[Senate Hearing 110-845]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 110-845
 
                          THE ECONOMIC OUTLOOK

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



                                HEARING

                               before the

                        JOINT ECONOMIC COMMITTEE
                     CONGRESS OF THE UNITED STATES

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                               __________

                           SEPTEMBER 24, 2008

                               __________

          Printed for the use of the Joint Economic Committee




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                        JOINT ECONOMIC COMMITTEE

    [Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]

SENATE                               HOUSE OF REPRESENTATIVES
Charles E. Schumer, New York,        Carolyn B. Maloney, New York, Vice 
    Chairman                             Chair
Edward M. Kennedy, Massachusetts     Maurice D. Hinchey, New York
Jeff Bingaman, New Mexico            Baron P. Hill, Indiana
Amy Klobuchar, Minnesota             Loretta Sanchez,  California
Robert P. Casey, Jr., Pennsylvania   Elijah Cummings, Maryland
Jim Webb, Virginia                   Lloyd Doggett, Texas
Sam Brownback, Kansas                Jim Saxton, New Jersey, Ranking 
John Sununu, New Hampshire               Minority
Jim DeMint, South Carolina           Kevin Brady, Texas
Robert F. Bennett, Utah              Phil English, Pennsylvania
                                     Ron Paul, Texas

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



                            C O N T E N T S

                              ----------                              

                                Members

Hon. Charles E. Schumer, Chairman, a U.S. Senator from New York..     1
Hon. Jim Saxton, a U.S. Representative from New Jersey...........     5
Hon. Carolyn B. Maloney, Vice Chair, a U.S. Representative from 
  New York.......................................................     6
Hon. Sam Brownback, a U.S. Senator from Kansas...................     8

                               Witnesses

Statement of The Honorable Ben Bernanke, Chairman, Board of 
  Governors of the Federal Reserve System........................     9

                       Submissions for the Record

Prepared statement of Hon. Charles E. Schumer, Chairman, a U.S. 
  Senator from New York..........................................    50
Prepared statement of Hon. Jim Saxton, a U.S. Representative from 
  New Jersey.....................................................    52
    Report entitled ``Government Policy Blunders Largely Caused 
      the Global Financial Crisis''..............................    53
    Report entitled ``The U.S. Housing Bubble and the Global 
      Financial Crisis: Housing and Housing-Related Finance''....    59
Prepared statement of Hon. Carolyn B. Maloney, Vice Chair, a U.S. 
  Representative from New York...................................    88
Prepared Statement of Hon. Ron Paul, a U.S. Representative from 
  Texas..........................................................    89
Prepared statement of Hon. Sam Brownback, a U.S. Senator from 
  Kansas.........................................................    90
Prepared Statement of Hon. Ben S. Bernanke, Chairman, Board of 
  Governors, Federal Reserve System..............................    92


                          THE ECONOMIC OUTLOOK

                              ----------                              


                     WEDNESDAY, SEPTEMBER 24, 2008

             Congress of the United States,
                          Joint Economic Committee,
                                                    Washington, DC.
    The committee met at 10:00 a.m. in room SD-106 of the 
Dirksen Senate Office Building, The Honorable Charles E. 
Schumer (Chairman) presiding.
    Senators Present. Bingaman, Klobuchar, Casey, Webb, 
Brownback, Sununu, DeMint, and Bennett.
    Representatives Present. Maloney, Hinchey, Hill, Cummings, 
Doggett, Saxton, English, Brady, and Paul.
    Staff Present: Christina Baumgardner, Heather Boushey, Nate 
Brustein, Gail Cohen, Nan Gibson, Colleen Healy, Marc Jarsulic, 
Aaron Kabaker, Michael Laskawy, David Min, Aaron Rottenstein, 
Justin Ungson, Ted Boll, Connie Foster, Chris Frenze, Bob 
Keleher, Tyler Kurtz, Robert O'Quinn, Jeff Schlagenhauf, 
Christina Valentine, Colm Willis, and Jeff Wrase.

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

    Chairman Schumer. Let's clear out. Okay, good morning. Our 
hearing will open.
    First, let me just make a little housekeeping note here. 
Because of the time constraints on Chairman Bernanke's 
schedule, he has to testify in front of House Financial 
Services this afternoon and must be gone by 12:30.
    We're going to limit opening statements today to the Chair, 
Vice Chair, Ranking Member and the Senior Senate Minority 
Member. I generally like to give everyone a chance to do 
opening statements, but, instead, what we've done, is given 
seven minutes of question period, instead of five, and we 
encourage members, if they wish to make--use part of that time 
to make a statement, to feel free to do so.
    We'll also, without objection, enter all other members' 
opening statements into the record.
    [The prepared statement of other members appears in the 
Submissions for the Record on page 89.]
    Chairman Schumer. Before I get into my statement, I'd like 
to acknowledge the service of one of our colleagues on this 
Committee, Congressman Jim Saxton. He's retiring at the end of 
this Congress.
    Jimmy and I have been friends since he came to the House. 
He's been a distinguished Member of this Committee for 15 
years; he's been chair of this Committee three times; Vice 
Chair three times.
    Jim, thanks for your service, and we'll miss you.
    Mr. Saxton. Thank you very much. [Applause.]
    Chairman Schumer. Okay, to begin, of course, I'd like to 
welcome you to this hearing, Mr. Chairman, and I'd like to 
thank you for appearing before this and the two other 
Committees you're testifying in front of.
    I think we all know how grueling this can be, but it's an 
important part of the process, and, frankly, sunlight is a 
great cleanser and disinfectant.
    If the Administration's plan can't withstand public 
scrutiny, we cannot make our case to the American taxpayers we 
represent, and I think hearings like those that began in the 
Senate Banking Committee, under the leadership of Chairman 
Dodd, and continuing in Financial Services this afternoon, have 
been important.
    Over the last 24 hours, I've seen greater signs of 
cooperation among my colleagues in the Congress, who, despite 
many of their well-founded reservations, recognize the 
magnitude of the problems we face and the importance of getting 
something done.
    So the hearings are part of this process, the so-called 
sausage-making. We're doing them under speedy circumstances 
this time, because of the worries we all have about the 
financial markets, but they're a necessary and important part 
of the process, and they help move things along.
    As I said, I think we're better off today in terms of 
getting this bill done, than we were yesterday, because of your 
and your colleagues' testimony.
    Now, when you were last before this Committee, Mr. 
Chairman, in April--and this was a regularly scheduled hearing 
of the Committee, where you always appear before us twice a 
year, and this was scheduled long before the crisis--the crisis 
we were facing then was the collapse of Bear Stearns.
    And I can say that most of us thought that we had just 
witnessed an event that we were never likely to see again in 
our lifetimes, and yet here we are, six months later, and we're 
discussing a crisis many orders of magnitude greater.
    Mr. Chairman, I believe you have been eloquent and 
impassioned in your warnings of the dangers we face, and that 
we must try to do all we can to resolve the threat to our 
financial system.
    And I will reiterate what I said yesterday at the Banking 
Committee: I do believe we must act and we must act soon.
    But let us be clear. Americans are furious. I am sure that 
every single one of my colleagues on both sides of the aisle 
has heard what I have heard from my constituents: Amazement, 
astonishment, and intense anger.
    And they are right to be astonished and very angry. Over 
the last eight years, we were told that markets knew best, that 
financial alchemy had reduced risk to an afterthought, and that 
we were entering a new world of global growth and prosperity.
    Instead, what we have learned, is that we now have to pay 
for the greed and recklessness of those who should have far 
known better.
    Unfortunately, that truth doesn't solve the crisis that 
confronts us, and while Wall Street may have caused these 
problems, if we do nothing, Main Street will also pay a severe 
price.
    Pension funds, money market mutual funds, and 401(k) plans 
will be negatively impacted. Credit is already tightening, 
which impacts households, as well as businesses large and small 
throughout the country.
    The lock down in lending has widespread consequences. I've 
heard from car manufacturers that it's virtually impossible to 
get an auto loan right now, unless you have a very high credit 
score.
    This year alone, they are likely to sell six million fewer 
cars than they otherwise would, if credit remains as tight as 
it is today.
    So, even though the workers in Buffalo and Detroit and St. 
Louis are blameless, they will suffer. It's not fair; it's not 
right, but, unfortunately, that's the world we live in today, 
and, to put our heads in the sand like ostriches and ignore it 
will not serve the interest of those workers very well.
    It's the reality we face and I think we, on both sides of 
the aisle here in Congress, recognize it.
    I want to assure the markets once again--and I think I 
speak for all of us--that we will no be dilatory and we will 
not add extraneous amendments; we will not Christmas-tree this 
bill, and we will work in a bipartisan way to act and act soon.
    In the last day, it has become clear to me that with the 
exception of a few outliers on either side, there is clear 
recognition among members of both parties, that we must act and 
act soon.
    And it has been good to hear from both Senators Obama and 
McCain, that they believe we must act, though, like us, they 
believe changes must be made in the Administration plan.
    Still, as I said yesterday, as well, we must beware that in 
taking actions, we do not choose a bad solution. The markets 
want action; we understand that, but if we act so quickly that 
we create an ineffective solution without adequate safeguards, 
then we risk the plan failing, which would be an even worse 
outcome for the markets, for the economy, and for our country.
    Even on Wall Street, $700 billion is a lot of money, and 
none of the thousands of money managers would invest that sum 
without appropriate due diligence. These hearings and the 
discussions that are happening as we speak, are our 
Congressional due diligence, and we take that responsibility 
seriously and we will make intelligent and relevant 
improvements to the Administration plan.
    We owe nothing less than that to the taxpayers who have put 
us in office to safeguard their economic well being. It is a 
sacred trust and I can say that it's a responsibility that all 
my colleagues, both Democrats and Republicans, whatever our 
philosophical differences, hold very dear.
    As I have said, I believe there are three essential 
components that must be part of this plan: THO, taxpayers, 
homeowners, and oversight.
    There can be no question--and this nonnegotiable--that we 
must put taxpayers first. They must come ahead of bondholders, 
shareholders, and executives, and we need to add to the 
Administration's legislation those types of protections.
    I think we must consider seriously, putting this program in 
place, in tranches or installments, so that we do not limit the 
Secretary's ability to act, as necessary, but are able to 
evaluate the effectiveness of these expenditures over time.
    If the program is working, Congress will certainly ratify 
continuing expenditures by the Treasury, but if it's not 
working, then we will need to review it before we once again 
find ourselves on the brink.
    I look forward to hearing your thoughts on that 
possibility, Mr. Chairman.
    Another idea I've proposed, is an insurance fund, modeled 
on the FDIC and paid for by the financial industry, that can 
defray some of the long-term costs of the Administration plan.
    It clearly cannot cover the entire cost, but it seems only 
fair that the industry that will receive the vast benefit of 
this taxpayer-funded program, pay for some share of it 
themselves.
    Both Secretary Paulson and you seemed positively disposed 
to that idea yesterday, and, again, I look forward to hearing 
further from you today, as well.
    Finally, on the taxpayer side, I remain puzzled by the 
resistance you and Secretary Paulson have offered to proposals 
that Senator Jack Reed and many of my colleagues have made 
about the need for equity being part of the process we are 
discussing.
    My constituents are asking me about it, as do many of the 
business people and many of your fellow economists who I've 
spoken to about this.
    This morning, Warren Buffett got an equity share in Goldman 
Sachs and it didn't stop Goldman Sachs from making the deal 
with Warren Buffett. It seems only fair that we reward 
taxpayers, if, as we hope, this plan succeeds.
    We also must do something to help homeowners. Chairman 
Bernanke, you, yourself, have repeatedly stated that until we 
find a floor in the housing markets--and foreclosures are 
directly related to finding this floor--we will not solve the 
problem.
    And that affects not just those who made bad mortgages and 
not just those who will lose their homes through no fault of 
their own--the second group should be protected, the first 
should not--but it affects every homeowner. The number of 
foreclosures and the price of the average American's home, are 
intrinsically related to one another and can't be separated.
    As we've seen the complications of securitization, where 
mortgages are placed into pools and then broken up into a large 
number of securities, has created an enormous problem, it seems 
to me that any voluntary program does not work, and the only 
mandatory program that's available, is bankruptcy, and I would 
also like to discuss that with you, as well.
    Finally, this is the last of what I call the three THO 
principles: There must be greater oversight as part of this 
plan. The Administration is simply asking for trust. However 
much we may like Secretary Paulson or you, Mr. Chairman, no 
sane person would put $700 billion in your hands on trust 
alone.
    I cannot in good faith, tell my constituents that ``it's 
fine; we know they'll do the right thing.'' Strict oversight is 
a sine qua non, and I think that this will be the easiest part 
of the three, taxpayers, homeowners, oversight, to accomplish.
    To close, I'd like to add a few words about something I 
worry has gotten lost in our focus on this crisis. As I have 
said, I do believe that we will fix the financial crisis we 
face, but that will not, in and of itself, fix many of the 
other problems that continue to bedevil American families.
    The economy of the past eight years, has hammered the 
American middle class; their incomes have declined, their 
healthcare coverage has weakened, the price of their gas and 
food has skyrocketed, the value of their homes has plummeted, 
and now many of them find their jobs threatened.
    The plan the Administration has put forward, with certain 
modifications, will, I hope, resolve this current mess, but 
many other obstacles remain ahead of us. It is not enough to 
maintain the status quo. We must find a way once again to make 
the American economy the engine of prosperity it once was for 
all Americans, and not a casino where we let some earn extreme 
rewards by taking excessive risks while the rest of us get 
stuck with the bill.
    [The prepared statement of Senator Schumer appears in the 
Submissions for the Record on page 50.]
    Chairman Schumer. Congressman Saxton?

     OPENING STATEMENT OF THE HONORABLE JIM SAXTON, A U.S. 
                 REPRESENTATIVE FROM NEW JERSEY

    Mr. Saxton. Mr. Chairman, I'd like to join in welcoming 
Chairman Bernanke, and before I begin my statement, I would 
like to thank you for the kind words at the outset.
    I've enjoyed very much being a Member, Chairman and Vice 
Chairman of the Joint Economic Committee. It's been a pleasure, 
and I hope that Members of Congress in both parties have 
benefitted from the discussions that we've had with the 
Administration, with regulators, and with representatives of 
the financial community, as well.
    I would like to say also that, little did I know, in all 
the years that I've been a Member and Chairman of this 
committee that my tenure would end on such a serious note.
    This is a serious problem for our economy and it's a 
serious problem for Wall Street. But, most of all, my 
heartstrings tug when I get telephone calls from my 
constituents, and from people all across the country, for that 
matter who call and ask, what's going to happen to their nest 
egg, what's going to happen to their savings, what's going to 
happen to their money market, what's going to happen to their 
hometown bank? Those are questions that are certainly important 
for them to ask and for us to help solve.
    The main cause of the financial turmoil in the market, as I 
see it, is the collapse of the housing bubble, inflated by 
various government policies over many years.
    Government policies supported in Congress, encouraged the 
expansion of the subprime and other risky mortgages that fueled 
the housing bubble. I've been a student of housing prices over 
the years, and it was clear to me over the past three years or 
so, that as we saw the housing bubble escalate, that there was 
sure to be a correction and here it is.
    In exchange, despite warnings for many years that both 
Fannie and Freddie were excessively leveraged to a degree that 
was dangerous, they continued to inflate the housing bubble, 
undeterred by accounting scandals.
    Now the country will have to pay a very high price for 
lending policies highly influenced by political and not 
economic objectives. Given their financial problems, created by 
politicization of decision making, Fannie and Freddie have 
essentially been taken over by the Federal Government.
    In another startling development over the last several 
weeks, a distinct investment banking industry, established by 
the provisions of the well-meaning Glass-Steagall Act, has 
essentially ceased to exist.
    The independent investment banking business model proved 
unable to withstand the stress in the financial markets, 
wracking the entire financial structure of our economy.
    These investment banks were highly leveraged and relied on 
short-term funds to finance longer-term investments. 
Unfortunately, many of these investments were mortgaged-backed 
securities whose value has plunged over the last year.
    The fact that the investment banking industry, created by 
government regulation, has proven unsound, is a reminder that 
government policies do not always provide effective solutions, 
but can, in fact, create problems.
    As a result, many investors are rightly concerned about the 
safety of their savings and their investments, and I'm not 
talking about big investors; I'm talking about mom and dad, who 
go to work every day and put some of their earnings in a 
savings account and that are now scared to death about what's 
going to happen to those nest eggs.
    Some action by government is now needed to recapitalize the 
banks and other financial institutions, either by injections of 
equity or removal of toxic investments.
    In this financial meltdown, there is plenty of blame to go 
around, but, ultimately, the American people expect action to 
deal with this crisis. One good place to start would be 
guaranteeing the safety of transaction accounts, checking 
accounts, and money market accounts, that is, to assure savers 
and small businesses, that their basic financial needs can be 
met without disruption.
    Thank you again, Mr. Chairman, and I yield back.
    [The prepared statement of Representative Saxton appears in 
the Submissions for the Record on page 52.]
    Chairman Schumer. Thank you, Congressman Saxton. Vice Chair 
Maloney?

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

    Vice Chair Maloney. Good morning. I'd first like to thank 
Chairman Schumer for holding this timely hearing to examine the 
economic outlook, especially in light of these sobering 
developments in our financial markets in recent days and 
months, and I want to welcome Chairman Bernanke.
    What started out as a subprime crisis last summer, has 
completely changed the face of Wall Street and created a 
tinderbox that poses a significant threat to our financial 
system.
    Treasury Secretary Paulson's $700 billion proposal for the 
Federal Government to buy toxic assets, is the equivalent of 
one-quarter of the entire federal budget in 2008, more than the 
total amount we spent this year on either the defense of our 
country--and we are in two wars--or the entire Social Security 
system.
    American taxpayers are being asked to pour more of their 
good money after bad, while not being provided with any 
alternatives. Your Senate testimony yesterday, made the 
distinction between the market price, the fire sale price, and 
the higher, hold-to-maturity value, which is the price the 
government would pay under your plan.
    Your critics have called this a multi-billion-dollar 
subsidy, and I would like you to clarify it further. Just a 
fraction of this money could be used to help millions of 
Americans avoid losing their homes.
    I am confused by the fact that the Paulson Plan prefers 
government intervention instead of the private sector acquiring 
these assets. Yesterday, it was announced that Berkshire 
Hathaway intends to invest $5 billion in Goldman Sachs. Morgan 
Stanley sold a portion of their firm to the private sector over 
the weekend.
    One could say this is in response to government actions and 
a backstop to the markets, but also it was reported that AIG 
had private offers, as did Lehman.
    The idea that the private sector does not want to buy these 
assets, and, instead, our government should pay a premium and 
that this is somehow good for the taxpayer, seems dubious.
    Upon receiving this taxpayer money, large multinational 
firms have three choices: They can provide credit in America, 
they could invest in other countries, or they could conserve it 
to replenish their capital, which is what happened in the 
Japanese banking crisis.
    Some critics have said that we are taking a big chance in 
not knowing where this money will end up.
    The other issue that has been repeatedly raised, is the 
daisy-chain reaction of one firm bringing down the system. One 
solution that has been proposed, would be to allow government 
to seize the assets and do an orderly sale, before default and 
the ensuing need for taxpayer-funded bailout.
    Perhaps you can explain why this alternative is not 
addressed in the Paulson program.
    When management of so-called too-big-to-fail firms, have a 
liquidity crisis that could be avoided, if they'd just accept a 
buyout offer, wouldn't it serve the public interest, if the Fed 
briefly guaranteed such firms' short-term obligations, 
eliminating systemic risk and then force the auction of the 
firm to the highest bidder? Isn't that better than effectively 
nationalizing the firm, as in the AIG case; letting it fail and 
damage the system, like Lehman; or worse, having the taxpayers 
buy only the very worst assets, as the plan proposes to do?
    These are questions that our constituents deserve to have 
answered. We all recognize the need to do what is best for the 
American economy, as a whole. We all recognize that the time 
will come for an investigation of how we came to this crisis, 
but any plan to use taxpayer funds, must require that the 
businesses using the plan, make sacrifices, just as we are 
asking current and future generations of Americans to do.
    I look forward to your testimony.
    [The prepared statement of Vice Chair Maloney appears in 
the Submissions for the Record on page 88.]
    Chairman Schumer. Senator Brownback?

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

    Senator Brownback. Thank you very much, Mr. Chairman.
    Mr. Chairman, we're at a crossroads. We face the most 
monumental economic decisions in modern times. This is not the 
time to posture in pursuit of political advantage.
    Two things, I believe, are certain: Inaction is not an 
option, and we have to get this right.
    To date, we've dealt with symptoms of the crisis and we now 
deal with the cancer itself. The American people are angry and 
they certainly have every right to be.
    To most, this looks like just one more example of the 
government making them pay for someone else's failures, and to 
paraphrase President Reagan, they want the government to walk 
by their side and stop riding on their back.
    This is, at its core, I believe, about the interaction of 
Wall Street and Main Street. Absent action, there's a prolonged 
period in which credit stops flowing, there is a severe adverse 
threat to the financial conditions of every household, every 
American family, every American business, small and large.
    This is certainly not an abstract fear. I'm sure that 
everybody on this Committee has heard real-world examples of 
how this crisis is hitting the real economy of their 
constituents.
    For example, a major automobile seller was unable to obtain 
funding at workable rates to finance sales of its automobiles. 
Since August 2007, 87 lenders have exited or temporarily 
stopped making student loans backed by the Federal Government.
    If your child is counting on a student loan for next 
semester's education, it could be tough, if this continues, 
tough to find.
    Sixty-seven percent of our small business owners, who are 
the engines of job creation in our economy, report that their 
businesses have been affected by the credit crunch. If we have 
a prolonged period in which credit flows virtually dry up, we 
can count on failures of businesses to be able to make 
payrolls, to employ workers, and to continue operations.
    Failure to act can result in severely depressed economic 
conditions. So I believe that it would be irresponsible to not 
act.
    But I also believe that we must act responsibly. Acting 
responsibly includes looking out for taxpayers as we consider 
devoting large amounts of taxpayer funds to resolve matters in 
credit markets.
    First, Chairman Bernanke, I would like you to explain in 
your testimony, what you feel would happen, if we did not act 
and credit flows remain frozen for a protracted period of time. 
Second, I'd like you to explain how you think Treasury's 
proposal would find true hold-to-maturity prices of the 
distressed assets that are now being valued in illiquid or 
nonexistent markets at fire sale prices, at best.
    If Treasury pays too much for the assets, taxpayers lose. 
If it doesn't pay enough, then banks end up taking severe 
write-downs and must seek more capital and moving toward 
selling more assets at fire sale prices.
    Third, I'd like you to help me understand why it would not 
be prudent to protect taxpayers by inserting into Treasury's 
plan, requirements that those who sell troubled assets, provide 
the taxpayers with preferred stock warrants.
    Why, for example, could we not have Treasury buy troubled 
assets at fire sale prices, inject capital into troubled 
institutions, and obtain preferred stock warrants? We used 
warrants when the Federal Government backed the Chrysler debt.
    Fourth, I'd like you to help me understand why we should 
consider Treasury's proposal of up to $700 billion of value. 
Would there not be merit in considering an initial set of 
purchases of certain classes of troubled assets, in the amount 
of, say, $100 billion?
    Then we could evaluate results and move on with $100 
billion of purchases of other classes of troubled assets. It 
seems to me that's only prudent, that an investor wouldn't just 
say, well, here's $700 billion, but, rather, let's work at this 
in tranches, and I'd like to understand why we couldn't go at 
it that way, as a prudent investor would go at this.
    Fifth, I'd like to know whether you believe that Treasury's 
proposed plan has any room for loan modifications by the 
Treasury, on troubled mortgages.
    We have a crisis in confidence in financial markets and we 
have a crisis of confidence of the American people in their 
government.
    When an American family seeks to borrow money to improve 
their home or start a business, or when a small business looks 
to borrow to expand operations, they have to explain in detail, 
what they are going to do with the money, what the collateral 
is, and how they are going to pay it back.
    I don't think the American people are unreasonable in 
asking the same questions of this proposal.
    I appreciate the help that I anticipate that you will give 
us and the country, in understanding how best to resolve the 
stresses in the financial markets that pose a very real adverse 
threat to our overall economy.
    Again, I believe it would be irresponsible not to act, but 
I also believe that we must act responsibly and get this right, 
including protecting the taxpayers. Thank you, Mr. Chairman.
    [The prepared statement of Senator Brownback appears in the 
Submissions for the Record on page 90.]
    Chairman Schumer. Thank you, Senator Brownback.
    Chairman Bernanke, the podium is yours.

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

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