[Senate Hearing 110-884]
[From the U.S. Government Publishing Office]




                                                       S. Hrg. 110-884

 
             THE ECONOMIC OUTLOOK AND OPTIONS FOR STIMULUS

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

                                HEARING

                               before the

                        COMMITTEE ON THE BUDGET
                          UNITED STATES SENATE

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                               ----------                              


    November 19, 2008--THE ECONOMIC OUTLOOK AND OPTIONS FOR STIMULUS

                                    
                                     



             The Economic Outlook and Options for Stimulus
             THE ECONOMIC OUTLOOK AND OPTIONS FOR STIMULUS


                                                        S. Hrg. 110-884

             THE ECONOMIC OUTLOOK AND OPTIONS FOR STIMULUS

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

                                HEARING

                               before the

                        COMMITTEE ON THE BUDGET
                          UNITED STATES SENATE

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                               __________


    November 19, 2008--THE ECONOMIC OUTLOOK AND OPTIONS FOR STIMULUS

                                     
                                     




           Printed for the use of the Committee on the Budget


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                        COMMITTEE ON THE BUDGET

                  KENT CONRAD, NORTH DAKOTA, CHAIRMAN

PATTY MURRAY, WASHINGTON             JUDD GREGG, NEW HAMPSHIRE
RON WYDEN, OREGON                    PETE V. DOMENICI, NEW MEXICO
RUSSELL D. FEINGOLD, WISCONSIN       CHARLES E. GRASSLEY, IOWA
ROBERT C. BYRD, WEST VIRGINIA        WAYNE ALLARD, COLORADO
BILL NELSON, FLORIDA                 MICHAEL ENZI, WYOMING
DEBBIE STABENOW, MICHIGAN            JEFF SESSIONS, ALABAMA
ROBERT MENENDEZ, NEW JERSEY          JIM BUNNING, KENTUCKY
FRANK R. LAUTENBERG, NEW JERSEY      MIKE CRAPO, IDAHO
BENJAMIN L. CARDIN, MARYLAND         JOHN ENSIGN, NEVEDA
BERNARD SANDERS, VERMONT             JOHN CORNYN, TEXAS
SHELDON WHITEHOUSE, RHODE ISLAND     LINDSEY O. GRAHAM, SOUTH CAROLINA


                Mary Ann Naylor, Majority Staff Director

                Denzel McGuire, Minority Staff Director

                                  (ii)


                            C O N T E N T S

                               __________

                                HEARINGS

                                                                   Page
November 19, 2008--The Economic Outlook and Options for Stimulus.     1

                    STATEMENTS BY COMMITTEE MEMBERS

Chairman Conrad..................................................     1
Ranking Member Gregg.............................................    11

                               WITNESSES

Simon Johnson, Senior Fellow, Peterson Institute for 
  International Economics........................................47, 50
John B. Taylor, Mary and Robert Raymond Professor of Economics, 
  Standford University, and Senior Fellow, Hoover Institute......    64
Mark Zandi, Chief Economist and Cofounder, Moody's Economy.com...13, 18


             THE ECONOMIC OUTLOOK AND OPTIONS FOR STIMULUS

                              ----------                              


                      WEDNESDAY, NOVEMBER 19, 2008

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10:04 a.m., in 
room 608, Dirksen Senate Office Building, Hon. Kent Conrad, 
chairman of the committee, presiding.
    Present: Senators Conrad, Murray, Nelson, Cardin, Sanders, 
Whitehouse, Gregg, and Sessions.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The hearing will come to order. I want to 
welcome everyone to the Budget Committee. Today's hearing will 
focus on the nation's economic outlook and the options for 
stimulus. We have birds chirping there, birds chirping in the 
sound system.
    I hope that this hearing proves timely because this is very 
central to the discussion and debate about what needs to be 
done to stimulate the economy, both during this truncated 
session, but also when Congress resumes, and we are being told 
that we will be right back at it during the first part of 
January, so no one should expect that the usual rhythm of this 
place will be the rule.
    I would like to particularly welcome our witnesses this 
morning, Mark Zandi, who has testified before this committee 
before and whom we see as a very valuable resource for this 
committee. He is the Chief Economist and co-founder of Moody's 
Economy.com.
    Simon Johnson, Senior Fellow at the Peterson Institute for 
International Economics and Professor of Entrepreneurship at 
MIT's Sloan School, welcome. It is good to have you here.
    And John Taylor, Senior Fellow at the Hoover Institution 
and Professor of Economics at Stanford University, my alma 
mater. I was there with our grandson this summer and I was 
showing him around and we had a wonderful time.
    This is a distinguished panel and I very, very much 
appreciate your being willing to come and share your thoughts 
with us.
    Let me just start with a few charts to put our current 
circumstance in some perspective. The downturn has featured a 
dramatic collapse in the housing market. All of us know that. 
We can see what has happened to the home foreclosure rate. It 
remains at the highest level ever. The housing decline rippled 
through the rest of our economy and helped trigger the 
financial market crisis.

[GRAPHIC] [TIFF OMITTED] T7518.001


    Let us go to the next slide, if we can. Credit markets were 
essentially frozen from late September through mid-October. 
This chart shows the clearest measure of what happened to our 
credit markets.

[GRAPHIC] [TIFF OMITTED] T7518.002


    This is the so-called TED spread, the difference between 
the interest rate at which banks can borrow from each other 
based on the London Interbank Overnight Rate and the rate on 
U.S. Treasury bills. It shows that the typical difference 
between the two, which is relatively modest, has absolutely 
skyrocketed. In fact, it went up ninefold before now falling 
back after all of these dramatic policy interventions, but 
still remains very high by historical standards.
    Third, we have lost 1.4 million private sector jobs since 
December of last year, with 263,000 jobs lost in October alone.

[GRAPHIC] [TIFF OMITTED] T7518.003


    Fourth, the economy is expected to contract further. We saw 
the economy shrink by three-tenths of 1 percent of GDP in the 
third quarter of this year. The blue chip consensus is that it 
will shrink by 2.8 percent of GDP in the fourth quarter.

[GRAPHIC] [TIFF OMITTED] T7518.004


    Fifth, retail sales have plummeted, falling 2.8 percent in 
October. What we are hearing from retailers around the country 
is that retail sales continue to slide. I am very pleased to 
report in my home State of North Dakota, retail sales are 
actually increasing during this period. So if anybody is 
looking for a job or economic opportunity, we welcome you to 
North Dakota.

[GRAPHIC] [TIFF OMITTED] T7518.005


    The unemployment rate has now climbed to 6.5 percent, so 
clearly the economy is struggling and we have to act. That is 
why we are here discussing a stimulus package today.

[GRAPHIC] [TIFF OMITTED] T7518.006


    There are several options to be considered. Many economists 
are urging that a package must be large enough to have an 
impact. We have heard estimates anywhere from, at the low end, 
1 percent of GDP of a stimulus package to 3 percent of GDP. 
Just to put that in some perspective, we have about a $14 
trillion economy, so we are talking about a stimulus package of 
anywhere from $140 billion to $420 billion. We have even heard 
some say that a stimulus package should be as much as $500 
billion. We have seen what China has done with a package of 
well over $500 billion on a much lower base in terms of the 
size of our economy than ours.

[GRAPHIC] [TIFF OMITTED] T7518.007


    In terms of specific options, we could extend unemployment 
insurance. That is considered stimulative because it goes to 
people who need it the most and who are most likely to spend 
those dollars. We could also do the same with Food Stamp 
assistance, broaden it, extend it. Again, those are dollars 
that are considered highly stimulative.
    Third, we could fund ready-to-go and near-term 
infrastructure projects. Typically, that is looked on somewhat 
dimly by those in the economic profession because often those 
packages are too slow to get into the economy to be considered 
timely. I think in this circumstance, we need to look again at 
infrastructure projects.
    I have just done community forums in 50 communities in 
North Dakota. It was very interesting, the reaction. It was 
overwhelming--overwhelming--in support of infrastructure 
projects as a means of stimulating the economy.
    And we could provide aid to homeowners. That is another 
option.
    The argument against infrastructure being effective, 
because it can be often delayed, I think may be contradicted by 
what we see as ready-to-go projects around the country. The 
American Association of State Highway and Transportation 
Officials has said that they have more than 3,000 ready-to-go 
highway and bridge projects across the country. The group's 
Executive Director said, and I quote, ``If Congress wants to 
support small business, create thousands of jobs here at home, 
and stimulate the economy, it should invest in the more than 
3,000 ready-to-go highway projects that could be under contract 
within the next 30 to 90 days.''

[GRAPHIC] [TIFF OMITTED] T7518.008


    I asked my own Transportation Director in North Dakota, 
what is their circumstance. He told me they have in my small 
State $300 million of projects ready to go. Engineering is 
completed. Design is completed. Land is acquired. They are 
ready to let contracts if they have the money.
    I am very interested in hearing the views of our witnesses, 
and with that, I want to turn to my very able colleague, 
Senator Gregg.

               OPENING STATEMENT OF SENATOR GREGG

    Senator Gregg. Thank you, Mr. Chairman. Thank you for 
calling this hearing and I appreciate the panel, which is an 
expert panel, to say the least, participating also.
    Obviously, we are confronting an economic situation which 
is extraordinarily difficult and for a period, well, this is a 
precipice which would have been potentially unique in our 
experience and also catastrophic, with the potential meltdown 
of our financial sector. We are still working through that 
process of how we make sure that our financial sector remains 
at least strong and substantive during these very difficult 
times.
    There has been some discussion, of course, as to what we 
should do with the additional TARP money, which it appears it 
will be $350 billion on the table for the next administration 
to use. I believe Secretary Paulson has made it fairly clear 
that at a minimum, that is what will be left available for use. 
I think that is a good decision by Secretary Paulson, to allow 
President-Elect Obama to make the decision as to how those 
additional funds will be moved in the area of protecting and 
promoting and strengthening our fiscal year structure.
    I would like to hear the panel's comment as to what they 
think should be done with those dollars, because those are 
ready dollars, so to say, to quote Phil Gramm but in a 
different context. What is important in my opinion is that we 
put the dollars on the problem, and the problem is foreclosures 
and stability of the real estate industry and the real estate 
markets.
    The decision by the Secretary to move the initial dollars 
directly into capital restructuring of the financial 
institutions which were at risk, I think was also the right 
decision, because it was fairly clear that getting those 
dollars out the door into the purchasing of non-performing 
assets was going to be very difficult. Pricing those assets was 
going to be extraordinarily difficult. Setting up the auction 
process appeared to be extremely complex.
    And although the Chairman and I worked very hard through a 
long 48-hour period to put the bill together with the 
expectation that it would be developed as a bill that would be 
focused on troubled assets and getting those off the books of 
the financial institutions, the decision to go directly to 
capital infusion, I think, was a correct decision and has 
stabilized those institutions and more institutions to come.
    But the question now is with the additional $350 billion, 
is there a structure which would allow us to use those dollars 
effectively to get at the underlying problem of the real estate 
pricing in this country and the overhead of inventory and 
specifically at allowing people who are in their home as 
homeowners, not as speculators, but are in their home as 
homeowners to stay in their homes through some sort of 
restructuring using those dollars, and does that have a 
stimulus effect and does that help the situation if we did 
that.
    The second issue which is on the table right now, of 
course, is the issue of dealing with the automobile companies 
and their weakened situation, which is more than weak, it 
appears, and whether or not it is appropriate for the Federal 
Government to go beyond what is the already $25 billion that is 
in the pipeline or whether that $25 billion should be 
reoriented in some way to be gotten out the door faster and in 
a more immediate way, as it appears to be at the present time 
delayed. I would be interested in the thoughts of the panel on 
that and what is the proper role relative to the question of 
the automobile companies and should this include not only the 
issue of compensation at the executive level, which it 
obviously should include if the Federal Government steps in, 
but also the issue of employee compensation and especially 
retiree compensation.
    I read, regrettably in my opinion, that the UAW has 
rejected out of hand any action in that area as an element of 
the taxpayers stepping forward. They appear to be willing to 
let the taxpayers take the risk, but not their membership. It 
would seem to me that any restructuring is going to have to by 
definition, in order for these companies to survive, include 
some sort of restructuring in the area of compensation, not 
only at the executive level, but on the line, and so I would be 
interested in your views on that.
    Obviously, the Chairman has alluded to various types of 
stimulus packages which are in consideration, the usual 
suspects of the Keynesian philosophy, which is unemployment 
extension and Food Stamps and initiatives in those areas, which 
have a checkered history of actually creating economic 
stimulus. In fact, we don't have to go too far back to see how 
checkered that history is when we look at the first stimulus 
package, which this Congress did this year earlier under the 
$60 billion, the vast majority of which was simply a direct 
repayment, rebate, whatever you want to call it, to Americans 
of $600 or more and which I would be interested in the reaction 
of this panel to what that stimulus package did and whether we 
got value for our dollars.
    It would seem to me, at the time, I said we should have 
spent that money on the problem, which again was real estate 
and stabilizing the real estate markets, especially ownership 
by individuals who are in a home who are finding themselves 
stressed by the fact the value of the home has dropped and the 
cost of the mortgage has reset. But we decided not to take that 
route. We decided instead to simply throw $600 in various 
packets out of a helicopter across this country which was then 
used to purchase Chinese goods, which may have stimulated the 
Chinese economy but I don't think stimulated ours all that 
much.
    So I would be interested in getting the panel's view as to 
what type of stimulus really does stimulate in the short term. 
The Chairman has made the argument for infrastructure. I don't 
have any argument or disagreement with the belief that 
infrastructure in the long term is a good capital investment 
for a nation. Building better roads, sewage systems, water 
systems, transportation systems is a good investment for our 
nation. But is it a short-term stimulus? That is a good 
question. In fact, if you look at the proposals, it looks like 
less than 20 percent of the dollars that are actually proposed 
for infrastructure stimulus would actually be spent in 2009. If 
that is the case, is it really a stimulus or is it a capital 
improvement program for the long term?
    So these are the questions which we are going to have to 
answer as a Congress. I do agree with the President-Elect and 
with the Chairman that a stimulus package is necessary, but how 
do we do it? How do we do it right, and where should it be 
focused? Should it be focused on the problem--obviously, I am 
asking rhetorically--which is the real estate issue? Should it 
be focused on the more philosophical approach, which would be 
Keynesian philosophy? Or should it be focused on infrastructure 
or some combination? And how do we deal with the real issue 
that is immediately on our table, which is the question of the 
automobile manufacturers, the American automobile 
manufacturers?
    So again, Mr. Chairman, I thank you for setting this 
hearing up so that we can get some answers to these questions.
    Chairman Conrad. Excellent questions that the Ranking 
Member has laid out, and I want to again thank him and his 
staff for their cooperation in setting up this hearing.
    And with that, we will proceed to Dr. Zandi. Welcome.

   STATEMENT OF MARK ZANDI, CHIEF ECONOMIST AND CO-FOUNDER, 
                      MOODY'S ECONOMY.COM

    Mr. Zandi. Well, thank you. Thank you, Mr. Chairman and the 
rest of the committee, for the opportunity to be here today.
    I strongly support the idea of a fiscal stimulus package 
for early 2009 into 2010 for two broad reasons. First, the 
economy is suffering a very severe recession that without 
stimulus will last through 2009 well into 2010 and it will be, 
in my judgment, the worst recession since the Great Depression, 
not in the league of the Great Depression, but the worst since 
that very dark time.
    Second, I think monetary policy, while working very hard to 
stimulate the economy, has been effectively neutered by the 
collapse in the financial system. It is very difficult for the 
lower interest rates and the liquidity that the Fed is 
providing to the economy to actually have an impact quickly 
because it only works through the financial system and the 
system is broken, so credit is not flowing and the cost of 
credit is not falling. Therefore, monetary policy is 
particularly ineffective at this point in time, and therefore 
that requires a fiscal stimulus response.
    I think the stimulus package should be large, I think at 
least $400 billion, which would be two-and-a-half, 3 percent of 
GDP. I think that would be a good starting point. I think it 
should be predominately temporary government spending 
increases. I do think the tax cuts, while helpful, get diluted 
in this environment because consumer confidence is completely 
shot and people are going to save the money. They are not going 
to spend it, and it is not going to be helpful near-term 
stimulus, and probably that is what happened with the first 
stimulus package.
    I think aid to State government to help in their operating 
expenses is absolutely vital. I think they are on the verge of 
significant cuts to everything that they do, and that would be 
very counterproductive in the current environment.
    And I think infrastructure spending is a good idea. It has 
a big bang for the buck, and I do think there are projects on 
the table that can get started relatively soon that will have a 
good measurable impact on the economy.
    I think some tax cuts are also in order, and I will go 
through that in a little bit more detail in a few minutes.
    Let me just say, before I dive into a PowerPoint to 
illustrate these points in more detail, I do think a much 
broader foreclosure mitigation plan is necessary, that the 
efforts to date, from FHA Secure to HOPE NOW to Hope for 
Homeowners, are good steps, but they are significant 
impediments for them to work in a significant way, and the 
foreclosure problem is very, very serious and will get much 
more serious next year and undermine all the good things that 
we are trying to do and you are trying to do unless we keep 
more people in their homes.
    I also think that help for the auto makers is essential, 
because I think they employ 250,000 people in the United 
States, but 2.5 million jobs are at risk if they go into 
bankruptcy, because if they go into bankruptcy, it is likely 
going to be a liquidation. We will see a lot of shuttered 
operations and a lot of lost jobs at just the wrong time. But I 
do think the best way to help them would be a prepackaged 
bankruptcy where the government would guarantee the financing 
in bankruptcy, so that the bankruptcy court would be 
responsible for restructuring the auto makers and making sure 
that they are viable institutions, companies going forward. I 
think that would be the most logical and best way to do it.
    OK. Now having said that, let me just reinforce some of 
these points with a few slides.
    First, I think stimulus is needed because the economy is in 
a very severe recession. Job loss has been serious. We have 
lost, as you can see here, jobs since the beginning of the 
year. This is the month-to-month change in jobs since January 
of 2007 through October of 2008. We have lost 1.2 million jobs 
since the beginning of the year.
    The job losses are very broad-based across all industries. 
The only industries that are adding to payrolls in a consistent 
way are health care and educational services, a little bit of 
defense, some ag, a little bit of energy, but that is it.
    The job losses and the problems are very broad-based across 
the country. Unlike other recessions, where the recessions were 
very regionally focused, this is coast to coast. This shows the 
States that I think nationwide that are in recession. They are 
in red. There are 30 States in all. The States that are in 
orange, they are not in recession but they are at risk. Not all 
of them will fall into recession. I don't think North Dakota 
will fall into recession. Wyoming, I doubt it. Texas probably 
will skirt by. But many of these States will end up in 
recession, and this is very disconcerting because in other 
recessions, people who got unemployed, let us say in 
California, had a place to go for a job. They could move to 
Phoenix or Las Vegas or Oregon. Now there is no obvious place 
to go. You are really stuck, and that is, I think, one of the 
reasons why consumer confidence is as weak as it is.
    The other distinguishing feature of this recession is that 
it is being led by consumers. Most other recessions have been 
led by over-leveraged businesses that got caught when the 
economy turned and had to pull back and cut hiring and 
investment. This go-around, it is being led by over-leveraged 
consumers, and you can see consumers are under severe financial 
pressure. This is data based on credit files that we collect 
from Equifax. The last data point is for the last week of 
October, so it is very timely data.
    As of the last week of October, there was $860 billion in 
household liabilities that were in delinquency or in default, 
so first mortgages, second mortgages, student loans, vehicle 
loans, credit cards, everything. In this data set, that 
accounts for 7.5 percent of all household liability, so it 
gives you a sense of the stress that consumers are under.
    I think the recession we are in, which in my view began 
over a year ago, without stimulus will continue on through 2009 
into 2010 and there are three links between what is going on in 
the financial system and the economy that are going to weigh on 
the economy seriously over the next--over a year.
    The first link is credit. The credit spigot has been 
closed. Credit markets have collapsed. The banking system is 
under severe stress. And you can see the collapsing credit 
here. This shows the growth, annualized percentage change 
growth in debt of households and non-financial businesses on a 
real basis after inflation. You can see that in the decade from 
1998 to 2007, although there is volatility, if you look 
through, it is about 6 percent annualized growth pretty 
consistently. Now, it is in negative territory, so it means 
debt is actually falling on a real basis, and the last time 
that happened was for a very brief period in 1990-1991 when the 
savings and loan crisis hit.
    The second link is confidence has been completely 
shattered. Consumer and business confidence is at record lows. 
Consumer confidence is shown here in the red line. This is a 
survey conducted by the Conference Board. It is an index, and 
you can see that it has collapsed in the last month, and this 
is a record low and this data goes all the way back into the 
1960's. It has never been as low as it is today.
    Small business confidence, this is from a survey conducted 
by the National Federation of Independent Businesses. That is 
the blue line. That is the right-hand scale, another index. And 
it, too--it is not a record low, but it is very close. And I 
think recent events are going to be extraordinarily scarring. I 
don't think confidence comes back easily. People are very 
nervous for lots of different reasons and that is going to 
weigh on the economy for a considerable period of time.
    The third link is we are all less wealthy and we are going 
to be a lot less wealthy for a long time to come. Total 
household net worth has fallen over $12 trillion from the peak, 
which was a year ago, and of that $12 trillion, $4 trillion is 
housing wealth, $8 trillion is stock wealth, and it is having 
an impact on consumers. Retail sales are sharply falling. You 
can see the relationship between retailing and house prices as 
a measure of wealth here.
    The blue line, right-hand scale, is the percent change a 
year ago in retail sales, core retail sales excluding vehicles 
and gasoline, so this is like Christmas sales. I have taken a 
3-month moving average of the data just to smooth out the 
volatility and get to the underlying trend.
    The red line is house price growth. That is year-to-year 
price growth in home values. That is the left-hand scale. The 
twist here is that house prices lead retailing by 6 months. So 
what happened in the housing market 6 months ago is saying 
something about retailing today, and what is going on in the 
housing market today is giving you a forecast for retailing 
over the next 6 months. And you can see the forecast. It shows 
nominal retail sales growth over the next 6 months of one to 2 
percent. Given inflation of a couple percent, that is real 
declines in retail sales through Christmas. So this will be the 
worst Christmas since the 1992 Christmas, and perhaps even the 
1982 Christmas.
    So three links from what is going on in the financial 
system to the economy, credit, confidence, and wealth. All 
three of those forces are going to weigh very heavily on the 
economy for a considerable period of time, well into 2010. So 
this does call--I am running a little bit out of time, so I am 
going to skip over monetary policy issues to give other 
speakers a chance.
    But this calls for a stimulus package. And just to give you 
a sense of what a large stimulus package could mean for the 
economy is this particular graphic that shows the rate of 
unemployment assuming no economic stimulus, that is the red bar 
in the chart, and with an economic stimulus package, the $400 
billion package that I mentioned and will just illustrate in a 
little bit more detail in the next slide. This is based on a 
simulation of our model of the national economy, and so we 
produce forecasts for clients and we can use this for 
simulation purposes to try to understand the impact of these 
kinds of things.
    You can see the unemployment rate with no economic stimulus 
will rise to 10 percent by the early part of 2010. That would--
ten percent, that is a large increase, the largest increase 
since the Great Depression.
    If we have a good, large, well-timed, well-structured 
stimulus package along with some other steps by policymakers, 
you can see the peak will still be very high, 8 percent in 
early 2010, but a measurable difference in the economy's 
performance.
    And here, just to illustrate, this is the package that I 
put together to illustrate the point. This is a $400 billion 
package distributed from 2009 to 2010. This is composed of $230 
billion of temporary government spending, $100 billion of which 
is State aid, UI benefits, Food Stamps, and another $100 
billion in infrastructure spending. And then $170 billion worth 
of tax cuts. The investment tax credits that were in the first 
stimulus package will expire at the end of this year and it 
makes sense to just extend them so that businesses don't cut 
investment early in 2009, a pretty simple, not very costly, 
thing to do.
    And I am also proposing some housing tax credits to 
stimulate home sales to work off some of the excess inventory 
and to provide some support to the housing market and house 
prices in 2009. And a temporary tax cut. Here, I just put in a 
payroll tax holiday, and we can talk about the merits and 
disadvantages of that if you care to.
    But you can see the impact. This shows the annualized 
growth in GDP, real GDP, from the first half of 2008 through 
the second half of 2010. You can see the impact of the first 
stimulus. It was positive, but it was small. And then the 
impact of the second stimulus, if it is well-timed and 
structured in the way that I have designed it here.
    So just to end, the point would be that I think a stimulus 
is vitally necessary. Without a stimulus, I think the economy 
is going to suffer an extraordinarily severe recession, and 
with it, it will still suffer a severe recession, but it will 
be measurably more manageable. Thank you.
    [The prepared statement of Mr. Zandi follows:]

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    Chairman Conrad. Thank you, Dr. Zandi.
    Dr. Johnson.

 STATEMENT OF SIMON JOHNSON, SENIOR FELLOW, PETERSON INSTITUTE 
                  FOR INTERNATIONAL ECONOMICS

    Mr. Johnson. Thank you. I would just like to supplement my 
written testimony by making three points, if I may. The first 
is about the unprecedented global nature of the financial and 
economic problems we are facing.
    The second is the case for fiscal policy or fiscal stimulus 
despite the very high level of uncertainties we face about 
exactly what is happening in the economy, what will happen, and 
how fiscal policy will work.
    And the third point is to argue strongly that we must not 
overdue the fiscal stimulus. Medium-term fiscal consolidation 
remains vitally important. If anything, this crisis reminds us 
that we must preserve our financial firepower for when we 
really need it, which is during a crisis like this.
    But first, on the global point, I think in the remarks 
which have already been made by Senator Conrad and Senator 
Gregg and by Mr. Zandi, I think you very clearly laid out the 
picture in the United States. What I would like to stress is 
that this is not just a U.S. problem, as you know. It is not 
just a problem in the U.S. and in Europe and in other 
industrialized countries. It has now spread through various 
mechanisms to almost every country in the world, including 
major emerging markets and now poorer countries.
    And I think in terms of the synchronization of the slow-
down, and certainly the synchronization is contraction of bank 
lending and now, of course, it is a fall in the demand for 
credit around the world, this is unprecedented. I do not think 
we have ever seen in the history of modern capitalism anything 
like this at all, where every economy and every credit system 
around the world, pretty much at the same time, contracts.
    Now, we don't know how far this goes. We don't know what 
levels of leverage the system will stabilize at. I am 
supportive of many, if not all, of the dramatic actions taken 
by the Federal Reserve and other leading central banks in this 
context. I am skeptical of their ability to stop this process 
or to--I think the market will find its own level of leverage, 
and this may come with a much bigger contraction in the global 
economy and global trade than we can now imagine.
    I would, with a great deal of respect, disagree with the 
Secretary of the Treasury, Mr. Paulson. I do not think the 
TARP, Troubled Asset Relief Program, has been a success. I do 
not think the situation in the financial system is yet 
stabilized. And if you look at the current developments in 
major U.S. banks, the banks at the very core of the program, 
they are still regarded by the market, I think correctly, as 
having deep problems that are not fully resolved.
    I think, just in that context, in passing, the meeting of 
the G-20 which was held last weekend in Washington achieved 
very little and potentially actually worsened the situation in 
ways I can elaborate on later if you're interested.
    My second point is about fiscal policy. If we are facing 
such a dramatic slowdown around the world and we are in a 
situation which is really unchartered in terms of the dangers 
ahead, what are the right policy responses? And I think the 
answer is that you have to try everything that you can. I think 
this is the approach of Mr. Bernanke at the Federal Reserve. I 
think the amount of credit provided or underwritten by the Fed 
is now at record levels. We will see how much effect that has.
    I completely agree with the remarks already made about the 
need to make progress on housing, on mortgage restructuring, 
and I think in terms of the flow of foreclosures, or foreclosed 
properties onto the market, we also need to make more progress.
    But I also think that in this context, there are ways to 
use government spending wisely, both in the shorter term and in 
the longer term. I would actually stress not just the likely 
debt to the recession we are facing, but the fact that the 
recovery will almost certainly be quite slow without government 
action. I think we are looking at a problem not of 2 years, but 
more likely of three or 4 years, and that is just in the United 
States. I would expect the U.S. economy to recover more quickly 
than most of our trading partners around the world. So I don't 
think you should look to exports any time soon to pull us out 
of this.
    I think in this context you could make a case for many of 
the forms of spending that have already been discussed. In the 
short term, direct aid to State and local governments makes a 
lot of sense. They are already contracting. That is where a lot 
of the job losses are occurring. You can extend unemployment 
benefits. I think there is a lot of agreement on that. Expand 
Food Stamp aid. And the loan modification for distressed home 
owners, I think also can give you relatively good value for the 
money.
    I would also want to express some more positive words about 
tax rebates or temporary tax cuts. I don't think we should get 
too hung up on the idea that if consumers don't spend the 
money, somehow it is wasted. We need consumers to rebuild their 
balance sheets. That is important for them. It is very 
important for the financial system, too. So the money that is 
saved is also a contribution to the economic recovery and to a 
faster, more sustainable recovery.
    In terms of longer-term spending, I support the ideas for 
both immediate spending on improving maintenance for 
infrastructure in the United States and projects that are ready 
to go. I think over a longer period of time, we can find more 
sensible uses of money on infrastructure.
    I think there is also good use of money, again, over a 
longer period of time--I am not saying we rush the money out, 
it is to try to get a strong, sustained recovery here--job 
training programs. Student loans are, as you know, under 
tremendous pressure because of what is happening in the credit 
market, as are small business loans, and those are both worth 
serious consideration in the longer-term context.
    And I also think that investment in alternative energy 
through various means typically used to support technology 
development is also a good long-term investment.
    I think the amount of fiscal stimulus that you can justify 
in these terms, in terms of what you can spend wisely, and I 
would include the tax cuts, if you want to put tax cuts in this 
overall number, is about 3 percent of GDP. That is a very large 
stimulus. I think there are some other proposals that are now 
being put forward.
    Let me say, when we first put this forward, it was a large 
stimulus. Now, it seems more in the middle of the range that is 
being proposed, and I think some of the numbers being talked 
about, up to $800 billion, are too large. I think there are 
risks here. There is a risk of doing nothing. There are risks 
of doing too much. And there are no risk-free proposals. I 
think that the appeal of temporary spending and temporary tax 
cuts is that it can help us more quickly get back on the route 
to medium-term fiscal consolidation.
    And my last point is that all the proposals put forward to 
try to deal with asset price bubbles in the future, in terms of 
monetary policy or in terms of regulation, I think are good 
proposals worth consideration. They are very unlikely to be 
successful. I think given the nature of the financial system 
that we have created in this country and around the world, 
unless something very unpleasant happens at a global level, 
which I am not expecting, I think we will keep that same 
financial system. That financial system will have crises. The 
only way to deal with crises is to have a very large amount of 
financial firepower available in the form of the U.S. 
Government balance sheet.
    So you run a careful fiscal policy. You try and keep debt 
low. You avoid the temptation of overspending in good times so 
that in bad times, when things are very difficult, when the 
risks are really mounting, you have the financial firepower 
available for direct support of the financial system, for other 
forms of direct support, and for fiscal stimulus. Thank you 
very much.
    [The prepared statement of Mr. Johnson follows:]

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    Chairman Conrad. Thank you.
    Dr. Taylor.

STATEMENT OF JOHN B. TAYLOR, MARY AND ROBERT RAYMOND PROFESSOR 
 OF ECONOMICS, STANFORD UNIVERSITY, AND SENIOR FELLOW, HOOVER 
                          INSTITUTION

    Mr. Taylor. Thank you, Mr. Chairman, and thanks to you and 
Senator Gregg and other members of the committee for giving me 
the opportunity to be here to talk about the economic situation 
and the need for a stimulus.
    I agree, these are tough economic times. We are in a 
recession. Last quarter had negative growth and this quarter 
will most likely have the number of minus-three percent that 
you put up, Mr. Chairman. I think the recession will be--
already--is longer and deeper than the previous two recessions 
we had in the United States and most likely more along the 
lines of the recessions we had in the 1970's and the early 
1980's in terms of the magnitude and length.
    I think the source of this really goes back to the boom and 
bust in housing. I will come back to that in a minute. There 
was a period of time where we had excessive stimulus, if you 
like, from the monetary side. It led to a run-up in housing 
prices that was unprecedented, spread around the world, and now 
the resulting bust has led to many foreclosures. People are 
underwater; the securities were put together into derivatives 
that were sold to banks and others and that has caused the 
financial crisis that we are facing in the United States and 
the rest of the world.
    So the story is pretty clear about how we got here, and now 
getting out. Clearly a good topic for discussion is how we get 
out of this. I think the first thing I would look at if I were 
you, in terms of considering a second stimulus, is to look as 
carefully as possible at the first stimulus, if you like, the 
Economic Stimulus Act of 1980.
    I have had a chance to look at this a bit, and I brought a 
chart. I am going to only have one chart in my presentation. It 
is in my testimony. I don't know if it is in front of the 
Senators. But it is simply just going back to the major part of 
the Stimulus Act, and that was, as Senator Gregg mentioned, the 
rebate checks or direct deposits into people's accounts.
    The idea, you recall, was that by giving people more 
income, more disposable income, they would spend more. It would 
give a boost to consumption demand, and that would boost 
aggregate demand which in turn would jump-start the economy. 
That is the logic.
    Well, we can look at what happened with this chart. As you 
can see, the top line is--well, it is on the chart here, so 
thank you. The top line is what we call disposable personal 
income, and this is the amount of money in the aggregate that 
people have to spend after the government takes taxes and gives 
money back in the form of transfers.
    You can see there is a big blip in that line. It started in 
May when the rebate checks were sent out, or money was 
deposited in people's accounts. It stayed high in June, July, 
and now it is basically back to the previous trend it was. So 
that is basically the stimulus package right there, at least on 
the consumer side.
    Now, again, the purpose was to stimulate consumption so the 
economy would get a jump-start. The lower line is what we call 
personal consumption expenditures. It is the total amount of 
consumption by the same people in the aggregate that were 
getting the rebate checks. As you can see, it is very hard to 
see that there was any impact of this stimulus on what it was 
advertised to affect. It seems to me that is something to 
consider seriously when you think about a second stimulus 
package.
    You might think it is surprising this happened. Actually, I 
think this is what economic theory will tell you would happen. 
Economic theory has something called the permanent income model 
developed by Milton Friedman, or the lifecycle hypothesis 
developed by Franco Modigliani at MIT, and these are the ideas 
that people's consumption behavior is largely influenced by 
their views about their permanent income. It is a famous and 
well-researched idea.
    It seems to me that that is what you are seeing in this 
picture, exactly what you'd expect, a temporary burst of 
income. People save almost all of it in this case. We can 
debate whether maybe it was offsetting some other things, like 
the high energy prices, but nonetheless, it seems to me that 
this is a verification of that theory.
    Now, it is because of that view of temporary rebates that 
the idea of stimulus, countercyclical fiscal stimulus, actually 
fell by the wayside until roughly 2000, 2002. I have some 
quotes in my testimony from distinguished economists who said 
there was a consensus that this approach doesn't work. I think 
the consensus broke down as, of course, evidenced by lots of 
testimony you heard earlier this year when you were considering 
the economic stimulus package. I think it broke down because in 
2001, there were checks sent to people and that did seem to 
have some impact. But remember, that was the first installment 
on a longer-term multi-year tax cut. So effectively, that was 
viewed as permanent by so many people who were getting those 
checks. Logically, that is what they would think. So in that 
sense, that is not surprising that had more impact.
    So in my last minute and a half, what are the lessons from 
this? It seems to me the lessons are pretty clear. We had in 
many of the debates last January-February the mantra that 
packages should be temporary, targeted, and timely. It seems to 
me we should think about changing that mantra, those 
principles, when you think about this next package. I like to 
stick with the alliteration, since that seems to be catchy, but 
I will choose a different alliteration.
    I would like to think of the stimulus being permanent, 
pervasive and predictable. Permanent will have more of an 
effect, obviously. By pervasive, I mean forget targeting. Try 
to make it as broad as possible. Don't worry about targeting so 
much, thinking it is going to have more of a stimulus. You need 
to be, if you like, broad-based if you don't like the word 
pervasive.
    And predictable seems so important to me. Many of the 
criticisms that we are hearing about policy these days is it is 
ad hoc. It seems to be changing all the time. The mere fact 
that we are considering a second stimulus so soon after the 
first stimulus is an indication of that, it seems to me.
    So what kind of policies would be permanent, pervasive, and 
predictable? There are many, quite frankly, that fit those 
principles. But the one that I would like to suggest is, No. 1, 
committing through legislation not to increase any tax rates 
for the foreseeable future, whatever you define as permanent. 
Put it in the books. No tax rate increases anywhere.
    Second is to go ahead with President-Elect Obama's proposal 
to have a workers' tax credit of 6.2 percent of wages, up to 
$8,000 in wages. Make it permanent, though. Forget about one-
time rebates. Just make it permanent. It will have more of an 
effect. So that is the pervasive aspect. It is across the 
board, but it is helping additional people.
    On the spending side, I think the most important thing is 
to lay out a spending path for the next few years to show how 
you are going to get from where you are now with the stimulus 
back to balance. And if you want to bring forward some of that 
spending as best you can, maybe things that are already on the 
books, that is fine, but the important thing is to lay out a 
path to get back to a balanced budget.
    And fourth, I would remind you all that we have a stimulus 
program automatically in this country. It is called the 
automatic stimulus, automatic stabilizers, and that is the fact 
that spending automatically increases in recession and revenues 
automatically come down. I estimate that the stimulus from the 
automatic side is going to be about 2.5 percent of GDP this 
fiscal year. So make that part of the package. You don't have 
to pass legislation to get that 2.5 percent, but that is there 
and it is part of the whole stimulus.
    The questions that Senator Gregg asked, I will just answer 
briefly. We can come back to them. I do think that some of the 
TARP money should be used directly for the borrowers and the 
homeowners to help directly the foreclosure problem that we 
have, but I do not think additional funding or loans are 
appropriate for the automobile industry. Thank you.
    [The prepared statement of Mr. Taylor follows:]
    Chairman Conrad. Thank you. I am going to go to Senator 
Sanders. I am going to reserve my time and go to Senator 
Sanders first on our side, then come back to Senator Gregg, 
then Senator Murray, then Senator Nelson on our side.
    Senator Sanders.
    Senator Sanders. Thank you very much, Mr. Chairman. I don't 
know that I have any profound questions, but I want to thank 
you for holding this hearing. We are dealing, as I think our 
very able panelists have told us, with something that is almost 
unprecedented. It is very frightening and we are all going to 
have to scramble to figure out how we come up with some 
sensible solutions.
    Just a few points that I want to throw out and maybe the 
panelists can comment on it later. We have talked about the 
immediate impact of the financial downturn in terms of 
increased unemployment and foreclosures and so forth, but one 
point, Mr. Chairman, I want to reiterate, one of my real 
frustrations with the Bush administration, well before the 
immediate financial crisis, is their refusal to address the 
reality that even before the crisis, the middle class in this 
country was in serious decline. So this didn't happen a few 
months ago.
    We have had--and the reality is, and we have to put this 
out on the table, is that in the United States, among all of 
the other industrialized nations, we have the dubious 
distinction of having the highest rate of childhood poverty. 
Forget the immediate financial crisis. Eighteen percent of our 
kids are living in poverty. We have the highest overall poverty 
rate. We have the highest infant mortality rate. We have the 
highest incarceration rate. We spend $50,000 a year to keep 
people in jail, and if anyone thinks that is not related to 
having a very high poverty rate, I would seriously question 
your judgment.
    We have also, Mr. Chairman, and I think we have to address 
this issue, as well, how does the grossly unequal distribution 
of income and wealth play into this financial crisis? According 
to at least some analysts, the top one-tenth of 1 percent earn 
more income than the bottom 50 percent, and we are moving in 
the direction of Brazil, of Russia, of very unindustrialized 
countries in terms of that discrepancy. Do we address that 
issue? How is it related to the crisis that we face?
    And, of course, we are the only major country on earth 
without a national health care program.
    So I want to maybe throw into the hopper here for further 
discussion some of these longer-term problems that our economy 
is facing, how that ties into the financial crisis, how do we 
address that.
    Mr. Chairman, I agree with much of what you laid out in 
terms of what a package would include, a stimulus package, but 
I agree with, I think, it was Dr. Zandi talking also about the 
need to move us to sustainable energy. I think there is 
enormous job creation in energy efficiency. I was just in the 
United Kingdom last week. They are talking about creating a 
whole lot of jobs in energy efficiency and I think we can do 
that. Maybe the panelists can discuss the impact on our economy 
of importing $700 billion a year of foreign oil and why not 
investing in sustainable energy--wind, solar, geothermal, 
biomass.
    The other things that I think we may want to also throw on 
this table for discussion is I think the loss of faith. We talk 
about loss of confidence from an economic perspective. I think 
there is a deeper loss of faith in corporate America in 
general. I could tell you that in my State, people are furious. 
People are struggling to keep their heads above water and the 
idea of placing at risk $700 billion of taxpayer money to bail 
out people on Wall Street who in the past have made just huge 
amounts of money investing in very reckless, exotic financial 
packages, that brings about the issue of re-regulation. It 
brings about the issue of greed in our society.
    Are we in a healthy state when so much money is being 
played about in the financial sector while our manufacturing 
sector is in rapid decline? Doesn't it make a lot more sense to 
maybe put money into producing products that the American 
people consume so, in fact, we don't have to import everything 
from China rather than have guys make huge sums of money 
playing on Wall Street?
    The other point that I want to make, we have heard some 
statistics about unemployment. There is a question about the 
validity of unemployment. For example, I believe we have about 
ten million people who are unemployed today, roughly speaking. 
We have another seven million people who are underemployed, 
i.e., who want to work full-time who are working part-time. Is 
that something that we should throw into the hopper? Is, in 
fact, the economic situation a lot worse? Do we have Ph.D.s out 
there who are driving taxicabs or working as waiters or 
waitresses? Is the problem even worse than we are suspecting it 
is?
    So, Mr. Chairman, those are a few of the issues. I think 
this has been an excellent presentation. I think you have 
different philosophical points of view and I think they all 
have something to say, so I just wanted to throw out some of 
those ideas to further the discussion. Thank you, Mr. Chairman.
    Chairman Conrad. I would give, if the panel wants to react 
to any of that, I would give them the opportunity. Mr. Zandi?
    Mr. Zandi. Sure. I do agree that the unemployment rate, 
where you ended your remarks, is not an adequate measure of the 
stress in the labor market and the job market. It is 6.5 
percent, but if you do add in discouraged workers, so-called 
discouraged workers who aren't even looking for work, that 
aren't counted as unemployed, and you consider those that are 
working part-time for economic reasons, certainly 
underemployed, and also some of the self-employed people whose 
payroll job end and they try to make it by becoming self-
employed, then we are already into the double-digits, 11, 12 
percent already there.
    Senator Sanders. Do you think, by the way, and I know that 
is out of the jurisdiction of this committee and maybe it is in 
the Health and Education Committee, that we might want to take 
a look at reconfiguring how we determine real unemployment in 
America?
    Mr. Zandi. I think the Bureau of Labor Statistics actually 
has different measures of stress in the labor market. We focus, 
we the economists focus on the unemployment rate, the 6.5 
percent, but in the monthly report that the BLS puts out, they 
have different measures of underemployment and you can measure 
it and you can see it and----
    Senator Sanders. The point you are making, though, is the 
economic situation is really perhaps a lot more severe than 
that 6.5 percent.
    Mr. Zandi. Yes. I think the 6.5 percent understates the 
stress and the change in the level of stress that is occurring.
    And again, just to reinforce a point, this is--one of the 
unique features of what we are in is how broad-based the 
problem is. It is across all industries. It is across all 
occupations. It is across all regions of the country. In other 
downturns and recessions, you had industries that were doing 
reasonably well. You had occupations that were OK. You had 
regions that were fine, so that people had some options. They 
could move from Michigan to Florida. They could move from 
California to Arizona. They could try to go get retrained for 
another job in the tech sector or in the health care industry. 
But those options are much more limited and I think that is 
weighing very heavily on the collective psyche. So the problems 
are much broader based.
    Senator Sanders. Say a word about income and wealth and 
equality. Can you have a sustainable strong economy when so few 
have so much and so many have so little?
    Mr. Zandi. My view is that income inequality is a problem. 
Income and wealth inequality is a problem, and a problem in the 
sense that there is a skewing of the distribution of income and 
wealth and the skewing hasten worse over time, and the forces 
at work creating this are firmly in place. So it suggests that 
it is not going to get any better, it is going to get worse 
going forward.
    I don't think it is a major contributing factor to the mess 
we are in right now, but I do think it is going to be a very 
serious problem that we are going to have to tackle in the 
future in that we have very significant long-term fiscal 
problems that we are going to have to address and I don't think 
we can address those problems without putting it through the 
prism of what it means for the distribution of income and 
wealth.
    Senator Sanders. Thank you.
    Dr. Johnson.
    Mr. Johnson. Yes. I would like to take up this--I agree 
with what Mr. Zandi is saying, the points he made, but I would 
like to take up the inequality point a little bit more. I 
actually think it does matter today and I think this feeds into 
what I think we can see developing as a bailout fatigue in the 
U.S. People are very annoyed, as you say, with the leadership 
that got them into this, and they are not really happy with 
some of the unions who are involved in the auto industry, as 
well. There are some issues there about differences in pay.
    Mostly, I think, though, there is a lot of pent-up 
frustration. This is a big problem, because unfortunately, in 
this very difficult situation where the credit system is 
collapsing, we have to consider bailouts or rescues for all 
kinds of different things. We are not going to hopefully do all 
of them, but some of them--they want to do things that we 
wouldn't ordinarily do and not be comfortable with, and that is 
going to make people very angry because of the inequality.
    I think the way to address that going forward is by working 
on education. I think a lot of the inequality comes from the 
fact that the income difference between people with high school 
education and college education is getting wider and wider, 
probably because of technology----
    Senator Sanders. Should we follow the route of many of the 
European countries and make college free or virtually free, 
does that make sense to you, for those who are qualified to get 
in?
    Mr. Johnson. I think what you want to do is find ways to 
make sure that people who leave high school have better, 
stronger technical skills, which is also what they do in 
Europe, without necessarily requiring or pushing them to go 
into a college education program.
    The other point I would like to make----
    Senator Sanders. I think my time has long expired, so----
    Mr. Johnson. On energy efficiency, I think investing in 
technology development would address exactly your concerns 
there. I think that makes sense.
    Senator Sanders. Thank you very much, Mr. Chairman.
    Chairman Conrad. Senator Gregg.
    Senator Gregg. Thank you. We could get into the education 
debate and spend hours on it, but your point, which is that in 
Europe, they basically two-track people in high school and you 
get to choose which track you want to take, a technical high 
school or a liberal arts high school, has always been a matter 
of considerable debate in the Education Committee, which I also 
serve on and had a chance to chair for a while.
    I was interested in your chart, Dr. Zandi, which showed the 
drop in the debt, because I am wondering if there might 
actually be a bright side to that in that we clearly, as a 
result of monetary policy over the last 6 years where money was 
made so available at such a cheap rate that there was an excess 
amount of debt put out there, it is clear that what we are 
going through now is an economic event which is a function of 
that excess debt being worked out of the system. How close are 
we?
    We heard in testimony in this committee that there was $2 
to $3 trillion of excess debt in the system, most of it in the 
real estate accounts, that had to be worked out of the system, 
and that that was what this event was all about, or not all 
about, but that was at the core of this event. How close are we 
to that work-out? I mean, are we at a point where--you had that 
line that came down rather dramatically. Are we at a point 
where we actually may be in a situation where we have shaken 
out the excess debt or close to it so that you can start a 
recovery based off of assets which have value as versus assets 
which are overvalued due to excess debt? Is that the bright 
side here, hopefully, or is that an overstatement?
    Mr. Zandi. Well, no, there are some rays of sunshine. You 
might have found one of the rays. We are working through our 
excesses rapidly. Let me just give you some numbers to sort of 
benchmark that.
    The financial system as a whole has written off about $650 
billion worth of assets, and that is U.S.-based assets. Those 
are assets that are held by U.S. financial institutions and 
overseas institutions, but they are all U.S.-based assets. Most 
of those are residential mortgage assets, so mortgage 
securities, mortgage loans. I think we have made a significant 
amount of progress there with respect to working off those bad 
assets, but because the economy is eroding and house prices are 
falling and we are going to see more foreclosures, we are not 
done. We have more work to do there.
    But the real problem is there are a lot of assets to be 
written off elsewhere in the financial system. Those would be 
credit cards, vehicle loans, other consumer finance. That would 
include commercial real estate loans, which are only now 
starting to go bad. That would include corporate debt that we 
have struggled with. And if you look at estimates of the losses 
there, I have done some, the IMF-World Bank have done some, 
that would suggest that we have at least another $700 or $800 
billion to go, that that is what is in train that we think we 
are going to have to----
    Senator Gregg. So the $2 trillion number we heard earlier 
is approximately in the ballpark?
    Mr. Zandi. It is in the ballpark, and we are not----
    Senator Gregg. We are halfway through that number----
    Mr. Zandi. If we are lucky, we are halfway through the 
number. Now, just one other point. I am sorry.
    Senator Gregg. Can you make it quickly?
    Mr. Zandi. Yes. I was just going to say, that is a moving 
target, right, because as the economy worsens, people lose 
jobs.
    Senator Gregg. Right.
    Mr. Zandi. Two trillion is----
    Senator Gregg. Dr. Johnson, you made the point that the 
banking industry may not be stabilized, or the financial houses 
may not yet be stabilized. The financial houses are gone. We 
are back to the banking industry. That the universal banks are 
not stabilized yet. I think there has been some--certainly, 
Secretary Paulson has said that he thinks we are past the 
systemic meltdown period threat, that we still are into an 
extraordinarily serious recession. Are you still of the view 
there is a potential for a systemic meltdown?
    Mr. Johnson. I think that is the right question, and that 
is still the question of the day. I think that the period of 
default by major U.S. banks has gone down, and that is 
reflected in the market view, for example, from the credit 
default swap spreads, which you are probably familiar with.
    However, the view in the market at the same time is that 
while the debt is probably OK, these banks' business models of 
profitability is going to erode, and the counterpart of the 
losses you were just discussing with Mr. Zandi is big hidden 
losses, or not yet disclosed losses or not yet understood 
losses on the balance sheets of these very large banks.
    So in other words--so, for example, one large U.S. bank I 
prefer not to name in public has a market capitalization 
substantially below its Tier I capital right now. So how is 
that possible? It is possible because the market view is they 
have a lot of losses. About half the Tier I capital is going to 
be wiped out based on what the market was seeking yesterday by 
the losses that you were talking about, when they take those 
write-downs.
    So is it a systemic crisis if the value of all the banks in 
the U.S. goes to zero at the same time as they continue to 
service their debts and the creditors are OK? It is not a 
classic systemic crisis. It is not a classic bank failure, but 
it is pretty bad because it will feed into a continuing 
downward contraction of credit.
    And remember, the key problem of the 1930's, the onset of 
the Great Depression we think of as being about bank runs and 
bank collapses. What it was really about was the collapse of 
credit. Now, credit can collapse either because banks fail and 
you don't rescue them, or because the banks just shrink their 
balance sheets down dramatically and they are basically putting 
themselves out of business. They wind down. Nobody wants to 
invest in them. And then you are faced with a very difficult 
situation, which is what do you do with these banks? Does the 
government come in and recapitalize them? I know that is not 
the question yet of the day, but I think it will be soon.
    And I think, going back to your original question about the 
top, which I didn't fully answer, I think you should save that 
money for recapitalizations that you are going to need to do if 
the recession becomes substantially worse.
    Senator Gregg. Well, that is a very optimistic view.
    [Laughter.]
    Senator Gregg. Dr. Taylor, I liked your three words. I 
think that those are the ones we should be focused on. You 
suggested that the Obama proposal should be made permanent. Do 
you include in that the Obama proposal to raise the top rate?
    Mr. Taylor. No. Actually, my list of items explicitly says 
we should commit now not to increase any tax rate, and that 
includes tax rates on small businesses, that includes tax rates 
on capital gains, that includes tax rates on dividends. 
Absolutely, I think that would be a mistake to increase those 
taxes. So the first part of my proposal, and I believe it would 
be a stimulus, it would be a stimulus that you might not count 
in terms of money because right now, if you just commit not to 
raise those taxes, if anything, it is going to raise revenue 
because it will stimulate the economy. So in terms of your 
measure of costs, it is really cheap.
    I would do that if you could possibly do it, and that is 
why I mentioned the second part, add to that President-Elect 
Obama's proposal to have a tax cut, rate cut--this is a rate 
cut. You take 6.2 percent of your wages and refund that and 
make it permanent. You could limit it as he proposes to $8,000. 
That is fine. But that would actually broaden the idea of this 
permanence of the tax cut.
    So I think combining those has a lot of appeal. First of 
all, it is bipartisan, if you like, because there are different 
parts of the aisle liking both of those. Second, there is this 
broadness, pervasiveness that I have--and it is permanent. So I 
think there is some appeal there.
    Senator Gregg. I appreciate that and I agree with that 
actual approach.
    I am sorry my time is up, but I do have one more issue that 
I think has to be asked, which is the elephant in the room that 
nobody has mentioned. If you put $400 billion of stimulus onto 
the Federal books, we are taking the Federal deficit over one 
trillion dollars. That is probably somewhere in the seven to 8 
percent range of GDP next year. What does that mean? Or doesn't 
that matter in the context of what we are facing relative to 
the economic slowdown?
    Mr. Taylor. See, in my view, it certainly matters. In fact, 
it seems to me you should be thinking of the stimulus not so 
much in is it going to be how big the deficit has increased, 1 
percent, 3 percent, but really what it is going to do to the 
economy. Just my example of the rebates, you could say, oh, 
that was $100 billion, a certain fraction of GDP, but it didn't 
do anything and I am giving you a proposal which would do a lot 
and wouldn't cost anything. So I don't think you should be 
measuring these by how much it is a share of GDP or increases 
the deficit.
    And I do agree that just flagrant ignoring a one trillion 
dollar deficit is a mistake. It is a concern, a very serious 
concern, and I think whatever the deficit is you decide, 
remember, it is going to be more than that because of the 
recession, 2 percent, 2.5 percent of GDP because of the 
recession. So you have to think about a glide path, a serious 
part of any proposal, it seems to me, to get back to balance, 
and you decide the new debates and the new administration will 
decide the debates. But it is very important for credibility to 
see we are on a glide path to stop this deficit spending.
    Mr. Johnson. Could I just add one point on the very 
important issue of automatic stabilizers Professor Taylor 
raised before. The U.S. does have automatic stabilizers, but it 
has the weakest automatic stabilizers of any major 
industrialized country because we have a relatively small 
government. So in most other industrialized countries, they 
don't have to have this conversation that we are having because 
they have a larger automatic stabilizer from all of the factors 
that Professor Taylor was talking about.
    So the question is, should the U.S. top that up with a 
discretionary decision that you would have to make, or should 
we rely on what we have, automatic stabilizers that are 
relatively weak compared to what other countries in our 
position rely on.
    Senator Gregg. Dr. Zandi.
    Mr. Zandi. Yes. I think deficits matter, but I think this 
is a very good time to deficit finance because no one else is 
borrowing. The private credit markets have completely shut 
down. Seriously, in a normal, quote-unquote, ``normal'' year, 
credit markets raise $5 trillion worth of capital. Right now, 
there is zero private capital. So you can borrow and borrow 
very cheaply and this would be a good time to do it.
    But this is important, and this is why temporary is 
important because that signals that in the longer run, you are 
very concerned about the fiscal situation. If you make all the 
tax cuts permanent, that is a permanent increase in our long-
term deficit situation, which is going to get very serious in 
the not-too-distant future. So that is the downside of 
permanent and why temporary is important and why I think we 
should be very careful about permanent or temporary.
    Chairman Conrad. Senator Murray.
    Senator Murray. Thank you very much, Mr. Chairman. This has 
been an excellent hearing. I can't say it has been uplifting, 
but it has certainly been, I think, an important one for all of 
us to understand why we are where we are and what the 
possibilities are trying to move us forward and what our 
responsibilities are in moving forward.
    I certainly agree with you, Mr. Chairman, on transportation 
infrastructure. It seems to me the best thing to do is to have 
people at work getting a paycheck, having a skill, creating 
economic development. I know my State has $98 million worth of 
highway infrastructure projects ready to go. I am sure every 
State does, and like yours, they don't have the capacity today 
to do that. We will have to work hard on that, obviously, over 
the next several months to put a package forward, but I hope 
that that is part of it.
    I did want to ask the panel a few questions? You outlined 
for us why we are where we are and consumer confidence. Housing 
foreclosures clearly got us to where we are in the tight credit 
market, but consumer confidence, it seems to me, is really 
keeping us here in a very difficult place. How do we increase 
consumer confidence, or consumer spending? Dr. Taylor, you said 
the rebate checks were essentially not going to get us there. 
What is it that we can do to increase consumer confidence? Dr. 
Zandi, let me start with you.
    Mr. Zandi. I think that requires a very concerted, 
consistent, overwhelming policy response, and that is fiscal 
stimulus, that is aid to homeowners, that is expanding out the 
use of TARP, not only for homeowners but for more capital 
infusions, and I personally believe that giving up on asset 
repurchases is a very significant mistake because that is 
necessary for price discovery, which is what you need to get 
private capital back into the financial system. So I think that 
should be also pursued.
    Senator Murray. The toxic asset purchases that we 
originally----
    Mr. Zandi. Exactly. I think abandoning that idea is a very 
significant mistake, yes.
    Senator Murray. And define for me why you think that again?
    Mr. Zandi. Because I don't think you are going to get 
private capital coming back into the financial system until 
they understand the value of the assets that are on the balance 
sheets of these institutions, and you are not going to get that 
until you get price discovery, until they know what the price 
is, and you are not going to get that unless you have a buyer 
for the assets, and there are no buyers except for the Federal 
Government, at least not in the foreseeable future.
    Senator Murray. So you are saying consumer confidence, 
dealing with the housing market has to be part of that----
    Mr. Zandi. I think it has to be all of those things. I 
think it has to be overwhelming. In my view, in times of 
crises, the only way out is overwhelming government response in 
a very concerted, consistent, and comprehensive way, and it is 
all of the above very quickly.
    Senator Murray. Dr. Johnson.
    Mr. Johnson. I think the way to think about your question 
is what is going to happen to spending? Whose spending is going 
to be affected by this very deep recession unless you have the 
fiscal stimulus? And I think this also--you want to take on 
board the points that Professor Taylor is making, which is, is 
somebody liquidity constrained? Is somebody really short of 
money? They didn't get their paycheck. They just got laid off. 
They have other problems.
    And I think there is a set of measures that you can take, 
both with the aid to State and local governments, because they 
are cutting back and they are laying people off directly. You 
know, that is going to have a big effect on spending by their 
employees. The unemployment benefit, extension of unemployment 
benefits, I think there is a lot of agreement that this is 
something that will support spending as well as being a good, 
fair idea. Food Stamp aid, again, does the same thing. If you 
can find ways to help the distressed homeowners, potentially, 
this is a way to affect spending, also.
    These are immediate things. These are things that will 
happen right away. These are people who are going to spend less 
money for the holidays because of the difficulty of the 
situation. So I think that even recognizing that there is a 
great deal of uncertainty, that nothing will work exactly as 
intended or hoped in this kind of situation, I think these 
things will really move spending.
    And I would just like to add, I would respectfully disagree 
with Mr. Zandi's view on top. I actually think not buying those 
distressed assets at this point was a good--actually, I never 
thought it was a good idea, to be totally honest. There is a 
private market for these assets. It has a very low price on 
them because their value is declining because the real economy 
is falling. And if, contrary to some of the initial hopes 
expressed for that program, if the economy goes down far 
enough, if house prices fall enough, then those assets are 
going to be worth essentially zero.
    The key thing is support the real economy. It is a very 
hard thing to do in this situation. The measures that we are 
proposing, which are pretty big--include a pretty big fiscal 
stimulus, may not work. It may not be enough. It may not save 
us from a very deep, prolonged recession. But I think it is 
worth trying.
    And I do also, on the point about budget deficits, I do 
worry about the budget deficit. I am not somebody who has ever 
previously argued in favor of big deficit spending in this kind 
of situation. I mean, this is a very unusual situation. This is 
why you saved the U.S. balance sheet. Save it for when you need 
it. Now, you need it.
    Senator Murray. Dr. Taylor, how do we increase consumer 
confidence?
    Mr. Taylor. The biggest drop in consumer confidence is just 
in the last month or so. The October numbers just fell like a 
rock. And I think in terms of what government can do, it seems 
to me is to, just as you were saying, be as clear as possible 
about the understanding of where this problem came from, 
articulate that. I think people still don't understand it. You 
know, your constituents are confused. The more that you can 
explain, and we in the private sector can explain it, the 
better.
    But I think in terms of instilling confidence, the more--I 
would say this, going back to this predictability thing, the 
more that you can outline a strategy for the longer term and 
don't keep changing it all the time and don't look ad hoc but 
look predictable and be predictable, the more confidence people 
will have in their government. When they see a testimony asking 
for $700 billion with apparently little documentation for that, 
that worries them. When they see the markets reacting 
negatively to that, it is very visible, of course, the stock 
markets.
    So I would say, to me, the most important thing--that is 
why I am stressing here today, yes, do something, but make sure 
that it is a strategy that you are not going to have to come 
back to in another 6 months. It is so important.
    Senator Murray. Are you going to break the tie here on 
whether we should purchase toxic assets on this panel?
    Mr. Taylor. Well, I think, and let me just say about it, 
this is another example where changing itself has some 
problems, OK. Obviously, you want to change when things aren't 
working or when the circumstances have changed. But I think 
people look at that change and they say, well, what did change 
between the testimony of Secretary Paulson here on the Hill 
with Chairman Bernanke and the new--what changed? Why did they 
do that?
    And so I think more explanation for it. I actually think a 
more balanced use of those funds, you mix it here and there, so 
you keep the toxic assets as a possibility. You keep the equity 
injections. You add in what Senator Gregg asked about, direct 
assistance to the borrowers, the home mortgage holders, the 
people that are underwater. Try to fix them. They are the heart 
of the problem. That is why the derivative securities are such 
a problem, because those payments aren't being made.
    And I would add a fourth one which doesn't cost much at 
all, is just to require more disclosure of what is in those 
toxic assets right now. You know, you try to tell someone, 
well, I have this CMO filled with a thousand or 10,000 
mortgages. We don't know what the status of the payments are on 
those mortgages. We should require that it be posted on the 
websites, what is in those things. Then people would begin to 
have a market for them. So I would add that as a fourth----
    Senator Murray. The unknown is contributing, as well.
    Mr. Taylor. Yes.
    Senator Murray. And I am absolutely out of time, but I just 
want to say, Mr. Chairman, we have focused a lot on what we 
need to be doing. I agree, it needs to be very focused, very 
clear, very predictable. But I also hope we have some point we 
can talk about what is happening in the global marketplace, 
too. I think several of you mentioned that in your opening 
remarks. What happens if other countries don't respond equally 
as we hope we will do.
    Chairman Conrad. Thank you, Senator Murray.
    Senator Sessions.
    Senator Sessions. Thank you, Mr. Chairman. I would just ask 
the panel if you agree with the statement that was in a USA 
Today editorial a month or so ago that said an economy founded 
on excessive personal debt, excessive government debt, and a 
huge trade deficit is an economy in trouble. Would you 
fundamentally agree with that? I don't see any disagreement, so 
I assume you would agree with that. Dr. Johnson?
    Mr. Johnson. I am sorry. I think it is rather too 
simplistic a statement. I think there are serious issues in the 
United States, including longer-term issues of poverty and 
inequality. I think you have to be very careful in terms of 
managing the fiscal accounts, and it is certainly the case that 
some consumers obviously went too much into debt.
    But I would like to emphasize that in the middle of 
September, or at the beginning of the second week of September, 
this economy was not in serious major recession. We did not 
have a global contraction of credit underway. The problems, the 
severity--we had these underlying problems. We had mortgages. 
We had issues with financial institutions. But the problem was 
nowhere near this size of this--the magnitude of this problem, 
the enormity of this problem and the global nature of it was 
caused by a crisis of confidence triggered by the way the U.S. 
Government, I am afraid to say, handled Lehman and then AIG. 
They created the strong impression that AAA credits were no 
longer secure anymore. This causes a massive loss of confidence 
in credit, and so everybody who has debt, even a little bit of 
debt, around the world has major problems right now.
    Senator Sessions. Well, one commentator wrote in 2006, that 
housing prices cannot continue to increase at a rate double 
that of GDP when wages are flat. Now, that is a bubble. That 
has been going on for some time. And when people's credit cards 
are at their limit, they can't keep spending. And when the 
trade deficit is enormous, it creates economic uncertainty in 
people who are buying our debt. And I don't think we can buy 
our way out of this one, Dr. Johnson.
    Dr. Taylor, do you have any view of it?
    Mr. Taylor. No, I agree with the general philosophy of what 
you are saying, Senator. In some sense, maybe you are always 
looking for silver linings here, I think a few people asked 
already. And one perhaps is that we will in the United States 
get our saving rate up----
    Senator Sessions. It is going up a little.
    Mr. Taylor. It is going up, yes.
    Senator Sessions. Last year, we had zero savings. This 
year, I think we have had two or 3 percent savings.
    Mr. Taylor. I hope it doesn't go so fast, but it has to 
be--if it is adjusting, that is a silver lining and that will 
affect our trade deficit and our borrowing from abroad, or will 
bring both of those down, which is a good thing.
    So ultimately, we probably had to make this adjustment and 
the difficult thing is it is happening so abruptly and with so 
much destruction. But the idea of gradually raising our saving 
rates, personal as well as government, reducing the trade 
imbalances, which always cause risk, reducing the amount of 
assets, of American assets, U.S. Treasuries held by foreign 
central banks and other governments, all those are good things 
if we can get to those.
    Over the long run, I think if again, making sure--before 
you came in, Senator, I said, let us be sure that we have 
agreement on some kind of a glide path when we get out of this 
that we are going to get back to a zero deficit. Put that in 
the plan, whatever stimulus plan it is you come up with, so 
that will include building up some confidence, as Senator 
Murray was asking about.
    Senator Sessions. Doctor, I will just comment on that. One 
commentator said recently--Mr. Chairman, I think I shared this 
with you--that during the decline of a nation's fiscal 
responsibility and discipline, the government and the leaders 
cite the old verities while doing just the opposite. So I am 
hearing people say, well, I wish we didn't have to go in so 
much debt. I wish we didn't have to bail this private company 
out. I wish we didn't have to do this, while we are pell mell 
doing it, and I don't think it is good policy.
    At a most fundamental level, Dr. Zandi, just one more 
thing. I do believe there are things government can do to 
minimize the destruction that you referred to. I am open to 
that, but I do think those actions need to be as targeted and 
as narrow as possible. Your comments, Doctor?
    Mr. Zandi. No, I agree with you that the fundamental 
problem is we took on too much debt as consumers--not all 
consumers, but a fair share of consumers, and that that debt is 
going bad and it is choking the financial system and the 
broader economy.
    I think, though, that wrong needs to be righted in an 
orderly way, and right now, it is being righted in an 
extraordinarily unproductive way that is hurting everybody, 
even the people who didn't borrow, because their housing values 
are falling, their stock portfolios are depreciating. They are 
losing their jobs. They are not getting credit, even though 
they are, under any normal circumstance, good credits.
    So that is, unfortunately, the situation we are in and it 
is becoming very self-reinforcing. If there isn't a response to 
that, then you run the risk of it all sort of devolving, and 
that is why I think we are at a very unusual point where it is 
very important for policymakers to be aggressive to try to 
short-circuit that cycle so that this righting of the wrong, 
which you are absolutely right about, happens in an orderly--a 
reasonably orderly way.
    Senator Sessions. Dr. Zandi and to you other panelists, let 
me just say to you that it is easy for business people and 
economists and theoreticians to announce all these things and 
you tend not to consider the deep fundamental philosophical 
problems we are creating when we do this. I heard Barney Frank 
on the TV today cite the 100-and-something billion dollar 
bailout of AIG in support of his belief that we should do 
another $25 billion on top of the one we are talking about for 
the automobile dealers.
    So when the floodgates are open, guys, I mean, I know if 
you could just run this economy and you could manipulate it 
all, you think you could do better than Secretary Paulson. I 
think you probably could, but----
    [Laughter.]
    Senator Sessions [continuing]. Once you start down that 
road, it creates a lot of problems. In the long run, I think we 
will look back and see that we would have been better being 
much more modest than our actions today would suggest.
    Chairman Conrad. Senator Nelson.
    Senator Nelson. Thank you, Mr. Chairman.
    In a few hours, we are going to vote on whether to proceed 
to a bill on auto bailout. It is $25 billion and it has some 
restrictions, I really don't know what restrictions, but any 
advice?
    Mr. Taylor. Well, I will just mention in answer to Senator 
Gregg's question, I think the $25 billion you have already 
decided on is there and should be used.
    Senator Nelson. That is in the past. It is in the past.
    Mr. Taylor. It is in the past. And so with respect to an 
additional amount, no, I don't think that is the way that you 
should go.
    I read the testimony of the three CEOs from yesterday and I 
read it very carefully with respect to the current economic 
situation. The main rationale they have, if you look for it, of 
course, they indicate why their companies are doing well and 
they are winning this award and that award, but they also 
mention that the reason they need this money is because of this 
credit crunch, the credit crunch that we all talked about in 
this testimony.
    Well, why not every company in the United States who is 
experiencing--you know, what about the small guys? What about 
the small businesses who are facing exactly the same credit 
crunch things? Why--and if you add them up around the country, 
there are more workers involved. So that is my----
    Senator Nelson. OK. Let me, with the limited amount of 
time, let me get the other two. Dr. Johnson?
    Mr. Johnson. I think that this is a terribly difficult 
decision, because I think you are in danger of opening the 
floodgates. The only case that I can see for--two cases I can 
see for this are if you believe that Chapter 11 bankruptcy 
would actually lead to the closure of the businesses and 
massive disruptions through the suppliers, which is what they 
claim. It is very hard for outsiders to evaluate fully. Some, I 
think, smart analysts think that that might be a possibility, 
and the question is do you want to take the risk in this 
situation.
    The second point is, why them and why not others? I think 
they could potentially be systemic. They owe a trillion dollars 
in debt. In fact, you could argue they have run their--at least 
car companies have been run rather like banks that gave away 
cars below cost as some sort of a very strange incentive 
program. They made money on the loans. All of these loans have 
now gone bad. Well, ordinarily, they should face the music and 
ordinarily they should have to restructure. I think that is 
where this is heading. Do you want to make them do it right 
now? Do you want to gamble with that at this moment in the U.S. 
economy and the global economy, with the importance of those 
jobs in the U.S. economy?
    I think it is really an unpleasant place to be in. But 
unfortunately, at this moment, I think you have to get them 
through the next few months. Then they have to do a Chrysler-
type deal. With or without officially going bankrupt, they have 
to have concessions from everybody, including the suppliers, 
including the executives, including the workers. That is the 
only way they are getting out of this.
    And they have to push through restructuring. GM cannot 
explain why they still have so many brands and so many models. 
There are a lot of things that still don't make sense about the 
way they run their business. I don't think we can afford to 
have them collapse right now.
    Senator Nelson. And the problem is, the collapse of 
Chrysler, which I voted on years ago as a young Congressman, we 
had a Lee Iacocca who offered some leadership. There are no Lee 
Iacoccas today. As a matter of fact, the way that they have 
conducted themselves over the years makes me doubt anything 
that they are saying, so that when they say, well, we will go 
into Chapter 11, well, I really don't know that that is true.
    Dr. Zandi, do you know if that is true?
    Mr. Zandi. I think there is a very good chance they will go 
into bankruptcy.
    Senator Nelson. Between now and January?
    Mr. Zandi. Yes, a reasonable probability that they would, 
just looking at their cash and how quickly they are burning 
through their cash. But I don't know that I would vote--I don't 
think I would vote for this legislation. I think bankruptcy is 
the appropriate way to go and I think when they got into 
bankruptcy, if they were having trouble getting financing to 
have an orderly bankruptcy, which would be why they would go 
from a Chapter 11 to an effective 7, a liquidation, and that is 
when you would see the massive layoffs, it would be at that 
point that I think you might want to respond, either through 
some kind of guarantee to that financing or it may even be a 
place, and I don't know this for sure, but it may even be a 
place for the Federal Reserve to enter in. They may be able to 
provide some guarantees on that financing.
    Because I think you are right. If you give them the money, 
it would be very surprising to me if they don't come back for 
more money. And it would also be very surprising to me that 
they could go through the restructuring that they need to to 
become viable companies in the long run. The only way that is 
going to happen, I think, is if they go through the very 
painful bankruptcy process, because that is going to bring all 
of the stakeholders of these companies together, the creditors, 
the management, the shareholders, the unions, and they are all 
going to have to make those tough choices together, and I don't 
think those are choices that they are going to make outside of 
bankruptcy.
    Senator Nelson. Let me go back a few weeks ago when we were 
told--we were all on a conference call on our Democratic Caucus 
with Paulson and Bernanke. The Republican Caucus had done the 
same thing. They, those two, told us that there could be a 
complete economic meltdown by Monday, when this was a Friday 
conference call. Was that accurate? They said there could be 
unless we signaled that we were going to do something, which we 
did. Was that true?
    Mr. Zandi. In my view, that was a very significant risk and 
threat, that the financial system broadly was literally on the 
precipice of collapse, meaning that you would have a lot of 
major institutions failing and it would shut down the system 
completely. Yes, I think that was a reasonable threat, yes, 
risk.
    Mr. Johnson. You didn't say which Friday it was, but if I 
can guess which Friday it was----
    Senator Nelson. Yes, it was when all this stuff started.
    Mr. Taylor. It was September 19.
    Senator Nelson. Yes.
    Mr. Johnson. Then I think their assessment on that day was 
correct, and I think--remember how they got there, or remember 
that the week before, they had declined to save Lehman and many 
people, including myself, thought that was a very brave move 
and I thought they must have done the math very carefully and I 
presume that they knew that the consequences would not be 
severe, and I don't know what they knew and they didn't know, 
but 2 days later, they had to save AIG because of the way these 
things are interconnected and the way that the financial system 
is structured.
    That is the danger here, is that you can make a decision 
about not saving an entity that is very interconnected, has a 
huge amount of debt, and 2 days later, you have to put a lot 
more money into preventing the system from collapsing.
    Senator Nelson. And we are still putting money into the 
black hole of AIG.
    Mr. Johnson. And I think you will be for some time.
    Senator Nelson. Did you have a comment, Dr. Taylor, and 
then I will----
    Mr. Taylor. Yes. I remember September 19 very well. I 
wasn't, unfortunately, privy to the conference calls or however 
the meetings took place here so I can't really assess what 
Chairman Bernanke or Secretary Paulson said that day----
    Senator Nelson. Well, they said just what I said.
    Mr. Taylor. I do feel that a lot of the things that 
happened, if you look at the TED spread that the Chairman put 
up or look at the chart in my picture, a lot of that happened 
after September 19, OK, so it was after the decision to go 
ahead and do something. So I think, again, going back to 
Senator Murray's question, there are a lot of questions about 
how the response to that took place and the confidence problems 
that that response itself created. It was the whole month of--
the rest of September and October were the worst performance we 
have had in these markets in a long, long time.
    Senator Nelson. Thank you, Mr. Chairman.
    Chairman Conrad. Thank you, Senator Nelson.
    Let me just reclaim my time, then we will go to Senator 
Whitehouse.
    Senator Nelson. You were very gracious, by the way, to 
defer so that your other members of the committee can ask 
questions first. That should be noted for the record.
    Chairman Conrad. Thank you.
    I was on that call, as well, and I remember, in fact, I 
thought the whole conversation was so striking, I wrote it 
down. I can't remember if it was a Thursday or a Friday, and we 
were told, I remember very, very clearly, No. 1, if you don't 
act, the following things are going to happen. No. 2, No. 1, 
there will be massive additional failures. No. 2, the stock 
market will collapse. No. 3, the country will enter a deep and 
possibly protracted recession.
    And those statements were notable for their absence of 
hedge words. There was no, this might happen, this could 
happen. These were declarative statements. There will be 
massive additional failures. The stock market will collapse. 
And this nation will enter a deep and possibly protracted 
recession, and I took that down as they talked because I 
thought it was historically an important conversation.
    Let me go back to how did we get in this mess. I have been 
asked--I have just done 50 community forums in my State and I 
was asked, what is the root cause of all this? And I know so 
much of the talk is housing, and I know, Dr. Zandi, you are a 
housing specialist. My own reaction has been my belief is that 
at the root of all this in terms of government responsibility 
is simultaneously, we had a very loose monetary policy and a 
very loose fiscal policy. Unusual if you look at economic 
history to have a very loose fiscal policy, a very loose 
monetary policy simultaneously, and we understand the roots of 
it.
    Dr. Taylor, you referenced the monetary policy side of it. 
We had the Federal Reserve go to 1 percent on the discount rate 
because of 9/11 and stayed there a long time. Simultaneously, 
we were running massive budget deficits. My own belief is that 
created a seedbed for bubbles. And we didn't get just a housing 
bubble. We certainly got that, but we also got an energy 
bubble. We got a commodity bubble. I mean, wheat went to $18 a 
bushel. These things all happened and they happened together, 
and I believe they had a common genesis.
    Coupled with that was deregulation. Coupled with that was 
individuals taking on debt they had no business taking on. 
Coupled with that, lenders making loans they had no business 
making, no documentation loans, liars' loans as they call them. 
So we really cooked a stew.
    So on the one hand, my own belief is that created the 
climate for bubbles to collapse, and when bubbles collapse, 
there is a lot of economic wreckage.
    So how do we get out of it? Short-term, I believe you do 
have to have stimulus. You have to have lift to this economy. 
Only the Federal Government can do it because credit markets 
are still debilitated and you have very serious falling demand, 
aggregate demand. So you have to give lift.
    On the other hand, I also believe that if we don't send a 
signal and enter a process to get us back to fiscal 
responsibility, we will lose credibility and we will have the 
danger of even greater long-term damage.
    So my view is, and this is what I would like your reaction 
to and response to----
    Senator Gregg. Can we, Mr. Chairman, before they react, put 
that opening statement by yourself in bold letters and 
distribute it to our membership, because you just hit the nail 
on the head, in my opinion.
    Chairman Conrad. Well----
    Senator Nelson. Amen.
    Chairman Conrad. I hope I have hit the nail on the head. We 
will see. I think it is so important that at the time we do 
another stimulus package, we also enter into a process to 
restore fiscal discipline. I think this whole exercise is not 
going to have much credibility, and I liked, Dr. Taylor, very 
much some of the words that you applied here. Dr. Zandi, I 
liked very much your specific proposals. Dr. Johnson, I liked 
your bringing to our attention, remember, this is global. This 
is unlike what we have seen before.
    But how about that basic construct, that while we do 
stimulus, simultaneously we set in place a process to restore 
fiscal discipline? Dr. Zandi, I would just go right down the 
line.
    Mr. Zandi. Yes, I think that is vital, because on the 
immediate other side of the crisis will be the next crisis, and 
that is our long-term fiscal problems, that we will be right 
into the middle of Medicare, Medicaid, Social Security, and the 
math is very daunting. So there is not--I had thought before 
the crisis that we would have a bit of a window where we could 
put a process together and really think about this carefully. 
But unfortunately, that is not the cards we have been dealt. So 
we are going to have a trillion-dollar deficit this year. We 
are going to have a trillion-dollar deficit next year. Even if 
the economy recovers reasonably well, we are going to have very 
large budget deficits unless we make real changes.
    One thing you could do in the fiscal stimulus package with 
respect--I think all the spending, which is very important for 
near-term stimulus, should be temporary and it should be very 
clear that this is temporary. And I think that provides a very 
large bang for the buck. It creates a lot of jobs and that 
fills the hole left by the pull-back by consumers.
    On the tax side, I do think it might be worthwhile to make 
permanent the lower tax rates for current lower-middle-income 
households, and then for upper-income households, tell them 
exactly how their tax rates are going to rise and when they are 
going to rise. It probably shouldn't be 2011, and I am not sure 
what date it should be, 2012, 2013, and it phase in over a 4-
year period, but it becomes very clear, to go to Dr. Taylor's 
predictable, that you know exactly when those tax rates are 
going to rise and people can plan for it.
    And all of the tax dollars that are generated from that 
should go to deficit reduction, that it shouldn't be used for 
anything other than this is going to be a starting point for 
paying for those big deficits we know we are going to face in 
the out years after we get by this crisis.
    But I think as part of the stimulus, if you can do that, I 
think it creates predictability and it also is at least a good 
start to trying to address the long-term fiscal problems.
    Chairman Conrad. Dr. Johnson.
    Mr. Johnson. I agree very much with what you are saying and 
I would reinforce it in the following way. I think because of 
the global nature of the economy and our global financial 
system, you have to expect that there will be bubbles, again, 
either somewhere else or actually in the United States. The 
capital will come in, and this is a little bit about the 
capital flows we talk about through financing the trade 
deficit, but much more than that, it is the gross capital 
flows. Capital comes in and goes out every day. The amount of 
capital that can come in whenever it sees an attractive 
opportunity in the United States is enormous and you will not 
stop it.
    The Federal Reserve will not stop the bubbles, I am afraid, 
just that is the nature of these things. The regulators, even 
though I am sure you will end up with much stronger, better 
regulators, they also are not likely to prevent all asset 
bubbles from developing.
    So the only thing you have is the balance sheet, the 
government balance sheet, and the willingness to deploy it when 
necessary, but only when necessary, and that you only have the 
balance, you only have the credibility if you preserve it in 
the good times.
    So I am a little reluctant to commit to exactly the glide 
path Mr. Zandi laid out because I don't know how long this 
recession is going to be. I need a bit more time, 6 months at 
least, to see where this is going. But I think the general idea 
that you are expressing and that Professor Taylor was talking 
about is right, that you want to keep the debt at sustainable 
levels. You want to preserve your financial firepower for when 
you need it.
    And I think you don't need it very often, all right. You 
need it in the aftermath of the collapse of these massive, 
massive bubbles. I don't know if that is once every--I hope it 
is not more than once every 10 years. That is the point of 
fixing the regulation. I think you need it now, but you also 
need to address the fiscal consolidation absolutely as a 
priority going forward.
    Chairman Conrad. Dr. Taylor.
    Mr. Taylor. Yes, I would just add that one way to add to 
the credibility that you rightly want to convey would be as 
disciplined as possible in the package itself. In other words, 
look for things, and I gave some suggestions, where you can 
stimulate the economy without increasing the deficit. And the 
more you--or even stimulate the economy and reduce the deficit. 
So the more you can do to demonstrate currently fiscal 
discipline, the more credibility you are going to have for the 
future.
    With respect to the tax rates, I see no reason to do 
anything except to commit to keeping those rates from rising. 
They are going to rise in 2010 right now in the law. I think 
that has people worried. Again, it is more than 50 percent of 
small business income is going to get a tax increase by current 
law. It is more than 50 percent of capital gains income is 
going to get a tax increase. And that can hurt--it is already, 
in my view, hurting the economy.
    So you can stimulate this economy by somehow, and I agree, 
you have a political problem here, somehow committing that we 
are not going to raise those taxes. We are going to put them 
and make it as permanent as you can, plus do the things that I 
mentioned that President-Elect Obama suggested.
    Chairman Conrad. Senator Whitehouse.
    Senator Whitehouse. Thank you, Mr. Chairman.
    It appears that we all agree with the need for a 
significant stimulus and soon. It also appears that we all also 
agree that whatever stimulus we go forward with, it will 
increase the deficit, whether it is tax cuts that reduce our 
revenues and add to the deficit or additional spending that 
adds to our spending and adds to the deficit. That is the 
predicament that we have here. It seems to be the consensus 
that right now, the stimulus is more important than the deficit 
issue in an immediate sense, but the deficit debt problem is 
one that is very significant, I think probably safe to say even 
dangerous.
    In balancing the stimulus that we require against the 
deficit that we create, it strikes me that infrastructure has a 
characteristic that is particularly valuable here, and that is 
that you end up with an asset when you are done with the 
spending. And if you presume for a moment that the asset was 
necessary in the first place, that the bridge had to be built, 
that the water treatment plant needed to be improved, that the 
highway needed to be repaved, that the school needed to be 
cleaned up, then in many respects, if you are doing that 
spending now, it strikes me that you are really accelerating a 
future liability and moving a cash asset into a physical asset 
more than you are pure deficit spending, the way you would if 
you just sort of threw it out there.
    Do you agree? I see heads nodding. Do you agree that that 
is an attribute of infrastructure stimulus, that it has a kind 
of an inherent counterbalance or mitigating effect with respect 
to the debt and deficit problem that we have?
    Mr. Zandi. Yes, I strongly agree with that statement. The 
only rap against infrastructure spending is it takes, at least 
historical rap, is that it takes a long time to really have a 
benefit to the economy. You have to do the plans. You have to 
cut the checks. You have to hire the people. That could be a 
year or two from now.
    Senator Whitehouse. Let me jump in on you there on that, 
because an enormous--I am not expert in this and you all, of 
course, are, but an enormous amount of what I hear talked about 
in this context is confidence. And it strikes me that if a 
Rhode Island carpenter or a Rhode Island laborer or a Rhode 
Island plumber knows that a significant contract for a 
significant project just got let and he has a job there for the 
next two or 3 years as that project gets built, that 
individual's confidence and their appreciation and their sense 
of relief that they might make it through this thing improves 
day one, even if the actual funding doesn't come through in the 
future. Isn't there some value to that?
    Mr. Zandi. Yes, I think that is a very reasonable argument. 
I was just going to make the other argument that the problems 
that we are in are longer-term. They are not the next 6 months. 
They are not even 12 months. This seems to be a two-, 3-year 
problem----
    Senator Whitehouse. Yes.
    Mr. Zandi [continuing]. That even if the money gets into 
the economy in 2010, that is going to do us a lot of good.
    Senator Whitehouse. Yes.
    Mr. Zandi. The other thing to consider, just from a pure 
mathematical perspective, if the Treasury borrows at 4 percent, 
I think most estimates, academic estimates I have seen on the 
return on public investment, public infrastructure, is much 
greater than 4 percent. So it almost makes sense from just a 
purely investment perspective. So it gives you the stimulus, 
and as you say, you get an asset that yields a return that is 
higher than the cost of the financing.
    Senator Whitehouse. And let me add one more factor in 
there. What if we were to focus the infrastructure in areas 
that were of added societal benefit? I mean, one of the things 
when we think about infrastructure, we very often think about 
things that the Romans could build, you know, roads, bridges, 
aqueducts, water facilities. But we need to transition to a 
green economy. If we do so, there will be substantial rewards 
in terms of the reduction of our reliance on foreign oil and 
the hemorrhaging of our funds to oil-producing countries.
    If we invest in, for instance, a health information 
technology infrastructure, almost every expert agrees that that 
investment will help turn around the direction of health care 
costs. It may even reduce them substantially.
    Is it worth, in the context of the infrastructure, looking 
beyond Roman infrastructure and looking at other elements that 
may provide added both economic and social benefit, 
particularly in the environmental/energy and health care areas?
    Mr. Zandi. I think it is very reasonable. That was your 
point.
    Mr. Johnson. Yes. I think that that is a very good 
additional point to think about. Investment in new technology 
often overlaps with infrastructure. I think that is what you 
are saying. And I think this is a very important opportunity 
because we are facing a longer-term problem and not a 1-year 
problem. But I think we are agreeing it is a two-, three-, or 
4-year problem. Now is the right time to make some sensible 
decisions.
    I would stress the need to be careful. There are countries 
out there that are spending a lot of money on infrastructure, 
countries like Japan, that end up spending a lot of money on 
bridges to nowhere. I don't think U.S. is in that situation. I 
think we have some very pressing infrastructure needs in terms 
of upgrading and doing proper maintenance on existing Roman 
infrastructure, Roman-type infrastructure, and then investing 
further in that kind of more traditional infrastructure. I 
would support that as long as it is done carefully. And you do 
have time to do it now.
    Senator Whitehouse. Yes, and the premise of my question was 
that this was, in fact, necessary infrastructure and not 
bridges to nowhere.
    Mr. Johnson. Well, the other point I would emphasize is 
that low oil prices, low commodity prices actually give you 
good value for money in terms of infrastructure spending now. 
Building bridges and roads now is much cheaper because oil 
prices are low and they are going to be lower, and other input 
prices are going to be lower. So this is actually a very good 
time in terms of the global cycle to make those kinds of 
investments. You get good returns.
    Senator Whitehouse. Dr. Taylor, I am down to 43 seconds. Do 
you have anything to add? I am sorry, we have kind of run you--
--
    Mr. Taylor. Just very quickly, it seems to me that if you 
do believe that the decisions are being made correctly about 
what infrastructure we need and that there have been decisions 
made, bring those forward as much as you can, the ones that 
already are authorized or even appropriated. Bring those 
forward. That is, to me, the place to start. And it goes back 
to the idea of looking for ways to stimulate without adding to 
the deficit, which is, really, we need to be doing that as much 
as possible.
    And I just say, when you talk about public sector, jobs 
created by the public sector, don't forget the private sector 
is by far the biggest source of job creation, and anything you 
can do to help create jobs at private firms should be the 
highest priority.
    Senator Whitehouse. Understood. I appreciate the witnesses' 
answers and I appreciate the Chairman's courtesy, Mr. Chairman.
    Chairman Conrad. I thank you Senator.
    Senator Gregg, would you like----
    Senator Gregg. I want to thank the panel. It has been 
extraordinarily informative.
    Chairman Conrad. I first of all want to thank Senator Gregg 
very much for helping us organize this panel. I think this has 
been really exceptionally good. We have had different 
perspectives from each one of you, very valuable to the work of 
this committee and more broadly to the work of the Senate in 
the days ahead. I am certain we will be calling on you in the 
future. I hope that you are available to us. I think you have 
provided a lot of food for thought here, and I want to thank 
you all very, very much.
    The hearing is adjourned.
    [Whereupon, at 11:55 a.m., the committee was adjourned.]

                                 
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