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MONETARY POLICY AND THE

STATE OF THE ECONOMY, PART I

HEARING

BEFORE THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED TENTH CONGRESS

SECOND SESSION

FEBRUARY 26, 2007

Printed for the use of the Committee on Financial Services

Serial No. 110–92

(

(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES 

BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

GWEN MOORE, Wisconsin, 

LINCOLN DAVIS, Tennessee 

PAUL W. HODES, New Hampshire 

KEITH ELLISON, Minnesota 

RON KLEIN, Florida 

TIM MAHONEY, Florida 

CHARLES WILSON, Ohio 

ED PERLMUTTER, Colorado 

CHRISTOPHER S. MURPHY, Connecticut 

JOE DONNELLY, Indiana 

ROBERT WEXLER, Florida 

JIM MARSHALL, Georgia 

DAN BOREN, Oklahoma 

SPENCER BACHUS, Alabama 

DEBORAH PRYCE, Ohio 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

STEVEN C. LATOURETTE, Ohio 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

CHRISTOPHER SHAYS, Connecticut 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

TOM FEENEY, Florida 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

GINNY BROWN-WAITE, Florida 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

STEVAN PEARCE, New Mexico 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

GEOFF DAVIS, Kentucky 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

ADAM PUTNAM, Florida 

MICHELE BACHMANN, Minnesota 

PETER J. ROSKAM, Illinois 

KENNY MARCHANT, Texas 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

DEAN HELLER, Nevada

JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel 

(III)

C O N T E N T S 

Page 

Hearing held on: 

February 26, 2008 ............................................................................................ 1

Appendix: 

February 26, 2008 ............................................................................................ 53

WITNESSES 

TUESDAY, FEBRUARY 26, 2008

Reinhart, Carmen M., Ph.D., Professor, School of Public Policy, Department 

of Economics, University of Maryland ................................................................ 13

Rivlin, Alice M., Ph.D., Senior Fellow, Brookings Institution ............................. 6

Roubini, Nouriel, Ph.D., Professor of Economics, Stern School of Business, 

New York University, and Chairman, RGE Monitor ........................................ 15

Taylor, John B., Ph.D., Mary and Robert Raymond Professor of Economics, 

Stanford University ............................................................................................. 9

Zandi, Mark, Ph.D., Chief Economist and Founder, Moody’s Economy.com ...... 11

APPENDIX 

Prepared statements: 

Paul, Hon. Ron .................................................................................................. 54

Reinhart, Carmen M. ....................................................................................... 55

Rivlin, Alice M. ................................................................................................. 59

Roubini, Nouriel ............................................................................................... 66

Taylor, John B. ................................................................................................. 87

Zandi, Mark ...................................................................................................... 91

(1)

MONETARY POLICY AND THE 

STATE OF THE ECONOMY, PART I 

Tuesday, February 26, 2008

U.S. HOUSE OF REPRESENTATIVES, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. 

The committee met, pursuant to notice, at 10:05 a.m., in room 

2128, Rayburn House Office Building, Hon. Barney Frank [chairman of the committee] presiding. 

Members present: Representatives Frank, Waters, Maloney, 

Capuano, Hinojosa, Clay, Miller of North Carolina, Scott, Green, 

Cleaver, Sires, Klein; Bachus, Castle, Paul, Manzullo, Jones, 

Shays, Feeney, Garrett, Pearce, Price, and Campbell. 

The CHAIRMAN. This is the second in a series of hearings this 

committee has had and will have while I chair it, around the state 

of the economy. We have under the Humphrey-Hawkins Act, and 

I should note I think—well, I guess I have before, but I’m not sure 

if this is the first or the second Humphrey-Hawkins hearing we 

have had since Gus Hawkins passed away at the age of 100, a really great man. And the value of the Act becomes all the clearer. As 

I look at the European Central Bank with its mandate only to deal 

with inflation and our Central Bank with its dual mandate to deal 

with inflation and high employment mandated by the HumphreyHawkins Act, I am again reminded, I think, of the wisdom of Gus 

Hawkins and Hubert Humphrey, because I think we are well 

served by the duality of that mandate compared to what the ECB 

does. 

But it was my view that in addition to hearing from the Chairman of the Federal Reserve Board, we ought to hear from other 

voices as well on the economy, and that is the purpose of this hearing. Tomorrow, Chairman Bernanke will testify before this committee, and Thursday he’ll testify before the Senate. But this is 

part of a process by which we solicit other views. 

I think the Federal Reserve is a very well-run institution. We 

have a former member here, of the Board. But I also believe that 

it gets in general more intellectual and political deference than is 

healthy in a democracy. It is often considered to be the case that 

it is legitimate for us in the democratic fora to debate war and 

peace and the physical future of the universe and the most intimate questions of human conduct, but if any politician dare talk 

about 25 basis points on the interest rate, that is somehow a great 

breach of the rules and could cause terrible consequences. That is 

nonsense; monetary policy is a legitimate subject for debate as well 

as any other as long as it is conducted in a sensible way. 

2

It is particularly the case in this particular period, because what 

we are seeing are, I think, the limits and constraints that the Federal Reserve faces in monetary policy. And I think—let me announce a change of mind. Some time ago when we talked about the 

multiplicity of Federal regulators in the banking area, a common 

subject, one question I raised was, well, why does the Federal Reserve need to be a bank regulator? We have all these other bank 

regulators. Why can’t they just be the monetary authority, as is the 

case in other places? And Alan Greenspan said at the time—and 

I was skeptical, but I now acknowledge that he was right—that 

being the regulator informs the Fed’s judgment about the economy 

in ways that help in the formulation of monetary policy. 

The problem I must say is that I do not think Chairman Greenspan fully followed through on this, because I think what we have 

is a disconnect between the Fed’s authority as a regulator and its 

role in monetary policy essentially for ideological reasons under 

Chairman Greenspan, the Federal Reserve consciously decided not 

to exercise a great deal of its regulatory authority. That is now 

changing under Mr. Bernanke. I don’t think that has been adequately addressed. 

For example, in 1994, Congress passed the Homeowners Equity 

Protection Act to give the Federal Reserve regulatory authority 

over all mortgages, not just those issued by depository institutions. 

Chairman Greenspan consciously and deliberately decided not to 

enforce that, not to use that authority. When the Comptroller of 

the Currency and the Office of Thrift Supervision issued their Federal preemption of a lot of State consumer protection laws, including some in the mortgage area, one response was to beef up what 

the Comptroller of the Currency could do with regard to consumer 

protection. 

I spoke at that point to the late Ned Gramlich, who was the Federal Reserve Governor with that responsibility. He said, ‘‘Well, here 

is what you need to do. Under the Federal Trade Act, the Federal 

Reserve system has the authority to promulgate a code of unfair 

and deceptive practices for the banks. That would be a replacement 

for some of the State consumer laws that were knocked out.’’ I said, 

‘‘Well, that’s good. Why are we not doing that?’’ And he said that 

Chairman Greenspan is opposed to that. He thinks that is too 

much regulation. We wrote, some of us, to the Chairman, and he 

said, no, he wasn’t going to do that. 

Mr. Bernanke, I think, is again going to reverse that decision, 

and I believe under Chairman Bernanke you are going to see an 

exercise of authority to promulgate that code that we didn’t have 

before. The relevance of that is this: I think there has been a tendency to look at monetary policy as the macro sector of the economy 

and financial regulation was micro, but the micro has decisively influenced the macro. We have a macroeconomic crisis today. 

Clearly, at least the worst financial crisis in the world since 

1998, and its impact in the United States is conceivably worse than 

1998, and the single greatest cause—obviously, all phenomena in 

a complex world have multiple causes—but the single greatest 

cause is regulatory failure. The single greatest cause of the current 

economic crisis is the failure of Federal regulators, in particular in 

the United States, to use regulatory authority. The result has been 

3

not just the subprime crisis, but the infection of the entire credit 

system by the subprime crisis. And both the fact that mortgage 

loans were made that should not have been made and the absence 

of any sensible regulation, and the fact that those loans were then 

allowed to spread in various ways that were obviously not fully understood throughout the system, is the single biggest cause of why 

we are here. 

So what we are talking about today—and in consequence, as a 

number of people have noted, monetary policy is somewhat constrained. I do note Chairman Greenspan generally, both during the 

dot.com issue and the irrationally exuberant stock market, to quote 

the Chairman at the time, and today, Chairman Greenspan’s inclination was to pose this choice. Either I deflate the entire economy 

or I allow these phenomena to continue. 

And, of course, the answer to that dilemma is sensible regulation. If you have inadequate regulation of abuses, yes, then you do 

get to a situation where your choice is deflation of the entire economy or allowing the abuses to flourish. And that’s why in the current context in particular, sensible consideration of monetary policy 

requires looking at the role of regulation. Because in the absence 

of regulation, you give monetary policy too heavy a lift, one that 

it conceptually and intellectually cannot make. 

And that is what I believe we will inevitably be talking about. 

I have reviewed much of the testimony, and not surprisingly, many 

of the witnesses in fact make that point, that the problem we face 

today is a problem of inadequate regulation of—and innovation, 

securitization, a good thing, because innovations that don’t serve 

some positive role die of their own lack of merit. But innovation 

that outstripped that any regulation, and the consequent problems 

that we have had have led us to where we are today. 

So I said, in this case, whether we are talking about monetary 

policy under the Humphrey-Hawkins Act, or the economy in general, we are talking about, in my judgment, the role that inadequate regulation has played in causing a dilemma for the monetary policymakers. And that is what we will be talking about today, 

and we will be talking about with the Chairman tomorrow. 

The gentleman from Alabama. 

Mr. BACHUS. I thank the chairman. Congressman Paul is going 

to deliver our opening statement, but I would like to comment on 

one thing. On this committee, it is difficult for us to assess exactly 

how much stress there is on the financial sector because, I think, 

of a lack of transparency, and in certain cases a lack of accountability. So as with the markets, there is a lot of uncertainty out 

there as to where this economy stands. 

You add to that economic conditions that in some cases are soft 

and in other cases are really not. The economy in many ways is 

doing quite well. And you add to that what is the proper response 

in light of what I would say is troublingly high inflation. This 

morning the PPI came out, and I’m sure Members know, it was 

very high, which obviously should be a concern to the Fed and 

should be a concern to us. When you have a slowing economy and 

a high inflation rate, it makes it particularly difficult to know what 

to do or what not to do. So we would be very interested in your 

4

advice in that regard, but I will say the inflation numbers this 

morning were not good news. 

The CHAIRMAN. Representative Paul, the gentleman from Texas. 

Dr. PAUL. Thank you, Mr. Chairman. I appreciate this. I would 

like unanimous consent to submit a written statement. 

The CHAIRMAN. Without objection, any written statements any of 

the witnesses or members would like to include will be included as 

part of the record. 

Dr. PAUL. I want to thank the chairman for holding these hearings, and especially for the title of the hearing. The title is very appropriate, ‘‘Monetary Policy and the State of the Economy,’’ because 

indeed they are related. Sometimes we in the Congress and for 

other reasons, economic problems are created, and we look to the 

Federal Reserve to solve the problems. From my viewpoint, we 

should look at the Federal Reserve a little earlier, because I see so 

many of our problems that we have coming from monetary policy. 

The Austrian economists, led by Mises and Hayek—Hayek, of 

course, won the Nobel Prize—talk significantly about monetary policy and how inflation of the money supply is the real culprit because it distorts interest rates and causes the malinvestment and 

the excessive debt. And it is for this reason that most economists 

accept the notion that inflation is always a monetary policy, and 

yet today we still talk about, well, the price of oil is going up, so 

therefore it might lead to inflation, rather than saying, what is 

happening to the money supply? 

Well, currently, we don’t get all the statistics on the money supply anymore; M3 was an important number, total money supply, 

and that hasn’t been looked at for a couple of years, and yet private 

sources report that is growing at about 16 percent a year. Now the 

significance of this is the distortion that causes in the marketplace. 

The Austrian economists predicted well before the collapse of socialism at the end of the 20th Century that it would collapse because they eliminated the pricing structure. If you don’t have free 

market pricing, you can’t determine what to produce, and at what 

quality and what quantity, and only the market can do that. But 

likewise, they were every bit as critical about the manipulation of 

interest rates, and that is what the Federal Reserve is doing, always making interest rates go up or down. And they generally get 

it wrong both times. They either have them too high or too low, 

and they will get criticism from both sides. 

But we as a nation who champion the marketplace have totally 

rejected the idea that the market can determine interest rates, and 

that is why I think we get into trouble like this. In the 1960’s, we 

faced a similar problem, because we were pretending that we could 

have guns and butter and it wouldn’t really cost us. Well, anybody 

who knows about the 1970’s knows that it cost us a lot. 

Right now, what we are looking forward to is a cost much greater 

than what we witnessed in the 1970’s, because we are much deeper 

in debt. Our foreign indebtedness is overwhelming. Our productive 

jobs are overseas and inflation is roaring again. Government statistics always lag reality, but even in government statistics today, as 

Congressman Bachus points out, inflation is over 12 percent a year. 

I mean, this is serious business. We are in stagflation. I don’t think 

there is a question about: are we in a recession? We are in a recesVerDate 0ct 09 2002 13:33 Apr 10, 2008 Jkt 041183 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 K:\DOCS\41183.TXT TERRIE
5

sion. The numbers will catch up, no matter what the government 

statistics say, just talk to the American people. They are having a 

tough time. Ask middle-class Americans what they are doing. They 

are being wiped out, because their cost of living is going up much 

faster than their wages can keep up. Same way with Social Security beneficiaries. 

This is all a consequence of monetary policy, the fact that we 

allow ourselves to resort to the creation of money. If we had to pay 

for this war and for the welfare programs we have here at home 

by taxes, this would all end quickly. But instead, you know, we tax 

to the hilt, then we borrow as much as we can. Then there is a 

limit on that because interest rates might go up, and we fear that. 

So then we resort to the creation of new money out of thin air, 

which is another tax, because the value of that dollar goes down, 

prices go up, and who gets hit the most? The middle-class Americans. This is why middle-class Americans are really suffering. 

So there are a lot of things that I believe could be done, but once 

the Fed causes this distortion, we can’t resort to the fact of saying, 

well, we need more regulations by the government. We need more 

regulations, but I would like to see the regulations come from the 

marketplace to make the adjustments necessary. But it is inevitable to have a recession once you create an artificial boom with 

the inflationary policy of the Fed, and that is what we are facing 

today. 

We are in the early stages of a recession, and unfortunately, 

many who have studied Austrian economics predict that this one 

is going to be long and tough and a lot worse than the problems 

we faced in 1979 and 1980. Hopefully, we can do the right things, 

but it would involve the Congress cutting back and not putting the 

pressure on the Fed to monetize this. 

And it is an inevitable myth we have lived with that war is an 

economic stimulus. That is absolutely false, and yet we live by that. 

We think, well, if we just spend money and the war spending participates in our GDP growth, and pretend that we’re growing by 

building bombs that are blown up—this is an absolute myth, and 

therefore, this economy, I think, is on shaky ground, and we need 

to go back to look at what sound economic policies are as well as 

sound monetary policy. I thank you, Mr. Chairman. 

The CHAIRMAN. I thank the gentleman, and we will now proceed 

with our witness panel. 

Mr. BACHUS. Mr. Chairman? 

The CHAIRMAN. Yes? 

Mr. BACHUS. I’d like to just briefly say that our witness is John 

Taylor, who is a distinguished professor at both Stanford and before that at Princeton, and I think at Columbia. He has a distinguished record at the Treasury Department, is considered an authority on monetary policy and currency, and we are proud to have 

him, as well as our other witnesses. 

The CHAIRMAN. I thank the gentleman. Let me add that I have 

good memories of the work we did together on debt relief and generally trying to show some flexibility with regard to aid to the poorest countries in the world through the international financial institutions which fell under Professor Taylor’s jurisdiction. 

6

Our first witness now is Dr. Alice Rivlin, who is a visiting professor at the Public Policy Institute of Georgetown, a senior fellow 

in the Economic Studies Program at Brookings, and was Vice Chair 

of the Federal Reserve System from 1996 to 1999. Dr. Rivlin. 

STATEMENT OF ALICE M. RIVLIN, PH.D., SENIOR FELLOW, 

BROOKINGS INSTITUTION 

Ms. RIVLIN. Thank you, Mr. Chairman. I, too, am glad you are 

having this hearing, and I am happy to be here to share my views. 

I agree with you that monetary policy is a very legitimate subject 

of debate, as is regulation. I do think you should separate them in 

your head, though. And I will use the term ‘‘monetary policy’’ as 

it is conventionally used by economists to mean what the Fed is 

doing to regulate the macroeconomy. 

Now I know you want to focus on monetary policy today because 

you have Chairman Bernanke coming tomorrow. But I actually 

think monetary policy, as I am defining it, should be pretty far 

down your list of worries. The Federal Reserve has used the tools 

of its monetary policy arsenal quite aggressively and imaginatively 

in the last few months, and clearly indicated its intention to do 

more if necessary, so it seems to me that they are doing a good job. 

I think you should also be extremely pleased with the swift bipartisan action of the Congress and the Administration on the 

stimulus package. You may need to take further action, but the initial package was well-designed for maximum effect, and it passed 

with remarkable alacrity. Our policy process doesn’t always function that well. 

Now if the consensus forecast is roughly right, and we have some 

on the panel who differ with the consensus, we will have slow 

growth for the next couple of quarters but will avoid recession and 

see growth resuming by the end of the year. But the situation, as 

you point out, is precarious. In housing, a spreading wave of foreclosures could undermine consumer confidence and increase the 

probability of recession. 

Continued risk aversion of investors and unwillingness to lend on 

the part of financial institutions could raise the probability even 

higher. The hardest challenges now are to minimize housing foreclosures and get the credit markets functioning more normally, 

both without spending excessive public resources or rewarding people who made dumb and irresponsible decisions. That is a tall 

order. It is a hard thing for the committee to be facing. 

The slowdown in the economic growth and job creation in the 

last quarter of 2007 was clearly the result of the decline in residential construction and housing prices, and the crisis in the subprime 

market. Nobody should have been surprised by that. We created a 

bubble, and bubbles burst. 

We shouldn’t forget that a lot of good came from the housing 

boom. Millions of people moved into new or better housing, and 

most of them, including most subprime borrowers, are living in 

those houses and making their mortgage payments on time. I think 

the downside was that many people came to believe that housing 

prices would go on rising forever. Lenders became lax. Borrowers 

became over-extended. Speculation took hold, and we simply built 

7

too many houses. It will take time for demand to catch up with 

supply. 

The explosion of subprime lending was a clear regulatory failure. 

My former Federal Reserve colleague, Ned Gramlich, to whom you 

referred, warned repeatedly that lax standards and predatory practices in the subprime market deserved urgent regulatory attention. 

But the problem is that we have a very fragmented regulatory system. Most of the questionable practices were not being perpetrated 

by federally regulated banks, and the Washington regulators, as 

you pointed out, just did not get on the case. 

The worldwide fallout from the subprime crisis is just an example of how complex and interrelated our international markets 

have become. It was also a black eye for market capitalism. It was 

an embarrassing moment for those who boast about the intelligence and sophistication of financial markets. How come so few 

people asked the simple question, what happens to the value of 

these mortgage-backed securities when the music stops? When 

housing prices level off or decline, adjustable rates reset, and people with not-so-great credit histories can’t make their monthly payments? Financial market participants now say they underpriced 

the risk. That is code for failing to ask some pretty obvious questions. 

A lot of financial institutions and funds found themselves owning 

securities worth less than they thought or whose values could not 

be easily determined. The result was some pretty big losses and a 

panicky flight from risk. Uncertainty about the future tightness of 

credit markets makes forecasting the real economy unusually difficult. A scenario in which the crunch gradually resolves and credit 

flows return to some semblance of normality produces a far rosier 

economic outlook than a scenario in which financial institutions 

suffer additional large losses and the crunch gets worse, and we 

just don’t know. 

But meanwhile, back in the real economy, activity looks slow but 

actually not disastrous. The consensus of forecasters is that the underlying resilience of the American economy, aided by surging exports reflecting the weak dollar, and buoyed by the monetary and 

fiscal stimulus, will keep the economy from spiraling into recession. 

And my guess, for what it’s worth, which is not a lot, is that the 

consensus will prove about right. 

But the uncertainty is very great, and you have to worry about 

the downside. As I said, I think the Federal Reserve has been 

using its tools aggressively and inventing new ones on the run. 

Most of the Federal Reserve’s action has been aimed at pumping 

liquidity into the credit system in hopes of getting the banks lending again. The Fed lowered the discount rate and encouraged borrowing at the discount window. That didn’t work very well. So they 

invented a new tool, the ‘‘term auction facility,’’ a mechanism to enable banks to borrow large, fixed amounts of credit from the Fed, 

and this was coordinated with other central banks. 

I think these actions have been appropriate and creative. I know 

there are those who think the Fed is behind the curve. I suspect 

that these critics have in their heads, for whatever reason, a forecast like Congressman Paul’s—a forecast of deep recession to come, 

8

and they don’t think the Fed is acting on that forecast. However, 

the consensus forecast and the Fed’s does not anticipate recession. 

Moreover, there are ample reasons for concern about bringing the 

short-term interest rate down too far and too fast. Fear of aggravating inflation is clearly one, and the other is apprehension about 

making monetary policy so accommodating that it fuels the next 

bubble in whatever asset class might catch the investors’ fancy. 

One way to take part of the onus off the Fed and avoid excessive 

easing of monetary policy is swift action on fiscal stimulus, and you 

have done that—a very great accomplishment. I was among those 

who urged several additions to the package, including an extension 

of unemployment compensation for an additional 13 or 26 weeks, 

a temporary increase in food stamp payments, and some relief to 

the States in the form of an increase in the Medicaid match. 

The States are always hard hit in an economic slowdown, and 

tend, as they have to balance their budgets, to cut spending, often 

on Medicaid and other benefits to low-income people, and to raise 

taxes. These actions tend to make the economic situation worse 

and Federal relief can help forestall them. 

I would urge the Congress, however, not to load a second stimulus package with slow-spending projects, however worthy, such as 

infrastructure, that do little to stimulate the economy in the short 

term, and add to the growing Federal debt. I also believe that the 

stimulus ought to be paid for. This is just a plea to remember that 

PAYGO is important and it should not be set aside—exceptions can 

become a very dangerous habit. 

But the difficult challenge, it seems to me now, is designing a 

workable way of minimizing foreclosures and keeping families who 

are able to pay their mortgages in their homes. Foreclosures are in 

nobody’s best interest; they are expensive for lenders and servicers, 

painful for families, and destructive of property values in the surrounding neighborhood and beyond. 

The Treasury has been working energetically to pull the 

servicers and the borrowers together, and many States are doing 

this. This effort will help, but by itself, it is very unlikely to be sufficient to prevent a wave of foreclosures in the next couple of years. 

Legislating in this area is very tricky, both legally and morally. 

Rescuing individuals and institutions from the consequences of imprudent decisions smacks of condoning those decisions. However, it 

may be worth some moral hazard to avoid the spreading contagion 

of foreclosures that is likely to damage the prudent along with the 

imprudent. 

There are a great many proposals before the Congress on avoiding foreclosures, and I will not go into those here. Many groups 

more knowledgeable than I are eager to inform you on their views 

on this subject. 

But in conclusion, so far I think the policy response to the current macro situation is on the right track, both from the monetary 

authorities and from the stimulus. But the difficult tasks still lie 

ahead, that of crafting a set of policies that will be successful in 

containing the spreading contagion of foreclosures. 

Thank you, Mr. Chairman. 

[The prepared statement of Dr. Rivlin can be found on page 59 

of the appendix.] 

9

The CHAIRMAN. Next, Professor Taylor, who has already been introduced. 

STATEMENT OF JOHN B. TAYLOR, PH.D., MARY AND ROBERT 

RAYMOND PROFESSOR OF ECONOMICS, STANFORD UNIVERSITY 

Mr. TAYLOR. Thank you, Mr. Chairman, and Mr. Bachus for inviting me. 

I would like to begin my testimony with just a brief review of the 

broader span of time in the role of monetary policy that has led us 

to where we are; in fact, I would like to go back 25 years. It seems 

to me if you look at the span of time since the early 1980’s, you 

see a remarkably improved economy compared to what we saw in 

the late 1960’s and 1970’s. 

We have had, since the early 1980’s, three of the longest expansions in American history. We have had recessions, of course, but 

they have been much shorter, much less frequent, and much milder 

than in the past, especially in this period in the 1970’s where we 

had recessions every 3 or 4 years. This is a much better situation 

than in the past. 

If you go back just a decade, you see the trend growth, even more 

impressive. I think this is important to note. Starting in the midto late 1990’s, the productivity growth rate in the United States 

picked up by substantial amount the way economists measure, by 

about one percentage point. That alone has produced, believe it or 

not, another $9 trillion of goods and services that would not otherwise have been produced in the United States; $9 trillion—that is 

a lot of money that has gone to good use. 

If you now think about even more recently, you have seen this 

remarkably good performance spread around the world. Since 2002, 

there has not been the emerging market financial crises that we 

saw so much of in the 1990’s. The 1990’s, one crisis after another 

in emerging markets, and since 2002, it has been much quieter. 

That growth and global expansion, if you like, global long boom, 

has also produced enormous amount of good things around the 

world. 

Economist magazine just wrote last month that between 1999 

and 2004, 135 million people have come out of poverty around the 

world. That is the benefits of this strong economy that we have 

been experiencing until recently. So I think there has been a lot 

here to note. Now what am I mentioning this for now? It is because 

I believe; and, I think economists who have studied this carefully—

monetary economists in particular—think that monetary policy 

played a great role in this stability in this unusual period of infrequent recessions and long expansions. And you can see that when 

you look carefully at the monetary policy decisions. They indeed 

have been more aggressive, more timely in responding to both increases in inflation and downturns in the economy—much more aggressive and timely—more flexible, if you like, than in the past, especially than in the 1970’s when we had this terrible problem with 

inflation. 

So in my view, and I think in the view of many monetary economists, monetary policy, not just in the United States, but even 

more recently in other countries deserves substantial credit for this 

10

unusual period. I think monetary policymakers at our Federal Reserve and other central banks around the world deserve praise and 

credit for this remarkable situation. 

I start here, because it seems to me that one of the risks we face 

in deciding how to adjust to the current situation is the risk of 

overdoing it if you look, providing an excess of these, we could very 

well bring this back to those bad, old days of higher inflation and—

listen to this—frequent recessions, deep recessions. 

That’s the most important thing that we could risk here and how 

it would respond to this crisis to bring us back to those days, which 

no one wants to go back to. So I would say this is especially a concern now as Mr. Bachus pointed out with the inflation data that 

are coming in. The CPI last week (4.3 percent over the year), that’s 

not just a 1-month number. 

If you try to look more carefully and take out some of the special 

factors, you always have to be wary about doing that. It’s still pretty high, over the comfort range that the Federal Reserve has mentioned. And when I go around the country and speak, I’m sure the 

members of this committee get this too. There is mention of inflation—frequently—just as there is the downside risks. 

So most of our focus here, rightly so, has been about the downside risks, and those are real. Growth much lower in the last quarter than in the third quarter of last year, it’s going to be slow this 

quarter too. Even if it’s not negative, it’s going to be slow. So there 

are these substantial risks; and, my written testimony I go through 

explanation of how we got here, and Alice Rivlin has already mentioned those. 

I think the financial sector is in a particularly difficult situation 

now. Starting last August, you saw the interest rates rising substantially in the money markets and the so-called LIBOR market. 

That has raised credit costs above what it otherwise would be, so 

the question to me for this committee and for the Federal Reserve 

is how to balance these risks. How do we balance the risks of 

down-side and the risks of inflation? 

There are benchmarks around that economists have used to try 

to balance out these two or three factors. One of them, by the way, 

is called the Taylor rule. If you look at things like that, it seems 

to me it gives you a way to balance. And if I look at the inflation 

rate and the degree of slow-down in the economy at this point, even 

adjusting for the turbulence in the money markets, I still get an 

interest rate which is somewhat above the current interest rate already. 

That suggests to me that when you balance the risk properly, the 

additional easing would be questioned, given the circumstances 

both on inflation, both on the risks in the economy, and in the financial markets. So that would be my main point to make in these 

opening remarks. 

I would just say briefly, in terms of the money markets, in assessing whether the term auction facility is working, I would say 

that additional transparency from the Federal Reserve would be 

useful. In particular, what the balance sheet of the Fed looks like, 

what the Fed balances are from the commercial banks, additional 

transparency would be useful. 

Thank you, Mr. Chairman. 

11

[The prepared statement of Dr. Taylor can be found on page 87 

of the appendix.] 

Mr. MILLER OF NORTH CAROLINA. [presiding] Thank you. 

Dr. Zandi? 

STATEMENT OF MARK ZANDI, PH.D., CHIEF ECONOMIST AND 

FOUNDER, MOODY’S ECONOMY.COM 

Mr. ZANDI. I want to thank the committee for the opportunity to 

present today. 

I would like to make three points in my remarks. First, I think 

the economy is in the midst of a recession. I think the economy contracted in December, January, and it feels like it is contracting in 

February. And if we string another several months of declines together, that will be considered a recession. 

I think there are some parts of the country that are already 

clearly in recession: California, Arizona, Nevada, Florida, and 

Michigan are, in my view, in recession. They account for one-fourth 

of the Nation’s GDP. And then there are 15 other States scattered 

across the country that if you total up their gross product, it is another fourth of GDP. So in total, we are close to half of the regional 

economies in recession or close. 

I also think the big metropolitan areas in the Northeast are 

struggling quite significantly, and particularly New York, because 

of the problems on Wall Street, and in Washington, D.C. If you 

total all that up, we’re well over half the Nation’s GDP, so I think 

we’re in the midst of an economic downturn. 

My second point is that obviously the problem is in the housing 

and mortgage markets, the securities markets. The housing market 

continues to literally evaporate. New and existing home sales are 

down 35 percent, and that overstates the strength of the market, 

because that includes foreclosure sales, which in the case of California accounts for half of all current sales in California. 

Housing starts are down over 60 percent, which is the steepest 

decline in the post-World War II period in terms of construction; 

and, house prices now are down 10 percent from their peak. The 

peak was just about 2 years ago in the spring of 2006, and the intensity of the price declines are very significant and quite severe. 

And over three-fourths of the Nation’s metropolitan areas are now 

experiencing significant, persistent price declines, year over year 

price declines. 

This of course along with the subprime armory setting, the lack 

of credit and the weakening job market is resulting in a surge in 

mortgage foreclosures and defaults. We collect very high quality 

data based on credit files from credit bureau Equifax. As of the last 

week of January, there were approximately 550,000 first mortgage 

loans in default; that translates into an annualized pace of $2.2 

million defaults. That is the first step in the foreclosure process. 

Just to give you context, in 2005 which was a good year, foreclosure defaults were under 800,000, so we’re almost 3 times that 

and rising very rapidly. Delinquency rates: 30, 60, 90, 120, 143 all 

jumping very rapidly; and that suggests that the foreclosures are 

going to continue to rise significantly at least to the spring and into 

the early summer. 

12

Obviously, one of the key problems here is the shut-down of the 

mortgage securities market. The residential mortgage securities 

market is in the non-conforming market, outside of what Fannie 

Mae, Freddie Mac, and the FHA do, which by the way was half the 

origination volume in 2006. It has completely shut down—literally 

shut down. There were zero bonds issued for Alt-A loans in the 

month of January and total subprime Alt-A, and jumbo loans 

issuance in January totaled at an annualized pace, less than $50 

billion. 

And to give you context there, in 2006, there was over a trillion 

dollars in issuance in those sectors. There was no credit flowing. 

So the problem in the housing and mortgage market, which go to 

the root of the economic problems that we face are not getting any 

better. They are at this point still getting worse. 

Point three goes to policy. I think policymakers are very slow to 

respond to events in the wake of the subprime shock last summer. 

I think the Federal Reserve misjudged the severity of the downturn 

and the breadth of the downturn and was slow. I do think they 

have caught up. I think a 3 percent fund rate target is appropriate 

at this point in time, and the futures market expect a 2 percent 

funds rate by the summer. 

That seems perfectly reasonable to me in the context of a recessionary economy. Fiscal policymakers also deserve plaudits. The 

fiscal stimulus package was a good one, particular the pace at 

which everyone got it together. Tax rebate, I think, is particularly 

efficacious, so I think that is helpful. I think the steps towards alleviating the problems in the housing mortgage markets are good 

steps, but they are baby steps. 

They are not enough. Hope Now, Project Lifeline, expanding the 

loan caps on Fannie, Freddie, and FHA will be helpful, particularly 

for California, Washington, D.C., New York, and South Florida, allowing States to issue more bonds to help refinancing efforts. All 

these steps though are not going to, you know, solve the problem. 

They are very, very small steps. I think we are coming to the point 

where policymakers need to be much more aggressive with respect 

to what is going on in the mortgage securities market. There are 

some good ideas that are now being formulated, and I just mentioned one. 

I do think it’s now time to think about a tax pair-financed fund 

to purchase mortgage loans and mortgage securities. I think this 

could be done through an option process. Set up a bidding process 

for sellers to come in with mortgage securities, loans, even pools of 

loans if possible. Make a bid. 

That bid certainly would be not at full value. They would take 

a big cut, but I think they would find that a way to restart the 

market. Once the market has restarted, once we have a price, I 

think credit will start to flow; and, more importantly, we have a 

price that all the other institutions with bad credit on their balance 

sheets could mark to; they could write that down quickly and get 

on with business. 

Moreover, the Federal Government would then be the owner of 

these mortgages, if they bought home mortgages in the auction 

process, and they could take their time and figure out exactly what 

13

to do with these mortgages and stem some of the foreclosures and 

the deleterious impact it’s having on the broader economy. 

So that’s a big step. That’s something that requires a big, philosophical jump, but I do think we’re getting to the point where the 

cost to taxpayers or something like that will be measurably less 

than the cost of doing nothing and watching the economy continue 

to slip away and undermine tax revenue increase spending to help 

support the people who are losing their jobs. 

Thank you. 

[The prepared statement of Dr. Zandi can be found on page 91 

of the appendix.] 

The CHAIRMAN. Next is Professor Carmen Reinhart, who is professor of economics in the School of Public Policy, Department of 

Economics, University of Maryland. And also relevant, she is a research associate at the National Bureau of Economic Research. 

Professor Reinhart? 

STATEMENT OF CARMEN M. REINHART, PH.D., PROFESSOR, 

SCHOOL OF PUBLIC POLICY, DEPARTMENT OF ECONOMICS, 

UNIVERSITY OF MARYLAND 

Ms. REINHART. Let me begin. 

The CHAIRMAN. Is your microphone on? 

Ms. REINHART. Thank you. This is my first hearing, so please 

bear with me if I fumble a little. I’m not sure what the procedures 

are, but let me divide— 

The CHAIRMAN. I guess the procedure is, you talk. 

[Laughter] 

The CHAIRMAN. Then, when you are through, we will ask you 

questions and you answer. Let me just say, of all the places in this 

building, I hope we are tied for last in protocol. So please go ahead. 

Ms. REINHART. So let me divide my remarks into four parts. 

First, I defer to everyone here on the very short-term issues of 

whether the employment numbers or the housing numbers, I’m 

going to talk first about a big issue which has to do with the stuff 

that I know, which is financial crises, which is what we’re in. 

And, then, I’m going to talk about three issues, and I’m going to 

take issue with you on policy response. And then I’m going to talk 

about regulation. And then I’m going to say something—lastly, 

where I’m relatively more ignorant about whether we can reverse 

these things. But let me start with the big picture of where I think 

we are. 

The CHAIRMAN. Dr. Reinhart, it may be rude not to look at people, but when you turn your head, you lose the microphone, so 

please look straight ahead. 

Ms. REINHART. Okay. So first, on the issue of where we are, if 

the past is any resemblance on the future, and we always like to 

think we’re different, but we’re not. We have been through several 

financial crises, including the most severe financial crises. Believe 

me, I have looked at all of them in the industrial countries in the 

post-war, and then I have also looked at emerging markets. I am 

not even going to touch emerging markets, but on the big financial 

crises and the advanced economies, they are associated with recessions, full stop. 

14

So, if you are lucky, it is a slow-down, and that is like in 1995 

when we had the Barings crisis, but that is a different order of 

magnitude. So the big crises are associated with recessions, fullstop. The recessions could be milder, or they could be softer. I think 

the Federal Reserve has been excellent in moving quickly; however, 

if we want to beat Japan, which had a crisis that lasted 10 years, 

then we should tell the Federal Reserve to start worrying about inflation, John. They shouldn’t worry about inflation now. They 

should worry about the recession. 

The second point is, if you don’t act quickly, then it is too little, 

too late. We are having a credit crunch, as you describe, believe 

me. I believe Dr. Zandi described the credit crunch to the tee. You 

know, this is a classic. I don’t study high frequency events. But I 

can tell you, I have looked at every, single banking crisis in the 

post-war, and credit crunches are a problem. 

And they are a problem that doesn’t go away in 1 month or 6 

months. It takes a while. This is not something that is easily reversed. Asset prices are falling as we speak—housing prices—equity prices. This creates a loss in wealth that is not easily undone 

and has serious consequences for consumption. 

You know, in industrial countries over the past 30 years on average, housing prices fell about 25 percent from their peak. That is 

non-trivial. So, the first part of my presentation is just on the magnitude of where we are at a broad brush. My second part is on the 

policy response of the Federal Reserve. 

The CHAIRMAN. I wanted to get to the second part. You are going 

to run out of time, so I wanted to get to each part, if you can, rather than get to the second part. 

Ms. REINHART. All right. Very quickly, I think we need more easing. Okay? I do think we need more easing. I do think that what 

we have to work on is the very quick reversal, if inflation, which 

I believe and I share completely. 

The CHAIRMAN. Dr. Reinhart, please address your remarks to the 

panel. I’m sorry, but I do have more time to take. But, just talk 

to us. 

Ms. REINHART. One last point. Regulation in the United States 

is more akin to Banana Republic than we would like to think. And 

in that regard, in the Federal Reserve’s actions, but also the delegation to the States, and I will end my remarks right there. The 

consolidation of regulation is an important issue. 

The CHAIRMAN. You have more time. You can get to your third 

point. I just wanted to move it on. 

Ms. REINHART. No. No, because I really do think the regulation 

issue is critical. You know, I have looked at Venezuela, and then 

there is somebody who says, oh, this guy did it and then this guy 

did it. No. We have to consolidate regulation. I want to make this 

point, because I think we have to consolidate. But, I also want to 

say we don’t want to be like Japan. 

We have to act quickly and decisively, because this is a financial 

crisis and, you know, too little too late is a problem. And I leave 

my remarks there. 

[The prepared statement of Dr. Reinhart can be found on page 

55 of the appendix.] 

The CHAIRMAN. Thank you. 

15

And, finally, Professor Roubini, who is a professor of economics 

at New York University’s Stern School of Business, and the cofounder and chairman of RGE Monitor. 

STATEMENT OF NOURIEL ROUBINI, PH.D., PROFESSOR OF ECONOMICS, STERN SCHOOL OF BUSINESS, NEW YORK UNIVERSITY, AND CHAIRMAN, RGE MONITOR 

Mr. ROUBINI. Thank you, Mr. Chairman, and members of the 

committee, for this opportunity to present my views. There are 

three questions I think that are in the minds of everybody about 

the economy. The first one is, of course, whether we’re going to 

have a soft landing or a hard landing, meaning a recession. The 

second is how much more severe this credit crunch and problem in 

the financial market is going to get; are they going to improve? And 

third, what can the Fed do? Can the Fed avoid this kind of hard 

landing in the economy? 

In my view, on the first one at this point, the debate is not anymore whether we’re going to have a hard landing or a soft landing, 

but rather on how hard the hard landing is going to be. I agree 

with Mr. Zandi, we’re already in a recession, when you look at the 

variety of macro-economic indicators, the economy starts to contract some time in December. And a rising number of economists 

now are suggesting that actually this recession is going to relatively shallow, two quarters, Q1 and then Q2, and then a recovery 

of economy growth. 

My view of it is actually that this recession is going go be much 

more severe, longer, and protracted than just two quarters. I expect 

that this recession might last at least 4 quarters, and possibly even 

more than that. 

If you look at the last two recessions in 1990 and 1991, and 2001, 

they lasted almost 3 quarters, 8 months each. And in my view, the 

conditions in the financial market and the economy, compared to 

the last two recessions, are worse. And that’s why I believe this recession is going to be much longer, at least 4 quarters, if not 6 

quarters. 

There are at least three dimensions in which I think that the 

condition and the macro-economy and financial markets that are 

worse today than they were in the previous two recessions in the 

United States. And that’s why I believe this recession is going to 

be more severe and more protracted. 

The first reason is that we’re experiencing right now the worst 

housing recession since the Great Depression. Housing starts have 

fallen sharply, but unfortunately new home sales have fallen even 

more, and therefore the gap between supply and demand, the stock 

of unsold homes, is at an unprecedented high. Home prices have 

already fallen by 10 percent and they might fall at least 20 percent 

from peak, and some people say all the way to 30 percent. 

If they fall 20 percent, that’s a wiping out of $4 trillion of hous- ing wealth in housing. If it’s 30 percent, it’s going to be $6 trillion. 

If there is a 20 percent fall in home prices, the number of houses 

that are going to be underwater with the value of their homes 

below the value of their mortgage is going to be something like $15 

million. 

16

If home prices fall by 30 percent, that number is going to be over $20 million, and we have no recourse loans. There is a huge incentive when you are in negative equity or underwater to essentially 

do jingle mail, put your keys in an envelope, send it to the banker, 

and walk away. 

So we’re facing a systematic problem in the housing market. This 

housing recession is getting worse, has not bottomed out. The consequences are going to be massive and severe like you haven’t seen 

since the Great Depression. First observation. 

Second observation is that the conditions for the housing sector 

are much worse today then were in 2001. In 2001, the problems 

were the corporate sector. Today we have a U.S. consumer that is 

shopped out, is saving less, and is debt-burdened, and the U.S. consumer is being buffeted by a whole series of negative shocks. 

Home prices are falling, home equity withdrawal is collapsing. Oil is at $100 and gasoline prices are very high. There is a slack 

in the labor market that’s starting. Consumer confidence is falling. 

Debt ratios for consumers are 136 percent of income. Debt servicing 

ratios are going up because of resetting of ARMs. There is a credit 

crunch in financial markets. 

All these shocks are buffeting the U.S. consumer, who has now 

started to retrench. And with consumption being 70 percent of aggregate demand, retrenchment of the U.S. consumer means a severe recession. 

Third observation of why this crisis is going to be worse and this 

recession is going to be worse. People talk about the subprime crisis and subprime meltdown. The problem is that we have a systematic problem in the financial system that goes well beyond the 

subprime problem. Now the problem in terms of the fault and so 

on are spreading from subprime to near-prime, to Alt-A to prime 

mortgages, to jumbo loans, default rates across the board for all 

sorts of mortgages are going up. 

Secondly, it’s not just a problem of residential real estate. The 

entire commercial real estate market is also frozen, and there is 

going to be a collapse of commercial real estate activity. Who would 

like to build shopping centers, stores, offices, as ghost towns in the 

West. Of course, we will lag, the collapse of housing is going to lead 

to collapsing of commercial real estate. 

It’s not just a problem of real estate. You’re seeing now a rise in 

the fault rates all across unsecured consumer debt, auto loads, 

credit cards, and student loans. There is going to be a sharp increase in these default rates. 

You have massive problems in the leverage loan market with 

these LVOs that were done in a reckless way, and now leverage 

loans are being priced 80 cents on the dollar. You have the problem 

with the monolines, and I don’t believe they’re going be able to rescue a downgrade of these monolines, and if that downgrade is going 

to occur, it will have severe effects, as we’ve seen in the money 

market, and a downgrade of other assets that were being ensured 

by the monolines, as backed securities. 

And finally people say the corporate sector is doing better today 

than in 2001. Yes, that’s true, on average. There is a fat tail of 

corporates that are actually highly distressed, with lots of that and 

not much profits. On an average in the United States, corporate deVerDate 0ct 09 2002 13:33 Apr 10, 2008 Jkt 041183 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 K:\DOCS\41183.TXT TERRIE
17

fault rates in the last 30 years has been something like 3.8 percent. 

For the last 2 years, that rate of default on corporate bonds was 

only 0.6 percent, 1⁄6 of what is normal. 

In a typical recession, corporate default rates go up as high as 

10 to 15 percent and recovery rates given default fall sharply. In 

a normal year, you recover 70 cents on the dollar, in a recession, 

you recover only 30 cents on the dollar. So you have a double 

whammy in a recession. Default rates are much higher and recovery rates are much lower. 

So there are going to be significant massive increases we’ve seen 

already in the data, in corporate default. In the last 2 years, there 

was slash of liquidity, credit spreads were very low, and they were 

bottomed out at 260 over Treasury’s last June; now they’re over 

700 basis points over Treasury on junk bonds. 

There is going to be a massive increase in corporate defaults. And once that happens, about $50 trillion of credit default swaps 

that are ensuring something like $5 trillion of corporate bonds are 

going to also get in trouble, because at that point those who sold 

the insurance, some of them might go belly-up. Might be some 

hedge funds, might be some investment banks, might be some 

monolines. And those who bought insurance might discover that 

they were not hedged, and you’re going to have another massive 

loss. 

So the problem we’re facing right now in the U.S. economy is not 

a subprime mortgage problem but the subprime financial system 

that has severe stress like we have not seen in the last 30 years. 

This is a severe financial crisis, and that’s why the recession is 

going to be more severe. 

A final point about Fed policy: In my view, whatever the Fed at 

this point does is too little, too late. Of course, the Fed is going to 

ease more aggressively, and that’s going to put the floor on how 

deep and how severe this recession is going to be, but it’s not going 

to prevent it, because the recession has already started. 

And monetary policy is ineffective in a number of ways. First of 

all, today we have a glut, a glut of housing, a glut of automobiles, 

a glut of consumer goods. And when you have a glut of these 

things, it takes time to work out the glut, and monetary policy becomes less effective. It’s like pushing on a string. In 2001, we had 

a glut of tech capital goods. The Fed slashed rates all the way from 

61⁄2 percent to 1 percent. We still had the recession and real investment on tech capital goods fell by 4 percent of the GDP. It took 

years to work out this glut. 

That’s why when you have a glut the demand for these capital 

goods becomes interest rate insensitive. Therefore, we are not going 

to resolve the problem of housing or auto or consumer durables 

with easy money. 

Second observation: Monetary problems can deal with problems 

of illiquidity, but today we don’t have just problems of illiquidity 

in the U.S. economy; we have problems of insolvency. We have millions of households that are bankrupt. We have had 200 subprime 

lenders already going out of business. We have dozens of home 

builders that are going to go out of business, or already have gone 

out of business. You’ve had dozens of financial institutions where 

highly leveraged got in trouble and lost money and shut down. And 

18

soon enough, as I argued, there is going to be a massive increase 

in corporate default rates. These are problems of insolvency of credit that you cannot resolve with money only. 

The third point is that right now we have a shoddy financial system that is not affected very much by the monetary policy. You 

have non-bank financial institutions, that like banks borrow short 

and illiquid ways and lend long or invest in illiquid ways, as savings, conduits, money market funds, hedge funds, investment 

banks. And unlike banks that have access to the lender-of-last-resort support of the fed, these non-bank financial institutions that 

have subject to this liquidity risk of a rollover of their claims that 

might lead to a crush because of illiquidity don’t have access to the 

lender-of-last-resort support of the fed. 

Final point: We have systematic problem in the financial system. 

The lack of transparency, the great opacity that exists of all these 

instruments that are hard to price, that are highly liquid, and 

therefore monetary policy cannot affect them. 

So, final observation: We are in a recession, and this is going to 

be a severe recession, and we are in the middle of systematic and 

systemic financial crisis that is becoming extremely dangerous. 

[The prepared statement of Dr. Roubini can be found on page 66 

of the appendix.] 

The CHAIRMAN. Thank you. Dr. Rivlin, let me just clarify one 

thing. Usually when people leave things out, and they have written 

statements, I am happy because we move quicker. But you left out 

one phrase for speed that I hope you’ll repeat. You talk about the 

importance of paying for the stimulus that we just did. In your 

written testimony, you said over 5 years. I assume you omitted to 

say that orally. 

Ms. RIVLIN. Sorry about that. Yes, I meant over 5 years. 

The CHAIRMAN. Right. Because there would be no point in doing 

the stimulus that immediately— 

Ms. RIVLIN. You certainly don’t want to pay for the stimulus in 

the year that you do it. 

The CHAIRMAN. No. And that would have been the speaker’s position, and it is within the PAYGO rules to have the 5-year payback 

period. 

Ms. RIVLIN. Yes. I’m just a fan of the PAYGO rules, and I don’t 

like— 

The CHAIRMAN. I understand. But I—now I do want to get back, 

and I also agree, as you pointed out, obviously monetary policy and 

regulatory policy are not the same. I understand that. I do think 

that what is happening here is that ordinarily when we do Humphrey-Hawkins hearings, both the hearings themselves and previously the focus is on the macro-economy. But it does again seem 

to be today—and many of the witnesses have said this—that it is 

a failure in what has been the micro, the particular subprime lending, a fairly specific sector, that’s the single biggest cause of the 

current macro problem. And you can’t solve the problem without 

getting back to it. 

Let me just—this is kind of a sequence—as I was reading the 

testimony this morning I was struck, and I have handed this out 

to people. Dr. Rivlin: ‘‘The exposure to subprime lending was a 

clear regulatory failure. So that regulatory failure cause of expoVerDate 0ct 09 2002 13:33 Apr 10, 2008 Jkt 041183 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 K:\DOCS\41183.TXT TERRIE
19

sure in the subprime lending.’’ Then Dr. Zandi: ‘‘The fundamental 

source of the economy’s problems is the housing downturn and 

surge in mortgage loan defaults and foreclosures.’’ That is, it was 

a regulatory failure that led to the subprime crisis, and it’s the 

subprime crisis that’s led to the border crisis. Professor Reinhart 

talks about multiple regulatory failures, which have led to this. 

And now let me turn to Professor Roubini, because we have already heard today the argument that ‘‘Well, yes, but if the government rushes in, you’ll just make it worse, leave the market to 

itself.’’ 

And let me just quote, and I’d ask you to expand on and ask others to comment on this. In your testimony, you say, ‘‘Policy makers’’—the executive branch I assume you’re talking about—‘‘stress 

that their preferred approach would be one of ‘self-regulation’ and 

reforms undertaken by private financial institutions rather than 

new rules and regulations imposed by authorities. While the right 

balance between principles and rules and regulations and supervision is open to discussion, the recent experience suggests that excessive reliance on principles not backed by appropriate rules, the 

delusional hope that internal models of risk management will provide the right amount of risk-taking, the wishful thinking that selfregulation will work, the hope that financial institutions will selfreform the system of compensation of bankers, are all mistaken 

views. A more robust set of rules, regulations, and supervisions will 

be necessary, as excessive reliance on self-regulation and market 

discipline has shown its failure.’’ 

I would ask any of the members to comment: I think that is absolutely the case. We used to have someone here who was a monetary economist, who was in the House: ‘‘Markets are smart and 

government is dumb.’’ I guess if you still wanted to hold to the 

question of ‘‘Government is dumb,’’ we would have a remake of the 

movie, ‘‘Dumb and Dumber.’’ 

[Laughter] 

The CHAIRMAN. So, Dr. Roubini, do you want to expand on that? 

And then I would ask the others, if they want to comment. 

Mr. ROUBINI. Yes. I present more detail in my written testimony, 

my points of view on the issue of regulation. And as I said, right 

now we’re facing a significant problem that goes well beyond 

subprime. Of course, many of the regulatory mistakes were done in 

the last years by allowing these reckless lending practices to occur. 

Things like zero down payment, no verification of income assets, 

and jobs, interest rate only, negative amortization, and TISA rates. 

And by the way, all this kind of stuff was occurring not only in 

subprime but in subprime, near prime, and prime, jumbo loans, 

piggyback loans, home equity loans. About 2/3 of all mortgage origination since 2005 had these reckless characteristics. 

But as I said, right now what the financial stability— 401—7 are 

discussing are these broader problems of the stability of the AngloSaxon financial system. You have issues of internal models of risk 

management, whether they work or not, whether liquidity risk is 

stress enough, what is the role of credit rating agencies and their 

conflicts of interest, what is the system of compensation of bankers, 

whether the system of originate and distribution of credit risk 

transfer securitization is working, or how can we reform it? WhethVerDate 0ct 09 2002 13:33 Apr 10, 2008 Jkt 041183 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 K:\DOCS\41183.TXT TERRIE
20

er Basel II should be reformed because its weakness is by relying 

too much on internal models, on rating agencies, not assessing correctly liquidity risk, having countercyclic—procyclical capital— 

ratio. 

So there is a whole set of things that are right now on the table, 

and if you want a financial system that works and everybody is in 

favor of financial innovation, but we know a financial system works 

only if there is a set of rules and regulations. Because otherwise 

we are in a financial market that is— 

The CHAIRMAN. Let me—because we are running out of time. But 

is it fair to summarize your view? Is it that these things that you 

are describing were all decisions made in the private sector, and 

you believe that in dealing with them and preventing repetitions, 

etc., some public sector decisions are going to have to be made setting up the rules, is that correct? 

Mr. ROUBINI. Yes. I mean there’s this debate on how much you 

want to rely on principles as opposed to rules, because of course 

there is a risk the financial innovations are— 

The CHAIRMAN. But in either case, they are promulgated— 

Mr. ROUBINI. —in the light of regulation, but I think the pendulum swung too much in the direction of relying only on principle 

and self-regulation— 

The CHAIRMAN. But in both cases, in principles and rules—and 

I agree with you that we need more rules—you are talking about 

binding legally promulgated restrictions on what the private sector 

does? 

Mr. ROUBINI. Yes, I do. I think that— 

The CHAIRMAN. All right— 

Mr. ROUBINI. —I think that a certain reliance on stronger 

rules—of course, you have to be cautious— 

The CHAIRMAN. Thank you. I have to move on. Dr. Reinhart? 

Ms. REINHART. The decentralization of governance, if you will, of 

regulation, is a problem. One of the things that if you look at the 

big picture, at the BIS, is that you try to get common rules. If you 

have every State having their own rules on what is deemed a worthy loan, we’re really steering away from actually the big picture 

that we’re pushing. 

The CHAIRMAN. Thank you. Dr. Zandi. 

Mr. ZANDI. Well, let me say that I think there’s plenty of blame 

to go around, a lot of actors that were involved in this and many 

mistakes made, not just the regulators. But I do think regulatory 

oversight was lacking in this period, and I think most fundamentally that’s because of the Byzantine nature of our regulatory structure. There are half a dozen regulatory bodies that oversee the 

mortgage and housing markets, and in fact the mortgage industry 

worked hard to find the cracks in the regulatory structure. In fact, 

some of the most egregious lending was done by institutions that 

were regulated by the FDIC, the OTS, the OCC, and the Federal 

Reserve. They— 

The CHAIRMAN. But could have been under the Homeowner’s Equity Protection Act if the Federal Reserve had promulgated rules. 

Mr. ZANDI. Yes, although this was a period that was fast moving, 

big changes. It was hard to see that the restructure was creating 

the kind of problems it was. But I sympathize with what you’re 

21

saying, and I do think if the regulatory agencies were more rationalized, if there was some way to centralize the process, although 

this is a big problem— 

The CHAIRMAN. I have to disagree there. With regard to the nonbank lender, originators, mortgage brokers, there wasn’t any split, 

there was the Federal Reserve. They had pretty primary jurisdiction. There was potentially some State things, but frankly the problem here was that the Comptroller of the Currency and the Office 

of Thrift Supervision pre-empted State authority in many areas. So 

I mean it’s not as if somebody tried to do something, and somebody 

else checked them. The Federal Reserve had authority and they decided not to use it. 

Mr. ZANDI. Yes. I think though, that you know, think back to the 

period of 2005 and 2006. These new institutions reforming very 

rapidly, they were literally under the radar screen. I mean, restructures I think weren’t really under their purview—thinking about it. 

The CHAIRMAN. I miss Ned Gramlich. He was a great man. I 

hope he left his radar screen to somebody, because they weren’t 

under his radar screen. Dr. Taylor? 

Mr. TAYLOR. Mr. Chairman, I think these are good points. I 

would say that, however, the problems were caused, as we know, 

by financial institutions making decisions in retrospect certainly 

they shouldn’t have had individuals making decisions like this. So, 

I think the first thing to say is the problems, the responsibility for 

dealing with them are with those individuals, are with the private 

investors, the private institutions. 

The role of policy right now, we discussed this, monetary policy 

in particular is to prevent spillovers of that to the rest of the economy. That’s— 

The CHAIRMAN. But can monetary policy prevent the spillover? I 

think that is the frustration that absent regulation— 

Mr. TAYLOR. Yes, I believe it can. 

The CHAIRMAN. You think monetary policy by itself can deal with 

the foreclosures? 

Mr. TAYLOR. I believe it’s having an effect already. You know, for 

example, some of these resets are going to be smaller with— 

The CHAIRMAN. You think that the only policy response we need 

for the current situation is to continue to have lower interest rates? 

Mr. TAYLOR. I think it’s part of the response. I think it prevents 

some of the— 

The CHAIRMAN. What would the rest be? 

Mr. TAYLOR. But you can overdo it, and that’s why I’ve said the 

inflation issues are important too. 

I think with respect to looking at changes, you need to be very 

specific about what the problems were. The off-balance sheet operations at the banks, the so-called structured investment vehicles, 

those should have been monitored. 

The CHAIRMAN. Can we mandate that they’ll be on the balance 

sheet? 

Mr. TAYLOR. —monitored in the future. You look at what the 

Fed— 

The CHAIRMAN. Should we mandate that they would be on the 

balance sheets, the regulators? 

22

Mr. TAYLOR. I think you need to see what the Fed comes up with 

in that— 

The CHAIRMAN. Well, it could be that the Fed is not out in Patagonia somewhere. This is a public policy question. 

Mr. TAYLOR. —think about what you’re mandating. Let me put 

it that way. So define what the structure investment vehicle is. If 

you think the regulators are not doing it right, then of course you 

need to change the law. But I’d say be specific, what’s the problem, 

address the problem, and then take some actions. 

But there is a concern about overdoing it, and try to change—

reform the whole system when there— 

The CHAIRMAN. My last question. Do you think regulation has 

been overdone in the last 5 years in this area? 

Mr. TAYLOR. No, I don’t think regulation has been overdone. 

The CHAIRMAN. Thank you. Dr. Rivlin? 

Ms. RIVLIN. Two points. I think you have to be careful not to 

overdo it. You do have a regulatory failure here. However, if everything that we can now think of with hindsight had been done, you 

might still have had a housing bubble. There’s not much that regulation can do to keep people from making dumb decisions. And 

what we know about market economies is that every once in a 

while they get really irrational, and it is very hard to stop people 

who think that housing prices are going to go up forever. 

But that said, I think now you need to look at who regulates 

what and make the system more rational and stronger, so that we 

don’t have a repeat of this particular set of issues. 

The CHAIRMAN. But you acknowledge that Ned Gramlich did say 

that we should step in and do something? 

Ms. RIVLIN. Yes, and I think he was right. We should have done 

something. But your problem is, ‘‘What do we do now?’’ 

The CHAIRMAN. No. Well, that is true, but in order to figure out 

what to do now, you have to figure out what went wrong. And assessing the role that regulation played in the past is part is part 

of what you do going forward. Ignoring history is not a good way 

to make policy prescriptions. 

Ms. RIVLIN. Right. And I think clearly we should have regulated—I don’t know who exactly ‘‘we’’ is—‘‘we’’ the government 

should have regulated all of the people who were making predatory 

loans. 

The CHAIRMAN. And I will close with one last point—and I didn’t 

get a chance to talk to Dr. Roubini—but we ought to be clear, we 

aren’t just talking about subprime. Subprime is where it started. 

But in fact, the absence of good decisionmaking in the private sector and the absence of any regulation allowed it to spread, and 

mechanisms in the private sector that we were told might be confining this, various forms of diversification and risk management, 

appeared to have exported it. But it does appear that among the 

major exports in the America these past years have been bad mortgages, and with negative consequences elsewhere in the world. 

So it started as a subprime crisis and then spread through the 

system and systemic aspects that we were told a couple of years 

ago were going to confine this seemed to have spread it. Mr. Bachus? 

[No response] 

23

The CHAIRMAN. Mr. Paul. 

Dr. PAUL. Thank you very much. My question is directed to Dr. 

Roubini, but first off I want to say once again that I have a little 

trouble with this assumption that if we have poor information sent 

out to us in the marketplace from the Federal Reserve with distortion of interest rates that regulation is all that we need that will 

solve all these problems, because mistakes are made by investors 

and savers, mainly because they’re getting bad information. 

But I wanted to address a subject with Dr. Roubini. In his written comments, he says the perception by markets that the Fed is 

trying to avoid necessary economic correction and the necessary adjustment in asset prices is something that I think is what’s going 

on right now and so important, because when there is a distortion, 

the market says correct. 

But because of the emotional and political aspect of people losing 

a house, you know, it’s virtually impossible. Nobody wants to take 

that position because it looks like you’re being cold-hearted. Yet at 

the same time when the pretense is that we’re going to save 

everybody’s home, frequently when we’re demanding lower interest 

rates, we know that behind the scenes what we’re really doing is 

propping up Wall Street. 

Every time there’s an announcement of significance with interest 

rates, the stock market pops up, and that seems to me to be the 

real goal is to bail out Wall Street because the people continue to 

lose their homes. 

But my question is related to a later statement that you said 

here. The Fed has now altogether ignored concern about moral hazard and concerns about future inflation and now starting to undermine the credibility of the Fed. And I think that is also true, but 

what I’d like to ask about is, when should we be concerned about 

that? After we have this crisis develop and the bubble seems to be 

unwinding? Where in your estimation does the bubble come from? 

And when was your concern about the housing market? Was it 

after we saw 2 years ago or so that this thing was collapsing, or 

was this something that you were able to predict? And were you 

concerned about it when overnight rates were 1 percent and we 

could get mortgages once again down at 4 percent in this age of fiat 

money where there’s zero amount of savings? This is astounding. 

You know, in capitalism, capital comes from savings, but we 

have no savings. And yet, you could go out and get a mortgage, a 

$500,000 or a $100 million mortgage and pay under 5 percent for 

this. Was your—did you have concern at that time about what the 

Fed was doing? And would you accept the premise that much of the 

mischief and the bubbles come from the Federal Reserve? If not, 

where do the bubbles come from? 

Mr. ROUBINI. You’re asking a set of very important and interesting questions. If I have to try to explain how we got into this 

housing bubble, I think there are a variety of factors. I think there 

is a consensus now that the Fed cut rates and kept them too low 

for too long. If you’re using, for example, the Taylor rule that Professor Taylor has developed, you probably should have started raising rates much faster than they did after the 2001 recession. So 

certainly, easy money was part of the story. 

24

Part of it was also global conditions that kept, you know, longterm interest rates low, this bull market conundrum that Chairman Greenspan was referring to that depends on global conditions 

like the relative supply of savings grow relative to investment. So 

that was a factor that kept the loan rates low in normal and real 

terms. 

But in my view, even more so the monetary policy was a failure 

of regulatory policy. Because if you’re expecting home prices to go 

up by, say, 20 or 30 percent per year, having a Fed fund at 100 

basis points higher is not going to make much of a difference. And 

that’s where the regulatory failure came, because literally, allowing 

things like zero downpayments, like not verifying the income and 

the assets and the loans, having interest rate-only loans. Having 

negative amortization where you’re paying even less than the interest and then the mortgage value is going up over time. Introducing 

teaser rates. 

These were forms of financial innovation that were dangerous 

and were reckless, and Governor Gramlich and others early on suggested these things were things they should have avoided. And unfortunately, Chairman Greenspan was the biggest cheerleader for 

these forms of financial innovation that led us into trouble. 

So the Fed made mistakes, but in terms of monetary policy and 

in terms of regulatory policy, it was not just the Fed. It was the 

entire attitude, I fear, in Washington the last few years which essentially wanted to emphasize any form of regulation, was this 

kind of laissez faire ideology that markets know better. But we 

know in financial markets, people are greedy. And greed is good in 

some sense, at least entrepreneurship, but it has to be controlled 

by institutions, rules and regulation. Otherwise, financial markets 

become a jungle where you have asset bubbles and credit bubbles 

and when this occurs, and they go bust, the economic consequences 

are severe. 

Dr. PAUL. May I have one short question? 

Ms. WATERS. [presiding] Yes, you may. 

Dr. PAUL. This is a short question for Dr. Taylor. You talk about 

the Taylor rule and how to figure out the proper Federal funds 

rate. Of course, from my viewpoint of the market, nobody is capable 

of doing this. But what would your estimate be if we allowed the 

market—what would happen if the market determined the Fed 

fund’s rate? And why would it be so bad? 

Mr. TAYLOR. Well, the only way the market could determine the 

Federal funds rate is if the Fed set money supply or the reserves 

and then the market could respond. So the system we work in now 

tries to come close to that, Mr. Paul, but it doesn’t do it exactly. 

Instead what the Fed does is sets the interest rates to be consistent, I believe, with these low inflation goals. And if they stick 

on that, we should be fine. I think if, again, to my opening, the last 

25 years, you have to recognize are remarkably stable and long expansions, relatively infrequent recessions, shallow recessions. That 

is much better than how it used to be, and it spread around the 

world. I think that’s a signal that monetary policy in these dimensions has done well. 

It’s made—it’s not always been that way. I think the ease in 

2002–2003, as I wrote before, did go too far. And that’s one of the 

25

reasons now why I would be concerned about going too far again. 

If you stick these basics—inflation, you’re right to point out concerns about inflation, but you consider that along with balancing 

the risks to the downside, I think we should be okay. 

Ms. WATERS. Thank you. I will recognize myself for 5 minutes. 

Let me just quickly ask this panel, do you believe that the recently 

passed economic stimulus package is the right kind of fiscal policy 

to stimulate spending in the economy? Just—you don’t have to expound on it, just yes or no. Starting with you, Mr. Roubini. 

Mr. ROUBINI. Yes. I do believe it’s a step in the right direction. 

Ms. WATERS. Yes? 

Mr. ROUBINI. Yes. 

Ms. WATERS. Thank you. 

Ms. REINHART. I concur. 

Mr. ZANDI. I think it was a laudable package, yes. 

Mr. TAYLOR. I would like to just add, I think some effort to worry 

about the tax increases that are coming down the line is important 

right now. If there’s not legislation introduced to prevent the tax 

increases in 2011, 2012, etc., then we could be actually undoing 

any stimulus that comes from what you’ve already passed. 

Ms. WATERS. Yes, Ms. Rivlin? 

Ms. RIVLIN. I think the package was a very good one and speedily enacted. I suggested in my written statement that there were 

some things you might have added and may still have to add. 

Ms. WATERS. Thank you. It appears that in this discussion this 

morning, there is a lot of attention on the subprime crisis, which 

appears to be at the center of this economic downturn. And I’d just 

like to ask Mr. Roubini, Mr. Frank was reading, I guess, part of 

your statement where you talk about self-regulation and you believe that public policymakers I think it is said here, would prefer 

self-regulation to regulation that’s developed by the public policymakers here. Do you really believe that there’s any chance for overregulation by this Congress in the financial services market in any 

shape, form, or fashion? Does anyone believe that, Mr. Roubini? 

Mr. ROUBINI. Certainly you have to be careful about, you know, 

not overregulating. I think that— 

Ms. WATERS. Who do you think would overregulate? Who do you 

think—how much power do you think the financial institutions 

have in this Congress? 

Mr. ROUBINI. I don’t know that. What I’m saying is that in this 

debate about regulation of the financial system, there is a long discussion on how much you should rely on market incentives, on 

principles on self-regulation, and also you should have also the 

stakes of actual rules. And I think that there has to be a fine balance between the two, and unfortunately in the last few years we 

have gone too much in the direction of essentially relying only on 

market discipline, on self-regulation and on internal incentive the 

financial system for a variety of reasons, and I’m not going to spell 

them now. They don’t work. So I think that the balance has to be 

brought back to a set of rules and regulations that are binding, together with reliance on these principles. 

Ms. WATERS. The financial institutions basically responsible for 

the subprime crisis are involved in a coalition of financial groups 

that are talking about self-regulation in dealing with the subprime 

26

crisis—Hope Now. Are any of you familiar with Hope Now? Dr. 

Rivlin, is it working? 

Ms. RIVLIN. I think it’s a good idea. As I said in my testimony, 

I don’t think it will solve the problem, but it may help. 

Ms. WATERS. Does anyone know what it has been doing or what 

it has accomplished since they got together and decided they were 

going to correct some of the problems and do some of the workouts 

and make sure that people stay in their homes? Has it been working? Does anyone know? Has it worked at all? 

Mr. ZANDI. They have put out information with regard to the 

amount of contacts they’ve made with distressed homeowners. They 

have put out information with regard to how many modifications 

have occurred to loan contracts and repayment plans. I think in a 

broad sense, it has helped only on the margin, and it has not 

helped in a significant way. Most of what the coalition of lenders 

and investors in Hope Now have done is put people on repayment 

plans, which simply says, you haven’t paid me in the past, but I’ll 

allow you the opportunity to pay me in the future. But by the way, 

I’m going to roll in penalties and fees on what you didn’t pay me 

before. So prospects are that these folks aren’t going to stay in 

their homes for very much longer. It’s just delaying the inevitable. 

So I think in general it’s fair to say that there has been some 

positives from it, but they have been very, very small and very 

minor. And I think fundamentally the problem is that the investor 

groups that own these mortgages are very conflicted with respect 

to what should and what they want done. And until they’re on the 

same page, we’re not going to see many modifications. And that 

may never happen without some pressure. 

Ms. WATERS. Would you suggest, Ms. Reinhart, that there should 

be public policy that would help these institutions really get in the 

modifications business? 

Ms. REINHART. Consolidation of regulation. I think part of the 

problem that we’re seeing is that nobody is held accountable, that, 

you know, it’s you blame that person and you blame that person. 

Ms. WATERS. Is there anyone here who thinks that the servicers 

should be given protection from liability in order to do modifications because they have said that they are afraid of having to—of 

being sued by the investors if they do modifications that would lose 

money or would not realize the profits that were anticipated? Do 

you think servicers should be given protection from liability? 

Mr. ZANDI. I don’t think—there’s legislation to do that. I think 

even if you passed it, it would be ineffective. I think servicers 

would still be nervous that they would get sued, because you could 

not write the legislation in a way that would satisfy them. They’re 

going to have to get the green light from the investor groups themselves before they engage in significant modification. And by the 

time you get this all together and in place and everyone figures it 

all out, you know, we’re past—we’re going to be deep into 2008, 

and we’re going to have a lot more foreclosures and a lot more 

problems. 

So, it’s not a bad road to go down, but I am very skeptical it will 

result in any substantive improvement in the market anytime in 

the near future. There’s other legislation for cram-downs in bankruptcy in Chapter 13. I think that’s a better idea. I think that’s a 

27

stick. I understand there are problems with it and I sympathize 

with those issues, but I do think that is a more—that could be 

more efficacious. 

Ms. WATERS. Does anyone here have a better idea of how to do 

this? 

Mr. ZANDI. Yes. My view is instead of doing it legislatively, you 

set up a taxpayer-based fund that would go in through an auction 

process and buy mortgage loans and mortgage securities in a bidding auction context. And in that kind of context, the sellers of 

these mortgages would take a loss. They would sell, but they would 

sell at a big discount, so they would get hurt. 

And you would start the securities market. You would revive the 

market because you know the Treasury is the buyer. Let’s say it’s 

the Treasury that’s conducting the auction. You would have a market. They say I’m buying. I’m going to get the best price. As soon 

as there’s a price, there’s a market. Credit will start to flow. 

Moreover, once you have a price, then all the other institutions 

with mortgage holdings can mark to that price. One of the problems we’re having right now is they don’t know what to mark to, 

therefore, they can’t clean off their balance sheet all their bad 

loans, and therefore they’re unwilling and unable to extend credit. 

This would allow them to do that. 

And then third, if you’re buying mortgage loans, the government 

is buying mortgage loans, they take possession of those loans. They 

are now the owner, and that gives the government significant latitude with respect to how to treat those mortgages. You could, you 

know, you could lower the mortgage amount to the value of the 

home and then refinance into an FHA loan. There are many things 

you could do. But that would be a process that would restart the 

securities market, get credit flowing, and also help some of these 

very hard-pressed homeowners. And no one’s getting a bailout. 

Ms. WATERS. Thank you. Very interesting. All right. We’re going 

to move on to Mr. Shays. Who is next? Oh, you’re back. 

The CHAIRMAN. I am glad to delegate to the gentleman from Connecticut. The gentleman from California is recognized. 

Mr. CAMPBELL. Thank you, Mr. Chairman. Let me preface my 

questions by saying I agree with Dr. Roubini and Dr. Zandi that 

I think we are in a period of negative GDP growth which is very 

likely, almost certain to be 6 months or longer, and therefore be the 

technical definition of a recession, and very likely to be longer than 

that. So I’m going to use the term ‘‘recession,’’ because I think we 

are in one, and that to deny that is just ignoring what is likely, 

what is almost certainly the truth. 

So my first question is to Dr. Taylor and Dr. Roubini. If this—

this was not a consumer-led downturn. This was a credit and capital downturn. Consumers, it would seem to me therefore, can’t 

lead us out of it, and that what we have to do is figure out ways 

to get capital moving again, get people to take risks again, to 

change risk premiums, etc., to get capital moving. Am I wrong on 

that? And if so—or if I’m right, what should we be doing to do 

that? 

Mr. TAYLOR. I think that’s certainly part of it. But remember, 

consumption and actually net exports has held up the economy for 

almost 2 years. You have 2 years of a housing decline. It’s really 

28

in some sense to me amazing as you look back on that we had two 

full years of recordbreaking declines in starts and construction. 

And for most of that period, this economy just kept going. That’s 

because of the strength of the consumer. Also, foreign trade and exports. So it is important to make sure that—in fact the biggest risk 

in my view is that you have some weakening on the consumer side. 

With that said, efforts to bolster investment, that’s where some 

of the interest rates effects come into play that the Fed has already 

taken, is very important. And I would say that’s—it has to be a 

balanced thing. You know, the best kind of recovery, which I think 

we should be thinking about now, by the way, because you’re right. 

Whether you call it a recession or a slowdown, we’re in it. So the 

thing to me to thinking about is how we—what’s this next expansion going to look like? I don’t think it’s going to be as deep as Dr. 

Roubini indicates. 

Mr. CAMPBELL. Dr. Roubini, your thoughts? 

Mr. ROUBINI. Yes. I mean, the problems, of course, started with 

housing, but in some sense the sector of the economy that has the 

most financial trouble and vulnerability is the housing sector. In 

the 1990’s, of course, it was the corporate sector that over-expanded, over-invested, and borrowed too much. And then you had 

the bust of the tech bubble, and the consumer was actually in 

much better shape. That’s why you didn’t have a contraction of private consumption during the last recession. 

But the last few years have been years in which there has been 

a massive increase in consumer debt. A lot of it was mortgages, but 

a lot of it was not just mortgages. It was, you know, auto loans, 

credit cards, student loans, you name it. And the total stock of 

that, of the housing sector’s share of their income went from 100 

percent to 136 percent, and the savings rate of the housing sector 

that was already low to begin with in the 1990’s fell further and 

went all the way into negative territory. 

So the worry that I have right now is that we have essentially 

the largest part of the economy, this private consumption and the 

housing sector, that is under severe financial distress, that has 

never had so much debt, and now we have this severe credit 

crunch, and you are also buffeted by slack in labor market, high 

oil prices and everything else. That’s why I worry about— 

Mr. CAMPBELL. So what brings us out? 

Mr. ROUBINI. Excuse me? 

Mr. CAMPBELL. What brings us out of this? 

Mr. ROUBINI. I think that you need fiscal stimulus, as you have 

done already. I don’t think it’s going to be enough, what you’ve already done. Last time around we started from a surplus of 2.5 percent of GDP. In 2000, it went to a deficit of 3.5. There was a 6 percent in fiscal policy. This package is 1 percent, first of all, and 

we’ve squandered the surplus that we had a few years ago. That’s 

why now we structure a budget that— 

Mr. CAMPBELL. But I guess—and I’m sorry to just—because I 

have several more questions. Is it capital? Is it capital that will 

bring us out of it, or will the consumer bring us out? 

Mr. ROUBINI. It will be capital, but I think that actually in the 

United States for the last few years, we have invested too much in 

unproductive capital, essentially the stock of housing capital, and 

29

we didn’t invest enough into the productive capital. Traditionally 

in the United States, housing is subsidized in a dozen of different 

ways. And then went this bubble. So, part of the adjustment is unavoidable. There was too much investment in residential real estate. That has to fall. And hopefully, the right economic policy is 

going to lead to a recovery of real investment in the true capital 

stock of the economy. 

Mr. CAMPBELL. Okay. Let me—because I’m actually already running out of time. Let me fire off two questions and then I’ll ask. 

One will be to you, Dr. Zandi. 

The CHAIRMAN. We’re being a little lax on time, so don’t—you 

don’t have to rush that much. Go ahead. 

Mr. CAMPBELL. Oh, okay. All right. Then, Dr. Zandi, let me ask 

you. Talking about your proposal of an auction of MBSes and so 

forth, I guess I don’t understand how if the Treasury—if there’s an 

auction, Treasury goes in and buys it, they’re by definition offering 

the highest price, or a higher price than anybody else, how that is 

not the Treasury thereby providing or essentially bailing out to 

some degree the investors and people who made some bad decisions, and in my view ought to lose money for having made those 

bad decisions. 

Mr. ZANDI. Right. Well, they’re making a market. And the market will determine the value, the appropriate value, the price, the 

appropriate price, because they’re going to take bids from multiple 

sellers who are going to be bidding against each other and know 

it, and determine the appropriate price for those securities. 

Mr. CAMPBELL. So you’re saying that if you have some MBSes 

now there is nobody—you can’t—even 20 cents on the dollar, you 

couldn’t sell it to anybody? 

Mr. ZANDI. Well, you will find somebody who will buy it for 10 

cents on the dollar or 20 cents on the dollar, but no one is going 

to sell it, because they know that’s not the appropriate value. And 

therefore there is no trading, and therefore there is no market. 

Mr. CAMPBELL. Well, then why does the Treasury need to buy 

these? If the idea is that all you need to do is create a market with 

some liquidity, why can’t a market be created without Treasury? 

Mr. ZANDI. What you need is a buyer who is willing to pay fair 

value, and says—and I can find that fair value because I’m big 

enough and I can set up an auction that’s deep enough and broad 

enough and have enough sellers in it that I can find the appropriate price. 

Mr. CAMPBELL. Okay. 

Mr. ZANDI. Right now, there is no price. 

Mr. CAMPBELL. Okay. 

Mr. ZANDI. There is no market. And there is no credit. 

Mr. CAMPBELL. All right. One more question for you, and then 

I have one question for the panel generally. Is—if we talk—you 

mentioned that the Alt-A, subprime, and largely the secondary 

market is kind of totally missing, dried up, gone as of January I 

think you said, out there. If we do additional regulation, don’t we 

have to be careful that we don’t perpetuate that situation? Don’t 

we want that market to come back, not like it was, but at least to 

some degree? 

30

Mr. ZANDI. Yes. Absolutely. And, you know, this discussion about 

regulation and what should be done about the regulatory process 

is an issue for the long run. This is a complicated issue. I would 

not jump in and make big decisions fast, because this is a can of 

worms that has been in the making since the Great Depression. It 

just can’t be fixed quickly. 

What needs to be fixed quickly is what you began with in your 

questioning, and that is the securities markets need to be restarted. Because if credit doesn’t flow, you can help homeowners 

today with problems, but you’re going to have hundreds of thousands behind them. So it’s key to get the credit flowing. And my 

point is, we’re coming to the realization, I’m coming to the realization that the markets aren’t going to do it on their own. Ninetyfive percent of the time, they figure it out, and markets should be 

left to their own devices and do it. Five percent of the time they 

can’t, and this seems to me like it may be one of those times, 5 percent. 

Mr. CAMPBELL. Okay. Then the last question I have. We have all 

talked about the economy. I share Dr. Taylor’s concern about inflation, by the way. But the one thing I didn’t hear anybody mention 

was the value of the dollar. And I guess this is for the whole panel, 

and then I’ll close, Mr. Chairman. Is anyone concerned about—that 

if the value of the dollar falls further from where it is that that 

is good, dangerous, or bad for United States economic policy longterm? Thank you. 

Ms. RIVLIN. I would be concerned if the dollar plummeted and 

added to disarray in the world markets, but an orderly decline in 

the dollar, which is what we have seen, seems to me what we need 

to stimulate exports—to reduce our very large deficit in the balance 

of payments. 

It’s getting better. We have a long way to go. And part of the 

self-corrective mechanism is the dollar falling and making it much 

more attractive for other people to buy from us, and less attractive 

for us to buy from them. 

Mr. TAYLOR. I certainly think we should be concerned about precipitous movements, but I also think we should be concerned about 

the strength of the dollar per se. It’s a very important part of policy 

for confidence in America to have what I used to call at the Treasury the strong dollar policy. 

I do think that there are potential inflationary consequences of 

the dollar depreciating, and that’s one of the concerns certainly 

that would be part of my thinking. I think with respect to the improvement in the trade deficit that we’ve seen, which we have, the 

current account has come down, I actually believe that’s largely 

due to in some sense the same thing we’re worried about here, is 

the housing. Because it means that the gap between saving and 

housing—saving and investment, excuse me—has come down, and 

that’s just what would cause the improvement in the current accounts. It’s one of the silver linings that we always try to think 

about for any event like this. But the trade deficit improvement is 

I think mainly related to the investment issue. 

Ms. REINHART. Add that can we take it one step at a time. Right 

now, the process that we are in, and I agree with Nouriel, is a recession or about to be in one. A weakening dollar helps the current 

31

account deficit. We can worry about the inflation consequences; but 

for the time being, let’s worry about the economic downturn, because it’s not likely to go away in a month or two. 

The CHAIRMAN. The gentlewoman from New York. 

Mrs. MALONEY. Thank you. 

Dr. Zandi, you mentioned that we need to get credit flowing in 

our country, but how do we get that credit flowing? How do we get 

that credit access moving? What can we in government do to stimulate or help that direction? 

Dr. ZANDI. Well, I think the root of the problem in the securities 

markets in the financial system obviously goes to the residential, 

mortgage securities market. That has been effectively shut down. 

So I think if you focus on that market, try to revive that market, 

that the rest of the financial system will follow, just as it followed 

down into the credit crunch or credit squeeze, it will follow it out. 

And I do think we are at a point where we shouldn’t wait for the 

markets to figure it out themselves, because it is affecting the 

broader economies resulting in a recession-like, if not a full-blown, 

recession. 

So my proposal is that the Federal Government become more actively involved in that process. I’ve described that to you. I could 

describe it again, but I think that would be the most efficacious 

way of reviving, restarting quickly, something that could be done 

very quickly. We have experience with auction processes. 

The Federal Reserve very ingeniously put together the Taft process, which has worked, I think in everyone’s view, quite well. I 

think we can do that quite easily. There’s obviously missing, complicated issues, but I think that’s the best approach. 

Mrs. MALONEY. Some of the candidates for President are saying 

that our tax credit system is skewed in this country and that what 

we need to do is be giving tax advantages, tax credits to those companies and corporations that create jobs in America. And some allege that our system now really rewards companies that go overseas and move their headquarters and jobs overseas. Could you 

comment on that Dr. Zandi? And do you think that is a direction 

we should be considering? 

Mr. ZANDI. Yes, I mean I think the Tax Code plays obviously a 

key role in the location and expansion decisions of businesses here 

in the United States and globally, and, because we are clearly a 

very globally-oriented economy in every aspect, that is important. 

We are competing with other countries with respect to our Tax 

Code and how attractive our Tax Code is. 

But let me say, I think this isn’t an issue for 2008 or 2009. That 

would be more of a longer-term issue for the next President. It’s 

not something I think I would be focusing on this year. 

Mrs. MALONEY. Now, many of you have testified that we are 

headed towards a downturn in our economy. Would you like to 

comment on whether you think this downturn will be short and 

shallow, or long and deep? And how limited might the Fed be in 

their capacity to act due to the rising inflation? 

Dr. Rivlin, and anyone else who would like to comment? 

Ms. RIVLIN. Frankly, I don’t think we know. What we can do is 

take out insurance to increase the probability that it will be short 

and shallow. I think you’ve already done that with the stimulus 

32

package. I think the Fed has done that by cutting rates. And now 

you need to take steps that will get the credit flowing again. I like 

Dr. Zandi’s proposal. 

There are others, but you need to work both on the credit markets, and, I think, on the ground where the foreclosures are. And 

I would consider in addition to his proposal, or that family of proposals, some direct grants either to States or to nonprofit organizations that can help keep people in communities in their houses, buy 

the foreclosed houses if necessary, and rent them back. 

Mrs. MALONEY. Well, we have taken steps. In fact, roughly 

300,000,000 RFPs are out now to community groups. In my home 

State and city, we are having meetings with homeowners with people on the ground, government sponsored, to try to help them. 

But in that vein, what additional measures give us, if you believe 

according to Dr. Zandi’s testimony where we are facing prices of $4 

a gallon that this would be the equivalent tax of $100 billion on 

our households? This burden on top of the losses and wealth to the 

home prices falling and higher heating oil and gases, what additional measures in addition to revenue sharing helped localities 

and the steps that we have taken in Congress would give us the 

biggest bang for the buck to help families the most during this 

challenging time? 

Dr. Rivlin, and anyone else who would like to comment? 

Ms. RIVLIN. I think we may need additional stimulus and I would 

do it through either increasing the Food Stamp Program, certainly 

lengthening the time for unemployment insurance, and some form 

of revenue-sharing with the States, which could be the Medicaid 

match. We’ve done that before. It works, and we know how to do 

it. 

Mrs. MALONEY. Some of us, including our chairman, tried to get 

that in our stimulus package. 

Mr. TAYLOR. Ms. Rivlin, just briefly I think what you’re doing in 

the communities is very important, and more of that needs to be 

done. I think at the higher levels, if you like what’s done, are the 

Treasury—and actually my Governor in California did the same 

thing—was to bring the servicers and the investors together, because there is a lot of commonality. 

I think they had a lot of mutual interest here. If they could figure out a way to get over this, I think that’s very important. I must 

say though, with respect to further action, I am beginning to worry 

about the psychology of tax increases coming down the line. Right 

now, unless there is a change in the law, we are going to get a tax 

increase, a big one, coming in 2010. 

And it’s going to be a tax increase on capital as well as labor. 

I think that’s beginning to be a concern for people and I think the 

next step, whatever it is, has to recognize that and take some actions, in my view, to prevent it. 

Mrs. MALONEY. Anyone else? My time is up if anyone else would 

to comment. 

The CHAIRMAN. That’s all right. We’ll move on to the gentleman 

from Florida. 

Mr. FEENEY. Well, thank you, Mr. Chairman, and thanks for 

holding this hearing. 

33

If we were hoping that consumer confidence was going to pull us 

out of this potential recession, anybody listening in today, you 

know, will be less likely to come to our rescue. Now, I think we are 

pretty much agreed that this is going to be something more significant than a soft landing and the question is what to do about it. 

Very briefly, with respect to fiscal policy, nobody has actually 

mentioned Milton Friedman’s concept of permanent income. The 

fact is that investors long term don’t change their behavior unless 

there is some positive change in permanent income and one-time 

stimulus packages, while they may or may not do very much harm, 

do very little long-term good. 

As Dr. Taylor pointed out, it is productivity that leads to prosperity for a society and that has always and everywhere been true. 

I view a stimulus package a little bit like a rain dance. The thing 

about a rain dance is that if you dance long enough, it will rain, 

but probably not because you were dancing, and it may not do a 

lot of harm. 

I will say that, you know, Dr. Zandi, your comments about the 

fact that we just don’t have a credit crisis, there simply is no credit, 

I think was one of the extemporaneous positions you took. Even 

borrowers with good credit are having a devil of a time getting access to mortgage loans. Obviously, this is starting to spill over into 

business loans, etc. 

Housing prices are declining. There are no buyers out there because buyers cannot get access to credit, and the correction in the 

easy credit has already occurred. No new regulation has to occur 

from this Congress, because investors simply are not willing to 

enter this mortgage lending market. 

Dr. Zandi, investors buying securitized loans, where was that, 

say, 2 or 3 years ago versus where it is today? The amount of total 

capital investors are putting into securitized mortgage loans, do 

you happen to know? 

Mr. ZANDI. At the peak in 2005, 2006, and the first half of 2007, 

annualized issuances were running at just about a trillion dollars. 

And that was per annum. 

Mr. FEENEY. Per annum? 

Mr. ZANDI. Per annum. That’s a non-conforming market, everything that Fannie, Freddie, and the FHA don’t do. 

Mr. FEENEY. And where is it now? 

Mr. ZANDI. In January, annualized, per annum, less than $50 billion. 

Mr. FEENEY. So roughly 95 percent of the market is gone? 

Mr. ZANDI. I would say it is effectively nothing. 

Mr. FEENEY. And with respect to encouraging the re-establishment or the resurrection, I guess we need a ‘‘Lazarus’’ act here. It’s 

dead. 

With respect to doing that, is it true that to the extent that you 

further impair security, that it will take longer for the investors to 

come back? 

Mr. ZANDI. I think I started to say yes. 

Mr. FEENEY. I spoke to a Realtor recently. She said the biggest 

problem she has on a daily basis is that appraisers are terrified to 

establish a price, because they are going to be held civilly responsible, etc., so she can’t get even today’s market value, because apVerDate 0ct 09 2002 13:33 Apr 10, 2008 Jkt 041183 PO 00000 Frm 00037 Fmt 6633 Sfmt 6633 K:\DOCS\41183.TXT TERRIE
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praisers are worried about what the market will be 6 months or 

a year from now. 

But along with that, I’m very interested, because I also serve on 

the Judiciary Committee, and you testified recently in front of that 

committee about your cram-down proposal. To the extent that residential mortgages are subject to the arbitrary decision of a judge, 

either to reduce the interest rate, to reduce the value of the security, or to lengthen payments, is that a factor as we try to pull a 

Lazarus with the credit market that will prolong the return of investors to start providing credit again to borrowers? 

Mr. ZANDI. No. I don’t believe so, because the legislation is for 

mortgages that have already been originated and not mortgages 

going forward, and, so, I don’t think it will have any material impact on the securities market. 

Mr. FEENEY. Well, presumably, number one, is that the opinion 

of Moody’s, whom you represent? 

Mr. ZANDI. That is my own personal opinion. 

Mr. FEENEY. Okay. Well, presumably, moral hazard, which is a 

concept the economists talk about, consumers, investors, etc., presumably even Congress can be subject to the theory of moral hazard, and if we do it once and like it, get patted on the back by news 

editorial boards and the few borrowers that will be helped, isn’t 

there a potential we will do it again, or, even more importantly, 

won’t there be a potential in the minds of the investors that have 

left the market? Maybe Dr. Taylor could answer that question. 

Mr. TAYLOR. Well, it’s the idea of moral hazard applies to government as well as to private individuals. Its incentives are really important. So if you are going to give the indication that is the problem with the so-called bail-out worries, that if you just make it 

easy for people to get out of mistakes that they made themselves, 

then you are going to perpetuate future mistakes in the future. 

And the ideal with respect to the subject of this hearing, monetary policy, as long as the focus is on the overall economy, interest 

rates coming down, looking at growth inflation issues, and not 

focus particularly on especially parts of the financial sector, that 

should be fine with respect to the moral hazard. So it’s a way to 

focus on the macro things in terms of the broad instruments we 

have, like interest rates, and as it said bail out particular sectors. 

Mr. FEENEY. I am happy to go on, but we have other questions. 

The CHAIRMAN. I appreciate it, and that you have come to an appropriate segue here, the gentleman from North Carolina, the author of the bankruptcy bill. 

Mr. MILLER OF NORTH CAROLINA. Thank you, Mr. Chairman. 

Quickly, before we turn to the bankruptcy bill, I want to disagree 

with the members of the panel or others who suggested what happened, that the calls of foreclosure prices was that lenders or financial institutions generally were not sufficiently cautious in making 

loans without making sure that people could repay the loans. 

Pretty much everyone involved in mortgage lending in 2005 and 

2006 knew perfectly well the people they were lending money to 

could not repay the loans according to the terms of the loans. They 

were loans that were designed to become unpayable, unaffordable. 

The absolute intention was that people would be in a position of 

being trapped and having to refinance again. And every time they 

35

refinanced again, they’d have to pay a prepayment penalty, maybe 

5 percent of the mortgage; to get out of the last mortgage, they 

would have to pay points and fees to get into the new mortgage. 

And every time they did that as housing appreciated, the middleclass families who owned the homes had less of the house, less of 

the equity. And everybody involved in mortgage lending, they’re 

the ones who ended up with it. It ended up in their pocket, not in 

the pockets of the middle-class families, and that was the exact intention. 

What went wrong? Dr. Rivlin used the phrase, ‘‘the music 

stopped.’’ Is the value housing stopped appreciating? And when 

that stopped happening, it didn’t work. Seventy percent of the 

subprime loans in 2005 and 2006 had prepayment penalties; 90 

percent had a quick reset of interest rates that might increase after 

2 or 3 years, so there are 2/28s and 3/27s. 

The monthly payments would typically go up 30 to 50 percent. 

Everyone knew that those could not be repaid, and the volume of 

subprime loans went from 8 percent of all mortgage lending in 

2003 to 28 percent of all mortgage lending, and 55 percent wasn’t 

to people with poor credit; 55 percent of the people who got 

subprime loans qualified for prime loans. They had their trust betrayed by the people they were dealing with. 

Dr. Zandi, you did testify before the Judiciary Subcommittee on 

what is being called the ‘‘cram-down’’ bill, the bill that would allow 

bankruptcy courts to modify home mortgages on the same terms, 

the same basis they would modify any other form of secured debt. 

And you did say then that you thought that would have a very 

modest, if any, effect. 

You did suggest that it be time-limited. There would be some 

said. The bill in the House now has been. You were by teleconference or you were by video, and after you left us, there were other 

witnesses. And one of those, actually, was Mr. Feeney, who asked 

one of the other witnesses or said, well, you know, I am sure that 

there are other economists who take a different point of view, and 

the witness for the mortgage bankers was nodding his head vigorously, as if to say, yes, that’s right. Yes, we do have economists 

who say that. 

Mr. ZANDI. I am sure you could find on any subject multiple 

economists, I understand. 

Mr. MILLER OF NORTH CAROLINA. Well, my question is, have you 

seen it published? Because I haven’t seen an analysis. My understanding of the way academics do things is that they publish their 

analysis. They set forth what their facts are. They take you 

through their analysis and give you their conclusions. In the 8th 

grade, we called it ‘‘show your work.’’ 

Showing your work in 8th grade math class is exactly the same. 

Peer review is exactly the same concept. Now I have heard—one 

Member who has been on the fence about this bill has told me that 

someone, an opponent of the bill, said that they were willing to 

show him, privately, their analysis, but it was privately. It was sort 

of, ‘‘Psst, want to see our economic analysis?’’ 

While the analysis that supports the conclusion that you reached 

has been published, there was a Georgetown study just a week or 

two ago of 40 some pages long; it had footnotes and charts and 

36

graphs and all the stuff that you think serious, academic work 

would have. 

Mr. ZANDI. No. Academic work doesn’t have charts. 

Mr. MILLER OF NORTH CAROLINA. What’s that? 

Mr. ZANDI. They don’t have charts. 

Mr. MILLER OF NORTH CAROLINA. Okay. I have yet to see anything. 

Mr. ZANDI. No. No charts. Yes. 

Mr. MILLER OF NORTH CAROLINA. By the opponents that really 

sets out their analysis for why interest rates are going to leap. Are 

you familiar with any published analysis? 

Mr. ZANDI. No, sir. I am not, and I am following this very carefully. And I have not seen any. No. 

Mr. MILLER OF NORTH CAROLINA. Okay, I have asked the Congressional Research Service. It seems that there are several comparisons that are apt here. In 1978, the law changed. It is one of 

the major re-writes of the bankruptcy law. Before that, as I understand it, with the exception of a few rare times in American history, secured debts could not be modified in bankruptcy. 

After 1978, everything but home mortgages for individuals could 

be modified in bankruptcy. I asked the Congressional Research 

Service to look at and compare investment properties, the availability of lending, the availability of credit, the terms of credit, the 

interest rates for investment property and for primary residence to 

see if they could see anything different coming out of 1978. They 

said, ‘‘No. Nothing.’’ 

The Georgetown study looked at the different places in the country where the courts were applying the law differently between 

1978 and 1994 said they could see no difference. Is that a valid 

analysis, to see if the law is different one place than it is somewhere else, to see if the terms of availability credit are different in 

the two places? 

Mr. ZANDI. Yes, I think the Georgetown study that you are referring to is a well-done study. It’s the best study I have seen and I 

think it provides strong evidence that there is no difference in interest rates, or no significant difference—nothing they can tease 

out of the data. 

Mr. MILLER OF NORTH CAROLINA. Well, there’s that. There’s the 

difference in different parts of the country based on what the 

courts decided—the split in the circuits, lawyers say. The mortgage 

lending industry says one of the big differences that the bankruptcy bill would mean that they couldn’t collect deficiencies beyond for the indebtedness beyond the buy of the home. But, in fact, 

a good many States now have anti-deficiency statutes, including 

the world’s 5th largest economy, California. 

Mr. ZANDI. Sure. 

Mr. MILLER OF NORTH CAROLINA. I am not aware of any difference in the terms of availability credit between States who have 

anti-deficiency statutes and those that do not. Are you aware of 

any difference? 

Mr. ZANDI. No, sir. I am not. 

Mr. MILLER OF NORTH CAROLINA. Okay, in 1986, the same thing, 

family farms, chapter 12 of the bankruptcy laws allowed exactly 

the same thing with respect to family farms. 

37

Are you aware of any? 

Mr. ZANDI. No. 

Mr. MILLER OF NORTH CAROLINA. Okay. Are those the kinds of 

things that you would expect to look to to see if there would be a 

difference in terms of availability of credit? 

Mr. ZANDI. I can’t think of a better approach than exactly that. 

Mr. MILLER OF NORTH CAROLINA. Okay, and you were aware of 

the Georgetown study. You reviewed it. 

Mr. ZANDI. And I have heard the arguments from the Mortgage 

Banker’s Association. I have heard the numbers. I think the added 

interest cost was 250 basis points. I think more recently they are 

saying 150, but I have not seen any research or work. I have tried 

to see it, but I have not seen it. No. 

Mr. MILLER OF NORTH CAROLINA. Okay, thank you, Mr. Chairman. 

The CHAIRMAN. The gentleman from New Jersey, the gentleman 

from Connecticut, the gentleman from North Carolina, and the gentleman from Illinois are on the list that the minority gave to me. 

So, the gentleman from New Jersey. 

Mr. GARRETT. Thank you, Mr. Chairman. And thank you gentlemen and ladies of the panel, as well. 

I appreciate you coming and your testimony. You know, taking 

a line from the gentleman from Florida who has raised questions 

with regard to doing the rain dance, the suggestion there of course 

is that you can do the rain dance, and keep on doing it, and it will 

do no harm. Of course, what we do in Congress is a little bit different than that. What we do may have negative implications. 

Mr. Taylor was referencing the idea that with stimulus today, 

there may be potential tax hikes down the road, and that could be 

doing some harm. And regulating in certain areas may be creating 

moral hazards in other areas, potentially, and that could be doing 

some harm. So, as light as the rain dance analogy might work in 

some cases, it may not work exactly as to what Congressmen do. 

I do appreciate all your testimony today. Let me just ask sort of 

a candid question as we sit here trying to figure out whether we 

should be regulating more or less or to what degree and what action should be taken and what the predictions are for the future. 

Can any of you comment on this? Back in 2005, when Congress 

was here discussing some other legislation and what have you, and 

the housing market was going pretty well—strong—what have you. 

I know we heard a recitation to the late Ned Gramlich, who was 

making his predictions. 

Can any of you reference us to your comments or papers predicting in 2007 that the market would be where it is today, that 

the balloon would have burst as it did, and that we would be in 

this significant credit problem we find ourselves in today? 

Who predicted this on the panel? 

Mr. ROUBINI. In July and August of 2006, I wrote a series of articles arguing that we will experience the worst U.S. housing recession in the last 50 years, that home prices would fall from pig to 

trough by at least 20 percent, and, that these housing recessions 

were going to lead to a severe credit crunch and eventually a recession. And it was not just me. There were seven other people in acaVerDate 0ct 09 2002 13:33 Apr 10, 2008 Jkt 041183 PO 00000 Frm 00041 Fmt 6633 Sfmt 6633 K:\DOCS\41183.TXT TERRIE
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demia and otherwise that predicted that this was just a housing 

bubble like we’ve never seen in U.S. history. 

If you look at the second edition of the book by Bob Shiller, ‘‘Irrational Exuberance,’’ there is a chart showing the real home prices 

for the United States for the last 120 years. It has like a flat chart 

with some booms and busts, 20 percent. Since 1997, this chart 

shows that the real prices go up 100 percent. This was not a bubble; I don’t know what’s a bubble. It was about to go bust. 

Mr. GARRETT. Thank you. Anyone else? 

Ms. REINHART. If I may say so, I wrote the twin crisis paper, 

which was about banking crises and currency crises in 1996 before 

the Asian crisis erupted. 

Mr. GARRETT. And anyone else? 

Ms. REINHART. Well, let me just make one quick point. 

Mr. GARRETT. Thank you. Thank you. Anyone else, because I 

have other questions. 

Ms. RIVLIN. I think quite a few people thought that this was a 

housing bubble—what was not really anticipated was how it would 

affect the credit markets through the mortgage-backed securities. 

I think that was the big surprise. 

Mr. GARRETT. Okay. And I have some other questions unless you 

want to chime in now. And I appreciate that, because I asked Alan 

Greenspan that question when he was here. Because to put the 

question this way, I want to get into the housing market as soon 

as this bubble bursts timing wise, and he could never answer that 

question for me, so I appreciate those of you who were out in front 

of it. 

One of the issues, of course, besides the housing market as you 

just mentioned, is the credit market. And part of that goes to the 

issue, first tied to it, is the bond market today and the problems 

that we are seeing with some of the big bond insurers that they 

are in trouble. 

Do any of you want to comment on this? What would happen to 

our overall economy if some of those insurers go belly-up? And, secondly, what would the effect of a downgrade on the GSEs? We have 

already seen the beginning of that, I guess, on Monday—a downgrade of Fannie Mae by Goldman Sachs. 

Is a ripple effect there and what is that effect on the economy 

as well? 

Ms. REINHART. Ratings are pro-cyclical, so do not look for help 

from that end, meaning that when you know, like Nouriel talks 

about things being bad, ratings are not going to help in that front, 

they are very pro-cyclical. They are pro-cyclical at the corporate 

level and at the sovereign level. 

Mr. GARRET. Thanks, I appreciate that. 

Mr. TAYLOR. So one thing, one of the certainly issues if you go 

back and look at what went wrong is the rating agencies themselves. I mean this is ridiculous, what they were calling high-quality paper. In retrospect, it seems to me as healthy to go back and 

now and try to get this right, and look into the future. 

So yes, it will have some negative impacts, absolutely. And hope 

to minimize the spillover of those, as I have tried to indicate. But 

I think now you don’t want to do anything to really question as 

39

best possible analysis from the rating agencies we can get, because 

it was terrible. 

Mr. GARRETT. Well there is talk that there may be downgrades of MBIA and AMBEC of an additional $40 to $70 billion in writedowns, a phenomenal number. Can the financial market basically 

absorb that large of a figure? 

Mr. ZANDI. Well, I think your focus on the monolines and on potential downgrade of the GSE’s highlights how significant the risks 

are, and that if in fact there are downgrades of the monolines, they 

will be out of business and there will be significant problems in the 

municipal bond market, which will affect many households. 

And it will also induce greater substantive write-downs, tens of 

billions if not hundreds of billions of dollars in the mortgage security markets, because there is insurance in those bonds as well. 

The GSE got downgraded, then of course the cost of—right now the 

only part of the mortgage market that is prior and current to the 

households is through Fannie, Freddie and the FHA. 

Fannie and Freddie are not as creditworthy, their cost of capital 

rises, therefore mortgage rates are going to rise, they are going to 

be less willing and able to extend out credit. 

So this highlights the very significant risks that exist and are 

playing out, and highlight the importance of policymakers to continue to be very aggressive and try to work on policies that are 

going to help the securities markets, I think that is what’s important here. 

The CHAIRMAN. Quickly, could—we are going to have a vote, so 

one more quick question, yes. 

Mr. GARRETT. Just one quick question. To the credit of the chairman, I know the chairman has been trying to move legislation with 

regard to the GSE’s for reform in that area, and we haven’t gotten 

that done. Is that a problem that we just expanded there, without 

doing what the chairman is trying to do as far as putting some 

reins on it as the chairman is trying to do? 

Mr. ZANDI. No. I don’t—because what you did was a temporary 

increase in their loan cap, and I think that is entirely appropriate 

in the context of the problems we are having. And the help that 

this will provide will be very significant to California, South Florida, New York, and Washington, D.C. Those are the markets where 

many of the securities are based; those are where the loans are. 

The CHAIRMAN. And the Secretary of the Treasury has my word 

that this committee will not consider a bill to extend that beyond 

the December 31st expiration. 

Mr. GARRETT. And I appreciate the chairman for that. 

The CHAIRMAN. Unless it is in the context of the broader reform, 

including, because some have been concerned, Mr. Roubini raised 

it about the upper-end bias. Money that would be using some of the 

money they would make off that for lower income, affordable housing. 

Well I just can’t resist. When I listen to the rating agencies, I 

do want to use a quote, if I may, that I have applied in other contexts. It says—I look at the role of the rating agencies in this, and 

it was triggered by Dr. Reinhart saying they were pro-cyclical, 

which is a polite way of saying that they come in after the fact and 

tell us what they should have told us before. 

40

The great editorial writer for the New York Post, Murray 

Kempton, once said that, ‘‘The function of editorial writers is to 

come down from the hills after the battle is over and shoot the 

wounded.’’ That does appear to be what the rating agencies have 

done in the current situation. The gentleman from Georgia. 

Mr. SCOTT. Thank you Mr. Chairman, and again welcome all of 

you to our committee. I would like to get your reaction to a couple 

of points. The first one deals with the housing crisis, and the other 

deals with what is happening with many of our companies going 

into bankruptcy with these two things. 

First, let’s deal with the housing crisis, and what a program that 

has been put forward is, do you think, is enough? And that is the 

Bush Administration’s new plan for homeowners facing foreclosure, 

which is Project Lifeline, I think you all are familiar with that. I 

would like to ask you if you think, if you truly believe that this 

plan will go far enough to keep these families in their homes. 

And that is particularly true, because as we look at banks who 

are continuing to restrict access to credit seems to me continues to 

acerbate the problem. In addition, property values are declining, 

making it difficult for an increasing amount of homeowners to refinance in the first place. By the end of the year, it is estimated that 

15 million households will actually owe more on their mortgages 

than their homes are worth. 

This has to be a major concern, and in fact there are hundreds 

of thousands of homeowners who, even if they wanted to refinance, 

just cannot do so because they are locked out. Do you believe that 

what the Administration is putting forward in Project Lifeline is 

enough to get the job done, given the complexes and the inter-reactions that are happening as a result of the banks number one, restricting access to credit and the derivatives of the problem as I 

outlined earlier. 

Ms. RIVLIN. No, I don’t. I think it will help some people, but 

probably not very many, and I think you need a two-pronged approach. One is the one that Dr. Zandi has discussed—some kind of 

a taxpayer fund, buying mortgages or mortgage pools at a considerable discount. The discount ensures that sellers are not making 

much money. And I think you also need to work at the community 

level. It will not be easy to design that; you might let the States 

do it. But you need to get people on the ground thinking about how 

to keep people in their homes and having some resources to do it. 

Mr. SCOTT. Yes, Dr. Taylor. 

Mr. TAYLOR. I think what the Treasury is doing, and what I said 

earlier Governor Schwarzenegger did in California to bring the 

servicers and the investors together, it is focused on the problem 

right now, which is to try to get some adjustments in the payments 

so people can stay in their houses and have the okay of that basically from the people who will benefit from that, the investors 

themselves. 

I think that is very good. I think Mrs. Maloney’s comment about 

the community organizations and doing this at the ground level, 

and Dr. Rivlin mentioned this too, is very important as well. My 

sense is those are the things we should be doing. The risk here is 

the housing prices falling even further it seems to me. And we 

41

don’t know what is going to happen with that, there is certainly a 

risk of that. 

But at the current levels, especially with the interest rates being 

lower, that reduces the reset issue significantly, the fact that you 

have a lot of the indexes that are used to reset the mortgages have 

come down, even the LIBOR index has come down substantially, a 

couple hundred basis points. 

Mr. ZANDI. Can I say in regard to Hope Now and Project Lifeline? 

Mr. SCOTT. Yes, you may. 

Mr. ZANDI. They are, I think, laudable efforts, but they will ultimately fail, at least to a degree that matters. And there are three 

reasons, because there are three different groups that have a significant problem with making it work. First are the investors that 

own highly rated traunches of these securities. They have no interest, financial interest in allowing modification to occur. 

Second, the servicers themselves, they are very nervous about 

being sued by the investors even though they are under tremendous pressure by you to do so. So they are going to be very reluctant to it. And third, just operationally, this is a very, very difficult 

thing for them to implement effectively, quickly and that is mucking it up. 

Mr. SCOTT. But let me get your thoughts on this, because I think 

there is one proposal that certainly needs to be put on the table 

I think, and I would like to get your response to it. And that is 

would not it make sense for us to put a moratorium, a type of moratorium on all foreclosures and put a time limit on it, maybe it’s 

for 6 months? But to give an opportunity to stop the bleeding and 

allow a refinancing to take place that would be patterned on that, 

a person’s ability to pay at that particular point. The moratorium 

on the mortgages, is that a real possibility that we should be looking at? 

Mr. TAYLOR. I think a government-mandated moratorium would 

be troublesome at this point. 

Mr. SCOTT. I didn’t hear you sir. 

Mr. TAYLOR. I think a government-mandated moratorium would 

be quite troublesome at this point. I think the lifeline idea of a 

month, a pause if you like, which is basically agreed to from the 

private sector is, it makes sense to me at this point. But if you are 

going to just go in and affect private contracts on a massive basis, 

it seems to me it could cause more problems in the future than you 

are trying to solve. 

Mr. SCOTT. But the point is that I would say I am getting at is 

that unfortunately throughout this country, the rate of foreclosures 

and the timeframe to enact the foreclosures varies. Some months 

if you are—in some States, if you are behind in your payments a 

month or 2 months, your property is on the courthouse being dealt 

with, and in other States, the timeframe stretches. 

And I think that is a fundamental flaw that we are not dealing 

with this disparity, and the lengths of time and the range of numbered payments that the individual consumer gets behind before 

his house is foreclosed, I think we need to address that. 

Mr. TAYLOR. It just seems to me that the plans that are in place 

now do try to narrow in on the people that can deal with this probVerDate 0ct 09 2002 13:33 Apr 10, 2008 Jkt 041183 PO 00000 Frm 00045 Fmt 6633 Sfmt 6633 K:\DOCS\41183.TXT TERRIE
42

lem and the ones that should be fine, or they are not affected by 

it. So it is a pretty big section in the middle there that it’s focused 

on and it seems to me that’s what we should try to do in the meantime. In the meantime you know, if it could get worse, risks are 

there for further housing price to decline. 

Mr. NOURIEL. Can I add a point. I think that the severity of the 

problem is that there are essentially two types of solutions. One is 

one in which essentially you do the auction and the government essentially nationalizes a good chunk of the mortgages, hundreds of 

billions of dollars. So that is socialization on a certain of these 

loses. 

The alternative is that in a market solution, eventually millions 

of people are going to go out, walk out of their homes, because as 

you have suggested millions, and many more are going to have a 

value of their homes that is below the mortgage, so they can walk 

out. In that case, you wipe out the capital of the banking, your systemic banking crisis and you nationalize the banking system. 

So either way you nationalize the mortgages or you nationalize 

the banks, that is what we are facing now. 

Ms. REINHART. Forgive my ignorance on this topic, but one of the 

chronic problems with commodity stabilization schemes is treating 

permanent shocks as temporary. And so that you try to treat it as 

temporary and patch it, but that it lasts. I think we are facing 

some of that here. 

The CHAIRMAN. We will now move on with that tearful close, and 

we will go to Mr. Shays. 

Mr. SHAYS. Thank you, I am going to make a few observations. 

First, I love this panel, and I read all your statements. So I wasn’t 

hearing some of the answers, but great statements, great panel. I 

am struck by the last questioner and it is like he is trying to, in 

my judgement, with no disrespect, repeal the law of gravity. 

The reason you have foreclosures is that people are stopping paying their mortgages and the people who own the properties have 

to pay someone else. And it would be like, it seems to me, saying 

if someone can’t quit a job, even if the employer isn’t paying them. 

Well you have to just keep working. Your employer isn’t paying 

you, but you have to keep working. In this case, someone isn’t making payment on property that someone else owns that owes money 

to someone else. 

And how are they going to pay that someone else if you just say 

the people can stop paying, but you can’t foreclose on them. I am 

getting from this that consumers, there is a them that they are 

shopped-out, saving less and debt-burdened, that is a pretty scary 

thing. And Ms. Rivlin, your comment that we built more houses 

than there was a demand for, and that is amazing in a way when 

you think about it, because what it says to me is as we were building more houses, we had to find people to buy them, and the people 

we found to buy them were people who couldn’t afford them. 

And so we were having more risky schemes to get them to buy 

them. But what it says to me is that there is no easy fix, which 

leads me to a second point. There are three CEO’s, all brothers of 

Fortune 500 companies, and they said, ‘‘What made you all successful?’’ And they said, ‘‘We faced up to reality and we dealt with reality.’’ 

43

And it strikes me that we are trying to ignore reality. Reality is 

we have more houses than there is a demand for right now, and 

that is one of the challenges. Another challenge is that we have a 

bond market where the bond companies, the insurance companies 

need about $15 billion. 

Another reality, it seems to me, is that credit agencies have destroyed their franchise. They—I don’t trust them. And now I am 

concerned that the credit agencies, to try to win back favor, and I 

would like you to comment on this are going to now really clamp 

down and then depreciate the value of what is on the market, of 

what people hold as having some value and further deteriorated. 

And I am concerned that the rating agencies, to try to win back 

favor, are going to overcompensate. I would like you to quickly, 

each of you, tell me about what role the credit agencies have in 

making things get worse or better. 

Mr. TAYLOR. I think it seems that a lot of the investors should 

look elsewhere than the credit agencies to get their information. 

That would keep them on their toes. And you know, the investors 

I know, they don’t even need these credit rating agencies. So the 

more we can find, if you like, substitutes, new ones, competitions 

for this business, the better off we will be. 

Mr. SHAYS. Others? 

Ms. REINHART. The literature on both on the corporate level and 

on the sovereign level, rating agencies are pro-cyclical. They do not 

help in economic downturns. 

Mr. SHAYS. Mr. Chairman, I would just like to say we have had 

some hearings on credit agencies, and I would love us to revisit 

this issue. 

The CHAIRMAN. Yes, I would say that the gentleman from Pennsylvania, Mr. Kanjorski, has been significantly engaged with that 

and we will return to that. 

Mr. SHAYS. Could I ask about—the first package was a stimulus 

package, you know we gave folks some money to spend, we allowed 

businesses to write off their capital and new planting equipment, 

and we raised the housing limits for Fannie Mae, Freddie Mac, and 

FHA. And that all seemed to make sense. It strikes me that the 

second package has to shore up the credit market in the sense of 

we have to somehow, should we be providing money to the bond 

market. And I mean you have mentioned it, but I would like to 

know if there is consensus. 

It strikes me that if we basically are not telling people whether 

or not their taxes are going to go up, the wise investor is going to 

hold back because of not knowing what is going to happen, or are 

they, because the capital gains may go up try to sell property even 

more quickly to take a lower price but pay a lower tax? 

Could you speak to that, and then I am done. 

Mr. TAYLOR. I briefly mentioned this before—I think anything 

that is in the future should deal with this tax increase that is coming down the line unless legislation is passed. I don’t think you can 

separate it out anymore; that was part of the way this moved so 

quickly. 

Mr. SHAYS. Now you were the request of the Republican members as a witness. I would like to know what some of our other 

44

members say. No, I mean, and I happen to agree with you. I am 

just curious if others agree with you, Dr. Taylor. 

Mr. ROUBINI. I don’t agree, I think that those tax cuts were 

things we couldn’t afford. And unfortunately, whoever is going to 

be in power in the next Administration will have to reverse some 

of these tax cuts. 

Mr. SHAYS. So—if dividends go up? 

Mr. ROUBINI. And income taxes for the higher-income individuals 

as well, absolutely. You have a fiscal time bomb. I mean your fiscal 

debt is already going from 150 to 410, and that doesn’t include Iraq 

and Afghanistan. And on top of it— 

Mr. SHAYS. And that will have no impact on slowing the growth 

of the economy? 

Mr. ROUBINI. No, but on top of it you are going to have another 

fiscal stimulus at the end of the year with a recession. The recession is going to make the deficit even bigger. And now people are 

talking about the government buying hundreds of billions of dollars 

worth of mortgages. So there are people saying we are going to 

have a budget deficit of $800 billion a year from now. 

That is the problem we are facing, so you want to make also the 

tax cuts permanent, another trillion dollars of losses of revenues? 

I think it is just kind of fiction. 

Mr. SHAYS. Doctor, do you believe that tax cuts stimulate any 

economic growth, or do you just think that is some kind of madeup story? 

Mr. ROUBINI. If you cannot afford them, they don’t stimulate economic growth; there is a budget constraint you have to finance. 

Mr. SHAYS. Dr. Zandi? 

Mr. ZANDI. Well I think this is a debate for the next president 

and the next Congress. I think if you try to tackle that one now, 

you will not get anywhere and you will not make any progress on 

things that you should. Secondly, I am all for lower tax rates, I 

think they are stimulatory, I think they are very helpful. The lower 

the tax rates we can have, the better. But I also think our most 

significant long-term economic problem is those very large, looming 

budget deficits. The budget math is very disconcerting, and if you 

have the lower tax rates great, but we have to figure out how to 

pay for them. 

Ms. REINHART. In a nutshell, short run gain, long-term pain. 

That is basically—meaning— 

Mr. SHAYS. I understand. 

Ms. RIVLIN. The reason the tax cuts were not made permanent 

was that we couldn’t afford them, and we knew that at the time, 

you all knew that at the time, and that is why they were made 

temporary. And it is still true, on a long-term basis, that we are 

going to need either to cut spending drastically or to raise revenues, and you have to face up to that. 

Mr. SHAYS. Okay, thank you. Thank you all very, very much. 

The CHAIRMAN. The gentleman from Texas. 

Mr. GREEN. Thank you, Mr. Chairman. Thank you and the ranking member for hosting this hearing, and I thank the witnesses for 

appearing today. Let me start with a question with reference to 

regulation. Are you of the opinion that regulation could have prevented this current crisis? And because I have not been here, I 

45

have not heard much of what you have answered. And by the way, 

I have had another hearing that I have been attending for the benefit of those who want to know why I wasn’t here. 

If you think that regulation could have prevented this crisis, 

could you just kindly extend a hand into the air, this way I can 

get through it quickly, if you think regulation could have prevented 

it. The current subprime crisis as it’s called, the current crisis in 

financial markets, could regulation have helped prevent it? 

Ms. RIVLIN. I think it could have mitigated it. If we had stronger 

regulation of predatory lending, we would have not had as much 

capital flowing into the housing markets, but I don’t think it would 

have solved the whole problem. The very low interest rates also exacerbated the housing bubble. 

Mr. GREEN. If we would have had regulations in place to prevent 

making loans at a teaser rate, but not having the purchaser qualified for the adjusted rate, would that have been helpful, anyone differ? If we had in place a regulation that required documentation 

showing that you had income, would that have been helpful? 

The CHAIRMAN. Could I just let you note that the recorder is very 

good at his job, but his ability to record head nods, eyebrow 

raises—we probably want to give some indication of people as to 

what they— 

Mr. GREEN. Yes, sir, thank you, Mr. Chairman. 

Ms. REINHART. I just want to make one observation. You know 

that I have studied crisis everywhere, banking crisis, and the problem is that regulation usually lags behind financial innovation. 

That is a chronic problem. 

Mr. GREEN. I concur with you. I right now am not going to challenge anyone on the notion of whether we could prognosticate what 

was going to happen as such as we could have had the regulations 

in place. I think there was some evidence to indicate that there 

was some regulations that we could have, based on empirical evidence, put in place. 

But be that as it may, I would like to go back to where I was 

with reference to undocumented loans, loans where you don’t have 

document to support, income. If you are of the opinion that would 

not have been helpful, raise your hand. For the record, all persons 

seem to agree that it would have been helpful, with one exception, 

Mr. Taylor. 

Mr. TAYLOR. What specifically is your question, sir? 

Mr. GREEN. My question is a basic statement. We had many 

loans made to persons who did not document income, commonly 

known as no-doc loans. If we had regulations, some regulation that 

would require some documentation of your income, would that have 

been helpful? 

Mr. TAYLOR. Now I am going to have to see what documentation 

you mentioned, but let me be more specific. I think that a lot of 

the loans given to people were based on statistics that they were 

paying, and the same quality of people who continue to pay. And 

that is because housing prices were rising so rapidly that people 

had an enormous incentive to keep up their payments. And so 

those data were used by the underwriters, by the automatic underwriting programs, and I think that was a big part of the problem. 

46

Mr. GREEN. So if I may, would I put you on the side of those who 

would contend that no-doc loans were not helpful? 

Mr. TAYLOR. I see specifically what you mean, but— 

Mr. GREEN. No-doc loans, a person gets a loan and does not 

produce evidence of income. 

Mr. TAYLOR. Basically you have to have evidence of the borrower’s capability of paying to get a loan. 

Mr. GREEN. So you would agree that making no-doc loans then 

does provide some degree or problem for an industry that depends 

on payback. 

Mr. TAYLOR. Yes. 

Mr. GREEN. Okay. For fear that I may not get this in, I probably 

will come back to my questions. But Dr. Zandi, are you familiar 

with the term ‘‘traunche warfare?’’ 

Mr. ZANDI. Yes, I think so. 

Mr. GREEN. You mentioned the persons who are at the higher 

traunches. 

Mr. ZANDI. Yes. 

Mr. GREEN. And you have persons who are at lower traunches. 

The statement has been made that no one benefits from what is 

occurring now. You said earlier however that the persons who are 

at these higher traunches, they don’t have the same risk if you 

will. You didn’t use that term, but that is the term that I would 

add. 

Mr. ZANDI. Incentives. 

Mr. GREEN. Yes, incentives as those in the lower traunches. 

Mr. ZANDI. Right. 

Mr. GREEN. Could you explain to us why the persons at the higher traunches, as briefly as you can, would not have the same incentives, please? 

Mr. ZANDI. The folks who are at the highest traunches, the triple 

A, double A traunches will get their money back unless 70 or 80 

percent failure rate, default rate, net loss rate occurs on the security. And in a modification, what they are worried about—let me 

back up. 

In most of these securities, what happens is you have a pool of 

money out there that is distributed to all the investors. This pool 

gets distributed based on how the underlying mortgages perform. 

So if the mortgages are performing well, then over time that pool 

of money gets distributed to all off the investors, the highly rated 

traunches, the lower rated traunches. 

What the highly rated traunche owners are worried about that 

in the modification that money will get distributed and then the 

modification will ultimately go bad and they will suffer a loss and 

there won’t be that pool of money to protect them and they will ultimately lose money. So they are much more interested in allowing 

these loans to go all the way through the process and wiping out 

the lower rated traunches. 

And what they have left are the homeowners who are going to 

pay and who are going to pay reliably and they are going to get 

their money back. So in the modification they are very nervous 

that they are not going to get their money, and in a foreclosure, 

they are more likely to get their money back. 

47

Mr. GREEN. Just a final comment, if I may, Mr. Chairman, and 

by the way the people who have these higher traunches, they paid 

more to occupy the positions that they occupy. 

Mr. ZANDI. Yes, they got a lower return because they took less 

risk. It is the guys at the bottom end who took a lot of risk got very 

high returns. And their view is, you know, why should I help them 

out, when this was the deal? If things got bad, the lower rated 

were going to suffer more than me. 

Mr. GREEN. Thank you, Mr. Chairman. I yield back. 

Mr. JONES. Mr. Chairman, thank you very much, and I want to 

thank the panel. I’ve been in and out like most members of other 

committees, and one major committee, military personnel talking 

about the needs of the active duty, the needs of our military— 

The CHAIRMAN. Well, we probably ought to stick with this subject, since we’re going to have a vote soon. 

Mr. JONES. I’m coming right to it. The book, ‘‘The Day of Reckoning,’’ by Pat Buchanan, says that any great nation that has to 

borrow money from foreign governments to pay its bills will not 

long be a great nation. America is borrowing money from other 

countries to pay our bills. Dr. Zandi, this will probably go to you, 

but if anybody else wants to join in, that will be great. 

My concern is—and I realize that debt is part of living—the issue 

when you can pay your debt each month, but you’re going to borrow money from another bank to pay your bills, which America is 

doing, by putting all these Treasury notes out for sale, then you 

can live within the debt. 

My question is this: At what point does America lose its financial 

credit with other countries? If the debt is growing at $1.61 billion 

a day, we’re borrowing money to fight the war in Iraq and Afghanistan, we’re borrowing money to pay for the surplus—I mean the 

stimulus package—at what point, Dr. Zandi, do we get to a point 

of no return? 

It happened to the Soviet Union during the Ronald Reagan days 

in the presidency. There was an arms race that they tried to compete with America. America was strong then, and therefore they 

couldn’t compete. They fought a 10-year war in Afghanistan. So 

we’re in a situation where now we’re having to borrow money to 

pay our national bill. At what point does this get beyond the point 

of no return? 

Mr. ZANDI. I think once we get into the next President’s term, 

when we start to grapple with the question of what do we do about 

the tax cuts, and how do we address Social Security, Medicare, and 

Medicaid, if you are not successful in addressing that issue, I think 

we will have a significant problem. 

Mr. JONES. Okay. Will you explain your point of a significant 

problem? The American people— 

Mr. ZANDI. I think what it would manifest itself in is that interest rates would rise measurably, long-term interest rates would 

rise measurably, and of course that would be a significant weight 

on the economy—and that would certainly exacerbate conditions—

that you will need to solve that long-term budget problem; otherwise, we’re going to face high long-term rates, much slower investment and productivity growth, and ultimately it feeds on itself. 

48

Mr. JONES. Would you say that the next President—he or she—

the next President would have 8 years to try to get a handle on 

this problem, or less or more? 

Mr. ZANDI. I think it’s in their term, because we are going to be 

faced with the question of: What are we going to do about those 

tax cuts? How are we going to pay for them, or not? And just how 

are we going to address Social Security or Medicare? 

The Baby Boomers are right there, and they are now sucking 

down Social Security, Medicare, and given the high cost of health 

care and the escalating cost of health care, we’re there. It’s going 

to be in this term. 

Mr. JONES. I have a couple more minutes. Would anyone else like 

to respond? 

Ms. RIVLIN. I don’t think we know the exact moment at which 

the reckoning comes, but I agree with everything Dr. Zandi has 

said. We’ve been taking chances for a long time. We need to fix this 

problem of the long-run budget deficit. That doesn’t mean we have 

a crisis in the budget right now. It’s a relatively small amount in 

relation to our economy, but our long-term problem is very serious. 

Mr. JONES. Anyone else? 

Mr. REINHART. Britain once dominated the world. It no longer 

does. Things happen. And the 1967 sterling crisis was a good end 

to that reign. So we have to be very careful. 

Mr. JONES. Mr. Chairman, thank you very much. I’ll yield back 

at this time. 

The CHAIRMAN. Clearly, Dr. Reinhart, Britain’s reign over the 

world did end some time before the sterling crisis of 1967. 

Ms. REINHART. But that finished the sterling zone. 

The CHAIRMAN. The gentleman from Illinois? 

Mr. MANZULLO. Well, thank you. I’m intrigued with the testimony, and if I could just make a few observations: Everybody on 

the panel agreed that the present stimulus package was good to 

put $600 to $1,800 in the hands of the American consumers so they 

could spend it, but only one agreed that the tax cuts should continue. 

I just find it totally contradictory that you could be in favor of 

this stimulus, and then sit back and look at the average family of 

4 having to pay about $2,700 more in taxes, when in fact Wall 

Street is already reacting to that. But that is more of a commentary. 

Second, Dr. Rivlin had mentioned in her testimony the fact 

that—and perhaps I read it wrong—residential construction is not 

a big part of the economy, even with its linkage to consumer durables and other real estate services. I would disagree with that entirely. 

If you take a look at what goes in home lumber, wire and electrical fixtures, plumbing, pipes, fixtures, appliances, windows, 

glass, flooring, wood, linoleum, paint, caulk, hardware, locks, 

hinges, nails, indirectly loggers, truck sales, for pick-up trucks, for 

construction sites, tires—I have a tire factory in my district—other 

construction tools and trucks and equipment, sales of these items 

have huge hits on manufacturing, whenever that happens in residential housing, and when you don’t have residential housing going 

49

up, you don’t have commercial housing going up, because one 

drives the other. 

And this is backed up into all aspects of the economy. You can 

sit here, we can sit here and solve the housing crisis today, but 

when people are losing their jobs because of the smack from the 

collapse of the residential construction industry, then all of us are 

the tiger chasing each other around the tree, trying to figure out 

what’s going on. 

But also services related to residential housing are Realtors, brokers, telecompany, mortgage brokers, then the people who build the 

office buildings for the people in these professions. And so I think 

we have to sit back and take a reality check as to the impact of 

construction and the impact of manufacturing. 

Dr. Greenspan did a great job of keeping down inflation, but he 

did not understand manufacturing. Chairman Bernanke does. Dr. 

Greenspan said that what jobs you lose in manufacturing, you 

more than compensate for in high-end, white-collar jobs, but on 

three different occasions, when I examined him before this committee, he couldn’t give me an example of one of those. 

But the real question I want to ask here is this: Lisa Madigan, 

who is the attorney general for the State of Illinois, put out her report as to what happened in the housing market, and she said this 

housing market collapsed even before the resetting of ARMs because people bought homes they could not afford in the first place. 

That is what is going on in Illinois. And my question to you is 

whether you have a federalism hat on or federalism hat off, whose 

job is it to govern these instruments of debt? The 2/28s, the 3/27s, 

the no-principal payments, the ARMs, the fact that people took out 

these layered loans. I mean, who has the jurisdiction over that? 

The States? And if not the States, then the Federal Government? 

And what agency? I’m trying to attach responsibility, if any, as to 

who would be in the position to get rid of these types of loans that 

cause the problem. 

Ms. RIVLIN. Part of the problem was that the answer to that 

question wasn’t clear. The States had jurisdiction over many of 

these loans. The chairman has pointed out that arguably, the Federal Reserve could have asserted its authority to regulate these 

loans, and certainly to pull the other regulators together and say, 

‘‘Let’s all do it together,’’ which they eventually did do. 

But it was a very unclear situation, and that’s what I think you 

as legislators have to straighten out. 

Mr. MANZULLO. Okay. Would everybody agree with that analysis? 

Mr. ZANDI. Yes. I think the problem is you had the Federal Reserve, the OCC, the OTS, the FDIC, the FCC, and every State regulatory agency having some part of the process, and it was only 

until—I believe it was November of 2006 that they collectively 

issued their first guidance with respect to interest-only neg-am 

jumbo loans. They didn’t even get to subprime loans. They didn’t 

issue collective guidance on subprime loans until I believe it was 

April/May of 2007, well after the fact. 

And that goes to the Byzantine nature of the— 

50

Mr. MANZULLO. Now the guidance on it is in terms of words of 

guidance or actual saying that you can’t have these documents, or 

governing the documents. 

Mr. ZANDI. No, it was strongly—it was worded guidancing—you 

know, you can’t make teaser rates to these types of loans. 

Mr. MANZULLO. But I guess my question is—and maybe we all 

scratch our heads—why would a bank or lending agency get involved in having somebody buy a house when you don’t even know 

if that person can make the first payment? I mean what—something happened that— 

The CHAIRMAN. Would the gentleman yield? 

Mr. MANZULLO. Of course. 

The CHAIRMAN. What happened was securitization. 

Mr. ZANDI. Yes. 

The CHAIRMAN. What happened was that you no longer had to 

worry about whether that individual could pay you back, because 

you made the loan and sold it, and then other people bought it, and 

packaged it, and sliced it, and they said, ‘‘We have all these techniques.’’ And what they did was take these loans that never should 

been made in the first place, and sent them all over the world. 

Mr. MANZULLO. But isn’t there something—I don’t want to use 

the word ‘‘dishonest,’’ but I just, I mean you’re a business person, 

and you’re sitting across the table from a person you know cannot 

make that first payment. 

The CHAIRMAN. Yes. 

Mr. MANZULLO. And there’s a problem there. 

Mr. ROUBINI. As the chairman suggested, you had essentially a 

securitization food chain, in which every step of the way somebody 

was making an income from a fee and not told in the credit risk. 

You started with the mortgage broker that wanted to maximize his 

or her own income by maximizing the number of mortgages that 

are being approved. Then there was the originating bank, that was 

essentially putting these things together into RMBS’s and sending 

them somebody else and getting a fee. It was the mortgage appraiser, who had an incentive to— 

The CHAIRMAN. But— 

Mr. ROUBINI. —over-appraise the value of the mortgages. Then 

the investment bank was repackage— 

The CHAIRMAN. Everybody at— 

Mr. ROUBINI. —into CDO’s, and the rating agency was making 

a fee and profit out of mis-rating this thing. So at every step of the 

way, somebody was making a fee and transferring— 

Mr. MANZULLO. I understand. Mr. Chairman, I do have one question. 

The CHAIRMAN. Yes, go ahead. 

Mr. MANZULLO. I didn’t mean to cut you off. If there is going to 

be a regulation here, and I’m just—we’re all thinking out loud, and 

that’s the purpose of the hearing—wouldn’t the regulation be at the 

level where you could say unless these certain underwriting criteria are met, that there can be no securitization? 

The CHAIRMAN. Will the gentleman yield? 

Mr. MANZULLO. Of course. 

The CHAIRMAN. We passed a bill that does a lot of that. The bill 

that came out of this committee that passed the House says that 

51

nobody in the country, including your broker, can make certain 

loans. And we then require that the securitizer do due diligence before packaging the loans, and we hold the securitizer liable if a 

loan has been sold without the due diligence, the borrower can 

then cancel out the loan, and the securitizer is on the hook. So 

much of what the gentleman— 

Mr. MANZULLO. There were some infirmities in that bill that 

compelled me to vote against it, but there’s— 

The CHAIRMAN. Well, I gather. But the gentleman is— 

Mr. MANZULLO. I understand. I understand. 

The CHAIRMAN. But what the gentleman is asking for, we have 

already passed in this House. 

Mr. MANZULLO. I understand that. I understand that. And thank 

you. I’m going to yield back to— 

The CHAIRMAN. Well, I’m going to take some time out, because 

I have to say, with all due respect, that I now know more about 

regulation, and Dr. Roubini, you got it wrong. And Mr. Zandi and 

Dr. Reinhart. No, it was not a multiplicity of regulators; it was an 

absence of regulators. 

First of all, under the Homeowner’s Equity Protection Act passed 

in 1994 out of this committee—not by me—John LaFalce, my predecessor, a senior Democrat, was the major advocate, and it is not 

an accident that was the last time the Democrats, frankly, were in 

control of the House—the Federal Reserve was given authority to 

promulgate rules for all mortgages, not just for depository institutions. Dr. Roubini, as you noted correctly in your written statement—frankly, you should have stuck with it—you say that there 

was a clear regulatory failure. Ned Gramlich started that; this is 

on your page 3. And then you note: ‘‘Most of the questionable practices were not perpetrated by federally regulated banks, and the 

Washington regulator didn’t know the case.’’ 

So there wasn’t much the OCC and the OTS could have done. 

Under Chairman Greenspan, as an ideological matter, he flatly refused to use the authority given to him by the Homeowner’s Equity 

Protection Act despite Ned Gramlich asking him to do it. He said 

that was the kind of intervention that would do more harm than 

good. 

We then had, frankly, a further problem because it was then up 

to the States, and the States had the right to do it or not do it. 

But Dr. Reinhart, I’d have to disagree with you on this one point. 

Some States were trying to do things. And then the Comptroller 

of the Currency and the Office of Thrift Supervision promulgated 

rules that significantly preempted rules not only concerning national banks, nationally—banks, but their affiliates, and their operating subsidiaries and their affiliates were a problem. 

So there were State laws. For example, we just had a lawsuit 

going through. Ohio had a law about mortgage brokers. State Farm 

had a bank, and they required mortgage brokers to be contractors, 

not employees of the bank. And Ohio had some rules about the 

mortgage brokers, and the Office of Thrift Supervision said, ‘‘No, 

no, we preempt that, they’re a national thrift.’’ 

What we have since done in the bill that this committee passed 

was in fact to not wait for the Fed anymore, but to pass a set of 

laws, as Dr. Roubini says in his written statement, where you had 

52

depository institutions making mortgages with insured deposit 

funds, there was regulation. And a very small percentage of the 

problem happened there. 

The problem came when pools of money not from depositors, liquidity that became available not subject to regulation, originated 

by non-regulated institutions, they weren’t subject to those national 

rules, they were subject to some State rules. Some of them got preempted. 

What we have now done is to pass this set of national rules, including—we were told oh, don’t interfere with the securitizers—we 

have given some liability to that securitizers. 

Chairman Bernanke takes credit, and I think he has a dilemma, 

because he doesn’t want to repudiate Alan Greenspan, so he’s been 

a little slower, but he is in fact taking different views with regard 

to this, with regard to the authority the Federal Reserve has under 

the Federal Trade Act to promulgate unfair and deceptive practice 

codes for banks. He’s moving. 

So the Fed now has begun the process of adopting rules on OPA. 

But the Fed did have some power. There were enforcement problems, I will concede. The statute didn’t give them an enforcement 

problem, although in the past when the Fed has wanted to do 

something and it didn’t have enough enforcement power, it found 

its way here pretty quickly and asked for it. 

So we should be very clear that it was not a tangle of regulators; 

it was the deregulatory theory of the time. It’s the philosophy that 

Dr. Roubini talked about: ‘‘We’ll handle it ourselves. You stay out 

of it. Don’t mess us up.’’ That was the philosophy that ruled the 

Congress, that markets are smart and government is dumb. 

And there was a conscious decision by people for ideological reasons to restrain themselves. We are now saying, ‘‘No, we do need 

to get into regulation,’’ and it’s a point Dr. Reinhart made. Innovation outstrips regulation. And innovation is a good thing. And innovation that produces no value, you don’t have to worry about. It 

will die, and no one will support it. 

But you do have to make sure that regulation catches up to innovation and to some extent allows the benefit without the harm. But 

this is a clear case of ideological preference for deregulation, leading to this problem. 

The panel is excused, and I thank you. 

Ms. RIVLIN. I don’t disagree with that. 

[Whereupon, at 12:58 p.m., the hearing was adjourned.] 

(53)

A P P E N D I X

February 26, 2008

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