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37–071 PDF 2007

S. HRG. 109–956

NOMINATIONS OF: EDWARD P. LAZEAR,

RANDALL S. KROSZNER, AND KEVIN M. WARSH

HEARING

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

ON

NOMINATIONS OF:

EDWARD P. LAZEAR, OF CALIFORNIA, TO BE CHAIRMAN OF

THE COUNCIL OF ECONOMIC ADVISERS

RANDALL S. KROSZNER, OF NEW JERSEY, TO BE A MEMBER OF

THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

KEVIN M. WARSH, OF NEW YORK, TO BE A MEMBER OF

THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

FEBRUARY 14, 2006

Printed for the use of the Committee on Banking, Housing, and Urban Affairs

(

Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

RICHARD C. SHELBY, Alabama, Chairman

ROBERT F. BENNETT, Utah 

WAYNE ALLARD, Colorado 

MICHAEL B. ENZI, Wyoming 

CHUCK HAGEL, Nebraska 

RICK SANTORUM, Pennsylvania 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

JOHN E. SUNUNU, New Hampshire 

ELIZABETH DOLE, North Carolina 

MEL MARTINEZ, Florida 

PAUL S. SARBANES, Maryland 

CHRISTOPHER J. DODD, Connecticut 

TIM JOHNSON, South Dakota 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

EVAN BAYH, Indiana 

THOMAS R. CARPER, Delaware 

DEBBIE STABENOW, Michigan 

ROBERT MENENDEZ, New Jersey

KATHLEEN L. CASEY, Staff Director and Counsel 

STEVEN B. HARRIS, Democratic Staff Director and Chief Counsel 

PEGGY R. KUHN, Senior Financial Economist 

MARK F. OESTERLE, Counsel 

MIKE NIELSEN, Professional Staff 

AARON KLEIN, Democratic Chief Economist 

DEAN V. SHAHINIAN, Democratic Counsel 

JOSEPH R. KOLINSKI, Chief Clerk and Computer Systems Administrator 

GEORGE E. WHITTLE, Editor

(II)

CONTENTS

TUESDAY, FEBRUARY 14, 2006

Page

Opening statement of Chairman Shelby ................................................................ 1

Opening statements, comments, or prepared statements of: 

Senator Bennett ................................................................................................ 2

Senator Schumer .............................................................................................. 3

Senator Sarbanes .............................................................................................. 4

Senator Carper ................................................................................................. 18

Senator Reed ..................................................................................................... 24

NOMINEES 

Edward P. Lazear, of California, to be Chairman of the Council of Economic 

Advisers ................................................................................................................ 6

Prepared statement .......................................................................................... 32

Biograpical sketch of nominee ......................................................................... 35

Randall S. Kroszner, of New Jersey, to be a Member of the Board of Governors of the Federal Reserve System ................................................................ 6

Prepared statement .......................................................................................... 32

Biograpical sketch of nominee ......................................................................... 57

Kevin M. Warsh, of New York, to be a Member of the Board of Governors 

of the Federal Reserve System ............................................................................ 8

Prepared statement .......................................................................................... 33

Biograpical sketch of nominee ......................................................................... 72

(III)

(1)

NOMINATIONS OF: 

EDWARD P. LAZEAR, OF CALIFORNIA,

TO BE CHAIRMAN OF

THE COUNCIL OF ECONOMIC ADVISERS; 

RANDALL S. KROSZNER, OF NEW JERSEY,

AND KEVIN M. WARSH, OF NEW YORK,

TO BE MEMBERS OF THE BOARD OF GOVERNORS OF

THE FEDERAL RESERVE SYSTEM 

TUESDAY, FEBRUARY 14, 2006

U.S. SENATE, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, 

Washington, DC.

The Committee met at 2:36 p.m., in room SD–538, Dirksen Senate Office Building, Senator Richard C. Shelby (Chairman of the 

Committee) presiding. 

OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY 

Chairman SHELBY. The hearing will come to order. We are sorry 

about this morning, but as I said to you privately, the floor takes 

precedence over everything. 

This afternoon, we will consider the nominations of three very 

distinguished individuals. Our first nominee is Dr. Edward Lazear, 

nominated by President Bush to be a Member of the Council of 

Economic Advisers. The Council of Economic Advisers, established 

by the Employment Act of 1946, provides the President with economic analysis and advice on the development and the implementation of domestic and international policy issues. Upon Senate 

confirmation, President Bush would designate Dr. Lazear to serve 

as Chairman of the CEA. 

Dr. Lazear currently serves as Professor of Human Resources 

Management at Stanford University, and as the Morris Arnold Cox 

Senior Fellow at the Hoover Institution. Previously, Dr. Lazear 

taught at the University of Chicago’s Graduate School of Business, 

and he has been a visiting professor at many universities and institutes around the world. Dr. Lazear received a Ph.D. in economics 

in 1974 from Harvard and has a B.A. and M.A. in economics in 

1971 from UCLA. 

Dr. Lazear also serves as a Research Associate at the National 

Bureau of Economic Research. Many people are also familiar with 

his work on the President’s Advisory Panel on Tax Reform. Dr. 

Lazear is a Founding Editor of the Journal of Labor Economics,

2

published by the University of Chicago. His 1996 book, Personnel 

Economics, was selected by MIT Press as an outstanding book and 

by Princeton as one of the 10 most important books in labor economics. Dr. Lazear is well-respected for his wide ranging research 

on employee incentives, promotions, compensations, and productivity in companies. 

The Committee will also consider two nominees to serve as Members of the Board of Governors of the Federal Reserve System, Dr. 

Randall S. Kroszner of New Jersey and Mr. Kevin M. Warsh of 

New York. 

This afternoon will be Dr. Kroszner’s second nomination hearing 

before the Committee. In November 2001, this Committee considered his nomination to serve as a Member of the Council of Economic Advisers. He was confirmed by the Senate for this position 

and served at the CEA through July 2003. 

He currently serves as Editor of the Journal of Law and Economics, on the Board of Directors of the National Association of Business Economists, as a Research Associate at the National Bureau 

of Economic Research, and as a Senior Fellow at the FDIC Center 

for Financial Research. He has also edited a number of academic 

journals, including the Journal of Financial Services Research, the 

Journal of Economics and Business and Economics and Governance. He has been a Visiting Scholar at the International Monetary 

Fund and the London School of Economics. 

He has spent time as a Visiting Scholar at the Federal Reserve 

in Washington, DC, and at regional Federal Reserve Banks in New 

York, Kansas City, St. Louis, Minneapolis, and Chicago. He received his Ph.D. from the Economics Department of Harvard University and graduated magna cum laude in 1984. 

Our second nominee to the Board of Governors is Mr. Kevin M. 

Warsh, who currently serves on the President’s National Economic 

Committee. Mr. Warsh is also no stranger to this Committee. During his tenure on the NEC, Mr. Warsh directed policy on a wide 

array of financial issues, including the implementation of Sarbanes-Oxley, regulatory reform for Government Sponsored Enterprises and terrorism risk insurance. 

Mr. Warsh worked closely with Members of this Committee and 

has earned our respect. Mr. Warsh is also Executive Secretary of 

the National Economic Council. Prior to coming to Washington, he 

was the Executive Director of the Mergers and Acquisitions Department of Morgan Stanley’s Investment Banking Division. Mr. 

Warsh is a graduate of Stanford University, where he graduated 

with honors in economics. He received his J.D. from Harvard Law 

School, where he graduated cum laude. 

We look forward to hearing your statements this afternoon and 

to an interesting discussion to follow. At this time, I will recognize 

Senator Bennett, and then, I will recognize Senator Schumer for 

any introduction he wants to make. 

STATEMENT OF SENATOR ROBERT F. BENNETT 

Senator BENNETT. Thank you, Mr. Chairman. 

I will just withhold my prepared statement and ask questions at 

the appropriate time. I have met Dr. Lazear, who has been in the 

office, and I am very impressed, and he and I had a long conversaVerDate 0ct 09 2002 16:46 Aug 21, 2007 Jkt 000000 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 S:\DOCS\37071.TXT SBANK4 PsN: KEVIN
3

tion which I will not repeat here, but we are on the same page on 

a number of very important issues. 

Chairman SHELBY. Senator Schumer is a Member of the Committee. We generally do not have him down there; he is up here, 

but——

Senator SCHUMER. Here I am. 

Chairman SHELBY. Senator Schumer, for any introduction you 

want to have. 

Senator SCHUMER. If you would like to nominate me to the Federal Reserve Board, maybe——

[Laughter.] 

Chairman SHELBY. I did not go that far. 

Senator SCHUMER. Exactly. 

Senator BENNETT. Would that get you out of the Senate? 

[Laughter.] 

Senator SCHUMER. Silver lining to every cloud. 

Chairman SHELBY. That would be a big cost, though. 

STATEMENT OF SENATOR CHARLES E. SCHUMER 

Senator SCHUMER. Thank you. Thank you, Mr. Chairman. 

I would like to welcome all the nominees here today. I want to 

welcome Mr. Kroszner and I want to welcome Mr. Lazear, who was 

born in New York but who left awhile ago; and a special welcome 

to Mr. Warsh, a New Yorker. 

I have said many times before this Committee to Mr. Warsh and 

to recent nominees in our meetings that our country is in need of 

economic leadership. Leadership, in my opinion, is, for the most 

part, nonideological and nonpartisan; true leaders that are committed to keeping America great by creating policy that will once 

again, for instance, get the United States to the top of rankings in 

areas like math education. 

Right now, we are in 21st place, tied with Poland, Hungary, and 

Spain, according to the OECD. We will not stay the greatest country in the world if that continues to happen. Creating policy that 

will cut our budget deficit as opposed to creating a budget deficit 

larger than nondefense, nonsecurity, discretionary spending and 

creating sound trade policy that demands that our trading partners, like China, play by world economic rules to further avoid the 

widening trade gap. 

All three of our nominees today, Mr. Chairman, have an opportunity, as a matter of fact a responsibility, to be the economic leaders that I am speaking of, and I will be watching all of them. And 

I am particularly pleased to be here to nominate one of those potential leaders. I am here today to introduce Kevin Warsh, who is 

nominated to be a Member of the Federal Reserve Board of Governors. Mr. Warsh is a lifelong New Yorker. He was born and 

raised in the capital region near Albany in the City of Loudonville, 

where he attended Shaker Senior High School, a high school I have 

had the occasion to visit. 

From Shaker, Mr. Warsh went on to Stanford University, where 

he graduated Phi Beta Kappa with a degree in public policy. Later, 

he studied economics and regulatory policy at Harvard Law School, 

where he focused his coursework on market economics and debt 

4

capital markets, taking classes at the Harvard Business School and 

the MIT Sloane School of Business. 

I know that you are proud to be here to support Kevin Warsh—

I am saying this to Jane, I want to welcome her, another New 

Yorker, whose family I am proud to know, and I know that Jane 

is proud to support Kevin, who decided shortly after September 11 

to leave Wall Street and accept his calling to public service, a commitment he is now clearly stating he is willing to make for 14 

years, which is a long time. 

For the last 4 years, Mr. Warsh has served as the Special Assistant to the President for Economic Policy and Executive Secretary 

of the National Economic Council. His areas of expertise have 

ranged from domestic finance, banking, and securities regulatory 

policy to consumer protection. He has advised the President and 

senior administration officials on issues related to the U.S. economy, particularly fund flows and capital markets, securities, banking, and insurance issues, and he participated in meetings of the 

President’s Working Group on Financial Markets. 

Prior to working in Washington, Mr. Warsh had a distinguished 

career on Wall Street as a Member of the Mergers and Acquisitions 

Department at Morgan Stanley, where he ultimately served as Vice 

President and Executive Director. 

So it is without question, Mr. Chairman, that Mr. Warsh is tremendously accomplished for a man his age, and for that reason, it 

is no surprise that he is already no stranger to the Federal Reserve. He spent a considerable amount of time over the past few 

years working with the System. He worked closely with Federal 

Reserve Governors, including Chairman Greenspan, on a host of 

economic issues and worked closely with Timothy Geithner, another gentleman I am proud to know, he is President of the New 

York Federal Reserve Bank, on broad issues facing the securities 

and banking industries. 

In our conversations, Mr. Warsh has assured me he will continue 

to focus on consumer protection issues at the Fed, an area many 

do not always see the Fed having oversight of, but protecting the 

rights of consumers through increased and significant disclosure 

mechanisms is very important as well. 

His significant finance experience as a banker and regulatory experience on the NEC will prove valuable, as the Fed carries out its 

responsibility beyond monetary policy, its responsibility beyond 

monetary policy, its responsibility to the supervision and regulation 

of bank and financial holding companies and State-chartered 

banks. 

He is committed to strong capital standards, effective supervision, and meaningful market discipline of these institutions. He 

knows unequivocally that the Fed must be independent, nonideological, and nonpartisan, and for this reason, I am proud to support 

his nomination. 

Chairman SHELBY. Thank you, Senator Schumer. 

Senator Sarbanes, any opening statement? 

STATEMENT OF SENATOR PAUL S. SARBANES 

Senator SARBANES. I will take just a moment, Mr. Chairman. 

5

I am pleased to join with you in welcoming the nominees before 

the Committee. The positions that we are considering today, one 

for the Council of Economic Advisers and two for the Board of Governors of the Federal Reserve System, are among the more significant economic positions in our national government. 

Dr. Lazear has been nominated by the President to be a Member 

of the Council of Economic Advisers, and I understand the President under the Act has the authority to designate one of the Members of the Council as Chairman, and it is the intention that if Dr. 

Lazear is confirmed, he will be appointed as Chairman of the 

Council of Economic Advisers. 

I have a longstanding interest in the CEA. I worked for Walter 

Heller when he was the Chairman, and I just want to quote into 

the record from the Employment Act of 1946 which established the 

Council of Economic Advisers: ‘‘The Council shall be composed of 

three Members, who shall be appointed by the President and with 

the advice and consent of the Senate, and each of whom shall be 

a person who, as a result of his training, experience, and attainments, is exceptionally qualified to analyze and interpret economic 

developments, to appraise programs and activities of the Government, and to formulate and recommend national economic policy to 

promote employment, production, and purchasing power under free 

competitive enterprise.’’ That is quite a charge, I might say. 

Dr. Lazear has been an academic economist for 30 years now. He 

has received a number of awards for his scholarly work. In addition 

to his work at Stanford, he has also been an adviser to a number 

of governments that have moved from command to market economies, and he recently served on the President’s panel on Federal 

tax reform. 

Our two nominees to be on the Federal Reserve System’s Board 

of Governors, of course, in addition to having a vote on the Open 

Market Committee, which determines the Nation’s monetary policy, 

the Fed plays a critical role in regulating and protecting the safety 

and soundness of our Nation’s banking system and enforcing many 

of our consumer protection laws. 

The two nominees are replacing Governors who, in my opinion, 

have served with great distinction. Dr. Kroszner’s seat was previously held by Governor Gramlich, and Mr. Warsh’s seat was previously held by Chairman Bernanke. Both of these nominees have 

worked in important roles as part of President Bush’s economic 

team. Dr. Kroszner served on the President’s Council of Economic 

Advisers for 2 years in addition to his career as an Economics Professor at the University of Chicago. Mr. Warsh is, of course, wellknown to the Committee, having worked in the White House as 

Special Assistant to the President for Economic Policy and as the 

Executive Secretary of the National Economic Council to the President for the past 3 years. Prior to this experience, he worked on 

Wall Street at Morgan Stanley. 

Mr. Chairman, I look forward to hearing the witnesses. 

Chairman SHELBY. Thank you. If you would stand and be sworn. 

[Witnesses sworn.] 

Dr. Lazear, we will start with you. All of your written statements 

will be made part of the record. If you have anyone you want to 

introduce your family you have here with you, you may proceed. 

6

STATEMENT OF EDWARD P. LAZEAR, OF CALIFORNIA

TO BE A MEMBER AND CHAIRMAN

THE COUNCIL OF ECONOMIC ADVISERS 

Mr. LAZEAR. Thank you. I would like to introduce my wife, Vicky, 

who is right behind me. 

Chairman SHELBY. Thank you. 

Mr. LAZEAR. Chairman Shelby, Ranking Member Sarbanes, and 

Members of the Committee, it is a great honor to be here today to 

be the President’s nominee to be Chairman of the Council of Economic Advisers. The Council, which has been in existence for 60 

years now, is charged with the task of advising the President on 

economic issues. Throughout its history, it has remained a body of 

experts and academicians who have taken it to be their duty to inform policymakers in an unbiased and professional manner. 

One colleague recently told me that in Washington, when people 

want the correct answer on economics, they go to the Council of 

Economic Advisers. The best compliment that can be paid to the 

CEA is that the CEA ‘‘tells it like it is,’’ so that the President and 

Congress, who are charged with the responsibility of weighing all 

factors, can make the best decisions possible. 

I was going to give you a bit of my background, but the Senators 

have done such a great job of describing, and I think I will skip 

that and simply close by mentioning that before I left California to 

testify, my senior colleague, Secretary George Schultz, told me that 

the role of the Chairman of the Council of Economic Advisers is to 

be an economist, to be straight, and to bring economics to the table, 

leaving the politics to others. If confirmed, I will devote all of my 

energy to ensuring that policymakers have the best economic analysis possible. 

Thank you, and I welcome your questions. 

Chairman SHELBY. Mr. Kroszner. 

STATEMENT OF RANDALL S. KROSZNER, OF NEW JERSEY

TO BE A MEMBER OF THE BOARD OF GOVERNORS OF

THE FEDERAL RESERVE SYSTEM 

Mr. KROSZNER. Thank you very much. I would like to introduce 

my mother, Helen Kroszner, and my niece, Kimberly Kroszner. 

Chairman SHELBY. Thank you. 

Mr. KROSZNER. Chairman Shelby, Senator Sarbanes, Senator 

Bennett, and other Members of the Committee, I am pleased to 

have the opportunity to appear before you today as one of President Bush’s nominees to serve on the Board of Governors of the 

Federal Reserve System. I am honored that the President has nominated me to serve on the Board. If I am confirmed by the Senate, 

I will work to the best of my abilities to fulfill the significant responsibilities of this office. 

After studying economics as an undergraduate at Brown University, I earned a master’s and Ph.D. degrees in economics from Harvard University. I then joined the Graduate School of Business at 

the University of Chicago, where I am a Professor of Economics 

and have been teaching money and banking since 1990. I will not 

go through the details of my background, because again, the Senators have done a terrific job of summarizing those background 

qualifications. 

7

As a Member of the President’s Council of Economic Advisers 

from 2001 to 2003, I have had policy experience in a variety of 

areas, including banking and financial regulation, international financial crises, and macroeconomic forecasting. In this capacity, I 

witnessed firsthand the importance of having accurate and timely 

economic statistics in order to make sensible policy judgments and 

decisions. I spearheaded an initiative to improve the quality of government statistics and enhance the protection of confidential information reported to the Government, resulting in the Confidential 

Information Protection and Statistical Efficiency Act of 2002. After 

returning to the University, I was delighted to be appointed by the 

Secretary of Labor to the Federal Economics Statistics Advisory 

Committee, which meets regularly with the major official statistical 

agencies to discuss how to improve measurement of economic activity. If confirmed, I would be devoted to further enhancement of the 

quality of economic statistics. 

Monetary policy is a fundamental responsibility of the Federal 

Reserve. Long-run price level stability is crucial to achieving maximum employment and overall economic stability. Under Chairman 

Greenspan and Chairman Volcker before him, the Federal Reserve 

has achieved much success in reducing and stabilizing inflation 

and inflation expectations. This success has helped to contribute to 

a tendency for the fluctuations in employment and output to be 

lower than in the past, and a reduction in the frequency and severity of recessions. If confirmed, I would look forward to working with 

Chairman Bernanke and other Members of the Federal Open Market Committee to continue to underscore the role that long-term 

price level stability has in achieving prosperity and maximum employment. I also applaud the increase under Chairman Greenspan 

in monetary policy transparency, which helps to reduce uncertainty 

for households, entrepreneurs, and investors, and thereby contributes to economic stability and growth. 

The Federal Reserve also has a fundamental responsibility for 

protecting the stability of the country’s banking and financial system. Much of my research and work with central banks has been 

devoted to analyzing banking and financial regulation as well as 

banking and financial crises. The safety and soundness of the U.S. 

banking and payment system is critical to achieving economic 

growth, maximum employment, and general economic stability, and 

the Federal Reserve works closely with other regulators to achieve 

this goal. The Federal Reserve also has an important role to play 

in responding to and mitigating the impact of financial crises and 

shocks. If confirmed, I will work vigorously to protect and promote 

the safety and soundness of the system. 

The Federal Reserve has an additional important responsibility 

to consumers and users of the banking and financial system. Discriminatory or abusive lending practices should not be tolerated, 

and the privacy of individuals and their financial data must be protected. 

The Federal Reserve is active in promoting financial literacy, and 

as an educator, I believe that financial literacy is fundamental to 

the proper functioning of the financial system. If confirmed, I will 

place a high priority on these responsibilities and look forward to 

being actively involved in promoting financial literacy. 

8

Thank you once again for holding this hearing, and I look forward to your questions. 

Chairman SHELBY. Mr. Warsh. 

STATEMENT OF KEVIN M. WARSH, OF NEW YORK

TO BE A MEMBER OF THE BOARD OF GOVERNORS OF

THE FEDERAL RESERVE SYSTEM 

Mr. WARSH. Chairman Shelby, Senator Sarbanes, Senator Bennett, thank you very much for allowing my colleagues and I to appear before the Committee, and before I get started, allow me to 

introduce my wife, Jane, and some dear friends who have joined us 

today. 

First off, I wish to express my sincere appreciation to President 

Bush for nominating me to serve as a Member of the Board of Governors of the Federal Reserve System. 

As the Members and staff on this Committee know, I have served 

on the National Economic Council for about the last 4 years, focusing on matters of domestic finance, capital markets, banking, securities, and insurance-related issues. In that capacity, I have had 

the privilege of working, Chairman Shelby, with you; Senator Sarbanes, with you and your staff as we have tackled many of these 

issues together. If confirmed, I look forward to continuing that productive close relationship going forward in carrying out the important responsibilities that this Committee and this Congress have 

assigned to the Federal Reserve. 

Market participants, policymakers, and the American people 

have all come to rely on the good judgment that flows from the 

Federal Reserve’s independence and credibility. If confirmed, I can 

assure this Committee I will be devoted solely to the Federal Reserve’s statutory mandate for monetary policy; that is, to ensure 

price stability and to ensure maximum output in employment and 

growth and will work to promote a secure, fair, and efficient financial system. 

The flexibility of our capital markets from which I come have 

really been tested in recent years, and they have been matched 

only by the resiliency of the American labor force. The Federal Reserve has been successful in chartering these waters but must remain attuned to any economic consequences that might arise. 

Under Chairman Greenspan’s leadership, the Federal Reserve 

has made significant progress in explaining its policies with greater 

transparency. As a result, market volatility is lower; our markets 

are deeper, broader, and more dynamic than ever before. Pools of 

free-flowing capital, in turn, have provided real-time, forward-looking information to help Federal Reserve officials make appropriate 

decisions. I hope that my prior experience on Wall Street, particularly my nearly 7 years at Morgan Stanley, would prove beneficial 

to the deliberations and communications of the Federal Reserve. 

Over the course of the last generation, the Federal Reserve has 

compiled an enviable track record in achieving price stability and 

successfully anchoring long-term inflation expectations. This stability has contributed to low long-term interest rates and promoted 

strong employment growth and productivity gains. 

The Federal Reserve’s work, however, goes on. Its responsibilities, of course, extend beyond monetary policy to the supervision 

9

and regulation of bank and financial holding companies. In working with other financial regulators, the Federal Reserve should continue to promote three complementary pillars of prudential oversight to which Senator Schumer referred: Strong capital standards, 

effective regulatory discipline, and meaningful market discipline, 

and these are principles to which I am committed. 

Finally, if confirmed, I would work to ensure that the Federal 

Reserve continues its important role in promoting literacy and fair 

dealing for consumers. The knowledge and credibility that the Federal Reserve brings to bear should help to bring people on the 

fringes of our financial system into the mainstream. 

The Federal Reserve’s decisions significantly impact America’s 

families and businesses, and I would take on the responsibility of 

joining the Board of Governors of the Federal Reserve System with 

great humility and would be honored if the Senate saw fit to approve my nomination. 

Thank you, and like my colleagues, I would be happy to respond 

to your questions. 

Chairman SHELBY. Thank you, Mr. Warsh. 

Dr. Lazear, you recently spent several months reviewing various 

aspects of the U.S. tax system and methods for reforming it to enhance economic growth. I am a strong proponent of a simplified tax 

structure, which would eliminate the inefficiencies of our current 

system and end the waste of vast resources currently dedicated to 

taking advantage of all the complexities that we have. 

What three words would you use, if you could, to describe our 

current system? 

Mr. LAZEAR. Three words? Chaotic, somewhat inflexible, and not 

necessarily conducive to economic growth. 

Chairman SHELBY. What would be the benefits of moving to a 

more straightforward structure? 

Mr. LAZEAR. Mr. Chairman, as you know, the President, in setting up the tax panel, instructed us to think about some of the 

things you mentioned; simplification in particular, but also growth 

and fairness. 

Now, when we think about these different aspects of tax policy, 

we have to realize that sometimes, there are tradeoffs, and that is 

one of the things that confronted the tax panel. 

When we thought about it, we came to the conclusion that the 

most important thing that we could do for the economy was to propose a tax system that would be not only simple but that would 

also focus on growth. And the reason is that if we think about the 

importance of economic growth, although simplification is extremely important, economic growth swamps it over any period of 

time. 

So if we are thinking about a 10-year period or so, and we could 

raise the growth rate by even a quarter of a percent per year, we 

would have very significant effects on the economy. 

Chairman SHELBY. What aspects of our tax structure would, in 

your judgment, be most in need of reform? 

Mr. LAZEAR. There are a number of issues that come to my mind 

in terms of thinking about the tax system. As you know, I am sure, 

the tax panel recommended that we eliminate the AMT. The AMT 

is a tax structure that has really run amok. There was a good purVerDate 0ct 09 2002 16:46 Aug 21, 2007 Jkt 000000 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 S:\DOCS\37071.TXT SBANK4 PsN: KEVIN
10

pose for it initially. The idea was to make sure that every American citizen paid taxes if they were able to do so, and there were 

some people who were escaping that. 

So the AMT targeted certain individuals, but over time, because 

of some quirks in the code, the AMT actually ended up going after 

individuals who it was not intended to go after. 

Chairman SHELBY. Unintended consequences, perhaps? 

Mr. LAZEAR. Absolutely, Mr. Chairman. 

Chairman SHELBY. Mr. Kroszner and Mr. Warsh, the new Fed 

Chairman, Dr. Bernanke, is a well-known proponent of inflation 

targeting. He talks of price stability, which you both alluded to. 

What are your views, both of you, on inflation targeting? Do you 

believe an inflation targeting regime is consistent with the Fed’s 

other goals, those of long-term sustainable growth and full employment? We will start with you. 

Mr. KROSZNER. Thank you very much, Mr. Chairman. The credibility of the Fed is crucial. It is really what contains expectations 

about inflation, and that has a large effect on interest rates and 

ultimately on economic activity. 

The Fed very clearly has a dual mandate from Congress to pursue low and stable prices as well as maximum employment. There 

are different monetary policy approaches for the Federal Reserve to 

achieve this, and one is the way that Chairman Bernanke has proposed, some variation of an inflation targeting regime. There are 

many different approaches that fall under the rubric of inflation 

targeting. 

I think the key behind it is trying to provide clarity and transparency about monetary policymaking and monetary policy processes, because I think what the Fed should be doing is not increasing volatility but trying to reduce volatility, trying to make it clear 

what the Fed is going to do, and that is the best way for individuals, for entrepreneurs, for households, and investors to make good 

decisions. 

So it is one possible way to increase transparency. I have an 

openness to different kinds of approaches, but the key is to have 

a policy and approach that reduces uncertainty, reduces volatility, 

provides a good backdrop for individuals and investors to make decisions and for the Fed to maintain its dual mandate of pursuing 

low and stable prices, at the same time maximizing employment. 

Chairman SHELBY. Mr. Warsh. 

Mr. WARSH. Chairman Shelby, I, too, strongly share the Federal 

Reserve’s dual mandate, and in that context, I think the questions 

about inflation targeting really are ripe for discussion. I think a 

discussion that Chairman Bernanke has suggested that if confirmed, we would be party to, because it is likely to be an ongoing 

deliberation. 

I think the transparency that has come to the Fed—really over 

the course of the last 10 or 12 years—has been incremental in nature, and I think it has been able to provide guidance to the capital 

markets that are keenly focused on the Federal Reserve’s moves 

and its actions. 

Inflation targeting may well be the next step—if we mean or suggest a numerical range which is further reinforcing the types of estimates that the markets expect of the Federal Reserve and that 

11

range is really an objective guided by market facts and does not in 

any way restrict the ability of Governors or of the Chairman to 

make policy judgments. 

Because at the end of the day, at the FOMC, there will be imperfect information, and I think it is essential that inflation targeting, 

if it is thought of really as an objective, another data point for the 

markets, the markets might well see that as additional clarity and 

provide some incremental benefit going forward. I think that is a 

deliberation we look forward to participating in. 

Chairman SHELBY. Mr. Warsh, I want to ask you a question 

about the Basel II capital requirements. The Federal Reserve, as 

you well know, is presently in the process of implementing the 

Basel II Capital Accord, which will establish new capital requirements for our largest banks. Due to the vital role capital requirements play in protecting the safety and soundness of the U.S. 

banking system, I believe it is important that there be no surprises 

in the implementation of Basel II, especially unanticipated reductions in capital requirements. 

Last year, this Committee held a hearing at which several witnesses expressed concerns that the adoption of Basel II would result in the lowering of capital requirements. In addition, last year, 

the fourth Quantitative Impact Study unexpectedly showed that 

Basel II would result in substantially lower capital requirements. 

What steps need to be taken to make sure that Federal banking 

regulators, Congress, and the public at large are confident that the 

implementation of Basel II will not adversely impact the safety and 

soundness of the U.S. banking system? 

Mr. WARSH. Thank you for that question, Chairman Shelby. I 

share the view of the importance of getting these capital standards 

right. The Basel II process, upon which this Committee has really 

spent a lot of time and attention, has been much debated among 

our various banking regulators, and I would say that there has 

been a meaningful and open dialogue between and among them 

and with this Committee. 

The QIS–IV results that you reference were a surprise. I think 

that the ‘‘doctrine of no surprises’’ should be the rule of thumb 

going forward. My understanding is that the Federal Reserve, 

working with the other bank regulators, have decided to go forward 

sometime this spring with a new proposed rulemaking to try to address some of the unexpected results of the QIS–IV results. 

Chairman SHELBY. Including capital? 

Mr. WARSH. Including capital, absolutely, Senator, and I think 

what you rightly do is point out that the capital standards are very 

important. The risk-based capital standards are very important, 

but so, too, are the rest of the tools in the supervisor’s toolkit. 

So as we proceed in the Basel II process, I think it is very important that the leverage ratio, another important measure of capital, 

be maintained; that the rest of the prompt corrective action authority be maintained, and our regulators are going to evaluate these 

standards during a lengthy process over the course of the next several years. 

One of the things that I think would be very helpful, which the 

regulators are keen to adopt, I believe, is as the Basel II standards 

are practiced, to really make sure there is a parallel run of Basel 

12

I and Basel II to ensure that these capital standards stay robust, 

because at the end of the day, as bank regulators and as the Committee of oversight, there are really few things as important as the 

safety and supervision of these underlying entities. 

Chairman SHELBY. Do you know of any bank, any financial institution, that has been well-capitalized, well-managed, and well-regulated that has gone under? 

Mr. WARSH. I do not, Senator, but I think the most important 

thing you point out is that these capital standards must remain robust, and they must taken into account risks that were hard to envision when Basel I and other capital standards were put in place. 

Chairman SHELBY. Thank you. 

Senator Sarbanes. 

Senator SARBANES. Mr. Chairman, I have a number of questions, 

but why do I not just follow-up on the Basel II inquiry first? 

Chairman SHELBY. Go ahead. 

Senator SARBANES. And this is obviously directed to Mr. 

Kroszner and Mr. Warsh. As I understand it, the Federal bank regulatory agencies have indicated that even if the Basel II risk-based 

capital agreement is implemented, the minimum leverage capital 

ratio will be preserved as a critical feature of the U.S. bank capital 

regulation. Is that your understanding, and do you agree with 

that? 

Mr. KROSZNER. Yes, that is my understanding, Senator. 

Senator SARBANES. And do you agree with it? 

Mr. KROSZNER. I certainly do agree with it. 

Senator SARBANES. Mr. Warsh. 

Mr. WARSH. Yes, I concur, Senator Sarbanes, and I think it is an 

extremely important supplement to the Basel II Accord. 

Senator SARBANES. Now, this latest QIS–IV study showed a 

much larger reduction in capital than the study that had previously been cited to the Committee at our hearings. It showed an 

aggregate capital reduction of 15.5 percent, a median capital reduction for the participating institutions of 26 percent; one participating institution had a capital reduction of nearly 50 percent. 

Now, even though the QIS–IV resulted in capital reductions that 

apparently all the bank regulators viewed as acceptable, the decision was made to go forward this year with a proposed regulation 

utilizing the same formula that produced the QIS results. Is that 

your understanding? 

Mr. KROSZNER. I am not familiar with the specifics of what the 

Federal Reserve has gone forward with, but I certainly do know 

that I was concerned about the reductions in capital that were suggested by the QIS–IV. I know that there are others in the regulatory community who are concerned about that and are continuing 

to take comment and working to make sure that we do not have 

significant reductions in capital if we were to go forward with this 

regulation. 

Senator SARBANES. Mr. Warsh. 

Mr. WARSH. Yes; I am again also not specifically familiar with 

the changes that are being contemplated in anticipation of the next 

proposed rulemaking. My understanding, Senator, is that the comments and the results from the QIS–IV process, particularly when 

you have cases of individual institutions that have very different 

13

capital even though they have very substantially similar assets, is 

something which ought to be considered, and hopefully will be considered, in the context of this rulemaking. 

Senator SARBANES. If we run an impact study, and it gives us 

these kinds of results, we should not just be continuing along the 

path, should we? Should we not be pulling back and reexamining 

what is out there if it is producing these kinds of results in an impact study? Do either of you think that the results of the impact 

study are acceptable results? 

Mr. WARSH. Senator, in my view, I think those results proved to 

be a surprise that, again, having similar assets with different capital——

Senator SARBANES. It is not satisfactory. 

Mr. WARSH. I do not think it is satisfactory if a company that 

has similar assets ends up holding very different capital, and my 

understanding is that safeguards are being built into the Basel II 

process going forward to address just your concerns. 

Senator SARBANES. If they had similar capital but at much lower 

levels, would that be acceptable to you? 

Mr. WARSH. It strikes me, Senator, as though the most important 

thing is that the modern risk management techniques be taken 

into consideration so that the Basel II standard matches that underlying risk but, again, not to the detriment of the other parts of 

the supervisor’s toolbox that I mentioned before, such as the leverage ratio. 

Senator SARBANES. Mr. Kroszner. 

Mr. KROSZNER. It is very important not to allow capital to get too 

low. I think we saw that in the United States with the savings and 

loan crisis. I have done a lot of research that conforms with what 

many others had found, that low capital led to bad choices by the 

savings and loan industry, an inefficient banking and financial system, and a large cost to taxpayers. 

I can assure you, Senator, that I would not support any regulatory moves that would subject the taxpayer to excess risk or 

undue risk. And certainly, capital is an important protection in 

that system. 

Senator SARBANES. Let us examine this phrase ‘‘too low.’’ When 

Vice Chairman Ferguson of the Fed was before us, and this was 

one of the issues that we looked into, that the Chairman focused 

some attention on, and the question was raised that Basel II was 

going to lower some capital standards. Chairman Ferguson said, ‘‘I 

would not jump to conclusions yet that it is going to lower capital 

overall in the industry. I think it will create greater dispersion of 

capital because there will be those banks that need to have higher 

regulatory minimum capital, and there will be some that will need 

to have lower regulatory minimum capital. When this Basel Committee got started in this process, the goal was to keep capital at 

about the same level as it is now, and thus far, first indications 

from early quantitative study,’’ this was before this QIS–IV that we 

referred to, ‘‘suggest that indeed if it lowers capital, it will be a 

very small amount, maybe 6 percent or so.’’ Do you agree with the 

Ferguson statement that the goal of Basel II was to keep capital 

at about the same level as it is now? 

14

Mr. KROSZNER. Senator, I was not privy to the discussions that 

led to the initiation of Basel II. My understanding was that there 

is general dissatisfaction with the ability of Basel I to take into account the more complex risks that have developed since Basel I 

was first implemented. So, I cannot comment directly on the initial 

motivation, but I do think it is important to ensure that capital is 

sufficient when we have new and more complex risks. 

Senator SARBANES. What does that mean in relation to the current level of capital? Are you open to substantially reducing the 

current levels of capital? 

Mr. KROSZNER. As I had said before, Senator, it is very important 

to maintain the minimum leverage ratio, and so, I would not, regardless of what processes we have in Basel II, I would certainly 

not want to reduce that at all. So that being part of the initial capital level from Basel I, I certainly would not want any reduction 

of that. 

Senator SARBANES. Of course, the purpose of Basel I was to increase the amount of capital in the banking system, was it not? 

Mr. KROSZNER. Again, I do not know what the particulars were 

for that motivation. Certainly, we have seen a large increase in the 

average amount of capital in the U.S. banking system over the last 

decade or so. 

Senator SARBANES. Mr. Warsh. 

Mr. WARSH. I, too, Senator, look forward to getting our hands on 

the data, seeing on a bank-by-bank basis what the QIS results 

would suggest and to make sure that the risk inherent in each of 

these banking institutions demands a degree of capital that is appropriate. And it strikes me that this is the overwhelming goal of 

Basel II, which is to make sure that the capital is more than sufficient to make sure that the safety and soundness is strong and to 

make sure that the safety net exists. And beyond that, it is hard 

for me to judge based on the data that we have seen at this point. 

I would only note that I think it is important going forward that 

there be a parallel run of the new proposed standards with the old 

standards, so to the extent there are surprises, that they would 

come to the attention not only of the Federal Reserve but also, of 

course, to other people such as Members of this Committee that are 

looking at the issue. 

Senator SARBANES. Now, the Fed has taken the lead in negotiating this internationally, but it is my understanding that any decision on how the United States acts has to be a shared decision 

by all the bank regulators. Is that your understanding? 

Mr. KROSZNER. Again, Senator, I am not sure of the specifics of 

how things work with respect to the law and regulation. Certainly, 

I think it would be very important to have agreement among the 

regulators on something so important as capital, and certainly, I 

would strive for that. 

Mr. WARSH. And Senator Sarbanes, I do think we would be wellserved by having our four regulators on an issue of this level of importance speak at the end of the day with one voice. 

The only other note that I would make, Senator Sarbanes, is that 

U.S. financial institutions are exceptionally well-capitalized generally and are able to provide their products and services on an 

international basis. And their capitalization is a focus not only of 

15

the bank regulators but also of the marketplace and of their customers domestically and overseas, which should provide another 

important check on their capital levels. 

Senator SARBANES. I have used a lot of time. I will come back. 

Thank you, Mr. Chairman. 

Chairman SHELBY. Thank you. We will have another round. 

Dr. Lazear, productivity for the fourth quarter of 2005 declined 

0.2 percent in the business sector and 0.6 percent in the nonfarm 

business sector. The productivity declines were unexpected by a lot 

of the market watchers. What is your assessment of these numbers? Do they represent a one-time aberration, or do they signal 

something else? And given your extensive background in labor economics, what advice would you be giving us, and what advice 

would you be giving to the President, maybe, would be better on 

long-term growth prospects in the economy? 

Mr. LAZEAR. Thank you, Chairman Shelby. That is obviously an 

extremely important issue. 

Labor productivity is a key determinant of wages. If we look over 

even the very short-run, we know there is an extremely close relationship between wages and productivity, so we want to make sure 

that productivity continues to grow. In the fourth quarter, productivity was down, and that was a reflection of the fact that GDP did 

not grow at the rate that we had expected. 

Most view that as an aberration and a result primarily of three 

factors: First, Federal spending was down in the fourth quarter; 

second, there was a drop in auto sales, which was really a reflection of the fact auto sales in the third quarter had been accelerated; and third, the hurricanes had an enormous impact on petroleum. 

Those are not expected to continue into the future, so most who 

have been looking at the fourth quarter view that as a blip rather 

than a trend and expect a continued strong economy. 

Chairman SHELBY. Dr. Kroszner and Mr. Warsh, housing markets: The possibility of a housing bubble has been circulating in the 

popular press for a long time. Households have used interest ratesonly loans and more exotic adjustable rate mortgages to make 

homes affordable while at the same time increasing household vulnerability to financial risk. 

What effect would a slowdown in the housing sector, we have already seen some of it but a real slowdown, have for our overall 

economy, and how do you believe the Federal Reserve should respond? 

Mr. KROSZNER. Thank you very much, Senator. 

Certainly, the former Chairman of the Federal Reserve, Chairman Greenspan, had suggested that there may be some markets 

that have some froth associated with them, particularly some localized housing markets. I do not think it is the role of the Federal 

Reserve to be second guessing asset prices or asset price movements, but as you point out, Mr. Chairman, it is extremely important for the Federal Reserve to think about how to respond to such 

changes and to such movements. 

So first, of utmost importance is making sure that the safety and 

soundness of the banking system is not at risk, and so, ensuring 

that there are proper standards for lending, making sure that the 

16

banks and other financial institutions who are lending into the 

housing market fully understand those risks and appropriately capitalize against them is of first order importance. I believe the Federal Reserve has been monitoring that issue, and obviously, that is 

something that needs attention to ensure that the safety and 

soundness of the banking system and that lending in the mortgage 

market is not subject to difficulties. 

Second, I think the important thing is as there are any changes 

in asset prices to just be fully aware of them and be very careful 

to respond to any changes that would affect household wealth, that 

would affect consumption, that would affect overall economic 

growth. And so, again, being very aware of what is going on and 

then thinking about what the appropriate monetary policy responses would be to that are key. 

Mr. WARSH. Chairman Shelby, I share the view that the housing 

price run-up in recent years is part of what has contributed to a 

strong consumer demand that has impacted GDP. If you look at the 

underlying fundamentals for housing over large parts of the country, however, with a low interest rate, low inflation environment, 

it should not surprise us that housing prices have been on the up 

slope. 

When you look at what the impact would be on Federal Reserve 

monetary policy in particular, we would look at the outputs, what 

are the results of that, and what are the results if, for example, 

home equity withdrawals were to dissipate here early in 2006. 

One thing that the regulators did some months ago was to provide some increased coordination of regulatory guidance—with respect particularly to nontraditional mortgages—to make sure that 

the underlying banks and financial institutions are safe and sound 

and, at least as important, to make sure that they are providing 

these sorts of nontraditional products to people that are fully qualified for those products. The purpose, of course, is to try to mitigate 

any dislocations and any troubles that might impact consumer demand. 

Chairman SHELBY. Thank you. 

Dr. Lazear, the Social Security system clearly faces challenges in 

its future financing that will prove difficult to resolve the longer we 

wait. The Medicare program probably faces a more significant financial problem. 

As a key economic adviser to the President, if you are confirmed, 

and you will be, how would you recommend that the Administration approach these problems? That is, is there a set of guiding 

principles that should be kept in mind as the Administration proposes various reform options, because we know what the entitlement are slated to do to the budget. 

Mr. LAZEAR. Mr. Chairman, as you point out, entitlements are 

growing and continuing to grow, and they are becoming a larger 

and larger part of the total budget. So if we do not succeed in getting entitlements under control, we will not be able to get the 

budget under control. So everything having to do with deficits and 

everything else that is of concern to us today are related to the 

issue that you raise. 

There are a number of possibilities for constraining the growth 

of entitlements and expenditures and doing so in a way that does 

17

not create harm to the typical American. I think that a number of 

things can be done in terms of solvency of the system. I think that 

we need to think about removing regulatory risk from the structure 

by getting the money back into the private sector. I think there are 

a number of ways suggested by the President and that your Committee, the Senate, and Congress in general has thought about, and 

those would be the lines along which I would go. 

Chairman SHELBY. Thank you. 

The Fed is a bank regulator, which you both will be part of. 

Much of the attention surrounding the Federal Reserve has to do 

with implementation of monetary policy. However, we all know 

that some of the duties of the Fed is bank regulation, and that also 

poses unique challenges. The largest and the most sophisticated 

banks develop, and market, complex financial products. 

Do you believe the current structure of financial regulation under 

the Fed and the other regulators is adequate to the task of overseeing the increasingly complex institutions and the products that 

they bring forth? In other words, it has to be one of the challenges 

to you as regulators at the Fed. 

Mr. WARSH. Chairman Shelby, I think that the question is particularly valid today, as we have seen an increase in sophistication 

of products, and we have seen the capital markets, in effect, providing credit that a generation or two ago was really coming from 

commercial banks on their own balance sheet. 

Chairman SHELBY. Right. 

Mr. WARSH. I think the challenges remain more robust and real 

today than perhaps they have been in some time. My understanding and knowledge of our existing regulatory structure, however, does not suggest to me that it should be scrapped; that is, our 

regulatory structure has built into it a degree of competition between the States and the Federal regulators and between and 

among Federal regulators, including the bank regulators and the 

SEC. 

So, I think it is incumbent upon us, if confirmed, as regulators 

to continue to reach out so that as a Government, we better understand these products, we are better able to ensure we understand 

who is taking that risk and who are the counterparties to that risk. 

But I think our existing system, including such mechanisms as 

the President’s Working Group on Financial Markets, is a very effective way for regulators to share this information and try to come 

to some broad policy prescriptions as these challenges move forward. 

Mr. KROSZNER. I would agree with that greater complexity of financial products in the financial markets present greater difficulties for the regulators to assess the risks, who is bearing those 

risks, and what the extent of the risks are. 

I think the regulators do have the tools to be able to approach 

those, to be able to understand those, but it is very important to 

have a coordinated approach amongst the different regulators so 

that there is a good sharing of information, that there is a good 

working relationship among them. The President’s Working Group 

is one such example, to make sure that we are aware, that the regulators are aware of the risks both to the individual institutions, 

to individual borrowers as well as to counterparties; who those 

18

counterparties are, who is bearing that risk, and if something goes 

wrong with one of those counterparties, if they cannot pay, what 

is the consequence for the rest of the system? Is that just limited 

to the two parties who are associated with one particular contract, 

or will that have a broader systemwide effect? 

And obviously, that is something that the regulators need to be 

aware of, and my understanding is that the regulators are looking 

at many of these issues and broadly have the tools in principle to 

be able to deal with them. 

Chairman SHELBY. How important is it for the Fed as a regulator, now, to work with the other regulators? 

Mr. KROSZNER. I think it is certainly important to work with the 

other regulators. In our discussion of Basel II earlier, we had discussed how important it was to have an agreement on something 

as important as capital. And so, I think it is very important that 

the regulators try to coordinate and have similar views. 

Will it always be the case that the regulators have the same 

views? No; we have a system that has different regulators, and we 

will have some differences of opinion. And I think some differences 

of opinion are not a bad thing, and having fora where there are 

people with differences to try to work them out is very valuable. 

Chairman SHELBY. Senator Sarbanes. 

Oh, excuse me, Senator? 

STATEMENT OF SENATOR THOMAS R. CARPER 

Senator CARPER. Thank you, Mr. Chairman. 

To our guests, welcome. Thank you for joining us today. I am 

looking for an email that I just read from someone who knows you, 

Mr. Warsh, and who had some very nice things to say about you. 

I do not often read this thing in public. Is your wife here with you 

today? 

Mr. WARSH. She is, behind me. 

Senator CARPER. Mrs. Warsh, this is a valentine to your husband. 

[Laughter.] 

Mr. WARSH. This is just where she wanted to spend Valentine’s 

Day. 

Senator CARPER. This comes from someone who previously served 

at a senior level for one of our senior colleagues on the Democratic 

side, and here is what he said: ‘‘I do not ordinarily have much nice 

to say about President Bush’s nominees, but I have had the opportunity to work with Kevin Warsh on a number of issues in the past 

few years, and he is really a rarity. Even when we have disagreed 

on the policy at issue, I have on every occasion found Kevin to be 

a remarkably balanced, even-handed, thoughtful, and astute person. I have always been struck how someone that smart, brilliant, 

actually, could also be so gracious. Kevin also has a terrific quality 

that is increasingly rare in Washington. He is a great listener and 

is always in learning mode. And every time I have met with him, 

I have come away smarter.’’ 

Now, I would just like to ask you for the record, how did you end 

up to be the person who is described in this email? 

[Laughter.] 

19

Mr. WARSH. Well, Senator, thank you for reading the email. 

When I came to Washington 4 years ago, I must admit I did not 

understand much of Banking Committee issues from the Government’s perspective. Having been in the capital markets, on Wall 

Street for nearly 7 years before, I came to these issues with some 

of that background and really arrived here seeking a whole lot of 

knowledge and seeking to make sure I understood how work got 

done effectively and efficiently here. 

So, I suspect it is at least in part because I came here knowing 

so little about this process and have had the opportunity to work 

with this Committee among others, and it has really been a very 

productive relationship during this period. 

Senator CARPER. My follow-up question is why do you suppose I 

received an email like this about you but not about the two colleagues sitting next to you? 

Mr. KROSZNER. I think my mother does not use email very well. 

[Laughter.] 

Senator CARPER. I do not think his mother was ever on the Senate staff, so I think her hands and his are clean in all of this. 

Actually, the person who sent this, I know him pretty well. For 

him to say these things about you is really high praise, and I understand Senator Schumer did as well. 

May I ask a question of Mr. Lazear, if I may. Talk to us about 

savings rate. You may have already talked a bit at some length, 

but I am going to ask you to revisit it. How do we go about fostering savings, not from people whose incomes are in the top 2, 3, 

4, 5, percent in this country; the Administration seems always interested in expanding IRA’s or expanding health savings accounts 

to give upper income people an opportunity to participate more. 

I worry not so much about the more affluent people saving. I 

worry about less affluent people saving, and I would welcome your 

thoughts in that regard. 

Mr. LAZEAR. Thank you, Senator. 

One of the things that came up when I was on the tax panel was 

thinking very carefully about saving. As you mentioned, the savings rate is low, and it is not only low across the board; but it is 

also low particularly for low-income individuals. 

We thought hard about that, and a number of the suggestions 

that we came up with try to address saving not only among the 

rich but also among middle and low-income individuals. One of the 

things that we came up with that I would support was saving at 

the level of the family, so there would be tax advantages for individuals even at the low end. 

Some of these would take the form of credits, refundable credits 

to low-income individuals. One took the form of a credit up to $500, 

that would be 25 percent of the savings for low-income individuals, 

and we were trying to encourage individuals to save. We had also 

suggested a saving-at-work plan that would allow individuals to 

take some of their current income and save it tax-free. And although taxes are not the only consideration, obviously, we thought 

that these would be steps in the right direction. So, I would support those. 

Senator CARPER. And I thank you very much for that. A followup question, if I may. 

20

I was reading in the paper today, I think we have actually finally 

calculated the trade deficit from this past year. I think it came in 

at about $725 billion. I think the trade deficit just for the month 

of January alone is probably greater than the trade deficits that we 

have had in most years that we have been alive. 

And just talk to us just a little bit of a primer about how, when 

we run a large trade deficit like this, how does it get financed? Who 

provides the money for us? How do we go about continuing on this 

path. Is it sustainable? What do we need to do? 

Mr. LAZEAR. Well, as you mentioned, Senator, the trade deficit 

is large. It has been large for a long period of time. 

Senator CARPER. Not at this rate. Even in the last 3, 4, 5 years, 

it has more than doubled, I believe. It was already big then. 

Mr. LAZEAR. Yes, it has gone up. It has gone up steadily. We 

have been running a trade deficit for quite awhile, but as you point 

out, it has gone up in recent years. 

On the other side of the trade deficit, of course, is the capital account surplus. And so, there are always two interpretations of a 

trade deficit. One is that we are buying more goods than we are 

selling, but on the other hand, the capital account surplus means 

that the United States is such an attractive market for investment 

opportunity that individuals from abroad are investing in the 

United States and doing so at a record rate. 

Senator CARPER. Can you give us an example of the kinds of investments you are referring to? 

Mr. LAZEAR. Okay; there are a number of investments. Obviously, Government investment is one, and we do see significant investment in Government securities in the United States, primarily 

to——

Senator CARPER. To help us finance our deficit? 

Mr. LAZEAR. It does help us finance our deficit, because the 

United States has to get these funds from somewhere, and as you 

pointed out earlier, unfortunately, we are not saving currently at 

the level that we should be. So in order to have very high levels 

of investment without high interest rates, which is key in terms of 

spurring the private economy to economic growth, we have to make 

sure that we do have funds from abroad. 

So when we look at the trade deficit, it is a double-edged sword. 

As you point out, it is not something that we want to have persist 

over time, for very long periods of time. On the other hand, we 

would like to see a soft landing. If, for some reason, the trade deficit immediately reversed or went to zero, that would also mean 

that our source of funds from abroad would go to zero, and that 

would not be a very good thing for the economy. 

So we want to make sure that things happen in moderation, that 

things occur at a gradual pace, and I would look forward to advising policies that would make that kind of——

Senator CARPER. In an article I was reading yesterday, one of the 

suggestions, instead of continuing to watch imports grow more rapidly than more exports, we should try the opposite. And how might 

we go about doing that? 

Mr. LAZEAR. One of the things that actually did happen very recently was that the percentage increase in exports actually exceedVerDate 0ct 09 2002 16:46 Aug 21, 2007 Jkt 000000 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 S:\DOCS\37071.TXT SBANK4 PsN: KEVIN
21

ed the percentage increase in imports for the first time, I think, in 

15 years. What we need to see happen, of course, is that——

Senator CARPER. For what period of time? I am sorry. 

Mr. LAZEAR. It was just the last quarter of last year. 

What we need to see happen, though, over a prolonged period of 

time is for other countries to make sure they open up their markets 

to us. Ninety-five percent of the consumers in the world lie outside 

the United States. One in five jobs in the United States is associated with export trade, and it is extremely important that we make 

sure that we have opportunities to compete abroad. 

As you know, the productivity of the American worker is higher 

than the productivity of any worker in the world. If we are on a 

level playing field, the American worker can compete anywhere. So, 

I would work hard to make sure that we have opportunities abroad 

to have our goods and services compete on a fair basis. 

Senator CARPER. You will have no quarrel with me or I suspect 

with any of us on that. 

But I have heard through several people who have led the Federal Reserve and people who have sat in the chair that you are 

about to take and raising this question about rising trade deficits, 

Federal budget deficits, the willingness of the rest of the world to 

lend us money, and this is just not sustainable. And for us to continue along this path and not figure out how to get out of it, we 

are on a—I call it—the road to destruction. 

We have an opportunity to do something about it I think later 

this week, maybe the following week. We watched the loss of manufacturing jobs, and they are exiting our country at a rapid clip, 

and one of the reasons why I think they are leaving is because—

there are a lot of reasons: Energy costs are one of the reasons, especially natural gas, but another reason deals with our civil justice 

system, and particularly, this week, we are taking up the issue of 

asbestos litigation reform to see if there is a way to come up with 

a system that is fair to people that have been injured, to make sure 

that the people who pay for their injuries and their impairment 

and breathing is the defendants and the insurance companies, in 

this case, but to try to make sure that we have a system at the 

end of the day that increases the likelihood that the claims that are 

paid will end up actually in the pockets of people who have been 

hurt and frankly not in the pockets of people who may have been 

exposed to asbestos or who will never be exposed to asbestos. 

I will close with this. My colleagues, I asked somebody the other 

day, I said do you think some of our policies in this country are 

contributing to the loss of manufacturing jobs, and he said we could 

not hasten their departure any more if we were taking a stick and 

chasing them out of this country, and there is an opportunity to do 

a number of things to stop chasing them out of this country, and 

we have a chance to make a little progress on it this week, and I 

hope to pursue some of the other things that you have suggested 

here. 

Thank you. Thanks, Mr. Chairman. 

Chairman SHELBY. Senator Sarbanes. 

Senator SARBANES. Thank you very much, Mr. Chairman. 

Just to follow-up on what Senator Carper has been asking about, 

this is the U.S. trade deficit. Now, you said, Mr. Lazear, that it was 

22

worsening at a continuing pace or something of that sort. This 

seems to be at a fast accelerating pace. I mean, $725 billion, this 

is by far the worst we have ever experienced. The trade deficit with 

China last year was $200 billion, the largest we have ever had with 

any one country. 

What are we to make of this? I mean, the current account deficit 

now exceeds 6 percent of our GDP. Do you regard this as a problem 

for our economy? 

Mr. LAZEAR. Yes, Senator, I think it is a problem if it is sustained into the long-run. 

It is certainly the case that we can have at any period in time 

trade deficits or trade surpluses, but over the long haul, it has to 

be the case that these trade deficits are going to be reversed, because countries are not going to be willing to continue to give us 

goods in return for our capital forever. 

So there is no question; I certainly agree with your premise that 

over time, this has to be reversed. Just to follow-up on your point, 

and that is that if we look at manufacturing jobs and the concern 

that they might be related to this, manufacturing productivity in 

the United States, as you know, is very high and has grown more 

rapidly, actually, than productivity in any other sector. Manufacturing productivity was up over 4 percent last year. 

That is a very good sign for the American worker, because it 

means, again, that we do have the opportunity to compete with 

anyone as long as we are given a fair access to their market, and 

I think that would be the way to help erase some of the deficits 

that you are concerned about. 

Senator SARBANES. Mr. Kroszner, do you agree that this is a 

problem? 

Mr. KROSZNER. Certainly, the rate of growth of the deficit could 

not be sustained forever. And so, exactly as Professor Lazear had 

said, ultimately, there will have to be some balancing. We have 

been experiencing much greater demand growth in the United 

States than in the rest of the world. This is really a reflection of 

that, that we are buying a lot more than the rest of the world is 

buying from us. 

Something that would be very valuable is to pursue policies that 

generated prosperity around the world, increased demand abroad, 

increased demand at home and also increased savings at home. 

Senator SARBANES. Now, Mr. Kroszner, you gave a speech in December in which you said, ‘‘the economy continues to post a solid 

and consistent performance, no matter what Mother Nature nor 

nattering nabobs of negativism may throw at it.’’

Interesting turn of phrase, I might say. It is not original, though. 

[Laughter.] 

Mr. KROSZNER. I claim no originality for it, Senator. 

Senator SARBANES. No, I think there was an official from my 

State who was the originator. 

[Laughter.] 

Mr. KROSZNER. I believe you are correct, Senator. 

Senator SARBANES. Paul Volcker wrote an editorial in the Washington Post. He said the following about our economy: ‘‘Under the 

placid surface, there are disturbing trends: Huge imbalances, 

disequilibria, risks; call them what you will. Altogether, the cirVerDate 0ct 09 2002 16:46 Aug 21, 2007 Jkt 000000 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 S:\DOCS\37071.TXT SBANK4 PsN: KEVIN
23

cumstances seem to me as dangerous and intractable as any I can 

remember, and I can remember quite a lot.’’

Warren Buffett recently said ‘‘Right now, the rest of the world owns $3 trillion more of us than we own of them. In my view, it 

will create political turmoil at some point. Pretty soon, I think 

there will be a big adjustment.’’

And Robert Rubin, writing in The Wall Street Journal, said ‘‘Virtually all mainstream economists take the view that sustained 

long-term deficits will crowd out private investment, increase interest rates, reduce productivity, and reduce growth. The far greater 

danger is that these various imbalances could at some point lead 

to fear of fiscal disarray and concern about our currency, causing 

sharply higher interest rates in our bond markets and the risk of 

a sharp exchange rate decline.’’

Do you consider Volcker, Buffett, and Rubin, to be nattering nabobs of negativism? 

[Laughter.] 

Mr. KROSZNER. Senator, there certainly are a number of risks 

and challenges out there in the economy, and I would certainly not 

want to minimize that. The reference there to the nattering nabobs 

of negativism was, in terms of the speech, focusing more precisely 

on consumer confidence numbers, and at the time the speech was 

given, consumer confidence numbers were relatively low. There 

were a number of challenges to them, but consumers continued to 

spend. 

And so, that was the particular focus of that comment. But obviously, there are a lot of challenges, a lot of risks both domestically 

and internationally. And as I had said in my opening statement, 

it is extremely important for the Federal Reserve to be monitoring 

the sources of those risks, to be ensuring that there is sufficient 

capital in the banking system so that if there is a change in the 

asset markets that the banking system is sound, that credit will 

continue to flow, and that it is very important to think about where 

the potential risks may lie. 

Senator SARBANES. Mr. Kroszner and Mr. Warsh, what do you 

understand the mandate of the Federal Reserve to be? 

Mr. WARSH. Senator Sarbanes, I take the Federal Reserve’s mandate to be both price stability and achieving sustainable growth in 

employment and outputs, along with, of course, a third mandate to 

try to do that consistent with moderate long-term interest rates. 

That mandate, as it has come to be known, the dual mandate, is 

a mandate that I strongly believe in and support. 

Senator SARBANES. Mr. Kroszner. 

Mr. KROSZNER. I certainly also agree that the dual mandate is 

extremely important. It is very clear in the law that we are to pursue both low and stable prices and maximum employment. 

Senator SARBANES. Where did that mandate come from? 

Mr. KROSZNER. My understanding is that is part of the Federal 

Reserve Act and the amendments to the Federal Reserve Act over 

time. 

Mr. WARSH. I concur; that is a judgment that Congress made for 

the Federal Reserve. 

Senator SARBANES. Do you believe the mandate could be changed 

without changing the law? 

24

Mr. KROSZNER. Senator, I think the law speaks clearly so that 

the mandate is set in law, and my understanding, although not a 

lawyer, my understanding is that the Federal Reserve must follow 

the mandate from this Act. 

Senator SARBANES. Mr. Warsh. 

Mr. WARSH. I concur, Senator Sarbanes. 

Chairman SHELBY. Senator Reed. 

STATEMENT OF SENATOR JACK REED 

Senator REED. Thank you very much, Mr. Chairman, Senator 

Sarbanes. Gentlemen, welcome. 

Let me ask a question to all of you that concerns me, even 

though I understand that you have different obligations and duties 

in your prospective jobs. One of the most troublesome aspects of 

the present economy is that people are working harder, but they 

are not seeing any significant increase in their wages. 

Family income seems to be flattening out or even going down. 

And I think we all feel that one of the fundamental values or benefits of the free market system is that it is able to give people who 

work sufficient wages to not only get by but to also save, to provide 

for their families in a very meaningful way. 

And when that is not working, something might be wrong with 

the economy, even if the stock market is doing well, and even if 

capital transfers are doing well, and all these other measures are 

doing well. So, I would begin with Mr. Warsh and Mr. Kroszner, 

understanding from the Federal Reserve’s perspective, you will 

have a different one from Mr. Lazear. But Mr. Warsh, what do you 

think we can do? What can the Fed do to try to get at this issue? 

Mr. WARSH. Senator Reed, the Federal Reserve’s role, obviously, 

is different from the role that Chairman-Designee Lazear would 

have. But I think the Federal Reserve must remain attuned to 

these issues, because included in the Federal Reserve’s economic 

forecasts are forecasts for what is the state of the U.S. consumer, 

what is the consumer’s ability to contribute to the GDP growth 

that we have seen in recent years. 

And with respect to wages, I would make two points: First, historically, when we have seen massive ramp-ups in productivity, as 

we saw in the late 1990’s and have really seen over the course of 

the last 5 years, we have typically seen wage growth ultimately 

catch up to those productivity gains. I think, Senator, you are making the valid point, which is we have seen the productivity, but we 

have not yet seen the full benefit of those wage gains accrue to this 

point. But those lines have crossed historically, and I would be surprised if that ultimate path is not repeated here. 

Senator REED. Not to interrupt, but the last take on productivity, 

it seems to be dipping downwards, I think, the last numbers I have 

seen, which might be a transitory event, but if we have not caught 

up, and it is dipping down, then, we are really in trouble under 

your analysis. 

Mr. WARSH. Senator Reed, I share your view. I think there is 

likely to have been a good bit of noise in that fourth quarter data. 

I think when the fourth quarter data is restated, we are likely to 

see that improve. And more importantly, as we look to 2006 and 

2007, again from the Federal Reserve’s perspective, trying to evaluVerDate 0ct 09 2002 16:46 Aug 21, 2007 Jkt 000000 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 S:\DOCS\37071.TXT SBANK4 PsN: KEVIN
25

ate the economy, I think we are going to continue to see productivity growth that is robust. 

If you look at the period, for example, from 1973 to 1995, productivity here in the United States was growing rather smartly at 

about 1.5 percent. If we looked at productivity growth rates from 

1995 to 2001, they nearly doubled. What that doubling means effectively is that our standards of living are able to double that much 

more quickly, and the productivity growth over the last 5 years is 

up yet again. 

I think it is extremely difficult for policymakers to rely on those 

sorts of productivity gains which may well have been outsized in 

years past with any high degree of certainty. 

The only point I am trying to make was that the wage growth 

that we would have expected has probably been delayed by many 

of the things that have impacted the economy in recent years, including the war on terrorism, including the market consequence of 

some of the corporate scandals. I would expect wage growth to increase. 

The second point I would make, Senator Reed, is when you look 

at labor wages as to corporate costs, those costs have been increasing over the last 5 years. But when we look at take-home wages 

to median workers, they have not increased at that same rate. 

So what explains that difference? I think part of that difference 

is that many of the costs of labor in corporations, large and small, 

have gone in to fund health care, with costs which have grown 

much faster than inflation, much faster even than productivity. So 

while the worker is costing more to the company, that worker does 

not feel richer when he or she gets his or her paycheck. 

So, I think the health care cost challenges, which are before this 

Congress, continue to explain part of the differential which you reference. 

Senator REED. Mr. Kroszner, please. 

Mr. KROSZNER. Yes, thank you. Family income is incredibly important. Roughly 70 percent of GDP is consumption, and so, that 

has to be the income of individuals, the income of families in making their consumption choices. So it is certainly important for the 

Fed to be cognizant of and concerned about total income in pursuing the goal of maximum employment and maximum growth in 

a low and stable inflation environment. And so, certainly, we want 

to be very much aware of that. 

I think, as Mr. Warsh has pointed out, one sees a difference in 

the total costs of compensation and the take-home wages that individuals have been receiving, because there are many benefits that 

they do not receive directly in their wages but are a part of their 

total costs and compensation, and these are areas that require a 

great deal of attention because they are increasingly costly. They 

are causing the differential between the take home pay and the 

amount of pay or the cost of each of the individual workers, and 

that is something that certainly is important to look at going forward. 

Senator REED. I thank both the answers, and I think it sets it 

up very well for Mr. Lazear, who is the policy guy, not the Fed guy, 

but just one other perhaps footnote is that what I am observing 

26

anecdotally is that a lot of companies are trying to solve this difficult medical cost dilemma by dropping people off coverage. 

So for some families, you are getting a double whammy: The 

wages are flat, and they lost what they had before, which were reasonably good benefits. But I think your points are well-taken, and 

I would hope that on the Fed, you would consider this issue as very 

central to what we all should be about. 

And Mr. Lazear, please. 

Mr. LAZEAR. Senator Reed, as you know, I spent my life thinking 

about labor issues, and so, your concern about wages is one that 

is certainly near and dear to my heart as well. 

The one thing we do know is that wages are very closely related 

to productivity, as pointed out, and productivity is very closely related to two kinds of investment: Investment in physical capital 

and investment in human capital. 

One of the issues that we need to focus on in this country is making sure that individuals have sufficient human capital, sufficient 

skills to be productive in the labor market, and that is particularly 

true at the bottom end and for some of our more disadvantaged 

citizens. 

I think that if we look at some of the programs that we think 

about in terms of K–12 education, that would certainly be one of 

the key aspects to focus on. We have done tremendously well at the 

college level and the graduate level of education. The United States 

leads the world in that. It is one of our big export industries. We 

have many people coming into the country for our education. 

We have not done quite so well at the K through 12 level, and 

I think that we need to focus on that, because individuals who do 

not get to go on to college or graduate school suffer as a result of 

a system that is not serving them well right now. 

So in terms of even the short-run but certainly in terms of the 

long-run, I think that the focus needs to be on the human capital 

side. 

Senator REED. I do not want to presume—any more questions? 

I just have a general question. One of the areas that concerns me 

also is the abysmal household savings rate, and I appreciate your 

answer before, but my time has expired, so if someone wants to 

comment briefly, particularly—perhaps Mr. Kroszner, from the 

Fed, from your perspective, your aspiration to the Fed, what would 

you do about household savings? 

Mr. KROSZNER. I think it is very important for the Federal Reserve to provide a stable macroeconomic environment, because that 

is the best one in which individuals will have much more certainty 

about their future, will be able to make their savings and consumption plans most sensibly. 

I think if the Federal Reserve causes uncertainty, causes volatility, that is problematic for individual decisions. If the Federal 

Reserve provides a very stable, very transparent, clear environment that is pursuing its goals of long-term price level stability 

that will maximize employment and maximize economic growth, 

that is the best—from the Federal Reserve perspective—that the 

Fed can do to provide an environment to try to foster good decisions on individuals’ parts and particularly fostering savings. 

27

Senator REED. If I may, Mr. Lazear, from the policy perspective 

of the Council of Economic Advisers, what is the significant thing 

that can be done to raise household savings? 

Mr. LAZEAR. Senator Reed, again, I would focus on tax issues. 

Our tax system right now penalizes future consumption relative to 

present consumption. We would be well-served by moving to a 

structure that is more flat, flat in the sense of treating present and 

future consumption in the same way. I think that would encourage 

saving. 

Some of the things that we focused on when I was on the tax 

panel involved helping low-income individuals save and trying to 

provide some refundable tax credits that would be instrumental in 

getting those individuals into the saving picture, and I think all of 

those things could be useful. 

Senator REED. Thank you. 

Thank you, Mr. Chairman. 

Chairman SHELBY. Senator Sarbanes. 

Senator SARBANES. Mr. Kroszner, I welcome the statement in 

your opening testimony about the importance of accurate and timely economic statistics. 

I remember often in his testimony before this Committee, former 

Chairman Greenspan would say that one area where he supported 

more government investment was with respect to statistics and 

that for a very small investment, he thought we could get a very 

large payoff in terms of the accuracy of the basis on which we were 

making important policy judgments. Dr. Lazear, why do we not get 

you on the record on statistics and then Mr. Warsh? 

Mr. LAZEAR. One of the things we talked about in your office, 

Senator Sarbanes, was the need for better statistics. And actually, 

right after leaving your office, I started thinking about some of the 

things that we really need to focus on. 

One involves some of these issues that came up earlier with respect to jobs. We do not have very good data right now about the 

kinds of jobs that the economy is creating and the kinds of jobs 

that are being lost, and that would be one of the things that I 

would like to focus on as Chairman of the Council of Economic Advisers if confirmed. 

There are a large number of other possible ways that we could 

beef up the statistics. I know that you have a connection to the 

CEA earlier, and you started working on those things even when 

you were on the CEA. I think we need to be even more diligent in 

terms of thinking about additional areas where statistics could be 

useful to provide information to us and then to you. 

Senator SARBANES. Mr. Warsh. 

Mr. WARSH. Senator Sarbanes, I would say the underlying dynamism in our economy has proven relatively difficult to be measured 

by Government data, which is put together in somewhat traditional 

ways. I think a lot of progress has been made in trying to improve 

the quality of that data, but in light of that problem, it strikes me 

that our markets, particularly our capital markets, are able to provide some important price signals with respect to the current account deficit, with respect to policy actions, which is not a perfect 

measure of how the economy is doing but is a necessary supplement given the data that we have. 

28

If U.S. companies were to try to make judgments based on the 

sorts of data that you, Senator, have at your disposal as a policymaker, they would be struggling. In fact, U.S. companies have 

moved to just-in-time inventory, real-time data that allows them to 

be much more nimble in their policy decisions, and I think it is a 

helpful model for us all to consider. 

Senator SARBANES. The President’s latest budget proposal calls 

for the elimination of the Survey of Income and Program Participation, the SIPP, which has been regarded as a unique source of high 

quality policy-relevant data on the economic well-being of the U.S. 

population. 

And I really would put this to you to take with you as something 

to examine. I think it would be a major step backward to drop the 

SIPP, and since you have this concern for statistics, I commend 

that to you for your thinking. I do not know whether any of you 

is either aware of this or conversant with this particular series. 

Mr. LAZEAR. I certainly know the data set. I have not used it, but 

many of my colleagues have, and I am certainly interested in following through on finding out more about that. 

Senator SARBANES. The money laundering title of the USA PATRIOT Act came out of this Committee. Chairman Shelby has had 

a number of oversight hearings on money laundering, and I want 

to ask the nominees for the Federal Reserve Board their evaluation 

of where the Fed is in terms of its supervisory activity with respect 

to money laundering. 

There have been some serious criminal investigations by the Department of Justice, which to some extent might suggest that the 

regulatory authorities were not doing all that they should have 

been doing for the matter to progress to the point where the Department of Justice would come along and undertake criminal investigations. I would like to hear from both of you about this 

money laundering issue. 

Mr. WARSH. Senator Sarbanes, while not privy to the details of 

what the Federal Reserve is contemplating currently, I do know 

that our bank regulators, along with different parts of the Administration, have been trying to increasingly speak with one voice and 

be coordinated; that is, FinCEN, the bank regulators, other parts 

of the Government that are aware of possible violations of the 

Bank Secrecy Act must, and I think are, continuing to take that 

responsibility very seriously. 

I believe that there was guidance offered toward the end of last 

year to try to provide an ability for these regulators to communicate, share information better between and among themselves. 

But I would take that responsibility, if confirmed at the Federal 

Reserve, very seriously, and I think part of the supervisory role is 

to ensure that the Bank Secrecy Act, the antimoney laundering initiatives which have been brought before this Committee, are taken 

very seriously so that our banking system is not used by people 

who are trying to circumvent our laws and engage in terrorist activities. 

Senator SARBANES. Mr. Kroszner. 

Mr. KROSZNER. Senator, this is a very important issue. It is intolerable to have our financial system be used to finance terrorist activities or aid and abet terrorists in any way in the United States 

29

or around the world. So it is very important to vigorously enforce 

the antimoney laundering statutes, to enforce the Bank Secrecy 

Act, and to ensure that we do not, in any way, allow our system 

to be used by terrorists. 

Again, I do not have the specific knowledge of exactly what the 

Federal Reserve has been doing with respect to enforcement activities, but I certainly do support maximal deterrence and making 

sure that our system is not used by terrorists in any way to aid 

or abet their activities. 

Senator SARBANES. Mr. Chairman, I just want to point out because you have taken such a strong interest in this issue that the 

September 11 Commission issued a final report on their recommendations in December. Of course, they had made a whole series of recommendations. They issued a final report on how well 

they were working and how well they were being implemented. 

The only recommendation they got an A, an A-minus, was with 

respect to terrorist financing. So they seem to have regarded the 

work we did here, not only the statutory work but also the oversight hearings, the follow-up, I remember a meeting the Chairman 

convened in his office with representatives of the Treasury to examine carefully what they were doing I think have all produced a 

result. 

Finally, the other issue I wanted to touch with you, because it 

is one that, again, this Committee has had a keen interest in is privacy and data security. We have had some horror stories about the 

loss of people’s sensitive information, the breaches of the privacy of 

Social Security numbers, credit and debit card numbers, security 

codes, bank account information. 

In fact, the Chairman convened, I think, three or four hearings 

of this Committee on data privacy. How important do you regard 

that issue? Everyone thinks the Federal Reserve does—I mean, obviously, it does monetary policy, but it does not only do monetary 

policy, and issues of this sort come directly under your jurisdiction. 

Mr. KROSZNER. Certainly, protecting people’s privacy is of the utmost importance. In that Act of 2002, the Confidential Information 

Protection and Statistical Efficiency Act of 2002 that I was very 

much involved in, the first part of it is confidential information protection. 

And so, one of the things that I wanted to ensure is not only that 

we allow the statistical agencies to be more efficient in the use of 

the data that they have but also that the information collected 

from individuals and firms has the highest level of protection possible. What this Act did was actually raise the safeguards and raise 

the protections for those. Obviously, this is an extremely important 

issue, and the Federal Reserve has a role to play. 

Some of the incidents that we have heard about have been outside of the Federal Reserve’s mandate, however. Some of them 

have been associated with institutions that are not banks or not 

regulated institutions by the Fed. But certainly, to the extent that 

the Fed can ensure the confidentiality of and protection of people’s 

privacy, of their information in financial institutions, I would work 

the utmost to make sure that does occur. 

Senator SARBANES. Mr. Warsh. 

30

Mr. WARSH. Senator, I think that part of the success of the domestic economy has been an increasing reliance by consumers in 

providing their financial information to those institution which 

they believe are really trusted intermediaries. 

So part of the reason why home mortgages are more prevalent 

in the United States than they are among our European trading 

partners is because of the depth and breadth of those commercial 

financing and securities markets, all of which are really critically 

important, then, to make sure that data is private so that those 

people continue to participate in these marketplaces. 

I think this Committee took on the challenge of identity theft in 

the reauthorization and signing by the President of the FACT Act, 

which is an important step down that road. But vigorous oversight 

by the regulators and oversight by this Congress is probably necessary going forward. 

Senator SARBANES. The final question I want to put: Mr. Lazear, 

you are going to be the President’s Chief Economist, in effect; I 

mean, that is the theory of it, at least, as Chairman of the Council 

of Economic Advisers. But the two Fed nominees are moving from 

being part of the President’s economic team to being members of 

the Federal Reserve Board. 

We give Members of the Federal Reserve Board a 14-year term 

if they get the full term. And of course, the purpose behind that 

is to give them independence so that they will call it as they see 

it and that the judgments will not be political judgments but represent well considered economic judgments. 

Given your past experiences as members of the President’s economic team, I think you need to address this question of the independence of the Federal Reserve. 

Mr. Kroszner and then Mr. Warsh. 

Mr. KROSZNER. The independence of the Federal Reserve is fundamental to the Federal Reserve’s mission. In order to be credible 

and make sure to reduce volatility, to reduce uncertainty, the central bank cannot be a political animal; it must be an independent 

animal, and that was the Congressional mandate in setting up the 

structure as you had discussed. 

I have been an academic for most of my life. I did take 2 years 

to have the honor to be confirmed by this Committee and to work 

in the White House as a Member of the President’s Council of Economic Advisers, which I think has given me a very useful perspective on taking the academic and bringing it to the policy world. 

I fully understand that when I am at the Federal Reserve, I am 

at the Federal Reserve; I am not part of any administration. I am 

there as an independent person. The vast majority of my life has 

been in academia, which, as you know, especially in the University 

of Chicago tradition, is one in which there is a lot of independence. 

Regardless of who may be giving a paper, who may be putting 

ideas forward, whether it is a new assistant professor, whether it 

is a Nobel Prize winner, those ideas are debated on their merits, 

and it is not the source of them; it is the substance of them. 

And at the Federal Reserve Board, I assure you, Senator, that 

is the approach that I would take, and I understand the independence is fundamental to the successful mission of the Federal Reserve Board. 

31

Mr. WARSH. Senator, if confirmed, I think it is essential that I 

take on the role to call them the way that I see them. And I absolutely intend to do just that. I think it is a dramatically different 

role than I have served and had the privilege to serve over the 

course of the last 4 years. I am very really comfortable taking off 

one hat and putting on the other. 

I think what is at least as important is the credibility the Federal Reserve in the marketplace; given the responsibilities that this 

Committee has given the Federal Reserve, it is at least as essential 

that the markets believe the judgments of the Federal Reserve, 

both Chairman Bernanke and the Governors, are really impartial 

judgments that are based on the best data and the best information 

that is available. I think that is part of the reason why the markets 

pay so much attention to the reactions of the Federal Reserve. 

Senator SARBANES. Thank you very much, Mr. Chairman. 

Chairman SHELBY. Thank you, Senator Sarbanes. 

I just want to throw out something you know just for emphasis: 

Identity theft is costing billions and billions of dollars. We have 

heard this. And we are trying to get a hold of it. As regulators, you 

will be right in the midst of it, but it seems to be not an issue that 

is going away despite our robust economy and the use of everything, the legislation that we have passed and the oversight that 

we do here. So we do want to work with you at the Fed and the 

other regulators to try to combat this, because it has reached epidemic stages, and I think it could get worse. I pray it will not. 

Thank all of you for your appearance here today. We will try to 

schedule a vote on your nomination as soon as we can. Thank you 

very much. The hearing is adjourned. 

[Whereupon, at 4:19 p.m., the hearing was adjourned.] 

[Prepared statements and biographical sketches of nominees supplied for the record follow:] 

32

PREPARED STATEMENT OF EDWARD P. LAZEAR

CHAIRMAN-DESIGNATE, COUNCIL OF ECONOMIC ADVISERS

FEBRUARY 14, 2006

Chairman Shelby, Ranking Member Sarbanes, and Members of the Committee, it 

is a great honor to be here today as the President’s nominee to be Chairman of the 

Council of Economic Advisers. The Council, which has been in existence for 60 years 

now, is charged with the task of advising the President on economic issues. 

Throughout its history, it has remained a body of experts and academicians who 

have taken it to be their duty to inform policymakers in an unbiased and professional manner. 

One colleague recently told me that in Washington, when people want the correct 

answer on economics, they go to the Council of Economic Advisers. The best compliment that can be paid to the CEA is that the CEA ‘‘tells it like it is’’ so that the 

President and Congress, who are charged with the responsibility of weighing all factors, can make the best decisions possible. 

Let me offer a brief summary of my background. I was born in New York, but 

raised in the San Francisco Bay Area, when my father, who worked as a machinist 

in the defense industry, followed the work to California. I attended UCLA where 

I obtained Bachelor’s and Master’s degrees and then went to Harvard to get my 

Ph.D., all in economics. After graduating, I taught at the University of Chicago for 

19 years and moved to Stanford University full-time in 1992, where I am currently 

a Professor in the Graduate School of Business and a Fellow of the Hoover Institution. I have founded two businesses and was the chairman of my company from 

2001 until recently. 

I am primarily an applied economist and have worked in a number of different 

areas. My specialty is issues involving incentives and productivity. Although most 

of my work has been in microeconomics, broadly defined, I have some well-known 

research in macroeconomics that examines the effects of government policies on employment. I have also spent much of my career studying education and am currently 

the sole economist on a National Academy of Sciences standing board that deals 

with education issues. 

My government experience is varied. I have advised a number of countries on economic growth and reform, specifically Eastern European nations as they moved from 

command to market economies. I was also a Member of the President’s Advisory 

Panel on Tax Reform last year. I am currently a Member of Governor 

Schwarzenneger’s Council of Economic Advisers. 

Before I left California to testify, my senior Stanford colleague, Secretary George 

Shultz, told me that the role of the Chairman of the Council of Economic Advisers 

is to be an economist to be straight and to bring the economics to the table, leaving 

the politics to others. If confirmed, I will devote all of my energy to ensuring that 

policymakers have the best economic analysis possible. 

Thank you. I welcome your questions. 

—————

PREPARED STATEMENT OF RANDALL S. KROSZNER

MEMBER-DESIGNATE

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

FEBRUARY 14, 2006

Chairman Shelby, Senator Sarbanes, and Members of the Committee, I am 

pleased to have the opportunity to appear before you today as one of President 

Bush’s nominees to serve on the Board of the Governors of the Federal Reserve System. I am honored that President Bush has nominated me to serve on the Board. 

If I am confirmed by the Senate, I will work to the best of my abilities to fulfill 

the significant responsibilities of this office. 

After studying economics as an undergraduate at Brown University, I earned 

M.A. and Ph.D. degrees in economics from Harvard University. I then joined the 

faculty of the Graduate School of Business of the University of Chicago, where I am 

Professor of Economics and have been teaching Money & Banking since 1990. I have 

researched and published on topics including domestic and international banking 

and financial regulation, corporate governance at both financial and nonfinancial 

firms, international banking and financial crises, debt defaults, and monetary economics. I am Editor of the Journal of Law and Economics and have been Associate 

Editor of a number of scholarly journals, including the Journal of Financial Services 

Research.

33

I have had extensive and regular contact with the Federal Reserve System as a 

visiting scholar and consultant to regional Federal Reserve Banks including Chicago, New York, Kansas City, Minneapolis, and St. Louis, as well as to the Federal 

Board in Washington. I also serve on the Academic Advisory Committee of the Federal Reserve Bank of Chicago. I have visited and consulted for many central banks 

and finance ministries around the world, including Central Bank of Argentina, Bank 

of Sweden, Swedish Finance Ministry, Bundesbank (Germany), and the European 

Central Bank. I have also visited and consulted for international financial institutions, including the Bank for International Settlements, the International Monetary 

Fund, World Bank, Inter-American Development Bank, and Asian Development 

Bank. 

As a Member of the President’s Council of Economic Advisers (2001–2003), I have 

had policy experience in a variety of areas including banking and financial regulation, international financial crises, and macroeconomic forecasting. In this capacity, 

I witnessed first-hand the importance of having accurate and timely economic statistics in order to make sensible policy judgments and decisions. I spearheaded an initiative to improve the quality of Government statistics and enhance the protection 

of confidential data reported to the Government, resulting in the Confidential Information Protection and Statistical Efficiency Act of 2002. After returning to the University, I was delighted to be appointed by the Secretary of Labor to the Federal 

Economic Statistics Advisory Committee (FESAC) which meets regularly with the 

major official statistical agencies to discuss how to improve measurement of economic activity. If confirmed, I would be devoted to further enhancement of the quality of economic statistics. 

Monetary policy is a fundamental responsibility of the Federal Reserve. Long-run 

price stability is crucial to achieving maximum employment and overall economic 

stability. Under Chairman Greenspan and Chairman Volcker before him, the Federal Reserve has achieved much success in reducing and stabilizing inflation and 

inflation expectations. This success has helped to contribute to a tendency for the 

fluctuations in employment and output to be lower than in the past and a reduction 

in the frequency and severity of recessions. If confirmed, I would look forward to 

working with Chairman Bernanke and the other members of the Federal Open Market Committee (FOMC) to continue to underscore the role of long-term price stability in achieving prosperity and maximum employment. I also applaud the increase under Chairman Greenspan in monetary policy transparency, which helps to 

reduce uncertainty for households, entrepreneurs, and investors, and thereby contributes to economic stability and growth. 

The Federal Reserve also has a fundamental responsibility for protecting the stability of the country’s banking and financial system. Much of my research and work 

with central banks has been devoted to analyzing banking and financial regulation 

as well as banking and financial crises. The safety and soundness of the U.S. banking and payments systems is critical to achieving economic growth, maximum employment, and general economic stability, and the Federal Reserve works closely 

with other regulators to achieve this goal. The Federal Reserve also has an important role to play in responding to and mitigating the impact of financial crises and 

shocks. If confirmed, I would work vigorously to protect and promote the safety and 

soundness of the system. 

The Federal Reserve has an additional important responsibility to consumers and 

users of the banking and financial system. Discriminatory or abusive lending practices should not be tolerated, and the privacy of individuals and their financial data 

must be protected. The Federal Reserve is active in promoting financial literacy and, 

as an educator, I believe that financial literacy is fundamental to the proper functioning of the financial system. If I am confirmed, I will place a high priority on 

these responsibilities and look forward to being actively involved in promoting financial literacy. 

Thank you for holding this hearing, and I look forward to your questions. 

—————

PREPARED STATEMENT OF KEVIN M. WARSH

MEMBER-DESIGNATE,

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

FEBRUARY 14, 2006

Chairman Shelby, Senator Sarbanes, and Members of the Committee, thank you 

for the opportunity to appear today and for the expeditious scheduling of this hearing. 

34

I wish to express my sincere appreciation to President Bush for nominating me 

to serve as a Member of the Board of Governors of the Federal Reserve System. 

I have served on the National Economic Council for the past 4 years, focusing on 

domestic finance, capital markets, banking, securities and insurance related issues. 

In that capacity, I have had the privilege of working closely and productively with 

Members and staff of this Committee. If confirmed, I look forward to continuing that 

cooperative relationship, along with Chairman Bernanke and the Board of Governors, in carrying out the important responsibilities that Congress has assigned to 

the Federal Reserve. 

Market participants, policymakers, and the American people rely on the credibility and sound judgment that flows from the Federal Reserve’s independence. If 

confirmed, I will be devoted solely to the Federal Reserve’s statutory mandate for 

monetary policy—to preserve price stability and foster maximum sustainable growth 

in employment and output—and will work to promote a secure, fair, and efficient 

financial system. 

The flexibility and resiliency of the U.S. capital markets are matched only by the 

remarkable innovation and adaptability of our Nation’s workers. Both of these markets—capital and labor—are a source of great strength to the American economy, 

and have proven in recent years equal to the task of cushioning external shocks to 

the economy. 

The capital markets, from which I come, are the transmission mechanism for 

monetary policy. Under Chairman Greenspan’s leadership, the Federal Reserve took 

meaningful steps during the past decade to describe and explain its policies with 

greater transparency. As a result, market volatility is lower, and our capital markets are deeper, broader, and more dynamic than ever before. Pools of free-flowing 

capital, in turn, are able to provide real-time, forward-looking information to help 

Federal Reserve officials make appropriate policy decisions. I hope and believe that 

my prior experience of nearly 7 years at Morgan Stanley—as an investment banker 

and mergers and acquisitions adviser—would prove beneficial to the deliberations 

and communications of the Federal Reserve. 

Over the course of the last generation, the Federal Reserve has compiled an enviable track record in achieving price stability and successfully anchoring long-term 

inflation expectations. This stability has contributed to low long-term interest rates 

and has promoted strong employment growth and significant productivity gains. The 

Federal Reserve must remain attuned, however, to the possibility of unexpected 

shocks. 

The Federal Reserve’s responsibilities extend, of course, beyond monetary policy. 

It is responsible for the supervision and regulation of bank and financial holding 

companies and State-chartered banks that are members of the Federal Reserve System. Working with other financial regulators, the Federal Reserve should continue 

to promote three complementary pillars of prudential oversight: Strong capital 

standards, effective supervision, and meaningful market discipline of these institutions. I am fully committed to these principles. 

The Federal Reserve also maintains significant responsibility for promoting an efficient and effective financial system, including protection from systemic risks. As 

a staff participant on the President’s Working Group on Financial Markets since 

2002, I would hope to continue to contribute as a Member of the Board to its important work in the years to come. The Federal Reserve remains on the front lines in 

avoiding financial crises—or mitigating their consequences—should they occur. The 

American people have come to rely upon the Federal Reserve in times of significant 

financial distress, and it is a responsibility that I take seriously. 

Finally, if confirmed, I will work to ensure that the Federal Reserve continues its 

important role in promoting financial literacy and fair dealing for consumers. The 

Federal Reserve’s knowledge and credibility should continue to be brought to bear 

to help bring those on the fringes of the U.S. financial system into the mainstream. 

In conclusion, the Federal Reserve System’s decisions significantly impact America’s families and businesses. I would take on the responsibility of joining the Board 

of Governors of the Federal Reserve System with humility, and would be honored 

if the Senate sought fit to confirm my nomination. 

Thank you. I am happy to respond to your questions.

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