[Senate Hearing 110-884]
[From the U.S. Government Publishing Office]
S. Hrg. 110-884
THE ECONOMIC OUTLOOK AND OPTIONS FOR STIMULUS
=======================================================================
HEARING
before the
COMMITTEE ON THE BUDGET
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
----------
November 19, 2008--THE ECONOMIC OUTLOOK AND OPTIONS FOR STIMULUS
The Economic Outlook and Options for Stimulus
THE ECONOMIC OUTLOOK AND OPTIONS FOR STIMULUS
S. Hrg. 110-884
THE ECONOMIC OUTLOOK AND OPTIONS FOR STIMULUS
=======================================================================
HEARING
before the
COMMITTEE ON THE BUDGET
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
__________
November 19, 2008--THE ECONOMIC OUTLOOK AND OPTIONS FOR STIMULUS
Printed for the use of the Committee on the Budget
U.S. GOVERNMENT PRINTING OFFICE
47-518 WASHINGTON : 2009
-----------------------------------------------------------------------
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; (202) 512�091800
Fax: (202) 512�092104 Mail: Stop IDCC, Washington, DC 20402�090001
COMMITTEE ON THE BUDGET
KENT CONRAD, NORTH DAKOTA, CHAIRMAN
PATTY MURRAY, WASHINGTON JUDD GREGG, NEW HAMPSHIRE
RON WYDEN, OREGON PETE V. DOMENICI, NEW MEXICO
RUSSELL D. FEINGOLD, WISCONSIN CHARLES E. GRASSLEY, IOWA
ROBERT C. BYRD, WEST VIRGINIA WAYNE ALLARD, COLORADO
BILL NELSON, FLORIDA MICHAEL ENZI, WYOMING
DEBBIE STABENOW, MICHIGAN JEFF SESSIONS, ALABAMA
ROBERT MENENDEZ, NEW JERSEY JIM BUNNING, KENTUCKY
FRANK R. LAUTENBERG, NEW JERSEY MIKE CRAPO, IDAHO
BENJAMIN L. CARDIN, MARYLAND JOHN ENSIGN, NEVEDA
BERNARD SANDERS, VERMONT JOHN CORNYN, TEXAS
SHELDON WHITEHOUSE, RHODE ISLAND LINDSEY O. GRAHAM, SOUTH CAROLINA
Mary Ann Naylor, Majority Staff Director
Denzel McGuire, Minority Staff Director
(ii)
C O N T E N T S
__________
HEARINGS
Page
November 19, 2008--The Economic Outlook and Options for Stimulus. 1
STATEMENTS BY COMMITTEE MEMBERS
Chairman Conrad.................................................. 1
Ranking Member Gregg............................................. 11
WITNESSES
Simon Johnson, Senior Fellow, Peterson Institute for
International Economics........................................47, 50
John B. Taylor, Mary and Robert Raymond Professor of Economics,
Standford University, and Senior Fellow, Hoover Institute...... 64
Mark Zandi, Chief Economist and Cofounder, Moody's Economy.com...13, 18
THE ECONOMIC OUTLOOK AND OPTIONS FOR STIMULUS
----------
WEDNESDAY, NOVEMBER 19, 2008
U.S. Senate,
Committee on the Budget,
Washington, DC.
The committee met, pursuant to notice, at 10:04 a.m., in
room 608, Dirksen Senate Office Building, Hon. Kent Conrad,
chairman of the committee, presiding.
Present: Senators Conrad, Murray, Nelson, Cardin, Sanders,
Whitehouse, Gregg, and Sessions.
OPENING STATEMENT OF CHAIRMAN CONRAD
Chairman Conrad. The hearing will come to order. I want to
welcome everyone to the Budget Committee. Today's hearing will
focus on the nation's economic outlook and the options for
stimulus. We have birds chirping there, birds chirping in the
sound system.
I hope that this hearing proves timely because this is very
central to the discussion and debate about what needs to be
done to stimulate the economy, both during this truncated
session, but also when Congress resumes, and we are being told
that we will be right back at it during the first part of
January, so no one should expect that the usual rhythm of this
place will be the rule.
I would like to particularly welcome our witnesses this
morning, Mark Zandi, who has testified before this committee
before and whom we see as a very valuable resource for this
committee. He is the Chief Economist and co-founder of Moody's
Economy.com.
Simon Johnson, Senior Fellow at the Peterson Institute for
International Economics and Professor of Entrepreneurship at
MIT's Sloan School, welcome. It is good to have you here.
And John Taylor, Senior Fellow at the Hoover Institution
and Professor of Economics at Stanford University, my alma
mater. I was there with our grandson this summer and I was
showing him around and we had a wonderful time.
This is a distinguished panel and I very, very much
appreciate your being willing to come and share your thoughts
with us.
Let me just start with a few charts to put our current
circumstance in some perspective. The downturn has featured a
dramatic collapse in the housing market. All of us know that.
We can see what has happened to the home foreclosure rate. It
remains at the highest level ever. The housing decline rippled
through the rest of our economy and helped trigger the
financial market crisis.
[GRAPHIC] [TIFF OMITTED] T7518.001
Let us go to the next slide, if we can. Credit markets were
essentially frozen from late September through mid-October.
This chart shows the clearest measure of what happened to our
credit markets.
[GRAPHIC] [TIFF OMITTED] T7518.002
This is the so-called TED spread, the difference between
the interest rate at which banks can borrow from each other
based on the London Interbank Overnight Rate and the rate on
U.S. Treasury bills. It shows that the typical difference
between the two, which is relatively modest, has absolutely
skyrocketed. In fact, it went up ninefold before now falling
back after all of these dramatic policy interventions, but
still remains very high by historical standards.
Third, we have lost 1.4 million private sector jobs since
December of last year, with 263,000 jobs lost in October alone.
[GRAPHIC] [TIFF OMITTED] T7518.003
Fourth, the economy is expected to contract further. We saw
the economy shrink by three-tenths of 1 percent of GDP in the
third quarter of this year. The blue chip consensus is that it
will shrink by 2.8 percent of GDP in the fourth quarter.
[GRAPHIC] [TIFF OMITTED] T7518.004
Fifth, retail sales have plummeted, falling 2.8 percent in
October. What we are hearing from retailers around the country
is that retail sales continue to slide. I am very pleased to
report in my home State of North Dakota, retail sales are
actually increasing during this period. So if anybody is
looking for a job or economic opportunity, we welcome you to
North Dakota.
[GRAPHIC] [TIFF OMITTED] T7518.005
The unemployment rate has now climbed to 6.5 percent, so
clearly the economy is struggling and we have to act. That is
why we are here discussing a stimulus package today.
[GRAPHIC] [TIFF OMITTED] T7518.006
There are several options to be considered. Many economists
are urging that a package must be large enough to have an
impact. We have heard estimates anywhere from, at the low end,
1 percent of GDP of a stimulus package to 3 percent of GDP.
Just to put that in some perspective, we have about a $14
trillion economy, so we are talking about a stimulus package of
anywhere from $140 billion to $420 billion. We have even heard
some say that a stimulus package should be as much as $500
billion. We have seen what China has done with a package of
well over $500 billion on a much lower base in terms of the
size of our economy than ours.
[GRAPHIC] [TIFF OMITTED] T7518.007
In terms of specific options, we could extend unemployment
insurance. That is considered stimulative because it goes to
people who need it the most and who are most likely to spend
those dollars. We could also do the same with Food Stamp
assistance, broaden it, extend it. Again, those are dollars
that are considered highly stimulative.
Third, we could fund ready-to-go and near-term
infrastructure projects. Typically, that is looked on somewhat
dimly by those in the economic profession because often those
packages are too slow to get into the economy to be considered
timely. I think in this circumstance, we need to look again at
infrastructure projects.
I have just done community forums in 50 communities in
North Dakota. It was very interesting, the reaction. It was
overwhelming--overwhelming--in support of infrastructure
projects as a means of stimulating the economy.
And we could provide aid to homeowners. That is another
option.
The argument against infrastructure being effective,
because it can be often delayed, I think may be contradicted by
what we see as ready-to-go projects around the country. The
American Association of State Highway and Transportation
Officials has said that they have more than 3,000 ready-to-go
highway and bridge projects across the country. The group's
Executive Director said, and I quote, ``If Congress wants to
support small business, create thousands of jobs here at home,
and stimulate the economy, it should invest in the more than
3,000 ready-to-go highway projects that could be under contract
within the next 30 to 90 days.''
[GRAPHIC] [TIFF OMITTED] T7518.008
I asked my own Transportation Director in North Dakota,
what is their circumstance. He told me they have in my small
State $300 million of projects ready to go. Engineering is
completed. Design is completed. Land is acquired. They are
ready to let contracts if they have the money.
I am very interested in hearing the views of our witnesses,
and with that, I want to turn to my very able colleague,
Senator Gregg.
OPENING STATEMENT OF SENATOR GREGG
Senator Gregg. Thank you, Mr. Chairman. Thank you for
calling this hearing and I appreciate the panel, which is an
expert panel, to say the least, participating also.
Obviously, we are confronting an economic situation which
is extraordinarily difficult and for a period, well, this is a
precipice which would have been potentially unique in our
experience and also catastrophic, with the potential meltdown
of our financial sector. We are still working through that
process of how we make sure that our financial sector remains
at least strong and substantive during these very difficult
times.
There has been some discussion, of course, as to what we
should do with the additional TARP money, which it appears it
will be $350 billion on the table for the next administration
to use. I believe Secretary Paulson has made it fairly clear
that at a minimum, that is what will be left available for use.
I think that is a good decision by Secretary Paulson, to allow
President-Elect Obama to make the decision as to how those
additional funds will be moved in the area of protecting and
promoting and strengthening our fiscal year structure.
I would like to hear the panel's comment as to what they
think should be done with those dollars, because those are
ready dollars, so to say, to quote Phil Gramm but in a
different context. What is important in my opinion is that we
put the dollars on the problem, and the problem is foreclosures
and stability of the real estate industry and the real estate
markets.
The decision by the Secretary to move the initial dollars
directly into capital restructuring of the financial
institutions which were at risk, I think was also the right
decision, because it was fairly clear that getting those
dollars out the door into the purchasing of non-performing
assets was going to be very difficult. Pricing those assets was
going to be extraordinarily difficult. Setting up the auction
process appeared to be extremely complex.
And although the Chairman and I worked very hard through a
long 48-hour period to put the bill together with the
expectation that it would be developed as a bill that would be
focused on troubled assets and getting those off the books of
the financial institutions, the decision to go directly to
capital infusion, I think, was a correct decision and has
stabilized those institutions and more institutions to come.
But the question now is with the additional $350 billion,
is there a structure which would allow us to use those dollars
effectively to get at the underlying problem of the real estate
pricing in this country and the overhead of inventory and
specifically at allowing people who are in their home as
homeowners, not as speculators, but are in their home as
homeowners to stay in their homes through some sort of
restructuring using those dollars, and does that have a
stimulus effect and does that help the situation if we did
that.
The second issue which is on the table right now, of
course, is the issue of dealing with the automobile companies
and their weakened situation, which is more than weak, it
appears, and whether or not it is appropriate for the Federal
Government to go beyond what is the already $25 billion that is
in the pipeline or whether that $25 billion should be
reoriented in some way to be gotten out the door faster and in
a more immediate way, as it appears to be at the present time
delayed. I would be interested in the thoughts of the panel on
that and what is the proper role relative to the question of
the automobile companies and should this include not only the
issue of compensation at the executive level, which it
obviously should include if the Federal Government steps in,
but also the issue of employee compensation and especially
retiree compensation.
I read, regrettably in my opinion, that the UAW has
rejected out of hand any action in that area as an element of
the taxpayers stepping forward. They appear to be willing to
let the taxpayers take the risk, but not their membership. It
would seem to me that any restructuring is going to have to by
definition, in order for these companies to survive, include
some sort of restructuring in the area of compensation, not
only at the executive level, but on the line, and so I would be
interested in your views on that.
Obviously, the Chairman has alluded to various types of
stimulus packages which are in consideration, the usual
suspects of the Keynesian philosophy, which is unemployment
extension and Food Stamps and initiatives in those areas, which
have a checkered history of actually creating economic
stimulus. In fact, we don't have to go too far back to see how
checkered that history is when we look at the first stimulus
package, which this Congress did this year earlier under the
$60 billion, the vast majority of which was simply a direct
repayment, rebate, whatever you want to call it, to Americans
of $600 or more and which I would be interested in the reaction
of this panel to what that stimulus package did and whether we
got value for our dollars.
It would seem to me, at the time, I said we should have
spent that money on the problem, which again was real estate
and stabilizing the real estate markets, especially ownership
by individuals who are in a home who are finding themselves
stressed by the fact the value of the home has dropped and the
cost of the mortgage has reset. But we decided not to take that
route. We decided instead to simply throw $600 in various
packets out of a helicopter across this country which was then
used to purchase Chinese goods, which may have stimulated the
Chinese economy but I don't think stimulated ours all that
much.
So I would be interested in getting the panel's view as to
what type of stimulus really does stimulate in the short term.
The Chairman has made the argument for infrastructure. I don't
have any argument or disagreement with the belief that
infrastructure in the long term is a good capital investment
for a nation. Building better roads, sewage systems, water
systems, transportation systems is a good investment for our
nation. But is it a short-term stimulus? That is a good
question. In fact, if you look at the proposals, it looks like
less than 20 percent of the dollars that are actually proposed
for infrastructure stimulus would actually be spent in 2009. If
that is the case, is it really a stimulus or is it a capital
improvement program for the long term?
So these are the questions which we are going to have to
answer as a Congress. I do agree with the President-Elect and
with the Chairman that a stimulus package is necessary, but how
do we do it? How do we do it right, and where should it be
focused? Should it be focused on the problem--obviously, I am
asking rhetorically--which is the real estate issue? Should it
be focused on the more philosophical approach, which would be
Keynesian philosophy? Or should it be focused on infrastructure
or some combination? And how do we deal with the real issue
that is immediately on our table, which is the question of the
automobile manufacturers, the American automobile
manufacturers?
So again, Mr. Chairman, I thank you for setting this
hearing up so that we can get some answers to these questions.
Chairman Conrad. Excellent questions that the Ranking
Member has laid out, and I want to again thank him and his
staff for their cooperation in setting up this hearing.
And with that, we will proceed to Dr. Zandi. Welcome.
STATEMENT OF MARK ZANDI, CHIEF ECONOMIST AND CO-FOUNDER,
MOODY'S ECONOMY.COM
Mr. Zandi. Well, thank you. Thank you, Mr. Chairman and the
rest of the committee, for the opportunity to be here today.
I strongly support the idea of a fiscal stimulus package
for early 2009 into 2010 for two broad reasons. First, the
economy is suffering a very severe recession that without
stimulus will last through 2009 well into 2010 and it will be,
in my judgment, the worst recession since the Great Depression,
not in the league of the Great Depression, but the worst since
that very dark time.
Second, I think monetary policy, while working very hard to
stimulate the economy, has been effectively neutered by the
collapse in the financial system. It is very difficult for the
lower interest rates and the liquidity that the Fed is
providing to the economy to actually have an impact quickly
because it only works through the financial system and the
system is broken, so credit is not flowing and the cost of
credit is not falling. Therefore, monetary policy is
particularly ineffective at this point in time, and therefore
that requires a fiscal stimulus response.
I think the stimulus package should be large, I think at
least $400 billion, which would be two-and-a-half, 3 percent of
GDP. I think that would be a good starting point. I think it
should be predominately temporary government spending
increases. I do think the tax cuts, while helpful, get diluted
in this environment because consumer confidence is completely
shot and people are going to save the money. They are not going
to spend it, and it is not going to be helpful near-term
stimulus, and probably that is what happened with the first
stimulus package.
I think aid to State government to help in their operating
expenses is absolutely vital. I think they are on the verge of
significant cuts to everything that they do, and that would be
very counterproductive in the current environment.
And I think infrastructure spending is a good idea. It has
a big bang for the buck, and I do think there are projects on
the table that can get started relatively soon that will have a
good measurable impact on the economy.
I think some tax cuts are also in order, and I will go
through that in a little bit more detail in a few minutes.
Let me just say, before I dive into a PowerPoint to
illustrate these points in more detail, I do think a much
broader foreclosure mitigation plan is necessary, that the
efforts to date, from FHA Secure to HOPE NOW to Hope for
Homeowners, are good steps, but they are significant
impediments for them to work in a significant way, and the
foreclosure problem is very, very serious and will get much
more serious next year and undermine all the good things that
we are trying to do and you are trying to do unless we keep
more people in their homes.
I also think that help for the auto makers is essential,
because I think they employ 250,000 people in the United
States, but 2.5 million jobs are at risk if they go into
bankruptcy, because if they go into bankruptcy, it is likely
going to be a liquidation. We will see a lot of shuttered
operations and a lot of lost jobs at just the wrong time. But I
do think the best way to help them would be a prepackaged
bankruptcy where the government would guarantee the financing
in bankruptcy, so that the bankruptcy court would be
responsible for restructuring the auto makers and making sure
that they are viable institutions, companies going forward. I
think that would be the most logical and best way to do it.
OK. Now having said that, let me just reinforce some of
these points with a few slides.
First, I think stimulus is needed because the economy is in
a very severe recession. Job loss has been serious. We have
lost, as you can see here, jobs since the beginning of the
year. This is the month-to-month change in jobs since January
of 2007 through October of 2008. We have lost 1.2 million jobs
since the beginning of the year.
The job losses are very broad-based across all industries.
The only industries that are adding to payrolls in a consistent
way are health care and educational services, a little bit of
defense, some ag, a little bit of energy, but that is it.
The job losses and the problems are very broad-based across
the country. Unlike other recessions, where the recessions were
very regionally focused, this is coast to coast. This shows the
States that I think nationwide that are in recession. They are
in red. There are 30 States in all. The States that are in
orange, they are not in recession but they are at risk. Not all
of them will fall into recession. I don't think North Dakota
will fall into recession. Wyoming, I doubt it. Texas probably
will skirt by. But many of these States will end up in
recession, and this is very disconcerting because in other
recessions, people who got unemployed, let us say in
California, had a place to go for a job. They could move to
Phoenix or Las Vegas or Oregon. Now there is no obvious place
to go. You are really stuck, and that is, I think, one of the
reasons why consumer confidence is as weak as it is.
The other distinguishing feature of this recession is that
it is being led by consumers. Most other recessions have been
led by over-leveraged businesses that got caught when the
economy turned and had to pull back and cut hiring and
investment. This go-around, it is being led by over-leveraged
consumers, and you can see consumers are under severe financial
pressure. This is data based on credit files that we collect
from Equifax. The last data point is for the last week of
October, so it is very timely data.
As of the last week of October, there was $860 billion in
household liabilities that were in delinquency or in default,
so first mortgages, second mortgages, student loans, vehicle
loans, credit cards, everything. In this data set, that
accounts for 7.5 percent of all household liability, so it
gives you a sense of the stress that consumers are under.
I think the recession we are in, which in my view began
over a year ago, without stimulus will continue on through 2009
into 2010 and there are three links between what is going on in
the financial system and the economy that are going to weigh on
the economy seriously over the next--over a year.
The first link is credit. The credit spigot has been
closed. Credit markets have collapsed. The banking system is
under severe stress. And you can see the collapsing credit
here. This shows the growth, annualized percentage change
growth in debt of households and non-financial businesses on a
real basis after inflation. You can see that in the decade from
1998 to 2007, although there is volatility, if you look
through, it is about 6 percent annualized growth pretty
consistently. Now, it is in negative territory, so it means
debt is actually falling on a real basis, and the last time
that happened was for a very brief period in 1990-1991 when the
savings and loan crisis hit.
The second link is confidence has been completely
shattered. Consumer and business confidence is at record lows.
Consumer confidence is shown here in the red line. This is a
survey conducted by the Conference Board. It is an index, and
you can see that it has collapsed in the last month, and this
is a record low and this data goes all the way back into the
1960's. It has never been as low as it is today.
Small business confidence, this is from a survey conducted
by the National Federation of Independent Businesses. That is
the blue line. That is the right-hand scale, another index. And
it, too--it is not a record low, but it is very close. And I
think recent events are going to be extraordinarily scarring. I
don't think confidence comes back easily. People are very
nervous for lots of different reasons and that is going to
weigh on the economy for a considerable period of time.
The third link is we are all less wealthy and we are going
to be a lot less wealthy for a long time to come. Total
household net worth has fallen over $12 trillion from the peak,
which was a year ago, and of that $12 trillion, $4 trillion is
housing wealth, $8 trillion is stock wealth, and it is having
an impact on consumers. Retail sales are sharply falling. You
can see the relationship between retailing and house prices as
a measure of wealth here.
The blue line, right-hand scale, is the percent change a
year ago in retail sales, core retail sales excluding vehicles
and gasoline, so this is like Christmas sales. I have taken a
3-month moving average of the data just to smooth out the
volatility and get to the underlying trend.
The red line is house price growth. That is year-to-year
price growth in home values. That is the left-hand scale. The
twist here is that house prices lead retailing by 6 months. So
what happened in the housing market 6 months ago is saying
something about retailing today, and what is going on in the
housing market today is giving you a forecast for retailing
over the next 6 months. And you can see the forecast. It shows
nominal retail sales growth over the next 6 months of one to 2
percent. Given inflation of a couple percent, that is real
declines in retail sales through Christmas. So this will be the
worst Christmas since the 1992 Christmas, and perhaps even the
1982 Christmas.
So three links from what is going on in the financial
system to the economy, credit, confidence, and wealth. All
three of those forces are going to weigh very heavily on the
economy for a considerable period of time, well into 2010. So
this does call--I am running a little bit out of time, so I am
going to skip over monetary policy issues to give other
speakers a chance.
But this calls for a stimulus package. And just to give you
a sense of what a large stimulus package could mean for the
economy is this particular graphic that shows the rate of
unemployment assuming no economic stimulus, that is the red bar
in the chart, and with an economic stimulus package, the $400
billion package that I mentioned and will just illustrate in a
little bit more detail in the next slide. This is based on a
simulation of our model of the national economy, and so we
produce forecasts for clients and we can use this for
simulation purposes to try to understand the impact of these
kinds of things.
You can see the unemployment rate with no economic stimulus
will rise to 10 percent by the early part of 2010. That would--
ten percent, that is a large increase, the largest increase
since the Great Depression.
If we have a good, large, well-timed, well-structured
stimulus package along with some other steps by policymakers,
you can see the peak will still be very high, 8 percent in
early 2010, but a measurable difference in the economy's
performance.
And here, just to illustrate, this is the package that I
put together to illustrate the point. This is a $400 billion
package distributed from 2009 to 2010. This is composed of $230
billion of temporary government spending, $100 billion of which
is State aid, UI benefits, Food Stamps, and another $100
billion in infrastructure spending. And then $170 billion worth
of tax cuts. The investment tax credits that were in the first
stimulus package will expire at the end of this year and it
makes sense to just extend them so that businesses don't cut
investment early in 2009, a pretty simple, not very costly,
thing to do.
And I am also proposing some housing tax credits to
stimulate home sales to work off some of the excess inventory
and to provide some support to the housing market and house
prices in 2009. And a temporary tax cut. Here, I just put in a
payroll tax holiday, and we can talk about the merits and
disadvantages of that if you care to.
But you can see the impact. This shows the annualized
growth in GDP, real GDP, from the first half of 2008 through
the second half of 2010. You can see the impact of the first
stimulus. It was positive, but it was small. And then the
impact of the second stimulus, if it is well-timed and
structured in the way that I have designed it here.
So just to end, the point would be that I think a stimulus
is vitally necessary. Without a stimulus, I think the economy
is going to suffer an extraordinarily severe recession, and
with it, it will still suffer a severe recession, but it will
be measurably more manageable. Thank you.
[The prepared statement of Mr. Zandi follows:]
[GRAPHIC] [TIFF OMITTED] T7518.009
[GRAPHIC] [TIFF OMITTED] T7518.010
[GRAPHIC] [TIFF OMITTED] T7518.011
[GRAPHIC] [TIFF OMITTED] T7518.012
[GRAPHIC] [TIFF OMITTED] T7518.013
[GRAPHIC] [TIFF OMITTED] T7518.014
[GRAPHIC] [TIFF OMITTED] T7518.015
[GRAPHIC] [TIFF OMITTED] T7518.016
[GRAPHIC] [TIFF OMITTED] T7518.017
[GRAPHIC] [TIFF OMITTED] T7518.018
[GRAPHIC] [TIFF OMITTED] T7518.019
[GRAPHIC] [TIFF OMITTED] T7518.020
[GRAPHIC] [TIFF OMITTED] T7518.021
[GRAPHIC] [TIFF OMITTED] T7518.022
[GRAPHIC] [TIFF OMITTED] T7518.023
[GRAPHIC] [TIFF OMITTED] T7518.024
[GRAPHIC] [TIFF OMITTED] T7518.025
[GRAPHIC] [TIFF OMITTED] T7518.026
[GRAPHIC] [TIFF OMITTED] T7518.027
[GRAPHIC] [TIFF OMITTED] T7518.028
[GRAPHIC] [TIFF OMITTED] T7518.029
[GRAPHIC] [TIFF OMITTED] T7518.030
[GRAPHIC] [TIFF OMITTED] T7518.031
[GRAPHIC] [TIFF OMITTED] T7518.032
[GRAPHIC] [TIFF OMITTED] T7518.033
[GRAPHIC] [TIFF OMITTED] T7518.034
[GRAPHIC] [TIFF OMITTED] T7518.035
[GRAPHIC] [TIFF OMITTED] T7518.036
[GRAPHIC] [TIFF OMITTED] T7518.037
Chairman Conrad. Thank you, Dr. Zandi.
Dr. Johnson.
STATEMENT OF SIMON JOHNSON, SENIOR FELLOW, PETERSON INSTITUTE
FOR INTERNATIONAL ECONOMICS
Mr. Johnson. Thank you. I would just like to supplement my
written testimony by making three points, if I may. The first
is about the unprecedented global nature of the financial and
economic problems we are facing.
The second is the case for fiscal policy or fiscal stimulus
despite the very high level of uncertainties we face about
exactly what is happening in the economy, what will happen, and
how fiscal policy will work.
And the third point is to argue strongly that we must not
overdue the fiscal stimulus. Medium-term fiscal consolidation
remains vitally important. If anything, this crisis reminds us
that we must preserve our financial firepower for when we
really need it, which is during a crisis like this.
But first, on the global point, I think in the remarks
which have already been made by Senator Conrad and Senator
Gregg and by Mr. Zandi, I think you very clearly laid out the
picture in the United States. What I would like to stress is
that this is not just a U.S. problem, as you know. It is not
just a problem in the U.S. and in Europe and in other
industrialized countries. It has now spread through various
mechanisms to almost every country in the world, including
major emerging markets and now poorer countries.
And I think in terms of the synchronization of the slow-
down, and certainly the synchronization is contraction of bank
lending and now, of course, it is a fall in the demand for
credit around the world, this is unprecedented. I do not think
we have ever seen in the history of modern capitalism anything
like this at all, where every economy and every credit system
around the world, pretty much at the same time, contracts.
Now, we don't know how far this goes. We don't know what
levels of leverage the system will stabilize at. I am
supportive of many, if not all, of the dramatic actions taken
by the Federal Reserve and other leading central banks in this
context. I am skeptical of their ability to stop this process
or to--I think the market will find its own level of leverage,
and this may come with a much bigger contraction in the global
economy and global trade than we can now imagine.
I would, with a great deal of respect, disagree with the
Secretary of the Treasury, Mr. Paulson. I do not think the
TARP, Troubled Asset Relief Program, has been a success. I do
not think the situation in the financial system is yet
stabilized. And if you look at the current developments in
major U.S. banks, the banks at the very core of the program,
they are still regarded by the market, I think correctly, as
having deep problems that are not fully resolved.
I think, just in that context, in passing, the meeting of
the G-20 which was held last weekend in Washington achieved
very little and potentially actually worsened the situation in
ways I can elaborate on later if you're interested.
My second point is about fiscal policy. If we are facing
such a dramatic slowdown around the world and we are in a
situation which is really unchartered in terms of the dangers
ahead, what are the right policy responses? And I think the
answer is that you have to try everything that you can. I think
this is the approach of Mr. Bernanke at the Federal Reserve. I
think the amount of credit provided or underwritten by the Fed
is now at record levels. We will see how much effect that has.
I completely agree with the remarks already made about the
need to make progress on housing, on mortgage restructuring,
and I think in terms of the flow of foreclosures, or foreclosed
properties onto the market, we also need to make more progress.
But I also think that in this context, there are ways to
use government spending wisely, both in the shorter term and in
the longer term. I would actually stress not just the likely
debt to the recession we are facing, but the fact that the
recovery will almost certainly be quite slow without government
action. I think we are looking at a problem not of 2 years, but
more likely of three or 4 years, and that is just in the United
States. I would expect the U.S. economy to recover more quickly
than most of our trading partners around the world. So I don't
think you should look to exports any time soon to pull us out
of this.
I think in this context you could make a case for many of
the forms of spending that have already been discussed. In the
short term, direct aid to State and local governments makes a
lot of sense. They are already contracting. That is where a lot
of the job losses are occurring. You can extend unemployment
benefits. I think there is a lot of agreement on that. Expand
Food Stamp aid. And the loan modification for distressed home
owners, I think also can give you relatively good value for the
money.
I would also want to express some more positive words about
tax rebates or temporary tax cuts. I don't think we should get
too hung up on the idea that if consumers don't spend the
money, somehow it is wasted. We need consumers to rebuild their
balance sheets. That is important for them. It is very
important for the financial system, too. So the money that is
saved is also a contribution to the economic recovery and to a
faster, more sustainable recovery.
In terms of longer-term spending, I support the ideas for
both immediate spending on improving maintenance for
infrastructure in the United States and projects that are ready
to go. I think over a longer period of time, we can find more
sensible uses of money on infrastructure.
I think there is also good use of money, again, over a
longer period of time--I am not saying we rush the money out,
it is to try to get a strong, sustained recovery here--job
training programs. Student loans are, as you know, under
tremendous pressure because of what is happening in the credit
market, as are small business loans, and those are both worth
serious consideration in the longer-term context.
And I also think that investment in alternative energy
through various means typically used to support technology
development is also a good long-term investment.
I think the amount of fiscal stimulus that you can justify
in these terms, in terms of what you can spend wisely, and I
would include the tax cuts, if you want to put tax cuts in this
overall number, is about 3 percent of GDP. That is a very large
stimulus. I think there are some other proposals that are now
being put forward.
Let me say, when we first put this forward, it was a large
stimulus. Now, it seems more in the middle of the range that is
being proposed, and I think some of the numbers being talked
about, up to $800 billion, are too large. I think there are
risks here. There is a risk of doing nothing. There are risks
of doing too much. And there are no risk-free proposals. I
think that the appeal of temporary spending and temporary tax
cuts is that it can help us more quickly get back on the route
to medium-term fiscal consolidation.
And my last point is that all the proposals put forward to
try to deal with asset price bubbles in the future, in terms of
monetary policy or in terms of regulation, I think are good
proposals worth consideration. They are very unlikely to be
successful. I think given the nature of the financial system
that we have created in this country and around the world,
unless something very unpleasant happens at a global level,
which I am not expecting, I think we will keep that same
financial system. That financial system will have crises. The
only way to deal with crises is to have a very large amount of
financial firepower available in the form of the U.S.
Government balance sheet.
So you run a careful fiscal policy. You try and keep debt
low. You avoid the temptation of overspending in good times so
that in bad times, when things are very difficult, when the
risks are really mounting, you have the financial firepower
available for direct support of the financial system, for other
forms of direct support, and for fiscal stimulus. Thank you
very much.
[The prepared statement of Mr. Johnson follows:]
[GRAPHIC] [TIFF OMITTED] T7518.038
[GRAPHIC] [TIFF OMITTED] T7518.039
[GRAPHIC] [TIFF OMITTED] T7518.040
[GRAPHIC] [TIFF OMITTED] T7518.041
[GRAPHIC] [TIFF OMITTED] T7518.042
[GRAPHIC] [TIFF OMITTED] T7518.043
[GRAPHIC] [TIFF OMITTED] T7518.044
[GRAPHIC] [TIFF OMITTED] T7518.045
[GRAPHIC] [TIFF OMITTED] T7518.046
[GRAPHIC] [TIFF OMITTED] T7518.047
[GRAPHIC] [TIFF OMITTED] T7518.048
[GRAPHIC] [TIFF OMITTED] T7518.049
[GRAPHIC] [TIFF OMITTED] T7518.050
[GRAPHIC] [TIFF OMITTED] T7518.051
Chairman Conrad. Thank you.
Dr. Taylor.
STATEMENT OF JOHN B. TAYLOR, MARY AND ROBERT RAYMOND PROFESSOR
OF ECONOMICS, STANFORD UNIVERSITY, AND SENIOR FELLOW, HOOVER
INSTITUTION
Mr. Taylor. Thank you, Mr. Chairman, and thanks to you and
Senator Gregg and other members of the committee for giving me
the opportunity to be here to talk about the economic situation
and the need for a stimulus.
I agree, these are tough economic times. We are in a
recession. Last quarter had negative growth and this quarter
will most likely have the number of minus-three percent that
you put up, Mr. Chairman. I think the recession will be--
already--is longer and deeper than the previous two recessions
we had in the United States and most likely more along the
lines of the recessions we had in the 1970's and the early
1980's in terms of the magnitude and length.
I think the source of this really goes back to the boom and
bust in housing. I will come back to that in a minute. There
was a period of time where we had excessive stimulus, if you
like, from the monetary side. It led to a run-up in housing
prices that was unprecedented, spread around the world, and now
the resulting bust has led to many foreclosures. People are
underwater; the securities were put together into derivatives
that were sold to banks and others and that has caused the
financial crisis that we are facing in the United States and
the rest of the world.
So the story is pretty clear about how we got here, and now
getting out. Clearly a good topic for discussion is how we get
out of this. I think the first thing I would look at if I were
you, in terms of considering a second stimulus, is to look as
carefully as possible at the first stimulus, if you like, the
Economic Stimulus Act of 1980.
I have had a chance to look at this a bit, and I brought a
chart. I am going to only have one chart in my presentation. It
is in my testimony. I don't know if it is in front of the
Senators. But it is simply just going back to the major part of
the Stimulus Act, and that was, as Senator Gregg mentioned, the
rebate checks or direct deposits into people's accounts.
The idea, you recall, was that by giving people more
income, more disposable income, they would spend more. It would
give a boost to consumption demand, and that would boost
aggregate demand which in turn would jump-start the economy.
That is the logic.
Well, we can look at what happened with this chart. As you
can see, the top line is--well, it is on the chart here, so
thank you. The top line is what we call disposable personal
income, and this is the amount of money in the aggregate that
people have to spend after the government takes taxes and gives
money back in the form of transfers.
You can see there is a big blip in that line. It started in
May when the rebate checks were sent out, or money was
deposited in people's accounts. It stayed high in June, July,
and now it is basically back to the previous trend it was. So
that is basically the stimulus package right there, at least on
the consumer side.
Now, again, the purpose was to stimulate consumption so the
economy would get a jump-start. The lower line is what we call
personal consumption expenditures. It is the total amount of
consumption by the same people in the aggregate that were
getting the rebate checks. As you can see, it is very hard to
see that there was any impact of this stimulus on what it was
advertised to affect. It seems to me that is something to
consider seriously when you think about a second stimulus
package.
You might think it is surprising this happened. Actually, I
think this is what economic theory will tell you would happen.
Economic theory has something called the permanent income model
developed by Milton Friedman, or the lifecycle hypothesis
developed by Franco Modigliani at MIT, and these are the ideas
that people's consumption behavior is largely influenced by
their views about their permanent income. It is a famous and
well-researched idea.
It seems to me that that is what you are seeing in this
picture, exactly what you'd expect, a temporary burst of
income. People save almost all of it in this case. We can
debate whether maybe it was offsetting some other things, like
the high energy prices, but nonetheless, it seems to me that
this is a verification of that theory.
Now, it is because of that view of temporary rebates that
the idea of stimulus, countercyclical fiscal stimulus, actually
fell by the wayside until roughly 2000, 2002. I have some
quotes in my testimony from distinguished economists who said
there was a consensus that this approach doesn't work. I think
the consensus broke down as, of course, evidenced by lots of
testimony you heard earlier this year when you were considering
the economic stimulus package. I think it broke down because in
2001, there were checks sent to people and that did seem to
have some impact. But remember, that was the first installment
on a longer-term multi-year tax cut. So effectively, that was
viewed as permanent by so many people who were getting those
checks. Logically, that is what they would think. So in that
sense, that is not surprising that had more impact.
So in my last minute and a half, what are the lessons from
this? It seems to me the lessons are pretty clear. We had in
many of the debates last January-February the mantra that
packages should be temporary, targeted, and timely. It seems to
me we should think about changing that mantra, those
principles, when you think about this next package. I like to
stick with the alliteration, since that seems to be catchy, but
I will choose a different alliteration.
I would like to think of the stimulus being permanent,
pervasive and predictable. Permanent will have more of an
effect, obviously. By pervasive, I mean forget targeting. Try
to make it as broad as possible. Don't worry about targeting so
much, thinking it is going to have more of a stimulus. You need
to be, if you like, broad-based if you don't like the word
pervasive.
And predictable seems so important to me. Many of the
criticisms that we are hearing about policy these days is it is
ad hoc. It seems to be changing all the time. The mere fact
that we are considering a second stimulus so soon after the
first stimulus is an indication of that, it seems to me.
So what kind of policies would be permanent, pervasive, and
predictable? There are many, quite frankly, that fit those
principles. But the one that I would like to suggest is, No. 1,
committing through legislation not to increase any tax rates
for the foreseeable future, whatever you define as permanent.
Put it in the books. No tax rate increases anywhere.
Second is to go ahead with President-Elect Obama's proposal
to have a workers' tax credit of 6.2 percent of wages, up to
$8,000 in wages. Make it permanent, though. Forget about one-
time rebates. Just make it permanent. It will have more of an
effect. So that is the pervasive aspect. It is across the
board, but it is helping additional people.
On the spending side, I think the most important thing is
to lay out a spending path for the next few years to show how
you are going to get from where you are now with the stimulus
back to balance. And if you want to bring forward some of that
spending as best you can, maybe things that are already on the
books, that is fine, but the important thing is to lay out a
path to get back to a balanced budget.
And fourth, I would remind you all that we have a stimulus
program automatically in this country. It is called the
automatic stimulus, automatic stabilizers, and that is the fact
that spending automatically increases in recession and revenues
automatically come down. I estimate that the stimulus from the
automatic side is going to be about 2.5 percent of GDP this
fiscal year. So make that part of the package. You don't have
to pass legislation to get that 2.5 percent, but that is there
and it is part of the whole stimulus.
The questions that Senator Gregg asked, I will just answer
briefly. We can come back to them. I do think that some of the
TARP money should be used directly for the borrowers and the
homeowners to help directly the foreclosure problem that we
have, but I do not think additional funding or loans are
appropriate for the automobile industry. Thank you.
[The prepared statement of Mr. Taylor follows:]
Chairman Conrad. Thank you. I am going to go to Senator
Sanders. I am going to reserve my time and go to Senator
Sanders first on our side, then come back to Senator Gregg,
then Senator Murray, then Senator Nelson on our side.
Senator Sanders.
Senator Sanders. Thank you very much, Mr. Chairman. I don't
know that I have any profound questions, but I want to thank
you for holding this hearing. We are dealing, as I think our
very able panelists have told us, with something that is almost
unprecedented. It is very frightening and we are all going to
have to scramble to figure out how we come up with some
sensible solutions.
Just a few points that I want to throw out and maybe the
panelists can comment on it later. We have talked about the
immediate impact of the financial downturn in terms of
increased unemployment and foreclosures and so forth, but one
point, Mr. Chairman, I want to reiterate, one of my real
frustrations with the Bush administration, well before the
immediate financial crisis, is their refusal to address the
reality that even before the crisis, the middle class in this
country was in serious decline. So this didn't happen a few
months ago.
We have had--and the reality is, and we have to put this
out on the table, is that in the United States, among all of
the other industrialized nations, we have the dubious
distinction of having the highest rate of childhood poverty.
Forget the immediate financial crisis. Eighteen percent of our
kids are living in poverty. We have the highest overall poverty
rate. We have the highest infant mortality rate. We have the
highest incarceration rate. We spend $50,000 a year to keep
people in jail, and if anyone thinks that is not related to
having a very high poverty rate, I would seriously question
your judgment.
We have also, Mr. Chairman, and I think we have to address
this issue, as well, how does the grossly unequal distribution
of income and wealth play into this financial crisis? According
to at least some analysts, the top one-tenth of 1 percent earn
more income than the bottom 50 percent, and we are moving in
the direction of Brazil, of Russia, of very unindustrialized
countries in terms of that discrepancy. Do we address that
issue? How is it related to the crisis that we face?
And, of course, we are the only major country on earth
without a national health care program.
So I want to maybe throw into the hopper here for further
discussion some of these longer-term problems that our economy
is facing, how that ties into the financial crisis, how do we
address that.
Mr. Chairman, I agree with much of what you laid out in
terms of what a package would include, a stimulus package, but
I agree with, I think, it was Dr. Zandi talking also about the
need to move us to sustainable energy. I think there is
enormous job creation in energy efficiency. I was just in the
United Kingdom last week. They are talking about creating a
whole lot of jobs in energy efficiency and I think we can do
that. Maybe the panelists can discuss the impact on our economy
of importing $700 billion a year of foreign oil and why not
investing in sustainable energy--wind, solar, geothermal,
biomass.
The other things that I think we may want to also throw on
this table for discussion is I think the loss of faith. We talk
about loss of confidence from an economic perspective. I think
there is a deeper loss of faith in corporate America in
general. I could tell you that in my State, people are furious.
People are struggling to keep their heads above water and the
idea of placing at risk $700 billion of taxpayer money to bail
out people on Wall Street who in the past have made just huge
amounts of money investing in very reckless, exotic financial
packages, that brings about the issue of re-regulation. It
brings about the issue of greed in our society.
Are we in a healthy state when so much money is being
played about in the financial sector while our manufacturing
sector is in rapid decline? Doesn't it make a lot more sense to
maybe put money into producing products that the American
people consume so, in fact, we don't have to import everything
from China rather than have guys make huge sums of money
playing on Wall Street?
The other point that I want to make, we have heard some
statistics about unemployment. There is a question about the
validity of unemployment. For example, I believe we have about
ten million people who are unemployed today, roughly speaking.
We have another seven million people who are underemployed,
i.e., who want to work full-time who are working part-time. Is
that something that we should throw into the hopper? Is, in
fact, the economic situation a lot worse? Do we have Ph.D.s out
there who are driving taxicabs or working as waiters or
waitresses? Is the problem even worse than we are suspecting it
is?
So, Mr. Chairman, those are a few of the issues. I think
this has been an excellent presentation. I think you have
different philosophical points of view and I think they all
have something to say, so I just wanted to throw out some of
those ideas to further the discussion. Thank you, Mr. Chairman.
Chairman Conrad. I would give, if the panel wants to react
to any of that, I would give them the opportunity. Mr. Zandi?
Mr. Zandi. Sure. I do agree that the unemployment rate,
where you ended your remarks, is not an adequate measure of the
stress in the labor market and the job market. It is 6.5
percent, but if you do add in discouraged workers, so-called
discouraged workers who aren't even looking for work, that
aren't counted as unemployed, and you consider those that are
working part-time for economic reasons, certainly
underemployed, and also some of the self-employed people whose
payroll job end and they try to make it by becoming self-
employed, then we are already into the double-digits, 11, 12
percent already there.
Senator Sanders. Do you think, by the way, and I know that
is out of the jurisdiction of this committee and maybe it is in
the Health and Education Committee, that we might want to take
a look at reconfiguring how we determine real unemployment in
America?
Mr. Zandi. I think the Bureau of Labor Statistics actually
has different measures of stress in the labor market. We focus,
we the economists focus on the unemployment rate, the 6.5
percent, but in the monthly report that the BLS puts out, they
have different measures of underemployment and you can measure
it and you can see it and----
Senator Sanders. The point you are making, though, is the
economic situation is really perhaps a lot more severe than
that 6.5 percent.
Mr. Zandi. Yes. I think the 6.5 percent understates the
stress and the change in the level of stress that is occurring.
And again, just to reinforce a point, this is--one of the
unique features of what we are in is how broad-based the
problem is. It is across all industries. It is across all
occupations. It is across all regions of the country. In other
downturns and recessions, you had industries that were doing
reasonably well. You had occupations that were OK. You had
regions that were fine, so that people had some options. They
could move from Michigan to Florida. They could move from
California to Arizona. They could try to go get retrained for
another job in the tech sector or in the health care industry.
But those options are much more limited and I think that is
weighing very heavily on the collective psyche. So the problems
are much broader based.
Senator Sanders. Say a word about income and wealth and
equality. Can you have a sustainable strong economy when so few
have so much and so many have so little?
Mr. Zandi. My view is that income inequality is a problem.
Income and wealth inequality is a problem, and a problem in the
sense that there is a skewing of the distribution of income and
wealth and the skewing hasten worse over time, and the forces
at work creating this are firmly in place. So it suggests that
it is not going to get any better, it is going to get worse
going forward.
I don't think it is a major contributing factor to the mess
we are in right now, but I do think it is going to be a very
serious problem that we are going to have to tackle in the
future in that we have very significant long-term fiscal
problems that we are going to have to address and I don't think
we can address those problems without putting it through the
prism of what it means for the distribution of income and
wealth.
Senator Sanders. Thank you.
Dr. Johnson.
Mr. Johnson. Yes. I would like to take up this--I agree
with what Mr. Zandi is saying, the points he made, but I would
like to take up the inequality point a little bit more. I
actually think it does matter today and I think this feeds into
what I think we can see developing as a bailout fatigue in the
U.S. People are very annoyed, as you say, with the leadership
that got them into this, and they are not really happy with
some of the unions who are involved in the auto industry, as
well. There are some issues there about differences in pay.
Mostly, I think, though, there is a lot of pent-up
frustration. This is a big problem, because unfortunately, in
this very difficult situation where the credit system is
collapsing, we have to consider bailouts or rescues for all
kinds of different things. We are not going to hopefully do all
of them, but some of them--they want to do things that we
wouldn't ordinarily do and not be comfortable with, and that is
going to make people very angry because of the inequality.
I think the way to address that going forward is by working
on education. I think a lot of the inequality comes from the
fact that the income difference between people with high school
education and college education is getting wider and wider,
probably because of technology----
Senator Sanders. Should we follow the route of many of the
European countries and make college free or virtually free,
does that make sense to you, for those who are qualified to get
in?
Mr. Johnson. I think what you want to do is find ways to
make sure that people who leave high school have better,
stronger technical skills, which is also what they do in
Europe, without necessarily requiring or pushing them to go
into a college education program.
The other point I would like to make----
Senator Sanders. I think my time has long expired, so----
Mr. Johnson. On energy efficiency, I think investing in
technology development would address exactly your concerns
there. I think that makes sense.
Senator Sanders. Thank you very much, Mr. Chairman.
Chairman Conrad. Senator Gregg.
Senator Gregg. Thank you. We could get into the education
debate and spend hours on it, but your point, which is that in
Europe, they basically two-track people in high school and you
get to choose which track you want to take, a technical high
school or a liberal arts high school, has always been a matter
of considerable debate in the Education Committee, which I also
serve on and had a chance to chair for a while.
I was interested in your chart, Dr. Zandi, which showed the
drop in the debt, because I am wondering if there might
actually be a bright side to that in that we clearly, as a
result of monetary policy over the last 6 years where money was
made so available at such a cheap rate that there was an excess
amount of debt put out there, it is clear that what we are
going through now is an economic event which is a function of
that excess debt being worked out of the system. How close are
we?
We heard in testimony in this committee that there was $2
to $3 trillion of excess debt in the system, most of it in the
real estate accounts, that had to be worked out of the system,
and that that was what this event was all about, or not all
about, but that was at the core of this event. How close are we
to that work-out? I mean, are we at a point where--you had that
line that came down rather dramatically. Are we at a point
where we actually may be in a situation where we have shaken
out the excess debt or close to it so that you can start a
recovery based off of assets which have value as versus assets
which are overvalued due to excess debt? Is that the bright
side here, hopefully, or is that an overstatement?
Mr. Zandi. Well, no, there are some rays of sunshine. You
might have found one of the rays. We are working through our
excesses rapidly. Let me just give you some numbers to sort of
benchmark that.
The financial system as a whole has written off about $650
billion worth of assets, and that is U.S.-based assets. Those
are assets that are held by U.S. financial institutions and
overseas institutions, but they are all U.S.-based assets. Most
of those are residential mortgage assets, so mortgage
securities, mortgage loans. I think we have made a significant
amount of progress there with respect to working off those bad
assets, but because the economy is eroding and house prices are
falling and we are going to see more foreclosures, we are not
done. We have more work to do there.
But the real problem is there are a lot of assets to be
written off elsewhere in the financial system. Those would be
credit cards, vehicle loans, other consumer finance. That would
include commercial real estate loans, which are only now
starting to go bad. That would include corporate debt that we
have struggled with. And if you look at estimates of the losses
there, I have done some, the IMF-World Bank have done some,
that would suggest that we have at least another $700 or $800
billion to go, that that is what is in train that we think we
are going to have to----
Senator Gregg. So the $2 trillion number we heard earlier
is approximately in the ballpark?
Mr. Zandi. It is in the ballpark, and we are not----
Senator Gregg. We are halfway through that number----
Mr. Zandi. If we are lucky, we are halfway through the
number. Now, just one other point. I am sorry.
Senator Gregg. Can you make it quickly?
Mr. Zandi. Yes. I was just going to say, that is a moving
target, right, because as the economy worsens, people lose
jobs.
Senator Gregg. Right.
Mr. Zandi. Two trillion is----
Senator Gregg. Dr. Johnson, you made the point that the
banking industry may not be stabilized, or the financial houses
may not yet be stabilized. The financial houses are gone. We
are back to the banking industry. That the universal banks are
not stabilized yet. I think there has been some--certainly,
Secretary Paulson has said that he thinks we are past the
systemic meltdown period threat, that we still are into an
extraordinarily serious recession. Are you still of the view
there is a potential for a systemic meltdown?
Mr. Johnson. I think that is the right question, and that
is still the question of the day. I think that the period of
default by major U.S. banks has gone down, and that is
reflected in the market view, for example, from the credit
default swap spreads, which you are probably familiar with.
However, the view in the market at the same time is that
while the debt is probably OK, these banks' business models of
profitability is going to erode, and the counterpart of the
losses you were just discussing with Mr. Zandi is big hidden
losses, or not yet disclosed losses or not yet understood
losses on the balance sheets of these very large banks.
So in other words--so, for example, one large U.S. bank I
prefer not to name in public has a market capitalization
substantially below its Tier I capital right now. So how is
that possible? It is possible because the market view is they
have a lot of losses. About half the Tier I capital is going to
be wiped out based on what the market was seeking yesterday by
the losses that you were talking about, when they take those
write-downs.
So is it a systemic crisis if the value of all the banks in
the U.S. goes to zero at the same time as they continue to
service their debts and the creditors are OK? It is not a
classic systemic crisis. It is not a classic bank failure, but
it is pretty bad because it will feed into a continuing
downward contraction of credit.
And remember, the key problem of the 1930's, the onset of
the Great Depression we think of as being about bank runs and
bank collapses. What it was really about was the collapse of
credit. Now, credit can collapse either because banks fail and
you don't rescue them, or because the banks just shrink their
balance sheets down dramatically and they are basically putting
themselves out of business. They wind down. Nobody wants to
invest in them. And then you are faced with a very difficult
situation, which is what do you do with these banks? Does the
government come in and recapitalize them? I know that is not
the question yet of the day, but I think it will be soon.
And I think, going back to your original question about the
top, which I didn't fully answer, I think you should save that
money for recapitalizations that you are going to need to do if
the recession becomes substantially worse.
Senator Gregg. Well, that is a very optimistic view.
[Laughter.]
Senator Gregg. Dr. Taylor, I liked your three words. I
think that those are the ones we should be focused on. You
suggested that the Obama proposal should be made permanent. Do
you include in that the Obama proposal to raise the top rate?
Mr. Taylor. No. Actually, my list of items explicitly says
we should commit now not to increase any tax rate, and that
includes tax rates on small businesses, that includes tax rates
on capital gains, that includes tax rates on dividends.
Absolutely, I think that would be a mistake to increase those
taxes. So the first part of my proposal, and I believe it would
be a stimulus, it would be a stimulus that you might not count
in terms of money because right now, if you just commit not to
raise those taxes, if anything, it is going to raise revenue
because it will stimulate the economy. So in terms of your
measure of costs, it is really cheap.
I would do that if you could possibly do it, and that is
why I mentioned the second part, add to that President-Elect
Obama's proposal to have a tax cut, rate cut--this is a rate
cut. You take 6.2 percent of your wages and refund that and
make it permanent. You could limit it as he proposes to $8,000.
That is fine. But that would actually broaden the idea of this
permanence of the tax cut.
So I think combining those has a lot of appeal. First of
all, it is bipartisan, if you like, because there are different
parts of the aisle liking both of those. Second, there is this
broadness, pervasiveness that I have--and it is permanent. So I
think there is some appeal there.
Senator Gregg. I appreciate that and I agree with that
actual approach.
I am sorry my time is up, but I do have one more issue that
I think has to be asked, which is the elephant in the room that
nobody has mentioned. If you put $400 billion of stimulus onto
the Federal books, we are taking the Federal deficit over one
trillion dollars. That is probably somewhere in the seven to 8
percent range of GDP next year. What does that mean? Or doesn't
that matter in the context of what we are facing relative to
the economic slowdown?
Mr. Taylor. See, in my view, it certainly matters. In fact,
it seems to me you should be thinking of the stimulus not so
much in is it going to be how big the deficit has increased, 1
percent, 3 percent, but really what it is going to do to the
economy. Just my example of the rebates, you could say, oh,
that was $100 billion, a certain fraction of GDP, but it didn't
do anything and I am giving you a proposal which would do a lot
and wouldn't cost anything. So I don't think you should be
measuring these by how much it is a share of GDP or increases
the deficit.
And I do agree that just flagrant ignoring a one trillion
dollar deficit is a mistake. It is a concern, a very serious
concern, and I think whatever the deficit is you decide,
remember, it is going to be more than that because of the
recession, 2 percent, 2.5 percent of GDP because of the
recession. So you have to think about a glide path, a serious
part of any proposal, it seems to me, to get back to balance,
and you decide the new debates and the new administration will
decide the debates. But it is very important for credibility to
see we are on a glide path to stop this deficit spending.
Mr. Johnson. Could I just add one point on the very
important issue of automatic stabilizers Professor Taylor
raised before. The U.S. does have automatic stabilizers, but it
has the weakest automatic stabilizers of any major
industrialized country because we have a relatively small
government. So in most other industrialized countries, they
don't have to have this conversation that we are having because
they have a larger automatic stabilizer from all of the factors
that Professor Taylor was talking about.
So the question is, should the U.S. top that up with a
discretionary decision that you would have to make, or should
we rely on what we have, automatic stabilizers that are
relatively weak compared to what other countries in our
position rely on.
Senator Gregg. Dr. Zandi.
Mr. Zandi. Yes. I think deficits matter, but I think this
is a very good time to deficit finance because no one else is
borrowing. The private credit markets have completely shut
down. Seriously, in a normal, quote-unquote, ``normal'' year,
credit markets raise $5 trillion worth of capital. Right now,
there is zero private capital. So you can borrow and borrow
very cheaply and this would be a good time to do it.
But this is important, and this is why temporary is
important because that signals that in the longer run, you are
very concerned about the fiscal situation. If you make all the
tax cuts permanent, that is a permanent increase in our long-
term deficit situation, which is going to get very serious in
the not-too-distant future. So that is the downside of
permanent and why temporary is important and why I think we
should be very careful about permanent or temporary.
Chairman Conrad. Senator Murray.
Senator Murray. Thank you very much, Mr. Chairman. This has
been an excellent hearing. I can't say it has been uplifting,
but it has certainly been, I think, an important one for all of
us to understand why we are where we are and what the
possibilities are trying to move us forward and what our
responsibilities are in moving forward.
I certainly agree with you, Mr. Chairman, on transportation
infrastructure. It seems to me the best thing to do is to have
people at work getting a paycheck, having a skill, creating
economic development. I know my State has $98 million worth of
highway infrastructure projects ready to go. I am sure every
State does, and like yours, they don't have the capacity today
to do that. We will have to work hard on that, obviously, over
the next several months to put a package forward, but I hope
that that is part of it.
I did want to ask the panel a few questions? You outlined
for us why we are where we are and consumer confidence. Housing
foreclosures clearly got us to where we are in the tight credit
market, but consumer confidence, it seems to me, is really
keeping us here in a very difficult place. How do we increase
consumer confidence, or consumer spending? Dr. Taylor, you said
the rebate checks were essentially not going to get us there.
What is it that we can do to increase consumer confidence? Dr.
Zandi, let me start with you.
Mr. Zandi. I think that requires a very concerted,
consistent, overwhelming policy response, and that is fiscal
stimulus, that is aid to homeowners, that is expanding out the
use of TARP, not only for homeowners but for more capital
infusions, and I personally believe that giving up on asset
repurchases is a very significant mistake because that is
necessary for price discovery, which is what you need to get
private capital back into the financial system. So I think that
should be also pursued.
Senator Murray. The toxic asset purchases that we
originally----
Mr. Zandi. Exactly. I think abandoning that idea is a very
significant mistake, yes.
Senator Murray. And define for me why you think that again?
Mr. Zandi. Because I don't think you are going to get
private capital coming back into the financial system until
they understand the value of the assets that are on the balance
sheets of these institutions, and you are not going to get that
until you get price discovery, until they know what the price
is, and you are not going to get that unless you have a buyer
for the assets, and there are no buyers except for the Federal
Government, at least not in the foreseeable future.
Senator Murray. So you are saying consumer confidence,
dealing with the housing market has to be part of that----
Mr. Zandi. I think it has to be all of those things. I
think it has to be overwhelming. In my view, in times of
crises, the only way out is overwhelming government response in
a very concerted, consistent, and comprehensive way, and it is
all of the above very quickly.
Senator Murray. Dr. Johnson.
Mr. Johnson. I think the way to think about your question
is what is going to happen to spending? Whose spending is going
to be affected by this very deep recession unless you have the
fiscal stimulus? And I think this also--you want to take on
board the points that Professor Taylor is making, which is, is
somebody liquidity constrained? Is somebody really short of
money? They didn't get their paycheck. They just got laid off.
They have other problems.
And I think there is a set of measures that you can take,
both with the aid to State and local governments, because they
are cutting back and they are laying people off directly. You
know, that is going to have a big effect on spending by their
employees. The unemployment benefit, extension of unemployment
benefits, I think there is a lot of agreement that this is
something that will support spending as well as being a good,
fair idea. Food Stamp aid, again, does the same thing. If you
can find ways to help the distressed homeowners, potentially,
this is a way to affect spending, also.
These are immediate things. These are things that will
happen right away. These are people who are going to spend less
money for the holidays because of the difficulty of the
situation. So I think that even recognizing that there is a
great deal of uncertainty, that nothing will work exactly as
intended or hoped in this kind of situation, I think these
things will really move spending.
And I would just like to add, I would respectfully disagree
with Mr. Zandi's view on top. I actually think not buying those
distressed assets at this point was a good--actually, I never
thought it was a good idea, to be totally honest. There is a
private market for these assets. It has a very low price on
them because their value is declining because the real economy
is falling. And if, contrary to some of the initial hopes
expressed for that program, if the economy goes down far
enough, if house prices fall enough, then those assets are
going to be worth essentially zero.
The key thing is support the real economy. It is a very
hard thing to do in this situation. The measures that we are
proposing, which are pretty big--include a pretty big fiscal
stimulus, may not work. It may not be enough. It may not save
us from a very deep, prolonged recession. But I think it is
worth trying.
And I do also, on the point about budget deficits, I do
worry about the budget deficit. I am not somebody who has ever
previously argued in favor of big deficit spending in this kind
of situation. I mean, this is a very unusual situation. This is
why you saved the U.S. balance sheet. Save it for when you need
it. Now, you need it.
Senator Murray. Dr. Taylor, how do we increase consumer
confidence?
Mr. Taylor. The biggest drop in consumer confidence is just
in the last month or so. The October numbers just fell like a
rock. And I think in terms of what government can do, it seems
to me is to, just as you were saying, be as clear as possible
about the understanding of where this problem came from,
articulate that. I think people still don't understand it. You
know, your constituents are confused. The more that you can
explain, and we in the private sector can explain it, the
better.
But I think in terms of instilling confidence, the more--I
would say this, going back to this predictability thing, the
more that you can outline a strategy for the longer term and
don't keep changing it all the time and don't look ad hoc but
look predictable and be predictable, the more confidence people
will have in their government. When they see a testimony asking
for $700 billion with apparently little documentation for that,
that worries them. When they see the markets reacting
negatively to that, it is very visible, of course, the stock
markets.
So I would say, to me, the most important thing--that is
why I am stressing here today, yes, do something, but make sure
that it is a strategy that you are not going to have to come
back to in another 6 months. It is so important.
Senator Murray. Are you going to break the tie here on
whether we should purchase toxic assets on this panel?
Mr. Taylor. Well, I think, and let me just say about it,
this is another example where changing itself has some
problems, OK. Obviously, you want to change when things aren't
working or when the circumstances have changed. But I think
people look at that change and they say, well, what did change
between the testimony of Secretary Paulson here on the Hill
with Chairman Bernanke and the new--what changed? Why did they
do that?
And so I think more explanation for it. I actually think a
more balanced use of those funds, you mix it here and there, so
you keep the toxic assets as a possibility. You keep the equity
injections. You add in what Senator Gregg asked about, direct
assistance to the borrowers, the home mortgage holders, the
people that are underwater. Try to fix them. They are the heart
of the problem. That is why the derivative securities are such
a problem, because those payments aren't being made.
And I would add a fourth one which doesn't cost much at
all, is just to require more disclosure of what is in those
toxic assets right now. You know, you try to tell someone,
well, I have this CMO filled with a thousand or 10,000
mortgages. We don't know what the status of the payments are on
those mortgages. We should require that it be posted on the
websites, what is in those things. Then people would begin to
have a market for them. So I would add that as a fourth----
Senator Murray. The unknown is contributing, as well.
Mr. Taylor. Yes.
Senator Murray. And I am absolutely out of time, but I just
want to say, Mr. Chairman, we have focused a lot on what we
need to be doing. I agree, it needs to be very focused, very
clear, very predictable. But I also hope we have some point we
can talk about what is happening in the global marketplace,
too. I think several of you mentioned that in your opening
remarks. What happens if other countries don't respond equally
as we hope we will do.
Chairman Conrad. Thank you, Senator Murray.
Senator Sessions.
Senator Sessions. Thank you, Mr. Chairman. I would just ask
the panel if you agree with the statement that was in a USA
Today editorial a month or so ago that said an economy founded
on excessive personal debt, excessive government debt, and a
huge trade deficit is an economy in trouble. Would you
fundamentally agree with that? I don't see any disagreement, so
I assume you would agree with that. Dr. Johnson?
Mr. Johnson. I am sorry. I think it is rather too
simplistic a statement. I think there are serious issues in the
United States, including longer-term issues of poverty and
inequality. I think you have to be very careful in terms of
managing the fiscal accounts, and it is certainly the case that
some consumers obviously went too much into debt.
But I would like to emphasize that in the middle of
September, or at the beginning of the second week of September,
this economy was not in serious major recession. We did not
have a global contraction of credit underway. The problems, the
severity--we had these underlying problems. We had mortgages.
We had issues with financial institutions. But the problem was
nowhere near this size of this--the magnitude of this problem,
the enormity of this problem and the global nature of it was
caused by a crisis of confidence triggered by the way the U.S.
Government, I am afraid to say, handled Lehman and then AIG.
They created the strong impression that AAA credits were no
longer secure anymore. This causes a massive loss of confidence
in credit, and so everybody who has debt, even a little bit of
debt, around the world has major problems right now.
Senator Sessions. Well, one commentator wrote in 2006, that
housing prices cannot continue to increase at a rate double
that of GDP when wages are flat. Now, that is a bubble. That
has been going on for some time. And when people's credit cards
are at their limit, they can't keep spending. And when the
trade deficit is enormous, it creates economic uncertainty in
people who are buying our debt. And I don't think we can buy
our way out of this one, Dr. Johnson.
Dr. Taylor, do you have any view of it?
Mr. Taylor. No, I agree with the general philosophy of what
you are saying, Senator. In some sense, maybe you are always
looking for silver linings here, I think a few people asked
already. And one perhaps is that we will in the United States
get our saving rate up----
Senator Sessions. It is going up a little.
Mr. Taylor. It is going up, yes.
Senator Sessions. Last year, we had zero savings. This
year, I think we have had two or 3 percent savings.
Mr. Taylor. I hope it doesn't go so fast, but it has to
be--if it is adjusting, that is a silver lining and that will
affect our trade deficit and our borrowing from abroad, or will
bring both of those down, which is a good thing.
So ultimately, we probably had to make this adjustment and
the difficult thing is it is happening so abruptly and with so
much destruction. But the idea of gradually raising our saving
rates, personal as well as government, reducing the trade
imbalances, which always cause risk, reducing the amount of
assets, of American assets, U.S. Treasuries held by foreign
central banks and other governments, all those are good things
if we can get to those.
Over the long run, I think if again, making sure--before
you came in, Senator, I said, let us be sure that we have
agreement on some kind of a glide path when we get out of this
that we are going to get back to a zero deficit. Put that in
the plan, whatever stimulus plan it is you come up with, so
that will include building up some confidence, as Senator
Murray was asking about.
Senator Sessions. Doctor, I will just comment on that. One
commentator said recently--Mr. Chairman, I think I shared this
with you--that during the decline of a nation's fiscal
responsibility and discipline, the government and the leaders
cite the old verities while doing just the opposite. So I am
hearing people say, well, I wish we didn't have to go in so
much debt. I wish we didn't have to bail this private company
out. I wish we didn't have to do this, while we are pell mell
doing it, and I don't think it is good policy.
At a most fundamental level, Dr. Zandi, just one more
thing. I do believe there are things government can do to
minimize the destruction that you referred to. I am open to
that, but I do think those actions need to be as targeted and
as narrow as possible. Your comments, Doctor?
Mr. Zandi. No, I agree with you that the fundamental
problem is we took on too much debt as consumers--not all
consumers, but a fair share of consumers, and that that debt is
going bad and it is choking the financial system and the
broader economy.
I think, though, that wrong needs to be righted in an
orderly way, and right now, it is being righted in an
extraordinarily unproductive way that is hurting everybody,
even the people who didn't borrow, because their housing values
are falling, their stock portfolios are depreciating. They are
losing their jobs. They are not getting credit, even though
they are, under any normal circumstance, good credits.
So that is, unfortunately, the situation we are in and it
is becoming very self-reinforcing. If there isn't a response to
that, then you run the risk of it all sort of devolving, and
that is why I think we are at a very unusual point where it is
very important for policymakers to be aggressive to try to
short-circuit that cycle so that this righting of the wrong,
which you are absolutely right about, happens in an orderly--a
reasonably orderly way.
Senator Sessions. Dr. Zandi and to you other panelists, let
me just say to you that it is easy for business people and
economists and theoreticians to announce all these things and
you tend not to consider the deep fundamental philosophical
problems we are creating when we do this. I heard Barney Frank
on the TV today cite the 100-and-something billion dollar
bailout of AIG in support of his belief that we should do
another $25 billion on top of the one we are talking about for
the automobile dealers.
So when the floodgates are open, guys, I mean, I know if
you could just run this economy and you could manipulate it
all, you think you could do better than Secretary Paulson. I
think you probably could, but----
[Laughter.]
Senator Sessions [continuing]. Once you start down that
road, it creates a lot of problems. In the long run, I think we
will look back and see that we would have been better being
much more modest than our actions today would suggest.
Chairman Conrad. Senator Nelson.
Senator Nelson. Thank you, Mr. Chairman.
In a few hours, we are going to vote on whether to proceed
to a bill on auto bailout. It is $25 billion and it has some
restrictions, I really don't know what restrictions, but any
advice?
Mr. Taylor. Well, I will just mention in answer to Senator
Gregg's question, I think the $25 billion you have already
decided on is there and should be used.
Senator Nelson. That is in the past. It is in the past.
Mr. Taylor. It is in the past. And so with respect to an
additional amount, no, I don't think that is the way that you
should go.
I read the testimony of the three CEOs from yesterday and I
read it very carefully with respect to the current economic
situation. The main rationale they have, if you look for it, of
course, they indicate why their companies are doing well and
they are winning this award and that award, but they also
mention that the reason they need this money is because of this
credit crunch, the credit crunch that we all talked about in
this testimony.
Well, why not every company in the United States who is
experiencing--you know, what about the small guys? What about
the small businesses who are facing exactly the same credit
crunch things? Why--and if you add them up around the country,
there are more workers involved. So that is my----
Senator Nelson. OK. Let me, with the limited amount of
time, let me get the other two. Dr. Johnson?
Mr. Johnson. I think that this is a terribly difficult
decision, because I think you are in danger of opening the
floodgates. The only case that I can see for--two cases I can
see for this are if you believe that Chapter 11 bankruptcy
would actually lead to the closure of the businesses and
massive disruptions through the suppliers, which is what they
claim. It is very hard for outsiders to evaluate fully. Some, I
think, smart analysts think that that might be a possibility,
and the question is do you want to take the risk in this
situation.
The second point is, why them and why not others? I think
they could potentially be systemic. They owe a trillion dollars
in debt. In fact, you could argue they have run their--at least
car companies have been run rather like banks that gave away
cars below cost as some sort of a very strange incentive
program. They made money on the loans. All of these loans have
now gone bad. Well, ordinarily, they should face the music and
ordinarily they should have to restructure. I think that is
where this is heading. Do you want to make them do it right
now? Do you want to gamble with that at this moment in the U.S.
economy and the global economy, with the importance of those
jobs in the U.S. economy?
I think it is really an unpleasant place to be in. But
unfortunately, at this moment, I think you have to get them
through the next few months. Then they have to do a Chrysler-
type deal. With or without officially going bankrupt, they have
to have concessions from everybody, including the suppliers,
including the executives, including the workers. That is the
only way they are getting out of this.
And they have to push through restructuring. GM cannot
explain why they still have so many brands and so many models.
There are a lot of things that still don't make sense about the
way they run their business. I don't think we can afford to
have them collapse right now.
Senator Nelson. And the problem is, the collapse of
Chrysler, which I voted on years ago as a young Congressman, we
had a Lee Iacocca who offered some leadership. There are no Lee
Iacoccas today. As a matter of fact, the way that they have
conducted themselves over the years makes me doubt anything
that they are saying, so that when they say, well, we will go
into Chapter 11, well, I really don't know that that is true.
Dr. Zandi, do you know if that is true?
Mr. Zandi. I think there is a very good chance they will go
into bankruptcy.
Senator Nelson. Between now and January?
Mr. Zandi. Yes, a reasonable probability that they would,
just looking at their cash and how quickly they are burning
through their cash. But I don't know that I would vote--I don't
think I would vote for this legislation. I think bankruptcy is
the appropriate way to go and I think when they got into
bankruptcy, if they were having trouble getting financing to
have an orderly bankruptcy, which would be why they would go
from a Chapter 11 to an effective 7, a liquidation, and that is
when you would see the massive layoffs, it would be at that
point that I think you might want to respond, either through
some kind of guarantee to that financing or it may even be a
place, and I don't know this for sure, but it may even be a
place for the Federal Reserve to enter in. They may be able to
provide some guarantees on that financing.
Because I think you are right. If you give them the money,
it would be very surprising to me if they don't come back for
more money. And it would also be very surprising to me that
they could go through the restructuring that they need to to
become viable companies in the long run. The only way that is
going to happen, I think, is if they go through the very
painful bankruptcy process, because that is going to bring all
of the stakeholders of these companies together, the creditors,
the management, the shareholders, the unions, and they are all
going to have to make those tough choices together, and I don't
think those are choices that they are going to make outside of
bankruptcy.
Senator Nelson. Let me go back a few weeks ago when we were
told--we were all on a conference call on our Democratic Caucus
with Paulson and Bernanke. The Republican Caucus had done the
same thing. They, those two, told us that there could be a
complete economic meltdown by Monday, when this was a Friday
conference call. Was that accurate? They said there could be
unless we signaled that we were going to do something, which we
did. Was that true?
Mr. Zandi. In my view, that was a very significant risk and
threat, that the financial system broadly was literally on the
precipice of collapse, meaning that you would have a lot of
major institutions failing and it would shut down the system
completely. Yes, I think that was a reasonable threat, yes,
risk.
Mr. Johnson. You didn't say which Friday it was, but if I
can guess which Friday it was----
Senator Nelson. Yes, it was when all this stuff started.
Mr. Taylor. It was September 19.
Senator Nelson. Yes.
Mr. Johnson. Then I think their assessment on that day was
correct, and I think--remember how they got there, or remember
that the week before, they had declined to save Lehman and many
people, including myself, thought that was a very brave move
and I thought they must have done the math very carefully and I
presume that they knew that the consequences would not be
severe, and I don't know what they knew and they didn't know,
but 2 days later, they had to save AIG because of the way these
things are interconnected and the way that the financial system
is structured.
That is the danger here, is that you can make a decision
about not saving an entity that is very interconnected, has a
huge amount of debt, and 2 days later, you have to put a lot
more money into preventing the system from collapsing.
Senator Nelson. And we are still putting money into the
black hole of AIG.
Mr. Johnson. And I think you will be for some time.
Senator Nelson. Did you have a comment, Dr. Taylor, and
then I will----
Mr. Taylor. Yes. I remember September 19 very well. I
wasn't, unfortunately, privy to the conference calls or however
the meetings took place here so I can't really assess what
Chairman Bernanke or Secretary Paulson said that day----
Senator Nelson. Well, they said just what I said.
Mr. Taylor. I do feel that a lot of the things that
happened, if you look at the TED spread that the Chairman put
up or look at the chart in my picture, a lot of that happened
after September 19, OK, so it was after the decision to go
ahead and do something. So I think, again, going back to
Senator Murray's question, there are a lot of questions about
how the response to that took place and the confidence problems
that that response itself created. It was the whole month of--
the rest of September and October were the worst performance we
have had in these markets in a long, long time.
Senator Nelson. Thank you, Mr. Chairman.
Chairman Conrad. Thank you, Senator Nelson.
Let me just reclaim my time, then we will go to Senator
Whitehouse.
Senator Nelson. You were very gracious, by the way, to
defer so that your other members of the committee can ask
questions first. That should be noted for the record.
Chairman Conrad. Thank you.
I was on that call, as well, and I remember, in fact, I
thought the whole conversation was so striking, I wrote it
down. I can't remember if it was a Thursday or a Friday, and we
were told, I remember very, very clearly, No. 1, if you don't
act, the following things are going to happen. No. 2, No. 1,
there will be massive additional failures. No. 2, the stock
market will collapse. No. 3, the country will enter a deep and
possibly protracted recession.
And those statements were notable for their absence of
hedge words. There was no, this might happen, this could
happen. These were declarative statements. There will be
massive additional failures. The stock market will collapse.
And this nation will enter a deep and possibly protracted
recession, and I took that down as they talked because I
thought it was historically an important conversation.
Let me go back to how did we get in this mess. I have been
asked--I have just done 50 community forums in my State and I
was asked, what is the root cause of all this? And I know so
much of the talk is housing, and I know, Dr. Zandi, you are a
housing specialist. My own reaction has been my belief is that
at the root of all this in terms of government responsibility
is simultaneously, we had a very loose monetary policy and a
very loose fiscal policy. Unusual if you look at economic
history to have a very loose fiscal policy, a very loose
monetary policy simultaneously, and we understand the roots of
it.
Dr. Taylor, you referenced the monetary policy side of it.
We had the Federal Reserve go to 1 percent on the discount rate
because of 9/11 and stayed there a long time. Simultaneously,
we were running massive budget deficits. My own belief is that
created a seedbed for bubbles. And we didn't get just a housing
bubble. We certainly got that, but we also got an energy
bubble. We got a commodity bubble. I mean, wheat went to $18 a
bushel. These things all happened and they happened together,
and I believe they had a common genesis.
Coupled with that was deregulation. Coupled with that was
individuals taking on debt they had no business taking on.
Coupled with that, lenders making loans they had no business
making, no documentation loans, liars' loans as they call them.
So we really cooked a stew.
So on the one hand, my own belief is that created the
climate for bubbles to collapse, and when bubbles collapse,
there is a lot of economic wreckage.
So how do we get out of it? Short-term, I believe you do
have to have stimulus. You have to have lift to this economy.
Only the Federal Government can do it because credit markets
are still debilitated and you have very serious falling demand,
aggregate demand. So you have to give lift.
On the other hand, I also believe that if we don't send a
signal and enter a process to get us back to fiscal
responsibility, we will lose credibility and we will have the
danger of even greater long-term damage.
So my view is, and this is what I would like your reaction
to and response to----
Senator Gregg. Can we, Mr. Chairman, before they react, put
that opening statement by yourself in bold letters and
distribute it to our membership, because you just hit the nail
on the head, in my opinion.
Chairman Conrad. Well----
Senator Nelson. Amen.
Chairman Conrad. I hope I have hit the nail on the head. We
will see. I think it is so important that at the time we do
another stimulus package, we also enter into a process to
restore fiscal discipline. I think this whole exercise is not
going to have much credibility, and I liked, Dr. Taylor, very
much some of the words that you applied here. Dr. Zandi, I
liked very much your specific proposals. Dr. Johnson, I liked
your bringing to our attention, remember, this is global. This
is unlike what we have seen before.
But how about that basic construct, that while we do
stimulus, simultaneously we set in place a process to restore
fiscal discipline? Dr. Zandi, I would just go right down the
line.
Mr. Zandi. Yes, I think that is vital, because on the
immediate other side of the crisis will be the next crisis, and
that is our long-term fiscal problems, that we will be right
into the middle of Medicare, Medicaid, Social Security, and the
math is very daunting. So there is not--I had thought before
the crisis that we would have a bit of a window where we could
put a process together and really think about this carefully.
But unfortunately, that is not the cards we have been dealt. So
we are going to have a trillion-dollar deficit this year. We
are going to have a trillion-dollar deficit next year. Even if
the economy recovers reasonably well, we are going to have very
large budget deficits unless we make real changes.
One thing you could do in the fiscal stimulus package with
respect--I think all the spending, which is very important for
near-term stimulus, should be temporary and it should be very
clear that this is temporary. And I think that provides a very
large bang for the buck. It creates a lot of jobs and that
fills the hole left by the pull-back by consumers.
On the tax side, I do think it might be worthwhile to make
permanent the lower tax rates for current lower-middle-income
households, and then for upper-income households, tell them
exactly how their tax rates are going to rise and when they are
going to rise. It probably shouldn't be 2011, and I am not sure
what date it should be, 2012, 2013, and it phase in over a 4-
year period, but it becomes very clear, to go to Dr. Taylor's
predictable, that you know exactly when those tax rates are
going to rise and people can plan for it.
And all of the tax dollars that are generated from that
should go to deficit reduction, that it shouldn't be used for
anything other than this is going to be a starting point for
paying for those big deficits we know we are going to face in
the out years after we get by this crisis.
But I think as part of the stimulus, if you can do that, I
think it creates predictability and it also is at least a good
start to trying to address the long-term fiscal problems.
Chairman Conrad. Dr. Johnson.
Mr. Johnson. I agree very much with what you are saying and
I would reinforce it in the following way. I think because of
the global nature of the economy and our global financial
system, you have to expect that there will be bubbles, again,
either somewhere else or actually in the United States. The
capital will come in, and this is a little bit about the
capital flows we talk about through financing the trade
deficit, but much more than that, it is the gross capital
flows. Capital comes in and goes out every day. The amount of
capital that can come in whenever it sees an attractive
opportunity in the United States is enormous and you will not
stop it.
The Federal Reserve will not stop the bubbles, I am afraid,
just that is the nature of these things. The regulators, even
though I am sure you will end up with much stronger, better
regulators, they also are not likely to prevent all asset
bubbles from developing.
So the only thing you have is the balance sheet, the
government balance sheet, and the willingness to deploy it when
necessary, but only when necessary, and that you only have the
balance, you only have the credibility if you preserve it in
the good times.
So I am a little reluctant to commit to exactly the glide
path Mr. Zandi laid out because I don't know how long this
recession is going to be. I need a bit more time, 6 months at
least, to see where this is going. But I think the general idea
that you are expressing and that Professor Taylor was talking
about is right, that you want to keep the debt at sustainable
levels. You want to preserve your financial firepower for when
you need it.
And I think you don't need it very often, all right. You
need it in the aftermath of the collapse of these massive,
massive bubbles. I don't know if that is once every--I hope it
is not more than once every 10 years. That is the point of
fixing the regulation. I think you need it now, but you also
need to address the fiscal consolidation absolutely as a
priority going forward.
Chairman Conrad. Dr. Taylor.
Mr. Taylor. Yes, I would just add that one way to add to
the credibility that you rightly want to convey would be as
disciplined as possible in the package itself. In other words,
look for things, and I gave some suggestions, where you can
stimulate the economy without increasing the deficit. And the
more you--or even stimulate the economy and reduce the deficit.
So the more you can do to demonstrate currently fiscal
discipline, the more credibility you are going to have for the
future.
With respect to the tax rates, I see no reason to do
anything except to commit to keeping those rates from rising.
They are going to rise in 2010 right now in the law. I think
that has people worried. Again, it is more than 50 percent of
small business income is going to get a tax increase by current
law. It is more than 50 percent of capital gains income is
going to get a tax increase. And that can hurt--it is already,
in my view, hurting the economy.
So you can stimulate this economy by somehow, and I agree,
you have a political problem here, somehow committing that we
are not going to raise those taxes. We are going to put them
and make it as permanent as you can, plus do the things that I
mentioned that President-Elect Obama suggested.
Chairman Conrad. Senator Whitehouse.
Senator Whitehouse. Thank you, Mr. Chairman.
It appears that we all agree with the need for a
significant stimulus and soon. It also appears that we all also
agree that whatever stimulus we go forward with, it will
increase the deficit, whether it is tax cuts that reduce our
revenues and add to the deficit or additional spending that
adds to our spending and adds to the deficit. That is the
predicament that we have here. It seems to be the consensus
that right now, the stimulus is more important than the deficit
issue in an immediate sense, but the deficit debt problem is
one that is very significant, I think probably safe to say even
dangerous.
In balancing the stimulus that we require against the
deficit that we create, it strikes me that infrastructure has a
characteristic that is particularly valuable here, and that is
that you end up with an asset when you are done with the
spending. And if you presume for a moment that the asset was
necessary in the first place, that the bridge had to be built,
that the water treatment plant needed to be improved, that the
highway needed to be repaved, that the school needed to be
cleaned up, then in many respects, if you are doing that
spending now, it strikes me that you are really accelerating a
future liability and moving a cash asset into a physical asset
more than you are pure deficit spending, the way you would if
you just sort of threw it out there.
Do you agree? I see heads nodding. Do you agree that that
is an attribute of infrastructure stimulus, that it has a kind
of an inherent counterbalance or mitigating effect with respect
to the debt and deficit problem that we have?
Mr. Zandi. Yes, I strongly agree with that statement. The
only rap against infrastructure spending is it takes, at least
historical rap, is that it takes a long time to really have a
benefit to the economy. You have to do the plans. You have to
cut the checks. You have to hire the people. That could be a
year or two from now.
Senator Whitehouse. Let me jump in on you there on that,
because an enormous--I am not expert in this and you all, of
course, are, but an enormous amount of what I hear talked about
in this context is confidence. And it strikes me that if a
Rhode Island carpenter or a Rhode Island laborer or a Rhode
Island plumber knows that a significant contract for a
significant project just got let and he has a job there for the
next two or 3 years as that project gets built, that
individual's confidence and their appreciation and their sense
of relief that they might make it through this thing improves
day one, even if the actual funding doesn't come through in the
future. Isn't there some value to that?
Mr. Zandi. Yes, I think that is a very reasonable argument.
I was just going to make the other argument that the problems
that we are in are longer-term. They are not the next 6 months.
They are not even 12 months. This seems to be a two-, 3-year
problem----
Senator Whitehouse. Yes.
Mr. Zandi [continuing]. That even if the money gets into
the economy in 2010, that is going to do us a lot of good.
Senator Whitehouse. Yes.
Mr. Zandi. The other thing to consider, just from a pure
mathematical perspective, if the Treasury borrows at 4 percent,
I think most estimates, academic estimates I have seen on the
return on public investment, public infrastructure, is much
greater than 4 percent. So it almost makes sense from just a
purely investment perspective. So it gives you the stimulus,
and as you say, you get an asset that yields a return that is
higher than the cost of the financing.
Senator Whitehouse. And let me add one more factor in
there. What if we were to focus the infrastructure in areas
that were of added societal benefit? I mean, one of the things
when we think about infrastructure, we very often think about
things that the Romans could build, you know, roads, bridges,
aqueducts, water facilities. But we need to transition to a
green economy. If we do so, there will be substantial rewards
in terms of the reduction of our reliance on foreign oil and
the hemorrhaging of our funds to oil-producing countries.
If we invest in, for instance, a health information
technology infrastructure, almost every expert agrees that that
investment will help turn around the direction of health care
costs. It may even reduce them substantially.
Is it worth, in the context of the infrastructure, looking
beyond Roman infrastructure and looking at other elements that
may provide added both economic and social benefit,
particularly in the environmental/energy and health care areas?
Mr. Zandi. I think it is very reasonable. That was your
point.
Mr. Johnson. Yes. I think that that is a very good
additional point to think about. Investment in new technology
often overlaps with infrastructure. I think that is what you
are saying. And I think this is a very important opportunity
because we are facing a longer-term problem and not a 1-year
problem. But I think we are agreeing it is a two-, three-, or
4-year problem. Now is the right time to make some sensible
decisions.
I would stress the need to be careful. There are countries
out there that are spending a lot of money on infrastructure,
countries like Japan, that end up spending a lot of money on
bridges to nowhere. I don't think U.S. is in that situation. I
think we have some very pressing infrastructure needs in terms
of upgrading and doing proper maintenance on existing Roman
infrastructure, Roman-type infrastructure, and then investing
further in that kind of more traditional infrastructure. I
would support that as long as it is done carefully. And you do
have time to do it now.
Senator Whitehouse. Yes, and the premise of my question was
that this was, in fact, necessary infrastructure and not
bridges to nowhere.
Mr. Johnson. Well, the other point I would emphasize is
that low oil prices, low commodity prices actually give you
good value for money in terms of infrastructure spending now.
Building bridges and roads now is much cheaper because oil
prices are low and they are going to be lower, and other input
prices are going to be lower. So this is actually a very good
time in terms of the global cycle to make those kinds of
investments. You get good returns.
Senator Whitehouse. Dr. Taylor, I am down to 43 seconds. Do
you have anything to add? I am sorry, we have kind of run you--
--
Mr. Taylor. Just very quickly, it seems to me that if you
do believe that the decisions are being made correctly about
what infrastructure we need and that there have been decisions
made, bring those forward as much as you can, the ones that
already are authorized or even appropriated. Bring those
forward. That is, to me, the place to start. And it goes back
to the idea of looking for ways to stimulate without adding to
the deficit, which is, really, we need to be doing that as much
as possible.
And I just say, when you talk about public sector, jobs
created by the public sector, don't forget the private sector
is by far the biggest source of job creation, and anything you
can do to help create jobs at private firms should be the
highest priority.
Senator Whitehouse. Understood. I appreciate the witnesses'
answers and I appreciate the Chairman's courtesy, Mr. Chairman.
Chairman Conrad. I thank you Senator.
Senator Gregg, would you like----
Senator Gregg. I want to thank the panel. It has been
extraordinarily informative.
Chairman Conrad. I first of all want to thank Senator Gregg
very much for helping us organize this panel. I think this has
been really exceptionally good. We have had different
perspectives from each one of you, very valuable to the work of
this committee and more broadly to the work of the Senate in
the days ahead. I am certain we will be calling on you in the
future. I hope that you are available to us. I think you have
provided a lot of food for thought here, and I want to thank
you all very, very much.
The hearing is adjourned.
[Whereupon, at 11:55 a.m., the committee was adjourned.]