[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]



 
                        MONETARY POLICY AND THE

                     STATE OF THE ECONOMY, PART II

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



                                HEARING

                               BEFORE THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                               __________

                           FEBRUARY 26, 2009

                               __________

       Printed for the use of the Committee on Financial Services

                            Serial No. 111-8


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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York         PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois          EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York         FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina       RON PAUL, Texas
GARY L. ACKERMAN, New York           DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California             WALTER B. JONES, Jr., North 
GREGORY W. MEEKS, New York               Carolina
DENNIS MOORE, Kansas                 JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts    GARY G. MILLER, California
RUBEN HINOJOSA, Texas                SHELLEY MOORE CAPITO, West 
WM. LACY CLAY, Missouri                  Virginia
CAROLYN McCARTHY, New York           JEB HENSARLING, Texas
JOE BACA, California                 SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts      J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina          JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia                 RANDY NEUGEBAUER, Texas
AL GREEN, Texas                      TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri            PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois            JOHN CAMPBELL, California
GWEN MOORE, Wisconsin                ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire         MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota             KENNY MARCHANT, Texas
RON KLEIN, Florida                   THADDEUS G. McCOTTER, Michigan
CHARLES A. WILSON, Ohio              KEVIN McCARTHY, California
ED PERLMUTTER, Colorado              BILL POSEY, Florida
JOE DONNELLY, Indiana                LYNN JENKINS, Kansas
BILL FOSTER, Illinois                CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana                ERIK PAULSEN, Minnesota
JACKIE SPEIER, California            LEONARD LANCE, New Jersey
TRAVIS CHILDERS, Mississippi
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
STEVE DRIEHAUS, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan
DAN MAFFEI, New York

        Jeanne M. Roslanowick, Staff Director and Chief Counsel


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    February 26, 2009............................................     1
Appendix:
    February 26, 2009............................................    39

                               WITNESSES
                      Thursday, February 26, 2009

Blinder, Dr. Alan S., Gordon S. Rentschler Memorial Professor of 
  Economics and Co-Director, Center for Economic Policy Studies, 
  Princeton University...........................................     2
Galbraith, Dr. James K., Lloyd M. Bentsen, Jr. Chair in 
  Government/Business Relations, Lyndon B. Johnson School of 
  Public Affairs, The University of Texas at Austin..............     7
Taylor, Dr. John B., Mary and Robert Raymond Professor of 
  Economics and Bowen H. and Janice Arthur McCoy Senior Fellow, 
  Hoover Institution, Stanford University........................     4

                                APPENDIX

Prepared statements:
    Blinder, Dr. Alan S..........................................    40
    Galbraith, Dr. James K.......................................    45
    Taylor, Dr. John B...........................................    56

              Additional Material Submitted for the Record

Posey, Hon. Bill:
    Additional information provided for the record by Dr. James 
      K. Galbraith...............................................    62


                        MONETARY POLICY AND THE


                     STATE OF THE ECONOMY, PART II

                              ----------                              


                      Thursday, February 26, 2009

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 10 a.m., in room 
2128, Rayburn House Office Building, Hon. Barney Frank 
[chairman of the committee] presiding.
    Members present: Representatives Frank, Waters, Watt, Moore 
of Kansas, McCarthy of New York, Baca, Miller of North 
Carolina, Scott, Green, Cleaver, Ellison, Perlmutter, Minnick, 
Adler, Kilroy, Driehaus, Kosmas; Bachus, Castle, Marchant, 
Posey, and Paulsen.
    The Chairman. The hearing will come to order. I am going to 
make a brief statement and get right to our witnesses. The 
Humphrey-Hawkins Act calls for semiannual hearings in which the 
Chairman of the Federal Reserve testifies on the state of the 
economy and the progress we are making in reaching the goals of 
low inflation and high employment. It seemed to me that while 
that obviously is very important, there ought to be some 
comment on it as well. That is probably substantive and 
something procedural. I have admired the work of Mr. Bernanke. 
I found a great deal to admire in the work of Mr. Greenspan. 
But I think we have suffered from excessive deference to the 
Federal Reserve. And the notion that these were oracular 
pronouncements not to be questioned is not healthy in a 
democracy.
    So we began having comments on the state of the economy 
right after the Federal Reserve testimony and on the testimony 
and what the Federal Reserve is doing. I think this is an 
important thing for us to continue, and that is this hearing 
today. With that, we are going to proceed right to our 
witnesses. The ranking member has graciously agreed with me 
that we don't need to do substantive statements now. There was 
a small enough membership. So I will announce that the 5-minute 
rule does not have to be strictly adhered to so that we can 
have some more rational conversation. And we will have perhaps 
8 or 9 minutes or so each. We will just tell members that we 
don't want to abuse it. But the 5-minute rule has always been 
one of the obstacles to intelligent dialogue, and we can relax 
it some.
    We will begin, in no particular order, just the way I am 
facing, with Dr. Alan Blinder, who is the Gordon S. Rentschler 
Memorial Professor of Economics at Princeton and Co-Director of 
the Center for Economic Policy Studies, as well as a former 
Vice Chair of the Board of Governors.
    Dr. Blinder.

STATEMENT OF DR. ALAN S. BLINDER, GORDON S. RENTSCHLER MEMORIAL 
   PROFESSOR OF ECONOMICS AND CO-DIRECTOR OF THE CENTER FOR 
         ECONOMIC POLICY STUDIES, PRINCETON UNIVERSITY

    Mr. Blinder. Thank you, Mr. Chairman, Ranking Member 
Bachus, and other members of the committee. I have read Mr. 
Bernanke's last two testimonies before this committee. I have 
not had the benefit of all the Q&A that went on. But based on 
that, I would like to say that I agree with the Chairman, that 
is the Federal Reserve Chairman, on almost every particular 
that he mentioned in those testimonies. Indeed, I feel the 
country is fortunate to have somebody as creative and 
thoughtful as Ben Bernanke sitting in that very difficult chair 
right now. Now to specifics. Regarding conventional monetary 
policy, I think the Fed got off to kind of a slow start when 
the crisis first broke in 2007. But it has more than made up 
for lost time.
    I was especially pleased and I applaud its decision to, 
first of all, reduce the Fed funds rate to zero in December, 
and then to state that it would continue to hold it there ``for 
some time,'' a vague period to be sure, but I would guess that 
probably means a year, maybe more. The Fed has not said that. 
Nevertheless, the economic outlook, as Chairman Bernanke said 
yesterday, is quite bleak.
    I would like to underscore two of the points that he made. 
Firstly, he suggested very strongly, I thought, that his own 
view of the economy was weaker than the FOMC consensus, and 
mine is too. The bottom end of that range is a 1\1/4\ percent 
decline during the four quarters of 2009. I think we will lose 
1\1/4\ percent in the first quarter alone. And I certainly 
don't expect the next three to be on a break even level. So I 
think we will probably do worse than that.
    Second, he emphasized that even that forecast was 
predicated, I think his words were, on the actions taken by the 
Fed, the Administration, and the Congress to try to get out of 
this mess. And I certainly agree with that. I would like to 
emphasize that I think it is important for congressional and 
public thinking to conceptualize this as fighting a two-front 
war. And as with most two-front wars, you have to win both 
fronts, otherwise you lose the war. One front is restoring 
aggregate demand. And that is what the stimulus and low 
interest rates and so on are about. The other front is reviving 
what is a pretty wounded, if not dead--dead in pieces, wounded 
elsewhere--financial system. And that is where TARP and the 
various bank bailouts and many of the extraordinary things that 
the Fed has done come into the picture.
    So let me turn to the unconventional monetary policy which, 
these days, is much more important. I would like to especially 
praise the Fed for moving away to the maximum possible extent--
which is not 100 percent--from going institution by institution 
with ad hoc rescue measures that while they solve an existing 
problem, don't take us even a baby step toward a solution, and 
also sometimes sow more confusion than clarity because there 
are no clear rules of who gets what when. And moving instead to 
a market by market approach, which the Fed has been doing since 
it intervened so heavily in the commercial paper market, where 
the objective is to restore a once moribund market to life. And 
it has already succeeded with CP.
    This approach has many advantages, including that it really 
gets to the root of the problem. It takes us some steps toward 
a cure and, importantly, is roughly speaking, though not 
literally, rules based. There are rules to the game. There are 
procedures that are set up for doing these things. I think this 
is a far better approach, and it is the one that the Fed is 
pursuing very aggressively these days. What it amounts to in 
the short term is the Fed providing the commodity that is now 
in shortest supply in the U.S. economy, which is the 
willingness to bear credit risk. Nobody really wants to do that 
these days except the Federal Reserve, and I guess you could 
say, the Treasury.
    Under normal circumstances, of course, we want the private 
sector, not the government, to be bearing and evaluating risk. 
And we will get back to that one day. But for now, with risk 
premia so wildly high, and some markets not working at all, the 
government is right to step in and provide the risk bearing 
services that nobody else seems willing to provide. That is the 
central idea, for example, behind the TALF, which is starting, 
I guess, any day now--I am not exactly sure when it is 
starting.
    I would like to contrast that, by the way, with another 
aspect of quantitative easing that has been much discussed, 
which is buying long-term Treasury debt. One could imagine a 
time and a place where that is an appropriate thing to do once 
you have beaten the short-term interest rate down to zero. But 
I don't see that this is the time or the place. I don't see 
what would really be accomplished by doing that. The problem is 
not that we have a yield curve that is too upward sloping and 
that is doing damage. In fact, that is helping the banks 
recapitalize themselves, so we really don't want to flatten it. 
And there is no problem with riskless borrowing by the U.S. 
Treasury, which is still cheap. We need to work on the risk 
premia that private borrowers have to pay above treasuries when 
they borrow. And that is when the TALF--
    The Chairman. The relaxation of the 5-minute rule will 
apply to all witnesses again. With the luxury of a fairly small 
membership, we can have some intelligent discussion 
unstructured by these time limits.
    Mr. Blinder. So did that mean I am cut off?
    The Chairman. No, you have some more time.
    Mr. Blinder. The last thing I would like to touch on, which 
has been much discussed in recent weeks, is nationalizing 
banks. I don't think the talk of doing that has been 
particularly helpful. You can see that in the markets. That 
said, I recognize the possibility that at the end of the road 
after plans A, B, C, and maybe D fail, if they do fail, we may 
be there. So we should be realistic about that. But I don't 
think we are there now. And as I say in my written testimony, 
my problems with rushing to nationalization can be summarized 
in four words, and those four words are, ``We are not Sweden.'' 
And by saying that, I mean a couple of things.
    The most important is that Sweden had just a handful of 
banks to manage. We have over 8,300 banks. This is not a 
trivial management task. And importantly, it is not at all 
clear where you draw the line. We can nationalize 2 banks, 4 
banks, 8 banks, 1,800 banks. There is a problem here because if 
you nationalize Bank A and Bank B has to go to market competing 
with Bank A, which has the power of the Federal Government 
behind it, you have put Bank B at a competitive disadvantage. 
You may drive Bank B into such a state of ill health that it 
has to be nationalized, too. And down the chain you go. As I 
say, we may have to get there at some point. But we are not 
there yet, and I hope we don't get there.
    A second problem is that once you start going down this 
list, you encounter what some people have called the ``slowest 
antelope in the herd'' problem as speculators set their eyes on 
who is likely to be the next nationalized bank, and then attack 
it with short selling and selling the CDS and so on.
    Thirdly, and here I would bow to the judgment of this 
committee, of course, but speaking as a citizen, the Swedes did 
their nationalization and denationalization with remarkably 
little political influence. It was a very technocratic 
operation. As a citizen, I am a little dubious that it would 
work that way in the United States of America. And let me leave 
it at that, Mr. Chairman.
    [The prepared statement of Dr. Blinder can be found on page 
40 of the appendix.]
    The Chairman. Thank you. I will just interject myself now 
to say I would hope people would keep in mind one very 
important fact. If you want something to be decided essentially 
nonpolitically do not ask 535 politicians to decide it. I think 
that is an endemic--not a bad thing either in our system, but 
something to be taken into account. Next, we have another 
frequent witness before the committee in a variety of 
capacities, Professor John Taylor is a Mary and Robert 
Professor of Economics and the Bowen H. and Janice Arthur McCoy 
Senior Fellow at the Hoover Institution, and a former, was a 
Deputy Secretary, John?
    Mr. Taylor. Under Secretary.
    The Chairman. Under Secretary of the Treasury for 
International Monetary Affairs, and so we are glad to have Dr. 
Taylor return.

   STATEMENT OF DR. JOHN B. TAYLOR, MARY AND ROBERT RAYMOND 
  PROFESSOR OF ECONOMICS AND BOWEN H. AND JANICE ARTHUR McCOY 
     SENIOR FELLOW, HOOVER INSTITUTION, STANFORD UNIVERSITY

    Mr. Taylor. Thank you, Mr. Chairman, and thank you, Ranking 
Member Bachus, for inviting me. I am going to focus my opening 
remarks, and in fact, much of my written testimony, on the 
extraordinary measures, part of the request to testify. I 
appreciate being invited here to do so. I think the first place 
to begin to think about these extraordinary measures is to look 
at the extraordinary increase in reserves at the Federal 
Reserve. And in my written testimony, I provided a chart. This 
chart, I think, is very useful, somewhat sobering, if you like, 
and it is worth a lot more than a thousand words. Reserves, of 
course, are the deposits that commercial banks hold at the 
Federal Reserve. It is a form of money. Economists call it 
central bank money or base money. It is really the foundation 
of the whole money supply in the United States economy. If you 
look at that chart, you can see that in September of last year, 
it started really exploding, I think is the word, and within a 
few months increased by 100 times from roughly $8 billion to 
over $800 billion. Again, these are the deposits that banks 
have on reserve at the Fed and can be converted into loans at 
an instant. This increase in reserves, I have both what has 
happened until now, it is a solid line in the picture, and also 
what might happen in the next few months based on current 
policy.
    But why has this increase in reserves taken place? Why has 
this huge expansion in the creation of money, if you like, 
taken place? Well, it is because the Fed has used these 
reserves, used the creation of this money to finance the 
purchases of securities in the private sector, whether it is 
mortgage-backed securities now, or whether it is the securities 
that resulted from the Bear Stearns intervention, or whether it 
is the AIG securities, or whether it is loans to AIG, or 
whether it is the new purchases that will take place under the 
TALF, or under the recent proposal from the Treasury to create 
an initiative for consumer and banking loans. In other words, 
just like any other organization, the Federal Reserve has to 
finance its purchases or its lending, and it finances them by 
creating money.
    It can finance them in other ways, but that is the main way 
it is doing it right now. If you look at that chart, you can 
see these reserves didn't increase for the first 13 months of 
the crisis. It was basically flat. And that was the way the Fed 
was controlling the interest rate. It started to explode when 
the Fed had to create money to provide these purchases. Now, 
where is this going in the future? I have estimated, based on 
the proposal from the Treasury and the existing proposals from 
the TALF, that we will have to increase a substantial amount 
more. And that is what that dotted line is trying to show you. 
It is really a continued explosion of this creation of money.
    So that is my assessment of where we are and where we are 
likely to go with respect to probably the best overall measure 
of the extraordinary measures that have taken place. I have a 
few questions and concerns and a couple of recommendations 
which I will mention in the time allotted to me now. One 
concern, and this, of course, is potentially inflationary. If 
the Federal Reserve doesn't bring those reserves back out of 
the system, at some point in time, it will cause inflation. 
That is a huge increase in the money supply, and it will 
translate into inflation at some point.
    People ask me about this all the time, it is on their 
minds, it is a concern. The Federal Reserve needs to address 
that concern. Right now, of course, we don't have an inflation 
problem. We seem to have the opposite. Inflation seems quite 
low. So it doesn't appear to be a problem now, and that is why 
the chairman has indicated he can withdraw these at the right 
time. I think the question for this committee and others to ask 
is, how will they be able to withdraw such a large amount of 
funds? That will mean selling these mortgage-backed securities, 
selling the consumer loans, etc., and it may be difficult 
politically.
    The second concern I have is, I think it raises questions 
about the independence of the Federal Reserve. The recent 
proposal from the Treasury, the consumer business loan 
initiative, seems to me very similar to the kind of things that 
the Treasury did with the Fed before the so-called accord of 
1950 when the Fed was given independence to conduct monetary 
policy. It is a request for the Federal Reserve to do things 
which it might not otherwise want to do or which might not be 
appropriate to do; that is to create this loan facility. The 
third concern I have is that not all of these measures are 
clearly productive. The statistical studies I have done, for 
example, show that the term auction facility has not alleviated 
the risk premia at all. And I think one of the reasons for that 
is that it is not to do with liquidity, it has to do with pure 
risk issues. Also, like my colleague Alan Blinder, a lot of the 
interventions have really not been rules based at all, but have 
really been ad hoc, and have caused more confusion, if you 
like, more uncertainty in the marketplace. I am not sure that 
we have improved the rules based aspect of this, but I 
certainly hope that he is right.
    And then finally, I think this raises issues about the 
future of the Federal Reserve. These actions, while viewed 
extraordinarily now, could, in principle, become part of the 
normal way of doing business at the Federal Reserve, and that 
would raise grave questions to me about the success that we 
have had for 20 years, if you like, with monetary policy 
focusing on the overall economy, stating interest rates 
according to inflation and output. But if it becomes an 
organization of selective credit provision, whether it is bad 
times or weak times or just not so good times, it will raise 
serious questions about the effectiveness of the institution.
    I have three recommendations: One, I think there could be 
more transparency about these operations. In this regard, I 
think the recent creation of a Web site by the Fed just this 
week, I think it began on Monday, is very good news. This is 
the first time people can get in and see exactly and understand 
this complication of their releases. And I congratulate this 
committee for encouraging that in the hearing on February 10th. 
I think more could be done. I have been urging that they 
publish the daily data. So, for example, we would know right 
now what the provision of reserves is for every day of last 
week and don't have to wait until the week is over on 
Wednesday. This is very important, and I have been urging it 
for years.
    I think the Fed should also set ranges for these reserves 
that I have showed you in my picture. Right now all they say in 
the minutes of the last meeting was that the balance sheet will 
be kept high. That seems to me too vague. What does that mean? 
Does it mean it is going to be at the top of my dotted line, or 
is it going to mean the top of the blue line? What does it mean 
that the reserves are going to be kept high? More specificity 
is needed.
    And finally I would recommend that each of these measures 
be subject to very serious evaluation studies, almost in real-
time, if you like. Perhaps by third parties, but certainly by 
the Federal Reserve, to show how and why and when they are 
working and when they are not, so that we can assess going 
forward whether this is a good set of measures to take. Thank 
you, Mr. Chairman.
    [The prepared statement of Dr. Taylor can be found on page 
56 of the appendix.]
    Mr. Watt. [presiding] Thank you very much for your 
testimony.
    Our next and final witness is Dr. James K. Galbraith, the 
Lloyd M. Bentsen, Jr. Chair in Government and Business 
Relations at Lyndon B. Johnson School of Public Affairs at the 
University of Texas at Austin. And you are recognized for your 
testimony.

  STATEMENT OF DR. JAMES K. GALBRAITH, LLOYD M. BENTSEN, JR. 
   CHAIR IN GOVERNMENT/BUSINESS RELATIONS, LYNDON B. JOHNSON 
  SCHOOL OF PUBLIC AFFAIRS, THE UNIVERSITY OF TEXAS AT AUSTIN

    Mr. Galbraith. Thank you very much, Mr. Chairman, Ranking 
Member Bachus, and members of the committee. It is again a very 
great privilege for me to appear today at these hearings, which 
as a member of the staff of this committee, I worked on from 
their inception in 1975. I wanted to make about six points that 
are really quite broad in their scope, but related to a central 
question or a central argument, which is that the crisis that 
we are passing through at the present time is qualitatively 
different from the economic downturns with which we have recent 
experience, and therefore requires us to adjust our thinking in 
certain important respects.
    The first one of these has to do with our treatment of the 
short-term outlook, that is to say of the baseline forecast, 
which is very similar as between the Congressional Budget 
Office's baseline and that offered by the Federal Open Market 
Committee, both of which show a mild to severe downturn this 
year followed by a turnaround and a period of growth beginning 
in 2010. I think this is substantially too optimistic.
    I think it is predicated on the mechanical inclusion in the 
model of a concept of a natural rate of unemployment toward 
which the economy will return by some unspecified process of 
labor market adjustment, and it is inconsistent with the likely 
path of liquidation of household debts which is very much 
underway at the present time. And the result of this is that I 
am very much in agreement with Alan Blinder that this year is 
likely to be substantially worse than the forecast.
    And even if there is a bottom at the end of this year and a 
slow rate of growth afterwards, that means that the ongoing 
rate of unemployment will be very high. I think Chairman 
Bernanke was at least minimally realistic about this, that we 
are talking about 9 percent with no short-term or medium-term 
recovery toward high employment in prospect. Automatic 
stabilizers and the recovery plan just passed will help, but 
they will not rectify that basic situation for a long period 
into the future.
    The second point is that in this situation, with a very, 
very strong liquidity trap in place, monetary policy has been 
very helpful in preventing a collapse of activity. And I, 
again, share Alan Blinder's high regard for the actions of the 
Federal Reserve in the crisis, and in particular of its 
effective measures in the commercial paper market.
    The fact remains that the ability of monetary policy to 
deal with the crisis going forward is relatively limited. We 
have had a policy of zero interest rates, we are going to have 
that policy for some time to come. It has not succeeded in 
restarting borrowing because the risk premia on private 
borrowers are too high, the profit expectations are too low, 
and the collateral is too weak.
    And in addition to that, the policy of zero interest rate 
has an adverse effect on the fiscal side because it depletes 
the incomes of those who have cash reserves, and that affects 
their spending power. This is particularly a problem for the 
elderly. Policy communication and selective support of asset 
classes are not useless, but they are weak reeds in this 
situation.
    The third point relates to the plan with respect to the 
banks. I think it is plainly an effort to buy time in the hope 
that a financial market or broader economic recovery will 
refloat some of the biggest banks from the troubles which they 
are presently in. And it is conceivable that it might do that, 
but it is also possible that the plans as presented might fail, 
which in that case, would compound the taxpayer losses which 
are already in view as the guarantees that may be offered on 
the troubled assets are finally called. I am pessimistic about 
this, mainly because I think that a proper due diligence on the 
underlying assets, particularly residential mortgage-backed 
securities--an inspection of the loan tapes, which, by and 
large, has not been done so far as I understand--would show 
them to be rather badly infested by misrepresentation and even 
outright fraud and therefore unmarketable in the private 
marketplace at essentially any price. And if that is the case, 
the sooner we come to grips with it the better, because it is 
only through coming to grips with it and writing off assets 
which cannot recover that we will put the banking system as a 
whole back on a footing where those banks which are in better 
shape will be able to lead the way toward a restoration of 
private credit markets.
    And here I do have a difference with Professor Blinder in 
that I think our experience would pass through receiverships in 
the workout of the savings and loan crisis, which was very 
extensive in the early 1990's, and more recently with such 
institutions as IndyMac, which is in such a receivership now, 
is reasonably good and reasonably free of political 
interference. This is indeed a job for the regulatory 
professionals. The only real question being whether they are 
sufficiently staffed up and prepared to handle that job with 
the scale of the institutions that we are talking about at the 
present moment.
    In any event, the banking plan is unlikely to restart 
credit effectively, because I believe it is based upon a 
misconception of what credit is. As a rhetorical, metaphorical 
matter we hear a lot about restarting credit flows. But credit 
is not a flow, it doesn't come from one place to another, the 
problem is not a blockage. Credit is a contract between two 
equal parties, the lender and the borrower. The borrowers have 
to have reasons to borrow--profits in prospect--and they need 
to be creditworthy, which is partly a problem of the underlying 
asset that they bring as collateral. The first condition 
requires strong growth of demand, and the second depends upon 
fixing the foreclosure crisis and the chronic oversupply of 
housing, at least as far as residential credit is concerned.
    The fourth point concerns the problem of demand: a compound 
of debt deflation in the household sector, and also I would 
argue of a terrific squeeze on the elderly, which is hitting 
them from all sides, affecting their home values, their equity 
holdings, and their interest income. The household income 
problem could be met by a substantially larger amount of tax 
relief working through the payroll tax--for example, a holiday 
on the payroll tax. The squeeze on the elderly could be met by 
raising Social Security benefits. And so from this point of 
view, I would suggest that as we go forward, we should stop 
thinking about the Social Security system as being a burden, 
but rather as potentially one of the more effective ways to 
restore effective demand in a crisis environment.
    Obviously, it is going to take time before we can decide 
for sure where we are, whether the optimistic forecasts that we 
are seeing are, in fact, accurate or, as I believe, too 
optimistic. But in 6 months or 9 months, we would be able to 
make a judgment on these matters, and we should, I think, at 
that point, be prepared to consider a substantially larger 
spectrum of aggressive interventions than we have seen so far.
    On the matter of housing, I want to say very briefly, as 
many members of this committee have said, it is important to 
stress the centrality of dealing with the foreclosure crisis to 
the ultimate resolution of these problems. In Texas, in the 
1980's, it took us 7 years to get through a housing crisis. 
This is one on a substantially larger scale. The problem has to 
do with the fact that homes don't disappear, they tend to stay 
as a drug on the market for quite a long period of time. 
Keeping people in their homes is about the only way one can 
effectively reduce the oversupply.
    That can be done either through resetting mortgages or by 
some mechanism that would convert to rentals and leave the 
former owners in a position to buy them back at an appropriate 
opportunity. But either way, that is a very big, arduous job, 
requiring a lot of judgments about individual cases. The sooner 
it is started, the sooner it can get finished. If it isn't 
started, this problem is simply going to hang on, as I think 
the fundamental obstacle to a recovery of the credit mechanism 
for quite a long time into the future.
    My broadest point is that we have been treating this crisis 
as an artifact of our economic projections--as something that 
is likely to be over within a couple of years, returning us to 
a situation of normality, in which we will be back dealing with 
more familiar problems. And I don't think that is an accurate 
perception. I think we will not return to normal. This is an 
historical event, like the Great Depression in that respect, 
which can only be dealt with by creating in effect a new world, 
a new economy, a future which will not resemble the 30 years of 
the recent past.
    So the future is something that we now have to build. It 
obviously is going to involve reconstructing our public 
infrastructure on a long-term basis. That is something that we 
should be planning to do now. And dealing with our energy and 
climate change problems, which are obviously essential to the 
sustainability of any economy that we may construct going 
forward. Thank you very much, Mr. Chairman.
    [The prepared statement of Dr. Galbraith can be found on 
page 45 of the appendix.]
    The Chairman. Thank you, gentlemen. Let me turn to a couple 
of the points that Professor Galbraith made. I was particularly 
pleased to see you include the language about Social Security, 
the notion that a long-term budget approach should be to focus 
on Social Security. There are two problems for me. One is not 
directly relevant here, except in the broader sense. And that 
is it puts way too much attention on Social Security and way 
too little attention on the military budget. We are in the 
process now, I believe, of being asked to commit, at least this 
is a policy from the previous Administration, several billion 
dollars in tax revenue to protect the Czech Republic from Iran.
    I am not a regular reader of all the fatwahs, but I am not 
aware that the Iranians have threatened the Czech Republic to 
the point where we need to put billions of dollars in to defend 
them. I was pleased to see the President refer to the need to 
cut unneeded Cold War weapons there. On the other hand, though, 
on the Social Security issue, and you mentioned, Professor 
Galbraith, obviously Medicare and Social Security, and I do 
think, and I know you agree, there is a separation.
    Because it is not that Medicare does not deserve attention, 
but it deserves that attention in the framework of a broader 
health care policy. So let us start with that one. There is a 
point I want to emphasize. You talk about, for example, the 
advantage of dropping the Medicare age. What would the impact 
be, for instance on the automobile industry if we were to do 
that. We are going to be confronted with a need to provide some 
aid to keep the automobile industry, the American automobile 
companies, functional. What would the impact be of the drop in 
the Medicare age, for example, and other related health care 
issues?
    Mr. Galbraith. Well, I think in a great many industries, 
including the auto industry, that are in crisis it would have 
two effects. It would relieve the industry of health care 
burdens for older workers, but it would also give a fair number 
of workers who have the resources to retire but are unwilling 
to do so because they don't want to lose health care coverage a 
chance to take that opportunity. And so it would enable the 
industries to downsize and restructure in a much more orderly 
way.
    The Chairman. I confess I have been thinking about the 
first of those, which was taking the burden off. Because if we 
could somehow get the burden of retiree and even current worker 
health care off the backs of GM, it would go a long way toward 
selling it. But the incentive to retire or the removal of 
disincentive against retirement is also very important. On 
Social Security, I will ask you, because I don't think this 
gets enough attention, to elaborate on the argument that Social 
Security is in a crisis and if we do not do some drastic 
changes, including some reduction of benefits, that we will 
default on our promise to people who plan to retire in 30 
years. What is your response?
    Mr. Galbraith. The U.S. Government need not default on any 
of its obligations. The issue for us going forward is how do we 
provide an adequate retirement for an elderly population which 
is growing. And we have of course had a balanced approach to 
that with a certain element of private asset building. The real 
crisis is there. Social Security exists as a way of buffering 
the elderly against that problem and should be seen as a tool 
toward that purpose. There is no reason, in other words, to 
treat Social Security as somehow a kind of financial albatross 
to the Federal Government. It is, after all, the one part of 
the Federal Government which has its own revenue stream 
assigned to it. That is not true of the Pentagon budget, not 
even true of the net interest, yet nobody believes that the 
Federal Government is going to fail to provide for national 
security or fail to pay the interest bill.
    The Chairman. Let me ask all, and I will start with Dr. 
Blinder, one of the things we are told we have to worry about 
is that U.S. Treasuries will lose their appeal as an investment 
vehicle and that we will be severely disadvantaged. I will say 
that I see no evidence of that happening now. When I think 
about whether or not people can buy U.S. Treasuries in the 
future I am reminded of a figure. I often quote the 20th 
Century philosopher, Henny Youngman, whose response to the 
question, ``How is your wife?'', was ``Compared to what?'' And 
I think when we are told people are not going to invest in U.S. 
Treasuries, the question is, compared to what? Are we in danger 
if we don't make some drastic changes in public policy, let me 
start with you Dr. Blinder, of seeing a drastic decrease in 
people's willingness to buy U.S. Treasury paper?
    Mr. Blinder. I think in the near term, we are in no danger 
for exactly the Henny Youngman principle. Look what has 
happened recently. As we all know, this mess, this worldwide 
mess, started here, right here in the good old U.S.A., and the 
whole world is trying to buy U.S. Treasury bonds, so we are 
really the safe haven. That said, as you all know, we are now 
looking at budget deficits of 10, 12, and 14 percent of GDP. I 
think that is the right thing to do in the current 
circumstances. We are in terrible need of stimulus, both from 
the monetary and from the fiscal side, given the state of the 
economy. But there is a limit to how many years you can keep 
that up.
    And so I think raising the deficit was really the right 
thing to do, even though a lot of commentators were scratching 
their heads about the security contradiction, of the 
Administration talking about long-run budget control at the 
same time that it was ballooning the budget deficit in the 
short-term. You are talking about long-run budget control over 
a period of a decade. But it is not a contradiction, it is the 
right thing to do. I do have some fear--I wouldn't put a very 
high probability on it--but some fear that, if the view became 
dominant in the marketplace that the U.S. Government was going 
to run a 10 percent of GPD deficit more or less indefinitely, 
then I think we have to worry about interest rates and the 
financial market's attitude toward the Treasury debt.
    Mr. Taylor. I am certainly concerned about making U.S. 
Treasuries attractive for the long-term. I think that we have 
to be vigilant about it, quite frankly, Mr. Chairman. And to 
the extent that we are going to run deficits like we are this 
year as far as the eye can see, and some people worry about 
that, it is going to be hard quite frankly to get people to buy 
these Treasuries for the long-term. I think it should be a 
direct concern. And by the way, I think there is an 
inconsistency about currently increasing the deficit by a large 
amount and simultaneously saying it is not going to be for 
long.
    I think it is one case, here is what I am doing, and the 
other case is, here is what I am saying I am going to do. And 
it raises questions about consistency which we should be 
concerned about. On Social Security, I would say it just seems 
to me this is something that could be addressed. It is more of 
a political than an economic issue. I think we would show a 
great deal of leadership and confidence in government if we 
could come to grips with that sooner rather than later. There 
are more difficult problems, the ones you are asking about. But 
why not take that on at this point. It is a long-term issue, 
but it is a very important one to show the government can 
address it.
    The Chairman. I would just add that I understand the 
potential inconsistency. I very much agree with Dr. Blinder; we 
often do things to respond to an emergency that we don't 
necessarily want to do in the future. But it does seem to me 
that was one argument for, as we did the economic recovery, or 
we do similar things if we had to do more, I would have done 
more, to try to do one-shot things, that contrary to some 
arguments to the extent that you are doing things that have an 
immediate impact but don't build in a repetitive pattern that 
you alleviate some of that inconsistency. Professor Galbraith.
    Mr. Galbraith. Just on the question of sustainability. I 
don't think there could, in principle, come a time when people 
would not buy Treasury securities. The issue is at what price, 
and specifically whether we are looking at an inflation problem 
down the road, which again is what Professor Taylor mentioned 
as a concern. And I think that is a concern, an appropriate 
concern for another day. I don't think it is likely in the 
present environment or for the foreseeable future, simply 
because there is so much excess capacity, because there is debt 
deflation at home, and because the rush into the dollar is 
actually driving down our costs.
    The Chairman. The gentleman from Alabama.
    Mr. Bachus. Thank you, Mr. Chairman. I want to say for the 
record that my wife is wonderful, so that is how I would answer 
the question as a married man.
    The Chairman. Well, I will listen carefully. You never 
know. Some day for me, so I will store that up.
    Mr. Bachus. I could never get away with that answer. Thank 
you, Mr. Chairman. I spoke to the women in the housing and 
finance group here in Washington about 6 weeks ago, and this is 
something I said, and I may want your comment on this. I said 
that the critical failure in the government's response to the 
financial crisis is that we are waiting for events to overtake 
us and then reacting in an environment of crisis. The essence 
of the problem is the core breakdown in decisionmaking. We 
postpone decisions until we are overwhelmed by the problems of 
the day.
    And I describe this as kind of a reactionary fire brigade 
mentality. Dr. Blinder, you, I think, called it an ad hoc 
piecemeal approach. And some of the problems I see with that is 
sometimes we cross the proverbial Rubicon. I mean, we are 
rushing to fix a problem and we go beyond points where normally 
we would sit back and say what are the long-term consequences 
of this. I would just like your comments.
    Mr. Blinder. I think there is some truth to that, both to 
the worry and to the criticism. That said, as these really 
stunning--and, I would say it is not too strong a word to say, 
unbelievable--events have unfolded since the pot blew in August 
2007, it would have required superhuman foresight to see what 
was coming. I mean, even just to take something concrete, I 
think it would have been extraordinary, even in early 
September, to foresee what was going to happen with AIG on 
around September 16th or 17th or whenever.
    Mr. Bachus. Of 2008.
    Mr. Blinder. 2008, yes. It would have been next to 
impossible. What happened on those days took my breath away. 
Now, if you raise the point, well, wasn't it very ad hoc? Yes 
it was. Might it have been done better? Probably.
    Mr. Bachus. Let me say this: I agree with you. In August-
September, I don't think anyone had any idea of the magnitude 
of this. I think by October-November we did, but generally 
there is still not a comprehensive approach, although the Term 
Asset-Backed Securities Loan Facility of $1 trillion may 
actually be an example of something that is more comprehensive. 
Now, let me say this. You asked about it. They are still going 
through the regs and rules for TALF and it is not out there 
yet.
    Mr. Blinder. So I agree with what I think you just 
implicitly said. I think the TALF is a rules-based, 
transparent, systemic, and systematic approach to restoring the 
viability of some of these credit markets. And that is what is 
warranted. I mean, I think that if I look at the pantheon of 
things that have been done, my favorite things start with the 
commercial paper facility and then lead into the TALF. I think 
those are real steps towards a cure. I think I said in the 
testimony that I was praising the Fed since October.
    You could look back to that September-October and even 
before, and I think find things to criticize. I see a turning 
point, although Chairman Bernanke didn't make a big deal of it 
at the time, as coming when they did the commercial paper 
facility. That was sort of the first step. And now it 
continues. And while there is no guarantee that it is going to 
work, but the early returns, I would say, are good. The 
commercial paper market now is very much back on its feet. When 
they started, there was only one buyer, the Federal Reserve. 
That is not true anymore. The Fannie and Freddie MBS market, 
because of the Fed's purchases, are looking much, much better 
than it did before. And that has had spill-overs to mortgage 
rates and so forth.
    Mr. Bachus. Let me ask Dr. Taylor and Dr. Galbraith, too.
    Mr. Taylor. Let me comment on this, because I think what 
you say has a great deal of truth, Mr. Bachus. In fact, I have 
been studying this crisis for a while and decided just about 
the time that Alan Blinder said things turned to just write up, 
if you like, my assessment of: first, what caused it; second, 
what caused it to last so long because it did flare up in 
August of 2007; and third, why did it worsen so much last fall 
in the panic of last fall? In each case, I look at the kind of 
things you are saying, that the government basically didn't get 
it right. They got off track from some policies that were 
working really well in much of the 1980's and 1990's.
    First, the monetary excesses which led to this boom and 
bust in housing, in terms of lengthening or prolonging it, if 
you like, misdiagnosing it and then reacting in ways which 
didn't do any good. By the way, I would include the stimulus 
package of last year, the stimulus of 2008, which sent checks 
to people and didn't do much good, or I would include the term 
auction facility in that.
    And then finally, last fall, the very ad hoc reaction which 
confused people. The testimonies were taken very negatively and 
caused a lot of fear. And so in all those cases, it seems to me 
you are right. So the government actions and interventions led 
to where we are, and I hope things are getting better. I still 
don't think a lot of, I think there could be more rules, if you 
like, with respect to how the Fed is operating.
    I don't like very vague statements about the total amount 
of reserves they are creating. I think that is going to lead to 
even more concerns. And it is good if they are being more 
specific about their initiatives. I worry about the Treasury's 
request for a whole new initiative for consumer and business 
lending. I don't know where that came from. I am sure I know 
the board has agreed to it. But still that raises questions 
about the nature of responses and the same kind of things you 
raise in your point.
    Mr. Bachus. Mr. Galbraith.
    Mr. Galbraith. A modest difference with my colleagues. I 
think it was possible and that there were people who had a 
reasonable understanding of how dangerous the situation was 
becoming as the subprime lending expanded, and as the housing 
bubble expanded. And there were people in the spring of 2008 
who were close enough to the markets and had the right sort of 
models who had a pretty good sense of how bad the crisis could 
get.
    And if I could submit for the record a memorandum that was 
based upon a seminar in June, which I think got the scale and 
character of the subsequent events approximately right. The 
problem here is that when you have a small group of people who 
do appreciate it, they are generally unable to project that to 
the larger policy-making community. And that is not by 
accident. It is simply that people who are very specialized and 
who see these things generally don't have the same reach and 
influence that people who are less close to the events may 
have.
    Cassandra was always right, but no one believed her. There 
were reasons for that. And so in this situation we are still, I 
think, underestimating the gravity of the crisis and still in a 
situation where time will have to pass before the policy-making 
community is willing to move at the scale that is going to be 
required actually to deal with events.
    Mr. Watt. [presiding] I fear that the number of people on 
the committee who show up will continue to grow. And while we 
gave pretty much latitude for the opening statements, that we 
probably ought to return to an element of discipline in the 
marketplace here. So if you all don't mind, we will try to 
return to the 5-minute parameters. And it may be necessary 
under those circumstances for you all to submit responses in 
writing to some of the questions that get asked because 
otherwise we are not going to be able to get to everybody. I 
will try to apply that discipline to myself since I am the next 
person to be recognized. Dr. Taylor, let me clarify the reserve 
chart that you have given us to this extent. The Fed--is this 
the same thing that yesterday Chairman Bernanke was describing 
as assets, or does the Fed itself have some kind of reserve. Is 
this a dollar-for-dollar assessment, or is this something, a 
reserve similar to what we would think of as reserves in a 
bank, for example?
    Mr. Taylor. These are the liabilities that correspond to 
the assets. He was talking about the assets, the commercial 
paper or the mortgage-backed securities that they were 
purchasing.
    Mr. Watt. But it is a dollar for dollar? If he has valued 
the liabilities and he has valued the assets correctly, it is a 
dollar for dollar. So in that sense, it is not 10 percent of 
the liabilities, it is an actual offset figure, is that right?
    Mr. Taylor. It is really as they are created. In other 
words, if you were to go out and buy a mortgage-backed 
security, you would have to pay for it with something. Well, so 
does the Fed. The Fed has to pay for it. What they can do is 
pay for it, either by actually printing the money, or in this 
electronic age, crediting their accounts to a commercial bank 
so the bank has a deposit. So that is how they pay for it. They 
have to pay for it, you know.
    Mr. Watt. So in that sense, it is a dollar for dollar.
    Mr. Taylor. As it is created, yes.
    Mr. Watt. I just wanted to be clear on that. Dr. Galbraith, 
your merger of this question of Social Security with the 
situation that we are in actually raises something that another 
academic with whom I was having a conversation last weekend 
suggested. And I will put it out here, although he has promised 
to send me something in writing that kind of fleshes it out. I 
may be misstating it. But his idea was that since we have now 
nationalized, federalized, taken over Fannie and Freddie, at 
some point their assets will be fairly substantial we hope, and 
that short-term we--longer term, I will deal with it longer 
term, when those assets become more and more valuable over time 
it would be a wonderful source of revenue for Social Security.
    And I guess the corollary of that is shorter term, we ought 
to be thinking about merging these entities to use some of the 
Social Security surplus to get us through this transition until 
housing stabilizes and those assets come back. Is that even 
remotely akin to what you are suggesting here, and can you give 
me your reaction to that notion.
    Mr. Galbraith. There are many ways to mobilize resources 
and put them to work. You mentioned the Social Security surplus 
at present, which is to say payroll tax revenues greatly in 
excess of benefits currently being paid. There is really no 
reason for that. I think that is a target of opportunity. If 
you wanted to provide tax relief to working families and cut 
the payroll tax, you will not harm the finances of the U.S. 
Government by doing so, but you will very effectively put cash 
in the pockets of working families who can use it to pay their 
mortgages and their car debt. And that is the useful way to 
think about this.
    On the other side, Social Security benefits are a great 
engine, very widely received in the elderly population. Putting 
more resources, putting more money into those accounts is a 
very effective way to hold that population a little bit 
harmless from all of the other losses that they are presently 
suffering.
    Mr. Watt. Do either of the other witnesses have a quick 
response to that notion? Dr. Blinder.
    Mr. Blinder. We are doing that in a sense. When you look at 
the unified budget, which is what you generally focus on in 
terms of measuring the deficit, the Social Security surplus 
part is in there and the non-Social Security part would have an 
even larger deficit. So it is all put into one pot. And you 
could say that we are now using it for something, because we 
are in a big overall deficit position. On the asset sales that 
you mentioned, if, and we all have our fingers crossed, we can 
sell some of these things at a profit some years down the road, 
that will again go into the Federal kitty, just as it is going 
out of the Federal kitty now. But, importantly, that is a one-
shot event. If you think about closing a long-run actuarial gap 
in Social Security, that is just a one-shot event and not a 
permanent flow.
    Mr. Watt. I am going to impose the discipline on myself 
first so nobody else thinks I am being unfair to them. Mr. 
Castle is recognized for 5 minutes.
    Mr. Castle. Thank you, Mr. Chairman. Dr. Taylor, you had 
three recommendations, and I took brief rights, I may not have 
gotten this quite right. But the last one was something to the 
effect of serious evaluation studies by the Federal Reserve, 
that is. Is that evaluation studies of how their programs are 
actually working in terms of the advances they have made to the 
various institutions on the outside, is that what that means 
basically?
    Mr. Taylor. Yes, that is basically what I have in mind. And 
it is very important to public policy always to evaluate the 
effectiveness. I think in this case it is particularly 
important because it actually, as Mr. Bachus was saying, there 
is a tendency to keep reacting and proposing new things. So my 
observation early on, for example, was that the term ``auction 
facility'' the Fed created, at least with the express purpose 
of reducing the spreads in the money markets, bringing LIBOR 
down, didn't really do that. And there are now multiple, 10 or 
15 more, programs that need to be evaluated in the same way. 
And it is important, too, because if these reserves, money is 
going to be brought down from my chart, it could be some of 
these things could be ended if they are not being effective. So 
the TALF is still very large, there are still large loans to 
foreign central banks. So those might be some of the ways this 
money could be brought in. But in order to know that, you have 
to see which are effective and basically just make some cost 
benefit analysis. I think that is very important.
    Mr. Castle. I tend to agree with you on that. And Dr. 
Blinder, you think the Federal Reserve has done a good job, 
maybe since October, but has done a good job on all of this?
    Mr. Blinder. [no verbal response]
    Mr. Castle. Dr. Taylor, had those three recommendations. 
One, I think we probably all agree on. But more transparency in 
the Web site is a good start he said in that area. And then 
setting the range of reserves and then the serious evaluation 
studies. Do you consider those, even if the Fed is doing a good 
job, do you think those to be good improvements or would you 
critique any of them or not recommend any of them?
    Mr. Blinder. I would be 100 percent behind 2 of them, the 
transparency and the evaluation. We should always be evaluating 
what we do, especially when we are stepping into unchartered 
waters. I might add that, when you step into unchartered 
waters, the evaluation is not a trivial task because you have 
no model for it. You have done this 6 times before. The one 
that I would not endorse by any means is trying to establish 
some sort of target for the Fed's balance sheet. I think the 
conceptualization of the target that Chairman Bernanke has now, 
which is not at all numerical, is exactly the right one: in 
this crisis, do whatever it takes. If it is another $500 
billion, it is another $500 billion. If it is not, it is not.
    We will get market signals as the markets return to 
normalcy and we learn that banks no longer want to hold these 
enormous amounts of excess reserves. That is what they are. 
That whole gap that you see in Dr. Taylor's charts are excess 
reserves. Deposits haven't skyrocketed like that. These are 
mostly excess reserves. That is the symptom of a banking system 
cowering in catatonic fear. The one thing you know is safe are 
reserves at the Fed. So they want those reserves now. As Dr. 
Taylor says, when the system normalizes, they will not want 
reserves like that. And if you leave them out there, you are 
going to have a lot of inflation. But the Fed will see that 
happening right away. I just don't see that it makes any sense, 
nor do I see how the Fed could actually execute it, if the Fed 
was to follow a suggestion to post a target for its balance 
sheet.
    Mr. Castle. Thank you. Dr. Galbraith, the mortgage bailout 
program, bank bailout program, to some degree was sold to us as 
troubled asset relief purchases, and of course, it didn't 
unfold that way as it turned out. Do you believe that we need 
to have some program that is going to go after those toxic 
assets and relieve the banks that we saw? I continue to read 
that banks just can't return to normalcy without that somehow 
being undertaken. Where should we be going with that issue?
    Mr. Galbraith. This is an area where evaluation would also 
be very useful, because we are, I think, working with a mental 
model of these assets as marketable assets which are being 
priced at below something that may be their long-term 
reasonable value, and I am not at all sure that that is 
correct. I suspect that a private investor who is charged with 
doing real due diligence on these assets, who looked at the 
underlying loan tapes, would find that there was just not, in 
the nature of a subprime security, not any way that you could 
in good faith tell your client that you had information on the 
basis of which to value them.
    And if that problem is really pervasive, as we have some 
indication it is, as some sampling of the files suggests it may 
be, then the sooner these assets are fully assessed and dealt 
with, written down, and the institutions who held them 
evaluated it on that basis, the more quickly we will get 
through the crisis, however big it is.
    If we make the other bet that these assets will recover or 
can recover and are proven wrong, then we are going basically 
the Japanese route of forbearance and holding the institutions 
afloat, but without any real prospect that they will return to 
a normal behavior as you have just heard the other witnesses 
describe.
    Mr. Castle. Thank you.
    Thank you, Mr. Chairman.
    Mr. Watt. The gentlelady from California.
    Ms. Waters. Thank you very much, Mr. Chairman.
    I think that the hearings that we have been holding, the 
bank CEOs that we have been bringing in and others, and, of 
course, Mr. Bernanke's testimony here yesterday is helping us 
to get a better handle on what we can do public policywise to 
help during this crisis.
    I have a question that I would like to ask of any of our 
witnesses here today, because some of the actions that we have 
taken are not quite understandable. We have a number of small 
and community and regional banks that were invested in Fannie 
and Freddie. They bought their preferred stock because it was 
so safe. And when we took over, those small regional minority 
banks lost all of their preferred stock investment. Now some of 
them, I suppose, will stand in line and beg for some TARP 
money. But it seems to me that somehow that preferred stock 
that they had in our government enterprise should have been 
protected and not taken from them. Are you aware of this? Do 
you have any thoughts on that? I can start with Mr. Blinder.
    Mr. Blinder. Yes, I am aware of it, though I hope you won't 
quiz me on the exact details for any bank. I think it would be 
appropriate for the bank regulatory agencies to make special 
allowances--and I think they are. It is a version of regulatory 
forbearance because after all, as you said, Congresswoman, the 
Federal Government did this to them. They were holding this 
stuff, this preferred stock. It was thought to be a safe asset. 
It was treated as a safe asset by the regulatory authorities. 
They liked banks having this on their balance sheets. And then 
it was a Federal intervention that devalued the asset.
    I think it is appropriate bank regulatory policy, and I am 
pretty sure the regulatory agencies agree with this, to treat 
that differently than when poor banking decisions lead you to 
balance sheet troubles. So I would treat it mostly--not so much 
in the way you suggested, but it is not so very different--with 
regulatory forbearance. That is, this is a piece of your 
capital structure that we, the national government, impaired. 
You didn't do anything. So we are going to give you a lot of 
time to get back to your proper capital position.
    Ms. Waters. Dr. Taylor?
    Mr. Taylor. I basically would say I agree and just add that 
I think it is an example of what we were talking about earlier, 
how so often what has happened here is there have been some 
government interventions that have had these unintended 
consequences. And, of course, it is not just these banks that 
have held that; a lot of other private citizens and people have 
as well. So it is an example to be careful before you do these 
kinds of things. But otherwise, I would agree.
    Ms. Waters. Well, this was brought to our attention, and I 
think our Chairman, Mr. Frank, dealt with it, but we did not 
deal with it in terms of getting our regulators to take a look 
at this. Chairman Frank, I just brought up the fact that for 
all of those regional banks, small banks, minority banks that 
had preferred stock in Fannie--and when our government-
sponsored enterprises were taken over, we allowed that 
preferred stock to be taken over from those banks. And now 
those banks, I suppose, have to get in line behind the big 
banks and try to beg for some TARP money. And it just seems to 
me there ought to be some kind of policy that would at least 
give some thought to how you give some protection to those 
regional banks rather than have them come back in line over in 
the TARP line and say, lend me some money or give me some money 
so that I can stay in business.
    Dr. Galbraith, what do you think about that? And do you 
think--well, let me just say this: I had a private citizen come 
yesterday, and the private citizen said his whole family, he, 
his mother and all, they also have preferred stock in Fannie, 
and that just a few days before the government took over the 
stock, Paulson and others were saying that it was not in 
trouble--I don't know where these statements were made. I am 
going to look for them--that there was no contact with them. 
There was no indication that these government-sponsored 
enterprises were in trouble, that they were going to be taken 
over. And they still to this day have not been contacted, even 
though they have lost everything.
    Dr. Galbraith, what do you think about the regional banks 
that lost all of their money, which put them in danger? And 
also private citizens who were not warned, have not been 
contacted, had no idea? This was a government--as you say--
intervention.
    Mr. Galbraith. Well, I am inclined to rely on Alan 
Blinder's authority on this matter as well, and to say that I 
think the position that he articulated is a very reasonable 
one. There are probably precedents from the era of the savings 
and loan crisis which are worth looking into for dealing with 
problems of this type. But I would have to look at the record 
just to give you a better, more complete answer than that.
    Ms. Waters. Thank you.
    The Chairman. Mr. Posey, the gentleman from Florida.
    Mr. Posey. Thank you very much, Mr. Chairman.
    A question for Mr. Blinder. You talked about the 
nationalization of banks in Sweden. What year was that?
    Mr. Blinder. I think about 1991. It was in the early 
1990's.
    Mr. Posey. Did they formally nationalize them or just 
control them like we are?
    Mr. Blinder. My understanding is they formally nationalized 
some banks. And then to get around the problem that I was 
mentioning about Bank A and Bank B, they subsidized the other 
banks so they wouldn't be forced to fail.
    Mr. Posey. Did it seem to solve their problems?
    Mr. Blinder. Yes, it did. I think they came out of that 
banking crisis, which was extremely deep and severe, quite 
quickly and reprivatized the banks that they had nationalized. 
That is why Sweden is held up as sort of the poster child for 
successful nationalization and then denationalization.
    Mr. Posey. Yes. Some of us think that is just a buzzword.
    Do you know what their corporate income tax rate was when 
they nationalized?
    Mr. Blinder. I am sorry; I do not.
    Mr. Posey. I think it was about 45 percent.
    Do you know what it is now?
    Mr. Blinder. I do not.
    Mr. Posey. The nationalization didn't improve GDP. It 
didn't solve any problems. You know, it created an illusion, 
kind of like we are. I think their corporate income tax rate is 
probably 10 or 12 points lower than ours now. I am not sure. I 
think it was to focus on increasing their GDP, on creating 
jobs, real jobs that solved their problem. And nationalization 
got credit for it, nationalization of the banks.
    Dr. Taylor, what happens if the foreign investors who are 
absorbed in their own domestic economic challenges decide it is 
not in their best interest to purchase our Treasury notes?
    Mr. Taylor. I am sorry, not in their best interest to what?
    Mr. Posey. Purchase our Treasury notes.
    Mr. Taylor. That is the kind of thing you should worry 
about, if not today, then in the future. That is why I say it 
is so important to think about the things like Social Security, 
to think about the fact that we have a large deficit coming in 
now. We should try to get that down. We probably shouldn't have 
had such a big one this year, it has been my view. So those are 
exactly the reasons I would be concerned. And you have a lot of 
people who have been buying our debt for a long time. Some 
people have been worrying about it for a long time, and I think 
we should worry about it. We think it is important to do 
everything we can to make sure that people have confidence in 
the United States and in our fiscal responsibilities and our 
intention to support our debt no matter what.
    Mr. Posey. The same thing with our secondary market 
securities?
    Mr. Taylor. Which securities?
    Mr. Posey. Mortgage notes, our other paper.
    Mr. Taylor. Well, that is anything that we are, of course, 
involved in now, absolutely. But from the point of view of 
individuals, yes. I mean, the idea is to do everything you can 
to be creditworthy, to maintain your creditworthiness and get 
back to basic principles.
    Mr. Posey. Do you see any way a cramdown could do anything 
but devastate that secondary market?
    Mr. Taylor. No. I think anything--these cramdowns or any of 
these special interventions to the extent that you always have 
to think about what that is going to do to future borrowing, 
and to get out of this you have to make lenders want to borrow. 
If they are worried about cramdowns, or they are worried about 
interventions by judges that are ad hoc, it is going to make 
them less willing to lend and not more willing to lend.
    Mr. Posey. I wouldn't think anybody would buy anything that 
the government can simply devalue tomorrow at an arbitrary, 
capricious rate.
    Dr. Galbraith, in your written testimony, you indicated 
that the arguments that Social Security and Medicare are a 
problem are mistaken dangers. Did I read that correctly?
    Mr. Galbraith. Yes. That is right.
    Mr. Posey. I just want to make sure. I thought they gave me 
a paper that had some errors in it possibly.
    You said the programs cannot go bankrupt any more than the 
Government of the United States can go bankrupt, which it 
cannot.
    Mr. Galbraith. Right.
    Mr. Posey. Would you describe bankruptcy for me?
    Mr. Galbraith. Bankruptcy is a term that applies to a 
private corporation which comes to the protection of a court 
when it is unable to pay its debts. And since the U.S. 
Government cannot get into that position, essentially it cannot 
go bankrupt in that sense.
    Mr. Posey. So you believe the U.S. Government can have no 
limit whatsoever on its liabilities and minimal assets, and 
that wouldn't be a problem?
    Mr. Galbraith. Well, there are two senses in which one can 
talk about the word ``limit.''
    Mr. Posey. Let us talk about infinite. Infinite debt means 
no assets.
    Mr. Galbraith. The question is whether there is an 
operational limit. The answer to that is no. Whether there are 
limits of prudence, the answer to that is yes. Obviously the 
government can spend too much or tax too little, and can 
conduct its affairs in ways that are economically unwise. The 
consequence for that--and this gets back again to the colloquy 
that you were having with Professor Taylor--is not that people 
would refuse to buy our--
    Mr. Posey. Because of time, could you give us a written 
answer to that?
    Mr. Galbraith. Sure. But in one word, the problem is 
inflation.
    The Chairman. The gentleman will get a written answer. I 
agree with what my colleague from North Carolina said: We don't 
have the luxury of time. We have more interests.
    The gentleman from Kansas.
    Mr. Moore of Kansas. Dr. Blinder, in these difficult times 
when our constituents are anxious and frustrated with the state 
of our economy, I believe transparency is very, very important 
to communicate what actions we are taking to protect the U.S. 
taxpayers. An issue that came up at our Subcommittee on 
Oversight and Investigations hearing on Tuesday of this week 
was a potential oversight blindspot that may exist at the Fed. 
In particular, I have a concern that there may be a lack of 
sufficient oversight of TARP funds that pass through the Fed.
    I understand the Fed's TALF program will use TARP funds to 
lend up to $1 trillion to thaw the consumer lending markets. 
The Acting Comptroller General, who testified as a witness 
before our hearing on Tuesday, expressed concern about GAO's 
ability to oversee TARP funds passing through the Fed.
    I believe independence for the Federal Reserve is very 
important, but when the Fed invokes emergency powers through 
section 13(3) of the Federal Reserve Act and greatly expands 
its balance sheet, should Congress consider adding emergency 
oversight authorities to better track the use of funds?
    Before you respond, let me give you one example. The 
congressional oversight panel at this hearing led by one of the 
witnesses, Professor Elizabeth Warren, testified at our hearing 
Tuesday that the Treasury Department overpaid an estimated $78 
billion in its first round of investments into troubled banks. 
Professor Warren testified that, ``There may be good policy 
reasons for overpaying, but without clearly delineated reasons, 
we can't know that. Without strong oversight protections of the 
Treasury's use of TARP funds, we would not have learned that.''
    So my question is, does this argue for having emergency 
oversight authorities at the Fed when they use emergency powers 
and taxpayers' money?
    Mr. Blinder. It is a hard question. Let me say a couple of 
things that I know and then speculate.
    The TARP legislation that was passed by the Congress has 
multiple layers of oversight. The original infamous 2\1/2\ 
pager, which you will remember, didn't.
    Mr. Moore of Kansas. Yes, sir.
    Mr. Blinder. But what was eventually passed had tremendous 
amounts of oversight, some of which you just cited. My answer 
to the question, should it have heavy, heavy oversight, is yes. 
And I think it has that.
    The problem that you were alluding to, Congressman, is that 
the early expenditures of the TARP--I don't want to say all of 
the first $350 billion, but a lot of it--seems to have been 
poorly documented, and poorly designed, by the way--poorly 
documented, poorly accounted for, etc. Some of this, I think, 
you can forgive because they were in a hurry. But I think a lot 
of it you can't forgive, that it just wasn't done the way it 
should have been.
    Regarding the Federal Reserve, this committee and the 
corresponding committee in the Senate have oversight over the 
Federal Reserve. Chairman Bernanke and others come down to 
testify frequently. It is not obvious to me you need any 
further authority. Do you have oversight authority over the 
Fed? It is reporting to you now, I think--you will correct me 
if I am wrong--bimonthly on the section 13(3) actions, the 
extraordinary actions. And, of course, should the Congress 
reach the judgment that is not frequently enough, it can 
request that the Fed report more frequently than that. It is 
not obvious to me that any further powers are necessary to get 
done what you quite correctly want to get done.
    Mr. Moore of Kansas. Thank you.
    I would ask the same question if any of the other witnesses 
have additional comments.
    Mr. Taylor. I think that the mere fact that you are asking 
this question about whether you need more powers over the Fed 
is an example of my concerns that the Fed moving in this 
direction raises tensions about their independence. I really 
think the independence of the Federal Reserve has been very 
important and why we have basically had good policy for 20 
years. And there is a concern about these actions, losing some 
of that. So I would say, whatever you do, you know, exercise 
the longer term and the shorter term, maybe find other ways to 
consider accountability, if you like.
    Mr. Moore of Kansas. Well, as I said, I agree with that, 
but I am concerned if, in fact, the Treasury Department 
overpaid an estimated $78 billion in its first round of 
investments in troubled banks, we need to address that 
situation and make sure that doesn't happen.
    Dr. Galbraith.
    Mr. Galbraith. I spent several years, Congressman, sitting 
behind where you are sitting now. So I very much take the view 
that while the Federal Reserve is properly independent of the 
President and the Executive Branch, it is in no sense 
independent of the Congress. It is a creature of the Congress, 
an artifact of the Federal Reserve Act, and you do have the 
authority and the responsibility to exercise appropriate 
authority over the central bank.
    Mr. Moore of Kansas. Thank you to our witnesses.
    And thank you, Mr. Chairman.
    The Chairman. The gentleman from Minnesota is next, I 
believe. Yes, the gentleman from Minnesota.
    Mr. Paulsen. Thank you, Mr. Chairman.
    Given that our economic system is generally designed to be 
self-correcting, what recommendations do you have to minimize 
the other sectors right now that are being protected somewhat, 
the financial sector, the auto sector where we have had some 
discussion, these organizations that are essentially too big to 
fail? Do not some of these sectors need to have some correction 
applied to them and through market forces? And are the 
interventionist policies of the government that are being 
discussed now, are they the answer to sorting out or downsizing 
or rightsizing these sectors? Can you provide some perspective 
on that?
    Mr. Blinder. I don't think they are the answer, 
Congressman. But I would appeal to analogies that have been 
made by Chairman Bernanke and others that when the house is 
burning, you put out the fire, and you don't worry about the 
fire code. But you do worry about the fire code later.
    And I take your point about the fire code. I think we need 
very large changes and multiple changes in the regulatory 
system. There is a very long list of things to do which I won't 
try to go over now. But just to take one point that you raised, 
about too big to fail, I think one of the things--once we have 
this problem, ``solved''--well, it will never be literally 
solved, but once we are back to something like normalcy, we are 
going to be facing a financial system that has some giants in 
it that we never contemplated, the results of these forced 
shotgun marriages. And that really raises the too big to fail 
doctrine to an entirely different level.
    I think we are going to have to think about whether--later, 
not now--we are going to have to think about whether one 
approach to too big to fail is to make it very difficult for 
organizations to actually get that big. That is a very large 
departure from what we have done in the past. But I think it 
should be on the congressional agenda--but again, for the 
future, not for today.
    Mr. Paulsen. I would be happy to hear some of the other 
comments you would have. In that sense, are we better off 
having one insurance company or 100 different ones to spread 
out the risks so that we don't have quite the too big to fail 
concepts, one AIG, for instance, which we could effectively 
nationalize some of these institutions?
    Mr. Blinder. Yes, that is a good example. I think it was a 
tremendous mistake, made largely by the private sector really 
and not by the State, to have so much of the CDS risk 
concentrated in one company. I mean, we should have never 
gotten to a position like that.
    Mr. Paulsen. Mr. Taylor.
    Mr. Taylor. With respect to the self-correcting mechanisms, 
I sometimes think that government should have more faith in 
these self-correcting mechanisms. And in some sense, it screws 
them up, if you will, by intervening too much and too often.
    Quite frankly, one way to deal with the too-big-to-fail 
problem is to establish a credibility about sometimes saying 
no. It seems to me more often it is going to help if you can 
establish the credibility of an institution--while this may not 
be too-big-to-fail, and we will have other ways to deal with 
the impacts if your institution fails--and therefore not just 
create the expectation that government will always be there.
    As I mentioned before, and I study this crisis, it seems to 
me so often it is the government actions that have prolonged 
and worsened things, not the market. And the presumption, of 
course, these days is the government will be able to fix it. 
But I think dealing with too-big-to-fail through better market 
mechanisms, better resolution mechanisms is important, but 
ultimately it is going to come down to the credibility of the 
policymakers occasionally in the right circumstances with a lot 
of notice saying no.
    Mr. Galbraith. I would say most living systems are self-
adjusting. Animals get sick. They normally recover, and 
sometimes medicine helps them recover a little more quickly. 
But there are circumstances when they won't or when it will 
require really exceptional interventions to prevent the animal 
from perishing, to make recovery possible. That is when you 
need the intervention to be conducted with the greatest skill. 
You are never entirely sure that it is going to succeed. And 
the trick is distinguishing between this normal condition when 
recovery is to be expected at some point, and the exceptional 
condition when you are at risk that recovery may not happen.
    That is the problem that I see facing the system at the 
moment. It is being subjected to such severe stress, failure 
both of vital internal institutions, the banks, and external 
shocks, that we have to think really quite freshly about what 
the appropriate degree of policy intervention is.
    Mr. Paulsen. I yield back.
    Mr. Watt. [presiding] Thank you.
    We have been called for a series of two votes, but we want 
to get one additional question in first. Mrs. McCarthy is 
recognized.
    Mrs. McCarthy of New York. Thank you. Thank you for the 
hearing.
    Dr. Galbraith, I was going through your testimony, and one 
of the sections was about keeping people in their homes. That 
is the area that I am really concerned about. This morning's 
unemployment numbers came out. They were not good. Also we have 
another 500,000 people without a job. And you came up with two 
ideas, and you also were looking at a Warren Mosler, who I 
don't know, coming up with an idea. Could you go over some of 
the ideas that you had? Certainly Dr. Blinder and Dr. Taylor, 
if you have ideas, too.
    Mr. Galbraith. My thinking on this is informed to a large 
extent by what was done by the Home Owners' Loan Corporation in 
the 1930's. What the government did at that time was basically 
to take over it and discount the troubled mortgages, 
renegotiate them, and manage the housing so that people could 
stay in their homes. And they managed that for about a million 
homeowners during a 15- or 20-year period.
    Mr. Mosler's idea, which I think is an interesting one 
because it would minimize the amount of institutional 
disruption, is that you allow people to go through the 
foreclosure process, but then have the government pick up the 
house at the lowest of the appraisal price or the mortgage 
balance and allow the previous owner, if they want to, to live 
in the house on a fair-market rental basis with an option to 
repurchase when conditions improve. At that point, you are 
essentially rebooting the market mechanism for housing, but 
also trying to the maximum extent to keep homes occupied so 
that you stop the cycle of blight, which is going to keep 
driving down home values and also damaging the quality of life 
in neighborhoods for an indefinite period into the future 
otherwise.
    Mrs. McCarthy of New York. Do either of you have a--
    Mr. Taylor. Just very briefly. I think that one of the 
problems here is the disconnect between the servicers and the 
investors. And in a normal circumstance, a bank would be able 
to work it out with the customers. They know them in the 
neighborhood, or know the nature of the loan. So dealing with 
that is an issue. And one suggestion is to give some incentive 
to the servicers. I think that is actually being considered now 
by the Administration.
    But I think another thing would be to work on transparency. 
A lot of the original loan documents are not made available to 
the investors. And it is complicated because of the securities 
being packaged. But if the servicers would provide more 
information about that original loan documentation, then you 
would be able to distinguish between if you like the 
creditworthy borrowers originally and the ones that, you know, 
was a no doc loan, if you like. And I think more maybe even 
require transparency, but certainly more transparency is needed 
there.
    Mr. Blinder. Very briefly, Congresswoman, first of all, the 
Administration's program has a number of things in it that 
would go to exactly what you are talking about--keeping people 
out of foreclosures--including the approach to the servicers to 
free them of the legal liability, or at least to minimize it, 
that they now have.
    Secondly, this committee and the corresponding committee in 
the Senate originated the HOPE for Homeowners program. As you 
will remember, to get that bill passed, the parameters were set 
so that the budget cost was practically nothing. That program 
could be liberalized and made to work. The problem basically 
was that it was put in a budgetary straitjacket that would cost 
nothing. You don't get too much when it costs nothing. But the 
parameters could easily be changed--I am talking about what it 
costs for the FHA guarantee, the eligibility requirements and 
so on--by an amendment to that Act.
    Thirdly, and finally to the specific point you made, 
foreclosure mitigation won't be the whole thing, because the 
sad truth is some people got into ownership who never should 
have. They always should have been renters, and some of these 
mortgages are just not salvageable. So some ideas of converting 
owned homes to rental units, I think, are going to be a logical 
part of the ultimate solution.
    Mrs. McCarthy of New York. My concern is, especially at the 
fair-market price--I come from New York. Fair-market price to 
rent an apartment is almost a mortgage payment, where, you 
know, you go south or you go to the Midwest, apartments are 
much--certainly you get a lot more for your money, I will put 
it that way. That is my concern. Because with all these people 
who are going to be going out on unemployment, they have been 
paying their mortgage. Most of them probably have a 30-year 
mortgage. And yet they are going to probably find several 
months down the road that they don't have the money to pay for 
their mortgage, and that is what I am concerned about.
    These are good people, good risks, hard-working people. 
Hopefully, we can work something out to protect those people. 
What are we going to have, several hundred thousand people 
homeless? I mean, one way or the other, we are going to have to 
pay for them.
    Thank you. I yield back.
    Mr. Watt. The gentlelady's time has expired.
    We are in the process of having two votes, so the committee 
will stand in recess until immediately after the votes. If 
anybody wants to ask questions, please come back immediately, 
and we will try to get back.
    The Chairman. These may be the only votes today, I think. 
So people will be able to come back undisturbed, if the members 
of the panel can stay. Thank you.
    [Recess]
    Mr. Scott. [presiding] The hearing will resume. We have 
members coming in from voting. But in all fairness to our 
guests, we want to get started. We are very considerate of your 
time. We certainly appreciate you all coming.
    It is my time next for comments, and I will start mine and 
then proceed with other members as they come in.
    First of all, I want to thank Dr. Galbraith for his help to 
me personally. When we were faced with the early response in 
this fall and October, and we were putting together the first 
effort to recover and help our financial institutions, we were 
very concerned that there was nothing in that package, as some 
of you may remember, for what we considered the crucible of the 
problem, which was this extraordinary slide in home prices, the 
real estate market, and certainly due to outstanding mortgages 
and people unable to pay for mortgages, and so we needed to 
address that. And there was a number of us who were very 
concerned about that. The leadership stopped the process. We 
couldn't get the votes there because we didn't have enough on 
foreclosure. We were assigned to go get a plan together to 
address that, and we put a call in to Dr. Galbraith down at the 
University of Texas, and we were responded with that. And for 
that, Dr. Galbraith, we are very, very grateful to you.
    I want to start my questioning off because I think we need 
to start right there on the whole issue of housing, home 
foreclosures, which is at the root of this problem, much of 
what we put forward in that first effort. The key word is 
remember, Dr. Galbraith, that we both secured that initial 
package was on, making sure there was sustainability, that we 
could come up with a way to sustain individuals in their homes, 
and we had put forward the effort of patterning it after the 
HCL, the housing corporate loan corporation back during the 
Depression. We were able to incorporate some of those. We laid 
the foundation for it. And I am very pleased that on the other 
issue of the moratoriums where we don't get success, we did get 
success last week when we had the leadership of the banking 
community before us. We asked that they put a moratorium on 
home foreclosures until we get this in place, and they did. So 
we have the pieces in place.
    Dr. Galbraith, let me start with you on this question. Are 
we doing enough right now in the home foreclosure area? If we 
are not, what do you recommend that we need to do?
    Mr. Galbraith. Well, first of all, Mr. Chairman, thank you 
for your remarks just now. I think that the housing plan that 
the Administration has announced is a very positive step, and I 
think that the step that you just mentioned, having gotten the 
commitment of the major banks to a moratorium on foreclosures, 
is another very positive step.
    At the same time, the force that drives down housing prices 
is very inexorable. It is a massive downdraft on the whole 
credit system. And, of course, it has spread far beyond the 
subprime adjustable-rate mortgages to prime credits, and put a 
great many people in the position where from an economic 
standpoint, they are better off walking on their debts. And 
many, many more will do that.
    So I think we are at the moment where we should be pulling 
all these pieces together and taking a comprehensive approach. 
And the trouble with a comprehensive approach is that, while 
there may be some way to do this without essentially checking 
on individual cases and sorting the hopeless cases from the 
sustainable ones and the honest cases from the fraudulent 
ones--but if there is a way of doing that, I certainly haven't 
come up with it. And I think that we need to adjust our ideas 
to the scale of this operation. As I have said before, the HOLC 
took 20,000 people to handle 1 million mortgages in the 1930's. 
It is a very big job and it will require a lot of effort.
    Mr. Scott. Do you believe, Dr. Galbraith, that given the 
fact that we have $75 billion in this new program that the 
President has put forward, do you believe that is sufficient 
going forward, especially given the fact that it is estimated 
that in the next 2 to 3 years, there will be 9 million families 
in homes that default to foreclosure?
    Mr. Galbraith. Well, my understanding is that the thrust of 
the President's program is to protect people who are shy of the 
threshold of foreclosure at this moment, so that people whose 
homes are too deeply underwater are not eligible for, for 
example, the extension on the limits of mortgage renegotiation. 
And so my answer to that is there is still a very large hole in 
the housing problem which has not been dealt with, and it has 
probably not been dealt with because it is pretty much the most 
difficult problem. But it is still, in my view, essential if 
one is going to shorten the period during which this excess 
supply of housing is acting as a drug on the market and driving 
down the asset prices.
    Mr. Scott. If I may, I know my time is short, on the final 
point of my question, before I turn it over to one of my 
colleagues, to each of you, to give--if you could each of you 
give a very succinct answer to this question. We are moving on 
the housing front stabilization. Do we have our hands around 
the stability of our banking system? It concerns me that we 
have some debate over an issue of what we call--various people 
call it various things. But let us just deal with it as it is 
being called, and that is nationalization of our bank. How does 
each of you feel about the extent of the government's role in 
the banking industry? And are we close to that?
    And specifically, I would like for to you comment to the 
Citigroup situation. I asked Fed Chairman Bernanke that 
yesterday, and as is the case with so many of our Fed Chairmen, 
out of great respect, your answer sometimes comes back to you 
in a way that even confuses the question that you put to get a 
clarity of the answer as to whether or not we are approaching 
nationalization.
    But I would like to submit you to the point on the front 
page of The Wall Street Journal from yesterday. The CEO of 
Citigroup made the comment that he was in touch with Federal 
regulators and Federal officials from the Fed, and the essence 
of the article was that he was asking, in effect, that they not 
make decisions regarding their senior management. That tells me 
right there that he who makes a decision about who stays and 
who doesn't stay in terms of running the bank is in charge of 
that bank.
    So I want to get an answer from each of you. Are we at that 
point of some form of nationalization? Is that what we are 
approaching? And the other thing, is it necessary in order to 
deal with the scope and the magnitude of the problem, I think, 
vis-a-vis what they did in a couple of our European countries? 
I will start with you, Dr. Blinder.
    Mr. Blinder. Well, very briefly, as I said in my testimony, 
I don't think we are at that point yet. I am hopeful that we 
won't get to that point. But I think we need to understand that 
we might get to that point, because one thing we have learned 
about this financial crisis is it keeps getting worse than we 
think. So I wouldn't rule it out. But I certainly wouldn't be 
eager to go there now for reasons that I outlined in the 
testimony.
    As to Citi and others, I wouldn't pull out Citi for special 
treatment other than it seems to be first in line in its 
talking to the government. I think--and there are many--I think 
the right approach is the so-called good bank/bad bank 
solution. Now, that is not a well-defined--there are many 
variants of good bank/bad bank. I point out that the first time 
this was actually used--I think it was in 1990 with Mellon. 
They did it themselves. It was a purely private operation 
without the government.
    Now, I think the holes in some of these balance sheets that 
we have now, especially if we mark the true market valuations, 
is so large that to make a good bank/bad bank solution to any 
of these large banks work now, public moneys would be needed. 
When you hive off the bad stuff into the bad bank, you start 
with an institution that has negative net worth. You have to 
bring that at least up to zero, which is a small number. And I 
don't think the private capital, frankly, in this state of the 
economy is going to be there, so it will need public funds. But 
that is not nationalization.
    Mr. Taylor. Just very briefly. I listened to part of 
Chairman Bernanke's testimony the last couple of days, and I 
thought it was actually very helpful in clarifying that 
nationalization was not as commonly defined--at least not the 
way he would go about this. And I think the markets responded 
positively to that. Again, it is talking more about these 
large, complex institutions, because the FDIC frequently has 
taken over banks before they are sold off. So I thought his 
testimony was--maybe your standards here are too high, Mr. 
Chairman, but I thought it was very clear about that.
    And also with respect to the Wall Street Journal article 
about Citi, it seems to me that is reflecting something very 
common today. The government is involved. It causes all sorts 
of issues, political. The government is not good at managing 
private firms, in my view. The New York Fed is now managing 
AIG. Look what is happening there. So it is something that we 
should be staying away from as much as we possibly can. I am 
not surprised when I read the tension in The Wall Street 
Journal. I am sure it is true, and in many of the other 
institutions.
    Finally, I think now the most important thing is to try to 
get some clarity about what our policy is, and people are 
really clamoring, if you like, for clarity. So whatever it is, 
let us get on with it. And I think that will be probably the 
most important thing to do to get the stability you are asking 
about.
    Mr. Scott. Thank you, sir.
    Dr. Galbraith.
    Mr. Galbraith. I take a different view. When a bank is 
troubled, when it is threatened with insolvency, let alone when 
it is, in fact, insolvent, the Federal Government, the 
regulatory authorities have the responsibility to intervene to 
protect the depositors who are insured by the FDIC, and the 
FDIC is charged with doing that under the law. A pass-through 
receivership is the standard mechanism for the resolution of 
these problems. In American law and practice, it was done 
scores of times with savings and loans in the late 1980's or 
early 1980's. It is being done with banks as we speak. It was 
done under the Bush Administration with IndyMac. It involves 
protecting the depositors, putting in new management, and the 
reason you want to do that, is that new management is required. 
It can be recruited from the banking industry, but it is 
required in order to get a clean audit so that you can 
effectively separate the bad assets from the good ones, and so 
that the public knows the extent of the hole in capital and the 
extent of potential liabilities to the insurance fund.
    And then you go about arranging for the bank to be 
reorganized for sale. It may be merged, it may be sold, it may 
be broken up and sold. It may require infusion of public money. 
But until you have gotten a clear assumption of responsibility 
and a clear accounting, you won't know exactly what to do. The 
FDIC has experience with this, is in general competent to do 
it, although obviously doing it with very large banks is a 
daunting challenge. And that should be their call and their 
responsibility free, I believe, of political interference from 
the Congress, for that matter, or from the Treasury Department. 
It really is a professional judgment. That is why I don't like 
the term ``nationalization,'' which implies a political 
decision. This really seems to me to be a professional 
regulatory responsibility.
    Mr. Scott. Very good. Thank you, all three of you. Very 
interesting.
    Mr. Green of Texas.
    Mr. Green. Thank you, Mr. Chairman.
    Friends, I will move as quickly as possible because I have 
a number of areas that I would like to cover. And I would like 
to employ the voir dire system wherein I ask you to simply 
raise your hands so I get a quick indication of where you 
stand. So let me start and thank you for coming.
    Let us start with Chairman Bernanke indicating yesterday 
that we were on the verge of what may have been considered a 
financial meltdown. Do you agree that we were on the verge of a 
financial meltdown last year? If so, would you just kindly 
extend a hand into the air? This will be helpful.
    I have one disagreement. Mr. Taylor, could you as tersely 
as possible indicate why you do not think we were not on the 
verge of a financial meltdown?
    Mr. Taylor. On the verge is so hard to describe. I didn't 
hear his testimony, didn't know the context. We are in a very 
serious financial crisis.
    Mr. Green. Let me ask you this: Last year were we in the 
midst of a very serious financial crisis? Is your answer yes or 
no?
    Mr. Taylor. Well, it worsened--
    Mr. Green. I borrowed your language, by the way.
    Mr. Taylor. Yes.
    Mr. Green. Given that we were in this serious financial 
crisis, do you agree that the TARP funds were spent such that 
they had a positive impact on the financial crisis? If you 
could kindly extend a hand into the air, it would be helpful. 
The TARP funds, were they spent such that they had a positive 
impact on the financial crisis, the possible meltdown?
    Mr. Blinder. Are we allowed to say positive but poorly 
spent?
    Mr. Green. Poorly spent, but positive impact. Okay. Mr. 
Taylor.
    Mr. Taylor. I didn't see a positive impact.
    Mr. Green. Positive impact, sir?
    Mr. Galbraith. I am right on the fence on that one, as Alan 
is. You can point to specific positive effects, but in general 
it could have been done much better.
    Mr. Green. Let me follow up with you. If you concur that we 
were on the verge of a financial meltdown, and I assume that 
you do not conclude that currently we are on the verge of a 
financial meltdown--
    Mr. Galbraith. No. My view actually is that the meltdown 
had already occurred.
    Mr. Green. That we had already gone through the financial 
meltdown?
    Mr. Galbraith. The problem here was the extraordinary 
explosion of these toxic assets, and that problem still sits in 
the banking system. The core of the system has melted. It is a 
question of whether the containment structure is--
    Mr. Green. All right. Let me move on with a few other 
things.
    The concept of the bad bank. Dr. Blinder, you indicated 
that you would employ this. We did not hear specifically from 
the other panelists as to where you stand. Mr. Taylor, where do 
you stand on it, please?
    Mr. Taylor. I would not like to go in that direction.
    Mr. Green. You would not. Okay.
    Dr. Galbraith.
    Mr. Galbraith. The good bank/bad bank?
    Mr. Green. Yes, sir.
    Mr. Galbraith. I think one--the reorganization of the banks 
should be the responsibility of the FDIC.
    Mr. Green. Is your answer no? I have other questions, that 
is why.
    Mr. Galbraith. They will isolate the bad assets.
    Mr. Green. Is your answer yes or no? I am not sure. 
Sometimes when people finish, I do not know whether they said 
yes or no.
    Mr. Galbraith. Well, I am not entirely sure I have 
understood the thrust of the question.
    Mr. Green. The thrust of the question is this: As the 
concept exists now, good bad/bad bank, the bad bank to take in 
assets, acquire these assets, these toxic assets, is that 
something you would see as doable?
    Mr. Galbraith. As a part of reorganizations of failed 
institutions, yes, that is what you do.
    Mr. Green. Moving to another area. Let us talk quickly 
about judicial modification of mortgages. Is as proposed, which 
is a retrospective approach, not a prospective, but a 
retrospective approach utilizing judicial modification, is this 
a part of one of the tools that we might utilize? And we will 
start with you, Doctor.
    Mr. Blinder. My brief answer is yes, though it is not my 
favorite approach.
    Mr. Green. As a last resort. Only after the person who 
happens to have the mortgage has made an effort to settle with 
the servicer who represents the investors.
    Mr. Blinder. Yes. My preference would be to take this out 
of the realm of bankruptcy courts. But if this is what--what 
you just said is actually on the congressional table right 
now--
    Mr. Green. Yes.
    Mr. Blinder. --it is a lot better than nothing.
    Mr. Green. Okay. And I must move quickly here.
    Mr. Taylor. No.
    Mr. Green. Dr. Taylor, no.
    Mr. Galbraith. Yes.
    Mr. Green. Yes. Let us move quickly to one additional 
thing, and maybe I will be able to get your rationale as to why 
not, Dr. Taylor.
    But credit default swaps. They have almost gone off the 
radar in terms of being an issue du jour. Let me ask you if 
this is something that is still lurking out there that could 
possibly overwhelm us in the sense that my understanding is 
that these credit default swaps can total more than what the 
entire stock market happens to have within it currently. So, 
Doctor, is this something that we have to give serious 
attention to?
    Mr. Blinder. I think absolutely. It was just in the paper 
the other day that AIG is liable to be coming in for yet more 
money because of yet more losses on credit default swaps. It is 
not over.
    Mr. Green. Dr. Taylor?
    Mr. Taylor. Yes. One of the proposals to create some kind 
of central-clearing mechanism is really what we need.
    Mr. Green. Dr. Galbraith.
    Mr. Galbraith. Yes.
    Mr. Green. I am sorry I had to move so quickly, friends. 
The final question will be sort of a general question. We 
talked about the Home Owners' Loan Corporation from the 1930's. 
That paradigm seems to have been somewhat efficacious at the 
time. Is there a means by which we can employ something similar 
at this time as a tool to help us through this crisis? Dr. 
Blinder.
    Mr. Blinder. Yes. I think you did. I think the HOPE for 
Homeowners was a variant of the HOLC. The HOLC made the 
government the banker and actually owned the mortgages. The 
HOPE for Homeowners made the government the guarantor; not the 
owner, but the guarantor.
    Mr. Green. I understand. But I will follow up with this: It 
was a voluntary system.
    Mr. Blinder. So was the HOLC.
    Mr. Green. We didn't get a lot of participation, but 
because of the lack of participation in the system, the 
question is, how do you tweak it so that it is utilized? 
Because while it is a great idea, if nobody embraces it, it is 
an idea unused.
    Mr. Blinder. I couldn't agree with you more. I learned in 
the break that this committee has actually passed the 
liberalization or a tweaking of it. I didn't even know that. I 
applaud that. I think what it also needs is some form of 
extensive outreach. The sad fact is that in all the 
government's programs--I mean, this is true even of food stamps 
and things--a lot of people who are eligible for these programs 
have no idea they are eligible. They don't even come in and ask 
for them. So this goes to your question of the take-up rate. I 
think you probably need to add to that some substantial 
outreach.
    Mr. Green. I am going to yield back, but I would like, if I 
may, to get answers to the two remaining--
    Mr. Taylor. I am not familiar with the modification of the 
bill to which you are referring, so I think I will just pass.
    Mr. Galbraith. I am in full agreement with Alan Blinder on 
this.
    Mr. Green. Thank you, Mr. Chairman.
    Mr. Scott. Dr. Galbraith, did you comment on that? Did you 
have a chance to comment on it?
    Mr. Galbraith. Yes. I said I fully agree.
    Mr. Scott. Okay. The gentleman from Missouri, Mr. Cleaver.
    Mr. Cleaver. Thank you, Mr. Chairman.
    I think, Dr. Blinder, you earlier mentioned how you thought 
that using the term ``nationalization of banks'' was negative, 
which I agree with. The problem we have is that, frankly, we 
are not in charge of how issues are framed, so people who are 
opposed to what we are doing begin to talk about 
nationalization of banks. It gets out. I don't think you can 
find any instances where the Chair or anybody in a responsible 
position in Congress would talk about nationalizing banks. I 
think that is dangerous. And also we are now inserting into the 
lexicon ``bad bank/good bank.'' It is going to be a problem as 
well. And I am hopelessly on a crusade to try to stop it, but I 
lost a long time ago. I guess crusades are supposed to take 
place with the possibility of not winning.
    I just think we are headed in the wrong direction on that, 
and it is going to be out. And then our constituents are going 
to be raising questions about, well, is this a good bank, or is 
this a bad bank? You know, you have a--you know, some kind of 
bad experience is a bad bank. It is not going to be a good 
thing. The Treasury, I think, may have made a mistake since 
they are the--I think on this issue--the framer.
    But anyway, that was some meaningless rambling about our 
lexicon, and it won't get us anywhere. What I want to talk to 
you about, Dr. Galbraith--actually I want the three of you to 
be engaged in it--but someone raised the issue earlier about 
our debt to China, which actually is not as great as our debt 
to Japan. But we are moving toward $2 trillion Chinese holdings 
of U.S. assets. And the question is constantly raised when I am 
out in my district about what happens when China decides they 
don't want to acquire any more U.S. paper? And my answer is 
usually that the Chinese have no other options for investments, 
and that they will, in all probability, want to continue to 
invest. We might have a problem of interest rates rising if 
they do become weary, and then we will have to go with the 
interest rates in order to continue to get the investment. Is 
there another scenario that you would like to add to what I 
have just said?
    Mr. Galbraith. I think the Chinese may not be very happy 
with their portfolio position, but they don't have much choice 
about it. They want to sell exports to us. They are going to 
earn dollars. They have to do something with them. They also 
accumulate a lot of those reserves actually not from trade, but 
converting dollars that were brought in to invest in the real 
estate and the stock market in China. That is also something 
that they did incidentally to other public purposes that they 
had.
    So I don't think it is likely that the Chinese are going to 
suddenly adopt a policy of active dollar dumping or moving away 
from dollar assets. If they chose not to renew their 
securities, we would simply debit their securities account and 
credit their reserve account. They would then have the dollars. 
They would have to sell them off to somebody else, and probably 
the Europeans would end up with the dollars.
    But with all that said, it just seems to me that it is not 
an immediate and maybe not even a distant problem that the 
Chinese or the Japanese would prefer to hold euro or some other 
major currency as a reserve asset rather than the dollar. The 
vulnerabilities of the banking system in that part of the world 
are at least as great as they are here, and the credits of the 
government--the security of the governments that are behind the 
euro--is much less than it is here.
    Mr. Cleaver. Is there any concern--and I have not been able 
to find the answer to this question. Is there any concern that 
the Chinese actually are holding substantial securities that 
were acquired from Fannie and Freddie which are actually 
subprime mortgages? I have not seen any information on whether 
or not that has, in fact, happened with the Chinese.
    Mr. Galbraith. I have not either. I know they have--they 
hold a lot of agency debt, but I don't believe that they have 
been--in their official accounts--holding the privately 
securitized subprime debt. But that is a question I don't have 
an answer to, for sure.
    Mr. Cleaver. Thank you, Mr. Chairman.
    Mr. Scott. Thank you.
    The gentleman from Colorado, Mr. Perlmutter.
    Mr. Perlmutter. Thank you, Mr. Chairman.
    And, gentlemen, thank you for your time today and your sort 
of advice on these things.
    I have a couple sort of macroeconomic questions. The first 
is, we have sort of divided this thing up into three parts. One 
was to try to stabilize the financial markets, which some 
positive effects out of TARP could have been done better. 
Second is, in my opinion, stimulate the economy, get it going 
again. Third is to restore confidence in the system. We have 
regulations to deal with. So we are going to have a hearing 
soon on some of the regulations that may have been eliminated 
in the past and some that are in place and seem to be 
compounding problems overall within the system.
    So my question to the three of you, let us start with mark-
to-market, which seems to get a lot of conversation here, and I 
am looking at it closely. Within the overall economy, do you 
all have an opinion on whether we should be maintaining on a 
daily basis some mark-to-market that banks need to collapse 
their capital or not? Does anybody have an opinion on that? And 
if you want to reframe the question, I am happy to have you do 
that, too.
    Mr. Blinder. I am generally very favorable to mark-to-
market. And while there is a lot of debate, as you have 
mentioned, on whether it is part of the problem or part of the 
solution, I am much closer to ``part of the solution.'' We need 
to know how big the balance sheet holes are. When I say ``we,'' 
the markets need to know. And then you can start doing things.
    That said, there are at least two things that I think we 
should think of as, I don't really mean exceptions, but 
qualifications. One is that banks have always had these hold-
to-maturity accounts where most loans are, for example. They 
are not going to sell these loans. They will hold them to 
maturity. They reserve against them, which is the version of 
mark-to-market that you get there. I don't see any big need to 
change that. Now, the reserving might be inadequate. That is 
what supervisors are supposed to be watching, to make sure 
there is enough reserving.
    The second thing, which is a much knottier problem, which 
we really haven't had to face until recently, is: what do you 
do when, so to speak, markets disappear? What if you have an 
asset that is ask 60/bid 20? Bids and asks are supposed to be 
right next to each other. But when it is 60/20, the whole 
notion of mark-to-market becomes a difficult one to deal with. 
And I don't have a fixed answer to that. Some people have said 
the answer is simple: you mark to 20. I am not so convinced 
that is the right answer, and I think it needs a lot of 
thought.
    Mr. Perlmutter. Okay. Thank you.
    Dr. Taylor.
    Mr. Taylor. I don't have too much to add to that. I think 
mark-to-market provides the information you need. But in some 
cases where the securities are going to be held to maturity and 
it is in a bank, then there are other ways to do it. I think 
there is some sense of forbearance here is what people are 
looking for, and I am very positive about that.
    Mr. Perlmutter. Dr. Galbraith.
    Mr. Galbraith. The argument against marking to market the 
subprime mortgage-backed securities has been that the market is 
somewhat artificially depressed relative to the real value of 
those securities. I am very suspicious of that argument. I 
think it is very unlikely that, even if you did take them off 
the books of the banks at a guaranteed value that was higher, 
that the Resolution Trust Corporation that would eventually 
sell them would be able to get rid of them for anything higher 
than the market price. And the reason is that I suspect that 
the markets understand that there is, in the case of these 
securities, practically no way to know what the underlying risk 
really is, because the documentation they would normally rely 
on isn't present. And that seems to be a real problem with 
modifying mark-to-market in this particular circumstance.
    Mr. Perlmutter. All right.
    The second question, which is similar to a mark-to-market, 
is the cramdown. I mean, that is marking to market. If we, and 
again on a macroeconomic basis, and I don't know exactly how 
many people will take advantage, if we do a cramdown in a 
Chapter 13 and we have 10 million potential foreclosures out 
there--I don't know what the number is, maybe you all know--
what is going to happen? Do you have any opinion of what will 
happen to the system if everybody takes advantage of a 
cramdown?
    I will start with you Dr. Galbraith, and work backwards.
    Mr. Galbraith. Well, if you replace a completely 
unmarketable security with a mortgage which has a lower return 
but which in fact is documented, has some capacity to be 
sustained, you might actually move to a better market 
environment after the cramdown than before. And that is what I 
think you would be hoping to accomplish by putting these 
mortgages on a sustainable 30 year, 40 year, 4 percent basis, 
if you can do it.
    Mr. Perlmutter. Dr. Taylor.
    Mr. Taylor. Any, if you like, force cramdown, like the one 
I think you are talking about, raises questions about future 
lending and what is going to happen in the future, especially 
if it is retroactive. So I am very cautious about any kind of 
legislation like that.
    Mr. Perlmutter. Dr. Blinder.
    Mr. Blinder. I actually think, going forward--and this is 
not the current congressional proposal--I would like to see 
homes treated like vacation homes and other assets. It is not 
the case that you can't get loans against assets that can be 
crammed down in bankruptcy. Basically, all business assets can 
be crammed down in bankruptcy. It probably results in a couple 
more basis points, I don't know, on the cost of credit. But 
that is going forward.
    The retroactivity, I think all of us are very uneasy about 
retroactivity. I am. It should be a general constitutional 
principle: You don't pass retroactive laws. This looks to me 
like an emergency. I think there may be better ways to do it. 
But as I said in an answer to another question, if that is the 
proposal that is actually on the congressional table, then I 
would support it, though it is not the sort of thing that, 
generically, I like to support.
    Mr. Perlmutter. Thank you.
    Thank you, Mr. Chairman. I yield back.
    Mr. Scott. [presiding] Thank you. In all fairness to the 
proposal that is on the table, it is narrowly drawn. It doesn't 
apply to all of the mortgages falling in foreclosure, and it 
would not extend beyond the enacting of the bill. The intent of 
what we are trying to do in grappling with this issue is to try 
to put a floor. At some point, you have to try to put a bottom 
and a floor on. And these are in the most desperate situations.
    And then, certainly, there is a fairness issue that, for 
the wealthy, who can have this benefit for their second home or 
third or vacation home, here you have the primary residence. 
And then the other issue is, certainly, going back to what we 
mentioned earlier with Dr. Galbraith, we have to find a way of 
sustainability to keep people in their homes.
    And this cramdown and this bankruptcy is a grappling issue, 
and hopefully, we can get it right.
    I think we will come back next week, as you know, Mr. 
Perlmutter, and try to wrestle with it again.
    Thank you very much.
    And now we will turn to the gentlelady from Ohio, Ms. 
Kilroy.
    Ms. Kilroy. Thank you very much, Mr. Chairman, and thank 
you to our guests.
    I have been very interested in your testimony and the 
various ideas that challenge us to find the right pathways to 
go and to do our work here in the Financial Services Committee 
well and appropriately, not--allowing the regulators to do the 
work that they are professionally trained to do. I thought 
those were very interesting comments.
    Many of the questions that I had come prepared to ask have 
already been covered by the committee. But I wanted to go to 
some of the thoughts and ideas that are a little bit, moving 
away a little bit from issues like retroactivity, which we 
could debate, and cramdowns. In talking about some of the ways 
that we can do to restore long-term financial stability to our 
country and to our economy, measures that we could take a look 
at the big picture, infrastructure, social security, health 
care, I would like to ask the panel to maybe revisit that a 
little bit before we adjourn today.
    Mr. Taylor. Well, I think the earlier questions about this 
is whether we should be addressing something like social 
security now or wait until later, and my view is, yes, now. We 
should be getting on with these things, because they 
demonstrate that we are concerned as a country with our fiscal 
imbalances. That is a huge imbalance down the road. So I would 
be of the view that let's get started with those now. That is 
actually economically one of the easier ones. It is politically 
very difficult. But I think it would demonstrate a great degree 
of confidence, if you like, that the government has taken on 
something like that.
    Mr. Blinder. I agree with that very much.
    And I would put just a slightly different nuance. Given the 
incredibly difficult issues that the Congress has been 
grappling with now, the huge sums of money, and it is not over, 
Social Security has actually become the low hanging fruit. This 
is an easy issue actually. You do not have to do horrific 
things to get Social Security back into actuarial balance.
    Secondly, because Social Security is running a big surplus 
now, and it is inherently a very long-run problem, the natural 
things to do will be clipping benefits, if you want to use that 
term, and raising revenue down the road. It is not at all 
urgent to do it now.
    So the Congress can enact now fixes that will take place 
years from now. That is what the Greenspan commission did in 
1983. That is not nearly as painful as appropriating $1 
trillion to rescue banks today. And I think it would send a 
terrific signal about this seemingly contradictory position 
that we are going for huge deficits today but fiscal 
responsibility tomorrow. That would be a tangible 
manifestation, written into law, of a modicum of fiscal 
responsibility tomorrow.
    Mr. Galbraith. I am in very deep disagreement with my 
colleagues on this point. I can see no economic reason why 
going forward we should be concerned about the balance between 
a stream of revenues called payroll taxes and a stream of 
obligations called Social Security benefits. If you are 
concerned with that question of balance, you could solve that 
problem. It actually is not a problem, but you could solve that 
cosmetic issue by assigning some other tax source to Social 
Security. The estate tax, as the late Social Security 
Commissioner Robert Ball suggested, could be put into the trust 
fund. You don't need to solve this problem, this alleged 
problem, by legislating today reductions in a core benefit on 
which 40 percent or more of the American elderly rely for 
practically all of their income, and particularly not at a time 
when the other sources of income and wealth that support the 
elderly population have taken an enormous hit, with housing 
values, stock equity values, and the interest income on cash 
holdings all going down simultaneously.
    Social Security is more important than ever as the bulwark 
of the middle class standing, the nonpoverty status of the 
elderly population. So I would hope very much that we would 
resist the temptation to make this what is essentially a 
symbolic and political gesture at this time or at any time.
    At the same time, on the broader question that you raised 
of whether one should be treating this as a long-term or a 
short-term problem, my view is this crisis is the opening act 
of a long-term transformation of the economy. And we are going 
to need, as we think about building the economy back up from 
the calamity through which it is passing, we need to think 
about this from a long-term perspective.
    And one of the defects of what we have been doing so far 
has been the assumption that the economy will recover within 2 
or 3 years and, therefore, we can limit the scope of action to 
the shovel-ready projects and the short-term expenditures. I 
don't think that is going to work. We will only discover over 
time whether I am right or not. But if I am right, then the 
right approach is to think about the public investments that 
are truly transformational and begin to do them now--to build 
institutions like a national infrastructure bank, the Dodd 
bill, that can finance that transformation going forward, and 
to build into these projects the kind of development of new 
industries that deal with our energy problems, with our climate 
change issues, with the creation in some sense of the living 
space that we want to have for the next generation. It seems to 
me that if we do that, we will be remembered for having made an 
opportunity out of a crisis.
    Ms. Kilroy. Thank you.
    I yield back.
    Mr. Scott. The gentlelady's time has expired.
    Thank you very much.
    On behalf of our Financial Services Committee, on behalf of 
the Congress, and of the American people, we really thank each 
of you. We are at a critical, crucial point in the history of 
our country. And the hopes and aspirations of millions of 
Americans, and our children and grandchildren have come to rest 
on what we do here today.
    And your intellect, your ideas, have been very helpful to 
us as we move forward to grappling with these very monumental 
and critical issues. You know, it is the tough times that 
determine the character. We have had tough times in our Nation 
before, and that is why we have a tough character that has made 
us a great Nation.
    We thank you, Dr. Galbraith, Dr. Taylor, and Dr. Blinder.
    This meeting is adjourned.
    [Whereupon, at 1:12 p.m., the hearing was adjourned.]


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