related securities.
Can you help us with why these changes were made and
whether you think they're appropriate?
Chairman Bernanke. Yes, I'll give you the logic. Again, I
think it's very important to distinguish what is the primary
goal of the plan that the Treasury Secretary has talked about,
which is to restore normal functioning to markets, by providing
liquidity to those markets, and helping to establish prices for
these impaired assets.
You asked a moment ago about how the Treasury would set
prices and how we would be assured of not overpaying. Clearly,
the more competitors we have offering these assets, competing
with each other to sell those assets to the Treasury, the
better the protection that the Treasury has against overpaying.
And so for the purpose of trying to introduce liquidity
into markets, the wider the range of participants we have in
the auction or the other mechanism, the better the chance that
the Treasury will get a good price and the better the chance
that the market's functioning will be improved by these
activities.
That's very different from a situation where an institution
is failing, the government comes in and injects capital, and
wipes out the shareholders--all those sorts of steps, like we
did with Fannie and Freddie, for example. That's not what we're
contemplating, at least for the biggest part of this program.
The biggest part is to try to improve market functioning
rather than to help individual institutions. Which is why it's
a mistake, I think, to punish or single out those firms which
sell the assets, because all firms will be benefitting, even if
they don't sell the assets, if they hold those or similar
assets.
Chairman Schumer. Vice Chair Maloney.
Vice Chair Maloney. Thank you. Before the Senate Banking
Committee yesterday, you testified that under this plan, and I
quote, ``Liquidity should begin to come back to the markets
when the credit markets unfreeze. New credit will become
available.''
Moving forward, is it more important that the plan focuses
on buying up existing assets, or should we focus on creating
new credit? Some critics have argued that our involving a
middle man and risk, when we could directly inject credit into
the economy with new mortgages, new loans, new auto loans and
other sluggish areas in our economy.
Chairman Bernanke. Well, two comments, Vice Chair: First,
the intermediaries, the financial intermediaries, need to be
able to make new credit available, and if their balance sheets
are so gummed up that they can't attract capital, they can't
even attract funding because counterparties don't know what
they're worth, then that's a problem.
So this program would help to try to create more
transparency and less uncertainty about those balance sheets,
giving institutions a chance to make new capital and new credit
available.
But let me also say that I agree with you that there is
some scope for supporting new lending, and, in particular, one
example of that is the initiative by the Treasury to use both
Fannie and Freddie and the Treasury's authorities to buy new
mortgage-backed securities, which would support the new
mortgage market and help create mortgage credit for home
buyers.
Vice Chair Maloney. Returning to the pricing argument, some
economists suggest that a preferred stock option would avoid
the pricing challenge, which is really huge in some people's
minds, and protect taxpayers by putting them in a senior
position, relative to the financial institutions we're helping.
What's your position on preferred stock as a better choice
than just common stock? It wouldn't dilute the common stock
value, so the companies can raise capital and the government
gets paid first.
Chairman Bernanke. Vice Chair, so the preferred stock or
capital injection approach, has, in fact, been one of the
favorite approaches in previous bank crises, like the S&L
crisis, or the Japanese or Scandinavian crises and others.
Those were situations, however, where the government was
dealing with institutions on the brink of failure, or had
already failed. In that case, the only way to keep the
institution going--if it's viewed as being appropriate to do
so, for systemic or other reasons--is to inject capital, wipe
out the existing shareholders, and impose many conditions on
the firm.
We're facing a somewhat different situation, which is,
firms that are valid, going concerns. While we may have a few
companies in trouble, which might be addressed in the way you
describe, companies that are strong, going concerns, we don't
want to take the risk that if the private markets perceive the
government injecting capital into these ongoing concerns is
going to wipe out other shareholders or take over the firm or
otherwise make it difficult for them to raise new capital.
Now, all different kinds of options should be discussed,
and I don't want to negotiate for the Treasury. You should
discuss lots of different ideas, but I think that is one
concern, that putting capital into healthy or at least
reasonably functioning banks might frighten off private money
that could come in, if we were just able to clean up their
balance sheets enough that private investors could understand
the risk/reward return better.
Vice Chair Maloney. Could you walk us through how you and
Secretary Paulson arrived at the $700 billion figure? How will
these funds affect the real economy? Will this act as a large
infusion of cash and affect future inflation?
Chairman Bernanke. Well, it's not science to figure out how
much is going to be needed to stabilize the firms and the
markets, but there are various metrics one can use, and one
that I mentioned yesterday, which I think is useful, is to note
that there's about $14 trillion outstanding of residential and
commercial mortgages, so $700 billion is about five percent of
that amount, which is similar to some of the loss rates we've
seen in some of these categories.
Likewise, the assets of U.S. commercial banks are in a
similar $10 to $12 trillion category, again, so it seems an
appropriate size, relative to the scale of the problem.
One could argue for slightly different numbers, but,
clearly, we need a strong response.
Vice Chair Maloney. But the real question is, will this
affect inflation, and do you think the Fed will have to raise
interest rates in order to float so much new debt?
Chairman Bernanke. No, this is not a fiscal stimulus; this
is not going to directly serve like a stimulus plan, for
example. If it does, in fact, strengthen the financial markets,
increase credit extension, and help the economy grow, then the
Fed would have to respond perhaps sooner raising rates than
otherwise, perhaps, but that would be part of the normal
process of recovery, as the economy goes back to a normal
growth pace, and then the Fed would want to return interest
rates back to a more normal level.
Vice Chair Maloney. And the effect on inflation?
Chairman Bernanke. I don't expect any effect on inflation,
other than the fact that we just want to stabilize the overall
economy.
Vice Chair Maloney. Okay, great. My time has expired.
Chairman Schumer. Thank you, Vice Chair Maloney. Senator
Brownback?
Senator Brownback. Thank you very much, Mr. Chairman.
Chairman Bernanke, I want to take you back to this preferred
stock issue and the warrants, because you were discussing this.
I think this is a key point in the discussion. Why couldn't
you condition the entry into this program upon the financial
institutions' willingness to put up preferred stock as a way of
saying to them, you know, you're getting rid of this bad paper,
this toxic paper, and the taxpayers deserve to be in on the up
side, if there is some up side, so we have less exposure?
And couldn't you condition it such that if we're not losing
money on what we're buying from you, we're not taking the
stock, but if we do and you're surviving, we are taking the
stock? That seems to me to be a fair offer in the type of
situation we're going into, one that's so extraordinary and
where we've got to protect the taxpayer at the same time we're
trying to get these institutions working again?
Chairman Bernanke. Senator, again, I think it's important
to distinguish two situations: The first is a situation where a
bank is failing and it needs injection of capital to continue
to operate, and the government decides that, for various
reasons, it wants the bank to continue to operate.
In that case, the injection of capital, taking warrants,
every other condition, is entirely appropriate. In the second
situation that I described, we're trying to return liquidity to
these markets.
As I mentioned to Congressman Saxton, if you want to have
auctions or other mechanisms to purchase these assets, to
protect the taxpayer, you want as wide a participation as
possible.
And, in fact, if you do succeed in making these markets
more liquid and raising prices in those markets, you'll be
benefitting everyone who holds that mortgage or that asset, not
just those who participate.
So, if you impose that condition, you have the risk of just
no one will want to participate, but will say, well, let
somebody else do it and I'll benefit indirectly from the higher
prices.
Then no one will participate, there will be no competition
in the auction, and this won't work.
Now, as I said, you may wish, if you prefer to do other
approaches, like injecting capital, that's a different matter,
but this approach to bidding up for assets, requires a broad
participation.
Senator Brownback. It just seems to me that we're all
talking about trying to protect the taxpayer, and here is a way
to better protect that taxpayer. I recognize you're saying that
it may not have as broad of an effect on the economy, but I
think, you know, we've got to look towards the taxpayer, who is
just very mad about this overall situation.
Chairman Bernanke. Another way to protect the taxpayer, is
to pay a lower price, a better, more reasonable price.
Senator Brownback. There've been proposals pushed about
that we should reform the bankruptcy code to allow bankruptcy
judges to reset the financial--reset home mortgages.
In looking at this, this seems like to me, that this would
actually raise mortgage rates on individuals. Do you have a
thought on that particular piece of a proposal that's been out
there?
Chairman Bernanke. Senator, I agree that the implications
of that change are very hard to know. They could be very
complex, they could be beneficial or they could restrict
credit.
The Federal Reserve did not take a position on the
bankruptcy reform a couple of years ago, and we've tried not to
take a position on this one, because we do view it as a very
complicated issue and one that we are not comfortable
predicting the outcome.
Senator Brownback. Could it have the potential of raising
mortgage rates?
Chairman Bernanke. It could, it's possible, yes.
Senator Brownback. It looks like to me, with what you've
described as the current financial situation that we're looking
at a very tough quarter right now, with the good possibility
even of a negative quarter that we're in already and maybe even
substantially, from what I heard you say based on the current
numbers you're getting back.
I would hope the Fed wouldn't be looking at raising
interest rates, and, if anything, would look at cutting
interest rates, moving forward. Exports have been one of our
key drivers. Low interest rates are important for to be able to
be competitive internationally as much as we can, even in a
slowing global marketplace.
So, I thought, on the current conditions, you sure wouldn't
want to raise interest rates, you'd sure want to be taking
those down.
Chairman Bernanke. Well, the Fed has to look at both its
mandate to maximize employment, as well as its mandate for
price stability, and we'll have to continue to evaluate how
those two factors evolve.
I do think that a sine qua non for a health recovery would
be trying to stabilize the financial situation. I think that's
very important.
Senator Brownback. I think that's far more important than
an inflationary concern at this point in time.
Chairman Bernanke. Well, again, Senator, you know, we will
look at the risks and the expectations on all aspects of this,
including both growth and inflation.
Senator Brownback. Finally, you're a student of the Great
Depression and a scholar on that. When you back up and look at
this situation, versus your knowledge of what led into that,
what circumstances, just as you overview it, cause you the most
pause of what we're entering into in this phase right now, with
your knowledge as a scholar on that period of U.S. history?
Chairman Bernanke. Well, Senator, certainly there are very
marked differences in terms of the underlying size and
sophistication and diversification of our economy. I would also
say that someone from 1929 would not recognize our financial
system. It is enormously more sophisticated and interconnected
and complex than it was in the 1930s, when basically it was
just banks and bonds and stocks. I mean, essentially, that was
all there was.
I think the one lesson I would draw from that experience,
but also from other international experiences, is that when
there are major dislocations in the financial sector and in the
credit creation process, it can have significant effects on
growth and employment in the economy, and that's been true, not
just in the United States, but in a number of other countries,
both emerging-market and industrial countries, and that would
be the main lesson I would take from that experience.
Senator Brownback. Thank you.
Chairman Schumer. Thank you, Mr. Chairman. I know we have a
lot of people here, and I know your time constraints, so I'm
going to try to get everybody in, and that's why I'm going to
try to stick to the seven minutes. I'm just going to read the
order, so people can plan their schedules.
This is an order of people coming in: Congressman Cummings,
Senator Sununu, Congressman Doggett, Congressman Paul, Senator
Klobuchar, Congressman Brady, Senator Bingaman, Senator DeMint,
Congressman Hinchey, Congressman English, Congressman Hill,
Senator Bennett, Webb, and Casey, and Congresswoman Sanchez.
Congressman Cummings?
Mr. Cummings. Thank you very much, Mr. Chairman. Chairman
Bernanke, it's good to see you again.
As I sit here and I listen to my colleagues, I'm reminded
of something that my mother used to say, that we have to be
careful that we don't have motion, commotion, emotion, but no
results.
And as I think about what has happened here, I realize that
there's a very--there is something that seems to be going
through all of us, and definitely, the people on Main Street
where I live, 40 miles away from here in Baltimore, and that is
whether the--and it goes to the question of trust.
People are beginning to get a bit upset as they see their
money being spent, and they're trying to figure out what that
has to do with them. They see estimates of various things, that
the government is spending money on, but then later on, they
find out that it's going to cost a lot more.
As I listened to the hearings yesterday, the Senate
hearings, I know that there is a question up in the air, as to
how much this is going to eventually cost. I know we're talking
about $700 billion today, but the reports are saying--I mean,
you hear on the news it could be $1.3 trillion. It's
questionable as to what--how much success we will have with all
of this, but I, for one, am convinced that we must do
something; I've got that.
But I also believe that we have to do something with regard
to make sure that we are not just shoring up the market and
what have you, but do some things with regard to Main Street.
And so I want to just ask you a few questions on that.
Clearly, the housing bubble, in my opinion, has burst. In my
home state of Maryland, it currently has approximately 21,500
vacant homes this year, and 431 homes in Baltimore City that
have been subjected to foreclosure filings.
And can you tell me the types of conditions that would
imply that we have reached the bottom? Are we seeing the upturn
in the housing market? Again, because people are--the experts
are telling us that this housing market has a lot to do with
what is taking place today.
Chairman Bernanke. That's absolutely correct. The housing
market has been central to this whole situation.
As I said in my testimony, there are a few signs of some
stabilization in the demand for housing, although I would say
that's quite tentative, because, particularly if the credit
markets freeze up and mortgage availability declines, that
would take a big chunk out of what demand there is for housing.
I do think that we will see, reasonably soon, some
bottoming out of the construction, it has come down so much
already, we're getting to the point that we will see some at
least slower decline in residential construction.
The issue which I think remains uncertain is house prices.
There are large inventories of homes, both new and
existing, in foreclosure, as you know. Those inventories put
downside pressure on house prices. As prices fall, we see both
a weakening economy because consumers have less equity in their
homes, and because firms, banks have weaker balance sheets and
therefore less willingness to extend credit. So I think house
prices are an important issue.
This I think is a bread-and-butter point that I would make,
which is that if the financial system freezes up and mortgage
credit and other kinds of credit are not available to Main
Street, one of the many adverse consequences would be a longer
and deeper decline in house prices and in housing activity,
which would be obviously a real effect on people.
Mr. Cummings. Now I notice, I note that when you were here
only a month prior to the passage of our stimulus package I
asked you specifically what recommendations you had for us with
regard to a stimulus package.
The reason why I bring up the stimulus package is that the
stimulus package affects--I mean this bailout affects my
constituents, but the stimulus package was direct. It is an
immediate effect. It has an immediate effect on them. And
indeed it was at that time that I pressed that an economic
stimulus be equated to rebuilding our infrastructure, boosting
food stamp support, increasing tax credits to families that
have children in college or daycare, extending Medicaid funding
to states that continued to be overburdened by increasing
Unemployment benefits well beyond those offered in the original
package back then.
Mr. Chairman, a bailout on Wall Street must also bring with
it a safety net to those on Main Street. You have this
opportunity, and you will be before the Financial Services
Committee in the House in a few minutes, and I am just
wondering what you--and I have said it before; I have a
tremendous amount of respect for you and Secretary Paulson. I
say you are the super star experts. That is what the taxpayers
pay you to do.
The question is: How do you say to the people on Main
Street, the ones that are looking at you right now looking for
some comfort, just as the Stock Market folks are looking for
comfort to be able to invest, what do you say to them, regular
mom and pop that got up--they may not be watching because they
got up at five o'clock this morning to go to work and they will
not get home until this evening, but they will catch you on the
news--what do you say to them, the super star that you are,
what effect will this have on them?
Because that is why counts. And that is who is going to
vote for all these people who are sitting up here.
Chairman Bernanke. Yes, sir, you are absolutely right.
The effects I think are very direct. If the credit markets
remain in their current condition, or if they worsen, then
increasingly credit conditions which are already very tight are
going to worsen as well, which means that small businesses that
want to get a loan and create jobs in the community will not be
able to do so; people who want to buy a car--and we have
already seen a drop in auto financing--will not be able to get
a loan to do so. That means also the auto workers will not have
as much employment.
The housing market, as I mentioned, will continue to come
under stress. House prices will continue to fall. So these
things will affect jobs. They will affect housing and house
prices. They are going to affect small business creation.
The credit system is like the plumbing. It permeates
throughout the entire system, and our modern economy cannot
grow, it cannot create jobs, it cannot provide housing without
effectively working credit markets. And my only concern here
today is to try to find a solution that will stabilize the
credit markets so that they can do their job, which is to
support our economy and help us get back into a strong growth
path that the underlying strengths of our economy would
otherwise support.
Mr. Cummings. Thank you, Mr. Chairman.
Chairman Schumer. Senator Sununu.
Senator Sununu. Thank you.
Chairman Bernanke, you described the most important
function of this Treasury proposal as restoring a normal
functioning to the credit markets. And I agree very much with
the point you just made, that the most important aspect of it
is restoring normal operation to the credit markets that
consumers depend on because that is such an important part of
our overall economy: student loans, home loans, automobile
loans. Those are the pieces of the credit market, whether you
are a family in New Hampshire, or a small business anywhere in
America, that is what keeps our economy going.
But it is unclear I think to a lot of people who do not
have your experience what the relationship is behind the
mortgage-backed securities that would be the principal
securities purchased under this Treasury Fund, and these
consumer credit markets.
I think it is important, and it would be very valuable for
you to describe in as much detail as you can how it is that $10
billion, or $20 billion of mortgage-backed securities that are
held in a firm today--it might be a Wall Street firm, it could
be a bank, it could be a savings and loan--affect the consumer
credit markets for school loans, auto loans, and home mortgages
that people across America are really worried about today?
Chairman Bernanke. Senator, an excellent question.
Our system is a very large and complex one, but our banks,
commercial and investment banks still play a very central role
in our credit markets, either by making direct loans, by
originating loans, by supporting other markets like the
commercial paper market, and so on.
So banks are critical to the health of the overall credit
system. Now banks, in order to make loans, must have capital.
They have to have some net worth that allows them to expand,
make loans, and extend credit to average people and to
businesses.
These losses from mortgage delinquencies and foreclosures
have caused global financial institutions to write down their
capital on the order of $500 billion. So that capital has
shrunken very considerably and has only been partially replaced
by raising new capital in the private sector.
If banks do not have enough capital, they do not have the
capacity to increase their lending. In fact, what they have to
do is contract their lending. They have to try to get rid of
the loans they have, and they certainly are not going to be
interested in making new loans to individuals or businesses.
So we need to find a way for banks to have more capital so
that they can make more loans to the economy. Now the way this
works to create more capital is a couple of ways.
First of all, by taking these assets off the balance
sheets, it takes some of these loans off, that burden capital
and gives more space for banks to make loans.
But more importantly, by getting these markets moving
again, by figuring out what the prices should be of these
complex securities, it is going to reduce considerably the
uncertainty about the value of these banks. And if that
uncertainty is reduced, then private equity will come in and
increase the capital and allow those banks to make more loans.
I realize that is a very complicated story. The bottom
line, though, is that banks are holding all of these complex,
hard-to-value securities and their capital is low. Those two
things together do not allow them to make adequate loans. We
need to address that problem, and this approach is one way to
address that problem.
Senator Sununu. Thank you. It is a complicated story, but
it is a direct relationship and it is one that I think is very
important for you to describe as much as you can, as clearly as
you can, not just to the Committee but to the American people,
because they are the ones that are going to be affected and
hopefully benefit by any action that we might take.
Along those lines, you have talked about protecting the
taxpayers' interests. Many Members of the Committee have talked
about the importance of putting taxpayers first, and I very
much agree with that priority.
We can do that by adding strong oversight measures, which
you referred to, and I think we should do that. I think it is
important that we make sure that this is a temporary facility;
that it is not going to be a permanent part of our bureaucracy.
I think we should add provisions to make sure that if there
are any taxpayer gains from any of these programs we use that
money to pay down debt, not to increase the size of government
spending.
But you mentioned one additional way that we can protect
the taxpayer, and that is by making sure that the government,
or the Treasury, ultimately pays an appropriate price.
You describe the fire sale price where distressed firms
have been selling some of these securities recently, and you
have previously described a hold-to-maturity price which is the
value that would be received if these securities were held to
the point where all the mortgages have either been paid or
dispensed with.
We want to make sure that the facility purchases at an
appropriate price. If the taxpayers, through the actions of the
Treasury pay above the hold-to-maturity price, we lose.
Now some people have said, well look, no one is going to
participate unless you are buying at or above the hold-to-
maturity price, and that would mean that the taxpayer loses
money.
My question is: Are there participants in the marketplace
that would be willing to sell their securities at a price below
the hold-to-maturity price? Would they find benefit from that
transaction, even if they thought it was less than the hold-to-
maturity price, would they still make the sale to the Treasury
facility?
Chairman Bernanke. Certainly if they have assets on their
books at fire sale prices then they are better off. And indeed
in some kind of auction or market-based mechanism, which is one
approach and you can combine it with other kinds of safeguards
and checks--we would be sure that we would be able to get the
prices between the hold-to-maturity price and the fire sale
price.
There are very good ways to make sure that you are not
overpaying for that.
Senator Sununu. Would there be firms that even had an
incentive to sell if the price that was being offered was below
the price that they held it on their books? Even if it meant an
additional write down, would there be market participants that
would even find that price beneficial to the way they operate
in the marketplace?
Chairman Bernanke. Well some would be worried about the
accounting issue, that's right, because they would have to mark
down. But even so, from an economic perspective they look at
the economics and over time there is no way to hide the real
value of an asset. If it is really impaired, that is going to
show up at some point in reserves or elsewhere.
I think many institutions would be willing to sell to get
it off their books and to get a reasonable price.
Senator Sununu. That would allow them to raise more
capital. That would then obviously help restore confidence in
their structure?
Chairman Bernanke. That's the idea.
Chairman Schumer. Thank you. Congressman Doggett.
Mr. Doggett. Thank you, Mr. Chairman.
Mr. Chairman, am I correct that the first time that you and
Secretary Paulson brought your bailout needs to the attention
of the Congressional leadership was last Thursday evening in
the United States Capitol?
Chairman Bernanke. I believe that is correct.
Mr. Doggett. When did you first bring it to President
Bush's attention?
Chairman Bernanke. That afternoon.
Mr. Doggett. In any of the visits with President Bush or
any of the discussions that you have had with Secretary
Paulson, any of these negotiations, at any point along the way
right up until today has anyone asked the question: Who is
going to pay for this? Is there any way to pay for it other
than taking the standard approach of the Bush Administration
which is, borrow and spend?
Have there been any other alternatives considered?
Chairman Bernanke. Well we have discussed a variety of
alternatives. The Secretary worked with a private-sector
approach early on.
Mr. Doggett. Oh, I understand you looked--but once you went
public, the only approach that this Administration has
considered is to borrow all the money that you need and
increase the debt ceiling, right?
Chairman Bernanke. The only one considered? No. We have
looked at all kinds of alternatives throughout, and we have
tried to do our best using all the powers we have to try to
keep the markets functioning and to try and maintain stability.
Mr. Doggett. I am just focusing--I understand, and I
applaud your efforts to do that. I agree with much of what you
have done in the past. But in terms of how to finance this
massive bailout, you concluded, or the Secretary and President
Bush concluded that the way to pay for it was to borrow all the
money to do it, right? That's what you have asked Congress to
do, is raise the debt ceiling and borrow the money?
Chairman Bernanke. That is what we have asked Congress to
do, that's correct.
Mr. Doggett. You know, it wasn't that long ago that we were
trying to see that children in this country got health
insurance in a comprehensive way. And if you look at the
President's web site today, or at least last night, you will
see that he rejected the notion of $35- to $50 million over
five years because it just costs too much to do that.
And yet, over night--not over five years--we are asked to
come up with $700 billion. You testified not just in answering
my questions in front of the House Budget Committee but in
numerous other places about the dangers of soaring national
debt.
We have added $3 trillion, I think even before this we were
on the way to $4 trillion, money borrowed, more money borrowed
from overseas, foreign creditors by President Bush than all the
Presidents in American history put together.
We were headed up before this request, but now you are
going to add even more debt on top of that. At some point
doesn't there become a limit where the dollar continues to
decline, the price of oil continues to go up, and we jeopardize
and mortgage the future of this country from over-borrowing?
Chairman Bernanke. Well, first of all, this is a very bad
situation, and I very much regret being the bearer of bad news
in this situation.
From a fiscal perspective, just a couple of comments. I
understand and share your concern. The first is that the net
fiscal cost to the taxpayer will certainly be much less than
$700 billion. This is an acquisition of assets----
Mr. Doggett. Just to be sure, you've asked us to raise the
debt limit, once again as this Administration has done so
often, a full $700 billion. Right?
Chairman Bernanke. That's correct, but I think that the
debt markets will recognize that much of the $700 billion is
being offset, or all of it is being offset by acquisition of
financial assets. So it is quite a different situation from a
pure expenditure of $700 billion.
Mr. Doggett. But these are assets you are acquiring because
we've been told they are toxic and no one really knows what
their value is, so that is why we are having the taxpayer buy
them.
Chairman Bernanke. Well the objective would be to buy them
at prices that are consistent with their economic value in a
more normal market.
The other comment, if I may, very quickly----
Mr. Doggett. Surely.
Chairman Bernanke [continuing]. Is simply, what is the
fiscal implication of doing nothing? It is my belief that if we
do nothing----
Mr. Doggett. I don't want to interrupt you, but I will
because I understand you want to talk about inaction. I think
all of us want to take responsible action to address this
problem.
My questions have focused on how we pay for it, and the
dangers of adding another $700 billion to the debt limit. You
know, as I look over the work you have done just in the last
few weeks, I think Bear Stearns was about $30 billion of public
money, Fannie Mae and Freddie was about $200 billion, AIG is
about $85 billion. And now $700 billion more. About $1
trillion. I think it works out to about $3000 for every man,
woman, and child in this country or, with my limited math,
$12,000 for a family of four.
That is a tremendous expenditure, all on borrowed money
once again. The solution that this Administration used to
finance the War in Iraq, the solution it uses for every fiscal
challenge, every public challenge is borrow more money.
You know, if you look back even to the savings and loan
debacle, if you look at the history of that we at least asked
the Federal Home Loan Banks--and they are still paying--to pay
20 percent of the interest on bonds that were issued to finance
the recovery.
Why isn't it reasonable to ask Wall Street to pay for a
little bit of the cost of cleaning up the mess that the Bush
Administration policies permitted Wall Street to engage in
instead of shifting all that cost to future generations of
Americans who did not have anything to do with this?
Chairman Bernanke. I think you ought to raise those
questions with Secretary Paulson.
Mr. Doggett. Well I certainly plan to do so, and that is
one of the reasons why we want to move expeditiously. We do not
want to move overnight. This notion that we would approve this
bailout, $700 billion, today or tomorrow is irresponsible. And
we need to move expeditiously, but we need to look carefully at
this question of why we would shift all the cost to the people
that weren't at the party.
I think President Bush did properly diagnose it down in
Houston at a fund raiser a few months ago when he said the
problem was Wall Street got drunk and has a hangover.
The problem is, the people that are asked to clean up all
the broken furniture, they didn't get invited to the party. And
I think that is why so many of the people that are contacting
me--and I expect it is true of every one of my colleagues--are
not just against this bailout, they are very angry they are
even being asked to contribute to the bailout.
Let me just say in my concluding eight seconds, in Texas we
would say that the chickens have come home to roost. This is
not the result of just bad luck, it is the result of bankrupt
ideology.
In this case the vultures have come home to roost, and I
think we need to look very critically at this giant bailout
before we place all the burden on the people who did not
benefit from what went wrong here.
Thank you for your service.
Mr. Saxton. Mr. Chairman----
(The chairman bangs the gavel.)
Mr. Saxton. Early in the----
Chairman Schumer. Congressman, if we are going to let
everyone get a chance----
Mr. Saxton. No, no----
Chairman Schumer.--we cannot have a dialogue.
Mr. Saxton. He asked the Chairman a question, and the
Chairman never got a chance to answer the question. Could
Chairman Bernanke just speak for a moment about the fiscal
implications of not doing a program? I think it is a very
important point.
Chairman Bernanke. If we do not do it, then the economy
will do worse and tax revenues will be significantly affected.
And so it is not evident that it is more expensive to take
action than not to take action. You said of course you want to
take action, so I understand that, and I appreciate it.
And let me just say that I think that this program ought to
meet three criteria:
First, it has to be big enough and aggressive enough to
solve this problem which is threatening our economy.
Second, it needs to protect the taxpayer as well as
possible.
And third, it should not benefit anybody unduly who was
involved in creating the problem.
So I think those are some principles we might try to take
as we design this program.
Chairman Schumer. Thank you. Congressman Paul.
Mr. Paul. Thank you, Mr. Chairman.
I appreciate the comments by the gentleman from Texas, but
actually you have confused me a little bit because now I do not
know who the conservatives are and who the liberals are.
[Laughter.]
Mr. Doggett. It is hard to tell here sometimes. [Laughter.]
Mr. Paul. Anyway, I am going to keep trying to figure it
out, but we obviously have a serious problem on our hands, and
it is something that I have been talking about for quite a few
years.
Earlier on the Senator brought up the subject of the
Depression, and you did allude to the fact that dislocations
and credit creations are a problem and can add fuel to this
fire. But at times I don't think you follow those rules very
well.
I mean, even though you recognize that is the case, because
I think, understanding the Depression is one of our problems,
or the lack of understanding of the Depression. Because
generally most of what people are taught these days is that it
was a lack of credit in the 1930s that caused the prolongation
of the Depression. They never talk about the excessive credit
and the misallocation and the malinvestment of the 1920s that
precipitated the bubble that had to be corrected.
Then in the Depression what did we try to do? We tried to
fix prices, which is exactly what we are doing now. We would
not in the Depression allow wages to go down, and we said the
price of farm products has to stay up. So in doing that, we
plowed crops under and people were starving.
And I do not think we have gained a whole lot of wisdom
since we were plowing under crops to keep prices up, because
now we are talking about illiquid assets, and we are talking
about price fixing, and we are talking about somebody in the
government, in the Federal Reserve and Treasury, who does
prices.
Now the Austrian School of Economics, which has been around
a long time--they predicted the Depression, they predicted the
1970s, the breakdown at Bretton Woods, they predicted all that
is happening today--their key point is: Do not mess around with
prices. Because if you do you become socialistic.
This is why Mises predicted the failure of socialism, and
why it did fail. But here we are in price fixing again. You say
that part of your mandate is price stability. But I hardly
think price stability comes by price fixing.
But the idea of you taking illiquid assets, for the most
part illiquid assets are illiquid because they are not worth
anything. And if somebody has a house that they bought for $4
million and it goes up to $5 million and he wants to sell and
nobody buys it, that is really not an illiquid asset. If he
takes it down to $1 million he might sell it.
But people are not smart enough. The Federal Reserve is not
smart enough. Treasury is not smart enough. Congress is not
smart enough. To know what prices are. So I think that is the
greatest danger of what we are doing here, is we are price
fixing and that is what I am convinced that prolonged the
Depression in the 1930s because we got into that.
This whole idea of credit creation. We have already created
$700 billion worth of credit because of the interference and
the involvement in the markets, and here we are coming along
with another $700 billion. The real question is: Where does it
come from?
We are surely not going to tax the economy $700 billion.
Nobody would even consider this. But are we going to borrow it?
Well, we could go to our bankers, our friends in China, they
might come up with $700 billion and loan it to us, but I doubt
it.
But where will it come from? They are going to come to you.
They are going to come to you to create credit. But I don't
even know where you get the authority to create credit out of
thin air. There is certainly no authority in the Constitution
for you to have endless authority to create money and credit
out of thin air, which is the basic problem that we have.
This is why we are here today, that we have not understood
that. All the blame is put on the fact that there is a downturn
in housing. Well that means they were overpriced. So all our
efforts right now are to keep the prices up, but the prices
should come down. That is what the market is saying. But to fix
prices at a higher level than they should be I think just
compounds our problem.
But I would like to just see if I can get an opinion from
you on where all this authority comes from. My estimation now
is that there are probably only about 15 percent of the people
in this country who really care about the Constitution and the
rule of law. Sometimes I think there are less here in
Washington.
But where does this authority come from for this unlimited
amount of money? At least the $700 billion is being
appropriated on this new, but the other is not. But you are
going to have to monetize a bunch of this, and quite frankly I
would have trouble finding anything in the Constitution that
said, ah, this is it. You know, this particular paragraph says,
oh, the Congress has the right to buy up illiquid assets.
Could you comment on this authority and the basic
fundamentals of when we are going to address this? If we do
not, we cannot solve the problem of inflation with more
inflation.
Chairman Bernanke. Thank you, Congressman.
First of all, I actually agree with you about the price
fixing in the Depression. I think there is a pretty wide
consensus that the National Recovery Act and the fixing of
wages and prices was a counterproductive step, and I agree with
you there.
On whether prices are being fixed for these securities, the
intention is to use market-based mechanisms, auctions and other
things, to try to discovery what the true prices are, or at
least something approximating a market price. It is not going
to be price setting in that respect, as I understand it.
I would note about the Depression that one has to balance
concerns about intervening in financial markets with concerns
about macroeconomic stability. In the case of the Depression,
the Federal Reserve essentially took no action as the banking
system collapsed. About a third of the banks in the country
failed.
The Fed, following the advice of Secretary Mellon,
liquidated the banks, liquidated labor, and so on, and that did
not work out so well.
With respect to your other questions--and I want to respond
also again to Vice Chair Maloney. There is no need for the
Federal Reserve to monetize any of this borrowing. The Federal
Reserve has independent instrument, its management of monetary
policy. I do not expect additional inflationary consequences
from this.
As to our authority, of course the Constitution gives the
Congress the right to coin money and regulate the value
thereof----
Mr. Paul. ``Coins.''
Chairman Bernanke. And that has been delegated to the
Federal Reserve through the Federal Reserve Act, and everything
we have done is directly based on that Act.
Now if you disagree with the Act, that is a different
issue, but we certainly have the authority from Congress.
Chairman Schumer. Senator Klobuchar.
Senator Klobuchar. Thank you very much, Mr. Chairman.
I said the other day, Chairman Bernanke, that basically my
view of this is that the Administration has allowed Wall Street
to operate like a casino, and unfortunately for you, you and
Secretary Paulson have been called in as the house managers at
the 11th hour to shut it down.
My concern, as you look at changing this and restructuring
it, and as we look at longer term regulations that need to be
put in place, that we minimize the exposure to the taxpayer.
I want to follow up on Congressman Doggett's questions
about the debt and the deficit. I know last time you appeared
before us in April I asked you about the danger of one out of
every twelve dollars of our federal tax money is to go pay
interest on the debt for individual taxpayers, and you
responded that it is crucial that we get control of the deficit
and that we find solutions before it gets so imminent that it
becomes very, very difficult to balance the budget.
Well this week a columnist named Nick Coleman in the
Minneapolis Star Tribune wrote an article about the share of
the debt, not just the increase that Congressman Doggett was
talking about, but if our debt is in fact raised to $11.3
trillion according to him every man, woman, and child would
carry about $38,000 of that debt, and in his case for a family
of five $190,000.
How will this hurt our long-term economy?
Chairman Bernanke. Well not to get into the weeds here too
much, but the $1.3 trillion includes lots of things like debt
held by the Federal Reserve, which is not really net debt to
the government.
That being said, I agree that it is critically important
that we have a stable, sensible, responsible fiscal plan going
forward. We have a lot of implicit obligations, for example, to
entitlements, to Medicare and Social Security, which are not
fully funded. The GSEs were not fully funded. That was always
an issue that the Federal Reserve pointed out.
I think that our economy will be fine. I think it will be a
strong economy in the medium term. I am obviously very unhappy
about the fiscal implications of this. I bring it to you
because I think the alternatives are even worse. But if your
complaint is that this will have adverse fiscal consequences
and make it harder to balance the budget and address other
needs, you are absolutely right and I agree with you on that.
Senator Klobuchar. What I am trying to search for here,
along some of the comments that Senator Schumer made and
others, is ways to pay for this that we can look at besides
putting it on the backs of the middle class. Because you know
how their wages have gone down $2000 a year average in the last
eight years, and their expenses have gone up $4500.
One of the issues that Senator Schumer raised was some kind
of charge on Wall Street, or some kind of charge that could be
made there. There has also been a proposal to put some kind of
surcharge on people that make over a million dollars a year,
and I would personally not really have proposed something like
this, but you keep talking about how we are in such an
extraordinary time and such an extraordinary crisis.
Why couldn't we actually be open to doing something like
that? What would the fiscal implications be? Because it could
collect like, there's one proposal, 10 percent on people making
over a million dollars a year, that could collect $300 billion
and we would not be putting it on the backs of the middle
class.
Why couldn't we do something like that? And what would the
fiscal implications be if we did?
Chairman Bernanke. $300 billion over what----
Senator Klobuchar. Over the time of this thing. It is just
trying to get at some kind of help and backing for this, aside
from on the backs of the people who have been suffering for so
long.
Chairman Bernanke. You know, I think that Congress needs to
make decisions about how it wants to manage its spending and
its taxing, and I am not going to tell you `'yes'' or ``no.''
It is your decision to make.
I would say this--and here I intrude very slightly, I hope
into your legislative decision-making, since I think it is very
important that we address this issue in some way relatively
soon and in particular before Congress leaves town--I hope that
it will not be involved in a whole list of other issues that
will prevent something from being done. That is my main
concern.
But in terms of the fiscal issues--taxes, spending
programs, all those things--that is Congress's job and that is
your decision. The point I have made is that we need sane
fiscal programs. And again I am very unhappy about this
development.
Senator Klobuchar. And Secretary Paulson has not been very
open to this idea of doing something about executive pay. Here
the idea is, because these people who have benefitted directly
from this and gotten these huge severance packages, $20
million, $40 million, do you understand why we would want to
structure something in this deal where, if they are taking
money, a company is taking money, a firm is taking money, that
the government then can get something in return to say there
has to be some limits about what you can make when you are
taking our money?
Chairman Bernanke. There are obviously legitimate issues.
Those include executives who walk away from companies with
large golden parachutes even though they did not perform well.
They include issues of corporate governance. Are the
shareholders in fact being appropriately represented?
There are issues of incentives for risk taking. I think it
may be a supervisory issue to ask whether these packages are
structured in a way that leads to excessively risky decisions.
So there are a lot of legitimate issues here, and I agree with
you about that, and there are tax issues, too, as you already
mentioned.
But one thing I would strongly ask you to consider. For
this to work we need very wide participation from a range of
financial institutions. This is not a handout to individual
institutions. This is trying to make the market as a whole work
by getting many institutions to participate in auctions and
other market-based processes.
If you particularly stigmatize the individual institutions
that participate, you are going to guarantee no participation.
So you should think about this as part of a longer term reform
for the overall system, not just for the individual firms that
are participating.
Senator Klobuchar. Okay, one last question. I know you are
an expert on the Depression and those things. Norman Ornstein
has suggested this week this idea of using the whole idea that
they had during the Depression when they bought the mortgages
that were going under, and I think they ended up for the
mortgages in default getting like 46 percent of them they
rejected, they got the rest, it went over 18 years, and it
worked for the most part.
Have you thought about doing something like that here?
Chairman Bernanke. Well this is related in some ways, but
there are some important differences. One is the HOLC took
mortgages off failed institutions, not buying them in the
market, as we are discussing here.
Secondly, those were simple mortgages, not these complex
securities that are creating such a problem in the markets
today. So I do not think it is exactly analogous, although I
would point out, as others have, that the HOLC made a profit
over time. Though I certainly do not guarantee anything like
that here, and there is a lot of risk being taken here which we
need to minimize, it does not mean that $700 billion of
taxpayer money is going to disappear.
I mean, there are risks but certainly a very substantial
part of it will be recouped as these assets are sold, and as
the economy recovers.
Senator Klobuchar. Thank you, very much.
Chairman Schumer. Congressman Brady.
Mr. Brady. Thank you, Mr. Chairman.
Can you be more specific about the economic consequences if
Congress does not act?
Chairman Bernanke. Yes. I see the financial markets as
already being quite fragile. The credit markets are not working
normally. For example, there has already been a tightening up
of lending. Corporations are not able to finance themselves
through commercial paper.
The money market mutual funds and other parts of the
financial system are not performing in the normal way. I would
think that even if the situation stayed about where it is today
that it would be a significant drag on the economy because of
the effects both on savers through asset values, but also on
the broad economy through the availability of credit.
If credit is not available for small businesses to create
jobs, for companies to finance their payrolls, for people to
buy cars, that in turn affects production of automobiles, for
student loans, for mortgages--which is affecting the housing
market and house prices--all those things. If those things are
all cut back and unavailable, it is going to have significant
adverse effects on our economy.
Now what I said was, if there was no change. I think
without any action it is very possible that we might see a
significant deterioration in financial conditions from here,
which would make the problems for the broader economy even
worse.
So I do think that this is quite consequential. I think
that this is the most significant financial crisis in the post-
War period for the United States, and it has in fact a global
reach. So it has implications for other countries, as well. So
I do think it is extraordinarily important that Congress take
action.
I understand how difficult this is, and how complex, and I
hope that you will take the time to think through your options
and consider all the issues, but I do believe it is very
important to take action.
Mr. Brady. Look forward, do you have a range of what that
loss of GDP or increase in unemployment--the range. Obviously
you are having to eyeball that. But do you have a range?
Chairman Bernanke. It is very difficult. But if you look at
historical examples, in many cases it has been quite
significant. The case of Japan was a case where growth was
suboptimal for a decade.
In Scandinavia, they acted relatively quickly to restore
capital to the banking system, and they still had a fairly
severe recession after that.
So there have been very few cases where you have had this
kind of financial disruption without a significant effect on
the economy. We have already seen a lot of that effect, and I
am just trying to argue that we should do what we can so it
does not get worse.
Mr. Brady. The reason I asked that is I think it is
important in this debate. A lot of us are being asked to walk
away from every principle we have had on government control and
free markets.
We understand the severity of the crunch we have today, but
when we listen to folks back home--and I do not think we always
give our constituents the credit for the smarts they have as we
should--and their point is simply that they do not want to
reward this risky behavior.
The feeling many of them have is, and I agree to a great
extent, why don't we allow the free market system to correct
itself and accept the consequences to avoid that risky behavior
in the future?
I think there is a general sense that we are living in a
financial house of cards; that action like this may only be a
temporary solution to it; that we need to return to firmer,
less complex, more financially sound, so that in the long run
those consequences are better for taxpayers.
How would you talk directly to them?
Chairman Bernanke. My response is that the pain would be
very significant. It would be very difficult for Main Street if
this credit system broke down. It would be very costly to
average people.
Here is a better solution: A better solution is to
recognize that things went wrong. We have a problem now that we
can solve if we address it with enough force. We can protect
taxpayers in doing that.
The second part of the program, though, is we need to come
back and look at our financial regulatory system, and look at
our financial markets, and ask, how could this have happened?
How can we make sure it does not happen again?
That is a much better way to prevent recurrence than by
letting things fall apart and letting that serve as an object
lesson to future market participants.
Mr. Brady. Thank you. Let me conclude with this. Are there
some other things Congress ought to be looking at to increase
capital flows in the United States? They are focused on credit.
Capital is important, too. Such as a holiday on the capital
gains tax might unlock some of those assets in the country.
Or Mr. English's proposal that I had the opportunity to
work with three years ago to temporarily lower the repatriation
roadblock that we have some estimated $350 billion of U.S.
profits stranded overseas that are simply too expensive to
bring back under the current tax rate.
When we lowered that barrier temporarily three years ago,
it brought in just about $300 billion. Is it time for
Congress--and it does not make sense at this point to be
blocking any of those capital inflows into the United States--
should Congress also be examining, in conjunction with this, or
parallel to this, some of those actions to increase, to raise
that capital flow?
Chairman Bernanke. Well there are ones that could be
positive. I think as I responded to Ms. Klobuchar that that is
Congress's determination to make. I would make the assessment
that by themselves those kinds of actions would not address the
larger problem that we are currently facing.
Mr. Brady. But in conjunction they might be helpful?
Chairman Bernanke. Congress certainly obviously can discuss
those issues and come to its own determination.
Mr. Brady. Thank you, Mr. Chairman.
Thank you, Mr. Chairman.
Chairman Schumer. Thank you, Congressman.
Senator Bingaman. Thank you, very much.
Thank you, Mr. Chairman, for your service at this very
difficult period. Let me just state a broad concern that occurs
to me.
I have heard your testimony that what is needed to get
credit markets functioning again is to get more capital into
these financial institutions. And the proposal that we have
been given by the Secretary of the Treasury is that the way to
do that is to essentially have the government come in and take
these so-called troubled assets off the books of these
companies by buying them up at whatever price, and that will
allow these companies to then be in a better position to
perform the function they need to perform in providing credit
and otherwise assisting the economy.
I am struck with the other way, the other obvious way, in
which capital is provided to these financial institutions. When
Warren Buffet invests $5 billion and gets preferred stock in
Goldman Sachs, or when Mitsubishi invests a little over $8
billion and gets, I'm not sure exactly, I assume some type of
preferred stock in Morgan Stanley, that is seen as a good thing
for those firms. It is an infusion of capital. It is welcomed
by the stockholders of those firms, presumably.
It is not wiping out the stockholders; it is helping the
stockholders of those firms. And it is a good investment for
Warren Buffet and for Mitsubishi, presumably.
So I guess my concern is that the way this thing is being
characterized and presented to the Congress, we are being asked
to endorse a bailout where we basically take the assets that
these companies, these firms cannot otherwise dispose of at a
reasonable price and take them off their hands, instead of us,
instead of being characterized as a recapitalization of these
firms.
If instead of a Resolution Trust Corporation, which we had
in the S&L crisis, we--at this point we are talking about a
Recapitalization Trust Corporation--where the taxpayer was
essentially putting up funds, or committing whatever number,
hundreds of billions of dollars of taxpayer money, but it was
for purposes of recapitalizing the financial sector so that the
financial sector can once again perform the function it needs
to, and the taxpayer would come away from that presumably just
like Warren Buffet does or Mitsubishi does with some ownership
and some ability to benefit once the financial sector is back
on its feet.
It seems to me that is a much better way to characterize
things. It gets you somewhere to the same point. It gets the
money into the system. It is much better for the taxpayer. But
for some reason this thing has been described and structured as
the taxpayers' job is to buy the assets that these firms no
longer want.
That is the reason there is so much pushback on this thing.
I think you get much better support, or much better
acquiescence at least by many of the folks I represent if they
thought that the government was going to go ahead and have
something in the way of an investment here once the dust
settled.
So what is your reaction to that? Am I not thinking about
this right?
Chairman Bernanke. No, it is a very good comment. As I
mentioned before, perhaps this is not a completely compelling
objection. There is a concern that investors might view this as
a prelude to forcible capital injections that would, as in the
case of Fannie or Freddie, wipe out common shareholders, or at
least put them at some risk in that respect.
I think that is one of the concerns that is underlying that
approach. But if it were possible to convince the markets that
in fact the government were going to act like Warren Buffet and
make investment banking deals based on negotiations and
approval by the common shareholders and the board, et cetera, I
think that is something that is probably worth discussing with
the White House to see if they see any benefit in that.
But, again, the concern that I have heard from a number of
people is: Does this open the door to effective
nationalization, as opposed to simply putting capital into the
banks?
Senator Bingaman. Well what if we were to say, okay, we are
going to set up this Recapitalization Trust Corporation. We are
going to start with a tranche of a couple hundred billion
dollars, and we are going to have a board that will operate
this, and we will ask Warren Buffet to volunteer his services
to head the board.
Now what is wrong with something like that, where he would
have clear instructions that we are looking out for the
taxpayer here but we also want to get this system functioning
again and get these financial institutions operating?
Why would that not be a much more politically and
substantively preferable course than this idea of us just
buying these troubled assets?
Chairman Bernanke. Well you are a better judge of the
politics than I am. I do not know whether that would be more
popular or not. I told you what I think is viewed as the
concern about it, but I certainly think that there is nothing
wrong with discussing this option with the Treasury.
Again, I am not empowered to negotiate for the Treasury.
Senator Bingaman. Thank you very much, Mr. Chairman.
Chairman Schumer. Thank you.
Congressman Hinchey.
Mr. Hinchey. Thank you very much, Mr. Chairman----
Mr. Saxton. Mr. Chairman----
Chairman Schumer. Well Hinchey came in before English, but
we usually try to go back and forth, so we will go to English
and then Hinchey.
Mr. English. Mr. Chairman, it is always a privilege to have
a couple of New Yorkers deferring to me. Thank you, sir.
[Laughter.]
Mr. English. Mr. Chairman, following up actually on a point
that Senator Bingaman made, and maybe approaching it from a
different angle, one of the concerns that I have is that the
architecture that has been outlined here gives extraordinary
power to the Treasury, to people who are unelected, to make
extraordinary interventions in the economy. And I do not think
that we can contemplate this without considering the political
implications.
Secretary Paulson has reportedly agreed that the Treasury
would be authorized to take an equity stake in financial
institutions that sell impaired financial assets to the
Treasury.
I have to wonder, Mr. Chairman, do we risk politicizing
credit decision making by giving the Federal Government equity
stakes in a whole array of banks and other financial
institutions?
And as a couple of commentators have gestured at, is there
a real danger here that we go down the path to crony
capitalism?
Chairman Bernanke. Well your question comes after Senator
Bingaman's question, which was on the other side of the same
issue.
I am not aware that the Treasury Secretary has agreed to
what you just indicated for the reasons I said before, that we
do not want to stigmatize those who participate in the asset
sales.
It would be a different matter if a firm was failing and
obviously needed some infusion of cash in that respect. I may
just be behind the discussions, but I am not aware that that
has been agreed to.
In any case, let me just say that I think it is very
appropriate, indeed essential, for Congress to have very tough
oversight over this program, and that there be a set of
principles under which the program operates, and that there be
close oversight by however Congress sees fit to structure that.
And I think that should give some comfort to taxpayers and
to others that indeed this program is being run in a serious
and fair way.
I think what would create some concern would be if too much
of the details of how this would be done, whether there is an
auction mechanism or something else, is written into the
legislation, then that would take away the flexibility that
might be necessary to deal with unexpected circumstances. So
that is a concern.
But from an oversight perspective, I absolutely agree with
you.
Mr. English. Very good. As we look at the recent market
turbulence, one of the things I have been concerned about is
the presence of new and unusual products of the market that may
have contributed to it.
It has been suggested that the value of complex derivatives
related to mortgages and credit fell further and faster than
investors and bank regulators thought likely. How does the Fed
view the role of these derivatives in contributing to the
turmoil recently in financial markets?
Chairman Bernanke. Well I think they played an important
role. Many factors have been involved--not just the housing
market, but the structure of financial markets, the structure
of financing, the structures of risk transfer such as these
derivatives that you are referring to.
I think at the time the argument for them was, by putting
all these things together and chopping them up different ways
we would spread risk more effectively. What we learned instead
was that, first, that risk was not always spread as well as was
thought, and that banks did not always realize what their
exposures were to different types of assets.
But secondly, transparency is a big issue. And investors
are not going to come in and buy incredibly complex instruments
at a time of serious financial stress because they have
essentially no way to value them under these circumstances,
which is one of the reasons for trying to get the market going
again.
But I agree that the opacity and complexity of these
instruments has been a factor, and that that needs to be
addressed going forward, as does the role of the credit rating
agencies who would bless them, and then investors did not have
to look at what was inside because they had a AAA rating.
So both of those things need to be looked at as a part of
the reform.
Mr. English. Where do you see the current failure of
transparency? Is this a case where our existing oversight
entities do not have the competence, or the resources, or
perhaps the focus to pursue these particular products? Or is
this a case where you mentioned the rating agencies, have the
rating agencies been from your perspective too casual in making
their assessments?
Where does the blame fall? Is this a regulatory failure? Is
this a--since we throw around a lot of blame right now--is this
a failure of Congressional oversight? Where do you see the most
immediate failings here?
Chairman Bernanke. Well I think there is a lot of blame to
go around. There have been a number of international and
domestic studies of the crisis that have tried to diagnose it
and point to different aspects or causes of the crisis, and all
the things you mentioned are in the list.
The credit rating agencies which did not really anticipate
the decline in housing prices, or that possibility, and had
problems with their methodologies, which have been discussed,
and they are trying to improve those now.
Secondly I think the regulators were not sufficiently
attentive to the risks of these derivative instruments, or off-
balance-sheet instruments in general, and we and our fellow
regulators are trying to remedy that. But I think that was an
issue.
And third I think the private sector in its zest for
financial innovation under-estimated the problems that might
arise in a situation of financial distress. Why it is hard to
value these assets at this point is really for two reasons. One
is simply that they are extraordinarily complex. But also,
there is an awful lot of uncertainty about the economy. We just
do not know where house prices are going to end up, where the
economy is going to end up, and that would make even a simple
security harder to value. Those two reasons affect the
securities' valuation.
Mr. English. Thank you, Mr. Chairman.
Chairman Schumer. Congressman Hinchey.
Mr. Hinchey. Thank you very much, Mr. Chairman.
Thank you very much, Mr. Chairman, for being here, for your
testimony, and for the very direct and honest answers I think
you have given to the statements that have been made and the
questions that have been asked. So I very much appreciate what
you are doing.
You said that you and the Secretary of the Treasury went to
the White House and spoke to the President on Thursday. I can
imagine, however, that both your operation and the Treasury
operation were focused on this issue for a lot longer than just
Thursday.
I wonder if you would kindly tell us how long that has
been, and what you have been doing together or independently to
try to deal with this situation up until Thursday?
Chairman Bernanke. Well as you may know, both the Treasury
and the Fed have been extraordinarily active over the last year
through a wide range of mechanisms--discount window lending,
the creation of new lending facilities, international swaps,
and a whole other range of activities that we have done--to try
to stabilize markets and to maintain as much stability in the
financial system as we can.
Our hope was that the actions that we took, together with
the natural healing process some stabilization in housing,
would allow us to get through this difficult period without any
extraordinary intervention from Congress. And we certainly did
not want to come to Congress prematurely and say do something
large when it was not yet evident that action was necessary.
However, in recent weeks market conditions have
deteriorated quite significantly. We are continuing to do what
we can to support markets, to increase liquidity, and so on,
but our judgment at this point is that Congress needs to act,
and only Congress can take the actions necessary to stabilize
the financial system.
Mr. Hinchey. Well I think there is no question you are
absolutely right. Congress needs to act, and the financial
system needs to be stabilized, but there are other elements of
this economy that need to be dealt with as well. Not just the
financial system.
In other opportunities that you and I have had to be
together we have asked questions and talked about the way in
which the economy was working. The last time that you were here
before this Joint Economic Committee in April, I believe it
was, the general response to the question was that everything
was going to be okay; that the economy was generally strong,
and everything was running fairly well.
I was very skeptical about that, and I think that there was
very good reason for it. It was very interesting in a question
that I asked Secretary Paulson, his answer was that our economy
was growing, unemployment levels were fine, there was housing
downturn and turmoil in capital markets, but all major
institutions are fundamentally healthy.
The fact of the matter is that that was not true. And I
understand that that did not mean that he might have been
focused on trying to deal with the issue, but I think that
there was some motivation here to try to keep this under cover
and try to present that the kind of things that were going
wrong were not really happening.
I understand the situation that we have been talking about
mostly here with regard to the mortgage market, but we are also
seeing something here about the way in which the mortgage
market has been manipulated; how it has been twisted and
distorted in order to engage in speculation, and the desire
there, the objective there is to make larger profits, and that
has been for a lot of people very successful.
Isn't that some aspect of this problem that we have to deal
with?
Chairman Bernanke. Thank you for the question. A couple of
comments. First, I do not recall exactly what I said in April,
but in January we made a number of sharp interest rate cuts,
and I think that was indicative of the fact that at that point
I was certainly, and the FOMC was quite concerned about the
economy. I think, looking back, that policy was justified.
On your second question, you are absolutely right. There
are a lot of problems, a lot of issues. I believe that the
Congress ought to look at a substantial reform of our
regulatory structure and of the financial markets to try to
assure that these kinds of problems do not occur again.
I think that is very important. You could think of this as
a one-two punch. First, stabilize the situation. Secondly, fix
it so it does not happen again.
My only concern is that, just given the realities of the
Congressional schedule and so on that doing the complete
regulatory reform is going to take awhile. It is going to take
a lot of thought, and hearings, and discussions, and so my
advice and my request is that you take step one today, but with
a strong promise for step two.
Mr. Hinchey. Well I appreciate that, and I am still
skeptical about engaging in it in that way because I think that
the situation has to be addressed more broadly. But I
understand that the main focus of your attention, because of
your responsibilities, has got to be on the financial market.
And I very much appreciate that.
I think that that is true, but there is a lot more to deal
with here. There is a lot of concern that a lot of people have
with the general operation that is going on, the way in which
this economy has been going down for more and more people.
When I talk to you I can't help but remember what an
authority you are on the Great Depression, and it seems to me
that there are so many aspects of this economic situation that
we are confronting today which are so similar to the situation
that we confronted during the Great Depression, I know that the
financial markets are much more complex, much more different
than they were back then, but in terms of that complexity
there's a lot more openness in terms of manipulation as well
within the financial markets.
But now you have a situation where you have a greater
concentration of wealth in the hands of fewer and fewer people
that we have had since 1929. You have an increase in poverty.
You have a shrinking of the middle class. You have a
downgrading of the Gross Domestic Product because the income of
working people is going down, going down particularly with
regard to the cost of living that is going up.
Aren't these things that this Congress must focus its
attention on, as well?
Chairman Bernanke. I would hope Congress would be focusing
attention on those issues on an ongoing basis. The things you
mention are related, for example, to education and workplace
skills, energy, a whole set of issues, and I assume the
Congress would be looking at those.
Mr. Hinchey. Some of us in Congress have been for some time
looking at these things. And what I am thinking about, as you
and I are talking now, is you might have an opportunity to go
back to the White House and say to the President: Maybe you,
Mr. President, need to focus on these aspects of the economic
circumstances that we are confronting, because he has been
adamantly opposed to any increase in spending for domestic
investment, infrastructure, health care, education, all the
things that are needed across this country have been rejected
by this Administration because they did not want to spend the
money. But they are very happy to spend $700 billion now to
deal with the circumstances in the financial market.
That inconsistency just does not make any sense.
Chairman Schumer. Congressman Hill.
Mr. Hill. Thank you, Mr. Chairman.
Chairman Bernanke, in this town it is hard to get the
facts, and it is very difficult to determine what reality is. I
want to take you through the last seven days in my life as a
Member of Congress, and then return to a question that
Congressman Cummings asked, because I thought it was very
significant, your answer.
Last week I was under the impression that the
Administration felt like the economy was fairly strong. I
disagreed, of course, but that was the message that was coming
to me and other Members of Congress before Thursday.
And then Thursday we adjourn, and suddenly we have a crisis
on our hands. I learn over the weekend that we are going to be
asked to appropriate $700 billion to try to get us out of this
jam.
I am wondering, at the time that I heard all of this over
the weekend, where have people been? Why is this suddenly a
crisis? What has triggered all of this?
I get back here on Monday and we are now discussing it
among ourselves as Members of Congress, and there is great
angst out there among Members of Congress about whether or not
we should be doing this.
In the last couple of days I have received over 200
telephone calls telling me: Don't do it.
Now, I, as a Member of Congress, am trying to make a
determination of whether or not we should be doing this or not.
But I will have to be quite frank with you--your answer to
Congressman Cummings' question of how this affects the Main
Street people, our constituents back home, was rather stunning.
Because what you are in fact asking us to do is to
appropriate $700 billion to make car loans more accessible, and
for small business people to have better credit. And quite
frankly, if I went home and had a town hall meeting and told my
constituents that we had to bail out Wall Street to the tune of
$700 billion so they could find an easier time to get a car
loan, or for small business people to get better credit so they
could build their businesses, they would laugh me out of that
town hall meeting, Mr. Chairman. There has got to be a better
answer than just that.
Can you give a better answer?
Chairman Bernanke. Yes, sir, I can try to give you an
answer on two fronts.
The first is, I recognize that this is always viewed as a
$700 billion program, but again the fiscal cost of it is going
to be much, much less than that because it is an acquisition of
assets which will be resold. So I think that needs to be kept
in mind.
With respect to the second part, which is very important,
in the first instance credit will be restricted further for
home ownership, for small business, for individual consumers
and so on, but that is not just an inconvenience.
What that is going to do is affect spending and economic
activity, and it will cause the economy as a whole to decline
and be much weaker than it otherwise would be. It will affect
the unemployment rate. It will affect job creation. It will
affect real incomes. It will affect everybody's standard of
living.
So it is much more than car loans. It is really about the
overall performance of the U.S. economy over perhaps a period
of years. So I think it is extraordinarily important to
understand that, as we have seen in many previous examples of
different countries and different times, choking up of credit
is like taking the lifeblood away from the economy. The economy
will not function in a healthy way without availability of
credit for business creation, job creation, and the like.
Mr. Hill. But are we talking about the threat of a
depression here? I talked to two economists yesterday who said,
yes, we are talking about a depression. Today, I am getting a
different feel for what the results are if we do not do
anything.
Warren Buffett invested $50[sic] billion yesterday, and I
read in the paper from several economists who say Congress
would be crazy to do this.
Chairman Bernanke. Warren Buffett said on the TV this
morning that he did it because he thought Congress was going to
do the right thing, and if Congress didn't act that we would go
over a precipice, quote, unquote.
So I think that it is important to do something. I don't
want to make comparisons to the Depression. That was an
extraordinary event. It lasted for many years. It was a
different time and place. But certainly there are going to be
very negative implications for our economy if the credit
markets are not functioning.
Mr. Hill. Is it fair to tell my Main Street people back
home that their stock portfolios are going to decrease
dramatically?
Chairman Bernanke. Very likely.
Mr. Hill. And their 401Ks, and retirement programs?
Chairman Bernanke. Very likely.
Mr. Hill. Okay. I yield back, Mr. Chairman.
Chairman Schumer. Thank you, Congressman Hill.
Senator DeMint.
Senator DeMint. Thank you, Mr. Chairman.
I appreciate, Mr. Chairman, you being here today. I know
you are doing what you think is best for our country, and I
think you know it is our job to question that, particularly
something of this significance.
You just indicated that the $700 billion is for stopping a
short-term problem, and that we need to get about really fixing
the problem afterwards. And it seems you are suggesting that
fix includes a lot more regulations.
My biggest concern at this point is that the casualty of
all of this is going to be our belief in the free enterprise
system, and that unbridled capitalism is being blamed for this
problem.
I learned after 25 years in business that you really cannot
solve a problem unless you understand the root causes. It is
hard for me to look at this and trace it back over the years
without recognizing that this is a problem that was clearly
caused by government.
Obviously, easy and cheap money from the Fed, government
requirements that banks make subprime loans, the implied
government guarantees behind Fannie Mae and Freddie Mac which
everyone, with a ``wink and a nod'' knew was an explicit
government guarantee.
Essentially what we did by trying to use the markets to put
more people in houses is we removed the accountability of risk
from the free enterprise system. And it only works when there
is a good balance between risk and reward.
I do not think anyone could question that that is what the
government did. We created a low risk, big reward environment
in which to sell a lot of these mortgages and move them around
as securities. Now they are embedded in all areas of our credit
market, and free markets are being blamed for this without any
criticism of bad government policies.
Now my question to you is--and I said this on a conference
call the other day and I am not sure I have gotten a straight
answer--Do you believe this is a failure of the free enterprise
system, or another example of how government intervention
destroys the dynamics of a free market system?
Chairman Bernanke. Well, we can discuss the origins of the
situation. I think there are different points of view on that.
I think that there were elements of the financial system--and
let me amplify in just a second--such as the inadequate risk
management and other things that amplified the problem and have
created the crisis we see now.
Historically, precisely because the financial system has
such a critical function in the economy, and because of the
too-big-to-fail problem, and the problem of runs on banks, and
those sorts of things, there has always been Deposit Insurance,
supervision, some regulation of the financial system.
What I was saying, I don't think I used the word ``heavier
regulation'' or anything like that. What I had in mind was
reform. I think our regulatory system now is a patchwork
system. It is not well structured. In some places it is too
heavy, and in other places it is nonexistent.
So I do think the financial system needs to be regulated,
and there are deep historical and economic reasons for that.
But it is important that it be done in a way which on the one
hand protects the safety of the economy and avoids crises of
the type we are currently having, but on the other hand allows
for innovations and the contributions that the financial sector
can make to growth and diversification of the economy.
So I think there is a lot of blame to go around, to make a
long story short, but I do think that part of the problem is
that the regulatory system we have is needing of reform, which
may involve in some cases less regulation but smarter
regulation.
Senator DeMint. I am not suggesting we do not need a good
regulatory structure for our financial markets. It just is very
clear to me that the accountability of risk was removed, and
the too-big-to-fail was primarily the government-created
entities of Fannie Mae and Freddie Mac. They were major players
in all of this.
I am concerned that that is being left out of a lot of the
word coming from the Administration and the Federal Reserve.
None of these proposals would actually support more free market
activity, and seemed to have actually taken the burden of taxes
and regulations off of our economy.
It would seem the Administration, while looking short term
with this immediate bailout, would insist on some long-term
changes in tax structure such as lowering our corporate tax
rate, or eliminating the capital gains.
We created this Sarbanes-Oxley monster in order to tell us
when Bear Stearns was going to go out of business but it
didn't. It didn't do anything it was supposed to do, but we
know it chased capital offshore. However, there's not advocacy
from the White House or the Federal Reserve that we need to fix
these things that are running capital out of our markets.
And so it is very frustrating for me, as someone who
believes in free markets and free enterprise, that the blame of
all this is being laid at the fact that we didn't have enough
regulation and oversight. As somebody who has been in business,
I know there is no amount of government regulation that can
stop the corruption in a system if you take the risk out of it.
Chairman Bernanke. Senator, first of all, on Fannie and
Freddie the Federal Reserve has long raised the issue of the
systemic risk there. And I think you are absolutely right on
that case.
With respect to regulatory reform, the Federal Reserve
contributed to, but of course Treasury took the lead in the
presentation of the blueprint that Secretary Paulson presented
before the crisis began, and that was in response to this issue
of capital moving offshore, as you put it.
His objectives in that blueprint were to try to simplify
the system, remove redundancies, reduce costs, and make the
regulatory system more industry friendly in that respect.
So again I reiterate that I am not sure that what is needed
necessarily is heavier, more regulation, but better, cleaner,
more efficient regulation.
Senator DeMint. Do you agree that insulating the market
from natural risk creates a problem?
Chairman Bernanke. Well what we have is a problem where the
financial system, because of too-big-to-fail, or just because
of other instabilities like runs on banks, historically has had
the potential to have very widespread effects on the rest of
the economy if it becomes unstable, more so than other
industries.
And so there has been a view--back to the introduction of
deposit insurance, or before--a long-term view that some
regulation is needed of the financial system. And given that,
and you said yourself that it is needed, I think we just need
to do it as well as possible.
Senator DeMint. Thank you, Mr. Chairman.
Chairman Schumer. Well thank you, Mr. Chairman.
We said we would try to get you out at 12:30, and we went
through a lot of questions. We very much appreciate your calm
nature here, but also the knowledge that you have. I think most
of us on either side of the aisle believe you look at these
things dispassionately without a particular axe to grind.
I just want to say, in conclusion, that the hearing
reinforces my view of two things:
That we do have to act, and act relatively quickly. And at
the same time we need some changes in the legislation proposed,
and I am glad to hear that you are open to the kinds of changes
that I have talked about on reducing the burden to the
taxpayers.
Thanks for being here.
Chairman Bernanke. Thank you, Mr. Chairman
Chairman Schumer. The hearing is adjourned.
(Whereupon, at 12:34 p.m., Wednesday, September 24, 2008,
the hearing was adjourned.)
SUBMISSIONS FOR THE RECORD
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Prepared Statement of Senator Charles E. Schumer, Chairman
To begin, I'd like to welcome you this hearing Mr. Chairman. And
I'd like to thank you for appearing before this and the two other
committees you are testifying in front of. I know how grueling this can
be. But like it or not, it is important part of the process. If the
Administration plan cannot withstand scrutiny, we cannot make our case
to the American taxpayers we represent.
I think these hearings--beginning in the Senate Banking committee
yesterday under the leadership of Chairman Dodd and continuing in the
House Financial Services Committee this afternoon under Chairman Frank,
have been important. Over the last twenty-four hours, I've seen signs
of greater cooperation from my colleagues in Congress, who, despite
many of their well-founded reservations, recognize the magnitude of the
problems we face and the importance of getting something done.
When you were last before this committee, in April, the crisis we
were facing was the collapse of Bear Stearns, and I can say that most
of us thought we had just witnessed an event that we were likely never
to see again in our lifetimes. And yet, here we are, only six months
later, and we are discussing a crisis many orders of magnitude greater.
Mr. Chairman, I believe you have been eloquent and impassioned in
your warnings of the dangers we face, and that we must try to do all we
can to resolve the threat to our financial system. And I will reiterate
what I said yesterday, I do believe we must act and we must act soon.
But let us be clear--Americans are furious. I am sure that every
single one of my colleagues has heard what I have heard from my
constituents--amazement, astonishment and intense anger. And they are
right to be astonished and very angry. Over the last eight years, we
were told that markets knew best, that financial alchemy had reduced
risk to an afterthought, and that we were entering a new world of
global growth and prosperity. Instead, what we have learned is that we
now have to pay for the greed and recklessness of those who should have
known far better.
Unfortunately that truth does not solve the crisis that confronts
us. While Wall Street caused these problems, if we do nothing, Main
Street will also pay a severe price. Pension funds, money market mutual
funds, and 401(k) plans will be negatively impacted. Credit is already
tightening, which impacts households as well as businesses large and
small throughout this country. The lock down in lending has widespread
consequences. I've heard from car manufacturers that it is virtually
impossible to get an auto loan right now unless you have a very high
credit score. This year alone they are likely sell six million fewer
cars than they otherwise would. So even though the workers in Buffalo,
Detroit and St. Louis are blameless, they will suffer. It's not fair,
it's not right, but that's the world we live in today.
That is the reality we face, and we in Congress recognize it. I
want to assure the markets once again--and I think I speak for all of
us--that we will not be dilatory and we will not add extraneous
amendments. We will not Christmas tree this bill. And we will work in a
bipartisan way to act, and act soon. In the last day it has become
clear to me, that, with the exception of a few outliers in either
party, there is a clear recognition among members of both parties that
we must act and act soon. And it has been good to hear from both
Senators Obama and McCain that they concur we must act, though like us,
they believe changes must be made to the Administration plan.
Still, as I said yesterday as well, we must beware that in taking
actions, we do not choose a bad solution. The markets want action. We
understand that. But if we act so quickly that we create an ineffective
solution, without adequate safeguards, then we risk the plan failing,
which would be an even worse outcome for the markets, for the economy,
and for our country.
Even on Wall Street, $700 billion is a lot of money, and none of
the thousands of money managers would invest that sum without
appropriate due diligence. These hearings, and the discussions that are
happening as we speak, are our Congressional due diligence, and we take
that responsibility seriously and will make intelligent and relevant
improvements to the Administration's plan. We owe nothing less than
that to the taxpayers who have put us in office to safeguard their
economic well-being. It is a sacred trust, and I can say that it is a
responsibility that all my colleagues, both Democrats and Republicans,
whatever philosophical differences, hold very dear.
As I have said, I believe there are three essential components to
that must be part of this plan--T H O--taxpayers, homeowners, and
oversight. There can be no question--and this is non-negotiable--that
we must put taxpayers first. They must come ahead of bondholders,
shareholders and executives and we need to add to the Administration's
legislation those types of protections. I think we must seriously
consider putting this program in place in tranches, or installments--so
that we do not limit the Secretary's ability to act as necessary, but
are able to evaluate the effectiveness of these expenditures over time.
If the program is working, the Congress will certainly ratify
continuing expenditures by the Treasury. But if it is not working, then
we will need to review it before we once again find ourselves on the
brink. I look forward to hearing your thoughts on that today, Mr.
Chairman.
Another idea I've proposed is insurance fund modeled on the FDIC
and paid for by the financial industry that can defray some of the
long-term costs of the Administration plan must also be part of this
legislation. It clearly cannot cover the entire cost. But it seems only
fair that the industry that will receive the vast benefit of this
taxpayer-funded program pay for some share of it themselves. Both
Secretary Paulson and you seemed positively disposed towards that idea
yesterday, and again, I look forward to hearing further from you today
on this as well.
I remain puzzled by the resistance you and Secretary Paulson have
offered to proposals that Senator Jack Reed and many of my colleagues
have made about the need for equity being part of the process we are
discussing. My constituents ask me about it, as do many of the business
people and many of your fellow economists who I've spoken with about
this. It seems only fair that we reward taxpayers if, as we all hope,
this plan succeeds.
We must also do something to help homeowners. Chairman Bernanke,
you yourself have said repeatedly until we find a floor in the housing
markets--and foreclosures are directly related to the housing markets--
we will not solve this problem. And that affects not just those who
made bad mortgages, not just those who will lose their homes through no
fault of their own, but every homeowner. The number of foreclosures and
the price of the average American's home are intrinsically related to
one another and cannot be separated. As we've seen, the complications
of securitization--where mortgages are placed into pools and then
broken up into a large number of securities, has created an enormous
problem. Unlike in the old days, homeowners can no longer go the local
bank, where they got their mortgage, to try to negotiate terms
beneficial for both sides. Instead, since their mortgage has been sold
into a pool with others, they find themselves trapped by servicing
agreements they were never party to in the first place. And that's to
say nothing of the complications presented by second lien holders, who
can often hold entire pools of mortgages hostage because they have
nothing to lose by not co-operating. I remain convinced that judicial
loan modifications, which would allow judges leeway in helping
homeowners facing foreclosure, are an essential step that we must
consider to resolving these problems, and the housing crisis.
Finally--this is the last of what I call the three THO principles--
there must be greater oversight as part of this plan. This
Administration is asking simply for trust. However much we may like
Secretary Paulson or you, Mr. Chairman, no sane person would put 700
million dollars in your hands on trust alone. I cannot in good faith
tell my constituents that ``it's fine, we know they'll do the right
thing.'' Strict oversight is a sine qua non. And when we return next
year, we must develop a regulatory system that fits today's financial
system. While we cannot do that this week, it has become crystal clear
that our system of regulation is broken and must be repaired, if not
entirely replaced.
To close, I would like to add a few words about something that I
worry has gotten lost in our focus on this crisis. As I have said, I do
believe we will act, and I do believe we will fix the financial crisis
we face. But that will not in and of itself fix many of the other
problems that continue to bedevil American families. The economy of the
past eight years has hammered the American middle class. Their incomes
have declined, their healthcare coverage has weakened, the price of
their gas and food have skyrocketed, the value of their homes has
plummeted, and now many of them find their jobs threatened. The plan
the Administration has put forward, with certain modifications, will, I
hope, resolve this current mess, but many other obstacles remain ahead
of us. It is not enough to maintain the status quo. We must find a way
to once again make the American economy the engine of prosperity it
once was for all Americans, and not a casino where we let some earn
extreme rewards by taking excessive risks while the rest of us get
stuck with the bill.
Prepared Statement of Representative Jim Saxton
I would like to join in welcoming Chairman Bernanke before the
Joint Economic Committee this morning. Given the recent financial
turmoil, his testimony comes at a critical juncture in economic policy.
The main cause of the financial turmoil is the collapse of the
housing bubble inflated by various government policies over many years.
Government policies supported by many in Congress encouraged the
expansion of subprime and other risky mortgages that fueled the housing
bubble. Strong Congressional support of Fannie Mae and Freddie Mac
depended on their investment in high risk mortgages for their own
investment portfolios.
In exchange, both Fannie Mae and Freddie Mac showered their
Congressional patrons with generous campaign contributions that
seriously corrupted the political process. Despite warnings for many
years that both Fannie and Freddie were excessively leveraged to a
degree that was dangerous, they continued to inflate the housing bubble
undeterred by their accounting scandals. Now the country will have to
pay a very high price for lending policies highly influenced by
political, not economic, objectives. Given their financial problems
created by a politicization of decision making, Fannie and Freddie have
essentially been taken over by the federal government.
In another startling development, over the last several weeks a
distinct investment banking industry, established by the provisions of
the well-intended Glass-Steagall Act, has essentially ceased to exist.
The independent investment banking business model proved unable to
withstand the stress of the financial market instability wracking the
entire financial structure. These investment banks were highly
leveraged and relied on short-term funds to finance longer term
investments.
Unfortunately, many of these investments were mortgage backed
securities whose value had plunged over the last year. The fact that
the investment banking industry, created by government regulation, has
proven unsound is a reminder that government policies do not always
provide effective solutions, but can in fact create further problems.
As a result, many investors are rightly concerned about the safety of
their savings and investments.
Some action by government is now needed to recapitalize the banks
and other financial institutions either by injections of equity or
removal of toxic investments. In this financial meltdown there is
plenty of blame to go around, but ultimately the American people expect
action to deal with the crisis. One good place to start would be
guaranteeing the safety of transactions accounts to assure savers and
small businesses that their basic financial needs can be met without
disruption.
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Prepared Statement of Representative Carolyn Maloney, Vice Chair
Good morning. I would like to thank Chairman Schumer for holding
this timely hearing to examine the economic outlook, especially in
light of the sobering developments in our financial markets in recent
days and months. I want to welcome Chairman Bernanke and thank him for
testifying here today.
What started out as a subprime crisis last summer has completely
changed the face of Wall Street and created a tinderbox that poses the
greatest threat to our financial system and our economy since the Great
Depression.
Despite a series of increasingly aggressive and unprecedented
actions by the Federal Reserve and Treasury Department, continuing
asset losses and deleveraging have continued to undermine confidence in
financial institutions, choked off the availability of credit, and led
to worrisome concerns about a domino effect from the interlocking
relationships between thousands of investors and banks worldwide.
Americans' economic security, indeed our future, depends on a swift
resolution of this problem. I am hopeful that we can work in a
bipartisan manner to stabilize our economy, but there will be no blank
check for the Administration.
Treasury Secretary Paulson's $700 billion proposal for the federal
government to buy toxic assets is the equivalent of one-quarter of the
entire Federal budget in 2008--more than the total amount we spent this
year on either the defense of our country or the entire Social Security
system.
American taxpayers cannot be asked to pour so much of their good
money after bad. Proper oversight of the Treasury's proposed facility
is imperative, so we are amending the proposal to include a system that
instills accountability. In addition, it would be inappropriate to have
CEOs collecting ``golden parachute'' compensation packages as they
leave their jobs, when taxpayers are on the hook for their mistakes. We
are also pressing for an equity stake in firms in exchange for bailing
them out.
Clearly, the distressed balance sheets of our elite financial
institutions threaten our economic well-being and require government
action. But rising unemployment, continued income stagnation, and the
bursting of the housing bubble are driving household balance sheets
deep in the red at the same time. The housing wealth that consumers
once relied on to fuel their spending--and the economy relied on to
grow--is quickly evaporating as house prices continue their downward
spiral. That's causing consumer spending to drop and sending
foreclosures to record levels--a major source of the problems on Wall
Street.
Ordinary homeowners also deserve some direct assistance. We need to
help them renegotiate their bubble-inflated mortgages so they can stay
in their homes and provide further economic stimulus to avoid a deep
downturn. By providing aid to the states, we can preserve families'
health insurance, extend unemployment benefits, provide energy
assistance, and invest in crumbling infrastructure to create good jobs
at good wages.
We are also working to help protect families on Main Street facing
unfair practices from the credit card industry. Yesterday, the House
passed the Credit Cardholders' Bill of Rights (HR 5422), to provide
crucial protections against unfair, but all too common, credit card
practices.
Finally, our regulatory system is in serious need of renovation
because financial innovation has surpassed our ability to protect
consumers and hold institutions accountable. In order to prevent this
sort of crisis from happening again, the next Congress and the next
President will have to rethink our fragmented system and correct the
systemic risk that we have witnessed.
Mr. Chairman, thank you for holding this hearing and I look forward
to Chairman Bernanke's insights on the best policies for strengthening
the economy.
Prepared Statement of Representative Ron Paul
Mr. Chairman, I believe that our economy faces a bleak future,
particularly if the latest $700 billion bailout plan ends up passing.
We risk committing the same errors that prolonged the misery of the
Great Depression, namely keeping prices from falling. Instead of
allowing overvalued financial assets to take a hit and trade on the
market at a more realistic value, the government seeks to purchase
overvalued or worthless assets and hold them in the unrealistic hope
that at some point in the next few decades, someone might be willing to
purchase them.
One of the perverse effects of this bailout proposal is that the
worst-performing firms, and those who interjected themselves most
deeply into mortgage-backed securities, credit default swaps, and
special investment vehicles will be those who benefit the most from
this bailout. As with the bailout of airlines in the aftermath of 9/11,
those businesses who were the least efficient, least productive, and
least concerned with serving consumers are those who will be rewarded
for their mismanagement with a government handout, rather than the
failure of their company that is proper to the market. This creates a
dangerous moral hazard, as the precedent of bailing out reckless
lending will lead to even more reckless lending and irresponsible
behavior on the part of financial firms in the future.
This bailout is a slipshod proposal, slapped together haphazardly
and forced on an unwilling Congress with the threat that not passing it
will lead to the collapse of the financial system. Some of the proposed
alternatives are no better, for instance those which propose a
government equity share in bailed-out companies. That we have come to a
point where outright purchases of private sector companies is not only
proposed but accepted by many who claim to be defenders of free markets
bodes ill for the future of American society.
As with many other government proposals, the opportunity cost of
this bailout goes unmentioned. $700 billion tied up in illiquid assets
is $700 billion that is not put to productive use. That amount of money
in the private sector could be used to research new technologies, start
small business that create thousands of jobs, or upgrade vital
infrastructure. Instead, that money will be siphoned off into
unproductive assets which may burden the government for years to come.
The great French economist Frederic Bastiat is famous for explaining
the difference between what is seen and what is unseen. In this case
the bailout's proponents see the alleged benefits, while they fail to
see the jobs, businesses, and technologies not created due to this
utter waste of money.
The housing bubble has burst, unemployment is on the rise, and the
dollar weakens every day. Unfortunately our leaders have failed to
learn from the mistakes of previous generations and continue to lead us
down the road toward economic ruin.
Prepared Statement of Senator Sam Brownback
Mr. Chairman, we are at a crossroad. We face the most monumental
economic decisions in modern time. This is not the time to posture in
pursuit of political advantage. Two things are certain: Inaction is not
an option, and we have to get this right. To date, we have dealt with
symptoms of the crisis. We must now deal with the cancer itself.
The American people are angry. They have every right to be. To
most, this looks like just one more example of the government making
them pay for someone else's failures. To paraphrase President Reagan,
they want the government to walk by their side and stop riding on their
back.
This is at its core about the interaction of Wall Street and Main
Street. Absent action, if there is a prolonged period in which credit
stops flowing, there is a severe adverse threat to the financial
conditions of every household, every American family, and every
American business, small and large.
This is not an abstract fear. I am sure that all of us on this
committee have heard real world examples of how this crisis is hitting
the real economy from our constituents and colleagues. For example, a
major automobile seller was unable to obtain funding at workable rates
to finance sales of its automobiles. Since August 2007, 87 lenders have
exited or temporarily stopped making student loans backed by the
Federal government. If your child is counting on a student loan for
next semester's education, it could be tough to get if things continue
the way they have been going. 67% of small business owners, who are the
engines of job creation in our economy, report that their businesses
have been affected by the credit crunch. If we have a prolonged period
in which credit flows virtually dry up, we can count on failures of
businesses to be able to make payrolls, employ workers, and continue
operations. Failure to act can result in severely depressed economic
conditions.
So, I believe that it would be irresponsible to not act. But, I
also believe that we must act responsibly. Acting responsibly includes
looking out for taxpayers as we consider devoting large amounts of
taxpayer funds to resolve matters in credit markets.
First, Chairman Bernanke, I would like you to explain what you feel
would happen if we did not act and credit flows remained frozen for a
protracted period.
Second, I would like you to explain how you think Treasury's
proposal would find true ``hold to maturity'' prices of the distressed
assets that are now being valued in illiquid or non-existent markets at
``fire sale'' prices, at best. If Treasury pays too much for the
assets, taxpayers lose. If it doesn't pay enough, then banks end up
taking severe write-downs, must seek more capital, and are moved toward
selling more assets at fire sale prices.
Third, I would like you to help me understand why it would not be
prudent to protect taxpayers by inserting into Treasury's plan
requirements that those who sell troubled assets provide the taxpayers
with preferred stock warrants. Why, for example, could we not have
Treasury buy troubled assets at fire sale prices, inject capital into
troubled institutions, and obtain preferred stock warrants? We used
warrants when the Federal government backed Chrysler debt.
Fourth, I would like you to help me understand why we should
consider Treasury's proposal of up to $700 billion of value. Would
there not be merit in considering an initial set of purchases of
certain classes of troubled assets in the amount of, say, $100 billion?
Then, we could evaluate results, and move on with $100 billion of
purchases of other of classes of troubled assets. Why would it not be
useful to attack the problem in a sequence of moves, rather than just
one very large authorization? At the very least, we must be sure that
there is adequate transparency and oversight in whatever Treasury ends
up doing.
Fifth, I would like to know whether you believe that Treasury's
proposed plan has any room for loan modifications by the Treasury on
troubled mortgages. The root cause of problems in credit markets and in
the economy seems to be declining home prices. And, to help stabilize
those prices, wouldn't it be advantageous to have Treasury get into the
mortgage-backed securities, separate out the troubled loans and work
out those that can be worked out. It seems to me that that would help
reduce foreclosures, meaning fewer properties placed on an already
over-supplied market, and thereby help arrest declines in home prices.
We have a crisis in confidence in financial markets. And we have
crisis of confidence of the American people in their government. When
an American family seeks to borrow money to improve their home or start
a business or when a small business looks to borrow to expand
operations, they have to explain in detail what they are going to do
with the money, what the collateral is, and how they are going to pay
it back. I don't think the American people are unreasonable in asking
the same questions of this proposal.
I appreciate the help that I anticipate you will give me in
understanding how best to resolve the stresses in financial markets
that pose a very real adverse threat to our overall economy. Again, I
believe that it would be irresponsible not to act. But, I also believe
that we must act responsibly and get this right, including protection
of taxpayers who we are putting at risk.
Prepared Statement of Ben S. Bernanke
Chairman Schumer, Vice Chair Maloney, Representative Saxton, and
other members of the committee, I appreciate this opportunity to
discuss recent developments in financial markets and to present an
update on the economic situation. As you know, the U.S. economy
continues to confront substantial challenges, including a weakening
labor market and elevated inflation. Notably, stresses in financial
markets have been high and have recently intensified significantly. If
financial conditions fail to improve for a protracted period, the
implications for the broader economy could be quite adverse.
The downturn in the housing market has been a key factor underlying
both the strained condition of financial markets and the slowdown of
the broader economy. In the financial sphere, falling home prices and
rising mortgage delinquencies have led to major losses at many
financial institutions, losses only partially replaced by the raising
of new capital. Investor concerns about financial institutions
increased over the summer, as mortgage-related assets deteriorated
further and economic activity weakened. Among the firms under the
greatest pressure were Fannie Mae and Freddie Mac, Lehman Brothers,
and, more recently, American International Group (AIG). As investors
lost confidence in them, these companies saw their access to liquidity
and capital markets increasingly impaired and their stock prices drop
sharply.
The Federal Reserve believes that, whenever possible, such
difficulties should be addressed through private-sector arrangements--
for example, by raising new equity capital, by negotiations leading to
a merger or acquisition, or by an orderly wind-down. Government
assistance should be given with the greatest of reluctance and only
when the stability of the financial system, and, consequently, the
health of the broader economy, is at risk. In the cases of Fannie Mae
and Freddie Mac, however, capital raises of sufficient size appeared
infeasible and the size and government-sponsored status of the two
companies precluded a merger with or acquisition by another company. To
avoid unacceptably large dislocations in the financial sector, the
housing market, and the economy as a whole, the Federal Housing Finance
Agency (FHFA) placed Fannie Mae and Freddie Mac into conservatorship,
and the Treasury used its authority, granted by the Congress in July,
to make available financial support to the two firms. The Federal
Reserve, with which FHFA consulted on the conservatorship decision as
specified in the July legislation, supported these steps as necessary
and appropriate. We have seen benefits of this action in the form of
lower mortgage rates, which should help the housing market.
The Federal Reserve and the Treasury attempted to identify private-
sector solutions for AIG and Lehman Brothers, but none was forthcoming.
In the case of AIG, the Federal Reserve, with the support of the
Treasury, provided an emergency credit line to facilitate an orderly
resolution. The Federal Reserve took this action because it judged
that, in light of the prevailing market conditions and the size and
composition of AIG's obligations, a disorderly failure of AIG would
have severely threatened global financial stability and, consequently,
the performance of the U.S. economy. To mitigate concerns that this
action would exacerbate moral hazard and encourage inappropriate risk-
taking in the future, the Federal Reserve ensured that the terms of the
credit extended to AIG imposed significant costs and constraints on the
firm's owners, managers, and creditors. The chief executive officer has
been replaced. The collateral for the loan is the company itself,
together with its subsidiaries.\1\ (Insurance policyholders and holders
of AIG investment products are, however, fully protected.) Interest
will accrue on the outstanding balance of the loan at a rate of three-
month Libor plus 850 basis points, implying a current interest rate
over 11 percent. In addition, the U.S. government will receive equity
participation rights corresponding to a 79.9 percent equity interest in
AIG and has the right to veto the payment of dividends to common and
preferred shareholders, among other things.
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\1\Specifically, the loan is collateralized by all of the assets of
the company and its primary non-regulated subsidiaries. These assets
include the equity of substantially all of AIG's regulated
subsidiaries.
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In the case of Lehman Brothers, a major investment bank, the
Federal Reserve and the Treasury declined to commit public funds to
support the institution. The failure of Lehman posed risks. But the
troubles at Lehman had been well known for some time, and investors
clearly recognized--as evidenced, for example, by the high cost of
insuring Lehman's debt in the market for credit default swaps--that the
failure of the firm was a significant possibility. Thus, we judged that
investors and counterparties had had time to take precautionary
measures.
While perhaps manageable in itself, Lehman's default was combined
with the unexpectedly rapid collapse of AIG, which together contributed
to the development last week of extraordinarily turbulent conditions in
global financial markets. These conditions caused equity prices to fall
sharply, the cost of short-term credit--where available--to spike
upward, and liquidity to dry up in many markets. Losses at a large
money market mutual fund sparked extensive withdrawals from a number of
such funds. A marked increase in the demand for safe assets--a flight
to quality--sent the yield on Treasury bills down to a few hundredths
of a percent. By further reducing asset values and potentially
restricting the flow of credit to households and businesses, these
developments pose a direct threat to economic growth.
The Federal Reserve took a number of actions to increase liquidity
and stabilize markets. Notably, to address dollar funding pressures
worldwide, we announced a significant expansion of reciprocal currency
arrangements with foreign central banks, including an approximate
doubling of the existing swap lines with the European Central Bank and
the Swiss National Bank and the authorization of new swap facilities
with the Bank of Japan, the Bank of England, and the Bank of Canada,
among others. We will continue to work closely with colleagues at other
central banks to address ongoing liquidity pressures. The Federal
Reserve also announced initiatives to assist money market mutual funds
facing heavy redemptions and to increase liquidity in short-term credit
markets.
Despite the efforts of the Federal Reserve, the Treasury, and other
agencies, global financial markets remain under extraordinary stress.
Action by the Congress is urgently required to stabilize the situation
and avert what otherwise could be very serious consequences for our
financial markets and for our economy. In this regard, the Federal
Reserve supports the Treasury's proposal to buy illiquid assets from
financial institutions. Purchasing impaired assets will create
liquidity and promote price discovery in the markets for these assets,
while reducing investor uncertainty about the current value and
prospects of financial institutions. More generally, removing these
assets from institutions' balance sheets will help to restore
confidence in our financial markets and enable banks and other
institutions to raise capital and to expand credit to support economic
growth.
I will now turn to a brief update on the economic situation.
Ongoing developments in financial markets are directly affecting
the broader economy through several channels, most notably by
restricting the availability of credit. Mortgage credit terms have
tightened significantly and fees have risen, especially for potential
borrowers who lack substantial down payments or who have blemished
credit histories. Mortgages that are ineligible for credit guarantees
by Fannie Mae or Freddie Mac--for example, nonconforming jumbo
mortgages--cannot be securitized and thus carry much higher interest
rates than conforming mortgages. Some lenders have reduced borrowing
limits on home equity lines of credit. Households also appear to be
having more difficulty of late in obtaining nonmortgage credit. For
example, the Federal Reserve's Senior Loan Officer Opinion Survey
reported that as of July an increasing proportion of banks had
tightened standards for credit card and other consumer loans. In the
business sector, through August, the financially strongest firms
remained able to issue bonds but bond issuance by speculative-grade
firms remained very light. More recently, however, deteriorating
financial market conditions have disrupted the commercial paper market
and other forms of financing for a wide range of firms, including
investment-grade firms. Financing for commercial real estate projects
has also tightened very significantly.
When worried lenders tighten credit, then spending, production, and
job creation slow. Real economic activity in the second quarter appears
to have been surprisingly resilient, but, more recently, economic
activity appears to have decelerated broadly. In the labor market,
private payrolls shed another 100,000 jobs in August, bringing the
cumulative drop since November to 770,000. New claims for unemployment
insurance are at elevated levels and the civilian unemployment rate
rose to 6.1 percent in August. Households' real disposable income was
boosted significantly in the spring by the tax rebate payments, but,
excluding those payments, real after-tax income has fallen this year,
which partly reflects increases in the prices of energy and food.
In recent months, the weakness in real income together with the
restraining effects of reduced credit flows and declining financial and
housing wealth have begun to show through more clearly to consumer
spending. Real personal consumption expenditures for goods and services
declined in June and July, and the retail sales report for August
suggests that outlays for consumer goods fell noticeably further last
month. Although the retrenchment in household spending has been
widespread, purchases of motor vehicles have dropped off particularly
sharply. On a more positive note, oil and gasoline prices--while still
at high levels, in part reflecting the effects of Hurricane Ike--have
come down substantially from the peaks they reached earlier this
summer, contributing to a recent improvement in consumer confidence.
However, the weakness in the fundamentals underlying consumer spending
suggest that household expenditures will be sluggish, at best, in the
near term.
The recent indicators of the demand for new and existing homes hint
at some stabilization of sales, and lower mortgage rates are likely to
provide some support for demand in coming months. Moreover, although
expectations that house prices will continue to fall have probably
dissuaded some potential buyers from entering the market, lower house
prices and mortgage interest rates are making housing increasingly
affordable over time. Still, home builders retain large backlogs of
unsold homes, which should continue to restrain the pace of new home
construction. Indeed, single-family housing starts and new permit
issuance dropped further in August. At the same time, the continuing
decline in house prices reduces homeowners' equity and puts continuing
pressure on the balance sheets of financial institutions, as I have
already noted.
As of midyear, business investment was holding up reasonably well,
with investment in nonresidential structures particularly robust.
However, a range of factors, including weakening fundamentals and
constraints on credit, are likely to result in a considerable slowdown
in the construction of commercial and office buildings in coming
quarters. Business outlays for equipment and software also appear
poised to slow in the second half of this year, assuming that
production and sales slow as anticipated.
International trade provided considerable support for the U.S.
economy over the first half of the year. Economic activity has been
buoyed by strong foreign demand for a wide range of U.S. exports,
including agricultural products, capital goods, and industrial
supplies, even as imports declined. However, in recent months, the
outlook for foreign economic activity has deteriorated amid unsettled
conditions in financial markets, troubled housing sectors, and
softening sentiment. As a consequence, in coming quarters, the
contribution of net exports to U.S. production is not likely to be as
sizable as it was in the first half of the year.
All told, real gross domestic product is likely to expand at a pace
appreciably below its potential rate in the second half of this year
and then to gradually pick up as financial markets return to more-
normal functioning and the housing contraction runs its course. Given
the extraordinary circumstances, greater-than-normal uncertainty
surrounds any forecast of the pace of activity. In particular, the
intensification of financial stress in recent weeks, which will make
lenders still more cautious about extending credit to households and
business, could prove a significant further drag on growth. The
downside risks to the outlook thus remain a significant concern.
Inflation rose sharply over the period from May to July, reflecting
rapid increases in energy and food prices. During the same period,
price inflation for goods and services other than food and energy also
moved up from the low rates seen in the spring, as the higher costs of
energy, other commodities, and imported goods were partially passed
through to consumers. Recently, however, the news on inflation has been
more favorable. The prices of oil and other commodities, while
remaining quite volatile, have fallen, on net, from their recent peaks,
and the dollar is up from its mid-summer lows. The declines in energy
prices have also led to some easing of inflation expectations, as
measured, for example, by consumer surveys and the pricing of
inflation-indexed Treasury securities.
If not reversed, these developments, together with a pace of growth
that is likely to fall short of potential for a time, should lead
inflation to moderate later this year and next year. Nevertheless, the
inflation outlook remains highly uncertain. Indeed, the fluctuations in
oil prices in the past few days illustrate the difficulty of predicting
the future course of commodity prices. Consequently, the upside risks
to inflation remain a significant concern as well.
Over time, a number of factors should promote the return of our
economy to higher levels of employment and sustainable growth with
price stability, including the stimulus being provided by monetary
policy, lower oil and commodity prices, increasing stability in the
mortgage and housing markets, and the natural recuperative powers of
our economy. However, stabilization of our financial system is an
essential precondition for economic recovery. I urge the Congress to
act quickly to address the grave threats to financial stability that we
currently face. For its part, the Federal Open Market Committee will
monitor economic and financial developments carefully and will act as
needed to promote sustainable economic growth and price stability.