[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
__________
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JOINT ECONOMIC COMMITTEE
[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]
SENATE HOUSE OF REPRESENTATIVES
Charles E. Schumer, New York, Carolyn B. Maloney, New York, Vice
Chairman Chair
Edward M. Kennedy, Massachusetts Maurice D. Hinchey, New York
Jeff Bingaman, New Mexico Baron P. Hill, Indiana
Amy Klobuchar, Minnesota Loretta Sanchez, California
Robert P. Casey, Jr., Pennsylvania Elijah Cummings, Maryland
Jim Webb, Virginia Lloyd Doggett, Texas
Sam Brownback, Kansas Jim Saxton, New Jersey, Ranking
John Sununu, New Hampshire Minority
Jim DeMint, South Carolina Kevin Brady, Texas
Robert F. Bennett, Utah Phil English, Pennsylvania
Ron Paul, Texas
Michael Laskawy, Executive Director
Christopher J. Frenze, Minority Staff Director
C O N T E N T S
----------
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.)
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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.
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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.
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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.
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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.
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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.
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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.