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



 
                        THE STATE OF THE ECONOMY

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


                                HEARING

                               before the

                        COMMITTEE ON THE BUDGET
                        HOUSE OF REPRESENTATIVES

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                               __________

              HEARING HELD IN WASHINGTON, DC, MAY 21, 2009

                               __________

                           Serial No. 111-10

                               __________

           Printed for the use of the Committee on the Budget


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                        COMMITTEE ON THE BUDGET

             JOHN M. SPRATT, Jr., South Carolina, Chairman
ALLYSON Y. SCHWARTZ, Pennsylvania    PAUL RYAN, Wisconsin,
MARCY KAPTUR, Ohio                     Ranking Minority Member
XAVIER BECERRA, California           JEB HENSARLING, Texas
LLOYD DOGGETT, Texas                 SCOTT GARRETT, New Jersey
EARL BLUMENAUER, Oregon              MARIO DIAZ-BALART, Florida
MARION BERRY, Arkansas               MICHAEL K. SIMPSON, Idaho
ALLEN BOYD, Florida                  PATRICK T. McHENRY, North Carolina
JAMES P. McGOVERN, Massachusetts     CONNIE MACK, Florida
NIKI TSONGAS, Massachusetts          JOHN CAMPBELL, California
BOB ETHERIDGE, North Carolina        JIM JORDAN, Ohio
BETTY McCOLLUM, Minnesota            CYNTHIA M. LUMMIS, Wyoming
CHARLIE MELANCON, Louisiana          STEVE AUSTRIA, Ohio
JOHN A. YARMUTH, Kentucky            ROBERT B. ADERHOLT, Alabama
ROBERT E. ANDREWS, New Jersey        DEVIN NUNES, California
ROSA L. DeLAURO, Connecticut,        GREGG HARPER, Mississippi
CHET EDWARDS, Texas                  ROBERT E. LATTA, Ohio
ROBERT C. ``BOBBY'' SCOTT, Virginia
JAMES R. LANGEVIN, Rhode Island
RICK LARSEN, Washington
TIMOTHY H. BISHOP, New York
GWEN MOORE, Wisconsin
GERALD E. CONNOLLY, Virginia
KURT SCHRADER, Oregon

                           Professional Staff

            Thomas S. Kahn, Staff Director and Chief Counsel
                 Austin Smythe, Minority Staff Director


                            C O N T E N T S

                                                                   Page
Hearing held in Washington, DC, May 21, 2009.....................     1

Statement of:
    Hon. John M. Spratt, Jr., Chairman, House Committee on the 
      Budget.....................................................     1
    Hon. Paul Ryan, ranking minority member, House Committee on 
      the Budget.................................................     2
    Douglas W. Elmendorf, Ph.D., Director, Congressional Budget 
      Office.....................................................     3
        Prepared statement of....................................     6
    Hon. Marcy Kaptur, a Representative in Congress from the 
      State of Ohio, questions for the record....................    48


                        THE STATE OF THE ECONOMY

                              ----------                              


                         THURSDAY, MAY 21, 2009

                          House of Representatives,
                                   Committee on the Budget,
                                                    Washington, DC.
    The Committee met, pursuant to call, at 10:05 a.m., in room 
210, Cannon House Office Building, Hon. John M. Spratt, Jr. 
[Chairman of the Committee] presiding.
    Present: Representatives Spratt, Schwartz, Becerra, 
Doggett, Etheridge, McCollum, Yarmuth, Langevin, Schrader, 
Ryan, Hensarling, Garrett, Diaz-Balart, Campbell, Jordan, 
Lummis, Austria, and Latta.
    Chairman Spratt. We convene today to review the state of 
our economy, a dismal state, and its interaction with the 
budget. As Director Elmendorf, our witness this morning, told 
the Committee back last January, our economy is clicking on 
only four out of six cylinders at best, running at 7 percent 
below its full employment capacity.
    To help put the economy back on its feet, Congress enacted 
the Troubled Assets Relief Program in October. This year, 
Congress has passed and the President has signed into law a 
$787 billion recovery package to spur demand and create 3 
million new jobs while reinvesting in our physical and human 
infrastructure. The Treasury, the Federal Reserve, the FDIC 
have all taken unprecedented actions.
    This morning, we want to explore what is the state of our 
economy, what is the course it has taken? Very importantly, 
what are the prospects of recovery? We have been told there are 
glimmers of hope. Are these glimmers real or they simply a 
mirage? What effect, in particular, are the extraordinary steps 
we have taken having upon the economy? The stimulus package, 
for example? The TARP package? The extraordinary intervention 
by the Fed and the Treasury? What impact is this having? What 
are the risks of deflation? And on the other hand, what are the 
risks of inflation given the extraordinary liquidity being 
pumped into the economy by the Fed, among others? What problems 
have we yet to face? I notice in the testimony, reading the 
testimony last night, that by CBO's estimate and others' 
estimates the banks of this country, the commercial banks, may 
face losses of nearly $1 trillion, of which only about a third 
have yet been recognized.
    All in all, we would like to know, what is the state of the 
economy today? What can we expect for the immediate future? And 
what policy actions do we need to be taking? To that end, Dr. 
Elmendorf, the Director of CBO, has prepared extensive 
testimony, excellent testimony if you have read it. And we will 
make it part of the record so that you can summarize as you see 
fit, but you are the only witness this morning.
    Now, you need to leave at 12:45. We want to give you wide 
berth to take as much time as you would like to discuss and to 
amplify your views of where the economy is going, what effect 
our policies have had to date, and what policies we should be 
considering for the future. Before turning to you for your 
testimony, let me turn to Mr. Ryan for his opening statement.
    Mr. Ryan. Thank you, Chairman Spratt. Welcome back, Dr. 
Elmendorf. First, I just want to say you have lived up to your 
reputation in coming to CBO, in providing integrity, 
intelligence, impartiality, and you are doing a good job of 
upholding the tradition of CBO of being a fair, honest broker 
with the facts. And I appreciate that. And we encourage you to 
continue doing what you all are doing. And you guys have a hard 
job ahead of you. So it is nice to have you back here, and it 
is nice to see you doing well.
    No question, all of us want to see this economy turn 
around. And all of us hope that the turnaround maybe in fact be 
on the horizon. And we see glimmers out there. But the economic 
and fiscal challenges we face are far too complex and too great 
to simply hope we get it right. We need to address the 
effectiveness of what we are doing to address today's 
challenges. And we need to consider where this path that we are 
speeding down will eventually lead us.
    I have a great concern that the administration and Congress 
have exploited the current economic crisis, and the fear and 
diverted attention of the American people, to justify rushing 
through a sweeping and possibly irreversible expansion of the 
federal government. Let me list just a few things beginning 
this year. TARP, which was signed into law last year and 
provided $700 billion in emergency funding intended to thaw 
credit markets. We have seen this program's scope expand beyond 
stabilizing the financial sector to auto industry 
restructuring, auto supplier support, mortgage loan 
modifications, and insurance industry assistance. Worse, we 
have seen Washington use this program to pick economic winners 
and losers. I was part of those original conversations. The 
idea was to insure or buy toxic assets. Now it is equity 
injections and owning shares of private organizations.
    On monetary policy, the Federal Reserve has pulled out all 
of the stops. They brought interest rates to all new lows. They 
have got massive assets on their balance sheets. They are 
actually monetizing debt. Our concern is that at some point the 
Fed is going to have to change direction. They are going to 
have to change course and take back this considerable monetary 
stimulus in order to prevent a nasty bout of inflation in the 
coming years. Getting the timing and magnitude of this 
adjustment right, while avoiding the political pressure to keep 
monetary policy loose will be critical. And quite frankly, I am 
skeptical that the Fed can pull it off.
    We had the trillion dollar stimulus, which may get us a 
temporary boost but is certain to result in debt and tax 
burdens that will hinder sustained economic growth.
    And then there is the President's budget, which this 
Congress has just adopted. We spent a lot of time here debating 
it, so I will be brief with a few concerns. The budget calls 
for record levels of spending, swelling this year's deficit to 
$1.8 trillion, more than triple its previous record; doubles 
the debt in five years and almost triples it in ten years. It 
puts us on a path of government controlled healthcare and paves 
the way for a cap and trade energy tax on nearly every American 
family, business, and individual, meaning everyone. It even 
adds almost $1.5 trillion to new entitlement spending, 
worsening our most severe fiscal problem. The budget calls for 
$1.5 trillion in new tax hikes in the midst of one of the worst 
recessions in generations.
    Clearly, this is a challenging time and it demands 
solutions. But I honestly fear the path that we are speeding 
down, and that this path will only make the situation worse. We 
are now debating this summer about creating a brand new 
entitlement program, before we even solve the other three that 
are exploding just within the next decade.
    At every juncture, we have offered alternatives that 
promote the kind of solid, sustained economic growth we need to 
keep America great for generations to come, and we have made 
proposals on how to rein in these entitlement programs so that 
they are sustainable. We certainly want to continue in this 
effort. I hope that we can shed some light on the details that 
are forthcoming in the economy with these programs. And I yield 
back the balance of my time, and I thank you, Chairman.
    Chairman Spratt. Thank you, Mr. Ryan. And before you 
proceed, Mr. Director, let me echo the remarks made by Mr. Ryan 
with respect to the tradition of excellence at CBO which you 
have continued. We are proud of the work you are doing and 
appreciate it very much.
    And now, the floor is yours. I would encourage you to take 
your time as you work your way through your testimony.

     STATEMENT OF DOUGLAS ELMENDORF, PH.D., DIRECTOR, THE 
                  CONGRESSIONAL BUDGET OFFICE

    Mr. Elmendorf. Thank you, Chairman Spratt and Ranking 
Member Ryan. I appreciate your very gracious introductions. And 
to all the Committee, I appreciate the invitation to testify to 
you today about the state of the U.S. economy.
    In CBO's judgment the economy will stop contracting and 
start growing again during the second half of this year. But 
the hardships caused by the recession will persist for some 
time. The growth in output later this year and next year is 
likely to be sufficiently weak, so the unemployment will 
probably continue to rise into the second half of next year, 
and peak above 10 percent. Economic growth over time will 
ultimately bring the unemployment rate back down to the 
neighborhood of 5 percent seen before this downturn began, but 
that process is likely to take a number of years.
    On a positive side, the fiscal stimulus, provided by the 
federal government, is now beginning to boost the economy, and 
financial markets show clear signs of improvement since the 
fall and winter. Moreover, the sharp reductions seen in 
manufacturing production will keep inventories to leaner levels 
than would have occurred otherwise so that upturns in sales, 
when they come, will lead to faster and larger increases in 
output.
    However, many factors will temper the strength of the 
recovery: the loss of household wealth, the fragility of 
financial institutions, persistently weak growth in the rest of 
the world, a surplus of housing units, and low utilization of 
manufacturing capacity. How much those factors will dampen the 
recovery is uncertain. They may be overcome relatively quickly 
by the jumpstart provided by the stimulus, and improvements in 
consumer and business confidence. Or they may cause the economy 
to slump again next year as the effects of the stimulus begin 
to wane.
    Recently released data are consistent with CBO's forecast, 
in March, that gross domestic product will bottom out this 
year. Indeed, a wide majority of economic forecasters share 
that view. However, CBO's assessment of developments in the 
financial system and the non-financial parts of our economy and 
other economies suggest that the initial stages of the economic 
recovery are likely to be more tepid than we had earlier 
projected. CBO's March forecast of roughly 3 percent growth in 
real GDP in 2010 is more optimistic than the current consensus, 
as is the Agency's March forecast for a peak unemployment rate 
of about 9.5 percent. We are now beginning the process of 
updating our previous forecast and will release a new forecast 
in August.
    The uncertainty surrounding our forecast, and the forecasts 
of private analysts, deserves emphasis. If we could put up 
slide one, please?
    The future course of the economy is always uncertain. This 
chart shows the confidence region around our March forecast of 
real GDP. The darker areas are the more likely outcomes and the 
progressively lighter areas are less likely outcomes. 
Uncertainty is especially great in economic forecasting, 
though, around turning points, and in unfamiliar conditions 
such as the current financial crisis. Moreover, even if the 
economy returns to positive growth this year, as we and almost 
all other forecasters expect, the loss in output and income 
during this downturn will be huge. As shown in the next slide 
depicting our March forecast, the difference between the 
economy's actual and potential output, what could be produced 
if all factors for production, labor and capital, were being 
fully utilized, will average 7 percent of GDP this year and 
next. That is about $1 trillion per year of lost output, and 
that gap in output will not close until 2013.
    Based on current information, our next forecast is likely 
to show even larger shortfalls in output over the next few 
years. By this measure, the current recession and its aftermath 
will be the most severe economic downturn of the postwar 
period.
    The persistence of high unemployment in our forecast does 
not stem from a failure of fiscal stimulus. We expect that the 
stimulus legislation will boost GDP a little more than dollar 
per dollar of reduced tax collections and increased outlays. 
However, as large as the stimulus package is, the contraction 
underlying private demand is far larger. So the stimulus will 
offset only part of the contraction.
    Let me conclude with a few words about the budget outlook. 
Most experts believe that larger deficits are appropriate 
during recessions, because higher spending and lower taxes can 
bring the levels of resource use and output closer to the 
economy's potential. From this perspective, the extremely large 
deficit this year, roughly $1.7 trillion, or nearly 12 percent 
of GDP in CBO's March projection, serves a purpose. However, 
most experts also believe that persistent large budget deficits 
reduce capital accumulation and thereby slow the growth of 
output and incomes in the medium and long run. Thus, the large 
deficits that we project for the years after the economy has 
returned to full employment, shown in the next slide, are more 
worrisome.
    Moreover, the sharp increase in debt this year and in the 
next few years, the last slide please, raises the risk that 
investors might lose confidence in government debt as a safe 
haven. This risk heightens the importance of putting the budget 
on a sustainable path as the economy returns to full 
employment.
    Thank you. I am happy to take your questions.
    [The prepared statement of Douglas Elmendorf follows:]

               Statement of Douglas W. Elmendorf, Ph.D.,
                 Director, Congressional Budget Office






































    Chairman Spratt. Dr. Elmendorf, one of the things you point 
out in your testimony is that the current economy, current 
recovery effort, may peter out as the effect of what we have 
done thus far becomes attenuated into 2010, or maybe 2011. 
Could you expound upon that? Just how big a risk is it that the 
effects will cease to have effect, and there might be a second 
slump?
    Mr. Elmendorf. Yes, Mr. Chairman. If we could put up the 
second table? I am not sure where that stands in the number of 
slides. I think that will help the, slide nine, please. In our 
estimate, Mr. Chairman, the stimulus package provides the 
largest boost to the level of GDP this year, near the end of 
this year, in 2009. And the range of those effects, as shown in 
the upper left set of numbers in this table, as you know we 
offered a range of estimates given the great uncertainty, so we 
estimate that the effect of the stimulus package is to raise 
the level of real GDP between 1.5 percent and 3.75 percent at 
the end of this year. And that reflects the initial burst of 
tax reductions and spending increases.
    But the effect wanes over time as the stimulus package 
wanes over time. In other words, the stimulus package 
principally cut taxes and raised spending in the near term, and 
as those effects wane then the direct effects on GDP wane as 
well. So we think the stimulus package will still be holding 
GDP next year but less so at the end of next year then this 
year, and even less still than that at the end of 2011. That is 
really a design feature of the stimulus package, to provide the 
biggest boost up front. But the effect of that, then, is that 
as the effect wanes the economy will slow again unless private 
demand picks up. And of course, the expectation in designing 
the stimulus package was that private demand would pick up.
    We are not forecasting as our basic outlook a renewed slump 
in the economy. But, as I said in the testimony, that continued 
growth depends on private demand coming up as the stimulus 
package wanes. And that is, I think, a reasonable forecast. I 
think it is the best forecast now. But it is a forecast. It is 
not by any means a fact that that will happen on a timetable 
that we project.
    Chairman Spratt. The deficit for this year is likely to be 
$1.8 trillion, something of that order, and for next year----
    Mr. Elmendorf. Yes.
    Chairman Spratt [continuing]. Your forecast is somewhere in 
the range of $1.1 trillion to $1.2 trillion. Does that $600 
billion decline in the deficit actually pose a threat to 
undermine the recovering growth of the economy?
    Mr. Elmendorf. Well, it is--yes. But I would say it not as 
the deficit, per se. It is, the decline in the deficit from 
this year to next in our forecast reflects partly the 
strengthening of the economy, and also, as I said, some waning 
of the effects of the stimulus. So the withdrawal of the tax 
boost, the withdrawal of the spending boost, all else equal 
will slow economic growth. And again, as I said, the 
presumption as this package was designed was that private 
demand would build up over time. That is what we have seen in 
past recoveries. But the timing of that increase in private 
demand is very uncertain. And that raises the question, I 
think, about whether the withdrawal of the stimulus, as this 
initial package wanes, whether the withdrawal of that stimulus 
will come too quickly and leave the economy still very weak or 
not.
    I think I would emphasize in our forecast, even with the 
private demand coming up and overall growth not faltering, it 
still takes a long time to catch up for the weak growth last 
year and this year. And it is that catching up process, 
bringing the level of output back up to the potential level of 
output, that corresponds to bringing the unemployment rate down 
from its current level around 9 percent, and we think 
ultimately higher, bringing that back down toward the 5 percent 
which is more standard outside of recessions. And that is the 
process we think will take a number of years.
    Chairman Spratt. Over the last year and a half some truly 
extraordinary steps have been taken, including the so-called 
TARP program, the Recovery Act program, and the Fed's own 
actions to make an extraordinary amount of collateralized loans 
to its member banks. Would you comment on each of these? In 
retrospect, does it appear that these actions were well taken? 
And are they working as intended, or at least having an impact 
on the economy that is positive?
    Mr. Elmendorf. Mr. Chairman, I think it is a widely held 
view that all of those actions have had positive effects on the 
economy. There is plenty of dispute about whether they were the 
best possible actions. And as is often the case in unusual 
circumstances when decisions are made in real time, hindsight 
offers lessons or information that would have been helpful if 
it had been known at the time. But the recovery package, as I 
said we, and the vast majority of private forecasters, think is 
making, and will make over the course of this year and next 
year a very important difference in the level of economic 
activity and the level of unemployment.
    Chairman Spratt. You quantify that as between 1.4 percent 
and 3.8 percent?
    Mr. Elmendorf. As of the fourth quarter of this year, and 
then tapering off to some extent next year and even more in 
2011. The effects of the TARP and the actions of the Federal 
Reserve are harder to quantify. I mean, one can count the 
dollars that have moved but the effects on GDP are harder to 
quantify. But again, I think a very widely held view that the 
aggressive actions in the fall and winter helped the financial 
system to step back from the edge of the abyss. And those 
actions have brought down household borrowing rates, 
particularly mortgage rates, they have brought down corporate 
borrowing rates. And that enhanced supply of credit has helped 
the economy in very important ways.
    The uncertainty going forward that I highlighted in our 
forecast is whether that help is enough to make the economy 
strong again. As one of my colleagues said to me, those actions 
have stabilized the health of the financial system at a low 
level. So, stable is a lot better than where it looked like it 
might be going a few months ago. But the fact that it 
stabilized at a low level of health raises concerns that there 
may not be enough loans provided to help the economy get on a 
robust growth path again.
    Chairman Spratt. Had we not taken those actions do you 
think we would be faced with a much bleaker situation now than 
otherwise?
    Mr. Elmendorf. Yes, absolutely.
    Chairman Spratt. Now, the Recovery Act itself has been slow 
to get out of the starting blocks. Only a few billion dollars 
out of a huge amount, $787 billion, has actually found its way 
into the real economy. Can you account for that? Apparently, 
CBO did expect it, and can we expect it to pick up at a more 
rapid rate in the near future?
    Mr. Elmendorf. Yes, Mr. Chairman. We warned at the time the 
recovery bill was being discussed that it was difficult to 
increase government outlays in the categories or the ways that 
were being proposed overnight. Some of the tax changes are 
having a larger initial effect. The spending changes take a 
little longer. And you are seeing that, now, in the numbers. It 
is very early to judge whether our assumptions were precisely 
right. We did not forecast outlays on a monthly basis, and we 
are really only a few months into the package. But we are not 
surprised at the slow start.
    As I said at the time, the package had a number of 
elements. And one of the virtues of having a combination of 
elements is that they affect the economy in different ways with 
different speed. So the details matter a lot about the sorts of 
tax cuts or the sorts of spending increases, but a broad 
generalization would be that the tax cuts worked more quickly 
but tend to have somewhat dollar for dollar effects on GDP in 
our judgment and most economists' judgment. And the spending 
increases work more slowly but have a little more bang for the 
buck when they get there. So the estimates that I am showing 
here reflect our going through the details of the bill on a 
fairly granular level and trying to judge, as best we can, the 
size and timing of the effects. So these estimates incorporate 
our view that some of the spending increases will be slow and 
will have their biggest effects next year, whereas other 
pieces, like some of the tax provisions, are having big effects 
right away.
    Chairman Spratt. In your testimony you point to some weak 
spots in the economy which have not been fully exploited yet 
such as, well you do not indicate, but bank losses $950 billion 
of which only about $300 billion thus far has been recognized 
and declared a loss. Are there some weak spots like that? Some 
sand pits that we still are faced with? Commercial real estate 
loans, credit card loans, things of this nature that could trip 
up the recovery?
    Mr. Elmendorf. Yes, Mr. Chairman. I am not a golfer but I 
think the number of sand pits that we see ahead would scare a 
good golfer. There are----
    Chairman Spratt. I was concerned by quicksand more than the 
sand pits.
    Mr. Elmendorf. So as you know, the largest U.S. banks have 
recently undergone a stress test, and the stress test was 
examining what might happen to their balance sheets if the 
economy turns out worse than most people expect. Not a lot 
worse, it is not the worst possible scenario, but it is a worse 
outcome for the economy than is the consensus view. And in 
those tests, most banks either had sufficient capital to 
weather that possible storm or were close to having enough 
capital and are now making plans to raise capital.
    But I should emphasize the uncertainty there. These banks 
have trillions of dollars of assets and even a small 
misjudgment in the value of those assets under a given economic 
scenario can make a world of difference in the amount of 
capital they need to raise.
    Having said that, I think the consensus view is as you 
said. There are a lot more losses to be realized, but that the 
losses that are coming will come progressively over time. That 
banks hold some combination of loans and securities, and again 
this is a generalization, but the securities tend to, the banks 
have to record losses in their value very quickly. Whereas for 
loans the losses can be realized over time. So a lot of the 
immediate losses have been realized, and the consensus view is 
that the losses they are going to suffer can be offset to a 
large extent by earnings they will have over the next several 
years, and thus that they will weather the storm. Again, I say 
the question of the overall economy is whether they are healthy 
enough to do enough new lending.
    Commercial real estate is I think another very important 
risk factor. There is a lot more commercial real estate in the 
world now, and in our country now certainly, than there is 
demand for. And there is a lot of concern about the effects of 
that. It matters directly for construction, but also on the 
financial side, and it is not just a matter of whether people 
can meet their current interest payments but whether they would 
be able to obtain new financing to roll over loans as they come 
due, say, given that there has been a tightening of credit 
standards since many of these loans were initially issued. 
Because of the financial problems and because of the recession 
they may have difficulty rolling over those loans. And that 
poses a very serious threat, particularly to some of the medium 
and small banks that have received less attention over the last 
year and a half than some of the biggest banks.
    Chairman Spratt. I have a number of other questions, but 
let me let others ask questions. We will come around for a 
second round. Mr. Ryan?
    Mr. Ryan. Thank you. Let me just pick up off on the 
commercial real estate. That is something I wanted to get into. 
That is what a lot of analysts are saying is going to be the 
next shoe to drop, is the commercial real estate market. And we 
had the stress test on the big banks, but we know that there is 
a lot of exposure in commercial real estate in the small and 
medium-sized banks. Have you seen or done any analysis on the 
kind of exposure to that segment of the banking system? And 
just give me kind of an assessment of your risk to the small 
and medium-sized banking system should that shoe drop, so to 
speak.
    Mr. Elmendorf. So we are monitoring the situation. You 
know, it is a big financial system and we have a reasonably 
compact staff of people following it. Let me report some of the 
analyses that others have done that seem to us to be a correct 
and relevant situation. The fundamentals in the market are 
quite weak. People are looking for price declines of 35 
percent, 45 percent, exceeding those in the early 1990's. Rent 
declines, the vacancy rates may approach those of the early 
1990's. And it really is a demand side shock. In the nineties 
there was more of an issue of overbuilding, and in this case it 
really is just a pull back, and we see this in employment as 
well, in the financial sector, and the retail sector, the 
businesses are contracting, not growing. So the delinquency 
rate is rising. And is expected to peak at the level of the 
early 1990's, say around 6 percent.
    So the Wall Street Journal, in fact, did an analysis of the 
exposure of banks to this, to this sector. And using the same 
scenario that the Fed used in the stress test the Wall Street 
Journal concluded the total losses of these banks could surpass 
$200 billion. That is a good deal of money. It is spread among 
a large number of banks, but nonetheless these are not the 
Citigroups and the Bank of Americas. So it is a, losses at that 
level would likely exceed the revenue that those banks would 
otherwise take in. That would mean a reduction in their capital 
over time. And I think a significant number of those banks 
might find themselves with capital low enough that regulators 
would become very concerned. We have not tried to calculate the 
expected effect on that on particular parts of the----
    Mr. Ryan. That is what I am----
    Mr. Elmendorf [continuing]. FDIC, and so on.
    Mr. Ryan. That is what I am trying to get a sense for. If 
the shoe drops, you know, what kind of percentage of the small 
and medium-sized banking system are we going to see shrink and 
be liquidated? Any----
    Mr. Elmendorf. So that, that I am sorry, we do not have 
estimates of. There are actions underway to try to help this 
market. The Federal Reserve has announced that it will, in 
parallel to a number of its credit facilities, help investors 
finance their purchases of top rated commercial mortgage-backed 
securities, CMBS, issued before the crisis. And there has been, 
you know, a rally in the market for those securities. So it is 
possible that they are already, as we know, the Federal Reserve 
has a lot of levers that it is using and that may help to 
stabilize the market without other action.
    Mr. Ryan. And they are going to prop up the secondary 
market in commercial paper? Commercial mortgage-backed paper?
    Mr. Elmendorf. Commercial mortgage-backed securities. I 
mean, prop up would not be their language. They are providing 
liquidity to help blah, blah.
    Mr. Ryan. Okay. Let me go to the bond markets. The bond 
markets are beginning to recover. Investors seem to be getting 
some risk appetite back, which means that many may start to 
move out of our Treasuries, that safe haven, you know, sort of 
dissipating it seems. Meanwhile, many other countries along 
with the U.S. are tapping global debt markets to raise money 
for economic recovery and to finance our deficits. The 
Treasury, our own Treasury is going to issue about $2 trillion 
in fresh debt this year alone. How might these factors, a 
higher risk tolerance and the flood of new sovereign bond 
issues, influence our government's borrowing costs going 
forward? How significant might there be upward pressure on 
medium and long term interest rates in your view, given this 
new climate we are kind of going into now?
    Mr. Elmendorf. I think certainly over the next several 
years there is likely to be very significant upward pressure on 
Treasury interest rates. Whether it is now or later is much 
less clear.
    Mr. Ryan. Yeah.
    Mr. Elmendorf. Although there are, as I have said, signs of 
improvement in the financial system and signs of improvement 
around the world in the financial markets, and some equity 
prices, and some improvements in confidence.
    Mr. Ryan. But that means----
    Mr. Elmendorf. We are still in a--excuse me?
    Mr. Ryan. That means our rates will then go up----
    Mr. Elmendorf. Yes.
    Mr. Ryan [continuing]. Because people will leave 
Treasuries, yeah?
    Mr. Elmendorf. Yes. But at the moment, despite some 
glimmers of hope and green shoots in the economy and other 
phrases like that, in our view our economy and the world 
economy still have a long way to go before they really come out 
of this slump. And I think the judgment of most economists is 
that these increases in interest rates are likely to be delayed 
until we come out of this slump. But the factors, the forces 
you describe, I think, are the pressures, which are that people 
will, the greater risk tolerance, there will be more demand for 
funds by the private sector as the economy improves, and that 
will tend to divert investors' interest from Treasuries.
    Mr. Ryan. I wonder if we are not a few years behind Great 
Britain with respect to the state of our finances? And what I 
mean when I say that is, they had a bond auction fail a month 
or two ago. Standard and Poor said yesterday that they are 
about to downgrade their credit, which I think has put a severe 
slump in their stock market today. They are basically saying if 
Britain does not get its finances their credit is going to go 
down.
    The question is, are we coming close to that moment here? A 
bond sale may not work, our credit is going to get downgraded. 
And the reason I ask you that is, in the context of your score 
of the President's budget which has passed and now is being 
implemented, our deficits never go below a 3 percent of GDP. We 
have a deficit this year of $1.8 trillion, $1.2 trillion you 
are saying next year. Our publicly held debt is going to 
triple, nearly, in about ten years. And now we are talking 
about creating a new entitlement program for everyone with a 
new healthcare option. And so the question is two-fold. Are we 
risking our credit? Are we going to have a problem selling our 
bonds? And if we create this new entitlement without fixing the 
other entitlements that are exploding? And we come up with a 
``pay for'' for this new entitlement that really does not track 
what the growth of this new entitlement?
    And that is one of my number of concerns. And I would like 
your comments on this. If we come up with a pay for for this 
new entitlement with a grab bag of revenue raisers, you know a 
MedPAC recommendation on Medicare payment reductions here, a 
loophole closer there, you know, a small tax change here, and 
they all culminate to get the $1.2 trillion that everybody says 
is needed to make this healthcare plan work, a lot of this 
stuff goes away but the entitlements grow. BBA 97, a perfect 
example, we had a lot of Medicare savings which led to the 
surplus, but Congress gave all that stuff back after, you know, 
people pounded on Congress to, you know, spend more.
    And so it looks to me like we are beginning to create a new 
entitlement without really actually paying for it, creating now 
a fourth unfunded entitlement liability. Given the state of 
that, given the state of your analysis says our deficits are 
never going below 3 percent of GDP, we are prone to create a 
new entitlement that probably will not be really, actually paid 
for. Britain could not sell their bonds, their credit is 
getting downgraded. Are we about to go down that path, in your 
judgment?
    Mr. Elmendorf. Well, could we put up slide twelve, which I 
think is good to look at as we have this conversation. Let me 
first tackle the forecast----
    Mr. Ryan. Yeah, I gave you four questions, there.
    Mr. Elmendorf [continuing]. As we have it, and then I will 
come to the new entitlement question. As slide twelve shows, 
this shows debt held by the public as a share of GDP over the 
last four decades and then looking ahead roughly a decade. The 
baseline projection is the solid line that is under current 
law. Even under that projection, as you have noted Congressman, 
the debt rises very sharply as a share of GDP. It rises to a 
level not seen since the 1950's when we were working down the 
debts accumulated in the Depression and the Second World War. 
U.S. debt peaked at a little over 100 percent of GDP at the end 
of the Second World War and then declined. But we are 
launching, with two successive years between them deficits of 
20 percent of GDP, the debt is rising by roughly 20 percentage 
points in GDP.
    Under current law the debt recedes again. But it is worth 
remembering that current law assumes that the 2001 and 2003 tax 
cuts expire. It assumes that the AMT remains as it is in 
current law. It assumes that other expiring tax provisions 
expire. It assumes the Medicare physician payments fall by 21 
percent next year and more in subsequent years. So it is the 
current law and our job is to follow that. But that list of 
factors embedded in current law I think suggests very clearly 
that that is not a path that will feel to most Americans like a 
continuation of what is happening now. It is a path that would 
feel like a tightening. That is what it requires to get to that 
dark line, which as you see leaves the debt as a share of GDP 
above what it has been at any point in my lifetime.
    The top line is our estimate of the President's budget 
released in March. That shows debt relative to GDP rising 
essentially because the annual deficits exceed the growth rate 
of the economy, and thus the debt rises. The budget resolution 
is the dashed line in the middle. There is no doubt, I think, 
that this is a worrisome picture. This is a grim outlook for 
the federal budget. And it poses the risk that you raise, 
Congressman, that at some point people may decide that the U.S. 
is not the safest haven.
    Now, I do not think that we are that close to that point 
right now. At the moment, the U.S. government can borrow money 
at incredibly low interest rates. Now there are special factors 
and those factors will wane, as we discussed. It is very 
difficult to assess how quickly they will wane. And there can 
be a range of views about that. I think in general--Rudi 
Dornbusch, who had been a leading international economist and 
passed away a few years ago, had a line to the effect of, when 
something is unsustainable it can go on longer than you would 
think possible and then swing more sharply and quickly than you 
thought possible. I think this may be a situation like that. It 
is hard to know when sentiment will turn, but it could turn 
quickly and that is a risk.
    Now on your question about the new entitlement, naturally 
given that picture policy changes that make the medium and long 
run budget deficit worse increase that risk that we have just 
discussed. Whether a particular piece of legislation does that 
is one that CBO will try to judge when the legislation is 
constructed. I do not think in principle it is a matter of 
whether you are paying for something in little pieces or big 
pieces. It is more a question, as I think you suggested, about 
the permanence of the various pieces.
    Mr. Ryan. Yes, the sustainability.
    Mr. Elmendorf. And that is a difficult thing to judge. We 
do not produce budget estimates that go out beyond ten years 
normally. I think that since that is the question you are 
getting at, if something can be paid for within ten years and 
not beyond that, and we do not normally produce formal 
estimates of that, I think it is appropriate for you and the 
other members to judge for yourselves what you think the 
political dynamic may be around certain changes that are being 
made.
    But I do want to say one quick positive word on behalf of 
changes in Medicare reimbursements. MedPAC, a congressionally 
established agency, studies very closely with a great deal of 
rigor the reimbursements in Medicare and the costs that 
providers receive. And we do not duplicate that work, but we 
have tremendous respect for what they do. I think in the cases 
where they think that there are overpayments in Medicare I 
would commend those to your attention because I think that it 
is important, although we talk now about trillions of dollars, 
obviously it is important not to lose sight of the billions of 
dollars that can legitimately be saved in terms of delivering 
health insurance in the most efficient possible way.
    Mr. Ryan. Thank you. I agree, basically, with your MedPAC 
point. From being on Ways and Means for a number of year now, 
what ends up happening is we might pass a MedPAC recommendation 
or two and what we find out is Congress then takes that away 
because of political pressures and time. And if we use those 
kinds of things to finance the creation of a new entitlement 
the funding stream is specious, in my opinion. Thank you, 
Chairman.
    Chairman Spratt. Ms. Schwartz?
    Ms. Schwartz. Thank you, Mr. Chairman. And thank you, Dr. 
Elmendorf. And I appreciate some of your both clear caution 
about where things are in the economy and on economic growth, 
but the positive feeling about the tax provisions, the tax cuts 
for 95 percent of Americans having an effect, and the fact that 
some of the dollars have already gone out fairly slowly, 
truthfully it has only been a couple of months.
    Mr. Elmendorf. Right.
    Ms. Schwartz. That is not in our timeframe really that 
slow. And for many of our states, we are seeing those dollars 
being not only announced but contracted, and so we will start 
to see them in a number of months.
    I wanted to follow a bit about something you touched on in 
the response to Mr. Ryan, and ask about it in a slightly 
different way, if I may. The President has made it very clear 
that in the economic recovery package we needed to make some 
real investments if we were going to both be more economically 
competitive, enable the private sector to really grow, and 
particularly I am talking about healthcare but energy is 
obviously an issue as well, and that both the effect on the 
economy and the effect on the federal budget requires us to 
tackle the growth in cost in healthcare in particular.
    And so what I wanted to ask you about is really to look at 
it a different way. If we do nothing, we are going to see quite 
substantial growth in healthcare costs. So the choice is to do 
nothing, either to help the private sector or businesses that 
are saying to us, ``We really need some action here to contain 
the growth of costs in healthcare, so that we can continue to 
provide those benefits and have some stability so that we can 
invest those dollars in other ways and produce those jobs.'' 
And secondly, for the federal government it is really not only 
a question about how do we address the issue that so many 
Americans spend dollars on healthcare, or we spend dollars on 
healthcare in very inefficient ways.
    The choice we are faced with is, do we do nothing? Or do we 
actually tackle this issue? And do we do it because of the 
concerns about the economy as well as the moral imperative 
around healthcare, and our own federal budget? So could you 
speak to two things? One, the consequences of doing nothing, 
and the growth that we might see, maybe you have a chart on 
this, if we do nothing in terms of the federal budget and our 
lack of economic competitiveness? And secondly, a maybe more 
insider discussion, but many of us believe, and I think you do 
as well, that certain investments in healthcare, particularly 
in redirecting dollars to primary care, to early intervention, 
to improving healthcare status of Americans and health 
outcomes, will in fact have a savings. It is difficult to 
score, as we say. It is difficult to calculate what those 
savings might be. But, again, to not do those things we are 
going to continue to see this unsustainable growth in cost. So 
if you could speak to both those aspects? Of doing nothing, and 
then also some of the investments we are making that in fact 
could have a really enormously positive effect on the rate of 
growth in cost, both for the private sector and for the federal 
budget?
    Mr. Elmendorf. Congresswoman, it is a widely held view 
among budget experts and experts about our health system that 
changes in that system are urgently needed. In contrast to, 
say, financial markets where things can change overnight, 
healthcare does not, and in that sense can appear to be less 
urgent. Next year will be much like this year. But in fact, the 
inertia in the way that system works is viewed by most analysts 
as an argument for urgent action. That the sorts of 
thoroughgoing changes that are desirable in the healthcare 
system in the views of most experts will not happen overnight, 
and one needs to therefore get started, most analysts will tell 
you.
    The reason these thoroughgoing changes are needed in the 
views of most analysts is not just that healthcare costs are 
rising, but that a lot of the money that is being spent on 
healthcare is viewed by experts as not contributing that much 
to people's health. And one of the most dramatic examples of 
this is that the amount of money that Medicare spends in 
different regions of the country, per patient, after 
controlling for differences in their ages and other aspects of 
their physical conditions, and after controlling for 
differences in underlying costs of living, Medicare will still 
spend much more, twice as much, in some areas of the country as 
in others. But the people do not seem to be any healthier in 
the areas where more money is being spent.
    So there is a widespread view that a lot of money going 
into the healthcare system is not being used very effectively 
in terms of producing good health as the outcome. And that fact 
combined with the rapidly growing share of the economy devoted 
to healthcare, leads many people to believe that urgent action 
is needed both on behalf of, from the private sector and for 
the government budget. And----
    Ms. Schwartz. But in the budget that we passed we actually 
have set out a course to tackle some of these issues. And that, 
in terms of greater efficiencies, the right kind of 
investments, both containing costs and expanding coverage--and 
my time is almost up. But if you could just, if you could say 
that that course of action, that we are going to take action 
and we are going to tackle these issues, would you say simply 
that that is an important path for us to be moving forward on 
so that we in fact are reducing costs, both for the government 
and for the private sector?
    Mr. Elmendorf. I think tackling, again a widespread view 
among experts that tackling those issues is very important and 
desirable. The precise nature of the tackling, however, is very 
important. And some aspects of the proposals being discussed 
would expand healthcare entitlement in this country. Other 
aspects of the proposals being discussed would generate 
efficiencies in how public money is used, and save public 
money. And the budgetary effects of this piece of the proposal 
can cut in different directions, and there are obviously many 
important considerations apart from the budget. So it depends 
how this shakes out.
    Ms. Schwartz. Maybe that is a topic for another hearing, 
but that is what we are working on, of course, to get that 
right both for our budget for the taxpayers and for the private 
sector. That is what our job is, and that is what we are 
working on. Thank you.
    Mr. Elmendorf. Thank you.
    Chairman Spratt. Mr. Hensarling?
    Mr. Hensarling. Thank you, Mr. Chairman. Thank you, Dr. 
Elmendorf. Following up on my colleague's questioning, I think 
everybody on the panel agrees that you will never control 
federal spending until you find a way to control healthcare 
costs. But my question is, if the administration's plan is 
supposed to save us money with various efficiencies, why did 
the budget include an approximately $600 billion line item for 
healthcare, and we were told that was merely a down payment?
    Mr. Elmendorf. Well, I cannot speak to the construction of 
the President's budget, of course. But nobody disputes----
    Mr. Hensarling. It sounds like a funny way to save money.
    Mr. Elmendorf. Nobody who has studied the problem disputes 
the fact that expanding health insurance coverage to a 
significant number of additional Americans could be done 
without spending federal money. I think nobody disputes the 
fact that there could be changes made in the way we run our 
current federal health programs, Medicare in particular, in a 
way that would save money. And as I suggested, there is a 
balancing of those actions that is up to Congress to decide. 
And as you note, the administration has clearly set aside in 
its budget a significant amount of money, a net to fund this 
program.
    Mr. Hensarling. Speaking of balancing, in your testimony 
you have, I guess on page seventeen, entitled a section, A 
Conflict Between Near Term and Long Term Fiscal Objectives, and 
you touched upon this subject earlier. I believe, Dr. 
Elmendorf, correct me if I am wrong, in your testimony you have 
stated that it is your opinion that the stimulus plan, that I 
guess borrowing the President's phrase, has helped create the 
little green shoots that you may see in the economy. Is that a 
fair assessment of your testimony today?
    Mr. Elmendorf. Well, we think on balance that the stimulus 
package will improve GDP. I do not want to link it to any 
particular piece of news.
    Mr. Hensarling. And if, as I understand it, though, you 
believe it can have a beneficial impact on the economy in the 
short term----
    Mr. Elmendorf. Yes.
    Mr. Hensarling [continuing]. But a detrimental impact in 
the long term, which I believe was contained in an analysis of 
a letter that you sent to Senator Grassley in March. Is that 
correct?
    Mr. Elmendorf. Yes, that is right.
    Mr. Hensarling. And I think you also testified----
    Mr. Elmendorf. Put up slide nine, and then you can see the 
point to which you are referring, Congressman.
    Mr. Hensarling. Please. Also, did I understand in your 
testimony--well, forgive me. When did you expect to see GDP 
growth turn positive?
    Mr. Elmendorf. We think it will turn positive later this 
year.
    Mr. Hensarling. Okay.
    Mr. Elmendorf. And that is the view we expressed in March 
as well.
    Mr. Hensarling. Okay, so you are projecting positive GDP 
for the latter part of this year. And when did you say, under 
your projections, that unemployment would peak?
    Mr. Elmendorf. Later next year.
    Mr. Hensarling. Later next year.
    Mr. Elmendorf. Traditionally in business cycle recoveries, 
the unemployment rate peaks maybe six to twelve months after 
output growth turns up again. In this particular case, we 
expect weak growth of output and thus a delayed turn in the 
unemployment rate.
    Mr. Hensarling. Well, here is my question, then, Dr. 
Elmendorf. Under your projections, we have positive GDP growth 
at the latter part of this year. We have unemployment peaking 
next year. You say the long term impact of the stimulus program 
could prove to be detrimental to the economy. Clearly, I 
believe you have said in your written testimony that any policy 
designed to provide short term fiscal stimulus will have to 
contend with the long term consequences. My question is this. 
The administration presented a ten-year, ten-year spending plan 
that spending dips to a low point of 22.7 percent of GDP in 
2012, after 2014 spending exceeds 23 percent of GDP through 
2019. We have not seen spending like this since World War II. I 
think under one of your slides the federal deficit decreases to 
about 2013, rises again, averages 5 percent of GDP over the 
ten-year budget horizon. By 2018 deficits exceed $1 trillion 
again.
    I mean the question is this, if you are predicting 
essentially that the economy is going to turn around in the 
next eighteen months, what economic rationale for the explosion 
of spending, debt, and deficits over a ten-year window?
    Mr. Elmendorf. Congressman, as I said in my remarks the 
widespread view among experts that deficits serve a useful 
purpose in recessions, equally widespread view among experts 
that persistent large deficits outside of recessions are 
damaging to a country's long run economic prospects. And I do 
not think anybody has actually defended those deficits over the 
ten years as a virtue. There is, obviously, an active debate 
about what changes in policy might be more or less desirable to 
put us on a different course.
    Mr. Hensarling. Well, they may not see the virtue but 
Congress just voted to approve it. I see I am out of time. 
Thank you, Mr. Chairman.
    Chairman Spratt. Mr. Becerra?
    Mr. Becerra. Thank you, Mr. Chairman. Dr. Elmendorf, good 
to see you. Thank you for your testimony. Actually, if you 
could put that chart back up that was just on, that would be 
helpful. Let me make sure I am settled on what I have heard you 
say in your testimony in response to some of these questions. 
The economic recovery package, which was deficit spending but 
at a time when we were seeing credit markets freeze up, when 
the economy was on a downward slide, jobs were being lost, 
deficit spending, so long as it is responsibly done, can help 
avoid a further fall and perhaps help us see the trough come 
sooner so we begin to see a pick up in the economy, with a pick 
up in economic activity, which means a pick up in jobs in the 
near term?
    Mr. Elmendorf. Yes, exactly.
    Mr. Becerra. And your chart begins to reflect that in 
showing that the drop that we are seeing in the economic 
activity concludes sooner as a result of the economic recovery 
package?
    Mr. Elmendorf. Yes.
    Mr. Becerra. And so, so long as that spending in the 
economic recovery package is smartly done, focused, and 
economists would agree that it is focused, we can have some 
reasonable projections by economists that we will begin to see 
an upturn in the economy? And there are some, in fact, signs 
right now that we may be seeing the end of the worst. Not that 
we are going to see sunshine over night, and blossoming of the 
economic flowers tomorrow. But we are beginning to see some 
signs that maybe there is the beginning of the end of this 
recession?
    Mr. Elmendorf. The rate of decline has lessened. So we are 
going downhill, but there are signs that we are reaching a 
leveling out. Now of course, people who know hills know 
sometimes it levels out and then worse things happen. Sometimes 
you turn up the other side of the valley very steeply and that 
is the uncertainty. But we are declining at a slower rate than 
we had been.
    Mr. Becerra. And so there are those who would have said, 
``Do not do this recovery package, do not do this.'' Who would 
have said, ``Let us just close our eyes. Let us not do 
anything. And let us just hope that this roller coaster that we 
are on that is going down actually ends and that we can survive 
the steep drop of this roller coaster. And if we just raise our 
hands and yell it will come to some conclusion on its own.'' 
That is a course we could have taken. And we at some point 
probably would have seen the economy recover on its own 
naturally. But we might have seen millions more Americans lose 
their jobs, thousands of other American businesses go under, 
and may have seen the suffering extended quite some time. So, 
so long as we have some smart spending it could help us out of 
this economic recession.
    Now on this chart I notice that that roller coaster drop 
did not begin on January 22, 2009 when President Barack Obama 
was sworn in. It actually began, I think the chart shows 
sometime around 2007. And so we were already on this roller 
coaster ride down not knowing how it was going to end, very 
steeply so, in fact steeper than any roller coaster ride we 
have been on in many decades, well before President Obama 
suggested we do this economic recovery package. I think 
President Obama was saying, ``For all of those who do not like 
the thrill ride of losing jobs and losing American businesses, 
let us try to get ourselves out of this sooner.''
    Now healthcare, you mentioned, could make things worse or 
make things better. There are some who, once again, will say, 
``Let us close our eyes. Let us not try to deal with this 
headache and heartburn that is now healthcare because too many 
Americans are not able to pay for their insurance, or get the 
coverage they want.'' Some Americans do not even have any of 
that whatsoever. And the President said, ``Let us move 
boldly.'' Now some folks say, ``We are not prepared to move 
boldly. We would rather have status quo.'' But the President 
said, ``We need to corral costs. There are ways to corral 
costs. You can still give people their choice of doctors but 
you can try to bring the price down of what they have to pay 
for.'' And there are a whole bunch of folks who cannot afford 
health insurance, and if we can get them to have health 
insurance they will make wiser spending decisions on their 
healthcare which could help us reduce the cost of overall 
healthcare.
    If we could do a smart program on healthcare, and I am not 
going to ask you to give us the elements of what smart 
healthcare reform would be, and I am not going to tell you what 
they would be. I am just going to ask, if we could be smart, 
the way I think we were smart in this economic recovery package 
to help with the recession, would corralling the cost of 
healthcare help us get out of this economic recession and also 
help us avoid the massive budget deficits we have been 
experiencing?
    Mr. Elmendorf. Reducing the path of federal spending on 
health costs is absolutely essential to bringing down budget 
deficits in the long run. If you look at the path of the 
deficit under, that we estimate for the President's budget, tax 
revenue is about the same share of GDP there that it has been 
on average historically in this country. All spending apart 
from social security, Medicare, and Medicaid is a smaller share 
of GDP than it has been for most of my lifetime. What is 
different about that, about the next ten years relative to the 
history, what gives the line that slope that it does, is 
basically rising health costs. So reducing the path of federal 
health spending is absolutely essential to the long run 
deficit, to addressing or solving the long run deficit problem.
    Mr. Becerra. Doing nothing keeps that line going down?
    Mr. Elmendorf. Yes. But one has to, as I have said, do the 
right sorts of things. So as you said, smart reform, and 
without either of us defining what that means in this context, 
the reform has to be one that reduces federal health spending 
over time.
    Mr. Becerra. Thank you. I appreciate it. Thank you, Mr. 
Chairman. I yield back.
    Chairman Spratt. Mr. Garrett?
    Mr. Garrett. Thank you, Mr. Chairman. I will have a couple 
of other charts if they can bring them up right now. Thank you, 
doctor. Earlier in January the chief economist to the President 
released a study entitled, ``The Job Impact of the Stimulus.'' 
And wow, the final bill was at that time still a month away 
from passage. The broad outline of the so-called stimulus 
package was already basically in that document, and they called 
for $775 billion. You know the final passage was $787 billion.
    Now in the study Drs. Romer and Bernstein said, ``A key 
goal enunciated by the President concerning the stimulus is 
that it should save or create at least 3 million jobs by 
2010.'' Now, disregarding for the moment the difficulty in 
measuring the number of jobs that have been saved, I do not 
know how anybody could explain that yet, by a particular action 
by the federal government, this was a key metric by which the 
incoming administration wished to measure the results of 
stimulus. Later in the report the authors provided a useful 
chart, there it is, from which we could visualize potential 
outcomes our economy would experience if we had stimulus and 
without it.
    [Chart]
    Mr. Garrett. If you look up on the chart there, with the 
recovery you see the bold line on the bottom. And without the 
stimulus plan you see things not going as well.
    Now on February 17th the stimulus became law. Later, after 
Congress had considered the legislation you folks at CBO issued 
a report on March 2nd outlining the bill's expected fiscal 
impact. And in that report you noted that CBO estimates that 
the stimulus will increase employment by .9 million to 2.3 
million by the fourth quarter of 2009.
    But now we have had a little over three months to evaluate 
the impact of this legislation and so far the results have not 
been all that promising. So let us look at chart two.
    [Chart]
    There we go. And as you can see, chart two shows where we 
really are. The actual unemployment rate jumped to 8.5 percent 
in March and then 8.9 percent in April. So this rate of job 
loss is considerably worse than what the President's top 
economic advisor predicted would happen without the stimulus. 
So just doing it on the back of an envelope here, unemployment 
would now need to drop a full percentage point in the next 
three months simply to catch up with the projections outlined 
in their initial document.
    So my first question, would you think that job creation of 
this magnitude, in other words dropping of unemployment by 1 
percent in three months, would that be totally unprecedented?
    Mr. Elmendorf. Well, as you understand, Congressman, 
everything about this sort of picture is uncertain. We do not 
know what would have happened without the legislation.
    Mr. Garrett. Right. But we know where we are now.
    Mr. Elmendorf. Yes.
    Mr. Garrett. And that is where we are now.
    Mr. Elmendorf. Yes.
    Mr. Garrett. We know what they said we were going to be, 
and that is what is up there as well. Now, my question to you 
is would dropping by one percentage point in order to get us 
down to where they say we should be in the next three months, 
is that something that has ever happened before? Is that 
unprecedented or is that what we should anticipate?
    Mr. Elmendorf. I am not sure if it has ever happened before 
but it would certainly be very unusual. And given the 
trajectory of the unemployment rate that you show the kind of 
reversal that would be required would be completely shocking.
    Mr. Garrett. Right. Okay. So, because the question on the 
other side was, ``Oh, it is between doing something and doing 
nothing.'' I have not heard anybody say do nothing. But now we 
can see what doing something did. Doing something put us at a, 
well----
    Mr. Elmendorf. But, I mean, doing something in combination 
with everything that was going on in the economy apart from the 
stimulus package. And my point I am trying to emphasize about 
the uncertainty of the economic forecast is that one could have 
drawn around that line that they graphed with or without a very 
large confidence region of the sort that I showed you around 
our forecast that would encompass a whole range of 
possibilities.
    Mr. Garrett. But, so they were wrong. And the projections 
of where we would be even with it, they were wrong. And the 
projections of where they would be without it, they were wrong. 
And where we are right now having done it, and spent almost 
$800 billion, we are in essence worse than where they project 
we would be even without doing anything. Just going by their 
projection.
    Mr. Elmendorf. Yes. We are, yes, the outcome has been worse 
than they projected at the time. As you know, our own March 
forecast was more negative than the forecast the administration 
formed earlier in the year.
    Mr. Garrett. The takeaway from your opening comments with 
regard to the stimulus is that the stimulus, I think you said, 
started out slow and then sort of petered out altogether by 
next year?
    Mr. Elmendorf. No, no----
    Mr. Garrett. Well, because you said that by next year you 
indicated that the stimulus would be winding down, was your 
words, and that----
    Mr. Elmendorf. Waning.
    Mr. Garrett. Waning.
    Mr. Elmendorf. So the peak effect of the stimulus on the 
level of GDP would be the end of this year.
    Mr. Garrett. And why is that?
    Mr. Elmendorf. And then----
    Mr. Garrett. Why do you say that? Because previously CBO 
testified that most of the money will not be actually out the 
door and onto the projects until 2010. So why is it that the 
peak positive effect is going to be this year if CBO testified 
that most, as a matter of fact I heard one person say that we 
will be celebrating the Fourth of July 2010 before most of the 
money will get out the door and actually in the ground doing 
projects?
    Mr. Elmendorf. So the stimulus legislation included both 
revenue and spending provisions. So in the estimate that we 
formed last winter, and I have in front of me the letter to 
Senator Grassley in March, we estimate that about three-
quarters of the total amount of money, tax cuts and spending 
increases, would have flowed out by the end of fiscal year 
2010, which is next September.
    Mr. Garrett. Right.
    Mr. Elmendorf. So three-quarters out by then. So the 
spending part, as I said earlier, lags the tax revenue effects. 
And that is why the spending is more lagged than the overall 
economic impact of the plan.
    I also want to be careful about stressing the fourth 
quarter of this year. The chart I showed looks just at the 
fourth quarters. So on a fourth quarter basis the biggest 
effect is this year and then it wanes next year. If we actually 
looked at this on a quarterly frequency, and I gave you a chart 
with more columns, we find a little more effect in the first 
half of next year, and then waning after that. So, but the 
effect on the level of GDP, it sort of goes up this year and 
then starts to come down later next year, and then wanes after 
that.
    Mr. Garrett. You know, Chairman Bernanke has come here 
before and he is a great historian on the Great Depression. And 
he educated us on the fact that during the Great Depression you 
had basically sort of two depressions. You had the original 
Depression most people know about, and then during the 
Roosevelt administration you have sort of a second Depression. 
And I am not saying that we are in a depression by any means. 
But hearing your testimony it almost sounds like we had the one 
recession and now we are going to have the next recession, 
potentially going forward.
    Mr. Elmendorf. So I think that is a risk. As I said, that 
is not our forecast, and it is not the consensus forecast. If 
you look at the, I think I have another chart which actually 
shows this. If you look at slide three you can see the 
forecast. These are private sector forecasts, something called 
the Blue Chip which surveys private forecasters. As you can see 
that for 2009, so I am looking now at the, let us look at the 
annual averages on the upper right corner. For 2009 all the 
forecasters, obviously expect a decline in GDP. For 2010 the 
most optimistic ten of this group of about fifty expect growth 
pushing 3 percent. The average is about 2 percent. And the 
bottom ten expect growth of 1 percent. So it is, I would not 
say that nobody predicts another dip in the recession next year 
but that is very far away from the consensus. The issue at 
hand, I think, is how quickly private demand rebounds. Whether 
it rebounds quickly enough to offset the waning of the effect 
of the stimulus package. And again our forecast, and almost 
everybody else's forecast, is that it does. But it is, as I 
have said, there are risks. And there is a risk of faster 
growth than people expect, of course. We have had faster growth 
than this in a number of previous recoveries. But there is also 
a risk of slower growth.
    Mr. Garrett. Right. Because that was your projection 
before, showing it going down. Thank you.
    Chairman Spratt. Mr. Doggett?
    Mr. Doggett. Thank you very much. When Dr. Peter Orszag 
appeared here in March I asked him to explain why President 
Obama believes that American families will be better served by 
auctioning 100 percent of pollution allowances instead of 
giving polluters ``pollute free'' cards. He responded that an 
approach which relies on giveaways instead of relying upon 
auctions would, ``represent the largest corporate welfare 
program that has ever been enacted in the history of the United 
States.'' Do you agree with him?
    Mr. Elmendorf. Yes, I do.
    Mr. Doggett. And on May 7th in your blog you discussed this 
and why simply giving away pollute-for-free allowances to 
certain industries does not work. That this would not hold down 
the price of the goods and services produced by these energy 
intensive manufacturers, and would only result in windfall 
profits for them which in turn would benefit the wealthy the 
most. Can you explain why the pollute-for-free approach would 
have such a regressive effect, and explain why the price of 
products to American families even after these pollute-for-free 
allowances are given out will not be held down?
    Mr. Elmendorf. Certainly. As I explain in testimony to the 
House Ways and Means Committee and also the Senate Finance 
Committee, the crucial aspect of the cap and trade program, or 
of a carbon tax, is to raise the price of carbon emissions. And 
that increase in price is created by the cap, the limit that is 
imposed. And that will raise the price of products that embody 
a lot of carbon emissions. And it is by raising the price of 
those products that businesses and households will change their 
behavior, develop new technologies in ways that economize on 
carbon emissions. That is the point of that sort of plan.
    When the government sets this cap, and then has a set of 
allowances to distribute, it is holding something of great 
value--because the ability to emit emissions will be valuable 
when the cap is set. And the distribution of those allowances 
matters critically for the distributional effects of the cap 
and trade plan.
    If you give an allowance to a business then it can use that 
allowance itself, or it can sell that allowance. In either case 
because the allowance has a price, that raises the cost of the 
business' activities. And it will pass that price along, in 
general, to its customers.
    Giving it an allowance with no strings attached does not 
prevent it from raising the price. It does not ensure that it 
continues to hire the workers it is hiring to do the production 
it is producing. It is just handing over a no strings attached 
gift. And that is the sense in which my more colorful 
predecessor used the term largest corporate giveaway.
    One can give allowances to companies with strings attached, 
and this is something I talked about in my testimony to the 
Senate Finance Committee. For example, linked to continuing 
employment or continuing a production in ways that would, that 
could in fact diminish the disruptive effects of the cap and 
trade system. But without any strings attached it just amounts 
to giving them money.
    Mr. Doggett. And do not giveaways to local utilities or 
local distribution companies just hoping they will pass along 
some of the benefit to the consumer, do they not have some 
similar problems?
    Mr. Elmendorf. Yes, similar. But because many electric 
utilities are regulated the ultimate effects depend on the 
specifics of regulation as they vary across the country.
    Mr. Doggett. On the other hand, if we fail to address this 
problem of global warming and climate change, has not CBO 
measured the effect on the economy and what we have real long 
term reduction in growth and economic reduction because of the 
effect of climate change on agriculture, fisheries, and a 
number of other industries?
    Mr. Elmendorf. As you know, Congressman, it is a very 
uncertain, there is a growing conviction and consensus that 
climate change aided by people's emissions of carbon dioxide is 
occurring, and it is occurring at a pace that will be very 
damaging to the natural world. The further link to economic 
conditions is a difficult one and one that is, I think, in its 
infancy of analysis. I think the consensus view is that climate 
change will have some costs for overall U.S. economic activity. 
In fact, the aggregate costs are much smaller than the costs 
for particular regions or sectors. Some parts of the country 
would be able to grow a wider range of crops, for example, and 
the people who own that land might become richer over time. 
Other parts of the country that, particularly say in the 
Southwest, would become drier, making growing much more 
difficult. So there is tremendous geographic differences, and 
sectoral differences depending on what part of the economy one 
is part of that are probably more important, in fact, than the 
aggregate economic impacts. And that is why, I think, most 
experts think it is appropriate for Congress to think about how 
to ameliorate some of those effects. It turns out that just 
giving over allowances without strings attached does not seem 
to be a particularly good one.
    Mr. Doggett. Mr. Chairman, just one quick healthcare 
question? Last week, as you are aware, a number of major lobby 
groups met President Obama, the health insurance lobby, the 
pharmaceutical lobby. And they said, ``We will do our part to 
achieve your goal to decreasing by 1.5 percent healthcare 
spending growth rates. And we will save you at least $2 
trillion.'' And then shortly thereafter at least one of those 
lobbies said, ``Our savings are not subject to the rigid 
scoring rules used by the Congressional Budget Office.'' Are 
not alleged savings that do not meet PAYGO fiscal 
responsibility rules truly illusory? And has not the 
Congressional Budget Office in the Budget Options document that 
you provided this Committee earlier in the year outline real 
ways to produce savings that could amount to $2 trillion, such 
as your $110 billion in savings by requiring manufacturers to 
pay a minimum rebate on drugs covered under Medicare Part D?
    Mr. Elmendorf. Yes.
    Mr. Doggett. Thank you. You want to add to that?
    Mr. Elmendorf. I would just say that we, one of the points 
to which I have testified several times about healthcare is 
that there is a widespread consensus, I think, around the types 
of changes that our health system should make to ensure that we 
are getting better value for our money. But much less agreement 
about exactly who should do what differently to which patients. 
And I think the question, I think this discussion among these 
representatives of the health sector with the President 
revealed both sides of that, essentially. That they came 
together with a widespread view that something different should 
be done, and I think some sense about the general direction. 
But much less specificity and willingness to be subject to----
    Mr. Doggett. Exactly.
    Mr. Elmendorf [continuing]. Particularly changes affecting 
particular providers over any sort of predetermined time 
period. And I think that is the fundamental challenge in 
healthcare reform, is to develop the specific approaches that 
one could have confidence will lead to great efficiency and 
save money.
    Mr. Doggett. Thank you. Thank you, Mr. Chairman.
    Chairman Spratt. Thank you, Mr. Doggett. I give you credit 
for being a better trial lawyer. You got your answer, and you 
still wanted elaboration. Mr. Diaz-Balart?
    Mr. Diaz-Balart. Thank you, Mr. Chairman. Good to see you, 
sir.
    Mr. Elmendorf. Thank you.
    Mr. Diaz-Balart. Your predecessor and current OMB Director, 
Mr. Orszag, testified on September 18th, and I am going to 
quote him. He said speaking about energy, ``Decreasing 
emissions would also impose a cost on the economy.'' He went on 
to say that much of those costs would be passed along to 
consumers in the form of higher prices for energy and energy 
intensive goods. On March 17th, Energy Secretary Chu testified 
before the Science Committee and he said, ``The cap and trade 
bill will likely increase the cost of electricity,'' to the 
point where he advocated adjusting for trade duties, etcetera. 
The Secretary also testified, ``If other countries do not 
impose a curb on carbon then we will be at a disadvantage.'' Do 
you disagree with any of those statements by Secretary Chu or 
by your predecessor Mr. Orszag?
    Mr. Elmendorf. I think I agree with all of them. CBO has 
been very clear that a cap and trade system or a carbon tax 
would raise the cost of carbon emissions, and the cost would 
ultimately be borne by households. It is also widely understood 
that if we raise the price of carbon emissions and our trading 
partners do not, that creates an additional challenge for our 
carbon emitting industries. A number of foreign countries, of 
course, are imposing caps on their emissions or taxes or 
establishing cap and trade systems, or in other ways moving 
down this path. But I think again it is not controversial that 
other countries would need to be brought into such a system, or 
that some sort of adjustments would need to be made at the 
border as affecting trade, or that some other thing would be 
done for domestic producers to try to redress the imbalance 
that would create.
    Mr. Diaz-Balart. Right. Because otherwise, you agree that 
otherwise it would put us at a disadvantage. So if China and 
India, as they have stated, do not do it and we do, that would 
put us at a disadvantage?
    Mr. Elmendorf. If we just put the price on carbon emissions 
and do not either get other countries on board or do some 
adjustments at our border to address that differential or do 
anything else to help those manufacturers, then they would be 
at a disadvantage. But I am trying to suggest here there are 
several courses of action that could be taken.
    Mr. Diaz-Balart. Sure, absolutely. Now, have you had a 
chance to, you know, the President has mentioned Spain as one 
of the countries that the United States needs to look at and 
follow. As you know, they are number one in green jobs. They 
went, however, from being a country a few years ago that 
created more jobs than Germany, France, and Italy combined, to 
now be the country that has lost more jobs than Germany, Italy, 
and France combined. There are a number of factors, obviously. 
It is not just their energy policies. But clearly, I think 
there is a consensus that their energy policy has been a major 
factor in losing jobs. Have you had an opportunity to study the 
Spain example? By the way, they are also now having blackouts, 
which is, I grew up in Spain. It is hard to believe that an 
industrialized country like that would now have to impose, you 
know, shut off electricity at certain times of the day to 
industry. But have you had an opportunity to look at that?
    Mr. Elmendorf. So Congressman, I do not know much at all. I 
now learned a fair bit about the Spanish situation. But I want 
to emphasize, read a line from testimony I gave on cap and 
trade a few weeks ago. ``CBO expects total employment to be 
only modestly affected by a cap and trade program to reduce 
greenhouse gas emissions.'' And we go on to explain that, 
except during recessions of course, most Americans who are 
interested in working can find a job. And that is a very 
desirable feature of our labor market and economic system. The 
biggest effects of cap and trade are felt regionally and in 
particular sectors. And the transition from current patterns of 
employment toward the patterns of employment that would prevail 
if we had a price on carbon that then changed our output and so 
on, it is the transition that can be costly, particularly to 
the workers who are most affected. And I think most economists 
would say that it is not that green jobs are necessarily better 
or more numerous, but it is the case that the whole nature of 
trying to limit carbon emissions is trying to change the 
production structure of the economy, and so that some jobs are 
lost and some jobs are created. And it is the process of 
helping workers or communities move from one world to the other 
that is disruptive and that warrants the attention of policy 
makers.
    Mr. Diaz-Balart. I just wanted to, it is important to look 
at Spain as an example. The President himself has mentioned 
Spain as an example, and Spain now has 18 percent unemployment, 
forecasted to go to 20 percent. So I think we just need to make 
sure that we look at that, and I hope you have an opportunity 
to do so. And Mr. Chairman, I know my time has expired. Thank 
you, sir.
    Mr. Yarmuth. Thank you, Mr. Chairman. Welcome back, Dr. 
Elmendorf.
    Mr. Elmendorf. Thank you.
    Mr. Yarmuth. Referring to Mr. Garrett's questioning about 
the effects of the Recovery Act, he made the statement, 
``having spent $800 billion.'' That is not an accurate 
statement, is it? I mean, we have not spent $800 billion.
    Mr. Elmendorf. No.
    Mr. Yarmuth. Approximately how much of the total 
appropriation have we spent?
    Mr. Elmendorf. To date the amount spent is quite small. I 
think I have that number with me. I do not have it at hand. 
Only a very small fraction of the spending has gone out the 
door. I think that has sometimes raised questions, but as I 
said it is not surprising to us.
    Mr. Yarmuth. So while that, the chart he showed about 
employment may indicate that the projections so far have not 
been what they were projected to be before the stimulus 
package, it is a little bit premature, would you not say, to 
project what the ultimate outcome in terms of employment for 
the country will be?
    Mr. Elmendorf. Yes. Absolutely. As I tried to suggest 
before, the crucial question is what would have happened 
otherwise? And that cannot be directly observed, and you 
cannot, as I said in my opening remarks, in our forecast the 
persistence of high unemployment is not because the stimulus 
did not work. It is because there were larger offsetting 
forces.
    Mr. Yarmuth. Right. I want to go to the question of, a 
related question about employment. I have a brother who is in 
the barbecue business. And he has done very well over the years 
in the barbecue business, and he has always been very concerned 
about his tax rate. And last year, I talked to him last fall 
and he said he had had an epiphany of sorts. And he said he 
realized that unless people could afford barbecue it did not 
really matter what his tax rate was. And in a sense, we are in 
that same position that he is in as the government. Unless 
people make money, and create income and so forth, we are not 
going to have any revenues to do anything. So my question is, 
looking at the forecast in terms of spending, you spent a lot 
of time on consumer spending but very little on wage and income 
in terms of projections. Do you have projections about when per 
capita income in this country will increase, and what the long 
term projection for that is? Because we know over the last 
seven or eight years that there has been a real decline in 
average income.
    Mr. Elmendorf. Let me put up slide four, which does not 
quite answer your question, but it starts in that direction and 
I will try to add to that. Slide four shows overall income from 
wages and salaries and overall disposable income. So wage and 
salary income is the bottom line. As you can see that has been 
declining for the last couple of years. That is just a 
reflection of the weak labor market. Disposable income at the 
top has done better. The little tent that you see in 2008 owes 
importantly to the rebates passed last year. And the turn up at 
the end owes, this predates, the data point here predates the 
effect of the stimulus so it really is the, but it owes 
importantly to the larger social security cost of living 
adjustments at the beginning of the year and so on.
    This chart does not show projections, and I do not have 
them offhand. One very important risk in the economic forecast 
is how long labor market weakness persists, and how that 
affects income, and how that affects the ability of households 
to spend. And although the spending data, since our March 
forecasts have been pretty closely aligned with what we had 
expected, the labor market has looked weaker. And the 
employment loss last month was very large. Initial claims for 
unemployment insurance remain quite high, including this 
morning's data. And the longer that persists and the more that 
drains income from households, the worse the economic prospects 
are.
    You also raise, I think, a different, important issue. 
Which is that these are aggregate numbers, the economy as a 
whole. The distribution of income, of course, has become much 
wider over the last several decades. And that means that the 
income of the typical person has not necessarily tracked the 
overall income. And that is probably being reversed to some 
extent during this economic downturn, particularly with 
problems in the financial sector which was a source of some of 
those very high incomes. But I do not think anybody expects 
that it is being completely reversed. And that is, I think that 
is an important issue for policy makers to consider. It is not 
one that is very readily addressed through macroeconomic 
policy, the actions of the Federal Reserve, or the amount of 
federal spending and taxes, although there are more specific 
changes in spending and taxes that one may make to address 
that.
    Mr. Yarmuth. Good. Thank you very much.
    Chairman Spratt. Mr. Langevin?
    Mr. Langevin. Thank you, Mr. Chairman.
    Chairman Spratt. I want to remind you we have got about 
nine minutes to make it to the floor for three votes. And I 
will stay here for along enough so that both you and Mr. 
Etheridge can pose questions, but we are going to have to 
hustle to the floor. Mr. Langevin?
    Mr. Langevin. Thank you, Mr. Chairman. And Dr. Elmendorf, 
thank you, welcome back here. I would like to turn I think it 
is to slide twelve. This is debt held by the public 1965 to 
2019. So I think it is the last slide in the pile.
    Mr. Elmendorf. Yes.
    Mr. Langevin. Can you just give us a little bit more 
perspective in terms of what went into coming up with these 
percentages? And what will the practical effects be on each of 
these levels? On the economy, interest rates, and such, or the 
fall out if, you know, each of these were to, at each level 
were to come to pass?
    Mr. Elmendorf. So the baseline projection follows current 
law.
    Mr. Langevin. And if you could also talk about maybe some, 
you know, maybe some historical or practical effects of the 
countries that have had publicly held debt that high at levels 
of GDP?
    Mr. Elmendorf. So the baseline projection follows current 
law. Obviously, debt jumps quite sharply in these couple of 
years with very large deficits because of the recession and 
because of the policy actions that have been taken. It jumps to 
a level above what we have seen for some time. Not a level that 
is out of the ordinary of other countries, I would say. And we 
have some advantages over other countries, in that our 
financial markets are viewed, despite their problems, as a 
relatively safe place to put money. And our Treasury securities 
are viewed as a particularly safe to put money. That vantage 
could be squandered. I do not think most experts would say we 
are at that point yet.
    The highest line, our projection of what would happen to 
debt under the President's budget, does push our debt up to 
levels that are, have been seen by other countries but are not 
common. And the slope of that line, of course, as one that 
beyond this picture comes into greater population aging and 
continued rising health costs I think is a very grim picture. 
And under that, we are in the process right now of producing a 
formal analysis of the economic effects of the President's 
budget which we plan to release next month. But qualitatively, 
that path certainly would lead to higher interest rates, less 
capital accumulation, less long term growth than the lower 
path.
    Mr. Langevin. Okay. Thank you. Let me just talk about the, 
obviously, the economic downturn and some of the responses that 
Congress and the administration have enacted, TARP, and the 
American Recovery and Reinvestment Act. In your estimation, 
which of the federal responses to the financial and economic 
turmoil have shown the most success in containing and 
alleviating the crisis? And thinking more broadly, what 
additional government measures really need to be taken to 
address both the housing and the financial crisis?
    Mr. Elmendorf. I think most experts would say that the 
collection of policy measures taken was important. And that the 
different policy measures address different aspects of the 
problem. That an overall weakness in private demand, and 
household and business spending, is being offset to some extent 
by the greater government spending and lower taxes. And that 
most experts would have said was the role of fiscal policy. At 
the same time, this particular recess we have a very serious 
financial system problem. And the actions of the Federal 
Reserve and the Congress through the TARP and the Fannie Mae 
and Freddie Mac, and so on were focused on those problems. And 
I think, again, most experts would say that one needed the 
combination of actions to address the different aspects of the 
underlying problem.
    I think further actions at this point, you know, the 
administration is trying to implement a plan to reduce mortgage 
foreclosures. Analysts have wrestled now for two years with 
what one might do, or a year and a half at least, one might do 
on the housing, on the foreclosure front, and it is a very 
difficult problem to solve. And it is difficult for various 
reasons, including particularly that underwriting standards, 
the standards for getting into housing became so lax that there 
are unfortunately a significant number of people who are in 
houses that they cannot reasonably afford. And they were 
counting on appreciation or other good things to happen that 
are not happening. So not everybody who is in a house can 
plausibly stay in it.
    Moreover, among those who with some amount of help might be 
able to stay in a house in a way that might be viewed as 
socially beneficial, helping them also changes the incentives 
of all the other people who are currently struggling but 
meeting their mortgage payments. And that one can actually, the 
cost to the government in even the number of foreclosures might 
rise sharply if one designed a plan to help some people that 
ended up providing incentive for others to engage in behavior 
that is less desirable. So it is a real, it has been I think a 
very problematic area for analysts who have tried to develop 
better solutions and have been unable to.
    Mr. Langevin. I will have some other questions for the 
record but I see my time has expired, so I yield back. Thank 
you.
    Mr. Elmendorf. Thank you, Congressman.
    Chairman Spratt. Mr. Etheridge?
    Mr. Etheridge. Thank you, Mr. Chairman. I just have one 
question. I mean, you may have covered it indirectly, because 
being in a state where unemployment has doubled in the last 
twelve months. We are the fourth highest in the nation, now, 
North Carolina. And, you know, all these things we talk about 
in the future, folks at home are not really concerned about 
that. They are worried about where they are right now. They are 
in a depression, those who have lost their jobs. In your 
professional opinion, given all the factors, because we have 
probably one of the worst economies in North Carolina in the 
country, from manufacturing automotive parts, to housing, 
etcetera, what are your best guesses as to when we are going to 
start seeing unemployment change and go down rather than go up? 
Because that is a critical issue that I hear every weekend. And 
I am sure next week I am going to get it everyday.
    Mr. Elmendorf. So I wish I had better news for you, 
Congressman. In our March forecast we thought that unemployment 
would peak in the first half of next year at around 9.5 
percent. If we were writing down a new forecast today we would 
put off that peak and we would raise it. So that we would now, 
currently we expect the unemployment rate might peak around 
10.5 percent in the second half of next year.
    Now a lot can, we will learn a lot more before we actually 
write down the forecast in August. And the worsening in the 
last few months in our outlook, you know, just reveals the 
uncertainties that surround this. But we think it will be a 
slow, a painfully slow recovery because there is still a 
substantial overhang of housing. Because the financial system, 
although it has crawled back from the edge of the abyss is 
still in a weakened state. Because households have lost a lot 
of wealth through house prices and stock prices, and thus will 
be pulling back on their spending. Because economies around the 
world and thus the demand for our products remain weak. And all 
those factors we think will lead to a tepid recovery, and 
somewhat more tepid than we thought when we assessed conditions 
a few months ago.
    Mr. Etheridge. Thank you, Mr. Chairman. I would like to go 
further but I know we are running out of time. But thank you.
    Chairman Spratt. Thank you, Mr. Etheridge. And Mr. 
Elmendorf, thank you very much for your excellent testimony and 
for your very responsive and complete answers. We will be 
working with you further on these issues, and we will probably 
want to do this again in the next quarter.
    Mr. Elmendorf. Thank you, Mr. Chairman.
    Chairman Spratt. Thank you very much indeed.
    [Questions for the record submitted by Ms. Kaptur follow:]

 Questions for the Record From Hon. Marcy Kaptur, a Representative in 
                    Congress From the State of Ohio

    Question 1: What is the projected effect on the economy of sending 
both Chrysler and GM into bankruptcy in the short and long term?

    It is impossible to distinguish the direct effects of bankruptcy 
from the underlying near-term difficulties faced by the auto industry 
in general, and by Chrysler and GM in particular. Assessing the longer-
term impact is even more difficult.
    The recession has sharply reduced vehicle sales, forcing the 
industry to shrink in order to regain profitability. However, the best 
estimate based on analysis conducted by others--most notably Goldman-
Sachs--suggests that the effects on the overall economy of chapter 11 
bankruptcy filings by the two firms are likely to be relatively small. 
Some vehicle sales may have shifted away from GM and Chrysler and 
toward Ford and one of the transplant manufacturers (such as Toyota). 
Since the vehicles produced by the transplant manufacturers have 
somewhat smaller domestic content than those produced by the Detroit 3, 
this would slightly reduce U.S. output of motor vehicles and parts. In 
addition, the uncertainty surrounding the fates of the two 
manufacturers may have temporarily depressed total vehicle sales while 
prospective vehicle buyers decide whether to go ahead with their 
planned purchases of GM and Chrysler products, wait until the future of 
the manufacturers is clearer, or buy a vehicle from Ford or one of the 
transplant manufacturers. Assuming that Ford and the transplants would 
split those sales in proportion to their current shares of the rest of 
the market each reduction of 10 percentage points in Chrysler and GM's 
combined market share due to the bankruptcy filings might reduce U.S. 
output of motor vehicles and parts by less than 1 percent.
    The impact on jobs is potentially somewhat larger, though again 
difficult to distinguish from underlying trends in the industry. 
Through April, employment in the motor vehicles and parts industry was 
already down by nearly 400,000 (37 percent) from its average level in 
2006, and employment at auto dealers was down by about 190,000 (15 
percent) over the same period. Following the bankruptcy filing by 
Chrysler, employment in May fell by an additional 30,000 in the auto 
industry and 7,000 among auto dealers (although it is not clear how 
many of these additional losses are directly attributable to Chrysler's 
filing and the subsequent idling of assembly plants). Chrysler has 
since emerged from bankruptcy, and a number of the idled plants have 
re-opened or are expected to in the near future.
    Plans submitted by GM and Chrysler will result in direct headcount 
reductions of nearly 40,000 by 2011, and the elimination of dealerships 
could, according to the analysis by Goldman Sachs, cost about another 
160,000 jobs. That analysis suggests that the total number of job 
losses could rise to as much as 400,000 after taking into account 
effects throughout the supply chain and, possibly, local multiplier 
effects. Further direct cutbacks at GM and Chrysler cannot be ruled 
out. But in light of the industry's difficulties, it's likely that many 
if not most of these jobs would have been lost even without a 
bankruptcy filing. As the economy recovers, however, the increased 
sales projected for Ford and the transplants should eventually result 
in some job creation, offsetting at least some of the lost jobs at GM, 
Chrysler, and their dealers and suppliers.
    Even under strong assumptions about changes in market share and 
possible job losses, the near-term impact on real gross domestic 
product should be small. Moreover, the bankruptcy process allows GM and 
Chrysler to control costs, permitting the viable parts of the companies 
to continue operating while freeing up resources that had been put to 
unproductive uses.

    Question 2: What is the projected effect of the continuing rise in 
the cost of a barrel of oil on the US economy?

    The price of oil has risen sharply in the past few months, driven 
in part by expectations that the global recession may be easing and the 
rate of inflation may be higher. The price of West Texas Intermediate 
crude oil has risen by about 50 percent this year to about $72, about 
half of its peak value of $145 of last year and close to its level in 
early November. The futures market expects the price to rise to about 
$75 by year-end and about $80 by the end of next year. The increase in 
the price to date has very likely raised the share of national income 
that is spent on oil imports, which acts like a tax on U.S. consumers, 
and slightly reduced the pace of economic activity.

    Question 3: The dollar's value has dropped during this financial 
crisis. Could the dollar continue to drop and what effect will that 
have on the economy and our deficit?

    Between February of 2002 and April 2008, the dollar's exchange 
value was falling in response to the continuing large deficit in the 
nation's current account balance. The dollar's exchange value reversed 
course and began to rise sharply thereafter, due to international 
investors' demand for safe-haven assets during the financial crisis as 
well as to U.S. companies' sales of foreign assets in their attempt to 
deleverage. Since March of this year, however, the dollar has declined 
slightly as the financial crisis has abated somewhat.
    If the financial crisis and the global economy continue to 
stabilize and recover, the short-term support for the dollar is likely 
to give way to the downward pressure exerted by long-term factors--
namely, the large current account deficit and U.S. net international 
liabilities. A gradual depreciation of the dollar, if sustained, will 
help to boost U.S. net exports and economic activity and narrow the 
current account deficit in an orderly fashion. An abrupt fall of the 
dollar will also help to boost U.S. net exports, but it will also 
subject the economy to risks of suddenly higher inflation and/or 
interest rates.

    Question 4: Has CBO done any analysis of the potential outcome if 
U.S. Treasury securities are not considered a safe haven in times of 
trouble, and if so, what was the result?

    CBO has not formally analyzed a scenario in which Treasury 
securities would no longer play a safe haven role. In CBO's view, the 
extent to which U.S. Treasury securities are considered a safe haven is 
closely tied to the U.S. dollar's role as the major reserve currency--
the dominant currency used for international transactions and held in 
reserves by major financial institutions around the world. For example, 
the U.S. dollar was involved in almost 90 percent of all foreign 
exchange transactions in 2007, and about two-thirds of the currency 
reserves of global central banks remain in dollars.\1\ Because of the 
size of the U.S. economy and financial markets relative to other 
economies, the dollar is expected to remain the reserve currency for 
years to come. Even though the euro may potentially rival the dollar as 
the global reserve currency at some point, at the present euro-area 
capital markets still lack the depth of U.S. markets.
---------------------------------------------------------------------------
    \1\ See Triennial Central Bank Survey 2007, Bank of International 
Settlements, December 2007, for the figure on foreign exchange 
transactions, and http://www.imf.org/external/np/sta/cofer/eng/
cofer.pdf for the most recent figures by the IMF on foreign currency 
reserves.
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    Nevertheless, the sustainability of the dollar's reserve-currency 
status cannot be taken for granted. If the U.S. indebtedness to 
foreigners were to keep rising relative to GDP, it is likely to erode 
the dollar's role as the main international reserve currency. If the 
dollar's reserve-currency status is sufficiently eroded, some of the 
advantages that accrue to the United States from that special role of 
the dollar--such as less costly financing of US spending and a more 
stable dollar exchange rate than otherwise--will also be notably 
diminished.

    Question 5: What actions can the Federal Reserve take to 
effectively return its balance sheet to about $1 trillion without 
negatively affecting the economy?

    The Federal Reserve's balance sheet is currently over $2 trillion, 
more than twice as large as it was before the crisis began in August 
2007. About $750 billion is allocated to relatively shorter-term 
lending such as central bank liquidity swaps, term auction credit and 
commercial paper. As the economy and credit markets return to health, 
the amount of shorter-term lending should decline in an orderly manner 
as existing loans mature and market participants find they can again 
obtain credit from markets at lower cost. Indeed, that process appears 
to be happening now.
    However, the composition of the balance sheet is shifting to a 
higher share of longer-term assets as the Federal Reserve continues to 
purchase Treasury, agency and mortgage-backed securities. Currently, 
about $1.25 trillion of the balance sheet is composed of those 
securities, along with small amounts of other long-term assets. For the 
Federal Reserve to reduce its balance sheet using its current operating 
procedures, it would likely have to sell some of those longer term 
securities. Many analysts expect that such selling will have to be done 
at a fairly deliberate pace so as not to flood markets with an excess 
supply. The risk is that the size of the balance sheet may constrain 
the Fed from tightening as rapidly as it otherwise would choose. Under 
this constraint, monetary policy might initially be too loose once 
economic recovery starts.
    As an alternative to shrinking the balance sheet, policymakers 
within the Federal Reserve System have suggested that the Fed itself 
issue longer-term debt. With funding locked in through longer-term 
debt, the Fed could increase its policy rate without concern about 
funding its balance sheet. A change in current law is necessary before 
the Fed would be allowed to issue longer-term debt.

    Question 6: Does the CBO analysis of the budget include any 
institutions repaying any of the TARP funds, and why or why not?

    The analysis of the TARP that CBO presented in its March 2009 
baseline did not assume any early repayments of TARP funds. At the time 
of that analysis, the Treasury had indicated that it was not favorably 
disposed to accepting repayments before the initial three-year holding 
period (as specified in the Treasury's term sheets) had passed. We had 
also assumed that most institutions would be unable to meet the 
Treasury's requirement for early redemption--selling equity to private 
investors.
    As of May 27, more than 20 small community banks had repaid TARP 
funds in the amount of approximately $1.7 billion. Since then, the 
Treasury has confirmed that ten of the largest banks to have received 
TARP funding have been cleared to begin repayments. Should all of those 
banks do so, the total level of repaid TARP funds would rise to about 
$70 billion. We are in the process of modifying our current analysis to 
appropriately account for repayments.

    Question 7: Has CBO examined the effect of the TARP dollars on the 
economy overall? Is there any way to quantify TARP's effect on the 
recovery, be it good or bad?

    CBO has not explicitly examined the effect of the TARP on the 
overall economy. Spending by the TARP has primarily been used to assist 
the financial and automotive sectors with additional money set aside 
for housing initiatives. While we can estimate the positive effects of 
the economic stimulus bill, trying to quantify the effects of the TARP 
on financial markets is difficult because so many other factors are 
affecting those markets. For example, actions by the Federal Reserve 
(some of which were fostered by the TARP), are undoubtedly playing a 
big role in the recent improvement in financial markets, as is the 
FDIC's guarantee program for bank debt.
    Nevertheless, few would disagree with the view that the provision 
of capital by the TARP helped to strengthen the banks and restore 
confidence in the banking system. At the height of the financial crisis 
last year, when accessing private capital markets was very difficult, 
some of the recipient banks would have had to cut back lending to meet 
their capital requirements in the absence of TARP money. The amount of 
loans and leases at large banks has fallen since October 2008, but that 
should not be taken to mean that the TARP was necessarily a failure. 
Without the TARP, banks probably would have reduced their lending by 
much greater amounts and our economy would be even weaker. Moreover, 
demand for credit declines in a recession, so looking at the changes in 
the actual amount of credit provided is a misleading indicator of 
TARP's effects on the financial system.
    Now that conditions in financial markets are improving and there is 
some clarity to banks' capital needs, some banks are again raising 
private capital. Bloomberg reports that financial institutions raised 
nearly $80 billion in the first quarter of 2009. Some of that money 
will be used to repay the TARP money to the government, but the amount 
of capital in the banking industry should increase, which will give the 
industry greater ability to support an economic recovery.
    The economic impact of the assistance to Chrysler and General 
Motors (GM) is difficult to estimate because it is impossible to know 
how the situation would have otherwise played out. Federal assistance 
gave Chrysler and GM some time to arrange for an orderly resolution of 
its difficulties, which very likely preserved some jobs at least 
temporarily. The firms' creditors might have responded differently in 
the absence of their expectations of federal assistance. Perhaps they 
would have been more agreeable to debt for equity conversions.
    The longer-run effects of the TARP depend on how productive that 
spending was relative to the cost of financing the additional debt and 
on other behavioral effects. For example, rescues of financial 
institutions and assistance auto manufacturers may reduce market 
discipline by undermining creditors' monitoring incentives and 
encouraging large ``too big to fail'' institutions to take on more 
risk. If those behaviors impair the market's ability to reward 
efficient companies and penalize inefficient companies, capital may be 
misallocated and future living standards lowered. Many analysts believe 
that the longer the government remains an owner, the greater the risk 
that politically determined allocations of capital rather than market-
based decisions will guide the firms. This concern is especially 
pertinent to the auto manufacturers, whose competitiveness has been 
declining for many years.

    Question 8: Has the CBO assessed the health of the Federal Reserve? 
If so, what was the result?

    In the process of putting together the estimate of the baseline 
federal budget, CBO must project the Federal Reserve's remittances to 
the Treasury. Those remittances depend on not only the income that the 
Federal Reserve receives on its assets, but also its payments on 
liabilities. (Since October 2008, the Federal Reserve has paid interest 
to banks on the reserves they hold with the Federal Reserve.) In our 
last baseline projection, CBO projected that the Federal Reserve would 
not experience net losses on its portfolio of assets, even though the 
Federal Reserve has experienced some losses on a few types of 
assets.\2\ The Federal Reserve is holding a riskier portfolio of assets 
than it did before the financial crisis, but it has taken precautions 
to limit its exposure to losses.

    \2\ Congressional Budget Office, A Preliminary Analysis of the 
President's Budget and an Update of CBO's Budget and Economic Outlook 
(March 2009).
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    Question 9: In your testimony, you state ``Indeed, economic 
recovery may be necessary for the full recovery of the financial 
system, rather than the other way around.'' When do you expect a full 
recovery, or when do you expect enough recovery to instigate a full 
financial recovery?

    When CBO published its last economic outlook in March, we expected 
the current recession to end in the fall of this year. (The consensus 
forecast of private economists currently points to an end of the 
current recession in the third quarter of this year.) We expected the 
recovery of the economy to proceed slowly and extend into late 2010, in 
part because of the weakened state of the financial sector.\3\ Because 
it generally takes several quarters of solid growth for financial 
institutions to see sustained improvements in their profits and capital 
positions, CBO also expected the recovery of financial markets to 
proceed slowly.
---------------------------------------------------------------------------
    \3\ The recovery period is the length of time it takes for real 
output to return to its peak before the recession.
---------------------------------------------------------------------------
    What, if any, policies can be enacted to further encourage full 
economic recovery? At this point, it is not clear whether policymakers 
will need to consider enacting more economic stimulus. The full impact 
of the American Recovery and Reinvestment Act of 2008 has yet to be 
felt because only a portion of the $787 billion has been spent. Any 
need for additional stimulus would be more evident when the effects of 
the ARRA begin to wane next year.
    Should we wait on financial institutional reform for a full 
recovery?
    Policymakers do not need to wait for a full recovery of the 
financial sector in order to strengthen the regulatory oversight of the 
industry. There is rarely a bad time to put in place safeguards against 
excessively risky lending practices.

    Question 10: Has CBO analyzed, assessed, or examined the potential 
creation of a systemic risk regulator and the resulting effects on the 
financial industry and economy?

    No. The Administration released its proposal on June 17th and 
others may follow.

    [Whereupon, at 11:38 a.m., the Committee was adjourned.]

                                  
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