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



                                                        S. Hrg. 110-856
 
      FALTERING ECONOMIC GROWTH AND THE NEED FOR ECONOMIC STIMULUS

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

                                HEARING

                               before the

                        JOINT ECONOMIC COMMITTEE
                     CONGRESS OF THE UNITED STATES

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                               __________

                            OCTOBER 30, 2008

                               __________

          Printed for the use of the Joint Economic Committee


                  U.S. GOVERNMENT PRINTING OFFICE
48-279                    WASHINGTON : 2009
-----------------------------------------------------------------------
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512ï¿½091800  
Fax: (202) 512ï¿½092104 Mail: Stop IDCC, Washington, DC 20402ï¿½090001


                        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

                              ----------                              

                      Opening Statement of Members

Statement of Hon. Carolyn B. Maloney, Vice Chair, a U.S. 
  Representative from New York...................................     1
Statement of Hon. Kevin Brady, a U.S. Representative from Texas..     3

                               Witnesses

Statement of Dr. J. Steven Landefeld, Director of the Bureau of 
  Economic Analysis, U.S. Department of Commerce, Washington, DC.     5
Statement of Dr. Nouriel Roubini, Professor of Economics and 
  International Business, New York University, New York, NY......     7
Statement of Dr. Simon Johnson, Ronald A. Kurtz Professor of 
  Entrepreneurship, MIT, Cambridge, MA...........................     9
Statement of Dr. Richard Vedder, Distinguished Professor of 
  Economics at Ohio University and Visiting Scholar, American 
  Enterprise Institute (Washington, DC), Athens, Ohio............    10
Statement of Vincent DeMarco, President, Maryland Citizen's 
  Health Initiative, Baltimore, Maryland.........................    31
Statement of Donald C. Fry, President and CEO, Greater Baltimore 
  Committee, Baltimore, Maryland.................................    33
Statement of Joseph Haskins, Jr., Chairman, President and Chief 
  Executive, The Harbor Bank of Maryland, Baltimore, Maryland....    34

                       Submissions for the Record

Joint Economic Committee Report ``Stemming The Current Economic 
  Downturn Will Require More Stimulus''..........................    50
Prepared statement of Hon. Carolyn B. Maloney, Vice Chair, a U.S. 
  Representative from New York...................................    63
Prepared statement of Hon. Kevin Brady, a U.S. Representative 
  from Texas.....................................................    64
Statement of Ben S. Bernanke, Chairman, Board of Governors of the 
  Federal Reserve System before the House Budget Committee on 
  October 20, 2008, submitted by Vice Chair Maloney..............    66
USA Today article ``Majority of Economists in USA TODAY Survey 
  Back 2nd Stimulus,'' submitted by Vice Chair Maloney...........    69
Prepared statement of Dr. J. Steven Landefeld, Director of the 
  Bureau of Economic Analysis, U.S. Department of Commerce, 
  Washington, DC.................................................    70
    BEA News Release ``Gross Domestic Product: Third Quarter 2008 
      (Advance)''................................................    71
    BEA Report ``GDP Declines in Third Quarter''.................    83
Prepared statement of Dr. Nouriel Roubini, Professor of Economics 
  and International Business, New York University, New York, NY..    86
Prepared statement of Dr. Simon Johnson, Ronald A. Kurtz 
  Professor of Entrepreneurship, MIT, Cambridge, MA..............    96
Prepared statement of Dr. Richard Vedder, Distinguished Professor 
  of Economics at Ohio University and Visiting Scholar, American 
  Enterprise Institute (Washington, DC), Athens, Ohio............   104
Prepared statement of Vincent DeMarco, President, Maryland 
  Citizen's Health Initiative, Baltimore, Maryland...............   111
    Baltimore Sun article ``Medicaid Reaches More''..............   114
Prepared statement of Donald C. Fry, President and CEO, Greater 
  Baltimore Committee, Baltimore, Maryland.......................   116
Prepared statement of Joseph Haskins, Jr., Chairman, President 
  and Chief Executive, The Harbor Bank of Maryland, Baltimore, 
  Maryland.......................................................   119


      FALTERING ECONOMIC GROWTH AND THE NEED FOR ECONOMIC STIMULUS

                              ----------                              


                       THURSDAY, OCTOBER 30, 2008

             Congress of the United States,
                          Joint Economic Committee,
                                                    Washington, DC.
    The committee met at 10:00 a.m. in room 106 of the Dirksen 
Senate Office Building, the Honorable Vice Chair Carolyn B. 
Maloney, presiding.
    Senators present: Bennett.
    Representatives present: Maloney, Hinchey, Cummings, and 
Brady.
    Staff present: Heather Boushey, Nate Brustein, Nan Gibson, 
Colleen Healy, Aaron Kabaker, Justin Ungson, Ted Boll, Chris 
Frenze, Bob Keleher, Tyler Kurtz, Gordon Brady, Robert O'Quinn, 
and Jeff Schlagenhauf.

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

    Vice Chair Maloney. The hearing will come to order. I 
believe a meeting should start on time. I know that other 
members are on their way.
    Unfortunately, Chairman Schumer is unable to attend today's 
hearing, ``Faltering Economic Growth and the Need for Economic 
Stimulus,'' and he has asked me to chair this meeting.
    I would like, first, to welcome our panel, Dr. Steve 
Landefeld, Director of the Bureau of Economic Analysis; Dr. 
Nouriel Roubini; Dr. Simon Johnson; and Dr. Richard Vedder. I 
thank all of you for coming, and I welcome my colleague, Mr. 
Hinchey.
    Today's news is bleak. The Gross Domestic Product, which is 
the broadest measure of our economy, fell by 0.3 percent, and 
consumer spending fell by 3.1 percent in the third quarter.
    This news comes on the heels of this week's dismal report 
that the Consumer Confidence Index plunged to an all-time low 
in October.
    All of this provides further confirmation that unless we 
act to bring real relief to Main Street, families will continue 
to suffer serious economic hardships.
    These data indicate that Speaker Pelosi has been right in 
pressing for additional economic stimulus, as Congressional 
hearings this month have shown.
    Over the past year, we have seen the subprime crisis turn 
into a full-blown financial crisis. Many economists now warn 
that we are in the midst of a recession, quite possibly the 
worst in decades, and the impact on families may be devastating 
without government intervention.
    This Committee has been tracking the unfolding economic 
crisis for over a year. In our monthly hearings on the 
unemployment situation, we have seen how the private sector has 
shed nearly a million jobs in 2008, and U.S. workers have lost 
all of the wage gains they had made during the 2000 recovery.
    There is now a growing consensus that Congress should enact 
a second stimulus package and that it should be larger than the 
one we passed in January.
    During recent testimony in front of the House Budget 
Committee, Federal Reserve Chairman Ben Bernanke, gave his 
support to another round of significant economic stimulus, and 
I quote, ``With the economy likely to be weak for several 
quarters and with some risk for a protracted slowdown, 
consideration of a fiscal package by the Congress at this 
juncture, seems appropriate.'' End quote.
    As detailed in a Joint Economic Committee report released 
yesterday, the need for stimulus is urgent. A consumer- or 
export-led recovery is unlikely, because this downturn follows 
the weakest recovery on record.
    [The report, ``Stemming The Current Economic Downturn Will 
Require More Stimulus'' appears in the Submissions for the 
Record on page 50.]
    Even as the economy expanded over the last eight years, 
household incomes never recovered from the last recession.
    Falling home values and rising debt have driven family 
balance sheets to their worst condition in decades, while, at 
the same time, banks have been curtailing access to credit. As 
consumers cut back on their spending, this drags down the 
economy further.
    Economists are also encouraging Congress to recognize that 
during a potentially protracted and deep downturn, concerns 
about budget deficits must be secondary to the goal of getting 
the economy back on track.
    Former Treasury Secretary, Lawrence Summers, has said, and 
I quote, ``The idea seems to have taken hold in recent days, 
that because of the unfortunate need to bail out the financial 
sector, the nation will have to scale back its aspirations in 
other areas such as healthcare, energy, education, and tax 
relief. This is more wrong than right.'' End quote.
    Congress has already taken numerous steps to help buffer 
families from the effects of the downturn. More than 130 
million American households have received a recovery rebate, 
and 3.1 million unemployed workers, have received extended 
unemployment benefits.
    In July, Congress enacted a housing package aimed at 
stemming the tide of foreclosures. As the financial crisis 
worsened this Fall, Congress began a sweeping investigation to 
examine the root of the crisis and lay the foundation for 
action on common-sense regulation of the financial and housing 
industries.
    This is grim news today, but I expect that this Congress 
will act with the current President and the next President to 
get the economy back on track and get America back to work.
    Clearly, we need a new direction on economic policy. 
American families need more help to weather this economic 
storm.
    I want to thank our distinguished panel of witnesses for 
appearing before us today, and thank Chairman Schumer for 
calling this hearing. I look forward to your testimony, as we 
work and help to lay the groundwork for the next economic 
stimulus package.
    [The prepared statement of Representative Maloney appears 
in the Submissions for the Record on page 63.]
    Vice Chair Maloney. I welcome all of my colleagues, and I 
now call on the Ranking Member, Mr. Brady, for his comments. 
Thank you for being here.

    OPENING STATEMENT OF THE HONORABLE KEVIN BRADY, A U.S. 
                   REPRESENTATIVE FROM TEXAS

    Representative Brady. Thank you. I join Vice Chair Maloney 
in thanking the panel of witnesses before us today.
    Congress and the Bush Administration have taken 
extraordinary steps to address this once in a lifetime global 
financial crisis, to unlock the credit markets, restore 
investor confidence, and work with other nations to prevent a 
worldwide financial meltdown.
    Given the resilience of the American economy, averting a 
sustained global recession, will, no doubt, allow us to recover 
much more quickly and strongly.
    But whether these actions are proven a success or a 
failure, depends a great deal on how smartly and timely they 
are implemented. The question now, is not how many more 
financial bills we can force down the market's throat, but how 
effectively they are administrated and given time to work.
    It would be wise, as well, for the financial institutions 
receiving this help, to act responsibly. Hoarding these 
taxpayer dollars or simply using them to swallow smaller 
competitors, does nothing to increase credit for the 
creditworthy or address the crisis in confidence facing this 
nation.
    If these banks choose to use these dollars simply to 
further a competitive advantage, rather than contribute to the 
recovery of our economy, I imagine there will be plenty of 
bipartisan scrutiny within Congress to those irresponsible 
actions.
    As for the need for a second stimulus package, I seriously 
question its effectiveness. Already, there is ample evidence 
that it will simply become a Christmas tree of pet 
Congressional projects, from Amtrak to Medicaid, adorned with 
financial handouts to local and state governments, whose 
spending has outpaced even that of Congress, a remarkable feat, 
given that this Congress is the Usain Bolt of spending.
    Should there be help for the unemployed and struggling 
states? Of course. Are there pro-growth tax measures that could 
help kick-start our economy? Yes, especially, in my view, 
lowering for one year, the tax levy that prevents American 
companies from flowing back an estimated $350 billion in 
foreign profits from overseas, and investing them in new jobs 
and research here at home.
    Could we create jobs by injecting a boost of funding in our 
crumbling highway and bridge infrastructure? If done right, 
probably, but only if we bypass the Federal Department of 
Transportation and inject those dollars directly into bid-ready 
construction projects that can churn over the next 12 months.
    But in the end, there is reality. The last stimulus did not 
work in a meaningful way. The dollars were negated by high gas 
prices, and, to their credit, taxpayers who chose to save their 
checks.
    The last time Congress provided financial aid to the 
Governors, in 2003, many states chose simply to pad their 
growing payrolls, which has only made worse, the financial 
crisis they face today.
    Given the size of our $14 trillion economy, the stimulus 
package is likely too small to have any significant impact. To 
put it in real terms, if the American economy were the size of 
a football field, the stimulus package represents only one 
yard, or if it grows larger, as some propose, two.
    It is difficult to see how that impacts the economic game 
in any meaningful way.
    Congress needs to do all it can to help this economy get 
back on its feet, but cannot forget the dire financial crisis 
of its own. Republicans, to our discredit, did not control 
spending and left control of Congress with an annual deficit of 
$160 billion.
    Democrats, in their first year of control, tripled the 
federal deficit to over $400 billion--tripled, in just one 
year. Worse, at the end of the current fiscal year, 
Congressional Democrats can boast the largest deficit in 
American history.
    And in the good news/bad news scenario, that's what counts 
for good. The bad is that it doesn't yet factor in the cost of 
the financial rescue plan, or the nearly $60 trillion in 
unfunded liabilities in Social Security, Medicare, and 
Medicaid.
    Any stimulus package Congress considers, should be debated 
in the context of both the current economy and the shaky 
financial foundation of the Federal Government. Given that the 
growing American deficit and the looming entitlement crisis, 
was a concern of world markets before the current financial 
crisis, perhaps one signal Congress could begin to send, is 
that we, too, are going to begin to act financially 
responsible, as well.
    With that, Madam Chairman, I yield back.
    [The prepared statement of Representative Brady appears in 
the Submissions for the Record on page 64.]
    Vice Chair Maloney. I thank the gentleman for his statement 
today, and I welcome all the panelists here.
    I would like unanimous consent to put into the record, 
Chairman Bernanke's testimony before the House Budget 
Committee, concerning the second stimulus, and also the survey 
that came out in USA Today, where 74 percent of the economists 
surveyed, backed a second stimulus as a way to soften the blow.
    They did not feel that it would prevent the recession, but 
they believed it would prevent a worse and deeper recession.
    [The statement of Ben S. Bernanke before the House Budget 
Committee appears in the Submissions for the Record on page 
66.]
    [The USA Today survey appears in the Submissions for the 
Record on page 69.]
    Vice Chair Maloney. I would now like to welcome the panel 
and introduce the panel. Also, I welcome all of my colleagues 
that are here today, including Mr. Cummings, Mr. Hinchey, 
Senator Bennett, and, of course, Mr. Brady, representing the 
Ranking Member.
    Dr. Steve Landefeld, has served as Director of the Bureau 
of Economic Analysis since 1995. Previously, he served as Chief 
of Staff for the Presidents Council of Economic Advisors.
    He holds a PhD in Economics from the University of 
Maryland.
    Dr. Nouriel Roubini, is a Professor of Economics at New 
York University's Stern School of Business and is also the Co-
Founder and Chairman of RGE Monitor, an innovative economic and 
geostrategic information service.
    He received an undergraduate degree at Boccini University 
in Milan, Italy, and a PhD in Economics at Harvard University.
    Dr. Simon Johnson is the Ronald A. Kurtz Professor of 
Entrepreneurship at the Sloan School of Management, MIT, and 
recently finished two years as the Director of the IMF Research 
Department.
    Professor Johnson's research focuses on the institutions 
that affect growth and crisis through their impact on 
entrepreneurs of all kinds.
    Dr. Richard K. Vedder, is a Visiting Scholar at the 
American Enterprise Institute, as well as the Edwin and Ruth 
Kennedy Distinguished Professor of Economics and Faculty 
Associate with the Contemporary History Institute at Ohio 
University.
    He received his PhD in Economics from the University of 
Illinois.
    Welcome. Dr. Landefeld, you're recognized for five minutes.

STATEMENT OF DR. J. STEVEN LANDEFELD, DIRECTOR OF THE BUREAU OF 
 ECONOMIC ANALYSIS, U.S. DEPARTMENT OF COMMERCE, WASHINGTON, DC

    Dr. Landefeld. Thank you very much, thank you for inviting 
me to discuss the GDP accounts, especially this morning's 
release. I'll present the highlights, and I ask that the GDP 
release itself, be included in the record.
    In the third quarter of 2008, real GDP decreased, as you 
said, Madam Chair, 0.3 percent, at an annual rate. By 
comparison, it had increased 2.8 percent in the previous 
quarter.
    The decrease reflected declines in consumer spending, 
residential investment, and business non-residential fixed 
investing. By contrast, government spending, net exports, and 
business inventory investment, increased.
    The price index for gross domestic purchases, which 
measures the prices paid by U.S. residents, increased 4.8 
percent, following a 4.2 percent increase in the second 
quarter.
    Consumer spending also, as you said, decreased 3.1 percent 
in the third quarter, following an increase of 1.2 percent in 
the second. The quarter decline in consumer spending, was the 
largest decline since the second quarter of 1980.
    Consumer spending on goods, fell 14 percent, with motor 
vehicles accounting for most of that decline.
    Consumer spending on nondurable goods, fell 6.4 percent, 
which is a rather significant decline for nondurable goods.
    In contrast, spending on services grew 0.6 percent.
    To the other part of the household sector, spending on 
residential investment, fell 19 percent in the third quarter, 
compared with a decline of 13 percent. This is the 11th 
consecutive quarter in which residential investment has now 
fallen.
    Since its peak in the fourth quarter of 2005, residential 
investment has fallen over 40 percent.
    Business nonresidential fixed investment, fell one percent 
in the third quarter, compared with an increase of 2.5 percent 
in the second. Third quarter spending on durable equipment and 
software, fell 5.5 percent, whereas spending on nonresidential 
structures, increased eight percent, much of that being in oil 
and gas drilling and some in manufacturing.
    Business inventory investment contributed this time to 
growth, adding about a half a percentage point to growth. Last 
quarter, it subtracted 1.5 percentage points from growth.
    Exports of goods and services, increased six percent in the 
third quarter, compared with an increase of 12 percent in the 
second. Exports have now increased for 21 consecutive quarters.
    Imports of goods and services, decreased 1.9 percent in the 
third quarter, compared with a decrease of 7.3 percent in the 
second.
    Spending on goods and services by the Federal Government, 
increased 14 percent in the third quarter, compared with an 
increase of 7 percent in the second.
    Most of the increase was in defense spending. Spending by 
state and local governments, increased 1.4 percent in the third 
quarter, compared with 2.5 percent in the second.
    During the third quarter, Hurricanes Gustav and Ike, struck 
the Gulf Coast region, especially impacting coastal Texas and 
Louisiana. Because the effects of these storms are not 
separately identified in our source data that we use to 
estimate GDP, we can't estimate their overall effect on GDP, 
but their impact is included in these estimates.
    In particular, disruptions to oil and gas extraction and to 
petroleum and petrochemical producers, are reflected in our 
estimates for inventory change in the nondurable manufacturing 
and wholesale trade industries.
    As I mentioned earlier, the price index for gross domestic 
purchases, increased 4.8 percent in the third quarter, 
excluding food and energy prices, the price index for gross 
domestic purchases, has increased 3.1 percent in the third 
quarter, after increasing 2.2 percent in the second.
    The personal consumption expenditures price index, 
increased 5.4 percent in the third quarter, after increasing 
4.3 percent in the second. Excluding food and energy prices, 
the PCE price index increased 2.9 percent in the third, after 
increasing 2.2 percent in the second.
    Turning to the household sector, real disposable personal 
income, fell 8.7 percent in the third quarter, after increasing 
11.9 percent in the second. The third quarter personal saving 
rate was 1.3 percent, compared with 2.7 percent in the second 
and 0.2 percent in the first.
    The second quarter increase in real disposable income, was 
boosted by tax rebate payments authorized by the Economic 
Stimulus Act.
    Excluding these payments, real disposable income increased 
0.3 percent in the third quarter, after decreasing 0.4 percent 
in the second.
    Thank you, Madam Chair.
    [The prepared statement of Dr. J. Steven Landefeld appears 
in the Submissions for the Record on page 70.]
    Vice Chair Maloney. Dr. Roubini.

 STATEMENT OF DR. NOURIEL ROUBINI, PROFESSOR OF ECONOMICS AND 
   INTERNATIONAL BUSINESS, NEW YORK UNIVERSITY, NEW YORK, NY

    Dr. Roubini. Madam Chair, members of the Committee, thank 
you for this opportunity to speak in front of the Joint 
Economic Committee.
    I would like to give you my outlook on the U.S. economy and 
on the need for a major fiscal stimulus package, and try to 
dampen the fact of a severe recession on the economy.
    The first observation I will make, is that this is clearly 
the worst financial crisis the U.S. and other advanced 
economies have experienced since the Great Depression. 
Hopefully, given the significant policy actions, the economic 
consequences are not going to be, of course, as severe as the 
Great Depression, but this is a most severe financial crisis.
    The second observation, which is confirmed by the data this 
morning about the third quarter GDP, is that the U.S. right now 
is in a recession, and in my view, and based on the analysis 
I've been doing for quite awhile, this is likely to be the most 
severe recession the United States has experienced in a number 
of decades.
    The last two recessions were relatively short and shallow; 
they lasted about eight months each, in 1991 and 2001, but even 
in 2001, when the economy bottomed out in November of 2001, job 
losses continued all the way through August of 2003, for a 
cumulative loss of jobs of over five million jobs.
    Therefore, even in a situation of a relatively short and 
shallow recession, the economic consequences in terms of 
falling income and employment, can be severe and protracted.
    Based on my own research on the weaknesses of the various 
components of aggregate demand, consumption, cutbacks in 
spending by the corporate sector, residential investment, I 
expect that this recession is going to last at least 18 months, 
if not 24 months.
    This is going to be much longer and more severe and more 
protracted than the average U.S. recession that lasts only ten 
months.
    In a typical U.S. recession, the cumulative fall in output 
is on the order of two percent, and during the last recession, 
that fall in output was only 0.4 percent.
    Unless there is a significant fiscal policy stimulus action 
taken, I expect that this recession might experience a 
cumulative fall in output of over four percent. It is the worst 
we've had since World War II.
    So, things are very, very much stressed, and the most 
important point here, is that the condition of the U.S. 
consumer is very, very strained right now. The last time we had 
a single quarter of fall in real consumption growth, was the 
1991 recession. In the 2001 recession, it was cut backs in 
spending by the corporate sector went bust.
    And as you know, consumption spending is about 71 percent 
of GDP. You have a U.S. consumer that is shopped out, saving 
less, debt burden, and now buffeted by negative shocks, falling 
home prices, falling equities, falling employment, falling 
consumer confidence, high and rising debt ratios and debt-
serving ratios.
    No wonder that the third quarter has seen a very sharp fall 
in consumption spending. And this consumption spending fall is 
going to continue for the next few quarters.
    Unfortunately, the first stimulus package, through the 
direction of tax rebates, were saved by consumers. Why? They 
are worried about jobs, they are worried about paying down 
their credit cards and mortgages, and, therefore, I think that 
is now a need for a second fiscal stimulus package.
    This second fiscal stimulus package, will have to take the 
form of more direct spending by the Government, on goods and 
services, because, currently, the private sector is not 
spending, households are not spending, corporations are now 
worried about the economy and are going to cut back 
significantly on their capital spending.
    And if the private spending is going to fall sharply and 
tax incentives are not going to work, the only other way to 
incentivate and stimulate aggregate demand and prevent an even 
more severe recession, is going to be direct government 
spending in goods and services.
    Of course, you want to have this spending on things that 
are productive, like infrastructure, like investments in maybe 
alternative energy or renewable energy, and you also have to 
provide aid and income to those parts of the economy that are 
more likely to spend it.
    So, aid to state and local governments, is going to be 
effective; increasing unemployment benefits, food stamps to 
people that are poor.
    Another part, of course, of the adjustment, is going to be 
that there is a huge amount of households that are right now 
very much distressed, buried under the burden of mortgage debt, 
credit cards, auto loans, student loans, and we need also some 
reduction through loan modification, of this debt burden, 
because as long as this debt burden stays high, consumers are 
not going to be able to consume.
    So I think that I see the role for a very significant 
fiscal policy package. It has to be large, at least $300 
billion, or even $400 billion, to compensate for the fall in 
private demand, which in the next year, could be on the order 
of $500 billion.
    And this action has to be taken right away, and soon; we 
cannot wait until the next Congress in February, because three 
months from now, the collapse of spending, consumption, and 
investments, will be so sharp that the economic contraction 
could become even more severe.
    So, action has to be taken now, soon, and in a large 
amount. That's going to be the only way we're going to try to 
make sure that this recession is going to be shorter and more 
shallow than otherwise. Otherwise, it's going to be very, very 
severe. Thanks.
    [The prepared statement of Dr. Nouriel Roubini appears in 
the Submissions for the Record on page 86.]
    Vice Chair Maloney. Dr. Johnson?

 STATEMENT OF DR. SIMON JOHNSON, RONALD A. KURTZ PROFESSOR OF 
              ENTREPRENEURSHIP, MIT, CAMBRIDGE, MA

    Dr. Johnson. Thank you, Madam Chair. I'd like to make three 
points this morning: The first is that we are undoubtedly in a 
period of unprecedented global slowdown. I think, measured at 
the world level, we will see a recession of the kind and 
magnitude that we haven't seen since World War II.
    It is very hard to find any country around the world, that 
is immune from this slowdown, and it's very hard to find a 
country that doesn't face severe pressures in its financial 
system.
    As I speak today, these pressures have continued to mount 
in emerging markets, for example, in East Central Europe, but 
also in Latin America and also in parts of Asia.
    These problems are not confined in their implications, to 
those places, because, as we have learned the hard way in the 
past few weeks, the extent of interconnections through finance 
and through trade, means that a problem in one part of the 
world, becomes a vulnerability and then a crisis in some other 
part of the world.
    In particular, I would stress the dangers of connections 
for emerging markets to western Europe. I think that the 
inflexibility of policy in the Euro zone and the rigidities of 
labor markets in the European Union, create the potential for a 
very large problem in, of course, the U.S.'s largest single 
trading partner region.
    The second point I'd like to make, is with regard to 
countercyclical policies in the United States. I do think that 
a great deal of progress has been made on this front since late 
September.
    In particular, I think that monetary policy, very broadly 
defined, has sprung into action, a little bit late, but now 
they're working very hard. In my opinion, Mr. Bernanke is 
working from the anti-deflation play book that he essentially 
published in a speech he made on November 21, 2002, before the 
National Economists Club in Washington, DC.
    He outlines there, very clearly, what one should do, if one 
is running the Federal Reserve and the threat of falling prices 
and all that entails, looms on the immediate horizon.
    I think the Fed continues to be very innovative, and I 
would commend them on the progress that has been made, but I 
also think that some of the measures taken by Treasury, 
particularly the recapitalization of the banking system and the 
moves made towards recapitalizing the insurance industry, are 
very helpful and supportive in this context.
    I would also point out that the measures announced or 
perhaps pre-announced yesterday with regard to housing and 
restructuring mortgages, are a major step in the right 
direction. I think they're coming about a month later than I 
would have preferred, but if they can implement that program 
and if they can, in particular, find ways to restructure 
mortgages that are locked up inside mortgage-backed securities, 
then we will have an important part of the overall approach in 
place.
    All of this means that measuring the scale of monetary 
policy response, is incredibly difficult. It is very hard to 
assess the impact of the amount of liquidity that has been 
placed into the U.S. system and into the global system, 
including, remarkably, the extension of swap lines, again, 
yesterday, to four emerging markets, from the Federal Reserve.
    The third point is directly on the fiscal stimulus. I think 
it is very hard to judge exactly, today, given the global 
dimensions of the crisis, and given the fact that 
countercyclical monetary policy, in particular, is working 
hard, with help from other supportive policies, it's very hard 
to know exactly how much fiscal stimulus will be required.
    I think we probably have a month or perhaps two months to 
really see the direction of the economy. I would agree 
completely with people who think that now is the time to 
prepare a large fiscal stimulus, and because I am so concerned 
about the global dimensions of this crisis and the way those 
can come back to the United States, my written testimony 
recommends, in detail, that we consider a fiscal stimulus on 
the order of $450 billion, let's say, roughly three percent of 
U.S. GDP, which would be an extraordinary measure to take under 
any circumstances, unless you think that we are entering into a 
potentially serious and prolonged recession.
    The timing of your hearings is extremely fortunate, and I 
would strongly recommend that you consider drafting and 
hopefully finding a way to pass this legislation, if it is 
needed, by the end of this calendar year.
    I do think the amounts of money that I'm outlining, can be 
spent well. I outline in detail, some particular 
recommendations in my written testimony, and I'd be happy to 
answer any specific questions you have in that regard. Thank 
you very much.
    [The prepared statement of Dr. Simon Johnson appears in the 
Submissions for the Record on page 96.]
    Vice Chair Maloney. Dr. Vedder?

  STATEMENT OF DR. RICHARD VEDDER, DISTINGUISHED PROFESSOR OF 
  ECONOMICS AT OHIO UNIVERSITY AND VISITING SCHOLAR, AMERICAN 
      ENTERPRISE INSTITUTE (WASHINGTON, DC), ATHENS, OHIO

    Dr. Vedder. Thank you. I guess the economy must be in 
trouble, for the JEC to have a hearing less than a week before 
an election.
    I thank you for the opportunity to speak. I wish to make 
two or three brief points.
    First, economic history tells us that in periods of sharply 
eroding public confidence in financial markets, that this 
erosion does have significant negative economic consequences.
    But it is important to note that these periods do pass, and 
there is some indication that that may be starting to happen 
already.
    I would observe also that this crisis is not simply an 
example of market failure, of irrational exuberance trumping 
common sense. I'm convinced that it's largely a reflection of a 
series of public policy miscues, and in the absence of these 
governmental mistakes, I think this financial crisis would 
never have happened.
    Third, I am very concerned that an overly zealous Congress, 
will craft an economic program that will have adverse economic 
effects, and, unlike the previous witnesses, I am concerned 
that an expansionary fiscal policy in the form of higher 
government spending, would be the wrong thing to do, 
aggravating a potential explosion in inflationary expectations, 
already noted in today's statement of a 4.8 percent rise in the 
GDP deflator.
    And I am concerned that if consumer confidence revives 
suddenly--and it does have a tendency to be volatile--this 
could have detrimental effects on markets.
    Of special concern to me, is the call for the second 
economic stimulus package. If we learned one lesson from the 
era of large budget deficits in the 1970s and so on, it is that 
fiscal stimulus does not promote economic recovery.
    I would note that the earlier stimulus package that went 
into effect, has been followed by a period of falling GDP and 
rising unemployment, rather than the reverse.
    Even in the heyday of Keynesian domination of the economics 
profession, scholars freely admitted that funding governmental 
infrastructure projects, was a dubious way to stimulate the 
economy, simply because of the practical difficulties of 
timing. It takes years, not months, for new appropriations in 
infrastructure, to actually lead to, for example, new roads or 
school construction.
    Very often, any stimulus provided by such construction, 
comes long after recovery has already occurred, creating 
inflationary conditions that could be avoided.
    If you're going to have a stimulus package--and I am 
dubious, given the fact that deficits are likely to be in the 
$600 billion to $1 trillion range, anyway--if you're going to 
have a stimulus package, certainly a tax cut or reduction, is 
preferable to a spending increase that would certainly take 
time to implement.
    And, of course, a tax cut would have some more positive 
long-run incentive effects.
    In conclusion, I would urge you not to panic. The Federal 
Government has taken the most aggressively interventionist 
position ever taken to deal with a crisis of investor 
confidence.
    The impact of all of this, may be to prevent an imminent 
collapse in the financial system--and I think it probably has 
been--but, only, perhaps, at the price of future stagflation, 
declining income and wealth, and a rise in national malaise, 
reminiscent of the 1970s, not the 1930s.
    As I calculate it, the misery index is currently 
approaching 11; it was seven or eight or nine a few years ago, 
which means, in effect, that rising inflationary expectations 
may already be taking hold, and we are already in a situation 
where we cannot move up the Phillips Curve in the way that 
Keynesian economics would suggest.
    I think, in other words, you perhaps have done enough for 
now--maybe more than enough. Maybe the time has come to relax, 
wait a month or two, and allow the healing properties of the 
markets to be asserted again. Thank you for your attention.
    [The prepared statement of Dr. Richard Vedder appears in 
the Submissions for the Record on page 104.]
    Vice Chair Maloney. I thank all of the panelists for their 
testimony. Your complete testimony will be part of the record.
    My first question to each of the panelists, is a simple 
one: Is the United States economy in a recession? And, give us 
any comment you'd like to make about it. Dr. Landefeld--and 
let's get everyone on the record. Are we in a recession?
    Dr. Landefeld. Sometimes people use rough rule of thumb 
that two successive quarters of declining real GDP, is a 
recession. We at BEA do not use that rule.
    We defer to the National Bureau of Economic Research, who 
makes these determinations of the data in business cycles and 
they look at a lot of variables, including real GDP, but, 
prominently, employment figures, in their numbers.
    Whatever we may call it, certainly we are seeing a period 
of dramatic slowdown in economic activity, from a growth rate 
of 2.8 percent in the previous four quarters, to zero.
    I discussed the sharp decline in consumer spending. We all 
know there's been a huge loss of consumer wealth during this 
period. Household disposable income share going to energy, has 
certainly gone up considerably over time, and the economy is 
growing at a rate too slow to generate new jobs, sufficient to 
keep up with labor force growth, population growth, and growth 
in productivity.
    And that's the reason we've seen the uptick in the 
unemployment rate over the past 12 months, and the loss of jobs 
over that period. Thank you.
    Vice Chair Maloney. Dr. Roubini?
    Dr. Roubini. I do believe we are already in a recession, 
and, actually, my analysis suggests that this recession started 
already in the first quarter of this year, when the NBER states 
that business cycle--they tend to look at five economic 
variables: GDP, income, employment, sales and production.
    If you look at the historical data, all five of these 
variables, peaked between October of last year and February of 
this year. So, I expect that when NBER is going to decide 
eventually--and they usually are cautious and wait until the 
recession is over, before they date the beginning of it, and 
they're going to date the beginning of this economic 
contraction to the first quarter.
    Already, the fourth quarter of 2007 data, were revised 
downward from positive to negative, and I expect that when re-
benchmarking of the labor data by the BLS, it will be down 
again. Even the first quarter of this year is going to be 
revised to negative, and, eventually, the NBER is going to date 
the beginning of this recession to the first quarter of this 
year.
    Certainly, the third quarter number now suggests that there 
is a significant contraction of economic activity. Not only has 
GDP fallen, but if you exclude now, inventory adjustment, then 
the fall in the sales of domestic product, is even larger.
    So, when it walks and quacks like a recession duck, it is a 
recession duck, and we are in a recession. Everybody out there 
feels it is a recession. It's obviously a recession. The only 
debate at this point, is how severe, how long, and how 
protracted, in my view.
    Vice Chair Maloney. Dr. Johnson?
    Dr. Johnson. I think the U.S. economy is in recession. I 
think it entered into recession, dramatically, in the late 
summer and particularly in September, with the global crisis of 
confidence in credit.
    I think the danger now, is that we're moving from a 
potential--what was seen previously to be a potential mild 
recession scenario, to a much more dramatic fall and a slow 
recovery.
    And, in that context, I would just highlight only one point 
in addition to what the two previous witnesses said, which is, 
the appreciation of the Dollar that has come about because 
there is so much global fear and so much running into Dollar 
assets, particularly U.S. Treasury assets. The Dollar has risen 
in value, dramatically, particularly over the past month, and, 
this, of course, hurts the U.S. in terms of its ability to 
export.
    That is the brightest part of the picture presented by the 
BEA this morning, and it's been the brightest part of the 
picture for some time.
    So, in addition to all the problems that we've become 
accustomed to in the past six months, and, particularly, in the 
past six weeks, the intensification, we also have to add on to 
that, I'm afraid, a more appreciated Dollar and a much harder 
time for the export sector in the U.S.
    Vice Chair Maloney. Dr. Vedder?
    Dr. Vedder. I like what Dr. Landefeld said, a lot, and I'll 
stick with that. I think the NBER makes the determination of 
when recessions are, not--obviously, we're not in good times. 
Maybe we will be in a recession at some future date, and I 
don't know where we stand with respect to that now.
    An 0.3 percent drop in the GDP, in and of itself, does not 
constitute a recession.
    Vice Chair Maloney. Thank you. My time is expired. I now 
recognize Mr. Brady for five minutes.
    Representative Brady. Thank you. Congress doesn't need much 
of an excuse to spend more. We tend to do it naturally.
    And we've seen this in the last number of years, in a major 
way. Dr. Johnson talked about, I think, appropriately, the 
scale of the monetary actions that have occurred.
    I question the scale of the fiscal actions that would occur 
with the stimulus. We have a $3 trillion federal budget, we are 
overspending it by, this year, $500 billion.
    I question whether increasing that to overspending by $650 
billion, really meaningfully improves our economy. In fact, I 
think it does the opposite.
    I think it raises more questions of consumer confidence, 
does little to improve investor confidence, especially in the 
financial foundation of our country.
    When I look at the scale of the U.S. economy, what I do 
note, that is standing out like a sore thumb in a very good 
way, is our exports across the global marketplace.
    One of the key reasons for government action across the 
world, is to avert a global recession or a sustained global 
recession. Exports have now become a major part of our economic 
growth, not just since a weak Dollar, but fully a year and a 
half beforehand, when the rate of growth of what we sell 
overseas, was better than the rate of growth of what we were 
buying into the United States.
    There is a great effort, I think, to draw walls, to build 
walls, to become more protectionist in this country, rather 
than opening up new markets overseas. I would ask Dr. Landefeld 
and Dr. Vedder, is there a real concern, economic concern, that 
Congress's actions to either close off these markets or to 
refuse to open more markets in Colombia, South Korea, and 
Panama, will that have a negative effect, a significant 
economic effect on the U.S. economy?
    Dr. Vedder?
    Dr. Vedder. I'm not an expert on Colombia, so far, but as 
an economist, I would say that any attempt to prevent an 
expansion of trade, a move towards freer trade, is going to 
have adverse economic effects.
    And what I do know about that agreement, is that the 
potential possible agreement, is that the effects are fairly 
severely negative. And, it's generally consistent with my 
overall view that much of what Congress has done in the last 
year or two, has not been promotive of economic growth, but 
destructive of it.
    Representative Brady. So Congress's actions have hurt, 
rather than helped?
    Dr. Vedder. That's right.
    Representative Brady. Okay, Dr. Landefeld.
    Dr. Landefeld. Well, as Director of a statistical agency, 
we don't comment on policy, but, certainly--
    Representative Brady. But as far as the economic impact of 
exports--
    Dr. Landefeld. The economic impact of net exports, it added 
about a percent during the previous four quarters, and it's now 
added almost a percentage and a half to growth, at a time when 
other things are moving in the other direction.
    So, clearly, it's the bright spot in economic growth and 
one that's at least, up till now, accelerating in its 
contribution to growth.
    Representative Brady. As far as economic scale, that's 
significant.
    Dr. Landefeld. Oh, yes. You know, we're talking about a 
growth rate that fell from 2.8 percent to .8 percent over the 
relative four-quarter period.
    Representative Brady. But exports are--
    Dr. Landefeld. Actually--
    Representative Brady [continuing]. Our ability to sell, 
manufacture, dramatically improved that financial picture?
    Dr. Landefeld. Yes, by a percentage point in the last 
previous four quarters, and a percentage point and a half in 
the most recent quarter.
    Representative Brady. So our ability to sell our goods and 
services across countries, really have been sort of the 
lifeline in our economy here the last four quarters, six 
quarters?
    Dr. Landefeld. The last eight quarters, they have been a 
significant positive contribution to growth.
    Representative Brady. Great. Thank you, Madam Chairwoman. I 
yield back.
    Vice Chair Maloney. The Chair now recognizes Representative 
Hinchey. We're recognizing members in the order of their 
appearance at the Committee. Representative Hinchey.
    Representative Hinchey. Chairman Maloney, thank you very 
much, and, gentlemen, thank you. It's very interesting to 
listen to everything that you've said.
    One of the interesting things about it, is the continuing 
controversy as to whether or not we are in some kind of 
economic decline. It seems obvious to me, frankly, for a long 
time, that this was coming.
    More than 18 months ago, we've been suggesting that our 
economic circumstances were in decline, and we've suggested 
that to people like Chairman Bernanke, but all across the 
board, including Secretary Paulson, the Chairman of the 
Securities and Exchange Commission, Chairman Cox, all of them 
have denied that we were in any economic problem, until 
September when the market collapsed.
    So, it seems pretty obvious that that's the set of 
circumstances we're facing, and it's regretful that no positive 
action was taken to prevent this set of circumstances from 
happening the way that they have, and I think that there are 
things that could have been done.
    One of the principal indicators, is the job loss. Normally, 
what we say, is, you need about 100,000 to 150,000 a month, 
just to sustain economic growth and development.
    In August, we lost 84,000 jobs, and we've been losing jobs 
for a long time. In September, we lost 159,000 jobs. All 
through 2008, we have now lost more than 760,000 jobs.
    The likelihood is that we will have lost perhaps a million 
jobs or more before the end of this year. So, it's pretty clear 
that we are suffering a very serious set of economic conditions 
here, and we need to act upon them.
    And so the idea of a stimulus package, just makes perfect 
sense, provided it's done in the right way. And we have 
obvious, long-time, ignored internal needs, and perhaps 
finally, this is the incentive that this Congress is going to 
need and this President, perhaps, is going to need--we may be 
able to get this done in November. There's a lot of interest 
now in that direction.
    So it seems to me--and I would appreciate your comments on 
this--it seems to me that about $300 billion is necessary for 
internal development, and in simple things that are needed, 
like basic infrastructure, bridges, roads, railroads, advancing 
mass transportation, water supply facilities, sewer treatment 
facilities.
    We know that with water supply facilities, for example, 
based upon history, you invest about a billion dollars, you get 
47,000 jobs generated out of that.
    So that's what we need, we need more jobs, we need more 
strength, we need a stable economy that's going to begin to 
grow, and we need to begin to meet the internal needs of this 
country, which have been ignored now for so long.
    So I would appreciate what you might suggest about that, 
where we should be focusing our attention. I know that Dr. 
Landefeld has laid out a very clear analysis, but he's not 
going to be commenting on the policies very much, so I'd like 
to start with Dr. Roubini.
    Dr. Roubini. I certainly agree with your points. Right now, 
we're facing a very severe contraction of most components of 
aggregate demand. Consumption is in free-fall, spending by the 
corporate sector is in free-fall, residential investment is 
still collapsing, and the only bright spot in aggregate demand, 
net exports, is going to slow down in improvement, for two 
reasons: A stronger Dollar and the fact that there is now a 
recession in the rest of the world.
    Our exports are the imports of other countries. We have a 
recession in Europe, in Canada, in Japan, and emerging markets, 
so there is going to be a sharp fall in our exports along the 
way.
    So I think that we need to do something, and, private 
demand right now, is not going to be incentivated by tax 
rebates, because people are so worried about their debts, about 
their jobs, about their income, that they did not spend the 
first tax rebate.
    So, if the private sector cannot spend and doesn't want to 
spend, the government can spend, and help to boost aggregate 
demand in a situation where aggregate demand is going to be 
very sharply falling, and if we don't do anything, we're going 
to have the most severe recession we've had in decades.
    The other point I would like to make, is that until now, 
we've spent a fortune trying to help and backstop the financial 
system. Think about it: $30 billion for the Bear Stearns; $120 
billion for AIG; $200 billion for Fannie and Freddie, all the 
new facilities of the Fed, TAF, TSLF, PDCF, swap lines, the 
commercial paper fund. The balance sheet of the Fed has been 
increasing from $800 billion to $1.8 trillion.
    If you add up all the support you have given to Wall 
Street, it adds up to something like, already, $2 trillion, and 
we have done almost nothing for Main Street.
    And even if we need to backstop Wall Street, because a 
collapse of Wall Street will have so much collateral damage on 
Main Street, unless we support, also, Main Street, by making 
sure that aggregate demand is not going to collapse, six months 
from now, everything we've done to backstop the banks, is going 
to be undone by collapse in aggregate demand, which is going to 
imply credit losses, non-performing loans, delinquencies, 
mortgage defaults, foreclosures, defaults by corporations, and, 
therefore, if we don't support Main Street, whatever we do to 
support Wall Street, is going to be undone.
    Therefore, we have to do both things. Until now, we've 
spent $2 trillion ahead of us, for Wall Street, and have done 
close to nothing for Main Street, for real America.
    Representative Hinchey. Unfortunately, my time is up.
    Vice Chair Maloney. Senator Bennett is recognized for five 
minutes.
    Senator Bennett. Thank you very much, Madam Chairman, and 
thank you for holding the hearing. It's very timely, and it's 
essential that we go forward.
    I'd like a simple yes or no from each of you on this 
question. Forget all of the surrounding activities with it.
    Was TARP a good idea, the $700 billion, was it a good idea? 
Yes or no? Dr. Landefeld.
    Dr. Landefeld. Again, I'm going to have to dodge this.
    Senator Bennett. Okay. Dr. Roubini.
    Dr. Roubini. My answer is yes, as long as most of the money 
is used in order to recapitalize the banks with public 
injection of capital. I think that buying at high prices, toxic 
assets, was a bad idea, so the current implementation of it, is 
in the right direction.
    Senator Bennett. Dr. Johnson.
    Dr. Johnson. The original design of TARP, to buy distressed 
assets, was a bad idea and remains a bad idea. Using those 
funds to recapitalize the banking system and the insurance 
industry and other financial institutions that may need 
recapitalization, as we head into serious recession, is a very 
good, if not essential idea.
    Senator Bennett. Okay, Dr. Vedder.
    Dr. Vedder. The original proposal that the Senate voted on, 
I reluctantly supported. When you got through revising and 
doing combinations and permutations on it, I was sort of luke-
warmly negative on it, and sort of neutral on the thing.
    Senator Bennett. Okay. You add $700 billion to the national 
debt, our normal activities, independent of that, as has been 
pointed out, are going to add another $500 billion this fiscal 
year.
    And whenever you go into a recession, revenues go down, 
because people aren't earning profits, and, therefore, they're 
not paying taxes on the profits, so the national debt goes up 
that much more, and now we're hearing calls for $350, $400, 
$450 billion in a stimulus package.
    Dr. Roubini, I hear what you're saying about Main Street. 
I'm not sure I completely agree with you, but I understand the 
impulse in that direction, but I ask all of you--and you can do 
a toss-up as to who answers the question--what's the impact in 
terms of the national debt and what it does to America's 
competitive position, what it does--Dr. Johnson, you talked 
about the EU, our primary trading partner.
    We are seeing enormous stress being placed on our fiscal 
condition overall, with these kinds of expenditures.
    I've just got a grudging acceptance that the $700 billion 
addition to the national debt, was probably a good idea, for 
various reasons. Now we're going to add some more with this 
stimulus package.
    Set aside the details of the package. I'd be happy to see 
our infrastructure get improved, not because of the financial 
stimulus, but because it's deteriorating and needs to be 
improved.
    But talk about it from the debt standpoint. Who wants to do 
that? Dr. Vedder.
    Dr. Vedder. Well, I think you're on to a good point, 
Senator. How are you going to pay for this? Are you going to 
print money? Are you going to raise taxes? Or, are you going to 
borrow the money?
    Presumably, we're talking about borrowing. In a financially 
stressed situation, we're talking about going out and 
borrowing, with, if you add $300 or $400 billion on to what 
we're already doing, the better part of a trillion dollars, 
seven to eight percent of GDP.
    I think that is a dangerous and somewhat fiscally 
irresponsible thing to do, and I think, in the long run, it 
will inspire a decline in confidence and will lead to 
inflationary expectations soaring, particularly since I expect 
that some of it will be monetized, because of political 
pressures, leading to greater inflationary conditions.
    Senator Bennett. Anybody else? Dr. Johnson.
    Dr. Johnson. Two points that I think you need to keep in 
mind: The first is that the United States, compared to almost 
all other industrialized countries, has very weak automatic 
stabilizers.
    Other countries have bigger governments, so when they go 
into recession, automatically, they swing into a bigger 
deficit, and that tends to counter the cycle.
    In the U.S., it requires a discretionary decision by 
Congress to have the same sort of countercyclical effect, so 
you have to make a decision to do what, in almost all other 
countries at this income level, happens automatically. That's 
the first point.
    The second point is that the demand for U.S. debt around 
the world, is enormous. This is the counterpart of the lack of 
global confidence. There is one asset that stands out as being, 
without question, the safe place to park your money, and that's 
U.S. Treasury debt.
    So I'm not proposing that you get of a path of medium-term 
fiscal stability and sustainability. Obviously, that would be a 
bad idea, but addressing these pressing needs right now, if the 
situation continues to deteriorate, and increase in the 
deficit, would be a good idea.
    Dr. Roubini. I would add another point, that you have to 
ask yourself: What is the alternative? If the alternative is 
one in which there is no fiscal stimulus and the recession is 
something like a cumulative fall of GDP of 4 percent, then the 
collapse in revenue is going to lead to such a widening of the 
fiscal deficit that actually if you do this fiscal stimulus the 
total effect on the fiscal balance is going to be smaller than 
the alternative. So you ask yourself: If you don't act, what is 
going to be the alternative? And I see a very severe recession.
    So paradoxically, by doing the spending you are going to 
make sure that the fiscal deficit is going to be smaller than 
otherwise.
    Vice Chair Maloney. You are yielding back your time?
    Senator Bennett. Yes. Thank you.
    Vice Chair Maloney. The Chair recognizes Representative 
Cummings.
    Representative Cummings. Thank you very much, Madam 
Chairwoman.
    Dr. Roubini, you said something that I have been saying, 
and I am glad to hear somebody like you say it. We bail out, or 
we tried to bail out Wall Street because we were worried about 
the bleeding into Main Street. And I have said it over, and 
over, and over again: The people in my City are losing their 
houses. They are, with regard to employment they do not have 
Unemployment Benefits. They have run out. So a lot of the 
arguments you are making, Dr. Vedder, folks are suffering 
badly.
    And as I listened to you, Dr. Vedder, I could not help but 
think about the many times I have sat in this hearing room 
right here and heard our experts come up there and said: Wait, 
wait, wait. Well the American people are suffering.
    Now going back to you, Dr. Roubini, I believe that it is 
one thing to bail out Wall Street but when you have got people 
being foreclosed upon who do not have jobs, who are losing 
their houses, who cannot get consumer loans, and I can go on 
and on as you talked about, Dr. Johnson. So you are doing what 
you can on the upper end--that is, Wall Street--but you have 
got to have something down there, like for example the efforts 
by the FDIC to help folks with these mortgages.
    That makes sense because you are stopping the bleeding down 
at the bottom. Because I don't care what you do up at the top, 
if you are not stopping the bleeding of the folks who are 
really suffering you have got a major problem. And it is like 
taking money and throwing it into a bucket with a hole in it, 
as far as I am concerned, if you are not dealing with that.
    So the question that I've got, we spent yesterday in 
another committee that I sit on--and that is the Transportation 
Committee--we spent eight or nine hours talking about a 
stimulus package, a stimulus package which would include 
infrastructure repairs, schools, and also of course creating 
jobs.
    This is my question: When I look at this total picture, I 
realize that one of the things that we want to do, yes, we want 
to inject money into our economy so that people will begin to 
spend, and so that everybody is affected, each job affects each 
construction job, which effects other jobs. The question is: 
What is the impact, and is it significant that it has impact, 
on consumer confidence and investment confidence?
    Those are the questions. Because I was just wondering if 
there is more impact than just the creation of jobs, people 
working--and that is major; I understand that--but I am trying 
to figure out how do we get a handle on this whole problem. 
Because as you all have said, this is monumental.
    The other thing I would ask you, Dr. Roubini, you stated 
that if we do not do something now, that we would basically see 
catastrophic results. And I want you to elaborate on that.
    Dr. Roubini. Yes, to elaborate on some of your points, 
first of all I think there is definitely a perception out there 
in the public that a lot of what is happening right now is 
because of reckless lending and reckless investing and 
arrogance and greed on Wall Street, and now what are we doing? 
We are essentially bailing out those reckless lenders and 
investors.
    Now we have to do it because the collateral damage to the 
real economy is going to be severe, but there is a perception 
out there, and that is why I think the House first voted 
against the TARP Legislation that we had privatized the profits 
and the gains, and now we are socializing the losses. This is 
like corporate welfare for the rich and for the well-connected 
on Wall Street, and there is an element of unfairness.
    So people out there are going to ask you who are spending 
$2 trillion to backstop the financial system what are we doing 
for U.S. housing? What are we doing for Main Street? What are 
we doing for people who are suffering and losing jobs? It is a 
question of efficiency and fairness.
    Leaving aside the fairness point, I think the crucial point 
right now is private demand is in freefall. If you look at the 
latest data on consumption, on residential investment, on 
cutback in spending, even before the shocks of September and 
October were dramatic and now there is a nasty credit crunch, 
aggregate demand was free falling and nothing is sustaining it.
    We have gotten into a situation right now in which Central 
Banks who are supposed to be the lenders of last resort have 
become the lenders of first and only resort because banks are 
not lending to each other. Banks are not lending to 
corporations. And corporations do not have credit and cannot 
spend and invest and hire people.
    So we have a nasty credit crunch. At this point, we have to 
start to do something for Main Street. Because as I said, if 
there is going to be a collapse of economic activity--and all 
the data suggest this is going to be the worst recession the 
U.S. has experienced in a decade--then bailing out Wall Street 
is not going to be enough. Because the losses, and the credit 
crunch, and the defaults are going to rise, and anything we do 
to recapitalize the banks are going to be undone.
    So both in terms of efficiency and fairness, we have to do 
something for Main Street. We have spent $2 trillion of money 
right now to help Wall Street, we can find $300 billion to do 
something for infrastructure, for aiding state and local 
governments, for unemployed, for food stamps is good, is 
necessary, it's fair, and if you don't do it things are going 
to get much worse.
    Representative Cummings. Thank you. I see my time is up.
    Vice Chair Maloney. Thank you. Dr. Roubini, you have 
testified that the U.S. is more likely to experience deflation, 
or falling prices in the coming recession rather than 
experiencing high inflation. And while we have seen falls in 
oil prices recently and corresponding drops in gasoline prices, 
both headline and core inflation remain relatively high 
compared to previous years.
    Could you elaborate on why you believe inflation will fall?
    Dr. Roubini. My view is that six months from now the 
biggest problem that the Fed is going to have to face is the 
problem of deflation. And the same thing, by the way, happened 
during the last recession that was short and shallow by 2002, 
as you recollect, the worry was not inflation but deflation. 
And Chairman Bernanke wrote several speeches about what to do 
if we get close to deflation in terms of nontraditional 
monetary policy.
    Why do I feel there is going to be deflation in the 
economy? Three reasons:
    There is a slack in aggregate demand relative to supply. 
Aggregate demand is falling very sharply. And when that 
happens, the pricing power of the corporate sector is reduced. 
And by the way, we already have price deflation in the sectors 
of the economy where there is this excess of supply: housing, 
consumer durables, and automobiles and motor vehicles. We 
already have deflation in those sectors.
    Secondly, there is a beginning of a very large slack in the 
labor market. The unemployment rate is sharply up. The job 
losses are mounting month after month. When there is a large 
increase in unemployment--it is going to peak above 8 percent--
labor costs and wage growth costs are going to be dampened 
significantly.
    The third reason is that oil prices have already fallen 
more than 60 percent from their peak in July, and other 
commodity prices have already fallen by something like 25 
percent from their peak. In a very large U.S. and global 
economic slump, commodity prices are going to fall from the 
current level by another 20, 25 percent for a cumulative fall 
in commodity prices by 40 percent. So slacking in goods market, 
slack in labor markets, slack in commodity market, and the huge 
excess supply of production of goods--think about China that's 
investing 50 percent of GDP to produce more capital goods for 
export--this excess supply relative to falling demand is going 
to imply that six months from now the Fed, the CB, and most 
advanced economies are going to start to worry about deflation.
    As we know from the experience of Japan, deflation can be 
very destructive. So that is what we have to worry about. 
Current headline inflation and core inflation are still high, 
and it is going to sharply decelerate in the next few months.
    Vice Chair Maloney. What risk would falling prices, could 
you elaborate, what risk would falling prices have on the U.S. 
economy, to Main Street, to the working man and woman? And how 
would the stimulus package fit into this? Would the fiscal 
package help? How would it help? Could you elaborate further?
    Dr. Roubini. Well deflation is dangerous for a variety of 
reasons, as the experience of Japan in the 1990s suggest where 
they had deflation and you had economic stagnation for a 
decade.
    The first risk is that when prices are falling you want to 
postpone consumption until the future rather than consuming 
today, and that reduces further demand and supply.
    Secondly, you get into a situation of a liquidity drop when 
if interest rates are going to go close to zero--and I think 
the Fed Funds soon enough is going to be at zero--if prices are 
falling, you cannot use interest rates below zero in nominal 
terms but the real interest rates are going up, because real 
rates are the difference between the nominal and inflation, so 
inflation becomes negative, real interest rates are going up.
    When you have price deflation there is also this process of 
debt deflation where the real value of the debt, of those who 
have borrowed, increases over time rather than being reduced. 
That increases the debt servicing problems of the debtor, and 
in a situation in which prices are falling and profit margins 
of the corporate sector are falling, they tend to produce less. 
If you produce less, there is less income, less employment, and 
the vicious circle of the contraction in output and employment, 
income, consumption continues over time.
    Situations of deflation are very, very dangerous and the 
situation in which the monetarist policy stimulus becomes 
ineffective. That's why in 2002 Chairman Bernanke wrote a 
series of speeches saying what can we do to prevent the 
deflation from occurring? We have to prevent it again this time 
around.
    Vice Chair Maloney. How will a fiscal stimulus package 
help?
    Dr. Roubini. It helps because in a situation of deflation 
demand is below supply, and because demand is below supply 
prices are falling. So you have to boost demand. And if the 
private sector is not spending and increasing demand by the 
public sector, government spending on goods and services 
hopefully productive stuff that are for the long run like 
infrastructure we need for things that are crumbling is going 
to boost demand and prevent deflation from occurring.
    Vice Chair Maloney. My time has expired.
    Mr. Brady.
    Representative Brady. Thank you for holding this hearing. I 
think it is important to do that.
    Secondly, it is, as we were talking, important to keep an 
open mind on the stimulus package. My concern is that we are 
offering false hope.
    A year ago this Joint Economic Committee met to consider 
the first economic stimulus, and I recall Chairman Schumer, who 
is one of our most engaged and involved Members of Congress, 
state that the only thing standing between America and a 
recession is this Congress.
    We know what occurred. I do not want to present, or market 
this proposed stimulus package as the magic beanstalk that will 
grow America's economy to the sky when it may in fact be closer 
to a bean, where just our deficit spending over the past year 
is three times--in direct spending--is three times the size of 
this proposed stimulus package.
    So I do not think we ought to market it in a way that it 
cannot accomplish. And again, if we can move to help those who 
are unemployed in states that have no job hope, let's do it. If 
we can find ways to create jobs on Main Street, let's do it. 
But let's not present this as the only thing standing between 
an economic collapse and the American public. Because by no 
measure is it.
    My question to the panelists is perhaps on the bigger 
picture. If you look at the last 30 years, we are remarkably 
resilient. We have bounced back from some huge hits, whether it 
is the '87 crash, the dotcom crash, the attacks of 9/11, 
amazingly resilient. It becomes much harder to bounce back in a 
global recession.
    As economists, what should we be--as Members of Congress, 
what should we be looking for as signals on how deep the global 
recession is headed, or what measurements? How much time should 
we allot to see if these global, remarkable actions by 
governments are working? What signals? What measurements should 
we be observing to determine what the global picture is and how 
it is unwinding so that we can measure our responses here in 
the United States?
    And I would open it up to just go down the panel, if you 
could. Dr. Landefeld?
    Dr. Landefeld. Again, I think I will have to not answer 
this question because it tends to get into policy and when one 
should respond at what signal.
    Representative Brady. Thank you.
    Dr. Roubini. My view is that even before the very severe 
financial shocks of September and October, when you look at the 
data for the second quarter of this year, there was an economic 
contraction starting in the Euro Zone. The GDP growth was 
negative. GDP growth was negative in the UK, in the rest of 
Europe, in Japan, in New Zealand, in Canada. So about 60 
percent of global GDP that is the part counted by most advanced 
economies was already contracting in the second quarter of this 
year, well before the very severe financial strains we have 
observed in September and October in the U.S., in Europe, in 
the emerging markets that have now led to more of a liquid and 
a credit crunch, more of a panic, more of a falling business 
and consumer confidence, and therefore there are actually a 
number of research firms on Wall Street like J.P. Morgan, or 
Goldman Sachs who are already estimating the third quarter and 
fourth quarter GDP growth globally is going to be close to 
zero, if not negative.
    And unfortunately now the crisis that started in the U.S. 
and became European and the advanced economies now is starting 
to lead to a hard landing in a number of emerging market 
economies. There is a sharp slowdown of growth in China, in 
Asia, in Africa, in Latin America, in emerging Europe. There 
are about a dozen emerging market economies right now that have 
been subject to this financial tsunami that are on the verge of 
a financial crisis: the Baltic countries, Latvia, Estonia, 
Lithuania, Bulgaria, Romania, Hungary, Turkey, Belarus, 
Ukraine; going to Asia: Pakistan, Korea, Indonesia; in Latin 
America, Argentina, Ecuador, Venezuela, to name just a few.
    So this is becoming a global financial crisis, and it is 
becoming also a global recession. And the consequence of what 
the U.S. is going to be to the rest of the world is 
contracting. The only bright spot in demand was exports. 
Exports are going to start to fall, and that becomes a more 
vicious circle. That is why we have to worry about it and do 
something about it.
    Representative Brady. I'm sure there was my answer in 
there. Dr. Johnson?
    Dr. Johnson. I suggest you can look at three things.
    The first is the interest rates which the market is 
charging, or trading, emerging market debt. This is indicating 
eminent default for a number of countries that I prefer not to 
name in public. Eminent meaning within the next few weeks.
    The second measure is stress within the Euro Zone. There 
you look at the probability of default in the credit default 
swap spreads that are traded for European governments. These 
have come down slightly in the last 24 hours, but they are at 
remarkably high levels. Really we have not seen anything like 
this since the 1930s for developed industrial countries.
    The third measure is the dollar. When everything is going 
back in the world, if the world is going into a deep level of 
recession, people are going to come back to the dollar. Again 
in the last couple of days the pressure has come off the dollar 
a little bit, but the more the world gets worse the more 
investors are going to want to come into the dollar, the more 
they are going to want to buy U.S. Treasuries.
    I think you will know a lot about where the world is 
heading, how deep and how sharp it is, in a month, one month.
    Representative Brady. Thanks, Doctor.
    Dr. Vedder. Well I am kind of old fashioned. When I look at 
the macro economy I look--and like Dr. Roubini--at the basic 
indicators, GDP, and unemployment growth. I do think looking at 
the dollar is fascinating, but I am not sure you can tell for 
sure.
    But getting to your export point, the decline in exports, 
your point earlier, Congressman, about moving towards a greater 
free trade policy and away from protectionism, if there ever 
was a time to do this it would be now, it would seem, in order 
to promote our export growth.
    Representative Brady. Right. Thank you, Doctor. I yield 
back.
    Vice Chair Maloney. Mr. Hinchey.
    Representative Hinchey. Thank you very much, Madam 
Chairman. This has been a fascinating hearing and I thank you, 
gentlemen, very much, for the insight that you are giving us 
here.
    The Gross Domestic Product is the driving force of this 
economy, and now we are seeing that GDP begin to go down. We 
know that the Gross Domestic Product is driven by middle-income 
working Americans, mostly blue and white-collar working 
Americans. They drive the GDP by at least two-thirds.
    And so we know that their circumstances are declining, and 
we know that in order to deal with this situation we are going 
to have to engage in economic growth that is going to create 
more jobs and deal with the internal issues of our country that 
have been ignored for so long.
    I mean, basic, simple things like sewer treatment plants 
which have not been updated since the 1980s; water supply 
facilities, the same thing. You have water supply systems all 
over this country falling apart, just literally falling apart.
    So all of these things, in addition to transportation, has 
to be addressed and dealt with. But it seems also that there's 
at least one other thing. That is, new technology. Very new, 
very sophisticated technology which in many instances is on the 
edge of really doing something very creative, particularly with 
regard to energy.
    This year we are going to spend more than $400 billion 
buying oil from countries outside of the United States. We 
import 70 percent. Obviously we need a new system of energy 
generation. So I am wondering if you can give us some insight 
as to what you think about the development of this new 
technology, particularly new technology which would begin to 
make this country more energy independent.
    Dr. Johnson, if you could begin I would appreciate it.
    Dr. Johnson. Certainly. I think you are making a very 
important point. I think there is a longer term need to invest 
in new technologies relative to energy, and to develop 
alternatives to oil. Oil prices are obviously falling at the 
moment and I expect they will fall further as the recession 
develops, but this is a cyclical development, and I think that 
technology has great promise.
    It takes years of course to bring that technology out of 
the labs, and it takes even more years to bring it to 
commercial fruition. I think though the right way to think 
about the stimulus is in terms of shorter term and longer term 
impact. So shorter term would be income support, it would be 
food stamps, it would be expanding Unemployment Benefits in 
ways I outline in my written testimony.
    Some of the longer term things would also be the kinds of 
infrastructure you are talking about--water treatment, and 
roads, and so on--that would fit as part of the same package. 
And I think supporting technology in that framework makes a lot 
of sense.
    It is going to be a long slog. I think the recession will 
be quite sharp, and it will be three or four really unpleasant 
quarters. And then I think we will start to grow again, but at 
a painfully slow pace, probably not creating enough jobs. So 
unemployment will continue to rise.
    I think in that context what you are proposing, as long as 
there is a short-term impact, we need that I think starting as 
soon as possible, and realistically it is hard to get 
infrastructure going in the next three months, unless you are 
talking about money for maintenance. I think there is a lot of 
good maintenance ideas out there that can be used right away.
    But in terms of developing your projects, that takes some 
time and technology takes a little bit longer. But I think we 
should be thinking out three, four, five years in terms of 
getting this economy back on what will hopefully be a 
sustainable longer term trajectory.
    Representative Hinchey. Thank you, Dr. Johnson. Dr. 
Roubini, would you comment on that, please?
    Dr. Roubini. I agree with you that the issue of energy 
security is going to be one of the most crucial economic, 
financial, and also national security issue for the United 
States, and you have to work on it both on the supply side and 
on the demand side.
    On the supply side, I think there is a huge amount of new 
potential technologies, alternative energy, renewable energy 
that you can develop over time. I mean, it is embarrassing that 
a country like Germany where there is barely any sun is much 
more advanced in solar technologies than the United States 
because we have not given enough support to the development of 
these technologies. That's the first observation. So we can do 
a huge amount of investment in research in all these renewable 
and alternative energy.
    On the demand side I think that the lesson is that probably 
a system of cap and trade is going to be beneficial for the 
U.S. and is going to essentially resolve four problems:
    The revenue from these auctions is going to be able to 
reduce the budget deficit and/or finance investment in 
alternative energy. Our trade deficit is going to fall because 
our demand for imported oil is going to fall. Our dependence 
geopolitically on unstable states that are producers of oil and 
energy is going to be reduced. And we are also going to 
contribute to improvement in global climate change.
    So you get four birds with one stone: lower budget deficit, 
lower trade deficit, less national security risk, and improving 
the environment. That is the direction we have to go both on 
the supply and on the demand side. [Applause.]
    Representative Hinchey. Thank you very much. A lot of 
support here for that, too.
    Dr. Vedder?
    Dr. Vedder. Yes, well, how can you talk against technology? 
It's like talking against motherhood. I'm all for it. But to 
pick up on Dr. Johnson's point, there is a short-run problem we 
have now of a business cycle problem.
    Long-term solutions may be desirable for the country for 
other reasons, and we could have that discussion, but I do not 
know that it is relevant in solving the current problems with 
respect to the economy at the moment.
    In fact, if you want to do an energy fix that will have a 
more immediate effect, I would just simply let people drill 
more in places like Alaska, if that is the goal. But I am not 
versed--I am not an expert on our energy policies enough, 
except to say that I do not think it will do anything for the 
short term problem that we have.
    Representative Hinchey. Thank you.
    Vice Chair Maloney. Senator Bennett.
    Senator Bennett. Thank you. I would be tempted to get into 
this energy debate, and if you want to create jobs you can 
create them a whole lot faster in ANWAR than you can with some 
of these other issues, but I will leave that, tempting as it 
is, and go back to this discussion of commodity prices.
    Dr. Roubini, you say commodity prices are falling from 
their peaks. That's true. And isn't that a good thing? 
Certainly the falling price in oil is a major lifeline to the 
airlines. The newspapers are reporting this morning that some 
of the airlines made long-term commitments at $145 a barrel, 
and now they are stuck with those and they would love to scrap 
those and start making commitments at $65 a barrel.
    That means more jobs in the airlines. That means more 
productivity in the airlines. The falling price of oil has 
enormous benefit to the chemical industry that is dependent on 
petrochemicals as feedstock for what they do. There is 
tremendous benefit to farmers because of the lower price of 
fertilizer, and that means falling prices in food, which deals 
with starvation around the world and helps that, which will 
increase demand.
    So I am giving you an opportunity to go a little farther in 
this because your comment left the impression that the falling 
commodity prices is one of the things we have to deal with, and 
that's terrible, and I think it's true of housing, yes, housing 
prices are falling, but they are falling from unsustainable 
peaks. And we will not have stability in the economy until 
housing prices get down to their intrinsic level of where they 
ought to be as people buy housing for shelter rather than 
buying housing for the purpose of selling it to some speculator 
who is going to buy it to sell it to another speculator who is 
buying it to sell it to another speculator, and that is what 
got us in this trouble in the first place was prices peaked.
    And now we are seeing the actual correction in those peaks. 
Take that and respond a bit, and then I would like some of the 
others to do it, as well.
    Dr. Roubini. Senator, you certainly make a valid point in 
suggesting that eventually the fall in oil and energy price is 
going to be beneficial for the economy and for the strapped 
consumer, given the very sharp rise in transportation cost and 
energy was a very major drain on the disposable income of that 
sector.
    But you have to ask yourself why are all energy and 
commodity prices falling so sharply. They are falling because 
in the commodity market in the short run the supply is very 
inelastic, and if you have a collapse of demand because there 
is a U.S., European, and global recession, then of course 
prices are going to fall sharply.
    So the falling prices is a signal of a malaise or a disease 
that we are entering a recession. Of course once these prices 
are going to fall very sharply, that's going to boost over time 
disposable income and is going to be one of the reasons why we 
are going to spin into an ever declining recession. It's going 
to be the bottom of it.
    An additional observation: While in the short run oil and 
energy prices are going to be falling because of the cyclical 
recession, ask yourself what is going to happen to oil and 
energy prices in the medium-run when the U.S. and the global 
economy gets out of this recession.
    The demand growth for energy is going to be huge, because 
most of the growth in the global economy is coming from 
emerging markets, countries that are industrializing or 
urbanizing like China and India. Their demand growth is going 
to be very large, and the question you have to ask yourself is: 
How much growth in supply is going to be out there in oil and 
energy?
    And unfortunately, most of the sources of supply of energy 
and oil are in a bunch of unstable petro states. One week you 
have trouble in Nigeria. The next week it is Venezuela. The 
next week is Iran. The next week is Iraq. The next week is 
Russia.
    Senator Bennett. Sure, I--
    Dr. Roubini. The growth of supply might be slower than the 
one of demand, and then we have to do something about the 
energy security because outside of this slump prices are going 
to start rising again and again we have the same problems.
    Senator Bennett. I am conscious of the time, and just one 
quick comment. I buy the argument that long-term renewables and 
technology and sustainables are all the thing we ought to go 
to. I believe in that promised land.
    The bridge to that promised land is built out of fossil 
fuels. That promised land is 20 years away. And if we do not 
start increasing our supply of fossil fuels in stable 
countries, including this one that is the third largest 
producer of fossil fuels in the world, then we are adding to 
the instability. So that is a separate question and a separate 
argument.
    Dr. Johnson, you wanted to comment.
    Dr. Johnson. Senator, I think you put your finger on a very 
important irony, or almost a paradox, which is how can falling 
commodity prices be bad? It obviously helps the U.S. consumer, 
it helps firms, as you said. The problem is that--and commodity 
prices falling by themselves, if that is the only thing that is 
happening, would not be bad; that would be good. But it is 
happening in this global context where there is downward 
pressure on other prices.
    For example, the price of imported goods are going to come 
down. The dollar is appreciating and our exporters are going to 
be fighting very hard to sell to us. There is downward pressure 
on the price level as a whole. And that by itself does not 
necessarily add up to a problem unless it also pushes down 
wages. Almost all of our debts are fixed in nominal terms, if 
our wages fall in nominal terms and our debt burden has gone 
up. And when Chairman Bernanke gave his speech saying--which is 
entitled, November 2002, Deflation: Making Sure It Doesn't 
Happen Here, he meant not only deflation, he meant the Great 
Depression.
    The key thing about avoiding the Great Depression is 
avoiding deflation. When our debts are in nominal terms, we 
have falling prices and falling wages, we are going to have a 
much, much bigger problem than the one we are considering and 
really focused on today.
    Senator Bennett. Dr. Vedder.
    Dr. Vedder. As an economic historian I am amused at this 
discussion. Between 1864 and 1896, wholesale prices in the 
United States fell more than 60 percent. We had a 4 percent 
economic growth, and we became the largest economy in the 
world.
    In the 1990s, yes, Japan had, quote, ``deflation,'' but it 
is interesting that the fiscal policy followed during that 
decade was one of great expansion, Keynesian expansion, along 
the lines that are being suggested here. A lot of good it did 
them.
    Senator Bennett. I see my time is up. Thank you, Madam 
Chairman.
    Vice Chair Maloney. Mr. Cummings.
    Representative Cummings. Thank you very much, Madam 
Chairwoman.
    You know I am just trying to put myself in the shoes of the 
people, the people like in every one of our Districts who never 
thought they would lose their job but they lost them and 
continue to lose them. In the City of Baltimore we have an 
unemployment rate of 7.1 percent, almost 20,000 people out of a 
population of less than 650,000 who do not have jobs.
    The duration of unemployment has risen from an average of 
16.7 weeks in September of 2007 to 18.4 weeks in September of 
2008. Additionally, the percent of unemployed who are 
unemployed for more than 27 weeks has risen from 18.1 percent 
to 21.1 percent from September 2007 to September 2008.
    BLS does not report statistics for unemployment greater 
than 27 weeks. However, since the average duration of 
unemployment has risen, and because more than 1 in 5 unemployed 
persons is unemployed for more than 27 weeks, is it not likely 
that there are a large number of unemployed persons who have 
exhausted their Unemployment Benefits even with the additional 
13 to 20 weeks allowed in high unemployment states?
    Also, isn't it likely that unemployment rates will rise 
over the next year, and that many more jobs will be lost adding 
further support for the need for more Unemployment Insurance?
    The reason why I raise this is because, you know, Mr. 
Vedder, when Bernanke testified before the JEC, sitting in one 
of the same seats you are sitting in, and we talked about the 
housing situation, basically he said: It'll work out. 
Everything will be fine. It will be fine. We talked about the 
way unemployment was rising, he said: It'll be fine. It'll work 
out.
    The problem is that a lot of people--I mean, everybody up 
here have people in their Districts who have lost jobs, and who 
will continue to lose jobs. You know, not long ago, everybody 
thought get a Whirlpool job, you know, you would be in good 
shape. You could retire and be fine. But people in Whirlpool 
today and other companies are losing their jobs.
    People in New York, I know many of them have lost jobs. It 
is estimated that by the end of this year 1.1 million people 
will have run out of Unemployment Benefits. So talk about that, 
Mr. Roubini.
    In other words, I was very glad to hear Mr. Brady say that 
perhaps we might want to look at trying to figure out how we 
can help people in areas where unemployment is high, but it did 
concern me--and I do not think there is anybody up here who is 
trying to create false hope.
    It is not about false hope. It is trying to help the 
American people as they go through a very difficult 
circumstance. And you, Mr. Johnson, said--Dr. Johnson, I 
apologize, you talked about how long this could go. You said 18 
months. Or longer? Is that what you're indicating?
    Dr. Johnson. Yes.
    Representative Cummings. Okay, or longer. And it seems to 
me that if you do not have a job, and let's say for example you 
had a consumer loan that you were trying to pay, you are not 
going to be able to pay it. I mean, that is why in some kind of 
way it seems to me we have got to address this whole issue of 
people on Main Street, and we have got to do it now.
    We have got to have a sense of urgency, because the people 
that I represent, you know, they listen to all of this, it 
sounds nice, but they are trying to figure out how they are 
going to survive from one day to another, how they are going to 
be able to afford the gasoline even if it comes down to $1.99 a 
gallon. That is what they are trying to figure out.
    So would you all talk about the unemployment situation and 
how you see it--Dr. Johnson, Dr. Roubini, and maybe even you, 
Dr. Vedder.
    Dr. Johnson. Thank you. In my written testimony I suggest 
very strongly that Unemployment Benefits should be extended 
beyond the current expiration time. I think the Food Stamp 
Program needs to be expanded. I think loan modifications for 
distressed homeowners are very important both to help people 
appropriately and because of the macroeconomic effect. And I 
think that for the longer term programs, job retraining 
programs, or grants are extremely important. They take a little 
bit longer to work. And expanded student loans, and expanded 
small business loans would all address the issues that you are 
raising--part of a broader package that includes 
infrastructure.
    But we are looking at four to five years, I think, of a 
problem, not a four- or five-year decline, but a sharp 
recession followed by a very slow recovery. There is plenty of 
time for all of these programs to work and to address exactly 
the concerns that you are raising, Mr. Cummings.
    Representative Cummings. Dr. Roubini, did you have a 
comment?
    Dr. Roubini. I think the issue with unemployment is going 
to be a very serious one. Even during the last recession in 
2001 which was very short and shallow and lasted only eight 
months, and the fall in output was only a mere 0.4 percent, job 
losses continued all the way through August of 2003. There were 
5 million jobs lost. And there is an agreement that this time 
around this is going to be a much more severe and protracted 
recession because at that time it was only a cutback in 
spending but the corporate sector was falling 10 percent of 
GDP. Right now, there is a beginning of a consumer recession 
and consumption is about 71 percent of GDP.
    So you have a U.S. consumer who is shopped out. He is 
saving less. That burden of debt to disposable income of the 
average household has gone from 100 percent in 2000 to 140 
percent. Now home prices are falling, so you cannot use your 
home as an ATM machine, borrowing against it. The value of your 
401K has sharply fallen, 40, 50 percent. Debt service ratios 
are now rising because of the resetting of interest rates on 
mortgages, credit cards, auto loan, student loans. Consumer 
confidence is collapsing. So everything is going south for the 
U.S. consumer.
    And people said until recently, yes, these are headwinds 
against consumption, but as long as there is job generation and 
income generation people are going to keep on spending. But 
guess what? Now for 10 months in a row employment in the 
private sector has fallen, and for 9 months in a row total 
employment including public employment has fallen. Every 
indicator of the labor market suggests that this rate of job 
loss is accelerating.
    A few months ago we were losing 50,000 jobs per month. In 
August it was 80,000. In September it has already been 160,000 
almost, and is getting worse. Indicators from initial claims 
for Unemployment Benefits, continuing claims suggest that the 
condition in the labor markets are worsening severely.
    There was a piece in The New York Times this morning on the 
front page on massive job losses in New York and New York 
State, and it is not just finance. Everything is related to 
finance. It is tourism. It is restaurants. It is corporations. 
It is law firms. It is services. It is industrial production. 
This is becoming a very, very severe recession, and unless we 
do something to boost incomes and Unemployment Benefits, Food 
Stamps, fiscal stimulus and things to try to make the recession 
shorter and more shallow, this is going to be the worst 
recession we have had in decades. That is why it is urgent and 
important to do something about it.
    Representative Cummings. Thank you.
    Vice Chair Maloney. Thank you for that fine statement. I 
thank all of the panelists. You have really given us very 
insightful and important testimony today.
    I would like to hear you all day long, but we have a second 
panel, residents from Main Street, who will tell us what it is 
like for them in their communities.
    Again, I want to thank all of you for your service here 
today, for your research. It has been invaluable. We appreciate 
it deeply. Thank you, very much.
    Vice Chair Maloney. I'd like to welcome the second panel. 
We are going to be hearing from community leaders from Main 
Street, but I would like to publicly thank my colleague and 
good friend, Representative Cummings, and his staff, especially 
Leah Perry, for their invaluable help in recruiting this panel 
of community leaders from the great state of Maryland.
    I am calling upon Representative Cummings to introduce the 
panel, many of whom are from the District and state he is 
honored to represent.
    Representative Cummings. Thank you very much, Madam 
Chairwoman. We are, indeed, honored to have three of Maryland's 
finest. I really mean that. I've known all of them for a long 
time.
    They give their blood, sweat, and tears every day in their 
jobs, lifting people's lives.
    Vincent DeMarco is President of the Maryland Citizens 
Health Initiative, a coalition of organizations that seeks to 
ensure better healthcare for Marylanders, by promoting 
universal and accessible health insurance.
    Previously, he was Executive Director for the Maryland 
Children's Initiative.
    Donald Fry is President and CEO of the Greater Baltimore 
Committee, the Central Maryland region's most prominent 
organization of business and civil leaders. Mr. Fry has also 
served in the Maryland General Assembly. As a matter of fact, 
we served together, and as a member of the Senate of Maryland.
    He is one of only a handful of legislators, past and 
present, to have served on each of the major Budget Committees 
of the Maryland General Assembly.
    Mr. Joseph Haskins, Jr., is the President of the Harbor 
Bank, one of the top ten African American-owned and operated 
financial institutions in these entire United States.
    He serves as a Director on the Board of CareFirst, Blue 
Cross/Blue Shield, Morgan State University Business School, and 
Security Title.
    He is also a very good friend, and he serves as the Chair 
of the East Baltimore Biotech Urban Development Project and 
Associated Black Charities.
    Thank you very much for the opportunity, Madam Chairwoman, 
to introduce these distinguished gentlemen, and I want to thank 
you all for being with us this morning.
    Vice Chair Maloney. Thank you for helping us put this panel 
together.
    Each panelist will be recognized for five minutes. We'll 
start with you, Mr. DeMarco, and then go to Mr. Fry and Mr. 
Haskins. Thank you.

  STATEMENT OF VINCENT DeMARCO; PRESIDENT, MARYLAND CITIZEN'S 
                HEALTH INITIATIVE, BALTIMORE, MD

    Mr. DeMarco. Thank you, Madam Chairwoman Maloney and 
members of the Committee, and Congressman Cummings, who has 
been a hero of mine for many, many years.
    I greatly appreciate the chance to talk with this Committee 
about how the economic downturn is hurting Marylanders' 
healthcare, and how this Congress can help resolve this 
problem.
    Over the past few years, under the leadership of Governor 
Martin O'Malley, the State of Maryland has made significant 
progress in expanding healthcare access in our state.
    Most importantly, because of the Governor's initiative, and 
after careful balancing of state priorities, Maryland went from 
44th in the country, to 21st, in providing Medicaid coverage to 
adults, and uninsured Marylanders are responding.
    In the three months since the law took effect, over 16,000 
uninsured Marylanders have signed up for coverage, 
demonstrating the great need for this expansion.
    Now, though, this healthcare coverage for tens of thousands 
of Marylanders, is directly threatened by the current economic 
crisis. As you know, the downturn is dramatically lowering 
sales tax revenues, forcing states to reevaluate priorities and 
to cut important programs.
    Maryland is among these states, facing a deficit of 
hundreds of millions of dollars, despite having recently taken 
aggressive measures to deal with the structural budget problem.
    Many of the people who would be hurt in Maryland, if 
Maryland's new Medicaid expansion is curtailed, are in 
particular need of healthcare coverage now because of the 
economic downturn.
    Among the people who are eligible for the new expansion, 
are a plumber on Maryland's Eastern Shore--not named Joe--and a 
single mom in Prince George's County. Both of them had 
healthcare coverage through their jobs until recently when both 
of them lost their jobs and their coverage, due to workforce 
cuts made by their employers, necessitated by the economic 
downturn.
    They both had jobs and coverage; the economic downturn 
comes, and they lost their jobs and their coverage.
    The impact of not having healthcare is devastating. I'll 
give you just one example: There's a sad story of the 54-year 
old brother of Mrs. Judith Campbell of Baltimore City. Ms. 
Campbell told us, and I quote her, ``My brother took his life 
earlier this year, because he found out that he had treatable, 
but potentially fatal cancer, and was turned down by the State 
for healthcare assistance.''
    He worked as a security guard for $8.49 an hour, and his 
company did not offer health insurance. Mr. Campbell would have 
been eligible for the new Medicaid expansion we enacted in 
Maryland. It would be very sad if the economic downturn 
prevented us from fully implementing this expansion and saving 
many other Marylanders from the economic distress, healthcare 
woes, and possibly even death that can result from the lack of 
healthcare insurance.
    We strongly urge this Congress to move quickly to enact an 
additional economic stimulus package that would help states 
like Maryland, pay for critical healthcare needs.
    Specifically, we ask that, in a new stimulus package, you 
include an increase in the Federal Medical Assistance 
Percentage, FMAP, that would provide additional Medicaid 
dollars to forestall significant cuts.
    Increasing FMAP would help Maryland in two important ways: 
First, it would spur economic growth. According to a recent 
Families USA analysis, for every one million dollars in 
additional Medicaid funds that Maryland would receive, there 
would be $2.2 million in additional business activity, 
including 20 new jobs and $765,000 in additional wages.
    A bill that didn't pass this Congress, S. 2819, would have 
given Maryland an additional $111.5 million in federal dollars, 
which would have generated $210 million in business activity, 
1800 new jobs, and $724 million in additional wages. That would 
have been the FMAP increase.
    In addition, if you do the FMAP increase that we're 
suggesting, it would put money directly into Maryland's 
Medicaid program, and we wouldn't have to cut people off who 
are now receiving healthcare coverage, people who really 
desperately need it.
    The FMAP increase is the most important thing we believe 
you could do in the stimulus package.
    In addition, though, besides the FMAP increase, we urge you 
to consider other ways to help keep healthcare alive and well 
in Maryland. Most importantly, pass the SCHIP law; the State 
Children's Health Insurance Program expansion and 
reauthorization. Congress previously passed SCHIP but 
unfortunately, it was vetoed. It's very important that you go 
back and pass SCHIP.
    Additionally, we urge you to do whatever you can to remove 
obstacles that the Federal Government is putting in front of 
us. We want to work with you to achieve healthcare for all at 
the federal level, but until we reach that goal, please don't 
block us from doing what we need to do.
    We passed in 2005, a great new prescription drug law that 
the Bush Administration blocked.
    Please help us by supporting a bill that Representative 
Chris Van Hollen has put in and help us remove the Employment 
Retirement Security Act blocks on state programs.
    [The prepared statement of Vincent DeMarco appears in the 
Submissions for the Record on page 111.]
    Vice Chair Maloney. Mr. Fry.

    STATEMENT OF DONALD C. FRY, PRESIDENT AND CEO, GREATER 
               BALTIMORE COMMITTEE, BALTIMORE, MD

    Mr. Fry. Madam Chair, members of the Committee, thank you 
very much for the opportunity to be here. First of all, I 
commend the Joint Committee for the foresight and initiative to 
pursue an aggressive agenda to achieve our economic recovery.
    The Greater Baltimore Committee has been actively engaged 
in advocating for a significant investment in transportation 
infrastructure in Maryland for a number of years.
    A focus on investment in infrastructure, in my opinion, is 
an appropriate and much needed step that will bring about 
positive results.
    Our nation's infrastructure, both transportation and public 
utilities, are under stress. If we do not invest to repair and 
build to keep pace with growth and changing population and 
employment patterns, the consequences will be enormous.
    We are already seeing intolerable congestion in our 
metropolitan cities. We are seeing longer commute times in our 
expanding outer suburban corridors.
    We're experiencing a stifling of growth and economic 
development as local governments attempt to keep pace with 
increased demands for public water, sewers, schools, and 
transportation.
    The failure to address these challenges, not only affects 
our economic growth, it negatively impacts the quality of life 
we've come to enjoy and cherish.
    At the national level, the price tag to address the 
condition of our transportation infrastructure, power grids, 
water and waste water systems, was placed at $1.6 trillion in a 
report by the American Society of Civil Engineers.
    The National Surface Transportation Policy and Revenue 
Study Commission report, released earlier this year, concluded 
that there was a need for an annual capital investment of three 
to four times what the Federal Government currently spends to 
address the investment gap.
    The cause for this deterioration regarding our 
infrastructure, the backbone of our economic growth, is 
twofold: First, lack of money, but, second, the failure to 
recognize infrastructure investment as a public policy 
priority, essential to economic growth.
    Those two factors have caused a significant backlog in the 
construction of new infrastructure projects, and resulted in 
many states only expending money for the very basic maintenance 
and repair of its systems.
    In Maryland, the state went almost 16 years without a 
significant investment in transportation funding.
    Last year, the six-year transportation plan included over 
90 projects in the planning phase, with not a single dollar 
designated for construction of those projects.
    The estimated total cost of the construction of those 90 
projects, was well in excess of $40 billion.
    Yet, just a few months ago, Maryland deferred $1.1 billion 
in transportation projects, in its current six-year plan, 
citing lagging revenues and uncertainty over federal funding, 
as the cause.
    It's estimated that every billion dollars in federal 
transportation investment, supports approximately 35,000 jobs 
and $1.3 billion in employment income.
    An investment in infrastructure at this time in our 
challenging economic state, would be significant. It would help 
buttress the struggling construction industry that's lost more 
than 600,000 jobs over the past two years, as a result of the 
declining housing market, and tightening credit markets.
    It would stimulate investment in our weakening 
infrastructure and benefit small businesses and minority and 
women-owned businesses, that significantly rely on major 
construction projects to grow and expand their business 
capacities.
    I thank you for the opportunity to address you on the 
importance of infrastructure investment and the vital role that 
it can and should play in your consideration of an economic 
stimulus package. Thank you.
    [The prepared statement of Donald C. Fry appears in the 
Submissions for the Record on page 1116.]
    Vice Chair Maloney. Mr. Haskins.

STATEMENT OF JOSEPH HASKINS, JR., CHAIRMAN, PRESIDENT, AND CEO, 
           THE HARBOR BANK OF MARYLAND, BALTIMORE, MD

    Mr. Haskins. Thank you very much, Vice Chairwoman Maloney, 
and I thank my Congressman, Elijah Cummings, for allowing me an 
opportunity to share thoughts from Main Street.
    I am a Main Street banker. I manage a $300 million bank 
that has experiences that I think would be important for you to 
hear and for me to share. So this is a tremendous opportunity, 
and again I thank the Committee.
    There are five points that I would like to make. I want to 
say first that I recognize that the government has taken very 
serious steps to address the crisis that is before us, the 
crisis that represents an erosion of the public confidence as 
well as an erosion in the confidence of the financial 
institutions.
    But as I look back at the many steps that have been taken, 
what I quickly recognize--and many of my colleagues, and in 
this case I speak both as a community banker from Maryland, but 
also as a community banker representing many other community 
banks across this country--what we see is a program that has 
largely focused on the large financial institutions.
    And while we recognize that there needed to be focus on the 
larger institutions, we also recognize and suggest to this 
Committee that we have got to give attention to Main Street, 
the street where we believe we have not seen any real measures 
taken.
    My five points, and I quickly make them:
    One, subprime. I am fortunate that my institution stopped 
doing subprime loans four years ago. The reason we stopped is 
not because we are smarter than my colleagues, it is simply 
because we recognized that there was too much fraud, too much 
misrepresentation, too much deception, and our due diligence 
process could not ferret out the magnitude of the problems such 
that it made sense for us to continue.
    And so we say to you that those larger institutions that 
continued, they overlooked or did not pay attention the way 
that some of the small community banks did. And when you look 
at the problem you will find that many of my colleagues, as I, 
do not have heavy weighted portfolios of subprime.
    Why am I raising this? I am raising this because as we 
looked at the increase that was made by the FDIC in terms of 
insurance coverage costs, we were increased along with everyone 
else. In many ways we see ourselves helping to bail out our 
larger, bigger brothers. And we questioned whether or not that 
is fair.
    The second point that I would like to make: Many of these 
financial institutions have suffered losses in deposits as the 
larger institutions stumbled. The stumbling created a 
confidence scare, and therefore led to a run on deposits. Those 
deposits are our life blood. We loan those out to the small 
businesses. And so I lost initially about 10 percent of my 
deposit base.
    Fortunately, with the changes made by the FDIC in coverage 
I was able to regain some of those, but not all of it, back.
    The third point that I would make: With the increased 
problems that have plagued the economy, the credit crunch, what 
we have experienced is an increased number of delinquencies and 
defaults. I am running two-and-a-half times what I had 
previously experienced in my worst year. I am a 26-year-old 
institution, and a 37-year banker. So I am not talking about 
something that is new, something that is recent in terms of an 
observation, I am talking about something that is very real.
    Our comment to you is that we at the community bank level 
need to see a stimulus package that helps us address those 
problems of securities, those problem loans to free us up to do 
the business that we need to handle.
    Smaller banks, the fourth point, smaller banks need to have 
you consider having us purchase and sell to you some of our 
problem loans. It frees us up with our smaller staffs, our 
smaller operations. We are committing our time to work out 
rather than giving money to desperate leaders, or desperate 
businesses in our communities.
    I know my time is up, but I've got to make one more point, 
and I'll leave my fifth one out. What I see every day, and what 
I am experiencing every day, are the small businesses that you 
won't hear from like the cleaners. The local cleaners are 
seeing less business because people are being laid off.
    I finance about 15 different cleaners. And so when I talk 
to them, they say to me: Mr. Haskins, we're not getting the 
same business. Restaurants, because larger companies don't like 
restaurants, we have been key in financing restaurants.
    Restaurant business in Maryland is down 50 percent. I would 
suspect and suggest that it probably represents that kind of 
number across the country. I also say to you that many of the 
larger banks have approved loans to businesses, and I can give 
names if necessary but I won't because of confidentiality, but 
those same businesses originally had approved loans and later 
were called to say that they could not be financed, and they 
have come to me for that financing.
    Ladies and gentlemen, in closing I say to you that there 
are hard times on Main Street. One of the fastest ways to get 
funds and money into the hands of these businesses that are 
vital to Main Street survival is by supporting the local 
community banks, those that know the community and deal with it 
every day.
    Thank you, very much.
    [The prepared statement of Joseph Haskins, Jr., appears in 
the Submissions for the Record on page 119.]
    Vice Chair Maloney. I thank all the panelists for your 
testimony. It is important, and very relevant.
    I would like to recognize my good friend Representative 
Cummings for the first questioning period and thank him again 
for helping me assemble this panel.
    Representative Cummings. Thank you very much, Madam 
Chairwoman.
    Mr. Haskins, many small businesses have had problems with 
lines of credit. I have had a number of businesses to tell me 
that the larger banks cut off their line of credit, and so they 
were placed in a position where they could not do business, 
literally could not do business.
    You might want to address this, too, Mr. Fry, but how does 
that affect you? I mean, have you seen some of that? In other 
words, is that a problem in our area?
    Mr. Haskins. It is a serious problem. I can tell you that 
we finance many of the small businesses, including law firms. 
For example, I have law firms that have had lines of credit 
with me for as long as five years that have never borrowed on 
those lines. They are now borrowing on those lines.
    I have those who are in the construction business who are 
in the middle of projects, and because their lines have been 
reduced and cut off at other institutions have come to me for 
payroll. And I can tell you that my cell phone rings endlessly. 
Before coming into this meeting, I had an individual calling to 
make payroll tomorrow. I mean, my views and my comments are 
very real. They are individuals that we can talk about and we 
can look at.
    There are people that you know that are calling me at this 
very moment seeking financing for projects that they are 
engaged in but they do not have the operating income to carry 
them forward.
    Many of the larger institutions, because of the challenges 
that they are experiencing, have cut off lines to smaller 
businesses. That is very real. That is not something that is 
made up. I mean, there are names and individuals that we can 
point to that are reflective of that situation.
    Where they turn is they turn to the community banks because 
they believe we understand and have a better and deeper 
appreciation for their need, and will find a way to try to get 
financial resources to them.
    Representative Cummings. One of the things that in our 
research--I also sit on the Government Reform Committee where 
Ms. Maloney and I are doing investigations with regard to all 
of this--and one of the things that we discovered is that a lot 
of the larger banks seemed to be careless with some of their 
lending requirements because they knew that they could sell 
them off to others.
    And as I listened to your comments about when you said that 
Harbor Bank stopped performing subprime loans four years ago, I 
am so glad you had the foresight. I assume you might not be in 
business today if you had stayed in there. Is that right?
    Mr. Haskins. That is a fair and accurate comment. You know 
it is easy when--and again this was not to be critical--there 
was a greed factor, and this Committee and others must accept 
that there was a greed factor that motivated that. The brokers 
that largely put together many of these deals would present 
them to the smaller banks, or to the different community banks, 
and the banks tried to do initial due diligence. It became 
challenging to do the due diligence.
    And because you were not holding that portfolio in your 
bank in your inventory, you packaged it, pooled it, sold it off 
to Wall Street to the Bear Stearns, and the Lehmans and so 
forth, and what they did is they reconfigured it and sold it 
around the world.
    Many of us, you know, in business school--and I am both an 
economist and a finance-trained individual--some of the 
training we go through is if you diversify enough you can 
diversify away risk. We are kind of trained and taught that.
    Well, you know, one could make a case arguing that there 
was diversity in it. Well we had geographical diversification 
because these pools were coming from across the country. There 
was income diversification. You had high income, low income. 
You had large house, small house. So you could argue that there 
was a lot of diversification.
    But the underlying problem to those toxic securities was 
the fact that you had too much fraud that was in. I mean, we 
saw misrepresentation of employment history. We saw altered 
credit scores. We saw fraudulent incomes. That ``stated 
income,'' any serious banker who has been around, ``stated 
income'' was a no-no.
    When I bought my first house I worked five years to 
accumulate my 20 percent down. We had an old rule-of-thumb. We 
said you should never buy a house for more than two-and-a-half 
times your gross income.
    Well we can look back and see that people were buying 
houses five, as much as ten times their income, because many 
times the income was stated at levels substantially higher than 
what they were actually earning. But there was no real due 
diligence done, and so for the problems to be resolved we have 
got to work that back through.
    But to the economic stimulus package, the reason why Main 
Street banks and financial institutions are important is 
because many of these individuals are coming back to us. We 
didn't create the problem, but we can help be a part of the 
resolution.
    Representative Cummings. Do you see much of a default rate 
with regard to your mortgages?
    Mr. Haskins. We have defaults. We have increasing 
delinquencies, and what we are trying to do is work with 
individuals. Our biggest challenge is working with the 
commercial clients.
    Many of the borrowers now are suffering, and we will see 
tremendous fatalities over the next six to twelve months if 
more financial resources are not moved into the direct hands of 
community bankers. It's too long for that money--it will take 
too long for the money to trickle down from the larger 
institutions.
    For example, many of the largest institutions' credit score 
small business. It's hard to credit score a business. So if 
that small business doesn't meet a credit score that's 
acceptable, they don't get the business.
    Well our experience reflects to us that there are 
extenuating situations, or there are different factors that you 
need to look at for making that loan other than just a credit 
score.
    Representative Cummings. I see my time is up. Thank you.
    Vice Chair Maloney. Mr. Brady.
    Representative Brady. Well thank you to the panel, 
especially those who have Congressman Cummings as their 
Representative. He is one of the more respected Members of this 
body, and we appreciate his work on a wide range of issues. You 
have got a class act there.
    Was that on TV? [Laughter.]
    Representative Brady. No, I'm kidding you. I'm kidding you. 
[Laughter.]
    Representative Brady. No, I mean I'm sincere about that.
    I do think there is merit in rebuilding our crumbling 
infrastructure. It is really an embarrassment. And whether we 
do it through this economic stimulus or really come together, 
Republicans and Democrats, on fixing the Highway Trust Fund, 
energizing our Freight Rail infrastructure, our water 
infrastructure, we have got to act.
    I do think there is a way we could bypass our federal 
middleman and inject dollars directly into bid-ready contracts 
back home. I actually think that that could create jobs at the 
local level, and fix just a looming problem we have, especially 
in fast-growth areas of the country, and then in the rural 
areas where they just don't have the resources to keep their 
roads and bridges safe at all.
    On the banking side, you sound just like my community banks 
in southeast Texas. When I was looking at the bailout package, 
I didn't get on the phone to talk to people from Wall Street, I 
talked to our community bankers. I got them on the phone and 
started asking them questions, and they made the same points 
you did, which is:
    One, you are scaring our depositors. You know, we don't 
have these problems. We didn't make these bad loans. We are 
running these things right. Stop scaring them. Which is why I 
think increasing the FDIC limit was helpful to reassure people, 
look at the community banks, the independent banks, they have 
got a very sound structure.
    They also made the same point you did, which is give us a 
chance to buy some of these mortgage-backed securities and some 
of these things because we know how to work a loan out. We 
think there's value in loans, if you know who the people are, 
if you will work with them and try to find the terms that, if 
they can, keep them in their homes. Keep the property values up 
and the quality of life in that neighborhood. They said exactly 
the same thing you did.
    My question is, Mr. Haskins, ought we not, as we go forward 
to try to prevent this from happening again, ought we not 
consider sort of back to the future? Going back to the basis of 
a down payment, even a minimal one, on home purchases? Have 
verifiable income so that you know there is an income stream?
    Perhaps having lenders, whether it is the original lender 
or the first purchaser, either hold those for a period of time, 
or keep a stake in them so that their standards are going to be 
higher at the outset before you allow bad loans to become an 
infection throughout, as we know now, the world? You know, that 
there would actually be value in them before that occurs? Is 
there merit in us insisting that those nonbanking institutions 
have the same scrutiny, same capitalization rate, the same 
leveraging restraints that our local banks have?
    Because it seems like to a layman these complicated 
financial instruments are way over many of our heads, and I am 
not sure if we can ever be smart enough to regulate the back 
end of all that. But it seems to me that if we set a good 
foundation early on in that whole asset-based financial 
structure, that we really limit the mischief later on.
    Can you give me your thoughts?
    Mr. Haskins. I think your comments are just so right on. 
Many of my colleagues in the banking worlds made the early 
statements that we were being sort of driven out of the 
origination market on residential mortgages because we were too 
conservative.
    We were trying to hold folks to those standards. We got the 
development of an industry, the brokers, who did not make any 
money unless a transaction was consummated. A deal had to be 
done.
    Then banks started getting very liberal--and I won't call 
names; you all have heard them and seen them--and banks started 
getting creative with the kind of products that steered away 
from that traditional kind of approach. And so we looked at 
teaser rates. We looked at adjustable rate mortgages. We looked 
at interest-only. We looked at stated income. And so we got 
creative because what we saw is an opportunity to make money.
    And if you get too much into that money-chasing vein, you 
are going to start overlooking what you need to overlook. And 
if--and going to your recommendation--if we start moving back 
to a policy of requiring people to have money, first of all I 
think you should never have an unregulated body such as the 
brokers were. They ought to have some standards.
    And I am not a big government kind of person, but you have 
got to have some standards and some regulation there. But we 
ought to require people--I mean, there is an old adage, and 
this I did not learn in business school, I learned this--if 
folks don't have some skin in the game, there is nothing to 
hold them to the table. And that's what you're talking about.
    That person who had to work to get their down payment is 
much more likely to be a good payer of that mortgage. They just 
are. I mean history is replete with evidence and examples of 
that.
    So I think while we talk about home ownership and say that 
it is the American dream, it shouldn't be the American dream if 
we are loaning somebody 100 percent of the mortgage and giving 
them the down payment. I mean, what do they really have at 
stake?
    So I would be one that would argue that absolutely you 
ought to have a requirement for someone to have something from 
their personal financial resources that is verifiable, and you 
certainly ought to require verification of work status as well 
as income.
    So I think you are right on. And if you are going to 
promote that, you can call me and I will be happy to come 
testify.
    Representative Brady. Thank you, sir, I appreciate you 
being here today.
    Vice Chair Maloney. Thank you for your testimony. And 
Congress did pass a Mortgage Reform bill that brings the 
broker/dealers under the same regulation as banks and community 
banks, and as we know the main problem was with the broker/
dealers that had no regulation. Your points are very clear and 
important on going back to the future to standards of having 
skin in the game and higher standards going forward.
    In your comments, Mr. Haskins, you said that your default 
rate and delinquency rates have increased. I would like to get 
a little more information on your bank's credit card accounts. 
Have they increased? Commercial real estate, what is the state 
of that? Residential real estate, auto loans, and other 
personal loans? If you could go through those categories and 
give us a sense of default or health that you're experiencing 
in your bank.
    Mr. Haskins. I would tell you that in all of the categories 
that you mentioned, to be quick, and then I can get specific, 
to be quick about it, have increased in delinquency some 30 to 
50 percent just automatically, I mean we saw increases.
    Credit cards are at the highest levels. So you're not 
talking about people now who have any access to credit. You're 
talking about people who have exhausted their credit.
    In the case of home equity lines, those lines are up to 
their max, so there's no place for them to go. And now they are 
delinquent on those. So we're seeing that piece.
    When we talk about residential developers--and that's the 
area probably where I'm experiencing the most difficulty--the 
residential developers that we have financed are those who are 
doing somewhere between 5 to 50 units, and they're in the 
Baltimore Metropolitan Area.
    These individuals are harder pressed for larger 
institutions to do. Now fortunately we have a lot of equity. We 
force our builders to put more of their money into the 
buildings. So while we don't have the same exposure, what we're 
seeing now with--and this is a bit of the challenge. See, many 
of the larger banks, as they get access to these resources, 
they then sell and turn over their products at substantially 
lower prices, which then drives down the price that we can get.
    So you get this kind of conundrum going on here that is 
really interesting. So because X bank, not to call the name of 
one, X bank, we have the same financing in the same community, 
and so because they have gotten a nice award they can sell off 
their project for 50 percent of the value, where if they didn't 
have the award they would be like me negotiating to get 80 
percent of my money.
    But when they get 50 percent of the money, then the next 
person that comes along that I'm negotiating with will say, 
well, X bank sold it for 50 percent on a dollar, why are you 
trying to get 80 percent on the dollar? Which is the reason I 
am coming back to the importance of getting this stimulus 
package down to Main Street to community bankers, because we 
are dealing with that every day person. We are putting folks in 
houses. We are still doing product and projects that other 
banks have since turned their backs on.
    So, yes, I am experiencing delinquencies. Fortunately, we 
have remained profitable through this. But when regulators come 
in, we are being asked to reserve for loans, by the way, which 
is very interesting, loans that are not delinquent but because 
they are in residential real estate we've got a reserve against 
those because the residential market is down.
    So there are many challenges that we are experiencing. And 
one last point--
    Vice Chair Maloney. Could you clarify when you say you have 
to reserve against those? Do they have a specific capital 
requirement, or what is the reserve that they make you put in 
for residential real estate?
    Mr. Haskins. For example, if it's assumed that--and they 
will come up with several different indices to determine, so 
for example you take let's say a $100,000 loan. If no property 
has been sold, or if this project is in the middle of its 
development, they will come in and give an assessed value of 
the lot and an assessed value of the house at the end of its 
completion. And if they assess that the value of this is 
$80,000 and not $100,000, then that loan becomes what's known 
as ``classified,'' and there are different states of 
classification.
    Then we are required to set aside 20 percent, $20,000, in a 
reserve in anticipation of that loan not paying off or 
defaulting.
    Vice Chair Maloney. Thank you.
    Mr. Fry, I would like to focus really on a concern that we 
have heard repeatedly on the fiscal stimulus to support state 
infrastructure spending and other infrastructure spending in 
our country.
    We know it is in dire straits. We know we have bridges 
crumbling. We have roads that need to be repaired. But many of 
our colleagues will say that this is not a good direction to go 
in because it's not immediate. We cannot spend those dollars 
immediately.
    I know from my own City of New York we have many projects 
that have stopped because of lack of money. We could start 
those projects moving immediately, and I would like to 
specifically ask you: Are there projects that have been 
postponed only because of financing problems that could be 
started immediately in your state if there was a fiscal project 
directed towards its infrastructure?
    Mr. Fry. I appreciate the concerns of those that are 
worried about the lag that may occur before a project moves 
forward, and that certainly could be true with respect to some 
projects that are in the planning mode, but even as recently as 
yesterday Maryland's transportation Secretary, John Porcari, 
before the House Transportation and Infrastructure Committee 
testified that he has identified as many as three dozen 
projects totalling about $150 million that could be obligated 
within about 120 days.
    So I think that because of the deferral that has occurred 
recently because of the lagging gas tax revenues that have come 
in, and the lagging sales taxes that have come in from the 
sales of cars and registrations, that there are a number of 
projects that had to be deferred that could have some immediate 
impact if those monies were available.
    I think you do have to pick and choose which projects are 
there, but I think the transportation secretaries of the states 
across the country could clearly identify those projects that 
could have that immediate impact.
    Vice Chair Maloney. Thank you very much. My time has 
expired. Mr. Cummings.
    Representative Cummings. Thank you very much, Madam 
Chairwoman.
    Mr. DeMarco, let me just ask you this. I think there are a 
lot of Americans who are suffering, and I say that they are 
dying every day in large numbers because they cannot afford 
medicine, and sometimes cannot afford treatment.
    I take it that these are the people you are concerned 
about, and your organization is concerned about. I live in the 
inner city in Baltimore and I have a fellow who showed me his 
medical bills for cancer. He had to have four chemotherapy 
treatments. The bill was $12,000 a treatment. He had insurance 
now. And he had to pay $1,172 of that.
    He had to have something else called Nulastin after every 
treatment. Just for a little prick in the arm of Nulastin it 
cost him something like $6000 or $7000. He had to pay $500-and-
some for that.
    And that does not even include the MRIs and the PET scans 
and the CAT scans and all the other things. And then when we 
look at bankruptcies we see in the United States that a huge 
percentage of bankruptcies have to do with medical bills. 
People can't pay them.
    And so in order to address that--and I say it's sort of a 
silent kind of problem because people suffer, and a lot of 
times they suffer but they don't talk about it to other people 
because it's so personal, but when I move around and I go 
throughout my District and I talk about this, I mean literally 
I see people sitting in the audience with tears running down 
their faces because they are going through it, or a family 
member is going through it.
    You gave an example in your testimony, but do you see a lot 
of that? Do you all hear a lot of those kinds of cases where 
people just hit the end of the rope? And there is another thing 
that is happening, too, that my constituents tell me about, is 
like when people get a little older and they have to make 
difficult choices, and they see that medicine may cost them, it 
may be only $2000, $3000 a year, but that $2000 or $3000 when 
you do not have very much income is a lot of money, and so they 
will say: You know what? I don't want to burden my family. I am 
already a little older. So just let me die so that they will 
have a chance to live.
    I mean, do you hear about those kinds of stories?
    Mr. DeMarco. Yes, Congressman Cummings, we do. We have had 
public hearings across the State where we constantly hear 
people telling us of devastation caused to their families 
because they cannot afford health care.
    You are right that some studies say that up to half of all 
bankruptcies are caused by health care bills that cannot be 
paid. Foreclosures happen a lot of times because people cannot 
pay their health care bills or have to put their money into 
staying alive so they cannot pay for their homes. There is a 
study by Families USA showing that. And it is just over and 
over again we see the devastation caused by people not having 
health care.
    I told the story of Ms. Campbell's brother. There is 
another story of a gentleman who was the kind of person we all 
talk about who does the right thing. He works as hard as he 
could every day. He did not have a high-paying job and he could 
not get health care at his job, but he had to keep working. He 
could not stop working, and he just kept working and kept 
working and did odd jobs here and there to just feed his 
family, feed himself, but he could not pay for health care. So 
he had some health problems and he just could not deal with 
them. So, okay, he just kept working.
    One day he was mowing somebody's lawn as part of his job 
and he had a heart attack and died. And if he had had health 
care coverage he could have dealt with these problems.
    Now the thing, Mr. Congressman, that you know so well is 
that it is not just the uninsured who pay these costs. We all 
do because when someone is very ill, if they do not have health 
insurance and they put it off for years and they got sicker and 
sicker, we do not let them die in the street, unless of course 
they have a heart attack and die, but if they get ill and they 
go to the hospital we take care of them, and that costs lots 
and lots of money.
    And somebody pays for it. Not the uninsured because they 
can't afford it. All of our insurance premiums go up to cover 
that. So there is a hidden health care tax that we all pay to 
keep people alive when, if we had had everybody covered with 
health care, they could have gotten their treatments and stayed 
alive. It would be much better for them and their families, and 
much better for all of us.
    That is why this new Medicaid expansion is so important in 
Maryland that Governor O'Malley enacted. It is so important. 
Over the next couple of years we estimate that it will provide 
health care to over 100,000 uninsured people. I want to thank 
Don Fry and the Greater Baltimore Committee for being amongst 
the people who really pushed for that and understood how 
important it was.
    We desperately need your stimulus package to include the 
FMAP money so that there is more money in the Medicaid Program 
to help us keep that program going.
    These 16,000 people who just got covered--and there are 
going to be more--but these 16,000 people are people who 
desperately needed it. Let me tell you, Mr. Chairman, about the 
very first couple:
    Alana and Adamontis Bollis, a couple whose kids were 
covered by the CHIP program for awhile but they could not get 
health care, and they had colon cancer issues, diabetes issues. 
They were not getting treated and they were getting sicker and 
sicker.
    On July 7th of this year, Governor Martin O'Malley handed 
them the very first cards under our new Medicaid Expansion 
Program, and they now can get treatment.
    Please help us keep that program going.
    Representative Cummings. Just one last question, Madam 
Chair.
    Mr. DeMarco, what would be the benefit of extending the 
Families and Small Business Health Care Coverage Act that we 
have in Maryland to the rest of the country? I am just curious.
    Mr. DeMarco. Well, Representative Cummings, we want health 
care for all for the whole country. That is our goal that we 
are pushing for in Maryland but we want to work with you to 
have it nationally. But, we believe that until we reach that 
goal states should do as much as they can with your help to 
expand Medicaid coverage. And in addition to Medicaid in our 
program gives grants to small businesses to help them provide 
health care.
    If in your stimulus package you included more Medicaid 
assistance for the states, other states would be able to do 
this, too, and we could help a lot of the people who just 
cannot afford private insurance and are out there getting sick 
like the Bollises. And again, let me emphasize this again, 
Congressman Cummings, it is not just the uninsured who suffer 
because of uninsurance. We all do.
    Representative Cummings. I want to thank all of you for 
being here today. We really do appreciate what you have done.
    Mr. Haskins, I have got to ask this because there has been 
a controversy here in the Congress with regard to these loans 
on mortgages and I want to ask you this question.
    Some people bring lending to low-income households and CRA, 
the Community Reinvestment Act in particular, to the current 
financial crisis. As a lender who has received the highest 
performance rating for CRA, do you see differences in defaults 
or delinquencies from lower and middle-income households? And 
how has CRA impacted the Baltimore and Prince Georges County 
communities that you serve? Because a lot of people seem to 
want to push this on Fannie Mae and Freddie Mack, and I am just 
wondering how you see it? I just want to clear that up, from 
your perspective.
    Mr. Haskins. This problem is across the board. When you 
start seeing the defaults that will begin to occur with some of 
the high-end properties you will know it is not CRA-based 
individuals who are a part of that problem, not at all.
    I mean, this was across the board. The stated incomes are 
really more in the area of individuals who were privately 
employed, or upper income individuals. Many of the 
delinquencies and defaults we are seeing are at housing prices 
that are in the half-million dollar range and up. That is no 
low income. No, this cannot be passed off.
    I served, by the way, three different terms on Fannie Mae's 
National Advisory Board and can speak very definitely to that 
program. Were there cases where those individuals were 
misrepresented or misrepresented? Absolutely. But I can tell 
you that more often than not what you will find with the lower 
income home buyers, they were more misled and duped than they 
were initiating.
    Most do not understand. If you fill out a mortgage 
application, anyone here who has bought a home who has filled 
out a mortgage application, it is a pretty involved 
application. And I can tell you, having done endless seminars 
on how to go about buying a house, and buying a home, or 
looking at property, that most low-income folks are totally in 
the dark about that and they take a lot of direction, which is, 
Madam Vice Chair, why it was important to regulate broker/
dealer individuals. Because they misled a lot of these 
individuals and were advising them that they, just by 
distorting this and distorting that, knowing what we look at 
for approving a loan, they could get over the hurdles.
    So, no, you cannot put this on the back of just low-income 
individuals. In fact, as data will reveal and reflect over 
time, you are going to see more and more defaults at much, much 
higher home pricing points.
    Representative Cummings. Thank you very much, Madam 
Chairlady, for your indulgence.
    Vice Chair Maloney. Thank you.
    One last question. Mr. Haskins, you testified that you did 
not invest and participate in these subprime loans. You saw 
fraud on the applications. So given that you did not engage in 
this risky behavior, what do you think about the financial 
rescue package for large banks?
    Mr. Haskins. I can't tell you my first reaction. 
[Laughter.]
    Mr. Haskins. That would not be printable or recordable. But 
I'll tell you this. Because of the importance of bringing 
confidence and stability back, those kinds of steps needed to 
and had to be taken. So for the greater good I have accepted it 
and said let's move forward.
    I do believe, though, that you just cannot give money away 
without having some requirements. You just can't do that. I 
mean, I am in a business that we set very specific requirements 
for getting repaid.
    So I agree that the actions taken by the Congress and the 
government in general needed to be taken, especially as it 
relates to Wall Street. However, I think there needs to be some 
requirements placed on that money, one; and two, I definitely 
think that you have got to have Main Street included in the 
proposition.
    Vice Chair Maloney. Thank you. And finally I would like to 
ask all of the panelists, beginning with you, Mr. Haskins, 
Congress is considering a fiscal stimulus package that would 
include aid to the states and infrastructure investment.
    How would such a fiscal stimulus package help consumers and 
businesses and individuals in your communities? Could you 
comment, all of you, Mr. Haskins, Mr. Fry, and Mr. DeMarco?
    Mr. Haskins. First, you are going to get people in 
positions to earn a living. You are going to get jobs. Creating 
jobs. Jobs are vital.
    As has been said by several of your colleagues, we have 
seen a reduction in the employment in our state, and especially 
in the City. The unemployment in Baltimore City, Congressman 
Cummings is quoting numbers that are official. The unofficial 
numbers are probably twice as high as his official numbers.
    I am living on Main Street. I work with Main Street. I am 
in those communities. You know, I walk down the street 
yesterday past what was part of a restaurant row. Of the five 
restaurants that I passed--and Wednesdays used to be a good 
restaurant day--only three of the restaurants had people in 
those restaurants. And of the three that had people, only in 
that case were there three tables that were occupied.
    I am just giving an example there. So this stimulus package 
is going to help create jobs where people can work and make a 
good living wage, and it is going to help those who are on the 
margin to be able to meet their obligations to pay the 
community bankers who are willing and ready to step forward to 
keep financial resources flowing into the community.
    Vice Chair Maloney. Mr. Fry.
    Mr. Fry. Madam Chair, I think that such a stimulus package 
that included aid to state governments and also investment in 
infrastructure would be a significant step forward for the 
State of Maryland and for the citizens there.
    Right now looking at state governments, they are looking at 
tremendous deficits themselves. They are looking at programs 
being cut. They are looking at possible layoffs as time goes 
on, and trickling down even of course to the local governments 
as well. Everybody is on pins and needles, not unlike what 
Congressman Cummings and I experienced during the early 1990s 
when we served in the Maryland General Assembly together.
    I think obviously what we see as significantly important 
would be that investment in infrastructure. The one thing that 
I think that provides a great opportunity, because 
transportation infrastructure in particular does not get a lot 
of attention, it does not move up that rank as far as political 
polls of something that is really critically important to the 
voters of the time or to the citizens, but transportation only 
becomes important when it becomes a crisis.
    Unfortunately, once it becomes a crisis it takes too long 
for you to complete the projects that will even address that 
concern. By coming forth with a stimulus package that would 
include some investment for infrastructure, I think that would 
give a jump-start to projects that have not had a chance to 
move forward.
    In Maryland over a year ago we were successful in getting 
the General Assembly to enact about $400 million in new 
revenue. We argued that we should have as much as $600 million 
in new revenue. Despite that influx of money, we've just seen a 
reduction of $1.1 billion over the six-year transportation 
plan. So this is something that is significantly needed. It 
will provide jobs not only to highway contractors and others, 
but to small businesses, to minority and women-owned companies 
who are also very dependent upon those major construction 
projects so that they can take part in those and also expand 
their capacity to grow.
    Vice Chair Maloney. Mr. DeMarco.
    Mr. DeMarco. Thank you, Madam Chair.
    We urge you to include in your stimulus package an increase 
in the FMAP for the states. And if you do it at the level that 
was in Senate Bill 2819, you would get a significant amount of 
new money into the State of Maryland, resulting in 1800 new 
jobs and a lot more money into the coffers of the State, which 
would be very important.
    And in addition, very importantly, you would help us keep 
this tremendous new Governors Working Families and Small 
Business Health Care Coverage Act going, which is going to over 
the next couple of years provide health care to over 100,000 
uninsured people, and deal with some of the major issues that 
Representative Cummings sees, and we all see in our community 
of people who cannot afford health care, whose lives are 
destroyed by it, and then we all pay the hidden health care 
tax.
    It is a great two-for that you can include in the stimulus 
package which would help our society in Maryland a whole lot. 
Thank you, very much.
    Vice Chair Maloney. Well thank you. And I would like to 
sincerely thank all the panelists and witnesses for their 
really meaningful testimony today.
    The panel today, and indeed the hearings that Congress has 
conducted over the past month, have been sobering and should 
leave no doubt that we need a new stimulus package to get the 
economy back on track and provide relief to struggling American 
families.
    Congressman Cummings and Senator Schumer and I released 
this report yesterday, ``Stemming The Current Economic Downturn 
Will Require More Stimulus.'' It can be seen on the Joint 
Economic Committee web site, and on my personal web site, and I 
would like unanimous consent to put it in the record.
    Vice Chair Maloney. With that, the meeting is adjourned.
    (Whereupon, at 12:35 p.m., Thursday, October 30, 2008, the 
meeting was adjourned.)

                       SUBMISSIONS FOR THE RECORD

[GRAPHIC] [TIFF OMITTED] T8279.024

[GRAPHIC] [TIFF OMITTED] T8279.025

[GRAPHIC] [TIFF OMITTED] T8279.026

[GRAPHIC] [TIFF OMITTED] T8279.027

[GRAPHIC] [TIFF OMITTED] T8279.028

[GRAPHIC] [TIFF OMITTED] T8279.029

[GRAPHIC] [TIFF OMITTED] T8279.030

[GRAPHIC] [TIFF OMITTED] T8279.031

[GRAPHIC] [TIFF OMITTED] T8279.032

[GRAPHIC] [TIFF OMITTED] T8279.033

[GRAPHIC] [TIFF OMITTED] T8279.034

[GRAPHIC] [TIFF OMITTED] T8279.035

[GRAPHIC] [TIFF OMITTED] T8279.036

[GRAPHIC] [TIFF OMITTED] T2773.001

                 Prepared Statement of Carolyn Maloney
    Today's news is bleak. The gross domestic product, which is the 
broadest measure of our economy, fell by 0.3 percent and consumer 
spending fell by 3.1 percent in the third quarter. This news comes on 
the heels of this week's dismal report that the consumer confidence 
index plunged to an all-time low in October. All of this provides 
further confirmation that unless we act to bring real relief to Main 
Street, families will continue to suffer serious economic hardships.
    These data indicate that Speaker Pelosi has been right in pressing 
for additional economic stimulus as the Congressional hearings this 
month have shown.
    Over the past year, we have seen the sub-prime crisis turn into a 
full-blown financial crisis. Many economists now warn that we are the 
midst of a recession, quite possibly the worst in decades, and the 
impact on families may be devastating without government intervention.
    This committee has been tracking the unfolding economic crisis for 
over a year. In our monthly hearings on the employment situation, we 
have seen how the private sector has shed nearly a million jobs in 2008 
and U.S. workers have lost all of the wage gains that they had made 
during the 2000s recovery.
    There is now a growing consensus that Congress should enact a 
second stimulus package and that it should be larger than the one we 
passed in January. During recent testimony in front of the House Budget 
Committee, Federal Reserve Chairman Ben Bernanke gave his support to 
another round of significant economic stimulus: ``[W]ith the economy 
likely to be weak for several quarters, and with some risk of a 
protracted slowdown, consideration of a fiscal package by the Congress 
at this juncture seems appropriate.''
    As detailed in a Joint Economic Committee report released 
yesterday, the need for stimulus is urgent. A consumer- or export-led 
recovery is unlikely because this downturn follows the weakest recovery 
on record. Even as the economy expanded over the last eight years, 
household incomes never recovered from the last recession. Falling home 
values and rising debt have driven family balance sheets to their worst 
condition in decades, while at the same time banks have been curtailing 
access to credit. As consumers cut back on their spending, this drags 
down the economy further.
    Economists are also encouraging Congress to recognize that during a 
potentially protracted and deep downturn, concerns about budget 
deficits must be secondary to the goal of getting the economy back on 
track. Former Treasury Secretary Lawrence Summers has said, ``The idea 
seems to have taken hold in recent days that because of the unfortunate 
need to bail out the financial sector, the nation will have to scale 
back its aspirations in other areas such as healthcare, energy, 
education and tax relief. This is more wrong than right.''
    Congress has already taken numerous steps to help buffer families 
from the effects of the downturn. More than 130 million American 
households have received a Recovery Rebate and 3.5 million unemployed 
workers have received extended Unemployment Benefits. In July, Congress 
enacted a housing package aimed at stemming the tide of foreclosures.
    As the financial crisis worsened this fall, Congress began a 
sweeping investigation to examine the root of the crisis and lay the 
foundation for action on common sense regulation of the financial and 
housing industries.
    This is grim news today, but I expect this Congress will act with 
the current President and the next President to get the economy back on 
track and get Americans back to work. Clearly, we need a new direction 
on economic policy. American families need more help to weather this 
economic storm.
    I want to thank our distinguished panel of witnesses for appearing 
before us today and thank Senator Schumer for calling this hearing. I 
look forward to today's testimony as we help to lay the groundwork for 
the next economic stimulus package. 

[GRAPHIC] [TIFF OMITTED] T8279.001

[GRAPHIC] [TIFF OMITTED] T8279.002

   Statement of Ben S. Bernanke, Chairman, Board of Governors of the 
Federal Reserve System Before the House Budget Committee on October 20, 
                 2008, Submitted by Vice Chair Maloney

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

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

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

    [GRAPHIC] [TIFF OMITTED] T8279.003
    
  Prepared Statement of Dr. J. Steven Landefeld, Director, Bureau of 
                           Economic Analysis

    Mr. Chairman and Members of the Committee:
    Thank you for inviting me to discuss the gross domestic product 
(GDP) accounts, including the data we released this morning. I will 
present highlights from this morning's release to the Committee, Mr. 
Chairman. I ask that the GDP release be included as part of my 
statement for the record.
    In the third quarter of 2008, real GDP decreased 0.3 percent at an 
annual rate. By comparison, in the second quarter real GDP increased 
2.8 percent. The decrease in third-quarter GDP reflected declines in 
consumer spending, residential investment, and business nonresidential 
fixed investment (which consists of investment in durable equipment, 
software, and structures). In contrast, government spending, net 
exports, and business inventory investment increased. The price index 
for gross domestic purchases, which measures the prices paid by U.S. 
residents, increased 4.8 percent, following an increase of 4.2 percent 
in the second quarter.
    Consumer spending decreased 3.1 percent in the third quarter, 
following an increase of 1.2 percent in the second. The third-quarter 
decline in consumer spending was the largest decline since the second 
quarter of 1980. Consumer spending on durable goods fell 14.1 percent, 
with motor vehicles accounting for most of the decline. Consumer 
spending on nondurable goods fell 6.4 percent. In contrast, spending on 
services grew 0.6 percent.
    Spending on residential investment fell 19.1 percent in the third 
quarter, compared with a decline of 13.3 percent in the second. This 
was the eleventh consecutive quarter in which residential investment 
has declined. Since its peak in the fourth quarter of 2005, residential 
investment has fallen 42.2 percent.
    Business nonresidential fixed investment fell 1.0 percent in the 
third quarter, compared with an increase of 2.5 percent in the second. 
Third-quarter business spending on durable equipment and software fell 
5.5 percent, whereas spending on nonresidential structures increased 
7.9 percent.
    Business inventory investment contributed +0.56 percentage point to 
the change in real GDP, compared to -1.50 percentage points in the 
second quarter.
    Exports of goods and services increased 5.9 percent in the third 
quarter, compared with an increase of 12.3 percent in the second. 
Exports have now increased for twenty-one consecutive quarters. Imports 
of goods and services decreased 1.9 percent in the third quarter, 
compared with a decrease of 7.3 percent in the second.
    Spending on goods and services by the federal government increased 
13.8 percent in the third quarter, compared with an increase of 6.6 
percent in the second. Most of the increase was in defense spending. 
Spending by state and local governments increased 1.4 percent in the 
third quarter, compared with 2.5 percent in the second.
    During the third quarter, hurricanes Gustav and Ike struck the Gulf 
Coast region, especially impacting coastal Texas and Louisiana. Because 
the effects of these storms are not separately identified in our source 
data, it is not possible to estimate their overall effect on GDP, but 
their impact is included in the GDP estimates. In particular, 
disruptions to oil and gas extraction and to petroleum and 
petrochemical producers are reflected in BEA's estimates for inventory 
change in the nondurable manufacturing and wholesale trade industries.
    As I mentioned earlier, the price index for gross domestic 
purchases increased 4.8 percent in the third quarter, after increasing 
4.2 percent in the second. Excluding food and energy prices, the price 
index for gross domestic purchases increased 3.1 percent in the third 
quarter, after increasing 2.2 percent in the second. The personal 
consumption expenditures price index increased 5.4 percent in the third 
quarter, after increasing 4.3 percent in the second. Excluding food and 
energy prices, the personal consumption expenditures price index 
increased 2.9 percent in the third quarter, after increasing 2.2 
percent in the second.
    Turning to the household sector, real disposable personal income 
fell 8.7 percent in the third quarter, after increasing 11.9 percent in 
the second. The third quarter personal saving rate was 1.3 percent, 
compared with 2.7 percent in the second quarter and 0.2 percent in the 
first. The second-quarter increase in real disposable personal income 
was boosted by tax rebate payments to individuals as authorized by the 
Economic Stimulus Act of 2008. Excluding these payments, real 
disposable income increased 0.3 percent in the third quarter after 
decreasing 0.4 percent in the second.
    My colleagues and I now would be glad to answer your questions.

    [GRAPHIC] [TIFF OMITTED] T8279.004
    
    [GRAPHIC] [TIFF OMITTED] T8279.005
    
    [GRAPHIC] [TIFF OMITTED] T8279.006
    
    [GRAPHIC] [TIFF OMITTED] T8279.007
    
    [GRAPHIC] [TIFF OMITTED] T8279.008
    
    [GRAPHIC] [TIFF OMITTED] T8279.009
    
    [GRAPHIC] [TIFF OMITTED] T8279.010
    
    [GRAPHIC] [TIFF OMITTED] T8279.011
    
    [GRAPHIC] [TIFF OMITTED] T8279.012
    
    [GRAPHIC] [TIFF OMITTED] T8279.013
    
    [GRAPHIC] [TIFF OMITTED] T8279.014
    
    [GRAPHIC] [TIFF OMITTED] T8279.015
    
    [GRAPHIC] [TIFF OMITTED] T8279.016
    
    [GRAPHIC] [TIFF OMITTED] T8279.017
    
    [GRAPHIC] [TIFF OMITTED] T8279.018
    
  Prepared Statement of Dr. Nouriel Roubini, Professor of Economics, 
 Stern School of Business, New York University and Chairman of Roubini 
                         Global Economics, LLC

    The U.S. Will Experience a Severe Recession; thus a Large Fiscal 
Policy Stimulus is Necessary to Dampen the Severity of this Economic 
Contraction
    The U.S. is currently in a severe recession that will be deeper, 
longer and more protracted than previous U.S. recessions. The last two 
economic recessions--in 1990-91 and 2001--lasted each 8 months and the 
cumulative fall in GDP from peak through the trough was only 1.3% in 
the 1990-91 contraction and 0.4% in the 2001 contraction. In a typical 
U.S. recession in the post-WWII period GDP falls by an average of 2% 
and the recession lasts 10 months. The current economic contraction--
that my analysis dates as having started in the first quarter of 2008 
will last through the fourth quarter of 2009 with a cumulative fall in 
GDP of the order of about 4% that is even larger than the worst post-
WWII recession (the one in 1957-68 when the GDP fall was 3.7%).
    Since most components of private aggregate demand are sharply 
falling right now (private consumption, residential investment, non-
residential investment in structures, capex spending by the corporate 
sector on software and machinery) a major additional fiscal stimulus is 
necessary to reduce the depth and length of the current economic 
contraction. And since direct tax incentives have not been effective in 
boosting consumption and capex spending (as worried households and firm 
are retrenching their spending) the new round of fiscal stimulus will 
have to take the form of direct government spending on goods and 
services (preferably productive investment in infrastructures) and 
provision to income to those agents in the economy more likely to spend 
it (block grants to state and local governments, increased unemployment 
benefits to unemployed workers, etc.).
    Given the size of the expected contraction in private aggregate 
demand (likely to be about $450 billion in 2009 relative to 2008) a 
fiscal stimulus of the order of $300 billion minimum (and possibly as 
large as $400 billion) will be necessary to partially compensate for 
the sharp fall in private aggregate demand.
    This fiscal stimulus should be voted on and spent as soon as 
possible as delay will make the economic contraction even more severe. 
A stimulus package legislated only February or March of next year when 
the new Congress comes back will be too late as the contraction of 
private aggregate demand will be extremely sharp in the next few 
months. Such policy action should be legislated right away--in a ``lame 
duck'' session right after the election--to ensure that the actual 
spending is undertaken rapidly in the next few months.

Financial Turmoil and Crisis
    The rich world's financial system is in significant and persistent 
turmoil. This is the worst financial crisis that the U.S. and other 
advanced economies have experienced since the Great Depression. Stock 
markets have been falling most days, money markets and credit markets 
have shut down as their interest-rate spreads skyrocket, and it is 
still too early to tell whether the raft of measures adopted by the US 
and Europe will stem the financial bleeding on a sustained basis.
    A generalized run on the banking system has been a source of fear 
for the first time in seven decades, while the shadow banking system--
broker-dealers, non-bank mortgage lenders, structured investment 
vehicles and conduits, hedge funds, money market funds and private 
equity firms--are at risk of a run on their short-term liabilities. On 
the real economic side, all the advanced economies--representing over 
60% percent of global GDP--entered a recession even before the massive 
financial shocks that started in late summer. So we now have recession, 
a severe financial crisis and a severe banking crisis in the advanced 
economies.
    Emerging markets were initially tied to this distress only when 
foreign investors began pulling out their money. Then panic spread to 
credit markets, money markets and currency markets, highlighting the 
vulnerabilities of many developing countries' financial systems and 
corporate sectors, which had experienced credit booms and had borrowed 
short and in foreign currencies. Countries with large current-account 
deficits and/or large fiscal deficits and with large short-term foreign 
currency liabilities have been the most fragile. But even the better-
performing ones--like Brazil, Russia, India and China--are now at risk 
of a hard landing. Many emerging markets are now at risk of a severe 
financial crisis.
    The crisis was caused by the largest leveraged asset bubble and 
credit bubble in history. Leveraging and bubbles were not limited to 
the US housing market, but also characterized housing markets in other 
countries. Moreover, beyond the housing market, excessive borrowing by 
financial institutions and some segments of the corporate and public 
sectors occurred in many economies. As a result, a housing bubble, a 
mortgage bubble, an equity bubble, a bond bubble, a credit bubble, a 
commodity bubble, a private equity bubble and a hedge funds bubble are 
all now bursting simultaneously.
    The hope that economic contraction in the US and other advanced 
economies would be short and shallow--a V-shaped six-month recession--
has been replaced by certainty that this will be a long and protracted 
U-shaped recession, possibly lasting at least two years in the US and 
close to two years in most of the rest of the world. And, given the 
rising risk of a global systemic financial meltdown, the prospect of a 
decade-long L-shaped recession--like the one experienced by Japan after 
the collapse of its real estate and equity bubble--cannot be ruled out.
    Indeed, the growing disconnect between increasingly aggressive 
policy actions and strains in the financial market is scary. When Bear 
Stearns' creditors were bailed out to the tune of US$30 billion in 
March, the rally in equity, money and credit markets lasted eight 
weeks. When the US Treasury announced a bailout of mortgage giants 
Fannie Mae and Freddie Mac in July, the rally lasted just four weeks. 
When the US$200 billion rescue of these firms was undertaken and their 
US$6 trillion in liabilities taken over by the US government, the rally 
lasted one day.
    Until the recent US and European measures were announced, there 
were no rallies at all. When AIG was bailed out to the tune of US$85 
billion, the market fell 5 percent. Then, when the US$700 billion US 
rescue package was approved, markets fell another 7 percent in two 
days. As authorities in the US and abroad took ever more radical policy 
steps in the last few weeks, stock, credit and money markets fell 
further, day after day for most days. Even the rally following the G7 
statement and radical policy actions taken to back stop the financial 
system lasted only one day and was followed by two weeks of sharply 
falling equity prices and rising CDS and credit spreads. Policy 
authorities seem to have lost their credibility in financial markets 
as--until recently--their actions were step by step, ad hoc and without 
a comprehensive crisis resolution plan.
    Do the recent measures go far enough? When policy actions don't 
provide real relief to market participants, it is clear that you are 
one step away from a systemic stress on the financial and corporate 
sector. A vicious circle of de-leveraging, plummeting asset prices and 
margin calls is underway.

Recent Policy Actions and Further Necessary Policy Actions to Stem the 
                                 Crisis
    As we have seen in recent weeks, it will take a big change in 
economic policy and very radical, coordinated action among all advanced 
and emerging-market economies to avoid an even more severe economic and 
financial crisis. This includes:

      Another rapid round of interest-rate cuts of at least 150 
basis points on average globally;
      A temporary blanket guarantee of all deposits while 
insolvent financial institutions that must be shut down are 
distinguished from distressed but solvent institutions that must be 
partially nationalized and given injections of public capital;
      A rapid reduction of insolvent households' debt burden, 
preceded by a temporary freeze on all foreclosures;
      Massive and unlimited provision of liquidity to solvent 
financial institutions;
      Public provision of credit to the solvent parts of the 
corporate sector in order to avoid a short-term debt refinancing crisis 
for solvent but illiquid corporations and small businesses;
      A massive direct government fiscal stimulus that includes 
public works, infrastructure spending, unemployment benefits, tax 
rebates to lower-income households and provision of grants to cash-
strapped local governments;
      An agreement between creditor countries running current-
account surpluses and debtor countries running current-account deficits 
to maintain an orderly financing of deficits and a recycling of 
creditors' surpluses to avoid disorderly adjustment of such imbalances.

    After the early October crash in stock markets and financial 
markets (and it was indeed a crash as during the week before the G7/IMF 
meetings equity prices fell as much as the two day crash of 1929) 
policy makers finally realized the risk of a systemic financial 
meltdown, they peered into the systemic collapse abyss a few steps in 
front of them and finally got religion and started announcing radical 
policy actions (the G7 statement, the EU leaders agreement to bailout 
European banks, the British plan to rescue--and partially nationalize--
its banks, the European countries plans along the same lines, and the 
Treasury plan to ditch the initial TARP that was aimed only at buying 
toxic assets in favor of plan to recapitalize--i.e., partially 
nationalize--US banks and broker dealers. The main policy actions that 
will be undertaken are:

      Preventing systemically important banks and broker 
dealers from going bust (i.e., the U.S. made a mistake letting Lehman 
fail; so Morgan Stanley and other systemically important financial 
institutions will be rescued) (``Take decisive action and use all 
available tools to support systemically important financial 
institutions and prevent their failure'' as in the G7 statement)
      Recapitalization of banks and broker dealers via public 
injections of capital via preferred shares (i.e., partial 
nationalization of financial institutions as it is already occurring in 
the UK, Belgium, Netherlands, Germany, Iceland and, soon enough the 
U.S.) matched by private equity injections (``Ensure that our banks and 
other major financial intermediaries, as needed, can raise capital from 
public as well as private sources, in sufficient amounts to re-
establish confidence and permit them to continue lending to households 
and businesses'')
      Temporary guarantee of bank liabilities: certainly all 
deposits, possibly interbank lines along the lines of the British 
approach, likely other new debts incurred by the banking system 
(``Ensure that our respective national deposit insurance and guarantee 
programs are robust and consistent so that our retail depositors will 
continue to have confidence in the safety of their deposits'')
      Unlimited provision of liquidity to the banking system 
and to some parts of the shadow banking system to restore interbank 
lending and lending to the real economy (``Ensure that our banks and 
other major financial intermediaries, as needed, can raise capital from 
public as well as private sources, in sufficient amounts to re-
establish confidence and permit them to continue lending to households 
and businesses'')
      Provision of credit to the corporate sector via purchases 
of commercial paper (certainly in the US, possibly in Europe)
      Purchase of toxic assets to restore liquidity in the 
mortgage backed securities market (U.S.) (``Take action, where 
appropriate, to restart the secondary markets for mortgages and other 
securitized assets. Accurate valuation and transparent disclosure of 
assets and consistent implementation of high quality accounting 
standards are necessary.'')
      Implicit triage between distressed that are solvent given 
liquidity support and capital injection and non-systemically important 
and insolvent banks that will need to be closed down/merged/resolved/
etc.
      Use of the IMF and other international financial 
institutions to provide lending to many emerging market economies--and 
some advanced ones such as Iceland--that are now at risk of a severe 
financial crisis.
      Use of any other tools that are available and necessary 
to avoid a systemic meltdown (including implicitly more monetary policy 
easing as well as possibly fiscal policy stimulus ``We will use 
macroeconomic policy tools as necessary and appropriate.'').

    At this stage central banks that are usually supposed to be the 
``lenders of last resort'' need to become the ``lenders of first and 
only resort'' as, under conditions of panic and total loss of 
confidence, no one in the private sector is lending to anyone else 
since counterparty risk is extreme. Only over time private lending will 
recover.
    While most of the economic and financial damage is already done and 
the global economy will not be able to avoid a painful recession, 
financial and banking crisis (i.e., the V-shaped short and shallow 6-
month recession is now out of the window and we will experience a 
severe and more protracted 18 to 24 months U-shaped recession) the 
rapid and consistent implementation of these and other action will 
prevent the US, European and global economies from experiencing a 
systemic financial meltdown and entering in a more severe L-shaped 
decade long stagnation like the one experienced by Japan after the 
bursting of its real estate and equity bubble.
    Are we close to the bottom of this financial crisis? Not really as 
financial markets are and will remain volatile with significant 
downside risks to markets remaining over the next few weeks and months 
as:

      Details of the policy plans are still very fuzzy and 
ambiguous and with uncertain effects on various assets classes (common 
shares, preferred shares, unsecured debt of financial institutions, 
etc.);
      Macroeconomic news will surprise on the downside as the 
economies sharply weaken and contract while fiscal policy stimulus is 
lagging. Indeed such macro news flow was worse than awful in the last 
couple of weeks: free fall in retail sales confirming a consumption 
recession that started in June; terrible news about housing (starts, 
permits, prices, homebuilders' sentiment); consumer confidence 
collapsing; awful leading indicators of supply from the regional Fed 
reports (Empire State and Philly); continued high initial claims; free 
fall in industrial production (only in part driven by temporary 
factors); fall in durable goods orders ex-transportation.
      Earnings news for financial and non financial firms will 
sharply surprise on the downside;
      The damage done to confidence and to levered investment 
is already severe and the process of deleveraging of the shadow 
financial system will continue;
      Major sources of future stress in the financial system 
remain; these systemic financial risks include: a major surge in 
corporate defaults rates and fall in recovery rates as the recession 
becomes severe thus leading to a further widening of credit spreads; 
the risk of a CDS market blowout as corporate defaults start to spike; 
the collapse of hundreds of hedge funds that, while being small 
individually, will have systemic effects as hundreds of small funds 
make the size of a few LTCMs in terms of their common deleveraging and 
selling assets in illiquid markets; the rising troubles of many 
insurance companies; a slow motion refinancing and insolvency crisis 
for many toxic LBOs once covenant-lite clauses and PIK toggles effects 
fizzle out; the risk that other systemically important financial 
institutions are insolvent and in need of expensive rescue programs 
while the $250 bn of recap of banks is way insufficient to deal with 
their needs; the ongoing process of deleveraging in illiquid financial 
markets that will continue the vicious circle of falling asset prices, 
margin calls, further deleveraging and further sales in illiquid 
markets that continues the cascading fall in asset prices; further 
downside risks to housing and to home prices pushing over 20 million 
households into negative equity by 2009; the risk that some significant 
emerging market economies and some advanced ones too (Iceland) will 
experience a severe financial crisis.

    The last factor is a crucially important one: there are now about a 
dozen of emerging market economies that are in serious financial 
trouble: they include Estonia, Latvia, Hungary, Bulgaria, Turkey, 
Pakistan, Korea, Indonesia, a few other ones in Central-South Europe 
and several Central American ones. There is now a significant and 
rising risk that several of them will experience a true financial 
crisis. Even a small tiny country of 300,000 souls like Iceland is now 
having systemic effects on global financial markets: since the country 
was like a huge hedge fund with banks having liabilities that were 12 
times the GDP of the country the collapse of these banks may now lead 
to a disorderly sale of their assets in already illiquid markets. Now 
the risk of a financial crisis in a number of twenty countries in the 
region that goes from the Baltics to Turkey is rising as they all have 
very large current account deficits and other macro and financial 
vulnerabilities.

 Need for Fiscal Policy Stimulus to Dampen the Contraction in Private 
                                 Demand

    More aggressive and consistent and rapid implementation of the 
policy plans will increase the likelihood that risky asset prices will 
bottom out sooner rather than later and then start recovering. A key 
policy tool--that is currently missing in the G7 and EU plans is to use 
fiscal policy to boost aggregate demand. Indeed, given the current 
collapse of private aggregate demand (consumption is falling, 
residential investment is falling, non-residential investment in 
structures is falling, capex spending by the corporate sector was 
falling already before the latest financial and confidence shock and 
will now be plunging at an even faster rate) it is urgent to provide a 
boost to aggregate demand to ensure that an unavoidable two-year 
recession does not become a decade long stagnation. Since the private 
sector is not spending and since the first fiscal stimulus plan (tax 
rebates for households and tax incentives to firms) miserably failed as 
households and firms are saving rather than spending and investing it 
is necessary now to boost directly public consumption of goods and 
services via a massive spending program (a $300 to $400 bn fiscal 
stimulus): the federal government should have a plan to immediately 
spend in infrastructures and in new green technologies; also 
unemployment benefits should be sharply increased together with 
targeted tax rebates only for lower income households at risk; and 
federal block grants should be given to state and local government to 
boost their infrastructure spending (roads, sewer systems, etc.). If 
the private sector does not spend and/or cannot spend old fashioned 
traditional Keynesian spending by the government is necessary. It is 
true that we are already having large and growing budget deficits; but 
$300-400 bn of public works is more effective and productive than just 
spending $700 bn to buy toxic assets and/or recapitalizing financial 
institutions. If such fiscal stimulus plan is not rapidly implemented 
any improvement in the financial conditions of financial institution 
that the rescue plans will provide will be undermined--in a matter of 
six months--with an even sharper drop of aggregate demand that will 
make an already severe recession even more severe. So a fiscal stimulus 
plan is essential to restore--on a sustained basis--the viability and 
solvency of many impaired financial institutions. If Main Street goes 
bust in the next six months rescuing in the short run Wall Street will 
still lead Wall Street to go bust again as the real economy implodes 
further.
    Moreover, the US government will need to implement a clear plan to 
reduce the face value of mortgages for distressed home owners and avoid 
a tsunami of foreclosures (as in the Great Depression HOLC and in my 
HOME proposal). Households in the US have too much debt (subprime, near 
prime, prime mortgages, home equity loans, credit cards, auto loans and 
student loans) while their assets (values of their homes and stocks) 
are plunging leading to a sharp fall in their net worth. And households 
are getting buried under this mountain of mounting debt and rising debt 
servicing burdens. Thus, a fraction of the household sector--as well as 
a fraction of the financial sector and a fraction of the corporate 
sector and of the local government sector--is insolvent and needs debt 
relief. When a country (say Russia, Ecuador or Argentina) has too much 
debt and is insolvent it defaults and gets debt reduction and is then 
able to resume fast growth; when a firm is distressed with excessive 
debt it goes into bankruptcy court and gets debt relief that allows it 
to resume investment, production and growth; when a household is 
financially distressed it also needs debt relief to be able to have 
more discretionary income to spend. So any unsustainable debt problem 
requires debt reduction. The lack of debt relief to the distressed 
households is the reason why this financial crisis is becoming more 
severe and the economic recession--with a sharp fall now in real 
consumption spending--now worsening. The fiscal actions taken so far 
(income relief to households via tax rebates) do not resolve the 
fundamental debt problem because you cannot grow yourself out of a debt 
problem: when debt to disposable income is too high increasing the 
denominator with tax rebates is ineffective and only temporary; i.e., 
you need to reduce the nominator (the debt). During the Great 
Depression the Home Owners' Loan Corporation was created to buy 
mortgages from bank at a discount price, reduce further the face value 
of such mortgages and refinance distressed homeowners into new 
mortgages with lower face value and lower fixed rate mortgage rates. 
This massive program allowed millions of households to avoid losing 
their homes and ending up in foreclosure. The HOLC bought mortgages for 
two years and managed such assets for 18 years at a relatively low 
fiscal cost (as the assets were bought at a discount and reducing the 
face value of the mortgages allowed home owners to avoid defaulting on 
the refinanced mortgages). A new HOLC will be the macro equivalent of 
creating a large ``bad bank'' where the bad assets of financial 
institutions are taken off their balance sheets and restructured/
reduced.
    A large fiscal stimulus plan and a plan to reduce the debt overhang 
of distressed home owners will also ease the political economy of the 
financial bailout: as the debate in Congress showed, the US public is 
mad about a system where gains and profits are privatized while losses 
are socialized, a welfare system for the rich, the well connected and 
Wall Street. Bernanke and Paulson and the US administration did a lousy 
job in explaining why partially bailing Wall Street is necessary to 
avoid severe collateral damage to Main Street in the form of a most 
severe recession and a risk of an even more severe economic stagnation. 
At least the redesign of the TARP into a program that will recapitalize 
banks with public capital (and thus provide the US government and the 
taxpayer with some upside potential) makes this bailout more socially 
fair and acceptable.
    But the current collapse of private aggregate demand makes it fair, 
necessary and efficient to directly help Main Street with a direct 
fiscal stimulus program and with a plan to reduce the debt burden of 
distressed home owners. Those two additional policy actions are 
necessary and fundamental--together with the rescue and 
recapitalization of financial institutions--to minimize the damage to 
the real economy and to the financial system.

    The Risks of a Global Stag-Deflation (Stagnation/Recession and 
                               Deflation)

    Another important risk that the economy faces--and that suggests 
the need for a large fiscal stimulus is the risk of a recession 
associated with price deflation. Last January--at a time when the 
economic consensus was starting to worry about rising global 
inflation--I wrote a piece titled Will the U.S. Recession be Associated 
with Deflation or Inflation (i.e., Stagflation)? On the Risks of 
``Stag-deflation'' rather than ``Stagflation'' where I argued that the 
US and other economies would soon have to worry about price deflation 
rather than price inflation.
    As I put it at that time last January:

    The S-word (stagflation that implies growth recession cum high and 
rising inflation) has recently returned in the markets and analysts' 
debate as inflation has been rising in many advanced and emerging 
markets economies. This rise in inflation together with the now 
unavoidable US recession, the risk of a recession in a number of other 
economies (especially in Europe) and the likelihood of a sharp global 
economic slowdown has led to concerns that the risks of stagflation may 
be rising.
    Should we thus worry about US and global stagflation? This note 
will argue that such worries are not warranted as a US hard landing 
followed by a global economic slowdown represents a negative global 
demand shock that will lead to lower global growth and lower global 
inflation. To get stagflation one needs a large negative global supply-
side shock that, as argued below, is not likely to occur in the near 
future. Thus the coming US recession and global economic slowdown will 
be accompanied by a reduction--rather than an increase--in inflationary 
pressures. As in 2001-2003 inflation may become the last of the worries 
of the Fed and one may actually start hearing again concerns about 
global deflation rather than inflation.
    Let me elaborate next why . . .
    . . . unlike a true negative supply side shock--that reduces growth 
while increasing inflation--a US recession followed by a global 
economic slowdown is a negative demand shock that has the effect of 
reducing US and global growth while at the same time reducing US and 
global inflationary pressures. Specifically such a negative demand 
shock will reduce inflation and across the world because of a variety 
of channels.
    First, a US hard landing will lead to a reduction in aggregate 
demand relative to the aggregate supply as a glut of housing, consumer 
durables, autos and, soon enough, other goods and service takes places. 
Such reduction in aggregate demand tends to reduce inflationary 
pressures as firms lose pricing power and then cut prices to stave off 
the fall in demand and the rising stock of inventories of unsold goods. 
These deflationary pressures are already clear in housing where prices 
are falling and in the auto sector where the glut of automobiles is 
leading to price discounts and other price incentives. Obviously, 
inflation tends to fall in recession led by a fall in aggregate demand.
    Second, during US recessions you observe a significant slack in 
labor markets: job losses and the rise in the unemployment rate lead to 
a slowdown in nominal wage growth that reduces labor costs and unit 
labor cost, thus reducing wage and price inflationary pressures in the 
economy.
    Third, the same slack of aggregate demand and slack in labor 
markets will occur around the world as long as the negative US demand 
shock is transmitted--through trade, financial, exchange rate and 
confidence channels--to other countries leading to a slowdown in growth 
in other countries (the recoupling rather than decoupling phenomenon). 
The reduction in global aggregate demand--relative to the global supply 
of goods and service--will lead to a reduction in inflationary 
pressures.
    Fourth, during any US hard landing and global economic slowdown 
driven by a negative demand shock the US and global demand for oil, 
gas, energy and other commodities tends to fall leading to a sharp fall 
in the price of all commodities. A US hard landing followed by a 
European, Chinese and Asian slowdown will lead to a much lower demand 
for commodities, pushing down their price. The fall in prices tends to 
be sharp because--in the short run--the supply of commodities tends to 
be inelastic; thus any fall in demand leads to a greater fall in 
price--given an inelastic supply curve--to clear the commodity prices. 
And indeed in recent weeks the rising probability of a US hard landing 
has already led to a fall in such prices: for example oil prices that 
had flirted with a $100 a barrel level are now down to a price closer 
to $90; or the Baltic Dry Freight index--that measures the cost of 
shipping dry commodities across the globe and that had spiked for most 
of 2007 given the high demand and the limited supply of such ships--is 
now sharply down by over 20% relative to its peak in the fall of 2007. 
Similar downward pressure in prices is now starting to show up in other 
commodities.
    Note that a cyclical drop in commodity prices--led by a US hard 
landing and global economic slowdown--does not mean that commodity 
prices will remain depressed over the middle term once this global 
growth slowdown is past. If in the medium term the supply response to 
high prices is modest while the medium-long term demand for commodities 
remains high once the US and global economy return to their potential 
growth rates commodity prices could indeed resume their upward trend. 
But in a cyclical horizon of 12 to 18 months a US hard landing and 
global economic slowdown would lead to a sharp fall in commodity 
prices. Note that even in the case of oil that is the commodity with 
the weakest supply response to prices--as the investments in new 
production in a bunch of unstable petro-states (Nigeria, Venezuela, 
Iran, Iraq and even Russia) are limited--a cyclical global slowdown 
could lead to a very sharp fall in oil prices. Indeed while oil today 
is closer to the $90-100 range in the last 12 months oil prices drifted 
downward at some point close to a $50-60 range even before a US hard 
landing and global slowdown had occurred. Thus, one cannot rule out 
that in such a hard landing scenario oil prices could drift to a price 
close to $60.
    The four factors discussed above suggest that--conditional on the 
negative global demand shock (US hard landing and global economic 
slowdown) materializing even the risks of stagflation-lite are 
exaggerated; rather US and global inflationary force would sharply 
diminish in this scenario and, if anything, concerns about deflation 
may reemerge again.
    This is not a far fetched scenario as one looks back at what 
happened in the 2000-2003 cycle. Until 2000 the Fed was worried about 
the economy overheating and rising inflation risk. But once the economy 
spinned into a recession in 2001 US and global inflationary pressures 
diminished and by 2002 the great scare became one of US and global 
deflation rather than inflation. Indeed the Fed aggressively cut the 
Fed Funds rate all the way to 1% and Ben Bernanke--then only a Fed 
governor--wrote speeches about using heterodox policy instruments to 
fight the risk of deflation once and if the Fed Funds rate were to 
reach its nominal floor of zero percent.
    Today, following a US hard landing and a global economic slowdown, 
the risks of outright deflation would be lower than in the 2001-2003 
episode because of various factors: US inflation starts higher than in 
2001; the Fed needs to worry about a disorderly fall of the US dollar 
that may increase inflationary pressures; the rise and persistence of 
growth rates in Chindia and other emerging market economies implies 
that--even if such economies likely recouple to the US hard landing--a 
global growth slowdown will not turn into an outright global recession 
that would be truly deflationary. Still, while the scenario outlined 
here--US recession and global slowdown--may not lead to outright 
deflationary pressures it would certainly lead to a slowdown of US and 
global inflation.
    The fact that the most likely scenario in the global economy in 
2008 is one of a negative global demand shock is the one that is priced 
by bond markets: if investors were really worried about a rise in US 
and global inflation--or about true stagflationary shocks--the yield on 
long term government bonds would have not fallen as sharply as it has 
since last summer. With US 10 year Treasury yield now well below 4% and 
sharply falling in the last few weeks it is hard to see a bond market 
that is worried about global inflation or global stagflation. And while 
until recently commodity prices pointed to the other directions, recent 
weakness in oil prices, the cost of shipping commodities and the price 
of some other commodities also signals that commodity markets are now 
pricing the risk of a US recession and the risk that--with a lag--a US 
recession will lead to a broader global economic slowdown.
    So in conclusion ``stag-deflation'' (i.e., low growth or recession 
with falling inflation rates and possible deflationary pressures) is 
more likely than ``stagflation'' (low growth or recession with rising 
inflation rates) if a US hard landing materializes and leads--as 
likely--to a slowdown in global demand and growth.

    So last January I argued that four major forces would lead to a 
risk of deflation (or stag-deflation where a recession would be 
associated with deflationary forces) rather than the inflation risk 
that at that time--and for most of 2008--mainstream analysts worried 
about: slack in goods markets, re-coupling of the rest of the world 
with the US recession, slack in labor markets, and a sharp fall in 
commodity price following such US and global contraction would reduce 
inflationary forces and lead to deflationary forces in the global 
economy.
    How have such predictions fared over time? And will the US and 
global economy soon face sharp deflationary pressures? The answer 
deflation and stag-deflation will in six months become the main concern 
of policy authorities.
    First, what has happened in the last few months? The US has entered 
a severe recession that is already leading to deflationary forces in 
sectors where supply vastly exceeds demand (housing, consumer durables, 
motor vehicles, etc.) while now aggregate demand is sharply falling 
below aggregate supply; the unemployment rate is sharply up while 
employment has been falling for 10 months in a row; and commodity 
prices are sharply down--about 30% from their July peak--in the last 
three months and likely to fall much more in the next few months as the 
advanced economies recession is becoming global. So both in the US and 
in other advanced economies we are clearly headed towards a collapse of 
headline and core inflation.
    Is there any doubt about this ongoing inflation capitulation and 
the beginning of sharp deflationary forces? Take the current views of 
the economic research group at JP Morgan; this group was in 2007-2008 
the leading voice arguing about the risks of rising global inflation, 
about the associated risks of a global growth reflation and arguing 
that policy rates would be sharply increased in 2008-2009.
    This past week instead this JP Morgan research group published its 
latest global economic outlook arguing that we are headed towards a 
global recession, negative global inflation and sharply lower policy 
rates in the US and advanced economies (a 180 degree turn from its 
previous position). As written in the most recent JP Morgan Global Data 
Watch:
    ``A bad week in hell
    Increasingly, the signs point to a deep and synchronized global 
recession. Today's reported slide in UK 3Q08 GDP is expected to be 
followed by contractions in the United States (next week), the Euro 
area, and Japan--confirming that the global downturn began last 
quarter. More troubling is the additional loss of momentum at quarter 
end, combined with collapsing October survey readings. These 
developments appear to be part of a negative loop in which economic and 
financial weakness are feeding on each other, making the prospects for 
growth in the coming months decidedly grim. Once again we have taken an 
axe to near-term growth forecasts for the developed world and will 
likely follow up with additional downward revisions for emerging market 
economies in the coming weeks. Already, our forecasts suggest that 
global GDP will contract at a near 1% annual rate in 4Q08 and 1Q09.
    It is still too early to accurately gauge the depth of the 
downturn, as the outlook depends on how well policy actions contain the 
financial crisis. From a US perspective, our current forecasts place 
the contraction in GDP somewhere between the last two mild recessions 
and the deep contractions of 1973-75 and 1981-82. This picture masks 
the degree to which the pain of the current downturn is falling on 
households. From the perspective of wealth losses and declines in real 
consumption, the current recession is likely to prove more severe than 
any of the previous ten in the post World War II era (see Special 
report: How deep is the ocean? Gauging US recession contours). For 
Western Europe, the current downturn is currently projected to look 
similar to the one in the early 1990s--the last episode in which 
regional GDP contracted. . .

             Inflation and real policy rates to go negative

    With part of this year's slide in global growth linked to an 
inflation shock, the recent collapse in global commodity prices should 
be seen as an important factor cushioning the downturn. In the six 
months through August 2008, global consumer prices rose at a 5.6% 
annual rate, prompting stagnation in real consumption across the globe. 
Based on recent moves in the price of oil and other commodities, it is 
likely that the coming six months will see headline inflation dip below 
zero. While this swing will be a plus for consumers across the globe, 
it is also a development that will promote a significant growth 
rotation towards the G3 and Emerging Asian economies that were hurt 
most severely by this negative shock. In the developed world, this 
backdrop of contracting GDP, collapsing inflation, and financial market 
stress opens the door to a powerful monetary policy response (emphasis/
bold added).''
    So the leading supporters of the view that the global economy 
risked rising inflation, rising growth reflation and sharply higher 
policy rates to fight this inflation are now predicting a global 
recession, global deflation and sharply falling policy rates. What a 
difference a year makes.
    Is there any further doubt that we are headed towards a global 
deflation or--better--a global stag-deflation? Aggregate demand is now 
collapsing in the US and advanced economies and sharply decelerating in 
emerging markets; there is a huge excess capacity for the production of 
manufactured goods in the global economy as the massive and excessive 
capex spending in China and Asia (Chinese real investment is now close 
to 50% of GDP) has created an excess supply of goods that will remain 
unsold as global aggregate demand falls; commodity prices are in free 
fall with oil prices alone down over 50% from their July peak (and the 
Baltic Freight Index--the best measure of international shipping 
costs--is 90% from its peak in May); while labor market slack is 
sharply growing in the US and rising in Europe and other advanced 
economies.
    And what are financial markets telling us about the risks of stag-
deflation?
    First, yields on 10 year Treasury bonds fell by about 50bps since 
October 14th getting close to their previous 2008 lows; also two-year 
Treasury yield have fallen by about l50bps in the last month. Second, 
gold prices--a typical hedge against rising global inflation--are now 
sharply falling. Finally, and more importantly, yields on TIPS 
(Treasury Inflation-Protected Securities) due in five years or less 
have now become higher than yields on conventional Treasuries of 
similar maturity. The difference between yields on five-year Treasuries 
and five-year TIPS, known as the breakeven rate, fell to minus 0.43 
percentage points; this is a record. Since the difference between the 
conventional Treasuries and TIPS is a proxy for expected inflation the 
TIPS market is now signaling that investors expect inflation to be 
negative over the next five years as a severe recession is ahead of us.
    So goods markets, labor markets, commodity markets, financial 
markets and bond markets are all sending the same message: stagnation/
recession and deflation (or stag-deflation) is ahead of us in the US 
and global economy.
    So, we should not be surprised if six months from now the Fed and 
other central banks in advanced economies will start to worry--as they 
did in 2002-03 after the 2001 recession--about deflation rather than 
inflation. In those years where the US experienced a deflation scare 
Bernanke wrote several pieces explaining how the US could resort to 
very unorthodox policy actions to prevent a deflation and a liquidity 
trap like the one experienced by Japan in the 1990s. Those writings may 
have to be soon carefully read and studied again as the US and global 
economy faces its worst recession in decades and as deflationary forces 
envelop the US and other advanced economies. It also highly likely that 
as deflationary forces mount the Fed will have to cut the Fed Funds 
rate even further: as I have argued for a while at the bottom of this 
business cycle the Fed Funds rate is likely to be closer to 0% than to 
1%. Indeed, if the Fed cut the Fed Funds rate to 1% during the last 
recession that was short and shallow it will cut this rate much further 
if--as likely--the recession will be much more severe and protracted 
this time around.
    Finally, while in the short run a global recession will be 
associated with deflationary forces shouldn't we worry about rising 
inflation in the middle run? This argument that the financial crisis 
will eventually lead to inflation is based on the view that governments 
will be tempted to monetize the fiscal costs of bailing out the 
financial system and that this sharp growth in the monetary base will 
eventually cause high inflation. In a variant of the same argument some 
argue that--as the US and other economies face debt deflation--it would 
make sense to reduce the debt burden of borrowers (households and now 
governments taking on their balance sheet the losses of the private 
sector) by wiping out the real value of such nominal debt with 
inflation.
    So should we worry that this financial crisis and its fiscal costs 
will eventually lead to higher inflation? The answer to this complex 
question is: likely not.
    First of all, the massive injection of liquidity in the financial 
system--literally trillions of dollars in the last few months--is not 
inflationary as it is accommodating the demand for liquidity that the 
current financial crisis and investors' panic has triggered. Thus, once 
the panic recedes and this excess demand for liquidity shrinks, central 
banks can and will mop up all this excess liquidity that was created in 
the short run to satisfy the demand for liquidity and prevent a spike 
in interest rates.
    Second, the fiscal costs of bailing out financial institutions 
would eventually lead to inflation if the increased budget deficits 
associated with this bailout were to be monetized as opposed to being 
financed with a larger stock of public debt. As long as such deficits 
are financed with debt--rather than by running the printing presses--
such fiscal costs will not be inflationary as taxes will have to be 
increased over the next few decades and/or government spending reduced 
to service this large increase in the stock of public debt.
    Third, wouldn't central banks be tempted to monetize these fiscal 
costs--rather than allow a mushrooming of public debt--and thus wipe 
out with inflation these fiscal costs of bailing out lenders/investors 
and borrowers? Not likely in my view: even a relatively dovish Bernanke 
Fed cannot afford to let the inflation expectations genie out of the 
bottle via a monetization of the fiscal bailout costs; it cannot 
afford/be tempted to do that because if the inflation genie gets out of 
the bottle (with inflation rising from the low single digits to the 
high single digits or even into the double digits) the rise in 
inflation expectations will eventually force a nasty and severely 
recessionary Volcker-style monetary policy tightening to bring back the 
inflation expectation genie into the bottle. And such Volcker-style 
disinflation would cause an ugly recession. Indeed, central banks have 
spent the last 20 years trying to establish and maintain their low 
inflation credibility; thus destroying such credibility as a way to 
reduce the direct costs of the fiscal bailout would be highly corrosive 
and destructive of the inflation credibility that they have worked so 
hard to achieve and maintain.
    Fourth, inflation can reduce the real value of debts as long as it 
is unexpected and as long as debt is in the form of long-term nominal 
fixed rate liabilities. The trouble is that an attempt to increase 
inflation would not be unexpected and thus investors would write debt 
contracts to hedge themselves against such a risk if monetization of 
the fiscal deficits does occur. Also, in the US economy a lot of 
debts--of the government, of the banks, of the households--are not long 
term nominal fixed rate liabilities. They are rather shorter term, 
variable rates debts. Thus, a rise in inflation in an attempt to wipe 
out debt liabilities would lead to a rapid re-pricing of such shorter 
term, variable rate debt. And thus expected inflation would not succeed 
in reducing the part of the debts that are now of the long term nominal 
fixed rate form, i.e., you can fool all of the people some of the time 
(unexpected inflation) and some of the people all of the time (those 
with long term nominal fixed rate claims) but you cannot fool all of 
the people all of the time. Thus, trying to inflict a capital levy on 
creditors and trying to provide a debt relief to debtors may not work 
as a lot of short term or variable rate debt will rapidly reprice to 
reflect the higher expected inflation.
    In conclusion, a sharp slack in goods, labor and commodity markets 
will lead to global deflationary trends over the next year. And the 
fiscal costs of bailing out borrowers and/or lenders/investors will not 
be inflationary as central banks will not be willing to incur the high 
costs of very high inflation as a way to reduce the real value of debt 
burdens of governments and distressed borrowers. The costs of rising 
expected and actual inflation will be much higher than the benefits of 
using the inflation/seignorage tax to pay for the fiscal costs of 
cleaning up the mess that this most severe financial crisis has 
created. As long--as likely--as these fiscal costs are financed with 
public debt rather than with a monetization of these deficits inflation 
will not be a problem either in the short run or over the medium run.
    Given the risk of a deflationary and recessionary spiral in the 
economy--like the one experienced by Japan in the 1990s after the 
bursting of its real estate and equity bubble--it is essential to 
prevent such destructive price deflation from occurring. Thus risk of a 
deflation is additional argument in favor of an aggressive fiscal 
stimulus package; such package will reduce the risk of such 
destabilizing deflationary spiral.

 Prepared Statement of Dr. Simon Johnson, Ronald A. Kurtz Professor of 
        Entrepreneurship, Massachusetts Institute of Technology

Main Points
    1) The US is facing a serious recession and subsequent slow growth, 
due to the effects of a crisis of confidence in and around the global 
credit system.
    2) Some sensible counter-cyclical policies are now being 
implemented in the US, but problems in other parts of the world are 
still emerging and most economic forecasts continue to be marked down.
    3) In this environment, a total fiscal stimulus of around $450 
billion (or roughly 3% of GDP) would be appropriate, with about half 
front-loaded in the first three quarters of 2009, when there will 
likely be recession, and the rest following over the next 8-12 
quarters, during which otherwise growth will be slow.
    Today, it is abundantly clear that not only the United States but 
much of the world is sliding rapidly into recession. While the Treasury 
Department, Federal Reserve, and Congress have taken multiple steps to 
ensure the stability of the financial system, the next question is how 
to protect the real economy from a severe, prolonged recession and 
construct a basis for long-term growth and prosperity in the future.
    My testimony includes three main sections: first, the roots and 
evolution of the current global financial crisis; second, the current 
situation; and third, my recommendations for the stimulus package 
itself.

The Global Financial Crisis
                          Roots of the Crisis
    For at least the last year and a half, as banks took successive 
writedowns related to deteriorating mortgage-backed securities, the 
conventional wisdom was that we were facing a crisis of bank solvency 
triggered by falling housing prices and magnified by leverage. However, 
falling housing prices and high leverage alone would not necessarily 
have created the situation we are now in.
    The problems in the U.S. housing market were not themselves big 
enough to generate the current financial crisis. America's housing 
stock, at its peak, was estimated to be worth $23 trillion. A 25% 
decline in the value of housing would generate a paper loss of $5.75 
trillion. With an estimated 1-3% of housing wealth gains going into 
consumption, this could generate a $60-180 billion reduction in total 
consumption--a modest amount compared to US GDP of $15 trillion. We 
should have seen a serious impact on consumption, but, there was no a 
priori reason to believe we were embarking on a crisis of the current 
scale.
    Leverage did increase the riskiness of the system, but did not by 
itself turn a housing downturn into a global financial crisis. There is 
no basis on which to say banks were too leveraged in one year but were 
safe the year before; how leveraged a bank can be depends on many 
factors, most notably the nature and duration of its assets and 
liabilities. In the economy at large, credit relative to incomes has 
been growing over the last 50 years, and even assuming that credit was 
overextended, today's crisis was not a foregone conclusion.
    There are two possible paths to resolution for an excess of credit. 
The first is an orderly reduction in credit through decisions by 
institutions and individuals to reduce borrowing, cut lending, and 
raise underlying capital. This can occur without much harm to the 
economy over many years. The second path is more dangerous. If 
creditors make abrupt decisions to withdraw funds, borrowers will be 
forced to scramble to raise funds, leading to major, abrupt changes in 
liquidity and asset prices. These credit panics can be self-fulfilling; 
fears that assets will fall in value can lead directly to falls in 
their value.

                         A Crisis of Confidence

    We have seen a similar crisis at least once in recent times: the 
crisis that hit emerging markets in 1997 and 1998. For countries then, 
read banks (or markets) today. In both cases, a crisis of confidence 
among short-term creditors caused them to pull out their money, leaving 
institutions with illiquid long-term assets in the lurch.
    This emerging market crisis started in June 1997 in Thailand, where 
a speculative attack on the currency caused a devaluation, creating 
fears that large foreign currency debt in the private sector would lead 
to bankruptcies and recession. Investors almost instantly withdrew 
funds and cut off credit to Malaysia, Indonesia and the Philippines 
under the assumption that they were guilty by proximity. All these 
countries lost access to foreign credit and saw runs on their reserves. 
Their currencies fell sharply and their creditors suffered major 
losses.
    From there, the contagion spread for no apparent reason to South 
Korea--which had little exposure to Southeast Asian currencies--and 
then to Russia. Russia also had little exposure to Asia. However, 
Russia was funding deficits through short-term ruble bonds, many of 
which were held by foreign investors. When short-term creditors 
panicked, the government and the IMF could not prevent a devaluation 
(and a default on those ruble bonds). GDP fell 10% in the following 12 
months. After Russia, the story repeated itself in Brazil. In December 
1998 Brazil let the currency float, leading to a sharp depreciation 
within one month.
    In each case, creditors lost confidence that they could get their 
principal back and rushed to get out at the same time. In such an 
environment, any institution that borrows short and lends long is 
vulnerable to an attack of this kind. The victims had one common trait: 
if credit were cut off they would be unable to maintain their existing 
activities. The decision of credit markets became self-fulfilling, and 
policy makers around the world seemed incapable of stopping these 
waves.

                     The Acute Stage of the Crisis

    The evolution of the current financial crisis seems remarkably 
similar to the emerging markets crisis of a decade ago.
    America's crisis started with creditors fleeing from sub-prime debt 
in summer 2007. As default rates rose, investment-grade debt--often 
collateralized debt obligations (CDOs) built out of sub-prime debt--
faced large losses. The exodus of creditors caused mortgage finance and 
home building to collapse.
    The second stage began with the Bear Stearns crisis in March 2008 
and extended through the bailout of Fannie Mae and Freddie Mac. As 
investment banks evolved into proprietary trading houses with large 
blocks of illiquid securities on their books, they became dependent on 
the ability to roll over their short-term loans, regardless of the 
quality of their assets. Given sufficient panic, it can become 
impossible to roll over those loans. And in a matter of days, despite 
no major news, Bear Stearns was dead. However, while the Federal 
Reserve and Treasury made sure that Bear Stearns equity holders were 
penalized, they also made sure that creditors were made whole--a 
pattern they would follow with Fannie and Freddie. As a result, 
creditors learned that they could safely continue lending to large 
financial institutions.
    This changed on September 15 and 16 with the failure of Lehman and 
the ``rescue'' of AIG, which saw a dramatic and damaging reversal of 
policy. Once Bear Stearns had fallen, investors focused on Lehman; 
again, as confidence faded away, Lehman's ability to borrow money 
evaporated. This time, however, the Fed let Lehman go bankrupt, largely 
wiping out creditors. AIG was a less obvious candidate target. Despite 
large exposure to mortgage-backed securities through credit default 
swaps, no analysts seemed to think its solvency was truly in question. 
Overnight, however, without any fundamental changes, the markets 
decided that AIG might be at risk, and the fear became self-fulfilling. 
As with Lehman, the Fed chose not to protect creditors; because the $85 
billion loan was senior to existing creditors, senior debt was left 
trading at a 40% loss.
    This decisive change in policy reflected a growing political 
movement in Washington to protect taxpayer funds after the Fannie Mae 
and Freddie Mac actions. In any case, though, the implications for 
creditors and bond investors were clear: RUN from all entities that 
might fail, even if they appear solvent. As in the emerging markets 
crisis of a decade ago, anyone who needed access to the credit markets 
to survive might lose that access at any time.
    As a result, creditors and uninsured depositors at all risky 
institutions pulled their funds--shifting deposits to Treasuries, 
moving prime brokerage accounts to the safest institutions (read 
JPMorgan), and cashing out of securities arranged with any risky 
institutions. The previously invincible Morgan Stanley and Goldman 
Sachs saw large jumps in their credit default swap rates. Washington 
Mutual and Wachovia vanished. LIBOR shot up and short-term US Treasury 
yields fell as banks stopped lending to each other and lent to the US 
government instead. The collapse of one money market fund (largely 
because of exposure to Lehman debt), and the pending collapse of more, 
sent the US Treasury into crisis mode.
    At the same time, the credit market shock waves spread quickly 
throughout the world. In Europe, interbank loan rates and EURIBOR rates 
shot up, and banks from Bradford & Bingley to Fortis were nationalized. 
Further afield, Russia and Brazil each saw major disruptions in their 
interbank markets and Hong Kong experienced a (small) bank run. From 
late September, credit markets around the world were paralyzed by the 
fear that any leveraged financial institution might fail due to a lack 
of short-term credit. Self-fulfilling collapses can dominate credit 
markets during these periods of extreme lack of confidence.

                              The Response

    There are two ways to end a crisis in confidence in credit markets. 
The first is to let events unfold until so much deleveraging and so 
many defaults have occurred that entities no longer rely on external 
finance. The economy then effectively operates in a ``financially 
autonomous'' manner in which non-financial firms do not need credit. 
This is the path most emerging markets took in 1997-1998. Shunned by 
the world investment community, it took many years for credit markets 
to regenerate confidence in their worthiness as counterparties.
    The second is to put a large balance sheet behind each entity that 
appears to be at risk, making it clear to creditors that they can once 
again safely lend to those counterparties without risk. This should 
restore confidence and soften the coming economic recession.
    Governmental responses to the crisis were fitful, poorly planned, 
and abysmally presented to the public. The US government, to its 
credit, was the first to act, while European countries boasted they 
would be little affected. Still, though, Messrs. Paulson and Bernanke 
had made the mistake of insisting right through the Lehman bankruptcy 
that the system was fundamentally sound. As a result, their rapid 
reversal and insistence that they needed $700 billion for Mr. Paulson 
to spend however he wished was greeted coldly on Capitol Hill and in 
the media.
    The initial Paulson Plan was designed to increase confidence in 
financial institutions by transferring their problematic mortgage-
backed securities to the federal government's balance sheet. The plan 
had many problems, ranging from uncertainty over what price the 
government would pay for the assets to questions about whether it would 
be sufficient to stop the crisis of confidence. On September 29, I 
recommended passing the plan and supplementing it with four additional 
measures: the first two were unlimited deposit insurance and an equity 
injection program for financial institutions. (My views throughout the 
crisis were published at http://BaselineScenario.com and in various 
other media outlets.)
    After the Paulson Plan was passed on October 3, it was quickly 
overtaken by events. First the UK announced a bank recapitalization 
program; then, on October 13, it was joined by every major European 
country, most of which also announced loan guarantees for their banks. 
On October 14, the US followed suit with a bank recapitalization 
program, unlimited deposit insurance (for non-interest-bearing 
accounts), and guarantees of new senior debt. Only then was enough 
financial force applied for the crisis in the credit markets to begin 
to ease, with LIBOR finally falling and Treasury yields rising, 
although they are still a long way from historical levels.

                      Dangers for Emerging Markets

    Although the US and Europe have grabbed most of the headlines, the 
most vulnerable countries in the current crisis are in emerging 
markets. Just like highly leveraged banks, highly leveraged countries--
such as Iceland--are vulnerable to the flight of capital. Countries 
that got rich during the commodities boom are also highly vulnerable to 
a global recession.
    The flight to safety is already destabilizing banks around the 
world. For companies that can get credit, the cost has skyrocketed. 
These financial sector tremors are sending shock waves through emerging 
market economies. While wealthy nations can use their balance sheets to 
shore up banks, many other countries will find this impossible. Like 
Latin America in the 1980s, or emerging markets after 1997-98, the 
withdrawal of credit after a boom can lead to steep recessions and 
major internal disruptions.
    Four sets of countries stand to lose.
    1. The over-leveraged. With bank assets more than ten times its 
GDP, Iceland cannot protect its banks from a run. Other countries that 
borrowed heavily during the boom face a similar situation.
    2. The commodity-dependent. Oil has already fallen below $70 per 
barrel, and demand continues to fall. All other major commodities are 
falling for the same reasons. Commodity exporters facing sharply 
reduced revenues will need to cut spending and let their currencies 
depreciate.
    3. The extremely poor. Sub-Saharan Africa, which was a beneficiary 
of the commodity boom, will be hit hard by the fall in commodity 
prices. At the same time, wealthy nations are likely to slash their 
foreign aid budgets. The net effect will be prolonged isolation from 
the global economy and increased inequality.
    4. China. The global slowdown has already had a major impact on 
several sectors of China's manufacturing economy. The collapse in the 
Baltic Dry Index shows that demand for commodities and manufactured 
goods is plummeting. While China's economic influence will only grow in 
the long term, a global recession could cause a severe crimp in its 
growth.
    Events of the past two weeks, with emerging markets currencies 
plunging relative to the yen and the dollar, and multiple countries 
petitioning the IMF for loans, show that the emerging markets crisis is 
only deepening. This will inflict damage on G7 economies, increase 
global inequality, and create geo-political instability.

The Current Situation

                          The Financial System

    Today, although it is by no means assured, it seems relatively 
likely that the financial panic will gradually ease and the successive 
collapse of many large banks in the US and Europe will not occur. 
However, the resumption of interbank lending alone will not be enough 
to reverse the downward trajectory of the real economy. Banks still 
need to deleverage in a major way and there are doubts about how much 
lending to the real economy will pick up. For example, mortgage rates 
in the US actually increased after the recapitalization plan was 
announced. In a worst case scenario, even some wealthy countries may 
not be able to absorb the losses sustained by their banks. The US will 
have to worry not just about its banks, but also about some insurance 
companies and potentially quasi-financial companies such as GMAC, Ford, 
and GE.

                            The Real Economy

    Before the severe phase of the crisis began on September 15, the 
world was already facing an economic slowdown. The credit crisis of the 
past month and the lingering uncertainty seem certain to produce a 
global recession. In the face of uncertainty and higher credit costs, 
many spending and investment decisions will be put on hold. US and 
European consumption decline along with housing prices. With interest 
rates rising around the world, companies will pay down debt and reduce 
spending and investment plans. State and municipal governments will see 
lower tax revenues and cut spending. No country can rely on exports to 
provide much cushion, as growth and spending around the world have been 
affected by the flight from credit.
    Recent economic indicators in the US show significant deterioration 
in the real economy. Because these indicators are from the entire month 
of September, they probably understate the effect of the acute credit 
crunch of the second half of the month, which we will not fully 
appreciate until October data appear in the middle of November. In the 
meantime, there is abundant anecdotal data, with layoffs by dozens of 
America's most prominent companies, ranging from Yahoo to Goldman Sachs 
to General Electric.

                     Unexpected Distress in Europe

    The most recent reports indicate a much sharper downturn in Europe 
than was expected even a few weeks ago, with the UK already in 
recession in the third quarter of this year. Even wealthy European 
countries and members of the Eurozone are threatened by two important 
developments, in addition to the acute credit crisis that has been with 
us since the middle of September.
    First, many European countries' banking sectors have imported 
serious financial problems from emerging market countries. In recent 
years, much of the investment in Eastern Europe and Latin America has 
come from European banks, which are now seeing their asset values 
plummet.
    Second, and potentially more dangerously, worries are mounting that 
even members of the Eurozone might default on their sovereign debts. By 
acting to guarantee the solvency of their domestic banks, European 
countries have implicitly taken the risk of default onto themselves. As 
the recession deepens, those banks may fall further and further into 
the red, requiring their government backers to provide more and more 
capital. Because, in some cases, domestic bank assets are significantly 
larger than GDP, there is risk that some governments may simply be 
unable to bail out their financial sectors. Investor nervousness over 
this prospect can be seen in the prices of credit default swaps on 
sovereign debt. The implied risk of default for countries such as 
Ireland, Italy and Greece has already quadrupled to 12% each.
    The real risk here is that these pressures may cause one or more 
countries to abandon the euro, or at least may require Eurozone nations 
to expend considerable resources to fight off that prospect. Nations 
threatened by fleeing creditors and rising interest rates will want 
looser monetary policy, but have ceded control over monetary policy to 
the European Central Bank (ECB), which is still dominated by inflation 
fighters. If the ECB fails to help threatened member nations, domestic 
politicians will argue that they are better off setting policy at home. 
The costs of abandoning the euro would be very high, but it could 
happen. If one nation breaks away, investors will wonder who is next, 
cutting off financing from other countries. The damage inflicted on the 
real economy would be enormous.

                Emerging Markets Getting Worse and Worse

    In just the last week, the outlook for emerging markets has gotten 
significantly worse. As the wealthiest nations protect their banking 
sectors, investors and lenders will be less likely to put their money 
in countries perceived as risky. Iceland is already facing default, 
either by its banking sector or by its government. After Iceland, the 
psychology of fear is likely to take over as creditors try to guess 
which country will be next, just as in 1997-98. Unless a country has a 
sufficient balance sheet and a very large amount of reserves, it may 
get drawn into a pattern of selective defaults and large devaluations.
    The IMF is stepping in with aid packages to Iceland, Ukraine, and 
Hungary. However, it is hard to see how the IMF or anyone else can 
provide resources on a sufficient scale to make a difference. Investors 
expect multiple countries across Eastern Europe to default, judging by 
the price of credit default swaps on those countries' debt.
    Falling commodity prices due to the coming recession will also hurt 
many exporting countries. Even Russia, with its large foreign currency 
reserves (and vast oil and gas reserves) may have a significant 
mismatch problem between short term liabilities and longer term assets. 
This is complicated further by large private sector debt in foreign 
currency. The government may be moving toward deciding which companies 
they will save. Hopefully, for the companies they do not support, it 
will be possible to have an orderly workout.
    The currency crisis that has blossomed over the last week is only 
exacerbating the crisis. As emerging market currencies fall, their 
foreign debts become more and more unmanageable, increasing the risk of 
default. Whether because of the unwinding of the carry trade or because 
of old-fashioned flight from assets that are falling in value, the 
currency crisis has become self-perpetuating. This will have two 
negative effects on the US economy: first, the strengthening dollar 
will make it harder for US exporters to compensate for the fall in 
domestic consumption; second, as all of our trade partners' economies 
become weaker, the prospects that an external source of economic growth 
will help lift us out of our recession become dimmer.

                                Summary

    In the United States, we have been aware of an impending economic 
slowdown for over a year. We will never know how pronounced the 
slowdown would have been in the absence of the acute credit crisis that 
began in mid-September. That crisis has triggered an ever-expanding 
series of impacts on the global economy that have almost certainly 
plunged our economy into a serious recession. The constriction in the 
availability of credit itself has a real impact on spending and 
investment by consumers and businesses. The widespread fear generated 
by events over the past six weeks has had an additional chilling effect 
on consumer and business confidence. The financial crisis has triggered 
severe economic problems in emerging markets, which have spilled back 
into the economies of some of our most important trading partners. Some 
prominent economists are raising warnings that de-leveraging in the 
``shadow banking system,'' such as by hedge funds, could trigger 
another wave of asset price falls across global markets.
    I am not saying that the sky is falling on the US economy. As of 
now, most forecasts indicate that we will experience a serious 
recession, perhaps comparable to the recession of the early 1980s, but 
nothing like the Great Depression. However, I want to underline the 
point that most of the most pedigreed economists and policy makers have 
failed to anticipate the serial effects that the crisis has had, and 
that it may yet have more surprises for us.

Economic Stimulus
    There are a number of steps that the US can take to address the 
many problems facing the global economy. These include continued action 
to recapitalize financial institutions under the Emergency Economic 
Stabilization Act, low interest rates, liquidity measures by the 
Federal Reserve, actions (coordinated with other G7 countries) to rein 
in the currency crisis, direct intervention in the housing market, and 
new forms of financial regulation, both domestic and international. The 
Federal Reserve must act decisively to forestall any risk of deflation 
(falling prices and wages). For today, however, the question is how 
best to stimulate the economy to cushion the impact of the recession 
and lay the foundation for future long-term growth: specifically, what 
form the stimulus should take, and how big it should be.

Stimulus Objectives
    Before deciding these specific questions, however, we need to 
define the general objectives of the stimulus. The US economy is going 
through a massive de-leveraging process that is causing significant 
declines in asset values--first in real estate markets, now in 
securities markets--that will reduce the purchasing power of consumers 
for years to come. Attempting to prop up those asset values by putting 
more money in people's pockets is likely to fail--the amount of money 
needed would be huge--and would likely only extend the de-leveraging 
process. The experience of the stimulus package earlier this year was 
that a large proportion of the tax rebates went toward household 
savings or paying down debt; asking the American consumer to spend his 
or her way out of this recession is unlikely to succeed.
    So what are we trying to achieve? I think there are three main 
objectives:
    1. Reduce the depth and severity of the recession. The constriction 
in lending and widespread pessimism among both consumers and businesses 
risk producing a sharp downturn that pushes asset values far below 
their sustainable levels. A classic economic stimulus, by encouraging 
economic activity, can counteract this pessimism and limit the damage. 
One condition of meeting this objective is that measures should be 
designed to flow into the economy quickly.
    2. Help those people who will be hurt most by the recession. One 
can argue that this is not, strictly speaking, necessary to economic 
recovery, but I believe it remains an obligation of our government and 
society to limit the human misery that will be caused by a recession.
    3. Invest in America's long-term growth and productivity. The 
stimulus plan should encourage behavior that will increase the long-
term economic prospects for the country. A simplistic way of putting 
this is that given the choice, we would rather see investments in 
infrastructure than in consumption of flat-screen TVs.
    Another factor we need to keep in mind is that this is likely to be 
a relatively long recession, where economic growth may not return to 
target levels for 24 months or longer. In this context, stimulus 
measures that might not be considered for a shorter recession should be 
put on the table.
    So, with these considerations in mind, what should the stimulus 
package include?
    I divide my recommended stimulus programs into two categories that, 
for want of a better term, I call short-term and long-term. Short-term 
programs are those intended to feed money into the economy quickly and 
in a form that will have a direct impact on economic activity; that is, 
they should encourage spending rather than saving. Long-term programs 
are those that may not boost economic growth within one or two 
quarters, but will help the economy grow out of the recession and will 
also help increase long-term productivity growth in the economy.

Short-term Programs
    Several of the programs I recommend are those favored by other 
economists and commentators and with which the Committee is already 
familiar, so I will not describe them in exhaustive detail.
    1. Direct aid to state and local governments. This direct aid is 
desirable for two reasons. First, because it replaces money that state 
and local governments have been forced to cut from their budgets, it 
can have a very rapid effect, without the need to design new programs. 
Second, the money will go to programs that these governments have 
already decided are important and worth funding, minimizing the risk 
that the stimulus will be wasted on inappropriate ends. Not only did 
many states cut budgets for the current fiscal year with the 
anticipation of reduced tax revenues, but several states have enacted 
midyear budget cuts as their expectations have deteriorated. According 
to the Center on Budget and Policy Priorities, states closed $48 
billion in shortfalls in enacting their current (fiscal year 2009) 
budgets, and so far another $12 billion in gaps have opened up since 
the year began (generally in July). The CBPP is also forecasting 
shortfalls in the $100 billion range for the following year.
    2. Extended unemployment benefits. Congress already extended 
unemployment benefits by 13 weeks in July 2008, but that measure will 
currently expire in March 2009. This provision should be extended past 
March 2009, and other means of expanding unemployment coverage should 
be considered, such as further extensions based on state-by-state 
unemployment rates. Extending unemployment benefits has a high ``bang 
for buck'' ratio, because needy people are more likely to spend each 
incremental dollar. According to testimony by Mark Zandi of Moody's 
Economy.com before the House Committee on Small Business in July, each 
dollar in extended unemployment benefits translates into $1.64 in 
incremental GDP over the following twelve months. Finally, this program 
helps some of the people who will be most sorely affected by the 
economic downturn, in most cases through no fault of their own.
    3. Expanded food stamp aid. Expanding food stamps has many of the 
same beneficial characteristics as extending unemployment benefits. 
Because food stamps cannot be put in the bank or used to pay down debt, 
they tend to contribute to economic activity quickly. According to Mark 
Zandi's testimony, each dollar in expanded food stamp aid contributes 
$1.73 to incremental GDP.
    4. Loan modifications for distressed homeowners. To these ideas I 
would add money for relief to distressed homeowners in the form of 
government-sponsored loan modifications. This may not be in the fiscal 
stimulus package per se, but it should not be far behind. The current 
proposal to guarantee modified loans as an incentive for lenders and 
servicers to make those modifications is promising. Like any guarantee, 
however, it raises the possibility that the government may lose money. 
This would be an appropriate usage of money as part of the stimulus 
package, as this program should help prevent housing prices from 
crashing far below their long-term values, and therefore prevent a 
further depletion of households' spending power.

                           Long-term programs

    In addition, however, a number of other stimulus programs should be 
considered, for two reasons. First, given the depth of the expected 
recession, the programs listed above may to be too small to have the 
desired impact. Second, the expected length of the recession provides 
an unusual opportunity: an opportunity to invest in our economic future 
while also combating the recession.
    For these reasons, the following initiatives should also be on the 
table:
    1. Investment in basic infrastructure, such as highways and 
bridges. In order to accelerate the economic impact, money could 
initially be put into maintenance projects, but new construction 
projects should not be ruled out.
    2. Job retraining programs or grants. The recession will accelerate 
some of the long-term changes in the American economy; the proposed 
merger of GM and Chrysler is just one sign of this trend. Tens of 
thousands of people will need to develop new skills.
    3. Expanded student loans. Even before the latest phase of the 
financial crisis, smaller lenders were exiting the student loan market, 
especially for community college students, and there is a risk that 
this trend could reduce the availability of college educations for 
lower-income students. Student loans will go directly toward paying for 
tuition and other costs, so they should have a direct impact on the 
economy.
    4. Expanded small business loans. The credit crisis has not only 
seen a reduction in the availability of credit, but also an increase in 
the price of credit for small businesses. Government programs to 
guarantee small business loans or otherwise increase the availability 
of credit should have a nearly direct impact on the economy. The 
programs could be designed to discourage companies from getting new 
loans to pay down existing loans.
    5. Investment in alternative energy, through tax incentives, direct 
grants, or other means. Someday in the next couple years the price of 
oil will start increasing again; despite its recent fall, long-term 
projections of the amount of oil in the world have not changed. Moving 
our economy away off of oil and onto alternative energy sources will 
not only protect us from inflation in the future, but will give our 
companies a new avenue for long-term growth.
    I am too far from being an expert on all of these topics to go into 
them in great detail. I know that several of them have been considered 
by members of Congress. My point is that given the amount of fiscal 
force that will need to be deployed, and the length of time over which 
it will need to be deployed, it is appropriate to consider measures 
that will both stimulate the economy and invest in our long-term 
future.

                            Size of Stimulus

    In his testimony to the House Budget Committee last week, Martin 
Baily proposed a stimulus of $200 to $300 billion. His recommendation 
was based on a range of forecasts about the severity of the recession. 
As this is not an exact science, I will follow a similar approach with 
slightly different results.
    Baily used two forecasts: the Blue Chip consensus forecast and a 
more pessimistic scenario that he defined. The Blue Chip forecast 
included three quarters of contraction, with a trough of -1.1% GDP 
growth (annual rate) in Q4 2008, with a relatively rapid return to 
healthy growth (+2.2% in the first post-recession quarter). His 
pessimistic forecast was for five quarters of recession, with a trough 
of -4.0% GDP growth in Q4 2008 and Q1 2009.
    There are three other forecasts I will mention to give a range of 
the expected outcomes:

      Goldman Sachs in early October forecast zero growth in Q3 
2008, contraction in Q4 and Q1 (trough of -2.0%), and zero growth in Q2 
2009.
      The current IMF forecast is for two quarters of 
recession, followed by one quarter of zero growth.
      JPMorgan forecast 3 quarters of contraction, with a 
trough of -1.6% and 12 quarters of slow growth.

    However, the main issue with any macroeconomic forecast is that, in 
this environment, it risks being out of date the day after it is made. 
In just the last week, plunging growth rates in Europe and a full-
blown, global currency crisis have become part of the economic 
landscape. In the US, insurance companies have been deemed at 
sufficient risk to be included in the Treasury recapitalization plan. 
Exports, which have been the one bright spot in the US economy in 
recent quarters, will be hurt by the rising dollar and the declining 
global economy. Asset values, including both housing and equities, 
continue to fall steeply. In short, the vast majority of the news has 
been negative, even relative to generally pessimistic expectations. As 
a result, I believe there is a large likelihood that all of these 
forecasts--with the possible expectation of Baily's pessimistic 
forecast--will later be revised downward.
    For planning purposes, then, I think we should think about a world 
in which the U.S. recession will last 4-5 quarters, with a trough at 
negative 2-3% GDP growth (annual rate), followed by 8-12 quarters of 
slow growth.
    Baily's method assumes that $1 in spending will contribute $1.50 to 
GDP, with the $0.50 in follow-on effects spread over several quarters. 
Based on this assumption, since US GDP is approximately $3.5 trillion 
per quarter, $35 billion in spending in a given quarter will contribute 
1.0% to GDP growth in that quarter, and small amounts thereafter. By 
matching expenditures on stimulus to the forecast GDP growth figures 
for each quarter, he concludes that $200-300 billion will be 
appropriate to cushion the recession and restore the economy to growth.
    I would suggest two modifications to this approach. First, I think 
it is optimistic to expect $1 in immediate impact for every $1 in the 
stimulus program. There is evidence that a significant proportion of 
this spring's tax rebates did not end up contributing to spending, and 
while the measures outlined above are more likely than tax rebates to 
result in direct increases in economic activity, it would be a mistake 
to overestimate the effectiveness of any macroeconomic intervention. As 
a result, I believe it more conservative to plan on something like 
$0.90 in immediate impact and $0.50 in follow-on impact.
    This implies that, for the 2-3 quarters of recession that remain to 
be affected (assuming there is nothing we can do about Q3 and Q4 this 
year), approximately $70 billion in stimulus expenditures per quarter 
may be called for, for a total of roughly $220 billion. The amount of 
stimulus should decline over the quarters due to follow-on effects, but 
a major issue is how to spend large sums early in 2009 while ensuring 
that the money is used well and has a high impact on GDP growth.
    Second, I would pay particular attention to the 8-12 quarters of 
prolonged slow growth. If we want to increase economic growth by an 
average of 0.5-1% (annual rate) in each of these quarters, this would 
imply approximately $25 billion in stimulus per quarter, or roughly 
$250 billion over the entire period.
    Added together, this yields a total stimulus package of around $450 
billion, or about 3% of GDP, spread over about 3-4 years. It also 
implies a way to time the short-term and long-term programs described 
above. Short-term programs can be implemented immediately to inject 
spending into the economy quickly. Long-term programs, such as 
infrastructure grants or alternative energy programs, should be 
announced and implemented quickly, but can take a longer time to bear 
fruit.
    There are, of course, many details that remain to be worked out. My 
goal has been to describe the types of programs that should be on the 
table and one approach to quantifying the size and timing of the 
stimulus package.

   Prepared Statement of Dr. Richard K. Vedder, American Enterprise 
                     Institute and Ohio University

    Madam Chairman, thank you for this opportunity to speak before the 
Joint Economic Committee. Since its creation by the Employment Act of 
1946, the JEC has been the premier congressional forum to discuss 
economic policy, and as a former staff member of the committee I am 
honored to participate in this hearing.
    I wish to make three points this morning. First, economic history 
tells us that periods of sharply eroding public confidence in financial 
institutions have significant negative economic consequences, but they 
do pass. Also, seeking retribution from persons or institutions 
perceived to be guilty of contributing to the crisis because of errors 
of business judgment (as opposed to illegal activity) often does not 
help, and may actually significantly deter recovery. I am not 
suggesting that Congress should do absolutely nothing further; for 
example, a review and probable modification of some existing regulatory 
and other practices relating to the financial services industry is no 
doubt in order, but I am urging that caution and moderation be used.
    Second, I would observe that this crisis is not simply an example 
of market failure, of irrational exuberance trumping common sense, 
thereby requiring government action. I, somewhat reluctantly, supported 
the $700 billion bailout package and advised some of your colleagues to 
vote for it. I also believe in perilous times that government has a 
role to play in restoring confidence. However, I am also convinced that 
the crisis itself largely reflects a series of public policy miscues. 
In the absence of these governmental mistakes, this financial crisis 
would never have happened.
    Third, I am very concerned about attempts by an overly zealous 
Congress to attempt to craft an economic program that likely will have 
adverse effects. In particular, expansionary fiscal policy in the form 
of higher government spending is precisely the wrong thing to do at 
this time, aggravating an explosion in inflationary expectations that I 
already fear will erupt, having detrimental effects on labor and 
financial markets.

Historical Observations
    Let me briefly comment on each of these factors. Anytime a firm or 
an entire sector of the economy has low rates of capitalization 
relative to its liabilities, the possibility of declining asset values 
leading to a dangerous erosion of net worth increases. When claims 
against the assets of firms can be made at any time, as is typically 
the case in the financial services industry, the problem is aggravated. 
In October 1929, there were roughly 11 dollars in bank deposits for 
every one dollar of currency in circulation, while in March 1933 there 
were only about four dollars of deposits per dollar of currency. As 
cash was removed from banks and converted to currency by nervous 
depositors, bank cash reserves fell, and with that confidence was 
eroded in the ability of the banks to meet remaining liabilities. Hence 
over 40 percent of the banks in the United States closed their doors 
between 1929 and 1933. I completely agree with Milton Friedman and Anna 
Schwartz that this was a significant factor in the Great Depression.
    As long as we have fractional reserve banking, confidence in 
financial institutions is vital. Deposit insurance has helped 
enormously in relieving problems relating to a lack of confidence, and 
bank failures went from an average of about 600 a year even in the 
prosperous 1920s to a handful annually shortly after the creation of 
the FDIC in the Banking Act of 1933. Scholars as diverse as Arthur 
Schlesinger and Milton Friedman have heralded this as great 
legislation. Implicitly, people have shown their confidence in the full 
faith and credit of the United State Government which they have 
believed is behind the deposit insurance guarantee. Yet that confidence 
is something we should not take for granted, and the excessive 
commitment of the government to protect virtually everyone from every 
possible loss could lead to erosion in confidence in government, and 
with that the ability of the government to serve as the protector of 
last resort for the financial system. The government's resources are 
not limitless, and the evidence from public opinion surveys that young 
people do not believe that the governmental commitment will be met to 
provide them with Social Security pensions is an early warning sign 
that excessive governmental commitments relative to available resources 
could conceivably lead to a confidence crisis where there is no viable 
governmental line of defense, and thus to true Financial Armageddon. 
You must maintain the credibility of that defense by not making 
commitments that the public knows cannot be met. By the way, Franklin 
D. Roosevelt was very much aware of this problem in 1933, and the large 
potential contingent liabilities to the government made him very cool 
to the whole idea of deposit insurance, and led him to successfully 
oppose high insurance limits favored by a bipartisan group of 
Congressmen.
    It is worth noting that in some previous panics private solutions 
to stemming eroding confidence were largely successful. For example, in 
the Panic of 1907, a group of private bankers led by J.P. Morgan 
amassed a fund that was used to prop up banks facing pressures from 
depositor withdrawals. On the other hand, in 1932, the Reconstruction 
Finance Corporation was created by a Republican President near the end 
of his term working with a Democratic controlled House and roughly 
evenly divided Senate, and it helped shore up bank capital by buying 
preferred stock in commercial banks. Sound familiar? It is also worth 
noting that the RFC outlived its usefulness, and in its later years 
after World War II became mired in scandal until it was finally 
abolished by Congress in 1953 during the Eisenhower Administration.
    The Great Depression was needlessly prolonged by dreadful public 
policies, some not directly related to financial services, especially 
the high wage policies of both Presidents Hoover and Roosevelt. But the 
bashing of bankers and other business leaders by governmental officials 
also contributed to extremely low levels of business confidence and 
investment during the 1930s. President Hoover supported an increase in 
top income tax rates from 25 to 63 percent near the bottom of the 
downturn, ostensibly to raise funds but in part to punish the alleged 
perpetrators of the 1929 downturn and its aftermath. Congress added to 
the problem by mercilessly attacking a prime symbol of American 
capitalism, the second J.P. Morgan, in hostile Congressional hearings 
in 1931. In the Roosevelt administration, the President's constant 
attack of businessmen as ``economic royalists'' and the absolutely 
unconscionable hounding of Paul Mellon, long time Secretary of the 
Treasury, donor of the National Gallery of Art located just blocks 
away, and a prominent leader of the American business community, added 
to the fear of businesses to invest. Net business investment did not 
return to 1929 levels until after World War II. The writings of Robert 
Higgs and Amity Shlaes document these points in far more elaborate 
detail.

Government Or Market Failure?
    There are already persons characterizing the current crisis as an 
example of market failure, of greedy bankers absorbed with increasing 
their wealth leading relatively innocent borrowers astray through 
inappropriate lending practices, aggravated by ill advised financial 
deregulation. In short, we are told that it was an act of market 
failure accompanied by a failure of government to perform its 
appropriate role in correcting market imperfections. I think this 
interpretation is mostly incorrect, and contributes to a form of 
governmental hubris that could lead to exceedingly ill advised 
retaliatory measures and stranglehold regulations that could stifle 
America in general and our financial services industry in particular, 
an industry already losing world preeminence because of previous ill 
advised policy moves, starting as early as the separation of commercial 
and investment banking in the Banking Act of 1933 (that, ironically, is 
a casualty of the current crisis) and continuing through Sarbanes-Oxley 
and beyond.
    To be sure, private business people have made lots of mistakes. 
Banks made too many loans to too many people who were not credit 
worthy, and also lowered their lending standards and made implicitly 
dubious and excessively optimistic assumptions about the future of 
housing prices. The securitization of mortgages, while making some 
sense in terms of promoting market efficiency, also often largely 
shielded banks and loan officers from the adverse consequences of 
making bad and inappropriate lending decisions. The separation of the 
lending decisions from the adverse consequences of those decisions may 
on balance have been a mistake.
    But even more important were government failures. The Federal 
Reserve System promoted excessively loose monetary policies including 
very low and even negative real interest rates, even on long term 
government securities. The market rate of interest fell below that 
interest rate consistent with the degree of human preferences for use 
of funds today rather than in the future, and that led to 
overinvestment in housing and other capital-intensive variables, very 
much in keeping with the business cycle theories of Ludwig von Mises 
and Friedrich A. Hayek. This is demonstrated in the accompanying graph. 
Inflation-adjusted t-bill rates fell from their customary long term 
average of roughly 2 percent or so into negative territory in the 2002-
2005 period, inappropriately contributing to an increased demand for 
housing which could be met in the short run only by sharply rising 
housing prices. When the Fed reversed course, especially in 2006, 
tighter monetary policies and rising interest rates caused housing 
prices to start falling and left some persons with not enough money to 
make payments on mortgages on properties for which they had little or 
no equity, leading, of course, to massive foreclosures beginning about 
two years ago.
    Congress did not help, failing to deal with Fannie Mae and Freddie 
Mac despite repeated warnings, and shielding those organizations from 
rigorous regulation despite their being extremely thinly capitalized 
and engaging in dubious practices. Politics and campaign contributions 
trumped good economics. Incidentally, I identified some problems with 
these organizations in a JEC study done 26 years ago. The Community 
Reinvestment Act, while well intentioned, has provided an environment 
where bankers have been encouraged to adopt substandard lending 
criteria for certain classes of borrowers, no doubt contributing to a 
culture where traditional lending standards have been considered old-
fashioned and no longer applicable. The old admonition that bankers who 
borrow short should not lend long too much, an adage that historically 
led banks from shunning very large scale real estate investments, went 
out the window. Regulators stopped requiring financial institutions to 
meet solid lending standards. The move to mark-to-market accounting 
standards, while arguably justified as promoting honest financial 
transparency, no doubt contributed to the nervousness of investors and 
the corresponding flight from investing in many businesses.
    Reliving the past has limited utility, but it does point out human 
frailties are not confined to either the private or the public sector 
of the economy. Seeking to replace private judgments on the allocation 
of capital resources with public judgments is not in itself a recipe 
for success, and given the politicization of many public economic 
decisions in modern times I would bet that on balance a dramatic tilt 
in decision-making with respect to the allocation of financial capital 
would have far reaching adverse effects. I rather have thousands of 
bankers making those allocation decisions rather than one or two Ben 
Bernankes and/or Treasury secretaries, independent of their competence, 
integrity, or political affiliation. And past efforts by Congress to 
mandate certain untenable arrangements, such as the separation of 
commercial and investment banking, or in more modern times the peculiar 
status of Fannie Mae and Freddie Mac, does not inspire confidence that 
rigorous regulation will work--the cure could well be worse than the 
disease.

Economic Stimulus And Appropriate Future Policy
    I am particularly worried that the already announced fiscal and 
monetary policies, rather than restoring investor confidence, may lead 
to a sharp rise in inflationary expectations, which, in term, will 
trigger increases in interest rates and employee compensation that will 
have significant adverse economic effects, a reprise of the stagflation 
of the 1970s. The growth in the money supply in recent months has been 
noteworthy, and the increase in governmental expenditures and the 
potential inflation arising from both factors bodes very poorly for 
actual investor performance and thus confidence in the community of 
persons who finance most of our economic growth. The accompanying table 
provides regression results that indicate that stock market averages 
tend to fall when government expenditures rise as a percent of GDP, and 
when inflation picks up--even adjusting for the business cycle. When 
government spending crowds out private activity, investors are 
disheartened, stock values fall, pension fund assets deteriorate, 
consumption declines, and so forth. The excessive increase in 
government spending in recent years along with some increased 
perception that inflation may not be completely under control are, in 
my judgment, the single most important factors in declining real equity 
wealth in the U.S. in this decade. The prospects of rising taxes and 
inflation in the coming years no doubt is contributing to a pall on 
equity values at the present.
    Of special immediate concern is the call for a second economic 
stimulus package. If we learned one lesson from the era of large budget 
deficits, it is that fiscal stimulus does not promote economic 
recovery. Even in the heyday of Keynesian domination of the economics 
profession, scholars freely admitted that funding governmental 
infrastructure projects was a dubious way to stimulate the economy, 
simply because of the practical difficulties of timing-- it takes 
typically years, not months, for new appropriations on infrastructure 
to actually lead to, for example, new road or school construction. Very 
often any stimulus provided by such construction comes long after 
recovery has already occurred, creating inflationary conditions that 
could have been avoided. That is in addition to other problems arising 
from financing such stimulus, such as the crowding out effects of 
higher spending that manifests itself through higher interest rates, 
inflation rates, and/or taxation. There are no free lunches, and the 
funding of stimulus packages inevitably would have adverse effects. 
Raising taxes to fund economic stimulus would be particularly 
foolhardy, as the disincentive effects of taxation could cause further 
damage to the real economy.
    The creation of an infrastructure construction bureau within the 
government was, of course, what the Works Progress Administration, or 
WPA, was all about during the Great Depression. This became the largest 
New Deal agency before World War II, and at its peak in November 1938 
the WPA employed 3.3 million persons. Relating to the timing issue 
previously mentioned, it is interesting that it took over 3 and one-
half years to get to that level of activity, and that was in the era 
before we had environmental impact and affirmative action requirements 
that inevitably delay construction. It is noteworthy that the 
unemployment rate when the WPA hit its peak size was 17.7 percent, only 
slightly less than the 18.7 percent rate prevailing in April 1935 when 
the agency was created. Relative to leading European countries like 
Britain or Germany, our recovery in this period was anemic. It is 
fairly clear that the WPA was not a big success in creating jobs, and 
it was formed at a time when the federal budget deficit as a percent of 
GDP was smaller than today but when unemployment in those days was 
greater than today, meaning that the crowding out problems implicit in 
funding stimulus packages are probably even greater today than it that 
era.

Conclusions
    In conclusion, I urge you not to panic. The Federal government has 
taken the most aggressively interventionist position ever taken to deal 
with a crisis of investor confidence. For example, your legislative 
actions have made the government stockholders in vast portions of our 
financial system. You seem to be poised to provide massive aid, totally 
inappropriately in my judgment, to the automobile industry, 
substituting your judgments for that of consumers and producers 
operating through markets. You have authorized a vast potential 
unfunded liability through the radical expansion of deposit insurance, 
which I think I can assure you Franklin D. Roosevelt would have opposed 
if somehow he could have come back to life for a day. By the way, I 
personally do believe some expansion in deposit insurance probably was 
justified, but it needs to be funded, and that is not without its 
problems, and raises the moral hazard issue and the possibility that 
unsound banking practices will be subsidized rather than discouraged. 
You have already muted the important signals that markets give off that 
lead to what on the whole are growth-inducing reallocations of 
resources. The impact of all of this may be to prevent an imminent 
collapse of the financial system, but only at the possible price of 
future stagflation, declining income and wealth, and a rise in national 
malaise reminiscent of the 1970s if not 1930s. You have done enough for 
now, probably more than enough. Relax and recover from your labors and 
allow the healing properties of markets to be asserted again.
    Thank you for your attention. 

    [GRAPHIC] [TIFF OMITTED] T8279.021
    
    [GRAPHIC] [TIFF OMITTED] T8279.022
    
    [GRAPHIC] [TIFF OMITTED] T8279.023
    
 Prepared Testimony of Vincent DeMarco, President, Maryland Citizens' 
                           Health Initiative

    Thank you, Chairman Schumer, Vice-Chairwoman Maloney, and Members 
of the Committee for this opportunity to testify before you. I am 
Vincent DeMarco, President of the Maryland Citizens' Health Initiative, 
a nonprofit advocacy organization working to achieve quality, 
affordable health care for all Marylanders. Over a thousand faith, 
community, labor, business and health care groups are part of our 
Health Care For All! Coalition (www.healthcareforall.com). We, like 
you, have been inspired by Dr. Martin Luther King, Jr., who taught us 
that, ``Of all the forms of inequality, injustice in health care is the 
most shocking and inhumane.''
    It is particularly an honor to be before the Honorable Elijah 
Cummings, who prior to joining your ranks was a courageous leader of 
the Maryland House of Delegates, and who then, as now, makes sure that 
we all do what is right for the people who need help the most.
    I greatly appreciate the chance to talk with this Committee about 
how the economic downturn is harming health care for Marylanders and 
how this harm would get increasingly worse without some help from the 
US Congress. I will describe what is happening in Maryland and present 
some ideas of how Congress can help us. Most importantly, we ask that 
you increase our state's Federal Medical Assistance Percentage (FMAP) 
to help us fund our very important new Medicaid expansion.
    Over the past two years, under the leadership of Governor Martin 
O'Malley, the State of Maryland has made great progress in expanding 
health care access. This includes allowing young people up to age 25 to 
stay on their parents' health care and helping seniors afford their 
prescription drugs. Most important was the Governor's Working Families 
and Small Business Health Care Coverage Act of 2007 which, over the 
next three years, is designed to provide health care coverage for over 
100,000 uninsured Marylanders by expanding Medicaid eligibility and 
providing grants to small businesses. The law increased Medicaid 
eligibility to 116% of the federal poverty level for custodial parents 
on July 1, 2008, and will expand benefits for adults without children 
on July 1, 2009.
    Because of Governor O'Malley's initiative, and after careful 
balancing of State Budget priorities, Maryland went from 44th in the 
country to 21st in providing Medicaid coverage to adults. We have been 
working hard since it took effect to inform Marylanders about this new 
law. Our outreach efforts include a media campaign we funded featuring 
Governor O'Malley and prominent Baltimore Ravens players such as Ed 
Reed. As a result, in just three months, over 16,000 uninsured 
Marylanders have signed up for coverage, demonstrating the great need 
for this expansion.
    On July 7, Governor O'Malley gave the first new Medical Assistance 
for Families card to Alanna and Adamantious Boulis. As you can see from 
the front page article in The Baltimore Sun that is attached to my 
written testimony, both of the Boulis' had several health issues, 
including colon cancer and diabetes. They were only able to receive the 
treatment they needed for these illnesses because of Maryland's new 
law. Because they now can address these health issues, the Boulis will 
not have to wait until they get so sick that they are forced to go to 
the emergency room for costly critical care. This will reduce the 
amount all Marylanders now pay through higher insurance premiums for 
the hospitalization of the uninsured.
    Now, the health care coverage of the Boulis' as well as the 
coverage for tens of thousands of other Marylanders is directly 
threatened by the current economic crisis. As you know, the downturn is 
dramatically lowering states' tax revenues, forcing them to re-evaluate 
priorities, and make necessary cuts to important programs. Right now 
Maryland is among those states--facing a deficit of hundreds of 
millions of dollars, despite having recently taken aggressive measures 
to deal with a structural budget problem. Governor O'Malley is to be 
commended for doing all that he can to deal with this deficit in a 
creative way that has not yet significantly reduced the Medicaid 
program or health care coverage. But, as the national economy keeps 
getting worse, the dire need for federal help continues.
    We know that many of the people who would be hurt if Maryland's new 
Medicaid expansion is curtailed are in particular need of health care 
coverage now because of the economic downturn. Among the people who are 
eligible for the new expansion are a plumber on the Eastern Shore and a 
single mom in Prince George's county. Both of them had health care 
coverage through their jobs until recently but both of them lost their 
jobs and their coverage this year due to workforce cuts made by their 
employers necessitated by the economic downturn. Now, thanks to the new 
Medicaid expansion made possible by the State, they can at least have 
health care coverage while they try to find new jobs.
    The impact of people not having health care coverage can be 
devastating. We all know the statistics that many bankruptcies and 
foreclosures are caused by unaffordable health care bills and that 
health care costs are rising much faster than wages. But these 
statistics translate directly into human disaster.
    There is, for example, the very sad story of Mr. William Paul from 
Fruitland, Maryland, who worked every day of his life at odd jobs 
trying to make ends meet. He had a tough family life, and though he 
graduated from high school and spent some time in the armed service, he 
was never able to find more than odd jobs in restaurants and yard work 
to make ends meet. He was diabetic. He also found out from a free 
clinic at the local health department that he needed to see a 
cardiologist, but no doctor would see him because he didn't have health 
insurance. The next day, he died of a heart attack, while mowing 
someone's lawn.
    Because he died in the yard alone, it was considered to be an 
unattended death. In Maryland, corpses under those guidelines must be 
sent to Baltimore for autopsy but there is a charge for this 
``service'' which cleaned out Paul's meager savings and life insurance 
policy benefits that would have been passed along to his companion 
Joanne. There was no money for a memorial service, but thankfully a 
friend donated a plot of land in the local cemetery. The widowed 
companion still mourns that she will not be able to be buried beside 
her beloved because she can't afford it. She lives on $660 monthly 
social security check, food stamps, and the invaluable friendship of 
neighbors in their small community. Paul was described as a man who 
``never had any luck in his life'' but someone who would ``help ANYBODY 
in the world; it didn't matter who they were or what they were going 
through. If he could help you out, he did.'' He is sorely missed. And 
it is unfortunate that if he had been able to see the doctor, he might 
still be with his friends and family.
    And, there is the sad story of the 54-year-old brother of Ms. 
Judith Campbell of Baltimore City. As Ms. Campbell told us, ``My 
brother took his life earlier this year because he found out he had 
treatable but potentially fatal cancer and was turned down by the state 
for health care assistance. He worked as a security guard for $8.49/hr 
and his company did not offer health insurance.''
    Both Mr. Paul and Mr. Campbell would have been eligible under 
Maryland's new Medicaid expansion. It would be very sad if the economic 
downturn prevented us from fully implementing this expansion and saving 
many other Marylanders from the economic distress, health care woes and 
possibly even death that can result from the lack of health insurance. 
But the current economic trend makes it much harder for states to 
sustain this kind of program.
    It is not just the Medicaid expansion that is threatened by cuts 
forced by the state of the national economy. Under Governor O'Malley 
and Maryland Secretary of Health John Colmers, our Health Department 
has done much to make sure that other health programs work well. For 
example, they put additional money into dental services to make sure 
that children in Maryland's Medicaid program get the dental care to 
which they are entitled. This will prevent the kind of tragedy that 
occurred a couple of years ago when a young boy in Prince George's 
County died because he did not get proper dental care. Congressman 
Cummings has spoken often and eloquently about the circumstances that 
led to the death of Deamonte Driver and we hope that the progress we 
have made to prevent such deaths will not be rolled back due to more 
forced cuts.
    We strongly urge that Congress and the next Administration move 
quickly to enact an additional economic stimulus package that would 
directly help states like Maryland pay for critical health care needs. 
Specifically, we ask that a new stimulus package include an increase in 
our state's Federal Medical Assistance Percentage (FMAP). Additional 
federal Medicaid dollars would help forestall significant cuts in the 
Medicaid program. As you can see from the attached letter to the US 
Congress from Governors Edward G. Rendell and James H. Douglas, the 
National Governors' Association is calling for an increase in FMAP as 
part of an economic stimulus package. Increasing the FMAP would help us 
in Maryland in two important ways.
    First, the stimulus package would spur economic growth which would 
generate more revenue for our state and thereby help prevent cutbacks 
in our Medicaid program. According to Families USA's well-documented 
Medicaid Multiplier Effect analysis, for every $1 million in additional 
Medicaid funds that Maryland would receive, there would be $2.2 million 
in additional business activity, including 20 new jobs and $765,000 in 
additional wages. So, if you enact a measure like S. 2819, which 
unfortunately did not pass in the 110th Congress, Maryland would 
receive an additional $118.5 million in federal dollars which would 
generate $210.6 million in additional business activity, or 1800 new 
jobs and $72.4 million in additional wages. In addition to putting 
people to work, this new business activity would translate into 
substantial new tax revenues for the state which would help fund our 
Medicaid expansion. Attached for you are charts done by Families USA on 
the economic impact on the states of both S. 2819 and the similar House 
passed H.R. 7110.
    Second, of course, the FMAP increase would put money directly into 
our Medicaid program, making funding of our expansion much easier. As 
described above, the expansion for custodial parents has already gone 
into effect but the expansion for non-parents is not set to take effect 
until July 1, 2009. There is already some pressure to delay the non-
parental expansion because of the budget deficit. Additional federal 
money added to the Medicaid program would help us ensure that the rest 
of the expansion takes effect on July 1, 2009 as planned. This would 
keep tens of thousands of Marylanders healthy and out of economic 
distress, and even save some from an early, preventable death.
    In addition to the critically necessary FMAP increase, there are 
two other ways that the United States Congress can help Maryland and 
other states expand health care access in these tough economic times. 
First, we urge you to pass as soon as possible an expanded State 
Children's Health Insurance Program--or SCHIP--extension like the one 
which you passed and President Bush unfortunately vetoed earlier this 
year. Passage of this legislation is vital to our ability to keep our 
Maryland Children's Health Insurance Program fully funded. We strongly 
support the tobacco tax increase funding mechanism that you included in 
the SCHIP bill. We passed a $1 per pack tobacco tax increase in 
Maryland in 2007 which experts estimate will save 50,000 Maryland 
children from smoking. Tobacco tax increases are a great way to fund 
health care expansion while at the same time saving lives from tobacco 
which will in the long run greatly reduce health care costs.
    Second, we ask your help in removing federal obstacles to health 
care expansion at the state level. Although we will work closely with 
you to achieve our common goal of a federal law that guarantees 
quality, affordable health care for all Americans, we hope you agree 
with us that the federal government should not stand in the way of 
states' efforts to expand health care while we are working toward that 
goal. Specifically, we are here asking your help in removing two 
federal obstacles to health care expansion in Maryland and across the 
country.
    In 2005, Maryland enacted a landmark measure that was unanimously 
approved by the Maryland General Assembly that would significantly 
reduce prescription drug prices for hundreds of thousands of lower 
income Marylanders by allowing them to get the same drug discounts that 
the State's Medicaid program gets. Unfortunately, the Bush 
Administration denied a waiver request that our state submitted to 
allow it to implement this measure. We strongly urge the Members of 
this Committee and your colleagues to support legislation introduced by 
Congressman Chris Van Hollen, The Voluntary State Discount Prescription 
Drug Plan Act--or H.R. 3309--that would allow states to implement such 
measures.
    In 2006, Maryland enacted another landmark law which would have 
required large companies to pay their fair share of the state's health 
care costs. Unfortunately, the Fourth Circuit Court of Appeals ruled 
that our Fair Share Health Care Law was preempted by ERISA. We were 
encouraged by the Ninth Circuit's recent decision upholding a similar 
San Francisco measure. We urge Congress and the next Administration to 
amend ERISA to allow states to enact measures that would make sure that 
all employers, particularly large ones, pay their fair share of the 
rising costs of health care. By doing so, you will help us expand 
health care access in our state and reduce the burden of paying for the 
hospitalization of the uninsured now borne by employers who provide 
full health care coverage for their employees.
    Thank you again so much for giving me this opportunity to share 
with you the harmful and very real effects that the economic downturn 
has on the health of Marylanders and how we think the United States 
Congress can help us. We look forward to working with you to enable 
states to alleviate the health care injustice Dr. King warned us about 
by achieving quality, affordable health care for all Americans. I would 
be happy to answer any questions you may have.

[GRAPHIC] [TIFF OMITTED] T8279.019

[GRAPHIC] [TIFF OMITTED] T8279.020

  Prepared Statement of Donald C. Fry, President and CEO, The Greater 
                          Baltimore Committee

    Mr. Chairman, and Members of the Committee, my name is Donald C. 
Fry. I am the President and Chief Executive Officer of the Greater 
Baltimore Committee (GBC). The GBC is the leading business organization 
serving Baltimore City and Anne Arundel, Baltimore, Carroll, Harford 
and Howard counties in the State of Maryland, a region with a 
population of approximately 2.6 million residents. The GBC is a fifty-
three year old private sector membership organization with a rich 
legacy of working in collaboration with government to find solutions to 
problems that negatively affect our competitiveness and viability as a 
region. It is an organization that prides itself on advocating for 
changes in public policies that strengthen the business community while 
improving the quality of life in the region.
    First of all, I want to thank the Joint Committee for the foresight 
and initiative to pursue an aggressive agenda to achieve economic 
recovery. By highlighting infrastructure needs, you definitely are 
keyed in to a vital means of sustained employment and of moving our 
country forward.
    I am pleased to be here today to discuss the need for economic 
stimulus and how the current economy is affecting business. I plan to 
discuss specifically the need to invest in infrastructure, particularly 
transportation infrastructure. While I am prepared to address some 
projects that would benefit from such a stimulus, it must be noted that 
as a business advocacy group we are not directly involved in decision 
making regarding project delivery from the State of Maryland's 
perspective. We have, been on the forefront, however, with respect to 
spurring the advocacy of the business community for increased 
investment in transportation projects and the need for a substantial 
increase in transportation funding. I am happy to lend my voice to the 
efforts to move our country forward in meeting its infrastructure and 
transportation needs.
    Our transportation systems are under stress. If infrastructure does 
not keep pace with growth and changing patterns in population and 
employment, as well as associated development trends, the consequences 
will be enormous. Already, we are seeing intolerable congestion, 
stifling of growth and economic development in cities, towns, and older 
suburbs, more sprawling development, more demands for public water, 
sewers, schools, and transportation, detrimental environmental impacts, 
and an overall degradation of our quality of life.
    Nationally, our transportation infrastructure is deteriorating from 
insufficient investment. Just last year, the Urban Land Institute and 
Ernst & Young reported in Infrastructure 2007: A Global Perspective 
that the emerging crisis in mobility will significantly affect the 
United State's ability to compete on the international stage. A report 
by the American Society of Civil Engineers expressed strong concern 
with not only the condition of our transportation infrastructure but 
also the electricity power grids, water and wastewater systems. The 
price tag placed on the needed repairs to our nation's infrastructure 
was $1.6 trillion. Further, the National Surface Transportation Policy 
& Revenue Study Commission examined the nation's surface transportation 
modes and concluded that an annual investment of 3-4 times in excess of 
the current annual capital investment was needed to sufficiently 
address the investment gap existing in surface transportation.
    The primary cause for our failure to invest in infrastructure is 
lack of money. I would suggest that another significant factor has been 
our failure to appropriately recognize infrastructure investment as a 
public policy priority essential to our economic growth.
    In Maryland, the state's 6-year Consolidated Transportation Plan 
(CTP) includes over 90 transportation projects in the planning cycle. 
These are projects that have been identified as meritorious by elected 
officials and transportation officials. None of these projects have a 
single dollar allocated for future construction. The current cost to 
construct those projects falls in the range of $40 billion to $60 
billion.
    Just a few months ago, Maryland deferred $1.1 billion in 
transportation projects in its current six year CTP, each of which is 
desperately needed. Maryland's Transportation Secretary cited lagging 
revenues to the state's Transportation Trust Fund and uncertainty over 
federal funding as the primary reasons for deferring budgeted spending.
    This action directly affects 100 state projects in the state's six 
year transportation plan. Some of the more pronounced projects affect 
our transit systems. These result in deferral of funds for light rail 
and Maryland Commuter Rail, or MARC, maintenance projects, including 
station rehabilitations and parking improvements. Moreover, just 
recently, the State has announced further cuts to its transit system, 
primarily to commuter bus routes, and eliminating several trains from 
MARC's Penn Line and Brunswick services. Such actions come at a time 
when the Baltimore area's transit needs were already stressed with 
increased ridership that grew significantly due to spiking fuel costs.
    It should be noted that Maryland, like many states in the country, 
as well as the federal government, relies heavily on motor vehicle 
related charges such as gasoline taxes, vehicle registration fees, 
sales tax on motor vehicles, and similar assessments to fund its 
Transportation Trust Fund. The sharp increase in the price of oil 
combined with the downturn in the economy significantly reduced the 
amount of funds available for transportation projects resulting in the 
decimation of the state's six year transportation plan. This deferral 
of transportation projects occurred despite the Maryland General 
Assembly enacting a series of funding increases in November 2007 that 
added close to $400 million per year to its Transportation Trust Fund.
    This dynamic highlights the need for Maryland and other states to 
alter transportation funding formulas to address growing transportation 
needs without a reliance on motor vehicle related taxes and 
assessments. To address this challenging issue, the Greater Baltimore 
Committee has formed a private sector task force to study, evaluate and 
recommend alternative revenue sources or formulas that are inflation 
sensitive and are capable of meeting ever expanding transportation 
needs and demands.
    Just yesterday, Maryland's Transportation Secretary John Porcari 
stated in testimony before the House Transportation and Infrastructure 
Committee that nearly three dozen projects have been identified with a 
cost of about $150 million that could be obligated within 120 days 
should federal funds be made available. Of these three dozen projects, 
approximately 80 percent are in urban/metropolitan areas with the 
balance located in the rural areas of the state. The fact remains that 
as these projects are deferred, the needs continue to grow and the 
price tag only escalates due to increased deterioration of roadways and 
inflationary material and construction costs. In order to avoid such 
circumstances the need is there to act now to effectuate these long 
sought repairs and construction plans.
    On August 1, 2007, our country was shocked at the vivid pictures of 
a critical bridge failure as the bulk of the I-35 bridge in 
Minneapolis, Minnesota, collapsed killing seven people and injuring 59. 
Similarly, the Chesapeake Bay Bridge connecting the eastern and western 
shores of Maryland, one year later, experienced a deadly crash as a 
swerving car sent a tractor trailer banging against both sides of the 
bridge until it punched a ten foot opening in the bridge's concrete 
railing. Subsequent examination by the State of Maryland's bridge 
experts revealed a previously undisclosed failure in the bolts that are 
critical to the structure. There was understandable public concern over 
each of these sad events. Yet, we inevitably go back into our torpor 
until the next tragedy. Mr. Chairman, something must be done, and soon, 
to avert similar catastrophes.
    Inasmuch as Baltimore is on the Northeast Corridor which is 
utilized by both our local commuter service and interstate passenger 
rail, I would like to emphasize two projects that have been lingering 
for many years without attention. They are the two tunnels--one 
northeast of Penn Station, the Union tunnel, and one southwest of Penn 
Station, the Baltimore & Potomac Tunnel. Both of these structures are 
well over one hundred years old and are in dire need of rehabilitation, 
or replacement. Legislation recently passed by Congress and signed into 
law by the President has authorized over $14 billion in railway 
improvements across the nation, with $60 million dedicated for 
attention to the Baltimore tunnel choke points. A stimulus package 
focused on infrastructure investment could very well move this project 
and other rail programs forward.
    One key statistic that has been noted in recent reports suggests 
that every one billion dollars in federal transportation investment 
supports approximately 35,000 jobs and $1.3 billion in employment 
income. An investment in infrastructure would be significant to the 
construction industry sector as the housing decline and tight credit 
market has caused many construction workers to join the ranks of the 
unemployed.
    The Bureau of Labor Statistics estimates a loss of more than 
600,000 jobs in the construction industry sector from 2007-2008. The 
time appears ripe to ``jump start'' the construction industry. An 
investment in infrastructure will buttress the construction industry's 
sagging employment levels while simultaneously investing in our 
weakening infrastructure.
    An infusion of money for needed infrastructure projects can also 
benefit small businesses and minority and woman owned businesses. 
Urging, and perhaps establishing incentives for equity relationships 
between majority and minority and woman-owned businesses, beyond the 
customary MBE/WBE requirements, can result in the creation of 
opportunities for minority and woman-owned companies to significantly 
participate in infrastructure projects thus expanding their capacity to 
compete for future project awards.
    Congressional efforts should be directed toward creating both short 
term jobs, as well as creating lasting value for our country by 
investing in infrastructure that can help the nation compete in a 
global economy, achieve energy independence, and provide capacity for 
the projected population growth that the United States will experience 
by 2050 and the threefold increase in GDP that will ensue over the same 
time period.
    As part of any stimulus package, I urge Congress to develop an 
Infrastructure Investment Plan that would invest in intercity and high-
speed rail networks, invest in goods movement and seaports, strengthen 
the electrical grid and its technology, extend broadband communication 
to rural areas, repair aging and ailing water and sewer infrastructure 
systems of our nation's metropolitan areas, and retrofit the nation's 
existing energy systems so that they are more energy efficient.
    If Congress were to enact such a plan it would create new jobs in 
engineering and construction, would move goods and people more 
efficiently thereby reducing costs to business, and would provide the 
necessary infrastructure to move to a renewable energy economy.
    I offer these points in the hopes that you and your colleagues can 
unite to pass legislation that will truly begin to restore the quality 
of our nation's infrastructure while strengthening our position in this 
competitive global economy.

 Prepared Statement of Joseph Haskins, Jr., President and CEO, Harbor 
                         Bankshares Corporation

    Good Morning, Chairman Schumer, Vice Chair Maloney and Members of 
the Committee. Thank you for the opportunity to address the Committee.
    I am the Chairman, President and CEO of Harbor Bankshares 
Corporation that owns a $300 million dollar bank (The Harbor Bank of 
Maryland) headquartered in Baltimore, Maryland. My market is Main 
Street America.
    I recognize that the U.S. Government has taken extraordinary steps 
over the course of the last few months to address the monumental 
problems we are experiencing in our credit markets and the erosion of 
public confidence in our financial institutions.
    While many, if not all, of these actions were necessary and went a 
long way to insure that our country did not fall into a deep recession 
or worse, these actions, by and large, were designed to aid and assist 
the larger financial institutions in the United States and, thus far, 
have done little to directly assist smaller financial institutions such 
as my bank, The Harbor Bank of Maryland (Harbor Bank).
    I am pleased to share my experiences and thoughts on the state of 
the economy from a community banker's perspective. I have five (5) 
points to make.
    First, I am fortunate to have avoided the subprime crisis. Senior 
Management of Harbor Bank decided four (4) years ago to get out of the 
market. Our decision was made based on increasing errors, 
misrepresentations, and in some cases out right fraud that we found on 
residential mortgage applications. Incomes were inflated, work 
histories were altered, and credit scores were changed.
    Harbor Bank and other small community banks for the most part did 
not participate in the subprime mortgage loan debacle but because of 
the misdeeds and bad judgments of many larger institutions have 
nonetheless suffered tremendously. These smaller financial institutions 
did not participate in making loans to people who could ill afford 
them. They did not package them up and sell them to unsuspecting 
investors all over the globe.
    These problems in part help to lead to a FDIC Insurance costs 
increase for all banks.
    Second point, when the major financial organizations continued to 
stumble and show large losses, a heightened level of concern spread 
throughout the deposit base of smaller banks. In particular, a major 
event that panicked the bank customers was watching television and 
seeing depositors attempting to get their money out of a failing bank.
    Shortly thereafter, Harbor Bank lost deposits as customers feared 
for the safety of their money. Many customers moved their money to 
larger banks as they believed they would be better protected. 
Fortunately, the increased FDIC coverage has allowed us to reclaim some 
of the lost deposits.
    Third point, the current negative economic conditions have led to 
increased delinquencies in our loan portfolio across all sectors. We 
have record leveled loan charge-offs (the 2008 level is 2.5 times 
higher than the highest previous years). Earnings have been 
substantially reduced as additional funds have been allocated to the 
Allowance for Loan Loss Reserves to protect against anticipated losses 
associated with residential development. Harbor Bank and other small 
banks have experienced eroding capital and reduced earnings.
    Harbor Bank and many other smaller Banks need the Treasury to make 
capital available. Smaller financial institutions are much more 
dedicated to the concept of using these capital infusions as a stimulus 
for additional lending in their communities. Some of the larger 
institutions are using the additional capital to purchase other 
institutions to gain market share or to make themselves more attractive 
takeover candidates instead of using this capital to support the 
banking footprint they serve. I am not suggesting that this additional 
capital should not be used to merge troubled institutions into 
healthier ones but I do feel that smaller institutions will be more 
prone to put the additional capital to work in the communities they 
serve. Even if smaller banks are allowed to participate in the capital 
assistance program from the Treasury and they use some of these 
proceeds to acquire troubled institutions in their trade areas, these 
combined institutions for the most part will remain small by comparison 
to the regional banks and major financial institutions that have 
already accessed capital from the Treasury. These combined or merged 
small banks will still be more prone to put the money out to small 
businesses and individuals residing in their banking territories.
    Fourth point, smaller banks need the opportunity to have the 
government buy out its problem loans and unmarketable mortgage backed 
securities and/or preferred shares with Fannie Mae or Freddie Mac. This 
will create more liquidity and free management from heavy loan 
monitoring and collection activities.
    Fifth point, I would like to address is the plight of small broker-
dealer firms that service small municipalities and counties in this 
country. Our bank also has a small broker-dealer subsidiary. It has 
struggled mightily under the strain of the locked up public debt 
markets. Our broker-dealer subsidiary underwrites investment grade 
public debt primarily for small municipalities comprised mostly of low 
income individuals and minorities. Most large broker-dealers do not 
seek or want this business because for them it is not profitable. It is 
a segment of the market that is often ignored by Wall Street. These 
small communities are suffering much more than larger cities and 
counties in the country. The tax base in these areas is much more 
limited but they are not immune from the foreclosure rates or job 
losses haunting larger areas. Their problems have become exacerbated 
with the virtual exit of insurance companies who historically have 
provided low cost guarantees of their bonded indebtedness. As a result, 
many public improvement projects such as schools, jails, infrastructure 
improvements, and the like are going unfunded. Our broker-dealer 
subsidiary has seen its capital diminish significantly due to the lack 
of business activity in the small municipal markets it has 
traditionally served. Also, securities issued by these small 
municipalities have been disproportionately devalued in the credit 
markets. Our firm has experienced maintenance calls due to haircuts 
assigned to the public debt of these small issuers of public debt 
resulting in the erosion of capital in our broker-dealer subsidiary. 
Our firm underwrites only investment grade municipal bonds which are 
being treated by clearing firms as junk bonds. The Treasury capital 
assistance program should be extended to include small broker-dealers 
who specialize in serving the under-served communities in our country. 
They are federally regulated just as banks are and serve a purpose in 
helping to unlock the credit markets in this country. Bolstering the 
capital base of the large banks will do nothing to help those 
municipalities and counties that are not heavily populated and do not 
have a large industrial base to provide jobs and a larger tax base. The 
default rate on bonds issued by these small towns and counties is 
practically non-existent but their access to the credit markets has 
completely dried up and they do not have investment banks willing to 
underwrite their debt.
    In closing I would like to reiterate one major point which I think 
deserves immediate attention. Small community banks and small broker-
dealer firms should be allowed to access the capital assistance program 
being sponsored by the Treasury. The preferred stock purchased by the 
Treasury from these smaller institutions should be less costly than the 
coupon rate currently being charged to the large institutions who were 
in large part responsible for the problems we are facing today. This 
will help to insure that the bailout program, which has thus far been 
limited and directed at only the large financial institutions, is 
expanded to assist those under-served borrowers who are customers of 
community banks and also small municipalities and counties which in the 
present credit crunch environment have been forgotten and neglected but 
are just as important to the economic recovery of our nation as the big 
banks and investment banking houses on Wall Street.
    Times are tough on Main Street and the best way to improve the 
economy is to get stimulus funds in the hands of community based 
financial services companies.
  

                                  
