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S. HRG. 110–856 

FALTERING ECONOMIC GROWTH AND THE NEED 

FOR ECONOMIC STIMULUS 

HEARING 

BEFORE THE

JOINT ECONOMIC COMMITTEE 

CONGRESS OF THE UNITED STATES 

ONE HUNDRED TENTH CONGRESS 

SECOND SESSION 

OCTOBER 30, 2008 

Printed for the use of the Joint Economic Committee 

( 

(II) 

JOINT ECONOMIC COMMITTEE 

[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress] 

SENATE 

CHARLES E. SCHUMER, New York, Chairman 

EDWARD M. KENNEDY, Massachusetts 

JEFF BINGAMAN, New Mexico 

AMY KLOBUCHAR, Minnesota 

ROBERT P. CASEY, JR., Pennsylvania 

JIM WEBB, Virginia 

SAM BROWNBACK, Kansas 

JOHN SUNUNU, New Hampshire 

JIM DEMINT, South Carolina 

ROBERT F. BENNETT, Utah 

HOUSE OF REPRESENTATIVES 

CAROLYN B. MALONEY, New York, Vice Chair 

MAURICE D. HINCHEY, New York 

BARON P. HILL, Indiana 

LORETTA SANCHEZ, California 

ELIJAH CUMMINGS, Maryland 

LLOYD DOGGETT, Texas 

JIM SAXTON, New Jersey, Ranking Minority 

KEVIN BRADY, Texas 

PHIL ENGLISH, Pennsylvania 

RON PAUL, Texas 

MICHAEL LASKAWY, Executive Director 

CHRISTOPHER J. FRENZE, Minority Staff Director 

(III) 

C O N T E N T S 

OPENING STATEMENT OF MEMBERS

Statement of Hon. Carolyn B. Maloney, Vice Chair, a U.S. Representative 

from New York ..................................................................................................... 1 

Statement of Hon. Kevin Brady, a U.S. Representative from Texas .................. 3 

WITNESSES

Statement of Dr. J. Steven Landefeld, Director of the Bureau of Economic 

Analysis, U.S. Department of Commerce, Washington, DC ............................. 5 

Statement of Dr. Nouriel Roubini, Professor of Economics and International 

Business, New York University, New York, NY ................................................ 7 

Statement of Dr. Simon Johnson, Ronald A. Kurtz Professor of Entrepreneurship, MIT, Cambridge, MA .................................................................................. 9 

Statement of Dr. Richard Vedder, Distinguished Professor of Economics at 

Ohio University and Visiting Scholar, American Enterprise Institute (Washington, DC), Athens, Ohio ................................................................................... 10 

Statement of Vincent DeMarco, President, Maryland Citizen’s Health Initiative, Baltimore, Maryland ................................................................................... 31 

Statement of Donald C. Fry, President and CEO, Greater Baltimore Committee, Baltimore, Maryland ............................................................................... 33 

Statement of Joseph Haskins, Jr., Chairman, President and Chief Executive, 

The Harbor Bank of Maryland, Baltimore, Maryland ...................................... 34 

SUBMISSIONS FOR THE RECORD

Joint Economic Committee Report ‘‘Stemming The Current Economic Downturn Will Require More Stimulus’’ ..................................................................... 50 

Prepared statement of Hon. Carolyn B. Maloney, Vice Chair, a U.S. Representative from New York ................................................................................. 63 

Prepared statement of Hon. Kevin Brady, a U.S. Representative from Texas .. 64 

Statement of Ben S. Bernanke, Chairman, Board of Governors of the Federal 

Reserve System before the House Budget Committee on October 20, 2008, 

submitted by Vice Chair Maloney ...................................................................... 66 

USA Today article ‘‘Majority of Economists in USA TODAY Survey Back 

2nd Stimulus,’’ submitted by Vice Chair Maloney ............................................ 69 

Prepared statement of Dr. J. Steven Landefeld, Director of the Bureau of 

Economic Analysis, U.S. Department of Commerce, Washington, DC ............ 70 

BEA News Release ‘‘Gross Domestic Product: Third Quarter 2008 (Advance)’’ ............................................................................................................ 71 

BEA Report ‘‘GDP Declines in Third Quarter’’ .............................................. 83 

Prepared statement of Dr. Nouriel Roubini, Professor of Economics and International Business, New York University, New York, NY ................................ 86 

Prepared statement of Dr. Simon Johnson, Ronald A. Kurtz Professor of 

Entrepreneurship, MIT, Cambridge, MA ........................................................... 96 

Prepared statement of Dr. Richard Vedder, Distinguished Professor of Economics at Ohio University and Visiting Scholar, American Enterprise Institute (Washington, DC), Athens, Ohio ................................................................. 104 

Prepared statement of Vincent DeMarco, President, Maryland Citizen’s 

Health Initiative, Baltimore, Maryland ............................................................. 111 

Baltimore Sun article ‘‘Medicaid Reaches More’’ ........................................... 114 

Prepared statement of Donald C. Fry, President and CEO, Greater Baltimore 

Committee, Baltimore, Maryland ....................................................................... 116 

Prepared statement of Joseph Haskins, Jr., Chairman, President and Chief 

Executive, The Harbor Bank of Maryland, Baltimore, Maryland .................... 119 

(1) 

FALTERING ECONOMIC GROWTH AND THE 

NEED FOR ECONOMIC STIMULUS 

THURSDAY, OCTOBER 30, 2008 

CONGRESS OF THE UNITED STATES, JOINT ECONOMIC COMMITTEE, Washington, DC. 

The committee met at 10:00 a.m. in room 106 of the Dirksen 

Senate Office Building, the Honorable Vice Chair Carolyn B. Maloney, presiding. 

Senators present: Bennett. 

Representatives present: Maloney, Hinchey, Cummings, and 

Brady. 

Staff present: Heather Boushey, Nate Brustein, Nan Gibson, 

Colleen Healy, Aaron Kabaker, Justin Ungson, Ted Boll, Chris 

Frenze, Bob Keleher, Tyler Kurtz, Gordon Brady, Robert O’Quinn, 

and Jeff Schlagenhauf. 

OPENING STATEMENT OF HON. CAROLYN B. MALONEY, VICE 

CHAIR, A U.S. REPRESENTATIVE FROM NEW YORK 

Vice Chair Maloney. The hearing will come to order. I believe 

a meeting should start on time. I know that other members are on 

their way. 

Unfortunately, Chairman Schumer is unable to attend today’s 

hearing, ‘‘Faltering Economic Growth and the Need for Economic 

Stimulus,’’ and he has asked me to chair this meeting. 

I would like, first, to welcome our panel, Dr. Steve Landefeld, Director of the Bureau of Economic Analysis; Dr. Nouriel Roubini; Dr. 

Simon Johnson; and Dr. Richard Vedder. I thank all of you for 

coming, and I welcome my colleague, Mr. Hinchey. 

Today’s news is bleak. The Gross Domestic Product, which is the 

broadest measure of our economy, fell by 0.3 percent, and consumer 

spending fell by 3.1 percent in the third quarter. 

This news comes on the heels of this week’s dismal report that 

the Consumer Confidence Index plunged to an all-time low in October. 

All of this provides further confirmation that unless we act to 

bring real relief to Main Street, families will continue to suffer serious economic hardships. 

These data indicate that Speaker Pelosi has been right in pressing for additional economic stimulus, as Congressional hearings 

this month have shown. 

Over the past year, we have seen the subprime crisis turn into 

a full-blown financial crisis. Many economists now warn that we 

are in the midst of a recession, quite possibly the worst in decades, 

2 

and the impact on families may be devastating without government 

intervention. 

This Committee has been tracking the unfolding economic crisis 

for over a year. In our monthly hearings on the unemployment situation, we have seen how the private sector has shed nearly a million jobs in 2008, and U.S. workers have lost all of the wage gains 

they had made during the 2000 recovery. 

There is now a growing consensus that Congress should enact a 

second stimulus package and that it should be larger than the one 

we passed in January. 

During recent testimony in front of the House Budget Committee, Federal Reserve Chairman Ben Bernanke, gave his support 

to another round of significant economic stimulus, and I quote, 

‘‘With the economy likely to be weak for several quarters and with 

some risk for a protracted slowdown, consideration of a fiscal package by the Congress at this juncture, seems appropriate.’’ End 

quote. 

As detailed in a Joint Economic Committee report released yesterday, the need for stimulus is urgent. A consumer- or export-led 

recovery is unlikely, because this downturn follows the weakest recovery on record. 

[The report, ‘‘Stemming The Current Economic Downturn Will 

Require More Stimulus’’ appears in the Submissions for the Record 

on page 50.] 

Even as the economy expanded over the last eight years, household incomes never recovered from the last recession. 

Falling home values and rising debt have driven family balance 

sheets to their worst condition in decades, while, at the same time, 

banks have been curtailing access to credit. As consumers cut back 

on their spending, this drags down the economy further. 

Economists are also encouraging Congress to recognize that during a potentially protracted and deep downturn, concerns about 

budget deficits must be secondary to the goal of getting the economy back on track. 

Former Treasury Secretary, Lawrence Summers, has said, and I 

quote, ‘‘The idea seems to have taken hold in recent days, that because of the unfortunate need to bail out the financial sector, the 

nation will have to scale back its aspirations in other areas such 

as healthcare, energy, education, and tax relief. This is more wrong 

than right.’’ End quote. 

Congress has already taken numerous steps to help buffer families from the effects of the downturn. More than 130 million American households have received a recovery rebate, and 3.1 million 

unemployed workers, have received extended unemployment benefits. 

In July, Congress enacted a housing package aimed at stemming 

the tide of foreclosures. As the financial crisis worsened this Fall, 

Congress began a sweeping investigation to examine the root of the 

crisis and lay the foundation for action on common-sense regulation 

of the financial and housing industries. 

This is grim news today, but I expect that this Congress will act 

with the current President and the next President to get the economy back on track and get America back to work. 

3 

Clearly, we need a new direction on economic policy. American 

families need more help to weather this economic storm. 

I want to thank our distinguished panel of witnesses for appearing before us today, and thank Chairman Schumer for calling this 

hearing. I look forward to your testimony, as we work and help to 

lay the groundwork for the next economic stimulus package. 

[The prepared statement of Representative Maloney appears in 

the Submissions for the Record on page 63.] 

Vice Chair Maloney. I welcome all of my colleagues, and I now 

call on the Ranking Member, Mr. Brady, for his comments. Thank 

you for being here. 

OPENING STATEMENT OF THE HONORABLE KEVIN BRADY, A 

U.S. REPRESENTATIVE FROM TEXAS 

Representative Brady. Thank you. I join Vice Chair Maloney 

in thanking the panel of witnesses before us today. 

Congress and the Bush Administration have taken extraordinary 

steps to address this once in a lifetime global financial crisis, to 

unlock the credit markets, restore investor confidence, and work 

with other nations to prevent a worldwide financial meltdown. 

Given the resilience of the American economy, averting a sustained global recession, will, no doubt, allow us to recover much 

more quickly and strongly. 

But whether these actions are proven a success or a failure, depends a great deal on how smartly and timely they are implemented. The question now, is not how many more financial bills we 

can force down the market’s throat, but how effectively they are administrated and given time to work. 

It would be wise, as well, for the financial institutions receiving 

this help, to act responsibly. Hoarding these taxpayer dollars or 

simply using them to swallow smaller competitors, does nothing to 

increase credit for the creditworthy or address the crisis in confidence facing this nation. 

If these banks choose to use these dollars simply to further a 

competitive advantage, rather than contribute to the recovery of 

our economy, I imagine there will be plenty of bipartisan scrutiny 

within Congress to those irresponsible actions. 

As for the need for a second stimulus package, I seriously question its effectiveness. Already, there is ample evidence that it will 

simply become a Christmas tree of pet Congressional projects, from 

Amtrak to Medicaid, adorned with financial handouts to local and 

state governments, whose spending has outpaced even that of Congress, a remarkable feat, given that this Congress is the Usain Bolt 

of spending. 

Should there be help for the unemployed and struggling states? 

Of course. Are there pro-growth tax measures that could help kickstart our economy? Yes, especially, in my view, lowering for one 

year, the tax levy that prevents American companies from flowing 

back an estimated $350 billion in foreign profits from overseas, and 

investing them in new jobs and research here at home. 

Could we create jobs by injecting a boost of funding in our crumbling highway and bridge infrastructure? If done right, probably, 

but only if we bypass the Federal Department of Transportation 

4 

and inject those dollars directly into bid-ready construction projects 

that can churn over the next 12 months. 

But in the end, there is reality. The last stimulus did not work 

in a meaningful way. The dollars were negated by high gas prices, 

and, to their credit, taxpayers who chose to save their checks. 

The last time Congress provided financial aid to the Governors, 

in 2003, many states chose simply to pad their growing payrolls, 

which has only made worse, the financial crisis they face today. 

Given the size of our $14 trillion economy, the stimulus package 

is likely too small to have any significant impact. To put it in real 

terms, if the American economy were the size of a football field, the 

stimulus package represents only one yard, or if it grows larger, as 

some propose, two. 

It is difficult to see how that impacts the economic game in any 

meaningful way. 

Congress needs to do all it can to help this economy get back on 

its feet, but cannot forget the dire financial crisis of its own. Republicans, to our discredit, did not control spending and left control of 

Congress with an annual deficit of $160 billion. 

Democrats, in their first year of control, tripled the federal deficit 

to over $400 billion—tripled, in just one year. Worse, at the end of 

the current fiscal year, Congressional Democrats can boast the 

largest deficit in American history. 

And in the good news/bad news scenario, that’s what counts for 

good. The bad is that it doesn’t yet factor in the cost of the financial rescue plan, or the nearly $60 trillion in unfunded liabilities 

in Social Security, Medicare, and Medicaid. 

Any stimulus package Congress considers, should be debated in 

the context of both the current economy and the shaky financial 

foundation of the Federal Government. Given that the growing 

American deficit and the looming entitlement crisis, was a concern 

of world markets before the current financial crisis, perhaps one 

signal Congress could begin to send, is that we, too, are going to 

begin to act financially responsible, as well. 

With that, Madam Chairman, I yield back. 

[The prepared statement of Representative Brady appears in the 

Submissions for the Record on page 64.] 

Vice Chair Maloney. I thank the gentleman for his statement 

today, and I welcome all the panelists here. 

I would like unanimous consent to put into the record, Chairman 

Bernanke’s testimony before the House Budget Committee, concerning the second stimulus, and also the survey that came out in 

USA Today, where 74 percent of the economists surveyed, backed 

a second stimulus as a way to soften the blow. 

They did not feel that it would prevent the recession, but they 

believed it would prevent a worse and deeper recession. 

[The statement of Ben S. Bernanke before the House Budget 

Committee appears in the Submissions for the Record on page 66.] 

[The USA Today survey appears in the Submissions for the 

Record on page 69.] 

Vice Chair Maloney. I would now like to welcome the panel 

and introduce the panel. Also, I welcome all of my colleagues that 

are here today, including Mr. Cummings, Mr. Hinchey, Senator 

5 

Bennett, and, of course, Mr. Brady, representing the Ranking 

Member. 

Dr. Steve Landefeld, has served as Director of the Bureau of Economic Analysis since 1995. Previously, he served as Chief of Staff 

for the Presidents Council of Economic Advisors. 

He holds a PhD in Economics from the University of Maryland. 

Dr. Nouriel Roubini, is a Professor of Economics at New York 

University’s Stern School of Business and is also the Co-Founder 

and Chairman of RGE Monitor, an innovative economic and 

geostrategic information service. 

He received an undergraduate degree at Boccini University in 

Milan, Italy, and a PhD in Economics at Harvard University. 

Dr. Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at the Sloan School of Management, MIT, and recently 

finished two years as the Director of the IMF Research Department. 

Professor Johnson’s research focuses on the institutions that affect growth and crisis through their impact on entrepreneurs of all 

kinds. 

Dr. Richard K. Vedder, is a Visiting Scholar at the American Enterprise Institute, as well as the Edwin and Ruth Kennedy Distinguished Professor of Economics and Faculty Associate with the 

Contemporary History Institute at Ohio University. 

He received his PhD in Economics from the University of Illinois. 

Welcome. Dr. Landefeld, you’re recognized for five minutes. 

STATEMENT OF DR. J. STEVEN LANDEFELD, DIRECTOR OF 

THE BUREAU OF ECONOMIC ANALYSIS, U.S. DEPARTMENT 

OF COMMERCE, WASHINGTON, DC 

Dr. Landefeld. Thank you very much, thank you for inviting me 

to discuss the GDP accounts, especially this morning’s release. I’ll 

present the highlights, and I ask that the GDP release itself, be included in the record. 

In the third quarter of 2008, real GDP decreased, as you said, 

Madam Chair, 0.3 percent, at an annual rate. By comparison, it 

had increased 2.8 percent in the previous quarter. 

The decrease reflected declines in consumer spending, residential 

investment, and business non-residential fixed investing. By contrast, government spending, net exports, and business inventory investment, increased. 

The price index for gross domestic purchases, which measures 

the prices paid by U.S. residents, increased 4.8 percent, following 

a 4.2 percent increase in the second quarter. 

Consumer spending also, as you said, decreased 3.1 percent in 

the third quarter, following an increase of 1.2 percent in the second. The quarter decline in consumer spending, was the largest decline since the second quarter of 1980. 

Consumer spending on goods, fell 14 percent, with motor vehicles 

accounting for most of that decline. 

Consumer spending on nondurable goods, fell 6.4 percent, which 

is a rather significant decline for nondurable goods. 

In contrast, spending on services grew 0.6 percent. 

To the other part of the household sector, spending on residential 

investment, fell 19 percent in the third quarter, compared with a 

6 

decline of 13 percent. This is the 11th consecutive quarter in which 

residential investment has now fallen. 

Since its peak in the fourth quarter of 2005, residential investment has fallen over 40 percent. 

Business nonresidential fixed investment, fell one percent in the 

third quarter, compared with an increase of 2.5 percent in the second. Third quarter spending on durable equipment and software, 

fell 5.5 percent, whereas spending on nonresidential structures, increased eight percent, much of that being in oil and gas drilling 

and some in manufacturing. 

Business inventory investment contributed this time to growth, 

adding about a half a percentage point to growth. Last quarter, it 

subtracted 1.5 percentage points from growth. 

Exports of goods and services, increased six percent in the third 

quarter, compared with an increase of 12 percent in the second. Exports have now increased for 21 consecutive quarters. 

Imports of goods and services, decreased 1.9 percent in the third 

quarter, compared with a decrease of 7.3 percent in the second. 

Spending on goods and services by the Federal Government, increased 14 percent in the third quarter, compared with an increase 

of 7 percent in the second. 

Most of the increase was in defense spending. Spending by state 

and local governments, increased 1.4 percent in the third quarter, 

compared with 2.5 percent in the second. 

During the third quarter, Hurricanes Gustav and Ike, struck the 

Gulf Coast region, especially impacting coastal Texas and Louisiana. Because the effects of these storms are not separately identified in our source data that we use to estimate GDP, we can’t estimate their overall effect on GDP, but their impact is included in 

these estimates. 

In particular, disruptions to oil and gas extraction and to petroleum and petrochemical producers, are reflected in our estimates 

for inventory change in the nondurable manufacturing and wholesale trade industries. 

As I mentioned earlier, the price index for gross domestic purchases, increased 4.8 percent in the third quarter, excluding food 

and energy prices, the price index for gross domestic purchases, 

has increased 3.1 percent in the third quarter, after increasing 2.2 

percent in the second. 

The personal consumption expenditures price index, increased 

5.4 percent in the third quarter, after increasing 4.3 percent in the 

second. Excluding food and energy prices, the PCE price index increased 2.9 percent in the third, after increasing 2.2 percent in the 

second. 

Turning to the household sector, real disposable personal income, 

fell 8.7 percent in the third quarter, after increasing 11.9 percent 

in the second. The third quarter personal saving rate was 1.3 percent, compared with 2.7 percent in the second and 0.2 percent in 

the first. 

The second quarter increase in real disposable income, was boosted by tax rebate payments authorized by the Economic Stimulus 

Act. 

7 

Excluding these payments, real disposable income increased 0.3 

percent in the third quarter, after decreasing 0.4 percent in the 

second. 

Thank you, Madam Chair. 

[The prepared statement of Dr. J. Steven Landefeld appears in 

the Submissions for the Record on page 70.] 

Vice Chair Maloney. Dr. Roubini. 

STATEMENT OF DR. NOURIEL ROUBINI, PROFESSOR OF ECONOMICS AND INTERNATIONAL BUSINESS, NEW YORK UNIVERSITY, NEW YORK, NY 

Dr. Roubini. Madam Chair, members of the Committee, thank 

you for this opportunity to speak in front of the Joint Economic 

Committee. 

I would like to give you my outlook on the U.S. economy and on 

the need for a major fiscal stimulus package, and try to dampen 

the fact of a severe recession on the economy. 

The first observation I will make, is that this is clearly the worst 

financial crisis the U.S. and other advanced economies have experienced since the Great Depression. Hopefully, given the significant 

policy actions, the economic consequences are not going to be, of 

course, as severe as the Great Depression, but this is a most severe 

financial crisis. 

The second observation, which is confirmed by the data this 

morning about the third quarter GDP, is that the U.S. right now 

is in a recession, and in my view, and based on the analysis I’ve 

been doing for quite awhile, this is likely to be the most severe recession the United States has experienced in a number of decades. 

The last two recessions were relatively short and shallow; they 

lasted about eight months each, in 1991 and 2001, but even in 

2001, when the economy bottomed out in November of 2001, job 

losses continued all the way through August of 2003, for a cumulative loss of jobs of over five million jobs. 

Therefore, even in a situation of a relatively short and shallow 

recession, the economic consequences in terms of falling income 

and employment, can be severe and protracted. 

Based on my own research on the weaknesses of the various components of aggregate demand, consumption, cutbacks in spending 

by the corporate sector, residential investment, I expect that this 

recession is going to last at least 18 months, if not 24 months. 

This is going to be much longer and more severe and more protracted than the average U.S. recession that lasts only ten months. 

In a typical U.S. recession, the cumulative fall in output is on the 

order of two percent, and during the last recession, that fall in output was only 0.4 percent. 

Unless there is a significant fiscal policy stimulus action taken, 

I expect that this recession might experience a cumulative fall in 

output of over four percent. It is the worst we’ve had since World 

War II. 

So, things are very, very much stressed, and the most important 

point here, is that the condition of the U.S. consumer is very, very 

strained right now. The last time we had a single quarter of fall 

in real consumption growth, was the 1991 recession. In the 2001 

8 

recession, it was cut backs in spending by the corporate sector went 

bust. 

And as you know, consumption spending is about 71 percent of 

GDP. You have a U.S. consumer that is shopped out, saving less, 

debt burden, and now buffeted by negative shocks, falling home 

prices, falling equities, falling employment, falling consumer confidence, high and rising debt ratios and debt-serving ratios. 

No wonder that the third quarter has seen a very sharp fall in 

consumption spending. And this consumption spending fall is going 

to continue for the next few quarters. 

Unfortunately, the first stimulus package, through the direction 

of tax rebates, were saved by consumers. Why? They are worried 

about jobs, they are worried about paying down their credit cards 

and mortgages, and, therefore, I think that is now a need for a second fiscal stimulus package. 

This second fiscal stimulus package, will have to take the form 

of more direct spending by the Government, on goods and services, 

because, currently, the private sector is not spending, households 

are not spending, corporations are now worried about the economy 

and are going to cut back significantly on their capital spending. 

And if the private spending is going to fall sharply and tax incentives are not going to work, the only other way to incentivate and 

stimulate aggregate demand and prevent an even more severe recession, is going to be direct government spending in goods and 

services. 

Of course, you want to have this spending on things that are productive, like infrastructure, like investments in maybe alternative 

energy or renewable energy, and you also have to provide aid and 

income to those parts of the economy that are more likely to spend 

it. 

So, aid to state and local governments, is going to be effective; 

increasing unemployment benefits, food stamps to people that are 

poor. 

Another part, of course, of the adjustment, is going to be that 

there is a huge amount of households that are right now very much 

distressed, buried under the burden of mortgage debt, credit cards, 

auto loans, student loans, and we need also some reduction 

through loan modification, of this debt burden, because as long as 

this debt burden stays high, consumers are not going to be able to 

consume. 

So I think that I see the role for a very significant fiscal policy 

package. It has to be large, at least $300 billion, or even $400 billion, to compensate for the fall in private demand, which in the 

next year, could be on the order of $500 billion. 

And this action has to be taken right away, and soon; we cannot 

wait until the next Congress in February, because three months 

from now, the collapse of spending, consumption, and investments, 

will be so sharp that the economic contraction could become even 

more severe. 

So, action has to be taken now, soon, and in a large amount. 

That’s going to be the only way we’re going to try to make sure 

that this recession is going to be shorter and more shallow than 

otherwise. Otherwise, it’s going to be very, very severe. Thanks. 

9 

[The prepared statement of Dr. Nouriel Roubini appears in the 

Submissions for the Record on page 86.] 

Vice Chair Maloney. Dr. Johnson? 

STATEMENT OF DR. SIMON JOHNSON, RONALD A. KURTZ 

PROFESSOR OF ENTREPRENEURSHIP, MIT, CAMBRIDGE, MA 

Dr. Johnson. Thank you, Madam Chair. I’d like to make three 

points this morning: The first is that we are undoubtedly in a period of unprecedented global slowdown. I think, measured at the 

world level, we will see a recession of the kind and magnitude that 

we haven’t seen since World War II. 

It is very hard to find any country around the world, that is immune from this slowdown, and it’s very hard to find a country that 

doesn’t face severe pressures in its financial system. 

As I speak today, these pressures have continued to mount in 

emerging markets, for example, in East Central Europe, but also 

in Latin America and also in parts of Asia. 

These problems are not confined in their implications, to those 

places, because, as we have learned the hard way in the past few 

weeks, the extent of interconnections through finance and through 

trade, means that a problem in one part of the world, becomes a 

vulnerability and then a crisis in some other part of the world. 

In particular, I would stress the dangers of connections for 

emerging markets to western Europe. I think that the inflexibility 

of policy in the Euro zone and the rigidities of labor markets in the 

European Union, create the potential for a very large problem in, 

of course, the U.S.’s largest single trading partner region. 

The second point I’d like to make, is with regard to countercyclical policies in the United States. I do think that a great deal 

of progress has been made on this front since late September. 

In particular, I think that monetary policy, very broadly defined, 

has sprung into action, a little bit late, but now they’re working 

very hard. In my opinion, Mr. Bernanke is working from the antideflation play book that he essentially published in a speech he 

made on November 21, 2002, before the National Economists Club 

in Washington, DC. 

He outlines there, very clearly, what one should do, if one is running the Federal Reserve and the threat of falling prices and all 

that entails, looms on the immediate horizon. 

I think the Fed continues to be very innovative, and I would commend them on the progress that has been made, but I also think 

that some of the measures taken by Treasury, particularly the recapitalization of the banking system and the moves made towards 

recapitalizing the insurance industry, are very helpful and supportive in this context. 

I would also point out that the measures announced or perhaps 

pre-announced yesterday with regard to housing and restructuring 

mortgages, are a major step in the right direction. I think they’re 

coming about a month later than I would have preferred, but if 

they can implement that program and if they can, in particular, 

find ways to restructure mortgages that are locked up inside mortgage-backed securities, then we will have an important part of the 

overall approach in place. 

10 

All of this means that measuring the scale of monetary policy response, is incredibly difficult. It is very hard to assess the impact 

of the amount of liquidity that has been placed into the U.S. system and into the global system, including, remarkably, the extension of swap lines, again, yesterday, to four emerging markets, 

from the Federal Reserve. 

The third point is directly on the fiscal stimulus. I think it is 

very hard to judge exactly, today, given the global dimensions of 

the crisis, and given the fact that countercyclical monetary policy, 

in particular, is working hard, with help from other supportive 

policies, it’s very hard to know exactly how much fiscal stimulus 

will be required. 

I think we probably have a month or perhaps two months to really see the direction of the economy. I would agree completely with 

people who think that now is the time to prepare a large fiscal 

stimulus, and because I am so concerned about the global dimensions of this crisis and the way those can come back to the United 

States, my written testimony recommends, in detail, that we consider a fiscal stimulus on the order of $450 billion, let’s say, roughly three percent of U.S. GDP, which would be an extraordinary 

measure to take under any circumstances, unless you think that 

we are entering into a potentially serious and prolonged recession. 

The timing of your hearings is extremely fortunate, and I would 

strongly recommend that you consider drafting and hopefully finding a way to pass this legislation, if it is needed, by the end of this 

calendar year. 

I do think the amounts of money that I’m outlining, can be spent 

well. I outline in detail, some particular recommendations in my 

written testimony, and I’d be happy to answer any specific questions you have in that regard. Thank you very much. 

[The prepared statement of Dr. Simon Johnson appears in the 

Submissions for the Record on page 96.] 

Vice Chair Maloney. Dr. Vedder? 

STATEMENT OF DR. RICHARD VEDDER, DISTINGUISHED PROFESSOR OF ECONOMICS AT OHIO UNIVERSITY AND VISITING 

SCHOLAR, AMERICAN ENTERPRISE INSTITUTE (WASHINGTON, DC), ATHENS, OHIO 

Dr. Vedder. Thank you. I guess the economy must be in trouble, 

for the JEC to have a hearing less than a week before an election. 

I thank you for the opportunity to speak. I wish to make two or 

three brief points. 

First, economic history tells us that in periods of sharply eroding 

public confidence in financial markets, that this erosion does have 

significant negative economic consequences. 

But it is important to note that these periods do pass, and there 

is some indication that that may be starting to happen already. 

I would observe also that this crisis is not simply an example of 

market failure, of irrational exuberance trumping common sense. 

I’m convinced that it’s largely a reflection of a series of public policy miscues, and in the absence of these governmental mistakes, I 

think this financial crisis would never have happened. 

Third, I am very concerned that an overly zealous Congress, will 

craft an economic program that will have adverse economic effects, 

11 

and, unlike the previous witnesses, I am concerned that an expansionary fiscal policy in the form of higher government spending, 

would be the wrong thing to do, aggravating a potential explosion 

in inflationary expectations, already noted in today’s statement of 

a 4.8 percent rise in the GDP deflator. 

And I am concerned that if consumer confidence revives suddenly—and it does have a tendency to be volatile—this could have 

detrimental effects on markets. 

Of special concern to me, is the call for the second economic stimulus package. If we learned one lesson from the era of large budget 

deficits in the 1970s and so on, it is that fiscal stimulus does not 

promote economic recovery. 

I would note that the earlier stimulus package that went into effect, has been followed by a period of falling GDP and rising unemployment, rather than the reverse. 

Even in the heyday of Keynesian domination of the economics 

profession, scholars freely admitted that funding governmental infrastructure projects, was a dubious way to stimulate the economy, 

simply because of the practical difficulties of timing. It takes years, 

not months, for new appropriations in infrastructure, to actually 

lead to, for example, new roads or school construction. 

Very often, any stimulus provided by such construction, comes 

long after recovery has already occurred, creating inflationary conditions that could be avoided. 

If you’re going to have a stimulus package—and I am dubious, 

given the fact that deficits are likely to be in the $600 billion to 

$1 trillion range, anyway—if you’re going to have a stimulus package, certainly a tax cut or reduction, is preferable to a spending increase that would certainly take time to implement. 

And, of course, a tax cut would have some more positive long-run 

incentive effects. 

In conclusion, I would urge you not to panic. The Federal Government has taken the most aggressively interventionist position 

ever taken to deal with a crisis of investor confidence. 

The impact of all of this, may be to prevent an imminent collapse 

in the financial system—and I think it probably has been—but, 

only, perhaps, at the price of future stagflation, declining income 

and wealth, and a rise in national malaise, reminiscent of the 

1970s, not the 1930s. 

As I calculate it, the misery index is currently approaching 11; 

it was seven or eight or nine a few years ago, which means, in effect, that rising inflationary expectations may already be taking 

hold, and we are already in a situation where we cannot move up 

the Phillips Curve in the way that Keynesian economics would suggest. 

I think, in other words, you perhaps have done enough for now— 

maybe more than enough. Maybe the time has come to relax, wait 

a month or two, and allow the healing properties of the markets 

to be asserted again. Thank you for your attention. 

[The prepared statement of Dr. Richard Vedder appears in the 

Submissions for the Record on page 104.] 

Vice Chair Maloney. I thank all of the panelists for their testimony. Your complete testimony will be part of the record. 

12 

My first question to each of the panelists, is a simple one: Is the 

United States economy in a recession? And, give us any comment 

you’d like to make about it. Dr. Landefeld—and let’s get everyone 

on the record. Are we in a recession? 

Dr. Landefeld. Sometimes people use rough rule of thumb that 

two successive quarters of declining real GDP, is a recession. We 

at BEA do not use that rule. 

We defer to the National Bureau of Economic Research, who 

makes these determinations of the data in business cycles and they 

look at a lot of variables, including real GDP, but, prominently, employment figures, in their numbers. 

Whatever we may call it, certainly we are seeing a period of dramatic slowdown in economic activity, from a growth rate of 2.8 percent in the previous four quarters, to zero. 

I discussed the sharp decline in consumer spending. We all know 

there’s been a huge loss of consumer wealth during this period. 

Household disposable income share going to energy, has certainly 

gone up considerably over time, and the economy is growing at a 

rate too slow to generate new jobs, sufficient to keep up with labor 

force growth, population growth, and growth in productivity. 

And that’s the reason we’ve seen the uptick in the unemployment 

rate over the past 12 months, and the loss of jobs over that period. 

Thank you. 

Vice Chair Maloney. Dr. Roubini? 

Dr. Roubini. I do believe we are already in a recession, and, actually, my analysis suggests that this recession started already in 

the first quarter of this year, when the NBER states that business 

cycle—they tend to look at five economic variables: GDP, income, 

employment, sales and production. 

If you look at the historical data, all five of these variables, 

peaked between October of last year and February of this year. So, 

I expect that when NBER is going to decide eventually—and they 

usually are cautious and wait until the recession is over, before 

they date the beginning of it, and they’re going to date the beginning of this economic contraction to the first quarter. 

Already, the fourth quarter of 2007 data, were revised downward 

from positive to negative, and I expect that when re-benchmarking 

of the labor data by the BLS, it will be down again. Even the first 

quarter of this year is going to be revised to negative, and, eventually, the NBER is going to date the beginning of this recession to 

the first quarter of this year. 

Certainly, the third quarter number now suggests that there is 

a significant contraction of economic activity. Not only has GDP 

fallen, but if you exclude now, inventory adjustment, then the fall 

in the sales of domestic product, is even larger. 

So, when it walks and quacks like a recession duck, it is a recession duck, and we are in a recession. Everybody out there feels it 

is a recession. It’s obviously a recession. The only debate at this 

point, is how severe, how long, and how protracted, in my view. 

Vice Chair Maloney. Dr. Johnson? 

Dr. Johnson. I think the U.S. economy is in recession. I think 

it entered into recession, dramatically, in the late summer and particularly in September, with the global crisis of confidence in credit. 

13 

I think the danger now, is that we’re moving from a potential— 

what was seen previously to be a potential mild recession scenario, 

to a much more dramatic fall and a slow recovery. 

And, in that context, I would just highlight only one point in addition to what the two previous witnesses said, which is, the appreciation of the Dollar that has come about because there is so much 

global fear and so much running into Dollar assets, particularly 

U.S. Treasury assets. The Dollar has risen in value, dramatically, 

particularly over the past month, and, this, of course, hurts the 

U.S. in terms of its ability to export. 

That is the brightest part of the picture presented by the BEA 

this morning, and it’s been the brightest part of the picture for 

some time. 

So, in addition to all the problems that we’ve become accustomed 

to in the past six months, and, particularly, in the past six weeks, 

the intensification, we also have to add on to that, I’m afraid, a 

more appreciated Dollar and a much harder time for the export 

sector in the U.S. 

Vice Chair Maloney. Dr. Vedder? 

Dr. Vedder. I like what Dr. Landefeld said, a lot, and I’ll stick 

with that. I think the NBER makes the determination of when recessions are, not—obviously, we’re not in good times. Maybe we 

will be in a recession at some future date, and I don’t know where 

we stand with respect to that now. 

An 0.3 percent drop in the GDP, in and of itself, does not constitute a recession. 

Vice Chair Maloney. Thank you. My time is expired. I now recognize Mr. Brady for five minutes. 

Representative Brady. Thank you. Congress doesn’t need 

much of an excuse to spend more. We tend to do it naturally. 

And we’ve seen this in the last number of years, in a major way. 

Dr. Johnson talked about, I think, appropriately, the scale of the 

monetary actions that have occurred. 

I question the scale of the fiscal actions that would occur with 

the stimulus. We have a $3 trillion federal budget, we are overspending it by, this year, $500 billion. 

I question whether increasing that to overspending by $650 billion, really meaningfully improves our economy. In fact, I think it 

does the opposite. 

I think it raises more questions of consumer confidence, does little to improve investor confidence, especially in the financial foundation of our country. 

When I look at the scale of the U.S. economy, what I do note, 

that is standing out like a sore thumb in a very good way, is our 

exports across the global marketplace. 

One of the key reasons for government action across the world, 

is to avert a global recession or a sustained global recession. Exports have now become a major part of our economic growth, not 

just since a weak Dollar, but fully a year and a half beforehand, 

when the rate of growth of what we sell overseas, was better than 

the rate of growth of what we were buying into the United States. 

There is a great effort, I think, to draw walls, to build walls, to 

become more protectionist in this country, rather than opening up 

new markets overseas. I would ask Dr. Landefeld and Dr. Vedder, 

14 

is there a real concern, economic concern, that Congress’s actions 

to either close off these markets or to refuse to open more markets 

in Colombia, South Korea, and Panama, will that have a negative 

effect, a significant economic effect on the U.S. economy? 

Dr. Vedder? 

Dr. Vedder. I’m not an expert on Colombia, so far, but as an 

economist, I would say that any attempt to prevent an expansion 

of trade, a move towards freer trade, is going to have adverse economic effects. 

And what I do know about that agreement, is that the potential 

possible agreement, is that the effects are fairly severely negative. 

And, it’s generally consistent with my overall view that much of 

what Congress has done in the last year or two, has not been promotive of economic growth, but destructive of it. 

Representative Brady. So Congress’s actions have hurt, rather 

than helped? 

Dr. Vedder. That’s right. 

Representative Brady. Okay, Dr. Landefeld. 

Dr. Landefeld. Well, as Director of a statistical agency, we don’t 

comment on policy, but, certainly— 

Representative Brady. But as far as the economic impact of 

exports— 

Dr. Landefeld. The economic impact of net exports, it added 

about a percent during the previous four quarters, and it’s now 

added almost a percentage and a half to growth, at a time when 

other things are moving in the other direction. 

So, clearly, it’s the bright spot in economic growth and one that’s 

at least, up till now, accelerating in its contribution to growth. 

Representative Brady. As far as economic scale, that’s significant. 

Dr. Landefeld. Oh, yes. You know, we’re talking about a growth 

rate that fell from 2.8 percent to .8 percent over the relative fourquarter period. 

Representative Brady. But exports are— 

Dr. Landefeld. Actually— 

Representative Brady [continuing]. Our ability to sell, manufacture, dramatically improved that financial picture? 

Dr. Landefeld. Yes, by a percentage point in the last previous 

four quarters, and a percentage point and a half in the most recent 

quarter. 

Representative Brady. So our ability to sell our goods and 

services across countries, really have been sort of the lifeline in our 

economy here the last four quarters, six quarters? 

Dr. Landefeld. The last eight quarters, they have been a significant positive contribution to growth. 

Representative Brady. Great. Thank you, Madam Chairwoman. I yield back. 

Vice Chair Maloney. The Chair now recognizes Representative 

Hinchey. We’re recognizing members in the order of their appearance at the Committee. Representative Hinchey. 

Representative Hinchey. Chairman Maloney, thank you very 

much, and, gentlemen, thank you. It’s very interesting to listen to 

everything that you’ve said. 

15 

One of the interesting things about it, is the continuing controversy as to whether or not we are in some kind of economic decline. It seems obvious to me, frankly, for a long time, that this was 

coming. 

More than 18 months ago, we’ve been suggesting that our economic circumstances were in decline, and we’ve suggested that to 

people like Chairman Bernanke, but all across the board, including 

Secretary Paulson, the Chairman of the Securities and Exchange 

Commission, Chairman Cox, all of them have denied that we were 

in any economic problem, until September when the market collapsed. 

So, it seems pretty obvious that that’s the set of circumstances 

we’re facing, and it’s regretful that no positive action was taken to 

prevent this set of circumstances from happening the way that they 

have, and I think that there are things that could have been done. 

One of the principal indicators, is the job loss. Normally, what 

we say, is, you need about 100,000 to 150,000 a month, just to sustain economic growth and development. 

In August, we lost 84,000 jobs, and we’ve been losing jobs for a 

long time. In September, we lost 159,000 jobs. All through 2008, we 

have now lost more than 760,000 jobs. 

The likelihood is that we will have lost perhaps a million jobs or 

more before the end of this year. So, it’s pretty clear that we are 

suffering a very serious set of economic conditions here, and we 

need to act upon them. 

And so the idea of a stimulus package, just makes perfect sense, 

provided it’s done in the right way. And we have obvious, longtime, ignored internal needs, and perhaps finally, this is the incentive that this Congress is going to need and this President, perhaps, is going to need—we may be able to get this done in November. There’s a lot of interest now in that direction. 

So it seems to me—and I would appreciate your comments on 

this—it seems to me that about $300 billion is necessary for internal development, and in simple things that are needed, like basic 

infrastructure, bridges, roads, railroads, advancing mass transportation, water supply facilities, sewer treatment facilities. 

We know that with water supply facilities, for example, based 

upon history, you invest about a billion dollars, you get 47,000 jobs 

generated out of that. 

So that’s what we need, we need more jobs, we need more 

strength, we need a stable economy that’s going to begin to grow, 

and we need to begin to meet the internal needs of this country, 

which have been ignored now for so long. 

So I would appreciate what you might suggest about that, where 

we should be focusing our attention. I know that Dr. Landefeld has 

laid out a very clear analysis, but he’s not going to be commenting 

on the policies very much, so I’d like to start with Dr. Roubini. 

Dr. Roubini. I certainly agree with your points. Right now, 

we’re facing a very severe contraction of most components of aggregate demand. Consumption is in free-fall, spending by the corporate sector is in free-fall, residential investment is still collapsing, and the only bright spot in aggregate demand, net exports, 

is going to slow down in improvement, for two reasons: A stronger 

16 

Dollar and the fact that there is now a recession in the rest of the 

world. 

Our exports are the imports of other countries. We have a recession in Europe, in Canada, in Japan, and emerging markets, so 

there is going to be a sharp fall in our exports along the way. 

So I think that we need to do something, and, private demand 

right now, is not going to be incentivated by tax rebates, because 

people are so worried about their debts, about their jobs, about 

their income, that they did not spend the first tax rebate. 

So, if the private sector cannot spend and doesn’t want to spend, 

the government can spend, and help to boost aggregate demand in 

a situation where aggregate demand is going to be very sharply 

falling, and if we don’t do anything, we’re going to have the most 

severe recession we’ve had in decades. 

The other point I would like to make, is that until now, we’ve 

spent a fortune trying to help and backstop the financial system. 

Think about it: $30 billion for the Bear Stearns; $120 billion for 

AIG; $200 billion for Fannie and Freddie, all the new facilities of 

the Fed, TAF, TSLF, PDCF, swap lines, the commercial paper 

fund. The balance sheet of the Fed has been increasing from $800 

billion to $1.8 trillion. 

If you add up all the support you have given to Wall Street, it adds up to something like, already, $2 trillion, and we have done 

almost nothing for Main Street. 

And even if we need to backstop Wall Street, because a collapse 

of Wall Street will have so much collateral damage on Main Street, 

unless we support, also, Main Street, by making sure that aggregate demand is not going to collapse, six months from now, everything we’ve done to backstop the banks, is going to be undone by 

collapse in aggregate demand, which is going to imply credit losses, 

non-performing loans, delinquencies, mortgage defaults, foreclosures, defaults by corporations, and, therefore, if we don’t support Main Street, whatever we do to support Wall Street, is going 

to be undone. 

Therefore, we have to do both things. Until now, we’ve spent $2 

trillion ahead of us, for Wall Street, and have done close to nothing 

for Main Street, for real America. 

Representative Hinchey. Unfortunately, my time is up. 

Vice Chair Maloney. Senator Bennett is recognized for five 

minutes. 

Senator Bennett. Thank you very much, Madam Chairman, 

and thank you for holding the hearing. It’s very timely, and it’s essential that we go forward. 

I’d like a simple yes or no from each of you on this question. Forget all of the surrounding activities with it. 

Was TARP a good idea, the $700 billion, was it a good idea? Yes 

or no? Dr. Landefeld. 

Dr. Landefeld. Again, I’m going to have to dodge this. 

Senator Bennett. Okay. Dr. Roubini. 

Dr. Roubini. My answer is yes, as long as most of the money 

is used in order to recapitalize the banks with public injection of 

capital. I think that buying at high prices, toxic assets, was a bad 

idea, so the current implementation of it, is in the right direction. 

Senator Bennett. Dr. Johnson. 

17 

Dr. Johnson. The original design of TARP, to buy distressed assets, was a bad idea and remains a bad idea. Using those funds to 

recapitalize the banking system and the insurance industry and 

other financial institutions that may need recapitalization, as we 

head into serious recession, is a very good, if not essential idea. 

Senator Bennett. Okay, Dr. Vedder. 

Dr. Vedder. The original proposal that the Senate voted on, I 

reluctantly supported. When you got through revising and doing 

combinations and permutations on it, I was sort of luke-warmly 

negative on it, and sort of neutral on the thing. 

Senator Bennett. Okay. You add $700 billion to the national 

debt, our normal activities, independent of that, as has been pointed out, are going to add another $500 billion this fiscal year. 

And whenever you go into a recession, revenues go down, because people aren’t earning profits, and, therefore, they’re not paying taxes on the profits, so the national debt goes up that much 

more, and now we’re hearing calls for $350, $400, $450 billion in 

a stimulus package. 

Dr. Roubini, I hear what you’re saying about Main Street. I’m 

not sure I completely agree with you, but I understand the impulse 

in that direction, but I ask all of you—and you can do a toss-up 

as to who answers the question—what’s the impact in terms of the 

national debt and what it does to America’s competitive position, 

what it does—Dr. Johnson, you talked about the EU, our primary 

trading partner. 

We are seeing enormous stress being placed on our fiscal condition overall, with these kinds of expenditures. I’ve just got a grudging acceptance that the $700 billion addition 

to the national debt, was probably a good idea, for various reasons. 

Now we’re going to add some more with this stimulus package. 

Set aside the details of the package. I’d be happy to see our infrastructure get improved, not because of the financial stimulus, but 

because it’s deteriorating and needs to be improved. 

But talk about it from the debt standpoint. Who wants to do 

that? Dr. Vedder. 

Dr. Vedder. Well, I think you’re on to a good point, Senator. 

How are you going to pay for this? Are you going to print money? 

Are you going to raise taxes? Or, are you going to borrow the 

money? 

Presumably, we’re talking about borrowing. In a financially 

stressed situation, we’re talking about going out and borrowing, 

with, if you add $300 or $400 billion on to what we’re already 

doing, the better part of a trillion dollars, seven to eight percent 

of GDP. 

I think that is a dangerous and somewhat fiscally irresponsible 

thing to do, and I think, in the long run, it will inspire a decline 

in confidence and will lead to inflationary expectations soaring, 

particularly since I expect that some of it will be monetized, because of political pressures, leading to greater inflationary conditions. 

Senator Bennett. Anybody else? Dr. Johnson. 

Dr. Johnson. Two points that I think you need to keep in mind: 

The first is that the United States, compared to almost all other 

industrialized countries, has very weak automatic stabilizers. 

18 

Other countries have bigger governments, so when they go into 

recession, automatically, they swing into a bigger deficit, and that 

tends to counter the cycle. 

In the U.S., it requires a discretionary decision by Congress to 

have the same sort of countercyclical effect, so you have to make 

a decision to do what, in almost all other countries at this income 

level, happens automatically. That’s the first point. 

The second point is that the demand for U.S. debt around the 

world, is enormous. This is the counterpart of the lack of global 

confidence. There is one asset that stands out as being, without 

question, the safe place to park your money, and that’s U.S. Treasury debt. 

So I’m not proposing that you get of a path of medium-term fiscal 

stability and sustainability. Obviously, that would be a bad idea, 

but addressing these pressing needs right now, if the situation continues to deteriorate, and increase in the deficit, would be a good 

idea. 

Dr. Roubini. I would add another point, that you have to ask 

yourself: What is the alternative? If the alternative is one in which 

there is no fiscal stimulus and the recession is something like a cumulative fall of GDP of 4 percent, then the collapse in revenue is 

going to lead to such a widening of the fiscal deficit that actually 

if you do this fiscal stimulus the total effect on the fiscal balance 

is going to be smaller than the alternative. So you ask yourself: If 

you don’t act, what is going to be the alternative? And I see a very 

severe recession. 

So paradoxically, by doing the spending you are going to make 

sure that the fiscal deficit is going to be smaller than otherwise. 

Vice Chair Maloney. You are yielding back your time? 

Senator Bennett. Yes. Thank you. 

Vice Chair Maloney. The Chair recognizes Representative 

Cummings. 

Representative Cummings. Thank you very much, Madam 

Chairwoman. 

Dr. Roubini, you said something that I have been saying, and I 

am glad to hear somebody like you say it. We bail out, or we tried 

to bail out Wall Street because we were worried about the bleeding 

into Main Street. And I have said it over, and over, and over again: 

The people in my City are losing their houses. They are, with regard to employment they do not have Unemployment Benefits. 

They have run out. So a lot of the arguments you are making, Dr. 

Vedder, folks are suffering badly. 

And as I listened to you, Dr. Vedder, I could not help but think 

about the many times I have sat in this hearing room right here 

and heard our experts come up there and said: Wait, wait, wait. 

Well the American people are suffering. 

Now going back to you, Dr. Roubini, I believe that it is one thing 

to bail out Wall Street but when you have got people being foreclosed upon who do not have jobs, who are losing their houses, who 

cannot get consumer loans, and I can go on and on as you talked 

about, Dr. Johnson. So you are doing what you can on the upper 

end—that is, Wall Street—but you have got to have something 

down there, like for example the efforts by the FDIC to help folks 

with these mortgages. 

19 

That makes sense because you are stopping the bleeding down 

at the bottom. Because I don’t care what you do up at the top, if 

you are not stopping the bleeding of the folks who are really suffering you have got a major problem. And it is like taking money 

and throwing it into a bucket with a hole in it, as far as I am concerned, if you are not dealing with that. 

So the question that I’ve got, we spent yesterday in another committee that I sit on—and that is the Transportation Committee— 

we spent eight or nine hours talking about a stimulus package, a 

stimulus package which would include infrastructure repairs, 

schools, and also of course creating jobs. 

This is my question: When I look at this total picture, I realize 

that one of the things that we want to do, yes, we want to inject 

money into our economy so that people will begin to spend, and so 

that everybody is affected, each job affects each construction job, 

which effects other jobs. The question is: What is the impact, and 

is it significant that it has impact, on consumer confidence and investment confidence? 

Those are the questions. Because I was just wondering if there 

is more impact than just the creation of jobs, people working—and 

that is major; I understand that—but I am trying to figure out how 

do we get a handle on this whole problem. Because as you all have 

said, this is monumental. 

The other thing I would ask you, Dr. Roubini, you stated that if 

we do not do something now, that we would basically see catastrophic results. And I want you to elaborate on that. 

Dr. Roubini. Yes, to elaborate on some of your points, first of 

all I think there is definitely a perception out there in the public 

that a lot of what is happening right now is because of reckless 

lending and reckless investing and arrogance and greed on Wall 

Street, and now what are we doing? We are essentially bailing out 

those reckless lenders and investors. 

Now we have to do it because the collateral damage to the real 

economy is going to be severe, but there is a perception out there, 

and that is why I think the House first voted against the TARP 

Legislation that we had privatized the profits and the gains, and 

now we are socializing the losses. This is like corporate welfare for 

the rich and for the well-connected on Wall Street, and there is an 

element of unfairness. 

So people out there are going to ask you who are spending $2 

trillion to backstop the financial system what are we doing for U.S. 

housing? What are we doing for Main Street? What are we doing 

for people who are suffering and losing jobs? It is a question of efficiency and fairness. 

Leaving aside the fairness point, I think the crucial point right 

now is private demand is in freefall. If you look at the latest data 

on consumption, on residential investment, on cutback in spending, 

even before the shocks of September and October were dramatic 

and now there is a nasty credit crunch, aggregate demand was free 

falling and nothing is sustaining it. 

We have gotten into a situation right now in which Central 

Banks who are supposed to be the lenders of last resort have become the lenders of first and only resort because banks are not 

lending to each other. Banks are not lending to corporations. And 

20 

corporations do not have credit and cannot spend and invest and 

hire people. 

So we have a nasty credit crunch. At this point, we have to start 

to do something for Main Street. Because as I said, if there is going 

to be a collapse of economic activity—and all the data suggest this 

is going to be the worst recession the U.S. has experienced in a decade—then bailing out Wall Street is not going to be enough. Because the losses, and the credit crunch, and the defaults are going 

to rise, and anything we do to recapitalize the banks are going to 

be undone. 

So both in terms of efficiency and fairness, we have to do some- thing for Main Street. We have spent $2 trillion of money right 

now to help Wall Street, we can find $300 billion to do something 

for infrastructure, for aiding state and local governments, for unemployed, for food stamps is good, is necessary, it’s fair, and if you 

don’t do it things are going to get much worse. 

Representative Cummings. Thank you. I see my time is up. 

Vice Chair Maloney. Thank you. Dr. Roubini, you have testified that the U.S. is more likely to experience deflation, or falling 

prices in the coming recession rather than experiencing high inflation. And while we have seen falls in oil prices recently and corresponding drops in gasoline prices, both headline and core inflation remain relatively high compared to previous years. 

Could you elaborate on why you believe inflation will fall? 

Dr. Roubini. My view is that six months from now the biggest 

problem that the Fed is going to have to face is the problem of deflation. And the same thing, by the way, happened during the last 

recession that was short and shallow by 2002, as you recollect, the 

worry was not inflation but deflation. And Chairman Bernanke 

wrote several speeches about what to do if we get close to deflation 

in terms of nontraditional monetary policy. 

Why do I feel there is going to be deflation in the economy? 

Three reasons: 

There is a slack in aggregate demand relative to supply. Aggregate demand is falling very sharply. And when that happens, the 

pricing power of the corporate sector is reduced. And by the way, 

we already have price deflation in the sectors of the economy where 

there is this excess of supply: housing, consumer durables, and 

automobiles and motor vehicles. We already have deflation in those 

sectors. 

Secondly, there is a beginning of a very large slack in the labor 

market. The unemployment rate is sharply up. The job losses are 

mounting month after month. When there is a large increase in unemployment—it is going to peak above 8 percent—labor costs and 

wage growth costs are going to be dampened significantly. 

The third reason is that oil prices have already fallen more than 

60 percent from their peak in July, and other commodity prices 

have already fallen by something like 25 percent from their peak. 

In a very large U.S. and global economic slump, commodity prices 

are going to fall from the current level by another 20, 25 percent 

for a cumulative fall in commodity prices by 40 percent. So slacking 

in goods market, slack in labor markets, slack in commodity market, and the huge excess supply of production of goods—think 

about China that’s investing 50 percent of GDP to produce more 

21 

capital goods for export—this excess supply relative to falling demand is going to imply that six months from now the Fed, the CB, 

and most advanced economies are going to start to worry about deflation. 

As we know from the experience of Japan, deflation can be very 

destructive. So that is what we have to worry about. Current headline inflation and core inflation are still high, and it is going to 

sharply decelerate in the next few months. 

Vice Chair Maloney. What risk would falling prices, could you 

elaborate, what risk would falling prices have on the U.S. economy, 

to Main Street, to the working man and woman? And how would 

the stimulus package fit into this? Would the fiscal package help? 

How would it help? Could you elaborate further? 

Dr. Roubini. Well deflation is dangerous for a variety of reasons, as the experience of Japan in the 1990s suggest where they 

had deflation and you had economic stagnation for a decade. 

The first risk is that when prices are falling you want to postpone consumption until the future rather than consuming today, 

and that reduces further demand and supply. 

Secondly, you get into a situation of a liquidity drop when if interest rates are going to go close to zero—and I think the Fed 

Funds soon enough is going to be at zero—if prices are falling, you 

cannot use interest rates below zero in nominal terms but the real 

interest rates are going up, because real rates are the difference between the nominal and inflation, so inflation becomes negative, real 

interest rates are going up. 

When you have price deflation there is also this process of debt 

deflation where the real value of the debt, of those who have borrowed, increases over time rather than being reduced. That increases the debt servicing problems of the debtor, and in a situation in which prices are falling and profit margins of the corporate 

sector are falling, they tend to produce less. If you produce less, 

there is less income, less employment, and the vicious circle of the 

contraction in output and employment, income, consumption continues over time. 

Situations of deflation are very, very dangerous and the situation 

in which the monetarist policy stimulus becomes ineffective. That’s 

why in 2002 Chairman Bernanke wrote a series of speeches saying 

what can we do to prevent the deflation from occurring? We have 

to prevent it again this time around. 

Vice Chair Maloney. How will a fiscal stimulus package help? 

Dr. Roubini. It helps because in a situation of deflation demand 

is below supply, and because demand is below supply prices are 

falling. So you have to boost demand. And if the private sector is 

not spending and increasing demand by the public sector, government spending on goods and services hopefully productive stuff 

that are for the long run like infrastructure we need for things that 

are crumbling is going to boost demand and prevent deflation from 

occurring. 

Vice Chair Maloney. My time has expired. 

Mr. Brady. 

Representative Brady. Thank you for holding this hearing. I 

think it is important to do that. 

22 

Secondly, it is, as we were talking, important to keep an open 

mind on the stimulus package. My concern is that we are offering 

false hope. 

A year ago this Joint Economic Committee met to consider the 

first economic stimulus, and I recall Chairman Schumer, who is 

one of our most engaged and involved Members of Congress, state 

that the only thing standing between America and a recession is 

this Congress. 

We know what occurred. I do not want to present, or market this 

proposed stimulus package as the magic beanstalk that will grow 

America’s economy to the sky when it may in fact be closer to a 

bean, where just our deficit spending over the past year is three 

times—in direct spending—is three times the size of this proposed 

stimulus package. 

So I do not think we ought to market it in a way that it cannot 

accomplish. And again, if we can move to help those who are unemployed in states that have no job hope, let’s do it. If we can find 

ways to create jobs on Main Street, let’s do it. But let’s not present 

this as the only thing standing between an economic collapse and 

the American public. Because by no measure is it. 

My question to the panelists is perhaps on the bigger picture. If 

you look at the last 30 years, we are remarkably resilient. We have 

bounced back from some huge hits, whether it is the ’87 crash, the 

dotcom crash, the attacks of 9/11, amazingly resilient. It becomes 

much harder to bounce back in a global recession. 

As economists, what should we be—as Members of Congress, 

what should we be looking for as signals on how deep the global 

recession is headed, or what measurements? How much time 

should we allot to see if these global, remarkable actions by governments are working? What signals? What measurements should we 

be observing to determine what the global picture is and how it is 

unwinding so that we can measure our responses here in the 

United States? 

And I would open it up to just go down the panel, if you could. 

Dr. Landefeld? 

Dr. Landefeld. Again, I think I will have to not answer this 

question because it tends to get into policy and when one should 

respond at what signal. 

Representative Brady. Thank you. 

Dr. Roubini. My view is that even before the very severe financial shocks of September and October, when you look at the data 

for the second quarter of this year, there was an economic contraction starting in the Euro Zone. The GDP growth was negative. 

GDP growth was negative in the UK, in the rest of Europe, in 

Japan, in New Zealand, in Canada. So about 60 percent of global 

GDP that is the part counted by most advanced economies was already contracting in the second quarter of this year, well before the 

very severe financial strains we have observed in September and 

October in the U.S., in Europe, in the emerging markets that have 

now led to more of a liquid and a credit crunch, more of a panic, 

more of a falling business and consumer confidence, and therefore 

there are actually a number of research firms on Wall Street like 

J.P. Morgan, or Goldman Sachs who are already estimating the 

23 

third quarter and fourth quarter GDP growth globally is going to 

be close to zero, if not negative. 

And unfortunately now the crisis that started in the U.S. and became European and the advanced economies now is starting to lead 

to a hard landing in a number of emerging market economies. 

There is a sharp slowdown of growth in China, in Asia, in Africa, 

in Latin America, in emerging Europe. There are about a dozen 

emerging market economies right now that have been subject to 

this financial tsunami that are on the verge of a financial crisis: 

the Baltic countries, Latvia, Estonia, Lithuania, Bulgaria, Romania, Hungary, Turkey, Belarus, Ukraine; going to Asia: Pakistan, 

Korea, Indonesia; in Latin America, Argentina, Ecuador, Venezuela, to name just a few. 

So this is becoming a global financial crisis, and it is becoming 

also a global recession. And the consequence of what the U.S. is 

going to be to the rest of the world is contracting. The only bright 

spot in demand was exports. Exports are going to start to fall, and 

that becomes a more vicious circle. That is why we have to worry 

about it and do something about it. 

Representative Brady. I’m sure there was my answer in there. 

Dr. Johnson? 

Dr. Johnson. I suggest you can look at three things. 

The first is the interest rates which the market is charging, or 

trading, emerging market debt. This is indicating eminent default 

for a number of countries that I prefer not to name in public. Eminent meaning within the next few weeks. 

The second measure is stress within the Euro Zone. There you 

look at the probability of default in the credit default swap spreads 

that are traded for European governments. These have come down 

slightly in the last 24 hours, but they are at remarkably high levels. Really we have not seen anything like this since the 1930s for 

developed industrial countries. 

The third measure is the dollar. When everything is going back 

in the world, if the world is going into a deep level of recession, 

people are going to come back to the dollar. Again in the last couple of days the pressure has come off the dollar a little bit, but the 

more the world gets worse the more investors are going to want to 

come into the dollar, the more they are going to want to buy U.S. 

Treasuries. 

I think you will know a lot about where the world is heading, 

how deep and how sharp it is, in a month, one month. 

Representative Brady. Thanks, Doctor. 

Dr. Vedder. Well I am kind of old fashioned. When I look at the 

macro economy I look—and like Dr. Roubini—at the basic indicators, GDP, and unemployment growth. I do think looking at the 

dollar is fascinating, but I am not sure you can tell for sure. 

But getting to your export point, the decline in exports, your 

point earlier, Congressman, about moving towards a greater free 

trade policy and away from protectionism, if there ever was a time 

to do this it would be now, it would seem, in order to promote our 

export growth. 

Representative Brady. Right. Thank you, Doctor. I yield back. 

Vice Chair Maloney. Mr. Hinchey. 

24 

Representative Hinchey. Thank you very much, Madam 

Chairman. This has been a fascinating hearing and I thank you, 

gentlemen, very much, for the insight that you are giving us here. 

The Gross Domestic Product is the driving force of this economy, 

and now we are seeing that GDP begin to go down. We know that 

the Gross Domestic Product is driven by middle-income working 

Americans, mostly blue and white-collar working Americans. They 

drive the GDP by at least two-thirds. 

And so we know that their circumstances are declining, and we 

know that in order to deal with this situation we are going to have 

to engage in economic growth that is going to create more jobs and 

deal with the internal issues of our country that have been ignored 

for so long. 

I mean, basic, simple things like sewer treatment plants which 

have not been updated since the 1980s; water supply facilities, the 

same thing. You have water supply systems all over this country 

falling apart, just literally falling apart. 

So all of these things, in addition to transportation, has to be addressed and dealt with. But it seems also that there’s at least one 

other thing. That is, new technology. Very new, very sophisticated 

technology which in many instances is on the edge of really doing 

something very creative, particularly with regard to energy. This year we are going to spend more than $400 billion buying 

oil from countries outside of the United States. We import 70 percent. Obviously we need a new system of energy generation. So I 

am wondering if you can give us some insight as to what you think 

about the development of this new technology, particularly new 

technology which would begin to make this country more energy 

independent. 

Dr. Johnson, if you could begin I would appreciate it. 

Dr. Johnson. Certainly. I think you are making a very important point. I think there is a longer term need to invest in new 

technologies relative to energy, and to develop alternatives to oil. 

Oil prices are obviously falling at the moment and I expect they 

will fall further as the recession develops, but this is a cyclical development, and I think that technology has great promise. 

It takes years of course to bring that technology out of the labs, 

and it takes even more years to bring it to commercial fruition. I 

think though the right way to think about the stimulus is in terms 

of shorter term and longer term impact. So shorter term would be 

income support, it would be food stamps, it would be expanding 

Unemployment Benefits in ways I outline in my written testimony. 

Some of the longer term things would also be the kinds of infrastructure you are talking about—water treatment, and roads, and 

so on—that would fit as part of the same package. And I think supporting technology in that framework makes a lot of sense. 

It is going to be a long slog. I think the recession will be quite 

sharp, and it will be three or four really unpleasant quarters. And 

then I think we will start to grow again, but at a painfully slow 

pace, probably not creating enough jobs. So unemployment will continue to rise. 

I think in that context what you are proposing, as long as there 

is a short-term impact, we need that I think starting as soon as 

possible, and realistically it is hard to get infrastructure going in 

25 

the next three months, unless you are talking about money for 

maintenance. I think there is a lot of good maintenance ideas out 

there that can be used right away. 

But in terms of developing your projects, that takes some time 

and technology takes a little bit longer. But I think we should be 

thinking out three, four, five years in terms of getting this economy 

back on what will hopefully be a sustainable longer term trajectory. 

Representative Hinchey. Thank you, Dr. Johnson. Dr. 

Roubini, would you comment on that, please? 

Dr. Roubini. I agree with you that the issue of energy security 

is going to be one of the most crucial economic, financial, and also 

national security issue for the United States, and you have to work 

on it both on the supply side and on the demand side. 

On the supply side, I think there is a huge amount of new potential technologies, alternative energy, renewable energy that you can 

develop over time. I mean, it is embarrassing that a country like 

Germany where there is barely any sun is much more advanced in 

solar technologies than the United States because we have not 

given enough support to the development of these technologies. 

That’s the first observation. So we can do a huge amount of investment in research in all these renewable and alternative energy. 

On the demand side I think that the lesson is that probably a 

system of cap and trade is going to be beneficial for the U.S. and 

is going to essentially resolve four problems: 

The revenue from these auctions is going to be able to reduce the 

budget deficit and/or finance investment in alternative energy. Our 

trade deficit is going to fall because our demand for imported oil 

is going to fall. Our dependence geopolitically on unstable states 

that are producers of oil and energy is going to be reduced. And 

we are also going to contribute to improvement in global climate 

change. 

So you get four birds with one stone: lower budget deficit, lower 

trade deficit, less national security risk, and improving the environment. That is the direction we have to go both on the supply and 

on the demand side. [Applause.] 

Representative Hinchey. Thank you very much. A lot of support here for that, too. 

Dr. Vedder? 

Dr. Vedder. Yes, well, how can you talk against technology? It’s 

like talking against motherhood. I’m all for it. But to pick up on 

Dr. Johnson’s point, there is a short-run problem we have now of 

a business cycle problem. 

Long-term solutions may be desirable for the country for other 

reasons, and we could have that discussion, but I do not know that 

it is relevant in solving the current problems with respect to the 

economy at the moment. 

In fact, if you want to do an energy fix that will have a more immediate effect, I would just simply let people drill more in places 

like Alaska, if that is the goal. But I am not versed—I am not an 

expert on our energy policies enough, except to say that I do not 

think it will do anything for the short term problem that we have. 

Representative Hinchey. Thank you. 

Vice Chair Maloney. Senator Bennett. 

26 

Senator Bennett. Thank you. I would be tempted to get into 

this energy debate, and if you want to create jobs you can create 

them a whole lot faster in ANWAR than you can with some of 

these other issues, but I will leave that, tempting as it is, and go 

back to this discussion of commodity prices. 

Dr. Roubini, you say commodity prices are falling from their 

peaks. That’s true. And isn’t that a good thing? Certainly the falling price in oil is a major lifeline to the airlines. The newspapers 

are reporting this morning that some of the airlines made longterm commitments at $145 a barrel, and now they are stuck with 

those and they would love to scrap those and start making commitments at $65 a barrel. 

That means more jobs in the airlines. That means more productivity in the airlines. The falling price of oil has enormous benefit 

to the chemical industry that is dependent on petrochemicals as 

feedstock for what they do. There is tremendous benefit to farmers 

because of the lower price of fertilizer, and that means falling 

prices in food, which deals with starvation around the world and 

helps that, which will increase demand. 

So I am giving you an opportunity to go a little farther in this 

because your comment left the impression that the falling commodity prices is one of the things we have to deal with, and that’s 

terrible, and I think it’s true of housing, yes, housing prices are 

falling, but they are falling from unsustainable peaks. And we will 

not have stability in the economy until housing prices get down to 

their intrinsic level of where they ought to be as people buy housing for shelter rather than buying housing for the purpose of selling it to some speculator who is going to buy it to sell it to another 

speculator who is buying it to sell it to another speculator, and that 

is what got us in this trouble in the first place was prices peaked. 

And now we are seeing the actual correction in those peaks. Take 

that and respond a bit, and then I would like some of the others 

to do it, as well. 

Dr. Roubini. Senator, you certainly make a valid point in suggesting that eventually the fall in oil and energy price is going to 

be beneficial for the economy and for the strapped consumer, given 

the very sharp rise in transportation cost and energy was a very 

major drain on the disposable income of that sector. 

But you have to ask yourself why are all energy and commodity 

prices falling so sharply. They are falling because in the commodity 

market in the short run the supply is very inelastic, and if you 

have a collapse of demand because there is a U.S., European, and 

global recession, then of course prices are going to fall sharply. 

So the falling prices is a signal of a malaise or a disease that we 

are entering a recession. Of course once these prices are going to 

fall very sharply, that’s going to boost over time disposable income 

and is going to be one of the reasons why we are going to spin into 

an ever declining recession. It’s going to be the bottom of it. 

An additional observation: While in the short run oil and energy 

prices are going to be falling because of the cyclical recession, ask 

yourself what is going to happen to oil and energy prices in the medium-run when the U.S. and the global economy gets out of this 

recession. 

27 

The demand growth for energy is going to be huge, because most 

of the growth in the global economy is coming from emerging markets, countries that are industrializing or urbanizing like China 

and India. Their demand growth is going to be very large, and the 

question you have to ask yourself is: How much growth in supply 

is going to be out there in oil and energy? 

And unfortunately, most of the sources of supply of energy and 

oil are in a bunch of unstable petro states. One week you have 

trouble in Nigeria. The next week it is Venezuela. The next week 

is Iran. The next week is Iraq. The next week is Russia. 

Senator Bennett. Sure, I— 

Dr. Roubini. The growth of supply might be slower than the one 

of demand, and then we have to do something about the energy security because outside of this slump prices are going to start rising 

again and again we have the same problems. 

Senator Bennett. I am conscious of the time, and just one quick 

comment. I buy the argument that long-term renewables and technology and sustainables are all the thing we ought to go to. I believe in that promised land. 

The bridge to that promised land is built out of fossil fuels. That 

promised land is 20 years away. And if we do not start increasing 

our supply of fossil fuels in stable countries, including this one that 

is the third largest producer of fossil fuels in the world, then we 

are adding to the instability. So that is a separate question and a 

separate argument. 

Dr. Johnson, you wanted to comment. 

Dr. Johnson. Senator, I think you put your finger on a very important irony, or almost a paradox, which is how can falling commodity prices be bad? It obviously helps the U.S. consumer, it helps 

firms, as you said. The problem is that—and commodity prices falling by themselves, if that is the only thing that is happening, 

would not be bad; that would be good. But it is happening in this 

global context where there is downward pressure on other prices. 

For example, the price of imported goods are going to come down. 

The dollar is appreciating and our exporters are going to be fighting very hard to sell to us. There is downward pressure on the 

price level as a whole. And that by itself does not necessarily add 

up to a problem unless it also pushes down wages. Almost all of 

our debts are fixed in nominal terms, if our wages fall in nominal 

terms and our debt burden has gone up. And when Chairman 

Bernanke gave his speech saying—which is entitled, November 

2002, Deflation: Making Sure It Doesn’t Happen Here, he meant 

not only deflation, he meant the Great Depression. 

The key thing about avoiding the Great Depression is avoiding 

deflation. When our debts are in nominal terms, we have falling 

prices and falling wages, we are going to have a much, much bigger 

problem than the one we are considering and really focused on 

today. 

Senator Bennett. Dr. Vedder. 

Dr. Vedder. As an economic historian I am amused at this discussion. Between 1864 and 1896, wholesale prices in the United 

States fell more than 60 percent. We had a 4 percent economic 

growth, and we became the largest economy in the world. 

28 

In the 1990s, yes, Japan had, quote, ‘‘deflation,’’ but it is interesting that the fiscal policy followed during that decade was one of 

great expansion, Keynesian expansion, along the lines that are 

being suggested here. A lot of good it did them. 

Senator Bennett. I see my time is up. Thank you, Madam 

Chairman. 

Vice Chair Maloney. Mr. Cummings. 

Representative Cummings. Thank you very much, Madam 

Chairwoman. 

You know I am just trying to put myself in the shoes of the people, the people like in every one of our Districts who never thought 

they would lose their job but they lost them and continue to lose 

them. In the City of Baltimore we have an unemployment rate of 

7.1 percent, almost 20,000 people out of a population of less than 

650,000 who do not have jobs. 

The duration of unemployment has risen from an average of 16.7 

weeks in September of 2007 to 18.4 weeks in September of 2008. 

Additionally, the percent of unemployed who are unemployed for 

more than 27 weeks has risen from 18.1 percent to 21.1 percent 

from September 2007 to September 2008. 

BLS does not report statistics for unemployment greater than 27 

weeks. However, since the average duration of unemployment has 

risen, and because more than 1 in 5 unemployed persons is unemployed for more than 27 weeks, is it not likely that there are a 

large number of unemployed persons who have exhausted their Unemployment Benefits even with the additional 13 to 20 weeks allowed in high unemployment states? 

Also, isn’t it likely that unemployment rates will rise over the 

next year, and that many more jobs will be lost adding further support for the need for more Unemployment Insurance? 

The reason why I raise this is because, you know, Mr. Vedder, 

when Bernanke testified before the JEC, sitting in one of the same 

seats you are sitting in, and we talked about the housing situation, 

basically he said: It’ll work out. Everything will be fine. It will be 

fine. We talked about the way unemployment was rising, he said: 

It’ll be fine. It’ll work out. 

The problem is that a lot of people—I mean, everybody up here 

have people in their Districts who have lost jobs, and who will continue to lose jobs. You know, not long ago, everybody thought get 

a Whirlpool job, you know, you would be in good shape. You could 

retire and be fine. But people in Whirlpool today and other companies are losing their jobs. 

People in New York, I know many of them have lost jobs. It is 

estimated that by the end of this year 1.1 million people will have 

run out of Unemployment Benefits. So talk about that, Mr. 

Roubini. 

In other words, I was very glad to hear Mr. Brady say that perhaps we might want to look at trying to figure out how we can help 

people in areas where unemployment is high, but it did concern 

me—and I do not think there is anybody up here who is trying to 

create false hope. 

It is not about false hope. It is trying to help the American people as they go through a very difficult circumstance. And you, Mr. 

Johnson, said—Dr. Johnson, I apologize, you talked about how long 

29 

this could go. You said 18 months. Or longer? Is that what you’re 

indicating? 

Dr. Johnson. Yes. 

Representative Cummings. Okay, or longer. And it seems to 

me that if you do not have a job, and let’s say for example you had 

a consumer loan that you were trying to pay, you are not going to 

be able to pay it. I mean, that is why in some kind of way it seems 

to me we have got to address this whole issue of people on Main 

Street, and we have got to do it now. 

We have got to have a sense of urgency, because the people that 

I represent, you know, they listen to all of this, it sounds nice, but 

they are trying to figure out how they are going to survive from 

one day to another, how they are going to be able to afford the gasoline even if it comes down to $1.99 a gallon. That is what they 

are trying to figure out. 

So would you all talk about the unemployment situation and how 

you see it—Dr. Johnson, Dr. Roubini, and maybe even you, Dr. 

Vedder. 

Dr. Johnson. Thank you. In my written testimony I suggest 

very strongly that Unemployment Benefits should be extended beyond the current expiration time. I think the Food Stamp Program 

needs to be expanded. I think loan modifications for distressed 

homeowners are very important both to help people appropriately 

and because of the macroeconomic effect. And I think that for the 

longer term programs, job retraining programs, or grants are extremely important. They take a little bit longer to work. And expanded student loans, and expanded small business loans would all 

address the issues that you are raising—part of a broader package 

that includes infrastructure. 

But we are looking at four to five years, I think, of a problem, 

not a four- or five-year decline, but a sharp recession followed by 

a very slow recovery. There is plenty of time for all of these programs to work and to address exactly the concerns that you are 

raising, Mr. Cummings. 

Representative Cummings. Dr. Roubini, did you have a comment? 

Dr. Roubini. I think the issue with unemployment is going to 

be a very serious one. Even during the last recession in 2001 which 

was very short and shallow and lasted only eight months, and the 

fall in output was only a mere 0.4 percent, job losses continued all 

the way through August of 2003. There were 5 million jobs lost. 

And there is an agreement that this time around this is going to 

be a much more severe and protracted recession because at that 

time it was only a cutback in spending but the corporate sector was 

falling 10 percent of GDP. Right now, there is a beginning of a consumer recession and consumption is about 71 percent of GDP. 

So you have a U.S. consumer who is shopped out. He is saving 

less. That burden of debt to disposable income of the average 

household has gone from 100 percent in 2000 to 140 percent. Now 

home prices are falling, so you cannot use your home as an ATM 

machine, borrowing against it. The value of your 401K has sharply 

fallen, 40, 50 percent. Debt service ratios are now rising because 

of the resetting of interest rates on mortgages, credit cards, auto 

30 

loan, student loans. Consumer confidence is collapsing. So everything is going south for the U.S. consumer. 

And people said until recently, yes, these are headwinds against 

consumption, but as long as there is job generation and income 

generation people are going to keep on spending. But guess what? 

Now for 10 months in a row employment in the private sector has 

fallen, and for 9 months in a row total employment including public 

employment has fallen. Every indicator of the labor market suggests that this rate of job loss is accelerating. 

A few months ago we were losing 50,000 jobs per month. In August it was 80,000. In September it has already been 160,000 almost, and is getting worse. Indicators from initial claims for Unemployment Benefits, continuing claims suggest that the condition in 

the labor markets are worsening severely. 

There was a piece in The New York Times this morning on the 

front page on massive job losses in New York and New York State, 

and it is not just finance. Everything is related to finance. It is 

tourism. It is restaurants. It is corporations. It is law firms. It is 

services. It is industrial production. This is becoming a very, very 

severe recession, and unless we do something to boost incomes and 

Unemployment Benefits, Food Stamps, fiscal stimulus and things 

to try to make the recession shorter and more shallow, this is going 

to be the worst recession we have had in decades. That is why it 

is urgent and important to do something about it. 

Representative Cummings. Thank you. 

Vice Chair Maloney. Thank you for that fine statement. I 

thank all of the panelists. You have really given us very insightful 

and important testimony today. 

I would like to hear you all day long, but we have a second panel, 

residents from Main Street, who will tell us what it is like for them 

in their communities. 

Again, I want to thank all of you for your service here today, for 

your research. It has been invaluable. We appreciate it deeply. 

Thank you, very much. 

Vice Chair Maloney. I’d like to welcome the second panel. We 

are going to be hearing from community leaders from Main Street, 

but I would like to publicly thank my colleague and good friend, 

Representative Cummings, and his staff, especially Leah Perry, for 

their invaluable help in recruiting this panel of community leaders 

from the great state of Maryland. 

I am calling upon Representative Cummings to introduce the 

panel, many of whom are from the District and state he is honored 

to represent. 

Representative Cummings. Thank you very much, Madam 

Chairwoman. We are, indeed, honored to have three of Maryland’s 

finest. I really mean that. I’ve known all of them for a long time. 

They give their blood, sweat, and tears every day in their jobs, 

lifting people’s lives. 

Vincent DeMarco is President of the Maryland Citizens Health 

Initiative, a coalition of organizations that seeks to ensure better 

healthcare for Marylanders, by promoting universal and accessible 

health insurance. 

Previously, he was Executive Director for the Maryland Children’s Initiative. 

31 

Donald Fry is President and CEO of the Greater Baltimore Committee, the Central Maryland region’s most prominent organization 

of business and civil leaders. Mr. Fry has also served in the Maryland General Assembly. As a matter of fact, we served together, 

and as a member of the Senate of Maryland. 

He is one of only a handful of legislators, past and present, to 

have served on each of the major Budget Committees of the Maryland General Assembly. 

Mr. Joseph Haskins, Jr., is the President of the Harbor Bank, 

one of the top ten African American-owned and operated financial 

institutions in these entire United States. 

He serves as a Director on the Board of CareFirst, Blue Cross/ 

Blue Shield, Morgan State University Business School, and Security Title. 

He is also a very good friend, and he serves as the Chair of the 

East Baltimore Biotech Urban Development Project and Associated 

Black Charities. 

Thank you very much for the opportunity, Madam Chairwoman, 

to introduce these distinguished gentlemen, and I want to thank 

you all for being with us this morning. 

Vice Chair Maloney. Thank you for helping us put this panel 

together. 

Each panelist will be recognized for five minutes. We’ll start with 

you, Mr. DeMarco, and then go to Mr. Fry and Mr. Haskins. Thank 

you. 

STATEMENT OF VINCENT DeMARCO; PRESIDENT, MARYLAND 

CITIZEN’S HEALTH INITIATIVE, BALTIMORE, MD 

Mr. DeMarco. Thank you, Madam Chairwoman Maloney and 

members of the Committee, and Congressman Cummings, who has 

been a hero of mine for many, many years. 

I greatly appreciate the chance to talk with this Committee 

about how the economic downturn is hurting Marylanders’ 

healthcare, and how this Congress can help resolve this problem. 

Over the past few years, under the leadership of Governor Martin O’Malley, the State of Maryland has made significant progress 

in expanding healthcare access in our state. 

Most importantly, because of the Governor’s initiative, and after 

careful balancing of state priorities, Maryland went from 44th in 

the country, to 21st, in providing Medicaid coverage to adults, and 

uninsured Marylanders are responding. 

In the three months since the law took effect, over 16,000 uninsured Marylanders have signed up for coverage, demonstrating the 

great need for this expansion. 

Now, though, this healthcare coverage for tens of thousands of 

Marylanders, is directly threatened by the current economic crisis. 

As you know, the downturn is dramatically lowering sales tax revenues, forcing states to reevaluate priorities and to cut important 

programs. 

Maryland is among these states, facing a deficit of hundreds of 

millions of dollars, despite having recently taken aggressive measures to deal with the structural budget problem. 

32 

Many of the people who would be hurt in Maryland, if Maryland’s new Medicaid expansion is curtailed, are in particular need 

of healthcare coverage now because of the economic downturn. 

Among the people who are eligible for the new expansion, are a 

plumber on Maryland’s Eastern Shore—not named Joe—and a single mom in Prince George’s County. Both of them had healthcare 

coverage through their jobs until recently when both of them lost 

their jobs and their coverage, due to workforce cuts made by their 

employers, necessitated by the economic downturn. 

They both had jobs and coverage; the economic downturn comes, 

and they lost their jobs and their coverage. 

The impact of not having healthcare is devastating. I’ll give you 

just one example: There’s a sad story of the 54-year old brother of 

Mrs. Judith Campbell of Baltimore City. Ms. Campbell told us, and 

I quote her, ‘‘My brother took his life earlier this year, because he 

found out that he had treatable, but potentially fatal cancer, and 

was turned down by the State for healthcare assistance.’’ He worked as a security guard for $8.49 an hour, and his company did not offer health insurance. Mr. Campbell would have been 

eligible for the new Medicaid expansion we enacted in Maryland. 

It would be very sad if the economic downturn prevented us from 

fully implementing this expansion and saving many other Marylanders from the economic distress, healthcare woes, and possibly 

even death that can result from the lack of healthcare insurance. 

We strongly urge this Congress to move quickly to enact an additional economic stimulus package that would help states like Maryland, pay for critical healthcare needs. 

Specifically, we ask that, in a new stimulus package, you include 

an increase in the Federal Medical Assistance Percentage, FMAP, 

that would provide additional Medicaid dollars to forestall significant cuts. 

Increasing FMAP would help Maryland in two important ways: 

First, it would spur economic growth. According to a recent Families USA analysis, for every one million dollars in additional Medicaid funds that Maryland would receive, there would be $2.2 million in additional business activity, including 20 new jobs and 

$765,000 in additional wages. 

A bill that didn’t pass this Congress, S. 2819, would have given 

Maryland an additional $111.5 million in federal dollars, which 

would have generated $210 million in business activity, 1800 new 

jobs, and $724 million in additional wages. That would have been 

the FMAP increase. 

In addition, if you do the FMAP increase that we’re suggesting, 

it would put money directly into Maryland’s Medicaid program, and 

we wouldn’t have to cut people off who are now receiving 

healthcare coverage, people who really desperately need it. 

The FMAP increase is the most important thing we believe you 

could do in the stimulus package. 

In addition, though, besides the FMAP increase, we urge you to 

consider other ways to help keep healthcare alive and well in 

Maryland. Most importantly, pass the SCHIP law; the State Children’s Health Insurance Program expansion and reauthorization. 

Congress previously passed SCHIP but unfortunately, it was vetoed. It’s very important that you go back and pass SCHIP. 

33 

Additionally, we urge you to do whatever you can to remove obstacles that the Federal Government is putting in front of us. We 

want to work with you to achieve healthcare for all at the federal 

level, but until we reach that goal, please don’t block us from doing 

what we need to do. 

We passed in 2005, a great new prescription drug law that the 

Bush Administration blocked. 

Please help us by supporting a bill that Representative Chris 

Van Hollen has put in and help us remove the Employment Retirement Security Act blocks on state programs. 

[The prepared statement of Vincent DeMarco appears in the Submissions for the Record on page 111.] 

Vice Chair Maloney. Mr. Fry. 

STATEMENT OF DONALD C. FRY, PRESIDENT AND CEO, 

GREATER BALTIMORE COMMITTEE, BALTIMORE, MD 

Mr. Fry. Madam Chair, members of the Committee, thank you 

very much for the opportunity to be here. First of all, I commend 

the Joint Committee for the foresight and initiative to pursue an 

aggressive agenda to achieve our economic recovery. 

The Greater Baltimore Committee has been actively engaged in 

advocating for a significant investment in transportation infrastructure in Maryland for a number of years. 

A focus on investment in infrastructure, in my opinion, is an appropriate and much needed step that will bring about positive results. 

Our nation’s infrastructure, both transportation and public utilities, are under stress. If we do not invest to repair and build to 

keep pace with growth and changing population and employment 

patterns, the consequences will be enormous. 

We are already seeing intolerable congestion in our metropolitan 

cities. We are seeing longer commute times in our expanding outer 

suburban corridors. 

We’re experiencing a stifling of growth and economic development as local governments attempt to keep pace with increased demands for public water, sewers, schools, and transportation. 

The failure to address these challenges, not only affects our economic growth, it negatively impacts the quality of life we’ve come 

to enjoy and cherish. 

At the national level, the price tag to address the condition of our 

transportation infrastructure, power grids, water and waste water 

systems, was placed at $1.6 trillion in a report by the American Society of Civil Engineers. 

The National Surface Transportation Policy and Revenue Study 

Commission report, released earlier this year, concluded that there 

was a need for an annual capital investment of three to four times 

what the Federal Government currently spends to address the investment gap. 

The cause for this deterioration regarding our infrastructure, the 

backbone of our economic growth, is twofold: First, lack of money, 

but, second, the failure to recognize infrastructure investment as a 

public policy priority, essential to economic growth. 

Those two factors have caused a significant backlog in the construction of new infrastructure projects, and resulted in many 

34 

states only expending money for the very basic maintenance and 

repair of its systems. 

In Maryland, the state went almost 16 years without a significant investment in transportation funding. 

Last year, the six-year transportation plan included over 90 

projects in the planning phase, with not a single dollar designated 

for construction of those projects. 

The estimated total cost of the construction of those 90 projects, 

was well in excess of $40 billion. 

Yet, just a few months ago, Maryland deferred $1.1 billion in 

transportation projects, in its current six-year plan, citing lagging 

revenues and uncertainty over federal funding, as the cause. 

It’s estimated that every billion dollars in federal transportation 

investment, supports approximately 35,000 jobs and $1.3 billion in 

employment income. 

An investment in infrastructure at this time in our challenging 

economic state, would be significant. It would help buttress the 

struggling construction industry that’s lost more than 600,000 jobs 

over the past two years, as a result of the declining housing market, and tightening credit markets. 

It would stimulate investment in our weakening infrastructure 

and benefit small businesses and minority and women-owned businesses, that significantly rely on major construction projects to 

grow and expand their business capacities. 

I thank you for the opportunity to address you on the importance 

of infrastructure investment and the vital role that it can and 

should play in your consideration of an economic stimulus package. 

Thank you. 

[The prepared statement of Donald C. Fry appears in the Submissions for the Record on page 1116.] 

Vice Chair Maloney. Mr. Haskins. 

STATEMENT OF JOSEPH HASKINS, JR., CHAIRMAN, PRESIDENT, AND CEO, THE HARBOR BANK OF MARYLAND, BALTIMORE, MD 

Mr. Haskins. Thank you very much, Vice Chairwoman Maloney, 

and I thank my Congressman, Elijah Cummings, for allowing me 

an opportunity to share thoughts from Main Street. 

I am a Main Street banker. I manage a $300 million bank that 

has experiences that I think would be important for you to hear 

and for me to share. So this is a tremendous opportunity, and 

again I thank the Committee. 

There are five points that I would like to make. I want to say 

first that I recognize that the government has taken very serious 

steps to address the crisis that is before us, the crisis that represents an erosion of the public confidence as well as an erosion in 

the confidence of the financial institutions. 

But as I look back at the many steps that have been taken, what 

I quickly recognize—and many of my colleagues, and in this case 

I speak both as a community banker from Maryland, but also as 

a community banker representing many other community banks 

across this country—what we see is a program that has largely focused on the large financial institutions. 

35 

And while we recognize that there needed to be focus on the larger institutions, we also recognize and suggest to this Committee 

that we have got to give attention to Main Street, the street where 

we believe we have not seen any real measures taken. 

My five points, and I quickly make them: 

One, subprime. I am fortunate that my institution stopped doing 

subprime loans four years ago. The reason we stopped is not because we are smarter than my colleagues, it is simply because we 

recognized that there was too much fraud, too much misrepresentation, too much deception, and our due diligence process could not 

ferret out the magnitude of the problems such that it made sense 

for us to continue. 

And so we say to you that those larger institutions that continued, they overlooked or did not pay attention the way that some 

of the small community banks did. And when you look at the problem you will find that many of my colleagues, as I, do not have 

heavy weighted portfolios of subprime. 

Why am I raising this? I am raising this because as we looked 

at the increase that was made by the FDIC in terms of insurance 

coverage costs, we were increased along with everyone else. In 

many ways we see ourselves helping to bail out our larger, bigger 

brothers. And we questioned whether or not that is fair. 

The second point that I would like to make: Many of these financial institutions have suffered losses in deposits as the larger institutions stumbled. The stumbling created a confidence scare, and 

therefore led to a run on deposits. Those deposits are our life blood. 

We loan those out to the small businesses. And so I lost initially 

about 10 percent of my deposit base. 

Fortunately, with the changes made by the FDIC in coverage I 

was able to regain some of those, but not all of it, back. 

The third point that I would make: With the increased problems 

that have plagued the economy, the credit crunch, what we have 

experienced is an increased number of delinquencies and defaults. 

I am running two-and-a-half times what I had previously experienced in my worst year. I am a 26-year-old institution, and a 37- 

year banker. So I am not talking about something that is new, 

something that is recent in terms of an observation, I am talking 

about something that is very real. 

Our comment to you is that we at the community bank level 

need to see a stimulus package that helps us address those problems of securities, those problem loans to free us up to do the business that we need to handle. 

Smaller banks, the fourth point, smaller banks need to have you 

consider having us purchase and sell to you some of our problem 

loans. It frees us up with our smaller staffs, our smaller operations. 

We are committing our time to work out rather than giving money 

to desperate leaders, or desperate businesses in our communities. 

I know my time is up, but I’ve got to make one more point, and 

I’ll leave my fifth one out. What I see every day, and what I am 

experiencing every day, are the small businesses that you won’t 

hear from like the cleaners. The local cleaners are seeing less business because people are being laid off. 

I finance about 15 different cleaners. And so when I talk to them, 

they say to me: Mr. Haskins, we’re not getting the same business. 

36 

Restaurants, because larger companies don’t like restaurants, we 

have been key in financing restaurants. 

Restaurant business in Maryland is down 50 percent. I would 

suspect and suggest that it probably represents that kind of number across the country. I also say to you that many of the larger 

banks have approved loans to businesses, and I can give names if 

necessary but I won’t because of confidentiality, but those same 

businesses originally had approved loans and later were called to 

say that they could not be financed, and they have come to me for 

that financing. 

Ladies and gentlemen, in closing I say to you that there are hard 

times on Main Street. One of the fastest ways to get funds and 

money into the hands of these businesses that are vital to Main 

Street survival is by supporting the local community banks, those 

that know the community and deal with it every day. 

Thank you, very much. 

[The prepared statement of Joseph Haskins, Jr., appears in the 

Submissions for the Record on page 119.] 

Vice Chair Maloney. I thank all the panelists for your testimony. It is important, and very relevant. 

I would like to recognize my good friend Representative Cummings for the first questioning period and thank him again for 

helping me assemble this panel. 

Representative Cummings. Thank you very much, Madam 

Chairwoman. 

Mr. Haskins, many small businesses have had problems with 

lines of credit. I have had a number of businesses to tell me that 

the larger banks cut off their line of credit, and so they were placed 

in a position where they could not do business, literally could not 

do business. 

You might want to address this, too, Mr. Fry, but how does that 

affect you? I mean, have you seen some of that? In other words, 

is that a problem in our area? 

Mr. Haskins. It is a serious problem. I can tell you that we finance many of the small businesses, including law firms. For example, I have law firms that have had lines of credit with me for 

as long as five years that have never borrowed on those lines. They 

are now borrowing on those lines. 

I have those who are in the construction business who are in the 

middle of projects, and because their lines have been reduced and 

cut off at other institutions have come to me for payroll. And I can 

tell you that my cell phone rings endlessly. Before coming into this 

meeting, I had an individual calling to make payroll tomorrow. I 

mean, my views and my comments are very real. They are individuals that we can talk about and we can look at. 

There are people that you know that are calling me at this very 

moment seeking financing for projects that they are engaged in but 

they do not have the operating income to carry them forward. 

Many of the larger institutions, because of the challenges that 

they are experiencing, have cut off lines to smaller businesses. 

That is very real. That is not something that is made up. I mean, 

there are names and individuals that we can point to that are reflective of that situation. 

37 

Where they turn is they turn to the community banks because 

they believe we understand and have a better and deeper appreciation for their need, and will find a way to try to get financial resources to them. 

Representative Cummings. One of the things that in our research—I also sit on the Government Reform Committee where Ms. 

Maloney and I are doing investigations with regard to all of this— 

and one of the things that we discovered is that a lot of the larger 

banks seemed to be careless with some of their lending requirements because they knew that they could sell them off to others. 

And as I listened to your comments about when you said that 

Harbor Bank stopped performing subprime loans four years ago, I 

am so glad you had the foresight. I assume you might not be in 

business today if you had stayed in there. Is that right? 

Mr. Haskins. That is a fair and accurate comment. You know 

it is easy when—and again this was not to be critical—there was 

a greed factor, and this Committee and others must accept that 

there was a greed factor that motivated that. The brokers that 

largely put together many of these deals would present them to the 

smaller banks, or to the different community banks, and the banks 

tried to do initial due diligence. It became challenging to do the due 

diligence. 

And because you were not holding that portfolio in your bank in 

your inventory, you packaged it, pooled it, sold it off to Wall Street 

to the Bear Stearns, and the Lehmans and so forth, and what they 

did is they reconfigured it and sold it around the world. 

Many of us, you know, in business school—and I am both an 

economist and a finance-trained individual—some of the training 

we go through is if you diversify enough you can diversify away 

risk. We are kind of trained and taught that. 

Well, you know, one could make a case arguing that there was 

diversity in it. Well we had geographical diversification because 

these pools were coming from across the country. There was income 

diversification. You had high income, low income. You had large 

house, small house. So you could argue that there was a lot of diversification. 

But the underlying problem to those toxic securities was the fact 

that you had too much fraud that was in. I mean, we saw misrepresentation of employment history. We saw altered credit scores. We 

saw fraudulent incomes. That ‘‘stated income,’’ any serious banker 

who has been around, ‘‘stated income’’ was a no-no. 

When I bought my first house I worked five years to accumulate 

my 20 percent down. We had an old rule-of-thumb. We said you 

should never buy a house for more than two-and-a-half times your 

gross income. 

Well we can look back and see that people were buying houses 

five, as much as ten times their income, because many times the 

income was stated at levels substantially higher than what they 

were actually earning. But there was no real due diligence done, 

and so for the problems to be resolved we have got to work that 

back through. 

But to the economic stimulus package, the reason why Main 

Street banks and financial institutions are important is because 

38 

many of these individuals are coming back to us. We didn’t create 

the problem, but we can help be a part of the resolution. 

Representative Cummings. Do you see much of a default rate 

with regard to your mortgages? 

Mr. Haskins. We have defaults. We have increasing delinquencies, and what we are trying to do is work with individuals. 

Our biggest challenge is working with the commercial clients. 

Many of the borrowers now are suffering, and we will see tremendous fatalities over the next six to twelve months if more financial resources are not moved into the direct hands of community bankers. It’s too long for that money—it will take too long for 

the money to trickle down from the larger institutions. 

For example, many of the largest institutions’ credit score small 

business. It’s hard to credit score a business. So if that small business doesn’t meet a credit score that’s acceptable, they don’t get the 

business. 

Well our experience reflects to us that there are extenuating situations, or there are different factors that you need to look at for 

making that loan other than just a credit score. 

Representative Cummings. I see my time is up. Thank you. 

Vice Chair Maloney. Mr. Brady. 

Representative Brady. Well thank you to the panel, especially 

those who have Congressman Cummings as their Representative. 

He is one of the more respected Members of this body, and we appreciate his work on a wide range of issues. You have got a class 

act there. 

Was that on TV? [Laughter.] 

Representative Brady. No, I’m kidding you. I’m kidding you. 

[Laughter.] 

Representative Brady. No, I mean I’m sincere about that. 

I do think there is merit in rebuilding our crumbling infrastructure. It is really an embarrassment. And whether we do it through 

this economic stimulus or really come together, Republicans and 

Democrats, on fixing the Highway Trust Fund, energizing our 

Freight Rail infrastructure, our water infrastructure, we have got 

to act. 

I do think there is a way we could bypass our federal middleman 

and inject dollars directly into bid-ready contracts back home. I actually think that that could create jobs at the local level, and fix 

just a looming problem we have, especially in fast-growth areas of 

the country, and then in the rural areas where they just don’t have 

the resources to keep their roads and bridges safe at all. 

On the banking side, you sound just like my community banks 

in southeast Texas. When I was looking at the bailout package, I 

didn’t get on the phone to talk to people from Wall Street, I talked 

to our community bankers. I got them on the phone and started 

asking them questions, and they made the same points you did, 

which is: 

One, you are scaring our depositors. You know, we don’t have 

these problems. We didn’t make these bad loans. We are running 

these things right. Stop scaring them. Which is why I think increasing the FDIC limit was helpful to reassure people, look at the 

community banks, the independent banks, they have got a very 

sound structure. 

39 

They also made the same point you did, which is give us a 

chance to buy some of these mortgage-backed securities and some 

of these things because we know how to work a loan out. We think 

there’s value in loans, if you know who the people are, if you will 

work with them and try to find the terms that, if they can, keep 

them in their homes. Keep the property values up and the quality 

of life in that neighborhood. They said exactly the same thing you 

did. 

My question is, Mr. Haskins, ought we not, as we go forward to 

try to prevent this from happening again, ought we not consider 

sort of back to the future? Going back to the basis of a down payment, even a minimal one, on home purchases? Have verifiable income so that you know there is an income stream? 

Perhaps having lenders, whether it is the original lender or the 

first purchaser, either hold those for a period of time, or keep a 

stake in them so that their standards are going to be higher at the 

outset before you allow bad loans to become an infection throughout, as we know now, the world? You know, that there would actually be value in them before that occurs? Is there merit in us insisting that those nonbanking institutions have the same scrutiny, 

same capitalization rate, the same leveraging restraints that our 

local banks have? 

Because it seems like to a layman these complicated financial instruments are way over many of our heads, and I am not sure if 

we can ever be smart enough to regulate the back end of all that. 

But it seems to me that if we set a good foundation early on in that 

whole asset-based financial structure, that we really limit the mischief later on. 

Can you give me your thoughts? 

Mr. Haskins. I think your comments are just so right on. Many 

of my colleagues in the banking worlds made the early statements 

that we were being sort of driven out of the origination market on 

residential mortgages because we were too conservative. 

We were trying to hold folks to those standards. We got the development of an industry, the brokers, who did not make any 

money unless a transaction was consummated. A deal had to be 

done. 

Then banks started getting very liberal—and I won’t call names; 

you all have heard them and seen them—and banks started getting 

creative with the kind of products that steered away from that traditional kind of approach. And so we looked at teaser rates. We 

looked at adjustable rate mortgages. We looked at interest-only. We 

looked at stated income. And so we got creative because what we 

saw is an opportunity to make money. 

And if you get too much into that money-chasing vein, you are 

going to start overlooking what you need to overlook. And if—and 

going to your recommendation—if we start moving back to a policy 

of requiring people to have money, first of all I think you should 

never have an unregulated body such as the brokers were. They 

ought to have some standards. 

And I am not a big government kind of person, but you have got 

to have some standards and some regulation there. But we ought 

to require people—I mean, there is an old adage, and this I did not 

learn in business school, I learned this—if folks don’t have some 

40 

skin in the game, there is nothing to hold them to the table. And 

that’s what you’re talking about. 

That person who had to work to get their down payment is much 

more likely to be a good payer of that mortgage. They just are. I 

mean history is replete with evidence and examples of that. 

So I think while we talk about home ownership and say that it 

is the American dream, it shouldn’t be the American dream if we 

are loaning somebody 100 percent of the mortgage and giving them 

the down payment. I mean, what do they really have at stake? 

So I would be one that would argue that absolutely you ought to 

have a requirement for someone to have something from their personal financial resources that is verifiable, and you certainly ought 

to require verification of work status as well as income. 

So I think you are right on. And if you are going to promote that, 

you can call me and I will be happy to come testify. 

Representative Brady. Thank you, sir, I appreciate you being 

here today. 

Vice Chair Maloney. Thank you for your testimony. And Congress did pass a Mortgage Reform bill that brings the broker/dealers under the same regulation as banks and community banks, and 

as we know the main problem was with the broker/dealers that had 

no regulation. Your points are very clear and important on going 

back to the future to standards of having skin in the game and 

higher standards going forward. 

In your comments, Mr. Haskins, you said that your default rate 

and delinquency rates have increased. I would like to get a little 

more information on your bank’s credit card accounts. Have they 

increased? Commercial real estate, what is the state of that? Residential real estate, auto loans, and other personal loans? If you 

could go through those categories and give us a sense of default or 

health that you’re experiencing in your bank. 

Mr. Haskins. I would tell you that in all of the categories that 

you mentioned, to be quick, and then I can get specific, to be quick 

about it, have increased in delinquency some 30 to 50 percent just 

automatically, I mean we saw increases. 

Credit cards are at the highest levels. So you’re not talking about 

people now who have any access to credit. You’re talking about people who have exhausted their credit. 

In the case of home equity lines, those lines are up to their max, 

so there’s no place for them to go. And now they are delinquent on 

those. So we’re seeing that piece. 

When we talk about residential developers—and that’s the area 

probably where I’m experiencing the most difficulty—the residential developers that we have financed are those who are doing 

somewhere between 5 to 50 units, and they’re in the Baltimore 

Metropolitan Area. 

These individuals are harder pressed for larger institutions to do. 

Now fortunately we have a lot of equity. We force our builders to 

put more of their money into the buildings. So while we don’t have 

the same exposure, what we’re seeing now with—and this is a bit 

of the challenge. See, many of the larger banks, as they get access 

to these resources, they then sell and turn over their products at 

substantially lower prices, which then drives down the price that 

we can get. 

41 

So you get this kind of conundrum going on here that is really 

interesting. So because X bank, not to call the name of one, X bank, 

we have the same financing in the same community, and so because they have gotten a nice award they can sell off their project 

for 50 percent of the value, where if they didn’t have the award 

they would be like me negotiating to get 80 percent of my money. 

But when they get 50 percent of the money, then the next person 

that comes along that I’m negotiating with will say, well, X bank 

sold it for 50 percent on a dollar, why are you trying to get 80 percent on the dollar? Which is the reason I am coming back to the 

importance of getting this stimulus package down to Main Street 

to community bankers, because we are dealing with that every day 

person. We are putting folks in houses. We are still doing product 

and projects that other banks have since turned their backs on. 

So, yes, I am experiencing delinquencies. Fortunately, we have 

remained profitable through this. But when regulators come in, we 

are being asked to reserve for loans, by the way, which is very interesting, loans that are not delinquent but because they are in 

residential real estate we’ve got a reserve against those because the 

residential market is down. 

So there are many challenges that we are experiencing. And one 

last point— 

Vice Chair Maloney. Could you clarify when you say you have 

to reserve against those? Do they have a specific capital requirement, or what is the reserve that they make you put in for residential real estate? 

Mr. Haskins. For example, if it’s assumed that—and they will 

come up with several different indices to determine, so for example 

you take let’s say a $100,000 loan. If no property has been sold, or 

if this project is in the middle of its development, they will come 

in and give an assessed value of the lot and an assessed value of 

the house at the end of its completion. And if they assess that the 

value of this is $80,000 and not $100,000, then that loan becomes 

what’s known as ‘‘classified,’’ and there are different states of classification. 

Then we are required to set aside 20 percent, $20,000, in a reserve in anticipation of that loan not paying off or defaulting. 

Vice Chair Maloney. Thank you. 

Mr. Fry, I would like to focus really on a concern that we have 

heard repeatedly on the fiscal stimulus to support state infrastructure spending and other infrastructure spending in our country. 

We know it is in dire straits. We know we have bridges crumbling. We have roads that need to be repaired. But many of our colleagues will say that this is not a good direction to go in because 

it’s not immediate. We cannot spend those dollars immediately. 

I know from my own City of New York we have many projects 

that have stopped because of lack of money. We could start those 

projects moving immediately, and I would like to specifically ask 

you: Are there projects that have been postponed only because of 

financing problems that could be started immediately in your state 

if there was a fiscal project directed towards its infrastructure? 

Mr. Fry. I appreciate the concerns of those that are worried 

about the lag that may occur before a project moves forward, and 

that certainly could be true with respect to some projects that are 

42 

in the planning mode, but even as recently as yesterday Maryland’s 

transportation Secretary, John Porcari, before the House Transportation and Infrastructure Committee testified that he has identified 

as many as three dozen projects totalling about $150 million that 

could be obligated within about 120 days. 

So I think that because of the deferral that has occurred recently 

because of the lagging gas tax revenues that have come in, and the 

lagging sales taxes that have come in from the sales of cars and 

registrations, that there are a number of projects that had to be deferred that could have some immediate impact if those monies were 

available. 

I think you do have to pick and choose which projects are there, 

but I think the transportation secretaries of the states across the 

country could clearly identify those projects that could have that 

immediate impact. 

Vice Chair Maloney. Thank you very much. My time has expired. Mr. Cummings. 

Representative Cummings. Thank you very much, Madam 

Chairwoman. 

Mr. DeMarco, let me just ask you this. I think there are a lot 

of Americans who are suffering, and I say that they are dying 

every day in large numbers because they cannot afford medicine, 

and sometimes cannot afford treatment. 

I take it that these are the people you are concerned about, and 

your organization is concerned about. I live in the inner city in Baltimore and I have a fellow who showed me his medical bills for 

cancer. He had to have four chemotherapy treatments. The bill was 

$12,000 a treatment. He had insurance now. And he had to pay 

$1,172 of that. 

He had to have something else called Nulastin after every treatment. Just for a little prick in the arm of Nulastin it cost him 

something like $6000 or $7000. He had to pay $500-and-some for 

that. 

And that does not even include the MRIs and the PET scans and 

the CAT scans and all the other things. And then when we look 

at bankruptcies we see in the United States that a huge percentage 

of bankruptcies have to do with medical bills. People can’t pay 

them. 

And so in order to address that—and I say it’s sort of a silent 

kind of problem because people suffer, and a lot of times they suffer but they don’t talk about it to other people because it’s so personal, but when I move around and I go throughout my District 

and I talk about this, I mean literally I see people sitting in the 

audience with tears running down their faces because they are 

going through it, or a family member is going through it. 

You gave an example in your testimony, but do you see a lot of 

that? Do you all hear a lot of those kinds of cases where people just 

hit the end of the rope? And there is another thing that is happening, too, that my constituents tell me about, is like when people 

get a little older and they have to make difficult choices, and they 

see that medicine may cost them, it may be only $2000, $3000 a 

year, but that $2000 or $3000 when you do not have very much income is a lot of money, and so they will say: You know what? I 

43 

don’t want to burden my family. I am already a little older. So just 

let me die so that they will have a chance to live. 

I mean, do you hear about those kinds of stories? 

Mr. DeMarco. Yes, Congressman Cummings, we do. We have 

had public hearings across the State where we constantly hear people telling us of devastation caused to their families because they 

cannot afford health care. 

You are right that some studies say that up to half of all bankruptcies are caused by health care bills that cannot be paid. Foreclosures happen a lot of times because people cannot pay their 

health care bills or have to put their money into staying alive so 

they cannot pay for their homes. There is a study by Families USA 

showing that. And it is just over and over again we see the devastation caused by people not having health care. 

I told the story of Ms. Campbell’s brother. There is another story 

of a gentleman who was the kind of person we all talk about who 

does the right thing. He works as hard as he could every day. He 

did not have a high-paying job and he could not get health care at 

his job, but he had to keep working. He could not stop working, 

and he just kept working and kept working and did odd jobs here 

and there to just feed his family, feed himself, but he could not pay 

for health care. So he had some health problems and he just could 

not deal with them. So, okay, he just kept working. 

One day he was mowing somebody’s lawn as part of his job and 

he had a heart attack and died. And if he had had health care coverage he could have dealt with these problems. 

Now the thing, Mr. Congressman, that you know so well is that 

it is not just the uninsured who pay these costs. We all do because 

when someone is very ill, if they do not have health insurance and 

they put it off for years and they got sicker and sicker, we do not 

let them die in the street, unless of course they have a heart attack 

and die, but if they get ill and they go to the hospital we take care 

of them, and that costs lots and lots of money. 

And somebody pays for it. Not the uninsured because they can’t 

afford it. All of our insurance premiums go up to cover that. So 

there is a hidden health care tax that we all pay to keep people 

alive when, if we had had everybody covered with health care, they 

could have gotten their treatments and stayed alive. It would be 

much better for them and their families, and much better for all 

of us. 

That is why this new Medicaid expansion is so important in 

Maryland that Governor O’Malley enacted. It is so important. Over 

the next couple of years we estimate that it will provide health care 

to over 100,000 uninsured people. I want to thank Don Fry and the 

Greater Baltimore Committee for being amongst the people who 

really pushed for that and understood how important it was. 

We desperately need your stimulus package to include the FMAP 

money so that there is more money in the Medicaid Program to 

help us keep that program going. 

These 16,000 people who just got covered—and there are going 

to be more—but these 16,000 people are people who desperately 

needed it. Let me tell you, Mr. Chairman, about the very first couple: 

44 

Alana and Adamontis Bollis, a couple whose kids were covered 

by the CHIP program for awhile but they could not get health care, 

and they had colon cancer issues, diabetes issues. They were not 

getting treated and they were getting sicker and sicker. 

On July 7th of this year, Governor Martin O’Malley handed them 

the very first cards under our new Medicaid Expansion Program, 

and they now can get treatment. 

Please help us keep that program going. 

Representative Cummings. Just one last question, Madam 

Chair. 

Mr. DeMarco, what would be the benefit of extending the Families and Small Business Health Care Coverage Act that we have 

in Maryland to the rest of the country? I am just curious. 

Mr. DeMarco. Well, Representative Cummings, we want health 

care for all for the whole country. That is our goal that we are 

pushing for in Maryland but we want to work with you to have it 

nationally. But, we believe that until we reach that goal states 

should do as much as they can with your help to expand Medicaid 

coverage. And in addition to Medicaid in our program gives grants 

to small businesses to help them provide health care. 

If in your stimulus package you included more Medicaid assistance for the states, other states would be able to do this, too, and 

we could help a lot of the people who just cannot afford private insurance and are out there getting sick like the Bollises. And again, 

let me emphasize this again, Congressman Cummings, it is not just 

the uninsured who suffer because of uninsurance. We all do. 

Representative Cummings. I want to thank all of you for 

being here today. We really do appreciate what you have done. 

Mr. Haskins, I have got to ask this because there has been a controversy here in the Congress with regard to these loans on mortgages and I want to ask you this question. 

Some people bring lending to low-income households and CRA, 

the Community Reinvestment Act in particular, to the current financial crisis. As a lender who has received the highest performance rating for CRA, do you see differences in defaults or delinquencies from lower and middle-income households? And how has 

CRA impacted the Baltimore and Prince Georges County communities that you serve? Because a lot of people seem to want to push 

this on Fannie Mae and Freddie Mack, and I am just wondering 

how you see it? I just want to clear that up, from your perspective. 

Mr. Haskins. This problem is across the board. When you start 

seeing the defaults that will begin to occur with some of the highend properties you will know it is not CRA-based individuals who 

are a part of that problem, not at all. 

I mean, this was across the board. The stated incomes are really 

more in the area of individuals who were privately employed, or 

upper income individuals. Many of the delinquencies and defaults 

we are seeing are at housing prices that are in the half-million dollar range and up. That is no low income. No, this cannot be passed 

off. 

I served, by the way, three different terms on Fannie Mae’s National Advisory Board and can speak very definitely to that program. Were there cases where those individuals were misrepresented or misrepresented? Absolutely. But I can tell you that more 

45 

often than not what you will find with the lower income home buyers, they were more misled and duped than they were initiating. 

Most do not understand. If you fill out a mortgage application, 

anyone here who has bought a home who has filled out a mortgage 

application, it is a pretty involved application. And I can tell you, 

having done endless seminars on how to go about buying a house, 

and buying a home, or looking at property, that most low-income 

folks are totally in the dark about that and they take a lot of direction, which is, Madam Vice Chair, why it was important to regulate 

broker/dealer individuals. Because they misled a lot of these individuals and were advising them that they, just by distorting this 

and distorting that, knowing what we look at for approving a loan, 

they could get over the hurdles. 

So, no, you cannot put this on the back of just low-income individuals. In fact, as data will reveal and reflect over time, you are 

going to see more and more defaults at much, much higher home 

pricing points. 

Representative Cummings. Thank you very much, Madam 

Chairlady, for your indulgence. 

Vice Chair Maloney. Thank you. 

One last question. Mr. Haskins, you testified that you did not invest and participate in these subprime loans. You saw fraud on the 

applications. So given that you did not engage in this risky behavior, what do you think about the financial rescue package for large 

banks? 

Mr. Haskins. I can’t tell you my first reaction. [Laughter.] 

Mr. Haskins. That would not be printable or recordable. But I’ll 

tell you this. Because of the importance of bringing confidence and 

stability back, those kinds of steps needed to and had to be taken. 

So for the greater good I have accepted it and said let’s move forward. 

I do believe, though, that you just cannot give money away without having some requirements. You just can’t do that. I mean, I am 

in a business that we set very specific requirements for getting repaid. 

So I agree that the actions taken by the Congress and the government in general needed to be taken, especially as it relates to 

Wall Street. However, I think there needs to be some requirements 

placed on that money, one; and two, I definitely think that you 

have got to have Main Street included in the proposition. 

Vice Chair Maloney. Thank you. And finally I would like to 

ask all of the panelists, beginning with you, Mr. Haskins, Congress 

is considering a fiscal stimulus package that would include aid to 

the states and infrastructure investment. 

How would such a fiscal stimulus package help consumers and 

businesses and individuals in your communities? Could you comment, all of you, Mr. Haskins, Mr. Fry, and Mr. DeMarco? 

Mr. Haskins. First, you are going to get people in positions to 

earn a living. You are going to get jobs. Creating jobs. Jobs are 

vital. 

As has been said by several of your colleagues, we have seen a 

reduction in the employment in our state, and especially in the 

City. The unemployment in Baltimore City, Congressman CumVerDate Nov 24 2008 10:43 Aug 04, 2009 Jkt 045037 PO 00000 Frm 00049 Fmt 6633 Sfmt 6633 C:\DOCS\48279.TXT SHAUN PsN: DPROCT
46 

mings is quoting numbers that are official. The unofficial numbers 

are probably twice as high as his official numbers. 

I am living on Main Street. I work with Main Street. I am in 

those communities. You know, I walk down the street yesterday 

past what was part of a restaurant row. Of the five restaurants 

that I passed—and Wednesdays used to be a good restaurant day— 

only three of the restaurants had people in those restaurants. And 

of the three that had people, only in that case were there three tables that were occupied. 

I am just giving an example there. So this stimulus package is 

going to help create jobs where people can work and make a good 

living wage, and it is going to help those who are on the margin 

to be able to meet their obligations to pay the community bankers 

who are willing and ready to step forward to keep financial resources flowing into the community. 

Vice Chair Maloney. Mr. Fry. 

Mr. Fry. Madam Chair, I think that such a stimulus package 

that included aid to state governments and also investment in infrastructure would be a significant step forward for the State of 

Maryland and for the citizens there. 

Right now looking at state governments, they are looking at tremendous deficits themselves. They are looking at programs being 

cut. They are looking at possible layoffs as time goes on, and trickling down even of course to the local governments as well. Everybody is on pins and needles, not unlike what Congressman Cummings and I experienced during the early 1990s when we served 

in the Maryland General Assembly together. 

I think obviously what we see as significantly important would 

be that investment in infrastructure. The one thing that I think 

that provides a great opportunity, because transportation infrastructure in particular does not get a lot of attention, it does not 

move up that rank as far as political polls of something that is 

really critically important to the voters of the time or to the citizens, but transportation only becomes important when it becomes 

a crisis. 

Unfortunately, once it becomes a crisis it takes too long for you 

to complete the projects that will even address that concern. By 

coming forth with a stimulus package that would include some investment for infrastructure, I think that would give a jump-start 

to projects that have not had a chance to move forward. 

In Maryland over a year ago we were successful in getting the 

General Assembly to enact about $400 million in new revenue. We 

argued that we should have as much as $600 million in new revenue. Despite that influx of money, we’ve just seen a reduction of 

$1.1 billion over the six-year transportation plan. So this is something that is significantly needed. It will provide jobs not only to 

highway contractors and others, but to small businesses, to minority and women-owned companies who are also very dependent upon 

those major construction projects so that they can take part in 

those and also expand their capacity to grow. 

Vice Chair Maloney. Mr. DeMarco. 

Mr. DeMarco. Thank you, Madam Chair. 

We urge you to include in your stimulus package an increase in 

the FMAP for the states. And if you do it at the level that was in 

47 

Senate Bill 2819, you would get a significant amount of new money 

into the State of Maryland, resulting in 1800 new jobs and a lot 

more money into the coffers of the State, which would be very important. 

And in addition, very importantly, you would help us keep this 

tremendous new Governors Working Families and Small Business 

Health Care Coverage Act going, which is going to over the next 

couple of years provide health care to over 100,000 uninsured people, and deal with some of the major issues that Representative 

Cummings sees, and we all see in our community of people who 

cannot afford health care, whose lives are destroyed by it, and then 

we all pay the hidden health care tax. 

It is a great two-for that you can include in the stimulus package 

which would help our society in Maryland a whole lot. Thank you, 

very much. 

Vice Chair Maloney. Well thank you. And I would like to sincerely thank all the panelists and witnesses for their really meaningful testimony today. 

The panel today, and indeed the hearings that Congress has conducted over the past month, have been sobering and should leave 

no doubt that we need a new stimulus package to get the economy 

back on track and provide relief to struggling American families. 

Congressman Cummings and Senator Schumer and I released 

this report yesterday, ‘‘Stemming The Current Economic Downturn 

Will Require More Stimulus.’’ It can be seen on the Joint Economic 

Committee web site, and on my personal web site, and I would like 

unanimous consent to put it in the record. 

Vice Chair Maloney. With that, the meeting is adjourned. 

(Whereupon, at 12:35 p.m., Thursday, October 30, 2008, the 

meeting was adjourned.) 

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SUBMISSIONS FOR THE RECORD 

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PREPARED STATEMENT OF CAROLYN MALONEY

Today’s news is bleak. The gross domestic product, which is the broadest measure 

of our economy, fell by 0.3 percent and consumer spending fell by 3.1 percent in the 

third quarter. This news comes on the heels of this week’s dismal report that the 

consumer confidence index plunged to an all-time low in October. All of this provides further confirmation that unless we act to bring real relief to Main Street, 

families will continue to suffer serious economic hardships. 

These data indicate that Speaker Pelosi has been right in pressing for additional 

economic stimulus as the Congressional hearings this month have shown. 

Over the past year, we have seen the sub-prime crisis turn into a full-blown financial crisis. Many economists now warn that we are the midst of a recession, quite 

possibly the worst in decades, and the impact on families may be devastating without government intervention. 

This committee has been tracking the unfolding economic crisis for over a year. 

In our monthly hearings on the employment situation, we have seen how the private 

sector has shed nearly a million jobs in 2008 and U.S. workers have lost all of the 

wage gains that they had made during the 2000s recovery. 

There is now a growing consensus that Congress should enact a second stimulus 

package and that it should be larger than the one we passed in January. During 

recent testimony in front of the House Budget Committee, Federal Reserve Chairman Ben Bernanke gave his support to another round of significant economic stimulus: ‘‘[W]ith the economy likely to be weak for several quarters, and with some risk 

of a protracted slowdown, consideration of a fiscal package by the Congress at this 

juncture seems appropriate.’’ 

As detailed in a Joint Economic Committee report released yesterday, the need 

for stimulus is urgent. A consumer- or export-led recovery is unlikely because this 

downturn follows the weakest recovery on record. Even as the economy expanded 

over the last eight years, household incomes never recovered from the last recession. 

Falling home values and rising debt have driven family balance sheets to their 

worst condition in decades, while at the same time banks have been curtailing access to credit. As consumers cut back on their spending, this drags down the economy further. 

Economists are also encouraging Congress to recognize that during a potentially 

protracted and deep downturn, concerns about budget deficits must be secondary to 

the goal of getting the economy back on track. Former Treasury Secretary Lawrence 

Summers has said, ‘‘The idea seems to have taken hold in recent days that because 

of the unfortunate need to bail out the financial sector, the nation will have to scale 

back its aspirations in other areas such as healthcare, energy, education and tax 

relief. This is more wrong than right.’’ 

Congress has already taken numerous steps to help buffer families from the effects of the downturn. More than 130 million American households have received 

a Recovery Rebate and 3.5 million unemployed workers have received extended Unemployment Benefits. In July, Congress enacted a housing package aimed at stemming the tide of foreclosures. 

As the financial crisis worsened this fall, Congress began a sweeping investigation 

to examine the root of the crisis and lay the foundation for action on common sense 

regulation of the financial and housing industries. 

This is grim news today, but I expect this Congress will act with the current 

President and the next President to get the economy back on track and get Americans back to work. Clearly, we need a new direction on economic policy. American 

families need more help to weather this economic storm. 

I want to thank our distinguished panel of witnesses for appearing before us 

today and thank Senator Schumer for calling this hearing. I look forward to today’s 

testimony as we help to lay the groundwork for the next economic stimulus package. 


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66 

STATEMENT OF BEN S. BERNANKE, CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM BEFORE THE HOUSE BUDGET COMMITTEE ON OCTOBER 20, 

2008, SUBMITTED BY VICE CHAIR MALONEY

Chairman Spratt, Representative Ryan, and other members of the Committee, I 

appreciate this opportunity to discuss recent developments in financial markets, the 

near-term economic outlook, and issues surrounding the possibility of a second package of fiscal measures. 

Financial Developments 

As you know, financial markets in the United States and some other industrialized countries have been under severe stress for more than a year. The proximate 

cause of the financial turmoil was the steep increase and subsequent decline of 

house prices nationwide, which, together with poor lending practices, have led to 

large losses on mortgages and mortgage-related instruments by a wide range of institutions. More fundamentally, the turmoil is the aftermath of a credit boom characterized by underpricing of risk, excessive leverage, and an increasing reliance on 

complex and opaque financial instruments that have proved to be fragile under 

stress. A consequence of the unwinding of this boom and the resulting financial 

strains has been a broad-based tightening in credit conditions that has restrained 

economic growth. 

The financial turmoil intensified in recent weeks, as investors’ confidence in banks 

and other financial institutions eroded and risk aversion heightened. Conditions in 

the interbank lending market have worsened, with term funding essentially unavailable. Withdrawals from prime money market mutual funds, which are important suppliers of credit to the commercial paper market, severely disrupted that 

market; and short-term credit, when available, has become much more costly for virtually all firms. Households and state and local governments have also experienced 

a notable reduction in credit availability. Financial conditions deteriorated in other 

countries as well, putting severe pressure on both industrial and emerging-market 

economies. As confidence in the financial markets has declined and concerns about 

the U.S. and global economies have increased, equity prices have been volatile, falling sharply on net. 

In collaboration with governments and central banks in other countries, the 

Treasury and the Federal Reserve have taken a range of actions to ameliorate these 

financial problems. To address ongoing pressures in interbank funding markets, the 

Federal Reserve significantly increased the quantity of term funds it auctions to 

banks and accommodated heightened demands for funding from banks and primary 

dealers. We have also greatly expanded our currency swap lines with foreign central 

banks. These swap lines allow the cooperating central banks to supply dollar liquidity in their own jurisdictions, helping to reduce strains in global money markets 

and, in turn, in our own markets. To address illiquidity and impaired functioning 

in the market for commercial paper, the Treasury implemented a temporary guarantee program for balances held in money market mutual funds, helping to stem 

the outflows from these funds. The Federal Reserve put in place a temporary lending facility that provides financing for banks to purchase high-quality asset-backed 

commercial paper from money market funds, thus providing some relief for money 

market funds that have needed to sell their holdings to meet redemptions. Moreover, we soon will be implementing a new Commercial Paper Funding Facility that 

will provide a backstop to commercial paper markets by purchasing highly rated 

commercial paper from issuers at a term of three months. 

The recently enacted Emergency Economic Stabilization Act provided critically 

important new tools to address the dysfunction in financial markets and thus reduce 

the accompanying risks to the economy. The Troubled Asset Relief Program (TARP) 

authorized by the legislation will allow the Treasury to undertake two highly complementary activities. First, the Treasury will use TARP funds to provide capital to 

financial institutions. Indeed, last week, nine of the nation’s largest financial institutions indicated their willingness to accept capital from the program, and many 

other institutions, large and small, are expected to follow suit in coming weeks. Second, the Treasury will purchase or guarantee troubled mortgage-related and possibly other assets held by banks and other financial institutions. Taken together, 

these measures should help rebuild confidence in the financial system, increase the 

liquidity of financial markets, and improve the ability of financial institutions to 

raise capital from private sources. 

As another measure to improve confidence, the act also temporarily raised the 

limit on the deposit insurance coverage provided by the Federal Deposit Insurance 

Corporation (FDIC) and the National Credit Union Administration from $100,000 

to $250,000 per account, effective immediately. Unfortunately, the loss of confidence 

67 

in financial institutions became so severe in recent weeks that additional steps in 

this direction proved necessary. The FDIC, the Federal Reserve Board, and the Secretary of the Treasury in consultation with the President determined that significant risks to the stability of the financial system were present. With this determination, the FDIC was able to use its authority to provide, for a specified period, unlimited insurance coverage of funds held in non-interest-bearing transactions accounts, 

such as payroll accounts. In addition, the FDIC announced that it would guarantee 

the senior unsecured debt of FDIC-insured depository institutions and their associated holding companies. In taking the dramatic steps of providing capital to the 

banking system and expanding guarantees, the United States consulted with other 

countries, many of whom have announced similar actions. Given the global nature 

of the financial system, international consultation and cooperation on actions to address the crisis are important for restoring confidence and stability. 

These measures were announced less than a week ago, and, although there have 

been some encouraging signs, it is too early to assess their full effects. However, I 

am confident that these initiatives, together with other actions by the Treasury, the 

Federal Reserve, and other regulators, will help restore trust in our financial system 

and allow the resumption of more-normal flows of credit to households and firms. 

I would like to reiterate the critical importance of the recent legislation passed by 

the Congress; without that action, tools essential for stabilizing the financial system 

and thereby containing the damage to the broader economy would not have been 

available. That said, the stabilization of the financial system, though an essential 

first step, will not quickly eliminate the challenges still faced by the broader economy. 

Economic Outlook 

Even before the recent intensification of the financial crisis, economic activity had 

shown considerable signs of weakening. In the labor market, private employers shed 

168,000 jobs in September, bringing the total job loss in the private sector since 

January to nearly 900,000. Meanwhile, the unemployment rate, at 6.1 percent in 

September, has risen 1.2 percentage points since January. Incoming data on consumer spending, housing, and business investment have all showed significant slowing over the past few months, and some key determinants of spending have worsened: Equity and house prices have fallen, foreign economic growth has slowed, and 

credit conditions have tightened. One brighter note is that the declines in the prices 

of oil and other commodities will have favorable implications for the purchasing 

power of households. Nonetheless, the pace of economic activity is likely to be below 

that of its longer-run potential for several quarters. 

As I noted, the slowing in spending and activity spans most major sectors. Real 

personal consumption expenditures for goods and services declined over the summer 

and apparently fell further in September. Although the weakness in household 

spending has been widespread, the drop-off in purchases of motor vehicles recently 

has been particularly sharp. Increased difficulty in obtaining auto loans appears to 

have contributed to the decline in auto sales. Consumer sentiment has been quite 

low, reflecting concerns about jobs, gasoline prices, the state of the housing market, 

and stock prices. 

In the business sector, orders and shipments for nondefense capital goods have 

generally slowed, and forward-looking indicators suggest further declines in business investment in coming months. Outlays for construction of nonresidential buildings, which had posted robust gains over the first half of the year, also appear to 

have decelerated in the third quarter. Although the less favorable outlook for sales 

has undoubtedly played a role, the softening in business investment also appears 

to reflect reduced credit availability from banks and other lenders. 

As has been the case for some time, the housing market remains depressed, with 

sales and construction of new homes continuing to decline. Indeed, single-family 

housing starts fell 12 percent in September, and permit issuance also dropped 

sharply. With demand for new homes remaining at a low level and the backlog of 

unsold homes still sizable, residential construction is likely to continue to contract 

into next year. 

International trade provided considerable support for the U.S. economy over the 

first half of the year. Domestic output was buoyed by strong foreign demand for a 

wide range of U.S. exports, including agricultural products, capital goods, and industrial supplies. Although trade should continue to be a positive factor for the U.S. 

economy, its contribution to U.S. growth is likely to be less dramatic as global 

growth slows. 

The prices of the goods and services purchased by consumers rose rapidly earlier 

this year, as steep increases in the prices of oil and other commodities led to higher 

retail prices for fuel and food, and as firms were able to pass through a portion of 

68 

their higher costs of production. These effects are now reversing in the wake of the 

substantial declines in commodity prices since the summer. Moreover, the prices of 

imports now appear to be decelerating, and consumer surveys and yields on inflation-indexed Treasury securities suggest that expected inflation has held steady or 

eased. If not reversed, these developments, together with the likelihood that economic activity will fall short of potential for a time, should bring inflation down to 

levels consistent with price stability. 

Over time, a number of factors are likely to promote the return of solid gains in 

economic activity and employment in the context of low and stable inflation. Among 

those factors are the stimulus provided by monetary policy, the eventual stabilization in housing markets that will occur as the correction runs its course, improvements in our credit markets as the new programs take effect and market participants work through remaining problems, and the underlying strengths and recuperative powers of our economy. The time needed for economic recovery, however, will 

depend greatly on the pace at which financial and credit markets return to more 

normal functioning. Because the time that will be needed for financial normalization 

and the effects of ongoing credit problems on the broader economy are difficult to 

judge, the uncertainty currently surrounding the economic outlook is unusually 

large. 

Fiscal Policy 

I understand that the Congress is evaluating the desirability of a second fiscal 

package. Any fiscal action inevitably involves tradeoffs, not only among current 

needs and objectives but also—because commitments of resources today can burden 

future generations and constrain future policy options—between the present and the 

future. Such tradeoffs inevitably involve value judgments that can properly be made 

only by our elected officials. Moreover, with the outlook exceptionally uncertain, the 

optimal timing, scale, and composition of any fiscal package are unclear. All that 

being said, with the economy likely to be weak for several quarters, and with some 

risk of a protracted slowdown, consideration of a fiscal package by the Congress at 

this juncture seems appropriate. 

Should the Congress choose to undertake fiscal action, certain design principles 

may be helpful. To best achieve its goals, any fiscal package should be structured 

so that its peak effects on aggregate spending and economic activity are felt when 

they are most needed, namely, during the period in which economic activity would 

otherwise be expected to be weak. Any fiscal package should be well-targeted, in the 

sense of attempting to maximize the beneficial effects on spending and activity per 

dollar of increased federal expenditure or lost revenue; at the same time, it should 

go without saying that the Congress must be vigilant in ensuring that any allocated 

funds are used effectively and responsibly. Any program should be designed, to the 

extent possible, to limit longer-term effects on the federal government’s structural 

budget deficit. 

Finally, in the ideal case, a fiscal package would not only boost overall spending 

and economic activity but would also be aimed at redressing specific factors that 

have the potential to extend or deepen the economic slowdown. As I discussed earlier, the extraordinary tightening in credit conditions has played a central role in 

the slowdown thus far and could be an important factor delaying the recovery. If 

the Congress proceeds with a fiscal package, it should consider including measures 

to help improve access to credit by consumers, homebuyers, businesses, and other 

borrowers. Such actions might be particularly effective at promoting economic 

growth and job creation. 

Thank you. I would be pleased to take your questions. 

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PREPARED STATEMENT OF DR. J. STEVEN LANDEFELD, DIRECTOR, BUREAU OF

ECONOMIC ANALYSIS

Mr. Chairman and Members of the Committee: 

Thank you for inviting me to discuss the gross domestic product (GDP) accounts, 

including the data we released this morning. I will present highlights from this 

morning’s release to the Committee, Mr. Chairman. I ask that the GDP release be 

included as part of my statement for the record. 

In the third quarter of 2008, real GDP decreased 0.3 percent at an annual rate. 

By comparison, in the second quarter real GDP increased 2.8 percent. The decrease 

in third-quarter GDP reflected declines in consumer spending, residential investment, and business nonresidential fixed investment (which consists of investment 

in durable equipment, software, and structures). In contrast, government spending, 

net exports, and business inventory investment increased. The price index for gross 

domestic purchases, which measures the prices paid by U.S. residents, increased 4.8 

percent, following an increase of 4.2 percent in the second quarter. 

Consumer spending decreased 3.1 percent in the third quarter, following an increase of 1.2 percent in the second. The third-quarter decline in consumer spending 

was the largest decline since the second quarter of 1980. Consumer spending on durable goods fell 14.1 percent, with motor vehicles accounting for most of the decline. 

Consumer spending on nondurable goods fell 6.4 percent. In contrast, spending on 

services grew 0.6 percent. 

Spending on residential investment fell 19.1 percent in the third quarter, compared with a decline of 13.3 percent in the second. This was the eleventh consecutive quarter in which residential investment has declined. Since its peak in the 

fourth quarter of 2005, residential investment has fallen 42.2 percent. 

Business nonresidential fixed investment fell 1.0 percent in the third quarter, 

compared with an increase of 2.5 percent in the second. Third-quarter business 

spending on durable equipment and software fell 5.5 percent, whereas spending on 

nonresidential structures increased 7.9 percent. 

Business inventory investment contributed +0.56 percentage point to the change 

in real GDP, compared to -1.50 percentage points in the second quarter. 

Exports of goods and services increased 5.9 percent in the third quarter, compared 

with an increase of 12.3 percent in the second. Exports have now increased for twenty-one consecutive quarters. Imports of goods and services decreased 1.9 percent in 

the third quarter, compared with a decrease of 7.3 percent in the second. 

Spending on goods and services by the federal government increased 13.8 percent 

in the third quarter, compared with an increase of 6.6 percent in the second. Most 

of the increase was in defense spending. Spending by state and local governments 

increased 1.4 percent in the third quarter, compared with 2.5 percent in the second. 

During the third quarter, hurricanes Gustav and Ike struck the Gulf Coast region, 

especially impacting coastal Texas and Louisiana. Because the effects of these 

storms are not separately identified in our source data, it is not possible to estimate 

their overall effect on GDP, but their impact is included in the GDP estimates. In 

particular, disruptions to oil and gas extraction and to petroleum and petrochemical 

producers are reflected in BEA’s estimates for inventory change in the nondurable 

manufacturing and wholesale trade industries. 

As I mentioned earlier, the price index for gross domestic purchases increased 4.8 

percent in the third quarter, after increasing 4.2 percent in the second. Excluding 

food and energy prices, the price index for gross domestic purchases increased 3.1 

percent in the third quarter, after increasing 2.2 percent in the second. The personal 

consumption expenditures price index increased 5.4 percent in the third quarter, 

after increasing 4.3 percent in the second. Excluding food and energy prices, the 

personal consumption expenditures price index increased 2.9 percent in the third 

quarter, after increasing 2.2 percent in the second. 

Turning to the household sector, real disposable personal income fell 8.7 percent 

in the third quarter, after increasing 11.9 percent in the second. The third quarter 

personal saving rate was 1.3 percent, compared with 2.7 percent in the second quarter and 0.2 percent in the first. The second-quarter increase in real disposable personal income was boosted by tax rebate payments to individuals as authorized by 

the Economic Stimulus Act of 2008. Excluding these payments, real disposable income increased 0.3 percent in the third quarter after decreasing 0.4 percent in the 

second. 

My colleagues and I now would be glad to answer your questions. 

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PREPARED STATEMENT OF DR. NOURIEL ROUBINI, PROFESSOR OF ECONOMICS, STERN

SCHOOL OF BUSINESS, NEW YORK UNIVERSITY AND CHAIRMAN OF ROUBINI GLOBAL

ECONOMICS, LLC 

The U.S. Will Experience a Severe Recession; thus a Large Fiscal Policy Stimulus 

is Necessary to Dampen the Severity of this Economic Contraction 

The U.S. is currently in a severe recession that will be deeper, longer and more 

protracted than previous U.S. recessions. The last two economic recessions—in 

1990–91 and 2001—lasted each 8 months and the cumulative fall in GDP from peak 

through the trough was only 1.3% in the 1990–91 contraction and 0.4% in the 2001 

contraction. In a typical U.S. recession in the post-WWII period GDP falls by an average of 2% and the recession lasts 10 months. The current economic contraction— 

that my analysis dates as having started in the first quarter of 2008 will last 

through the fourth quarter of 2009 with a cumulative fall in GDP of the order of 

about 4% that is even larger than the worst post-WWII recession (the one in 1957– 

68 when the GDP fall was 3.7%). 

Since most components of private aggregate demand are sharply falling right now 

(private consumption, residential investment, non-residential investment in structures, capex spending by the corporate sector on software and machinery) a major 

additional fiscal stimulus is necessary to reduce the depth and length of the current 

economic contraction. And since direct tax incentives have not been effective in 

boosting consumption and capex spending (as worried households and firm are retrenching their spending) the new round of fiscal stimulus will have to take the 

form of direct government spending on goods and services (preferably productive investment in infrastructures) and provision to income to those agents in the economy 

more likely to spend it (block grants to state and local governments, increased unemployment benefits to unemployed workers, etc.). 

Given the size of the expected contraction in private aggregate demand (likely to 

be about $450 billion in 2009 relative to 2008) a fiscal stimulus of the order of $300 

billion minimum (and possibly as large as $400 billion) will be necessary to partially 

compensate for the sharp fall in private aggregate demand. 

This fiscal stimulus should be voted on and spent as soon as possible as delay 

will make the economic contraction even more severe. A stimulus package legislated 

only February or March of next year when the new Congress comes back will be 

too late as the contraction of private aggregate demand will be extremely sharp in 

the next few months. Such policy action should be legislated right away—in a ‘‘lame 

duck’’ session right after the election—to ensure that the actual spending is undertaken rapidly in the next few months. 

Financial Turmoil and Crisis 

The rich world’s financial system is in significant and persistent turmoil. This is 

the worst financial crisis that the U.S. and other advanced economies have experienced since the Great Depression. Stock markets have been falling most days, 

money markets and credit markets have shut down as their interest-rate spreads 

skyrocket, and it is still too early to tell whether the raft of measures adopted by 

the US and Europe will stem the financial bleeding on a sustained basis. 

A generalized run on the banking system has been a source of fear for the first 

time in seven decades, while the shadow banking system—broker-dealers, non-bank 

mortgage lenders, structured investment vehicles and conduits, hedge funds, money 

market funds and private equity firms—are at risk of a run on their short-term liabilities. On the real economic side, all the advanced economies—representing over 

60% percent of global GDP—entered a recession even before the massive financial 

shocks that started in late summer. So we now have recession, a severe financial 

crisis and a severe banking crisis in the advanced economies. 

Emerging markets were initially tied to this distress only when foreign investors 

began pulling out their money. Then panic spread to credit markets, money markets 

and currency markets, highlighting the vulnerabilities of many developing countries’ 

financial systems and corporate sectors, which had experienced credit booms and 

had borrowed short and in foreign currencies. Countries with large current-account 

deficits and/or large fiscal deficits and with large short-term foreign currency liabilities have been the most fragile. But even the better-performing ones—like Brazil, 

Russia, India and China—are now at risk of a hard landing. Many emerging markets are now at risk of a severe financial crisis. 

The crisis was caused by the largest leveraged asset bubble and credit bubble in 

history. Leveraging and bubbles were not limited to the US housing market, but 

also characterized housing markets in other countries. Moreover, beyond the housing market, excessive borrowing by financial institutions and some segments of the 

corporate and public sectors occurred in many economies. As a result, a housing 

87 

bubble, a mortgage bubble, an equity bubble, a bond bubble, a credit bubble, a commodity bubble, a private equity bubble and a hedge funds bubble are all now bursting simultaneously. 

The hope that economic contraction in the US and other advanced economies 

would be short and shallow—a V-shaped six-month recession—has been replaced by 

certainty that this will be a long and protracted U-shaped recession, possibly lasting 

at least two years in the US and close to two years in most of the rest of the world. 

And, given the rising risk of a global systemic financial meltdown, the prospect of 

a decade-long L-shaped recession—like the one experienced by Japan after the collapse of its real estate and equity bubble—cannot be ruled out. 

Indeed, the growing disconnect between increasingly aggressive policy actions and 

strains in the financial market is scary. When Bear Stearns’ creditors were bailed 

out to the tune of US$30 billion in March, the rally in equity, money and credit 

markets lasted eight weeks. When the US Treasury announced a bailout of mortgage giants Fannie Mae and Freddie Mac in July, the rally lasted just four weeks. 

When the US$200 billion rescue of these firms was undertaken and their US$6 trillion in liabilities taken over by the US government, the rally lasted one day. 

Until the recent US and European measures were announced, there were no rallies at all. When AIG was bailed out to the tune of US$85 billion, the market fell 

5 percent. Then, when the US$700 billion US rescue package was approved, markets fell another 7 percent in two days. As authorities in the US and abroad took 

ever more radical policy steps in the last few weeks, stock, credit and money markets fell further, day after day for most days. Even the rally following the G7 statement and radical policy actions taken to back stop the financial system lasted only 

one day and was followed by two weeks of sharply falling equity prices and rising 

CDS and credit spreads. Policy authorities seem to have lost their credibility in financial markets as—until recently—their actions were step by step, ad hoc and 

without a comprehensive crisis resolution plan. 

Do the recent measures go far enough? When policy actions don’t provide real relief to market participants, it is clear that you are one step away from a systemic 

stress on the financial and corporate sector. A vicious circle of de-leveraging, plummeting asset prices and margin calls is underway. 

Recent Policy Actions and Further Necessary Policy Actions to Stem the Crisis 

As we have seen in recent weeks, it will take a big change in economic policy and 

very radical, coordinated action among all advanced and emerging-market economies to avoid an even more severe economic and financial crisis. This includes: 

• Another rapid round of interest-rate cuts of at least 150 basis points on average 

globally; 

• A temporary blanket guarantee of all deposits while insolvent financial institutions that must be shut down are distinguished from distressed but solvent institutions that must be partially nationalized and given injections of public capital; 

• A rapid reduction of insolvent households’ debt burden, preceded by a temporary freeze on all foreclosures; 

• Massive and unlimited provision of liquidity to solvent financial institutions; 

• Public provision of credit to the solvent parts of the corporate sector in order 

to avoid a short-term debt refinancing crisis for solvent but illiquid corporations 

and small businesses; 

• A massive direct government fiscal stimulus that includes public works, infrastructure spending, unemployment benefits, tax rebates to lower-income households and provision of grants to cash-strapped local governments; 

• An agreement between creditor countries running current-account surpluses 

and debtor countries running current-account deficits to maintain an orderly financing of deficits and a recycling of creditors’ surpluses to avoid disorderly adjustment of such imbalances. 

After the early October crash in stock markets and financial markets (and it was 

indeed a crash as during the week before the G7/IMF meetings equity prices fell 

as much as the two day crash of 1929) policy makers finally realized the risk of a 

systemic financial meltdown, they peered into the systemic collapse abyss a few 

steps in front of them and finally got religion and started announcing radical policy 

actions (the G7 statement, the EU leaders agreement to bailout European banks, 

the British plan to rescue—and partially nationalize—its banks, the European countries plans along the same lines, and the Treasury plan to ditch the initial TARP 

that was aimed only at buying toxic assets in favor of plan to recapitalize—i.e., parVerDate Nov 24 2008 10:43 Aug 04, 2009 Jkt 045037 PO 00000 Frm 00091 Fmt 6601 Sfmt 6621 C:\DOCS\48279.TXT SHAUN PsN: DPROCT
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tially nationalize—US banks and broker dealers. The main policy actions that will 

be undertaken are: 

• Preventing systemically important banks and broker dealers from going bust 

(i.e., the U.S. made a mistake letting Lehman fail; so Morgan Stanley and other 

systemically important financial institutions will be rescued) (‘‘Take decisive action and use all available tools to support systemically important financial institutions and prevent their failure’’ as in the G7 statement) 

• Recapitalization of banks and broker dealers via public injections of capital via 

preferred shares (i.e., partial nationalization of financial institutions as it is already occurring in the UK, Belgium, Netherlands, Germany, Iceland and, soon 

enough the U.S.) matched by private equity injections (‘‘Ensure that our banks 

and other major financial intermediaries, as needed, can raise capital from public as well as private sources, in sufficient amounts to re-establish confidence 

and permit them to continue lending to households and businesses’’) 

• Temporary guarantee of bank liabilities: certainly all deposits, possibly interbank lines along the lines of the British approach, likely other new debts incurred by the banking system (‘‘Ensure that our respective national deposit insurance and guarantee programs are robust and consistent so that our retail 

depositors will continue to have confidence in the safety of their deposits’’) 

• Unlimited provision of liquidity to the banking system and to some parts of the 

shadow banking system to restore interbank lending and lending to the real 

economy (‘‘Ensure that our banks and other major financial intermediaries, as 

needed, can raise capital from public as well as private sources, in sufficient 

amounts to re-establish confidence and permit them to continue lending to 

households and businesses’’) 

• Provision of credit to the corporate sector via purchases of commercial paper 

(certainly in the US, possibly in Europe) 

• Purchase of toxic assets to restore liquidity in the mortgage backed securities 

market (U.S.) (‘‘Take action, where appropriate, to restart the secondary markets for mortgages and other securitized assets. Accurate valuation and transparent disclosure of assets and consistent implementation of high quality accounting standards are necessary.’’) 

• Implicit triage between distressed that are solvent given liquidity support and 

capital injection and non-systemically important and insolvent banks that will 

need to be closed down/merged/resolved/etc. 

• Use of the IMF and other international financial institutions to provide lending 

to many emerging market economies—and some advanced ones such as Iceland—that are now at risk of a severe financial crisis. 

• Use of any other tools that are available and necessary to avoid a systemic 

meltdown (including implicitly more monetary policy easing as well as possibly 

fiscal policy stimulus ‘‘We will use macroeconomic policy tools as necessary and 

appropriate.’’). 

At this stage central banks that are usually supposed to be the ‘‘lenders of last 

resort’’ need to become the ‘‘lenders of first and only resort’’ as, under conditions of 

panic and total loss of confidence, no one in the private sector is lending to anyone 

else since counterparty risk is extreme. Only over time private lending will recover. 

While most of the economic and financial damage is already done and the global 

economy will not be able to avoid a painful recession, financial and banking crisis 

(i.e., the V-shaped short and shallow 6-month recession is now out of the window 

and we will experience a severe and more protracted 18 to 24 months U-shaped recession) the rapid and consistent implementation of these and other action will prevent the US, European and global economies from experiencing a systemic financial 

meltdown and entering in a more severe L-shaped decade long stagnation like the 

one experienced by Japan after the bursting of its real estate and equity bubble. 

Are we close to the bottom of this financial crisis? Not really as financial markets 

are and will remain volatile with significant downside risks to markets remaining 

over the next few weeks and months as: 

• Details of the policy plans are still very fuzzy and ambiguous and with uncertain effects on various assets classes (common shares, preferred shares, unsecured debt of financial institutions, etc.); 

• Macroeconomic news will surprise on the downside as the economies sharply 

weaken and contract while fiscal policy stimulus is lagging. Indeed such macro 

news flow was worse than awful in the last couple of weeks: free fall in retail 

sales confirming a consumption recession that started in June; terrible news 

about housing (starts, permits, prices, homebuilders’ sentiment); consumer confidence collapsing; awful leading indicators of supply from the regional Fed reVerDate Nov 24 2008 10:43 Aug 04, 2009 Jkt 045037 PO 00000 Frm 00092 Fmt 6601 Sfmt 6621 C:\DOCS\48279.TXT SHAUN PsN: DPROCT
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ports (Empire State and Philly); continued high initial claims; free fall in industrial production (only in part driven by temporary factors); fall in durable goods 

orders ex-transportation. • Earnings news for financial and non financial firms will sharply surprise on the 

downside; • The damage done to confidence and to levered investment is already severe and 

the process of deleveraging of the shadow financial system will continue; • Major sources of future stress in the financial system remain; these systemic 

financial risks include: a major surge in corporate defaults rates and fall in recovery rates as the recession becomes severe thus leading to a further widening 

of credit spreads; the risk of a CDS market blowout as corporate defaults start 

to spike; the collapse of hundreds of hedge funds that, while being small individually, will have systemic effects as hundreds of small funds make the size 

of a few LTCMs in terms of their common deleveraging and selling assets in 

illiquid markets; the rising troubles of many insurance companies; a slow motion refinancing and insolvency crisis for many toxic LBOs once covenant-lite 

clauses and PIK toggles effects fizzle out; the risk that other systemically important financial institutions are insolvent and in need of expensive rescue programs while the $250 bn of recap of banks is way insufficient to deal with their 

needs; the ongoing process of deleveraging in illiquid financial markets that will 

continue the vicious circle of falling asset prices, margin calls, further 

deleveraging and further sales in illiquid markets that continues the cascading 

fall in asset prices; further downside risks to housing and to home prices pushing over 20 million households into negative equity by 2009; the risk that some 

significant emerging market economies and some advanced ones too (Iceland) 

will experience a severe financial crisis. 

The last factor is a crucially important one: there are now about a dozen of emerging market economies that are in serious financial trouble: they include Estonia, 

Latvia, Hungary, Bulgaria, Turkey, Pakistan, Korea, Indonesia, a few other ones in 

Central-South Europe and several Central American ones. There is now a significant and rising risk that several of them will experience a true financial crisis. Even 

a small tiny country of 300,000 souls like Iceland is now having systemic effects on 

global financial markets: since the country was like a huge hedge fund with banks 

having liabilities that were 12 times the GDP of the country the collapse of these 

banks may now lead to a disorderly sale of their assets in already illiquid markets. 

Now the risk of a financial crisis in a number of twenty countries in the region that 

goes from the Baltics to Turkey is rising as they all have very large current account 

deficits and other macro and financial vulnerabilities. 

Need for Fiscal Policy Stimulus to Dampen the Contraction in Private Demand 

More aggressive and consistent and rapid implementation of the policy plans will 

increase the likelihood that risky asset prices will bottom out sooner rather than 

later and then start recovering. A key policy tool—that is currently missing in the 

G7 and EU plans is to use fiscal policy to boost aggregate demand. Indeed, given 

the current collapse of private aggregate demand (consumption is falling, residential 

investment is falling, non-residential investment in structures is falling, capex 

spending by the corporate sector was falling already before the latest financial and 

confidence shock and will now be plunging at an even faster rate) it is urgent to 

provide a boost to aggregate demand to ensure that an unavoidable two-year recession does not become a decade long stagnation. Since the private sector is not spending and since the first fiscal stimulus plan (tax rebates for households and tax incentives to firms) miserably failed as households and firms are saving rather than 

spending and investing it is necessary now to boost directly public consumption of 

goods and services via a massive spending program (a $300 to $400 bn fiscal stimulus): the federal government should have a plan to immediately spend in infrastructures and in new green technologies; also unemployment benefits should be 

sharply increased together with targeted tax rebates only for lower income households at risk; and federal block grants should be given to state and local government 

to boost their infrastructure spending (roads, sewer systems, etc.). If the private sector does not spend and/or cannot spend old fashioned traditional Keynesian spending by the government is necessary. It is true that we are already having large and 

growing budget deficits; but $300-400 bn of public works is more effective and productive than just spending $700 bn to buy toxic assets and/or recapitalizing financial institutions. If such fiscal stimulus plan is not rapidly implemented any improvement in the financial conditions of financial institution that the rescue plans 

will provide will be undermined—in a matter of six months—with an even sharper 

drop of aggregate demand that will make an already severe recession even more seVerDate Nov 24 2008 10:43 Aug 04, 2009 Jkt 045037 PO 00000 Frm 00093 Fmt 6601 Sfmt 6621 C:\DOCS\48279.TXT SHAUN PsN: DPROCT
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vere. So a fiscal stimulus plan is essential to restore—on a sustained basis—the viability and solvency of many impaired financial institutions. If Main Street goes bust 

in the next six months rescuing in the short run Wall Street will still lead Wall 

Street to go bust again as the real economy implodes further. 

Moreover, the US government will need to implement a clear plan to reduce the 

face value of mortgages for distressed home owners and avoid a tsunami of foreclosures (as in the Great Depression HOLC and in my HOME proposal). Households 

in the US have too much debt (subprime, near prime, prime mortgages, home equity 

loans, credit cards, auto loans and student loans) while their assets (values of their 

homes and stocks) are plunging leading to a sharp fall in their net worth. And 

households are getting buried under this mountain of mounting debt and rising debt 

servicing burdens. Thus, a fraction of the household sector—as well as a fraction 

of the financial sector and a fraction of the corporate sector and of the local government sector—is insolvent and needs debt relief. When a country (say Russia, Ecuador or Argentina) has too much debt and is insolvent it defaults and gets debt reduction and is then able to resume fast growth; when a firm is distressed with excessive debt it goes into bankruptcy court and gets debt relief that allows it to resume investment, production and growth; when a household is financially distressed 

it also needs debt relief to be able to have more discretionary income to spend. So 

any unsustainable debt problem requires debt reduction. The lack of debt relief to 

the distressed households is the reason why this financial crisis is becoming more 

severe and the economic recession—with a sharp fall now in real consumption 

spending—now worsening. The fiscal actions taken so far (income relief to households via tax rebates) do not resolve the fundamental debt problem because you cannot grow yourself out of a debt problem: when debt to disposable income is too high 

increasing the denominator with tax rebates is ineffective and only temporary; i.e., 

you need to reduce the nominator (the debt). During the Great Depression the Home 

Owners’ Loan Corporation was created to buy mortgages from bank at a discount 

price, reduce further the face value of such mortgages and refinance distressed 

homeowners into new mortgages with lower face value and lower fixed rate mortgage rates. This massive program allowed millions of households to avoid losing 

their homes and ending up in foreclosure. The HOLC bought mortgages for two 

years and managed such assets for 18 years at a relatively low fiscal cost (as the 

assets were bought at a discount and reducing the face value of the mortgages allowed home owners to avoid defaulting on the refinanced mortgages). A new HOLC 

will be the macro equivalent of creating a large ‘‘bad bank’’ where the bad assets 

of financial institutions are taken off their balance sheets and restructured/reduced. 

A large fiscal stimulus plan and a plan to reduce the debt overhang of distressed 

home owners will also ease the political economy of the financial bailout: as the debate in Congress showed, the US public is mad about a system where gains and 

profits are privatized while losses are socialized, a welfare system for the rich, the 

well connected and Wall Street. Bernanke and Paulson and the US administration 

did a lousy job in explaining why partially bailing Wall Street is necessary to avoid 

severe collateral damage to Main Street in the form of a most severe recession and 

a risk of an even more severe economic stagnation. At least the redesign of the 

TARP into a program that will recapitalize banks with public capital (and thus provide the US government and the taxpayer with some upside potential) makes this 

bailout more socially fair and acceptable. 

But the current collapse of private aggregate demand makes it fair, necessary and 

efficient to directly help Main Street with a direct fiscal stimulus program and with 

a plan to reduce the debt burden of distressed home owners. Those two additional 

policy actions are necessary and fundamental—together with the rescue and recapitalization of financial institutions—to minimize the damage to the real economy and 

to the financial system. 

The Risks of a Global Stag-Deflation (Stagnation/Recession and Deflation) 

Another important risk that the economy faces—and that suggests the need for 

a large fiscal stimulus is the risk of a recession associated with price deflation. Last 

January—at a time when the economic consensus was starting to worry about rising 

global inflation—I wrote a piece titled Will the U.S. Recession be Associated with 

Deflation or Inflation (i.e., Stagflation)? On the Risks of ‘‘Stag-deflation’’ rather than 

‘‘Stagflation’’ where I argued that the US and other economies would soon have to 

worry about price deflation rather than price inflation. 

As I put it at that time last January: 

The S-word (stagflation that implies growth recession cum high and rising inflation) has recently returned in the markets and analysts’ debate as inflation has been 

rising in many advanced and emerging markets economies. This rise in inflation toVerDate Nov 24 2008 10:43 Aug 04, 2009 Jkt 045037 PO 00000 Frm 00094 Fmt 6601 Sfmt 6621 C:\DOCS\48279.TXT SHAUN PsN: DPROCT
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gether with the now unavoidable US recession, the risk of a recession in a number 

of other economies (especially in Europe) and the likelihood of a sharp global economic slowdown has led to concerns that the risks of stagflation may be rising. 

Should we thus worry about US and global stagflation? This note will argue that 

such worries are not warranted as a US hard landing followed by a global economic 

slowdown represents a negative global demand shock that will lead to lower global 

growth and lower global inflation. To get stagflation one needs a large negative global supply-side shock that, as argued below, is not likely to occur in the near future. 

Thus the coming US recession and global economic slowdown will be accompanied 

by a reduction—rather than an increase—in inflationary pressures. As in 2001–2003 

inflation may become the last of the worries of the Fed and one may actually start 

hearing again concerns about global deflation rather than inflation. 

Let me elaborate next why . . . 

. . . unlike a true negative supply side shock—that reduces growth while increasing 

inflation—a US recession followed by a global economic slowdown is a negative demand shock that has the effect of reducing US and global growth while at the same 

time reducing US and global inflationary pressures. Specifically such a negative demand shock will reduce inflation and across the world because of a variety of channels. 

First, a US hard landing will lead to a reduction in aggregate demand relative 

to the aggregate supply as a glut of housing, consumer durables, autos and, soon 

enough, other goods and service takes places. Such reduction in aggregate demand 

tends to reduce inflationary pressures as firms lose pricing power and then cut prices 

to stave off the fall in demand and the rising stock of inventories of unsold goods. 

These deflationary pressures are already clear in housing where prices are falling 

and in the auto sector where the glut of automobiles is leading to price discounts and 

other price incentives. Obviously, inflation tends to fall in recession led by a fall in 

aggregate demand. 

Second, during US recessions you observe a significant slack in labor markets: job 

losses and the rise in the unemployment rate lead to a slowdown in nominal wage 

growth that reduces labor costs and unit labor cost, thus reducing wage and price 

inflationary pressures in the economy. 

Third, the same slack of aggregate demand and slack in labor markets will occur 

around the world as long as the negative US demand shock is transmitted—through 

trade, financial, exchange rate and confidence channels—to other countries leading 

to a slowdown in growth in other countries (the recoupling rather than decoupling 

phenomenon). The reduction in global aggregate demand—relative to the global supply of goods and service—will lead to a reduction in inflationary pressures. 

Fourth, during any US hard landing and global economic slowdown driven by a 

negative demand shock the US and global demand for oil, gas, energy and other 

commodities tends to fall leading to a sharp fall in the price of all commodities. A 

US hard landing followed by a European, Chinese and Asian slowdown will lead 

to a much lower demand for commodities, pushing down their price. The fall in 

prices tends to be sharp because—in the short run—the supply of commodities tends 

to be inelastic; thus any fall in demand leads to a greater fall in price—given an 

inelastic supply curve—to clear the commodity prices. And indeed in recent weeks the 

rising probability of a US hard landing has already led to a fall in such prices: for 

example oil prices that had flirted with a $100 a barrel level are now down to a price 

closer to $90; or the Baltic Dry Freight index—that measures the cost of shipping dry 

commodities across the globe and that had spiked for most of 2007 given the high 

demand and the limited supply of such ships—is now sharply down by over 20% relative to its peak in the fall of 2007. Similar downward pressure in prices is now 

starting to show up in other commodities. 

Note that a cyclical drop in commodity prices—led by a US hard landing and 

global economic slowdown—does not mean that commodity prices will remain depressed over the middle term once this global growth slowdown is past. If in the medium term the supply response to high prices is modest while the medium-long term 

demand for commodities remains high once the US and global economy return to 

their potential growth rates commodity prices could indeed resume their upward 

trend. But in a cyclical horizon of 12 to 18 months a US hard landing and global 

economic slowdown would lead to a sharp fall in commodity prices. Note that even 

in the case of oil that is the commodity with the weakest supply response to prices— 

as the investments in new production in a bunch of unstable petro-states (Nigeria, 

Venezuela, Iran, Iraq and even Russia) are limited—a cyclical global slowdown could 

lead to a very sharp fall in oil prices. Indeed while oil today is closer to the $90- 

100 range in the last 12 months oil prices drifted downward at some point close to 

a $50–60 range even before a US hard landing and global slowdown had occurred. 

92 

Thus, one cannot rule out that in such a hard landing scenario oil prices could drift 

to a price close to $60. 

The four factors discussed above suggest that—conditional on the negative global 

demand shock (US hard landing and global economic slowdown) materializing even 

the risks of stagflation-lite are exaggerated; rather US and global inflationary force 

would sharply diminish in this scenario and, if anything, concerns about deflation 

may reemerge again. 

This is not a far fetched scenario as one looks back at what happened in the 2000– 

2003 cycle. Until 2000 the Fed was worried about the economy overheating and rising inflation risk. But once the economy spinned into a recession in 2001 US and 

global inflationary pressures diminished and by 2002 the great scare became one of 

US and global deflation rather than inflation. Indeed the Fed aggressively cut the 

Fed Funds rate all the way to 1% and Ben Bernanke—then only a Fed governor— 

wrote speeches about using heterodox policy instruments to fight the risk of deflation 

once and if the Fed Funds rate were to reach its nominal floor of zero percent. 

Today, following a US hard landing and a global economic slowdown, the risks 

of outright deflation would be lower than in the 2001–2003 episode because of various factors: US inflation starts higher than in 2001; the Fed needs to worry about 

a disorderly fall of the US dollar that may increase inflationary pressures; the rise 

and persistence of growth rates in Chindia and other emerging market economies implies that—even if such economies likely recouple to the US hard landing—a global 

growth slowdown will not turn into an outright global recession that would be truly 

deflationary. Still, while the scenario outlined here—US recession and global slowdown—may not lead to outright deflationary pressures it would certainly lead to a 

slowdown of US and global inflation. 

The fact that the most likely scenario in the global economy in 2008 is one of a 

negative global demand shock is the one that is priced by bond markets: if investors 

were really worried about a rise in US and global inflation—or about true 

stagflationary shocks—the yield on long term government bonds would have not fallen as sharply as it has since last summer. With US 10 year Treasury yield now well 

below 4% and sharply falling in the last few weeks it is hard to see a bond market 

that is worried about global inflation or global stagflation. And while until recently 

commodity prices pointed to the other directions, recent weakness in oil prices, the 

cost of shipping commodities and the price of some other commodities also signals 

that commodity markets are now pricing the risk of a US recession and the risk 

that—with a lag—a US recession will lead to a broader global economic slowdown. 

So in conclusion ‘‘stag-deflation’’ (i.e., low growth or recession with falling inflation 

rates and possible deflationary pressures) is more likely than ‘‘stagflation’’ (low 

growth or recession with rising inflation rates) if a US hard landing materializes 

and leads—as likely—to a slowdown in global demand and growth. 

So last January I argued that four major forces would lead to a risk of deflation 

(or stag-deflation where a recession would be associated with deflationary forces) 

rather than the inflation risk that at that time—and for most of 2008—mainstream 

analysts worried about: slack in goods markets, re-coupling of the rest of the world 

with the US recession, slack in labor markets, and a sharp fall in commodity price 

following such US and global contraction would reduce inflationary forces and lead 

to deflationary forces in the global economy. 

How have such predictions fared over time? And will the US and global economy 

soon face sharp deflationary pressures? The answer deflation and stag-deflation will 

in six months become the main concern of policy authorities. 

First, what has happened in the last few months? The US has entered a severe 

recession that is already leading to deflationary forces in sectors where supply vastly exceeds demand (housing, consumer durables, motor vehicles, etc.) while now aggregate demand is sharply falling below aggregate supply; the unemployment rate 

is sharply up while employment has been falling for 10 months in a row; and commodity prices are sharply down—about 30% from their July peak—in the last three 

months and likely to fall much more in the next few months as the advanced economies recession is becoming global. So both in the US and in other advanced economies we are clearly headed towards a collapse of headline and core inflation. 

Is there any doubt about this ongoing inflation capitulation and the beginning of 

sharp deflationary forces? Take the current views of the economic research group 

at JP Morgan; this group was in 2007–2008 the leading voice arguing about the 

risks of rising global inflation, about the associated risks of a global growth reflation 

and arguing that policy rates would be sharply increased in 2008–2009. 

This past week instead this JP Morgan research group published its latest global 

economic outlook arguing that we are headed towards a global recession, negative 

global inflation and sharply lower policy rates in the US and advanced economies 

93 

(a 180 degree turn from its previous position). As written in the most recent JP 

Morgan Global Data Watch: 

‘‘A bad week in hell 

Increasingly, the signs point to a deep and synchronized global recession. Today’s 

reported slide in UK 3Q08 GDP is expected to be followed by contractions in the 

United States (next week), the Euro area, and Japan—confirming that the global 

downturn began last quarter. More troubling is the additional loss of momentum at 

quarter end, combined with collapsing October survey readings. These developments 

appear to be part of a negative loop in which economic and financial weakness are 

feeding on each other, making the prospects for growth in the coming months decidedly grim. Once again we have taken an axe to near-term growth forecasts for the 

developed world and will likely follow up with additional downward revisions for 

emerging market economies in the coming weeks. Already, our forecasts suggest that 

global GDP will contract at a near 1% annual rate in 4Q08 and 1Q09. 

It is still too early to accurately gauge the depth of the downturn, as the outlook 

depends on how well policy actions contain the financial crisis. From a US perspective, our current forecasts place the contraction in GDP somewhere between the last 

two mild recessions and the deep contractions of 1973–75 and 1981–82. This picture 

masks the degree to which the pain of the current downturn is falling on households. 

From the perspective of wealth losses and declines in real consumption, the current 

recession is likely to prove more severe than any of the previous ten in the post World 

War II era (see Special report: How deep is the ocean? Gauging US recession contours). For Western Europe, the current downturn is currently projected to look similar to the one in the early 1990s—the last episode in which regional GDP contracted. 

. . 

Inflation and real policy rates to go negative 

With part of this year’s slide in global growth linked to an inflation shock, the recent collapse in global commodity prices should be seen as an important factor cushioning the downturn. In the six months through August 2008, global consumer prices 

rose at a 5.6% annual rate, prompting stagnation in real consumption across the 

globe. Based on recent moves in the price of oil and other commodities, it is likely 

that the coming six months will see headline inflation dip below zero. While this 

swing will be a plus for consumers across the globe, it is also a development that 

will promote a significant growth rotation towards the G3 and Emerging Asian 

economies that were hurt most severely by this negative shock. In the developed 

world, this backdrop of contracting GDP, collapsing inflation, and financial market 

stress opens the door to a powerful monetary policy response (emphasis/bold added).’’ 

So the leading supporters of the view that the global economy risked rising inflation, rising growth reflation and sharply higher policy rates to fight this inflation 

are now predicting a global recession, global deflation and sharply falling policy 

rates. What a difference a year makes. 

Is there any further doubt that we are headed towards a global deflation or—better—a global stag-deflation? Aggregate demand is now collapsing in the US and advanced economies and sharply decelerating in emerging markets; there is a huge excess capacity for the production of manufactured goods in the global economy as the 

massive and excessive capex spending in China and Asia (Chinese real investment 

is now close to 50% of GDP) has created an excess supply of goods that will remain 

unsold as global aggregate demand falls; commodity prices are in free fall with oil 

prices alone down over 50% from their July peak (and the Baltic Freight Index— 

the best measure of international shipping costs—is 90% from its peak in May); 

while labor market slack is sharply growing in the US and rising in Europe and 

other advanced economies. 

And what are financial markets telling us about the risks of stag-deflation? 

First, yields on 10 year Treasury bonds fell by about 50bps since October 14th 

getting close to their previous 2008 lows; also two-year Treasury yield have fallen 

by about l50bps in the last month. Second, gold prices—a typical hedge against rising global inflation—are now sharply falling. Finally, and more importantly, yields 

on TIPS (Treasury Inflation-Protected Securities) due in five years or less have now 

become higher than yields on conventional Treasuries of similar maturity. The difference between yields on five-year Treasuries and five-year TIPS, known as the 

breakeven rate, fell to minus 0.43 percentage points; this is a record. Since the difference between the conventional Treasuries and TIPS is a proxy for expected inflation the TIPS market is now signaling that investors expect inflation to be negative 

over the next five years as a severe recession is ahead of us. 

94 

So goods markets, labor markets, commodity markets, financial markets and bond 

markets are all sending the same message: stagnation/recession and deflation (or 

stag-deflation) is ahead of us in the US and global economy. 

So, we should not be surprised if six months from now the Fed and other central 

banks in advanced economies will start to worry—as they did in 2002–03 after the 

2001 recession—about deflation rather than inflation. In those years where the US 

experienced a deflation scare Bernanke wrote several pieces explaining how the US 

could resort to very unorthodox policy actions to prevent a deflation and a liquidity 

trap like the one experienced by Japan in the 1990s. Those writings may have to 

be soon carefully read and studied again as the US and global economy faces its 

worst recession in decades and as deflationary forces envelop the US and other advanced economies. It also highly likely that as deflationary forces mount the Fed 

will have to cut the Fed Funds rate even further: as I have argued for a while at 

the bottom of this business cycle the Fed Funds rate is likely to be closer to 0% 

than to 1%. Indeed, if the Fed cut the Fed Funds rate to 1% during the last recession that was short and shallow it will cut this rate much further if—as likely— 

the recession will be much more severe and protracted this time around. 

Finally, while in the short run a global recession will be associated with deflationary forces shouldn’t we worry about rising inflation in the middle run? This argument that the financial crisis will eventually lead to inflation is based on the view 

that governments will be tempted to monetize the fiscal costs of bailing out the financial system and that this sharp growth in the monetary base will eventually 

cause high inflation. In a variant of the same argument some argue that—as the 

US and other economies face debt deflation—it would make sense to reduce the debt 

burden of borrowers (households and now governments taking on their balance 

sheet the losses of the private sector) by wiping out the real value of such nominal 

debt with inflation. 

So should we worry that this financial crisis and its fiscal costs will eventually 

lead to higher inflation? The answer to this complex question is: likely not. 

First of all, the massive injection of liquidity in the financial system—literally trillions of dollars in the last few months—is not inflationary as it is accommodating 

the demand for liquidity that the current financial crisis and investors’ panic has 

triggered. Thus, once the panic recedes and this excess demand for liquidity shrinks, 

central banks can and will mop up all this excess liquidity that was created in the 

short run to satisfy the demand for liquidity and prevent a spike in interest rates. 

Second, the fiscal costs of bailing out financial institutions would eventually lead 

to inflation if the increased budget deficits associated with this bailout were to be 

monetized as opposed to being financed with a larger stock of public debt. As long 

as such deficits are financed with debt—rather than by running the printing presses—such fiscal costs will not be inflationary as taxes will have to be increased over 

the next few decades and/or government spending reduced to service this large increase in the stock of public debt. 

Third, wouldn’t central banks be tempted to monetize these fiscal costs—rather 

than allow a mushrooming of public debt—and thus wipe out with inflation these 

fiscal costs of bailing out lenders/investors and borrowers? Not likely in my view: 

even a relatively dovish Bernanke Fed cannot afford to let the inflation expectations 

genie out of the bottle via a monetization of the fiscal bailout costs; it cannot afford/ 

be tempted to do that because if the inflation genie gets out of the bottle (with inflation rising from the low single digits to the high single digits or even into the double 

digits) the rise in inflation expectations will eventually force a nasty and severely 

recessionary Volcker-style monetary policy tightening to bring back the inflation expectation genie into the bottle. And such Volcker-style disinflation would cause an 

ugly recession. Indeed, central banks have spent the last 20 years trying to establish 

and maintain their low inflation credibility; thus destroying such credibility as a 

way to reduce the direct costs of the fiscal bailout would be highly corrosive and 

destructive of the inflation credibility that they have worked so hard to achieve and 

maintain. 

Fourth, inflation can reduce the real value of debts as long as it is unexpected 

and as long as debt is in the form of long-term nominal fixed rate liabilities. The 

trouble is that an attempt to increase inflation would not be unexpected and thus 

investors would write debt contracts to hedge themselves against such a risk if 

monetization of the fiscal deficits does occur. Also, in the US economy a lot of 

debts—of the government, of the banks, of the households—are not long term nominal fixed rate liabilities. They are rather shorter term, variable rates debts. Thus, 

a rise in inflation in an attempt to wipe out debt liabilities would lead to a rapid 

re-pricing of such shorter term, variable rate debt. And thus expected inflation 

would not succeed in reducing the part of the debts that are now of the long term 

nominal fixed rate form, i.e., you can fool all of the people some of the time (unexVerDate Nov 24 2008 10:43 Aug 04, 2009 Jkt 045037 PO 00000 Frm 00098 Fmt 6601 Sfmt 6621 C:\DOCS\48279.TXT SHAUN PsN: DPROCT
95 

pected inflation) and some of the people all of the time (those with long term nominal fixed rate claims) but you cannot fool all of the people all of the time. Thus, 

trying to inflict a capital levy on creditors and trying to provide a debt relief to debtors may not work as a lot of short term or variable rate debt will rapidly reprice 

to reflect the higher expected inflation. 

In conclusion, a sharp slack in goods, labor and commodity markets will lead to 

global deflationary trends over the next year. And the fiscal costs of bailing out borrowers and/or lenders/investors will not be inflationary as central banks will not be 

willing to incur the high costs of very high inflation as a way to reduce the real 

value of debt burdens of governments and distressed borrowers. The costs of rising 

expected and actual inflation will be much higher than the benefits of using the inflation/seignorage tax to pay for the fiscal costs of cleaning up the mess that this 

most severe financial crisis has created. As long—as likely—as these fiscal costs are 

financed with public debt rather than with a monetization of these deficits inflation 

will not be a problem either in the short run or over the medium run. 

Given the risk of a deflationary and recessionary spiral in the economy—like the 

one experienced by Japan in the 1990s after the bursting of its real estate and equity bubble—it is essential to prevent such destructive price deflation from occurring. Thus risk of a deflation is additional argument in favor of an aggressive fiscal 

stimulus package; such package will reduce the risk of such destabilizing deflationary spiral. 

96 

PREPARED STATEMENT OF DR. SIMON JOHNSON, RONALD A. KURTZ PROFESSOR OF

ENTREPRENEURSHIP, MASSACHUSETTS INSTITUTE OF TECHNOLOGY

Main Points 

1) The US is facing a serious recession and subsequent slow growth, due to the 

effects of a crisis of confidence in and around the global credit system. 

2) Some sensible counter-cyclical policies are now being implemented in the US, 

but problems in other parts of the world are still emerging and most economic forecasts continue to be marked down. 

3) In this environment, a total fiscal stimulus of around $450 billion (or roughly 

3% of GDP) would be appropriate, with about half front-loaded in the first three 

quarters of 2009, when there will likely be recession, and the rest following over 

the next 8–12 quarters, during which otherwise growth will be slow. 

Today, it is abundantly clear that not only the United States but much of the 

world is sliding rapidly into recession. While the Treasury Department, Federal Reserve, and Congress have taken multiple steps to ensure the stability of the financial system, the next question is how to protect the real economy from a severe, prolonged recession and construct a basis for long-term growth and prosperity in the 

future. 

My testimony includes three main sections: first, the roots and evolution of the 

current global financial crisis; second, the current situation; and third, my recommendations for the stimulus package itself. 

The Global Financial Crisis 

Roots of the Crisis 

For at least the last year and a half, as banks took successive writedowns related 

to deteriorating mortgage-backed securities, the conventional wisdom was that we 

were facing a crisis of bank solvency triggered by falling housing prices and magnified by leverage. However, falling housing prices and high leverage alone would 

not necessarily have created the situation we are now in. 

The problems in the U.S. housing market were not themselves big enough to generate the current financial crisis. America’s housing stock, at its peak, was estimated to be worth $23 trillion. A 25% decline in the value of housing would generate a paper loss of $5.75 trillion. With an estimated 1-3% of housing wealth gains 

going into consumption, this could generate a $60–180 billion reduction in total consumption—a modest amount compared to US GDP of $15 trillion. We should have 

seen a serious impact on consumption, but, there was no a priori reason to believe 

we were embarking on a crisis of the current scale. 

Leverage did increase the riskiness of the system, but did not by itself turn a 

housing downturn into a global financial crisis. There is no basis on which to say 

banks were too leveraged in one year but were safe the year before; how leveraged 

a bank can be depends on many factors, most notably the nature and duration of 

its assets and liabilities. In the economy at large, credit relative to incomes has been 

growing over the last 50 years, and even assuming that credit was overextended, 

today’s crisis was not a foregone conclusion. 

There are two possible paths to resolution for an excess of credit. The first is an 

orderly reduction in credit through decisions by institutions and individuals to reduce borrowing, cut lending, and raise underlying capital. This can occur without 

much harm to the economy over many years. The second path is more dangerous. 

If creditors make abrupt decisions to withdraw funds, borrowers will be forced to 

scramble to raise funds, leading to major, abrupt changes in liquidity and asset 

prices. These credit panics can be self-fulfilling; fears that assets will fall in value 

can lead directly to falls in their value. 

A Crisis of Confidence 

We have seen a similar crisis at least once in recent times: the crisis that hit 

emerging markets in 1997 and 1998. For countries then, read banks (or markets) 

today. In both cases, a crisis of confidence among short-term creditors caused them 

to pull out their money, leaving institutions with illiquid long-term assets in the 

lurch. 

This emerging market crisis started in June 1997 in Thailand, where a speculative attack on the currency caused a devaluation, creating fears that large foreign 

currency debt in the private sector would lead to bankruptcies and recession. Investors almost instantly withdrew funds and cut off credit to Malaysia, Indonesia and 

the Philippines under the assumption that they were guilty by proximity. All these 

97 

countries lost access to foreign credit and saw runs on their reserves. Their currencies fell sharply and their creditors suffered major losses. 

From there, the contagion spread for no apparent reason to South Korea—which 

had little exposure to Southeast Asian currencies—and then to Russia. Russia also 

had little exposure to Asia. However, Russia was funding deficits through shortterm ruble bonds, many of which were held by foreign investors. When short-term 

creditors panicked, the government and the IMF could not prevent a devaluation 

(and a default on those ruble bonds). GDP fell 10% in the following 12 months. After 

Russia, the story repeated itself in Brazil. In December 1998 Brazil let the currency 

float, leading to a sharp depreciation within one month. 

In each case, creditors lost confidence that they could get their principal back and 

rushed to get out at the same time. In such an environment, any institution that 

borrows short and lends long is vulnerable to an attack of this kind. The victims 

had one common trait: if credit were cut off they would be unable to maintain their 

existing activities. The decision of credit markets became self-fulfilling, and policy 

makers around the world seemed incapable of stopping these waves. 

The Acute Stage of the Crisis 

The evolution of the current financial crisis seems remarkably similar to the 

emerging markets crisis of a decade ago. 

America’s crisis started with creditors fleeing from sub-prime debt in summer 

2007. As default rates rose, investment-grade debt—often collateralized debt obligations (CDOs) built out of sub-prime debt—faced large losses. The exodus of creditors 

caused mortgage finance and home building to collapse. 

The second stage began with the Bear Stearns crisis in March 2008 and extended 

through the bailout of Fannie Mae and Freddie Mac. As investment banks evolved 

into proprietary trading houses with large blocks of illiquid securities on their 

books, they became dependent on the ability to roll over their short-term loans, regardless of the quality of their assets. Given sufficient panic, it can become impossible to roll over those loans. And in a matter of days, despite no major news, Bear 

Stearns was dead. However, while the Federal Reserve and Treasury made sure 

that Bear Stearns equity holders were penalized, they also made sure that creditors 

were made whole—a pattern they would follow with Fannie and Freddie. As a result, creditors learned that they could safely continue lending to large financial institutions. 

This changed on September 15 and 16 with the failure of Lehman and the ‘‘rescue’’ of AIG, which saw a dramatic and damaging reversal of policy. Once Bear 

Stearns had fallen, investors focused on Lehman; again, as confidence faded away, 

Lehman’s ability to borrow money evaporated. This time, however, the Fed let Lehman go bankrupt, largely wiping out creditors. AIG was a less obvious candidate 

target. Despite large exposure to mortgage-backed securities through credit default 

swaps, no analysts seemed to think its solvency was truly in question. Overnight, 

however, without any fundamental changes, the markets decided that AIG might be 

at risk, and the fear became self-fulfilling. As with Lehman, the Fed chose not to 

protect creditors; because the $85 billion loan was senior to existing creditors, senior 

debt was left trading at a 40% loss. 

This decisive change in policy reflected a growing political movement in Washington to protect taxpayer funds after the Fannie Mae and Freddie Mac actions. In 

any case, though, the implications for creditors and bond investors were clear: RUN 

from all entities that might fail, even if they appear solvent. As in the emerging 

markets crisis of a decade ago, anyone who needed access to the credit markets to 

survive might lose that access at any time. 

As a result, creditors and uninsured depositors at all risky institutions pulled 

their funds—shifting deposits to Treasuries, moving prime brokerage accounts to 

the safest institutions (read JPMorgan), and cashing out of securities arranged with 

any risky institutions. The previously invincible Morgan Stanley and Goldman 

Sachs saw large jumps in their credit default swap rates. Washington Mutual and 

Wachovia vanished. LIBOR shot up and short-term US Treasury yields fell as banks 

stopped lending to each other and lent to the US government instead. The collapse 

of one money market fund (largely because of exposure to Lehman debt), and the 

pending collapse of more, sent the US Treasury into crisis mode. 

At the same time, the credit market shock waves spread quickly throughout the 

world. In Europe, interbank loan rates and EURIBOR rates shot up, and banks 

from Bradford & Bingley to Fortis were nationalized. Further afield, Russia and 

Brazil each saw major disruptions in their interbank markets and Hong Kong experienced a (small) bank run. From late September, credit markets around the world 

were paralyzed by the fear that any leveraged financial institution might fail due 

98 

to a lack of short-term credit. Self-fulfilling collapses can dominate credit markets 

during these periods of extreme lack of confidence. 

The Response 

There are two ways to end a crisis in confidence in credit markets. The first is 

to let events unfold until so much deleveraging and so many defaults have occurred 

that entities no longer rely on external finance. The economy then effectively operates in a ‘‘financially autonomous’’ manner in which non-financial firms do not need 

credit. This is the path most emerging markets took in 1997–1998. Shunned by the 

world investment community, it took many years for credit markets to regenerate 

confidence in their worthiness as counterparties. 

The second is to put a large balance sheet behind each entity that appears to be 

at risk, making it clear to creditors that they can once again safely lend to those 

counterparties without risk. This should restore confidence and soften the coming 

economic recession. 

Governmental responses to the crisis were fitful, poorly planned, and abysmally 

presented to the public. The US government, to its credit, was the first to act, while 

European countries boasted they would be little affected. Still, though, Messrs. 

Paulson and Bernanke had made the mistake of insisting right through the Lehman 

bankruptcy that the system was fundamentally sound. As a result, their rapid reversal and insistence that they needed $700 billion for Mr. Paulson to spend however he wished was greeted coldly on Capitol Hill and in the media. 

The initial Paulson Plan was designed to increase confidence in financial institutions by transferring their problematic mortgage-backed securities to the federal 

government’s balance sheet. The plan had many problems, ranging from uncertainty 

over what price the government would pay for the assets to questions about whether 

it would be sufficient to stop the crisis of confidence. On September 29, I recommended passing the plan and supplementing it with four additional measures: 

the first two were unlimited deposit insurance and an equity injection program for 

financial institutions. (My views throughout the crisis were published at http:// 

BaselineScenario.com and in various other media outlets.) 

After the Paulson Plan was passed on October 3, it was quickly overtaken by 

events. First the UK announced a bank recapitalization program; then, on October 

13, it was joined by every major European country, most of which also announced 

loan guarantees for their banks. On October 14, the US followed suit with a bank 

recapitalization program, unlimited deposit insurance (for non-interest-bearing accounts), and guarantees of new senior debt. Only then was enough financial force 

applied for the crisis in the credit markets to begin to ease, with LIBOR finally falling and Treasury yields rising, although they are still a long way from historical 

levels. 

Dangers for Emerging Markets 

Although the US and Europe have grabbed most of the headlines, the most vulnerable countries in the current crisis are in emerging markets. Just like highly leveraged banks, highly leveraged countries—such as Iceland—are vulnerable to the 

flight of capital. Countries that got rich during the commodities boom are also highly vulnerable to a global recession. 

The flight to safety is already destabilizing banks around the world. For companies that can get credit, the cost has skyrocketed. These financial sector tremors are 

sending shock waves through emerging market economies. While wealthy nations 

can use their balance sheets to shore up banks, many other countries will find this 

impossible. Like Latin America in the 1980s, or emerging markets after 1997–98, 

the withdrawal of credit after a boom can lead to steep recessions and major internal disruptions. 

Four sets of countries stand to lose. 

1. The over-leveraged. With bank assets more than ten times its GDP, Iceland 

cannot protect its banks from a run. Other countries that borrowed heavily during 

the boom face a similar situation. 

2. The commodity-dependent. Oil has already fallen below $70 per barrel, and demand continues to fall. All other major commodities are falling for the same reasons. Commodity exporters facing sharply reduced revenues will need to cut spending and let their currencies depreciate. 

3. The extremely poor. Sub-Saharan Africa, which was a beneficiary of the commodity boom, will be hit hard by the fall in commodity prices. At the same time, 

wealthy nations are likely to slash their foreign aid budgets. The net effect will be 

prolonged isolation from the global economy and increased inequality. 

99 

4. China. The global slowdown has already had a major impact on several sectors 

of China’s manufacturing economy. The collapse in the Baltic Dry Index shows that 

demand for commodities and manufactured goods is plummeting. While China’s economic influence will only grow in the long term, a global recession could cause a 

severe crimp in its growth. 

Events of the past two weeks, with emerging markets currencies plunging relative 

to the yen and the dollar, and multiple countries petitioning the IMF for loans, show 

that the emerging markets crisis is only deepening. This will inflict damage on G7 

economies, increase global inequality, and create geo-political instability. 

The Current Situation 

The Financial System 

Today, although it is by no means assured, it seems relatively likely that the financial panic will gradually ease and the successive collapse of many large banks 

in the US and Europe will not occur. However, the resumption of interbank lending 

alone will not be enough to reverse the downward trajectory of the real economy. 

Banks still need to deleverage in a major way and there are doubts about how much 

lending to the real economy will pick up. For example, mortgage rates in the US 

actually increased after the recapitalization plan was announced. In a worst case 

scenario, even some wealthy countries may not be able to absorb the losses sustained by their banks. The US will have to worry not just about its banks, but also 

about some insurance companies and potentially quasi-financial companies such as 

GMAC, Ford, and GE. 

The Real Economy 

Before the severe phase of the crisis began on September 15, the world was already facing an economic slowdown. The credit crisis of the past month and the lingering uncertainty seem certain to produce a global recession. In the face of uncertainty and higher credit costs, many spending and investment decisions will be put 

on hold. US and European consumption decline along with housing prices. With interest rates rising around the world, companies will pay down debt and reduce 

spending and investment plans. State and municipal governments will see lower tax 

revenues and cut spending. No country can rely on exports to provide much cushion, 

as growth and spending around the world have been affected by the flight from 

credit. 

Recent economic indicators in the US show significant deterioration in the real 

economy. Because these indicators are from the entire month of September, they 

probably understate the effect of the acute credit crunch of the second half of the 

month, which we will not fully appreciate until October data appear in the middle 

of November. In the meantime, there is abundant anecdotal data, with layoffs by 

dozens of America’s most prominent companies, ranging from Yahoo to Goldman 

Sachs to General Electric. 

Unexpected Distress in Europe 

The most recent reports indicate a much sharper downturn in Europe than was 

expected even a few weeks ago, with the UK already in recession in the third quarter of this year. Even wealthy European countries and members of the Eurozone are 

threatened by two important developments, in addition to the acute credit crisis 

that has been with us since the middle of September. 

First, many European countries’ banking sectors have imported serious financial 

problems from emerging market countries. In recent years, much of the investment 

in Eastern Europe and Latin America has come from European banks, which are 

now seeing their asset values plummet. 

Second, and potentially more dangerously, worries are mounting that even members of the Eurozone might default on their sovereign debts. By acting to guarantee 

the solvency of their domestic banks, European countries have implicitly taken the 

risk of default onto themselves. As the recession deepens, those banks may fall further and further into the red, requiring their government backers to provide more 

and more capital. Because, in some cases, domestic bank assets are significantly 

larger than GDP, there is risk that some governments may simply be unable to bail 

out their financial sectors. Investor nervousness over this prospect can be seen in 

the prices of credit default swaps on sovereign debt. The implied risk of default for 

countries such as Ireland, Italy and Greece has already quadrupled to 12% each. 

The real risk here is that these pressures may cause one or more countries to 

abandon the euro, or at least may require Eurozone nations to expend considerable 

100 

resources to fight off that prospect. Nations threatened by fleeing creditors and rising interest rates will want looser monetary policy, but have ceded control over monetary policy to the European Central Bank (ECB), which is still dominated by inflation fighters. If the ECB fails to help threatened member nations, domestic politicians will argue that they are better off setting policy at home. The costs of abandoning the euro would be very high, but it could happen. If one nation breaks away, 

investors will wonder who is next, cutting off financing from other countries. The 

damage inflicted on the real economy would be enormous. 

Emerging Markets Getting Worse and Worse 

In just the last week, the outlook for emerging markets has gotten significantly 

worse. As the wealthiest nations protect their banking sectors, investors and lenders 

will be less likely to put their money in countries perceived as risky. Iceland is already facing default, either by its banking sector or by its government. After Iceland, the psychology of fear is likely to take over as creditors try to guess which 

country will be next, just as in 1997–98. Unless a country has a sufficient balance 

sheet and a very large amount of reserves, it may get drawn into a pattern of selective defaults and large devaluations. 

The IMF is stepping in with aid packages to Iceland, Ukraine, and Hungary. 

However, it is hard to see how the IMF or anyone else can provide resources on 

a sufficient scale to make a difference. Investors expect multiple countries across 

Eastern Europe to default, judging by the price of credit default swaps on those 

countries’ debt. 

Falling commodity prices due to the coming recession will also hurt many exporting countries. Even Russia, with its large foreign currency reserves (and vast oil and 

gas reserves) may have a significant mismatch problem between short term liabilities and longer term assets. This is complicated further by large private sector debt 

in foreign currency. The government may be moving toward deciding which companies they will save. Hopefully, for the companies they do not support, it will be possible to have an orderly workout. 

The currency crisis that has blossomed over the last week is only exacerbating 

the crisis. As emerging market currencies fall, their foreign debts become more and 

more unmanageable, increasing the risk of default. Whether because of the 

unwinding of the carry trade or because of old-fashioned flight from assets that are 

falling in value, the currency crisis has become self-perpetuating. This will have two 

negative effects on the US economy: first, the strengthening dollar will make it 

harder for US exporters to compensate for the fall in domestic consumption; second, 

as all of our trade partners’ economies become weaker, the prospects that an external source of economic growth will help lift us out of our recession become dimmer. 

Summary 

In the United States, we have been aware of an impending economic slowdown 

for over a year. We will never know how pronounced the slowdown would have been 

in the absence of the acute credit crisis that began in mid-September. That crisis 

has triggered an ever-expanding series of impacts on the global economy that have 

almost certainly plunged our economy into a serious recession. The constriction in 

the availability of credit itself has a real impact on spending and investment by consumers and businesses. The widespread fear generated by events over the past six 

weeks has had an additional chilling effect on consumer and business confidence. 

The financial crisis has triggered severe economic problems in emerging markets, 

which have spilled back into the economies of some of our most important trading 

partners. Some prominent economists are raising warnings that de-leveraging in the 

‘‘shadow banking system,’’ such as by hedge funds, could trigger another wave of 

asset price falls across global markets. 

I am not saying that the sky is falling on the US economy. As of now, most forecasts indicate that we will experience a serious recession, perhaps comparable to the 

recession of the early 1980s, but nothing like the Great Depression. However, I want 

to underline the point that most of the most pedigreed economists and policy makers have failed to anticipate the serial effects that the crisis has had, and that it 

may yet have more surprises for us. 

Economic Stimulus 

There are a number of steps that the US can take to address the many problems 

facing the global economy. These include continued action to recapitalize financial 

institutions under the Emergency Economic Stabilization Act, low interest rates, liquidity measures by the Federal Reserve, actions (coordinated with other G7 countries) to rein in the currency crisis, direct intervention in the housing market, and 

101 

new forms of financial regulation, both domestic and international. The Federal Reserve must act decisively to forestall any risk of deflation (falling prices and wages). 

For today, however, the question is how best to stimulate the economy to cushion 

the impact of the recession and lay the foundation for future long-term growth: specifically, what form the stimulus should take, and how big it should be. 

Stimulus Objectives 

Before deciding these specific questions, however, we need to define the general 

objectives of the stimulus. The US economy is going through a massive deleveraging process that is causing significant declines in asset values—first in real 

estate markets, now in securities markets—that will reduce the purchasing power 

of consumers for years to come. Attempting to prop up those asset values by putting 

more money in people’s pockets is likely to fail—the amount of money needed would 

be huge—and would likely only extend the de-leveraging process. The experience of 

the stimulus package earlier this year was that a large proportion of the tax rebates 

went toward household savings or paying down debt; asking the American consumer 

to spend his or her way out of this recession is unlikely to succeed. 

So what are we trying to achieve? I think there are three main objectives: 

1. Reduce the depth and severity of the recession. The constriction in lending and 

widespread pessimism among both consumers and businesses risk producing a 

sharp downturn that pushes asset values far below their sustainable levels. A classic economic stimulus, by encouraging economic activity, can counteract this pessimism and limit the damage. One condition of meeting this objective is that measures should be designed to flow into the economy quickly. 

2. Help those people who will be hurt most by the recession. One can argue that 

this is not, strictly speaking, necessary to economic recovery, but I believe it remains an obligation of our government and society to limit the human misery that 

will be caused by a recession. 

3. Invest in America’s long-term growth and productivity. The stimulus plan 

should encourage behavior that will increase the long-term economic prospects for 

the country. A simplistic way of putting this is that given the choice, we would rather see investments in infrastructure than in consumption of flat-screen TVs. 

Another factor we need to keep in mind is that this is likely to be a relatively 

long recession, where economic growth may not return to target levels for 24 months 

or longer. In this context, stimulus measures that might not be considered for a 

shorter recession should be put on the table. 

So, with these considerations in mind, what should the stimulus package include? 

I divide my recommended stimulus programs into two categories that, for want 

of a better term, I call short-term and long-term. Short-term programs are those intended to feed money into the economy quickly and in a form that will have a direct 

impact on economic activity; that is, they should encourage spending rather than 

saving. Long-term programs are those that may not boost economic growth within 

one or two quarters, but will help the economy grow out of the recession and will 

also help increase long-term productivity growth in the economy. 

Short-term Programs 

Several of the programs I recommend are those favored by other economists and 

commentators and with which the Committee is already familiar, so I will not describe them in exhaustive detail. 

1. Direct aid to state and local governments. This direct aid is desirable for two 

reasons. First, because it replaces money that state and local governments have 

been forced to cut from their budgets, it can have a very rapid effect, without the 

need to design new programs. Second, the money will go to programs that these governments have already decided are important and worth funding, minimizing the 

risk that the stimulus will be wasted on inappropriate ends. Not only did many 

states cut budgets for the current fiscal year with the anticipation of reduced tax 

revenues, but several states have enacted midyear budget cuts as their expectations 

have deteriorated. According to the Center on Budget and Policy Priorities, states 

closed $48 billion in shortfalls in enacting their current (fiscal year 2009) budgets, 

and so far another $12 billion in gaps have opened up since the year began (generally in July). The CBPP is also forecasting shortfalls in the $100 billion range for 

the following year. 

2. Extended unemployment benefits. Congress already extended unemployment 

benefits by 13 weeks in July 2008, but that measure will currently expire in March 

2009. This provision should be extended past March 2009, and other means of expanding unemployment coverage should be considered, such as further extensions 

based on state-by-state unemployment rates. Extending unemployment benefits has 

a high ‘‘bang for buck’’ ratio, because needy people are more likely to spend each 

102 

incremental dollar. According to testimony by Mark Zandi of Moody’s Economy.com 

before the House Committee on Small Business in July, each dollar in extended unemployment benefits translates into $1.64 in incremental GDP over the following 

twelve months. Finally, this program helps some of the people who will be most 

sorely affected by the economic downturn, in most cases through no fault of their 

own. 3. Expanded food stamp aid. Expanding food stamps has many of the same beneficial characteristics as extending unemployment benefits. Because food stamps cannot be put in the bank or used to pay down debt, they tend to contribute to economic 

activity quickly. According to Mark Zandi’s testimony, each dollar in expanded food 

stamp aid contributes $1.73 to incremental GDP. 

4. Loan modifications for distressed homeowners. To these ideas I would add 

money for relief to distressed homeowners in the form of government-sponsored loan 

modifications. This may not be in the fiscal stimulus package per se, but it should 

not be far behind. The current proposal to guarantee modified loans as an incentive 

for lenders and servicers to make those modifications is promising. Like any guarantee, however, it raises the possibility that the government may lose money. This 

would be an appropriate usage of money as part of the stimulus package, as this 

program should help prevent housing prices from crashing far below their long-term 

values, and therefore prevent a further depletion of households’ spending power. 

Long-term programs 

In addition, however, a number of other stimulus programs should be considered, 

for two reasons. First, given the depth of the expected recession, the programs listed 

above may to be too small to have the desired impact. Second, the expected length 

of the recession provides an unusual opportunity: an opportunity to invest in our 

economic future while also combating the recession. 

For these reasons, the following initiatives should also be on the table: 

1. Investment in basic infrastructure, such as highways and bridges. In order to 

accelerate the economic impact, money could initially be put into maintenance 

projects, but new construction projects should not be ruled out. 

2. Job retraining programs or grants. The recession will accelerate some of the 

long-term changes in the American economy; the proposed merger of GM and Chrysler is just one sign of this trend. Tens of thousands of people will need to develop 

new skills. 

3. Expanded student loans. Even before the latest phase of the financial crisis, 

smaller lenders were exiting the student loan market, especially for community college students, and there is a risk that this trend could reduce the availability of college educations for lower-income students. Student loans will go directly toward 

paying for tuition and other costs, so they should have a direct impact on the economy. 

4. Expanded small business loans. The credit crisis has not only seen a reduction 

in the availability of credit, but also an increase in the price of credit for small businesses. Government programs to guarantee small business loans or otherwise increase the availability of credit should have a nearly direct impact on the economy. 

The programs could be designed to discourage companies from getting new loans to 

pay down existing loans. 

5. Investment in alternative energy, through tax incentives, direct grants, or other 

means. Someday in the next couple years the price of oil will start increasing again; 

despite its recent fall, long-term projections of the amount of oil in the world have 

not changed. Moving our economy away off of oil and onto alternative energy 

sources will not only protect us from inflation in the future, but will give our companies a new avenue for long-term growth. 

I am too far from being an expert on all of these topics to go into them in great 

detail. I know that several of them have been considered by members of Congress. 

My point is that given the amount of fiscal force that will need to be deployed, and 

the length of time over which it will need to be deployed, it is appropriate to consider measures that will both stimulate the economy and invest in our long-term 

future. 

Size of Stimulus 

In his testimony to the House Budget Committee last week, Martin Baily pro- posed a stimulus of $200 to $300 billion. His recommendation was based on a range 

of forecasts about the severity of the recession. As this is not an exact science, I 

will follow a similar approach with slightly different results. 

Baily used two forecasts: the Blue Chip consensus forecast and a more pessimistic 

scenario that he defined. The Blue Chip forecast included three quarters of contracVerDate Nov 24 2008 10:43 Aug 04, 2009 Jkt 045037 PO 00000 Frm 00106 Fmt 6601 Sfmt 6621 C:\DOCS\48279.TXT SHAUN PsN: DPROCT
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tion, with a trough of -1.1% GDP growth (annual rate) in Q4 2008, with a relatively 

rapid return to healthy growth (+2.2% in the first post-recession quarter). His pessimistic forecast was for five quarters of recession, with a trough of -4.0% GDP growth 

in Q4 2008 and Q1 2009. 

There are three other forecasts I will mention to give a range of the expected outcomes: 

• Goldman Sachs in early October forecast zero growth in Q3 2008, contraction 

in Q4 and Q1 (trough of -2.0%), and zero growth in Q2 2009. 

• The current IMF forecast is for two quarters of recession, followed by one quarter of zero growth. 

• JPMorgan forecast 3 quarters of contraction, with a trough of -1.6% and 12 

quarters of slow growth. 

However, the main issue with any macroeconomic forecast is that, in this environment, it risks being out of date the day after it is made. In just the last week, plunging growth rates in Europe and a full-blown, global currency crisis have become part 

of the economic landscape. In the US, insurance companies have been deemed at 

sufficient risk to be included in the Treasury recapitalization plan. Exports, which 

have been the one bright spot in the US economy in recent quarters, will be hurt 

by the rising dollar and the declining global economy. Asset values, including both 

housing and equities, continue to fall steeply. In short, the vast majority of the news 

has been negative, even relative to generally pessimistic expectations. As a result, 

I believe there is a large likelihood that all of these forecasts—with the possible expectation of Baily’s pessimistic forecast—will later be revised downward. 

For planning purposes, then, I think we should think about a world in which the 

U.S. recession will last 4–5 quarters, with a trough at negative 2–3% GDP growth 

(annual rate), followed by 8–12 quarters of slow growth. 

Baily’s method assumes that $1 in spending will contribute $1.50 to GDP, with 

the $0.50 in follow-on effects spread over several quarters. Based on this assumption, since US GDP is approximately $3.5 trillion per quarter, $35 billion in spending in a given quarter will contribute 1.0% to GDP growth in that quarter, and 

small amounts thereafter. By matching expenditures on stimulus to the forecast 

GDP growth figures for each quarter, he concludes that $200–300 billion will be appropriate to cushion the recession and restore the economy to growth. 

I would suggest two modifications to this approach. First, I think it is optimistic 

to expect $1 in immediate impact for every $1 in the stimulus program. There is 

evidence that a significant proportion of this spring’s tax rebates did not end up contributing to spending, and while the measures outlined above are more likely than 

tax rebates to result in direct increases in economic activity, it would be a mistake 

to overestimate the effectiveness of any macroeconomic intervention. As a result, I 

believe it more conservative to plan on something like $0.90 in immediate impact 

and $0.50 in follow-on impact. 

This implies that, for the 2–3 quarters of recession that remain to be affected (assuming there is nothing we can do about Q3 and Q4 this year), approximately $70 

billion in stimulus expenditures per quarter may be called for, for a total of roughly 

$220 billion. The amount of stimulus should decline over the quarters due to followon effects, but a major issue is how to spend large sums early in 2009 while ensuring that the money is used well and has a high impact on GDP growth. 

Second, I would pay particular attention to the 8–12 quarters of prolonged slow 

growth. If we want to increase economic growth by an average of 0.5–1% (annual 

rate) in each of these quarters, this would imply approximately $25 billion in stimulus per quarter, or roughly $250 billion over the entire period. 

Added together, this yields a total stimulus package of around $450 billion, or 

about 3% of GDP, spread over about 3–4 years. It also implies a way to time the 

short-term and long-term programs described above. Short-term programs can be 

implemented immediately to inject spending into the economy quickly. Long-term 

programs, such as infrastructure grants or alternative energy programs, should be 

announced and implemented quickly, but can take a longer time to bear fruit. 

There are, of course, many details that remain to be worked out. My goal has 

been to describe the types of programs that should be on the table and one approach 

to quantifying the size and timing of the stimulus package. 

104 

PREPARED STATEMENT OF DR. RICHARD K. VEDDER, AMERICAN ENTERPRISE

INSTITUTE AND OHIO UNIVERSITY

Madam Chairman, thank you for this opportunity to speak before the Joint Economic Committee. Since its creation by the Employment Act of 1946, the JEC has 

been the premier congressional forum to discuss economic policy, and as a former 

staff member of the committee I am honored to participate in this hearing. 

I wish to make three points this morning. First, economic history tells us that periods of sharply eroding public confidence in financial institutions have significant 

negative economic consequences, but they do pass. Also, seeking retribution from 

persons or institutions perceived to be guilty of contributing to the crisis because 

of errors of business judgment (as opposed to illegal activity) often does not help, 

and may actually significantly deter recovery. I am not suggesting that Congress 

should do absolutely nothing further; for example, a review and probable modification of some existing regulatory and other practices relating to the financial services 

industry is no doubt in order, but I am urging that caution and moderation be used. 

Second, I would observe that this crisis is not simply an example of market failure, of irrational exuberance trumping common sense, thereby requiring government 

action. I, somewhat reluctantly, supported the $700 billion bailout package and advised some of your colleagues to vote for it. I also believe in perilous times that government has a role to play in restoring confidence. However, I am also convinced 

that the crisis itself largely reflects a series of public policy miscues. In the absence 

of these governmental mistakes, this financial crisis would never have happened. 

Third, I am very concerned about attempts by an overly zealous Congress to attempt to craft an economic program that likely will have adverse effects. In particular, expansionary fiscal policy in the form of higher government spending is precisely the wrong thing to do at this time, aggravating an explosion in inflationary 

expectations that I already fear will erupt, having detrimental effects on labor and 

financial markets. 

Historical Observations 

Let me briefly comment on each of these factors. Anytime a firm or an entire sector of the economy has low rates of capitalization relative to its liabilities, the possibility of declining asset values leading to a dangerous erosion of net worth increases. 

When claims against the assets of firms can be made at any time, as is typically 

the case in the financial services industry, the problem is aggravated. In October 

1929, there were roughly 11 dollars in bank deposits for every one dollar of currency 

in circulation, while in March 1933 there were only about four dollars of deposits 

per dollar of currency. As cash was removed from banks and converted to currency 

by nervous depositors, bank cash reserves fell, and with that confidence was eroded 

in the ability of the banks to meet remaining liabilities. Hence over 40 percent of 

the banks in the United States closed their doors between 1929 and 1933. I completely agree with Milton Friedman and Anna Schwartz that this was a significant 

factor in the Great Depression. 

As long as we have fractional reserve banking, confidence in financial institutions 

is vital. Deposit insurance has helped enormously in relieving problems relating to 

a lack of confidence, and bank failures went from an average of about 600 a year 

even in the prosperous 1920s to a handful annually shortly after the creation of the 

FDIC in the Banking Act of 1933. Scholars as diverse as Arthur Schlesinger and 

Milton Friedman have heralded this as great legislation. Implicitly, people have 

shown their confidence in the full faith and credit of the United State Government 

which they have believed is behind the deposit insurance guarantee. Yet that confidence is something we should not take for granted, and the excessive commitment 

of the government to protect virtually everyone from every possible loss could lead 

to erosion in confidence in government, and with that the ability of the government 

to serve as the protector of last resort for the financial system. The government’s 

resources are not limitless, and the evidence from public opinion surveys that young 

people do not believe that the governmental commitment will be met to provide 

them with Social Security pensions is an early warning sign that excessive governmental commitments relative to available resources could conceivably lead to a confidence crisis where there is no viable governmental line of defense, and thus to true 

Financial Armageddon. You must maintain the credibility of that defense by not 

making commitments that the public knows cannot be met. By the way, Franklin 

D. Roosevelt was very much aware of this problem in 1933, and the large potential 

contingent liabilities to the government made him very cool to the whole idea of deposit insurance, and led him to successfully oppose high insurance limits favored by 

a bipartisan group of Congressmen. 

105 

It is worth noting that in some previous panics private solutions to stemming 

eroding confidence were largely successful. For example, in the Panic of 1907, a 

group of private bankers led by J.P. Morgan amassed a fund that was used to prop 

up banks facing pressures from depositor withdrawals. On the other hand, in 1932, 

the Reconstruction Finance Corporation was created by a Republican President near 

the end of his term working with a Democratic controlled House and roughly evenly 

divided Senate, and it helped shore up bank capital by buying preferred stock in 

commercial banks. Sound familiar? It is also worth noting that the RFC outlived 

its usefulness, and in its later years after World War II became mired in scandal 

until it was finally abolished by Congress in 1953 during the Eisenhower Administration. 

The Great Depression was needlessly prolonged by dreadful public policies, some 

not directly related to financial services, especially the high wage policies of both 

Presidents Hoover and Roosevelt. But the bashing of bankers and other business 

leaders by governmental officials also contributed to extremely low levels of business 

confidence and investment during the 1930s. President Hoover supported an increase in top income tax rates from 25 to 63 percent near the bottom of the downturn, ostensibly to raise funds but in part to punish the alleged perpetrators of the 

1929 downturn and its aftermath. Congress added to the problem by mercilessly attacking a prime symbol of American capitalism, the second J.P. Morgan, in hostile 

Congressional hearings in 1931. In the Roosevelt administration, the President’s 

constant attack of businessmen as ‘‘economic royalists’’ and the absolutely unconscionable hounding of Paul Mellon, long time Secretary of the Treasury, donor of 

the National Gallery of Art located just blocks away, and a prominent leader of the 

American business community, added to the fear of businesses to invest. Net business investment did not return to 1929 levels until after World War II. The writings 

of Robert Higgs and Amity Shlaes document these points in far more elaborate detail. 

Government Or Market Failure? 

There are already persons characterizing the current crisis as an example of market failure, of greedy bankers absorbed with increasing their wealth leading relatively innocent borrowers astray through inappropriate lending practices, aggravated by ill advised financial deregulation. In short, we are told that it was an act 

of market failure accompanied by a failure of government to perform its appropriate 

role in correcting market imperfections. I think this interpretation is mostly incorrect, and contributes to a form of governmental hubris that could lead to exceedingly 

ill advised retaliatory measures and stranglehold regulations that could stifle America in general and our financial services industry in particular, an industry already 

losing world preeminence because of previous ill advised policy moves, starting as 

early as the separation of commercial and investment banking in the Banking Act 

of 1933 (that, ironically, is a casualty of the current crisis) and continuing through 

Sarbanes-Oxley and beyond. 

To be sure, private business people have made lots of mistakes. Banks made too 

many loans to too many people who were not credit worthy, and also lowered their 

lending standards and made implicitly dubious and excessively optimistic assumptions about the future of housing prices. The securitization of mortgages, while making some sense in terms of promoting market efficiency, also often largely shielded 

banks and loan officers from the adverse consequences of making bad and inappropriate lending decisions. The separation of the lending decisions from the adverse 

consequences of those decisions may on balance have been a mistake. 

But even more important were government failures. The Federal Reserve System 

promoted excessively loose monetary policies including very low and even negative 

real interest rates, even on long term government securities. The market rate of interest fell below that interest rate consistent with the degree of human preferences 

for use of funds today rather than in the future, and that led to overinvestment in 

housing and other capital-intensive variables, very much in keeping with the business cycle theories of Ludwig von Mises and Friedrich A. Hayek. This is demonstrated in the accompanying graph. Inflation-adjusted t-bill rates fell from their 

customary long term average of roughly 2 percent or so into negative territory in 

the 2002–2005 period, inappropriately contributing to an increased demand for 

housing which could be met in the short run only by sharply rising housing prices. 

When the Fed reversed course, especially in 2006, tighter monetary policies and rising interest rates caused housing prices to start falling and left some persons with 

not enough money to make payments on mortgages on properties for which they had 

little or no equity, leading, of course, to massive foreclosures beginning about two 

years ago. 

106 

Congress did not help, failing to deal with Fannie Mae and Freddie Mac despite 

repeated warnings, and shielding those organizations from rigorous regulation despite their being extremely thinly capitalized and engaging in dubious practices. 

Politics and campaign contributions trumped good economics. Incidentally, I identified some problems with these organizations in a JEC study done 26 years ago. The 

Community Reinvestment Act, while well intentioned, has provided an environment 

where bankers have been encouraged to adopt substandard lending criteria for certain classes of borrowers, no doubt contributing to a culture where traditional lending standards have been considered old-fashioned and no longer applicable. The old 

admonition that bankers who borrow short should not lend long too much, an adage 

that historically led banks from shunning very large scale real estate investments, 

went out the window. Regulators stopped requiring financial institutions to meet 

solid lending standards. The move to mark-to-market accounting standards, while 

arguably justified as promoting honest financial transparency, no doubt contributed 

to the nervousness of investors and the corresponding flight from investing in many 

businesses. 

Reliving the past has limited utility, but it does point out human frailties are not 

confined to either the private or the public sector of the economy. Seeking to replace 

private judgments on the allocation of capital resources with public judgments is not 

in itself a recipe for success, and given the politicization of many public economic 

decisions in modern times I would bet that on balance a dramatic tilt in decisionmaking with respect to the allocation of financial capital would have far reaching 

adverse effects. I rather have thousands of bankers making those allocation decisions rather than one or two Ben Bernankes and/or Treasury secretaries, independent of their competence, integrity, or political affiliation. And past efforts by 

Congress to mandate certain untenable arrangements, such as the separation of 

commercial and investment banking, or in more modern times the peculiar status 

of Fannie Mae and Freddie Mac, does not inspire confidence that rigorous regulation 

will work—the cure could well be worse than the disease. 

Economic Stimulus And Appropriate Future Policy 

I am particularly worried that the already announced fiscal and monetary policies, rather than restoring investor confidence, may lead to a sharp rise in inflationary expectations, which, in term, will trigger increases in interest rates and employee compensation that will have significant adverse economic effects, a reprise 

of the stagflation of the 1970s. The growth in the money supply in recent months 

has been noteworthy, and the increase in governmental expenditures and the potential inflation arising from both factors bodes very poorly for actual investor performance and thus confidence in the community of persons who finance most of our economic growth. The accompanying table provides regression results that indicate that 

stock market averages tend to fall when government expenditures rise as a percent 

of GDP, and when inflation picks up—even adjusting for the business cycle. When 

government spending crowds out private activity, investors are disheartened, stock 

values fall, pension fund assets deteriorate, consumption declines, and so forth. The 

excessive increase in government spending in recent years along with some increased perception that inflation may not be completely under control are, in my 

judgment, the single most important factors in declining real equity wealth in the 

U.S. in this decade. The prospects of rising taxes and inflation in the coming years 

no doubt is contributing to a pall on equity values at the present. 

Of special immediate concern is the call for a second economic stimulus package. 

If we learned one lesson from the era of large budget deficits, it is that fiscal stimulus does not promote economic recovery. Even in the heyday of Keynesian domination of the economics profession, scholars freely admitted that funding governmental 

infrastructure projects was a dubious way to stimulate the economy, simply because 

of the practical difficulties of timing— it takes typically years, not months, for new 

appropriations on infrastructure to actually lead to, for example, new road or school 

construction. Very often any stimulus provided by such construction comes long 

after recovery has already occurred, creating inflationary conditions that could have 

been avoided. That is in addition to other problems arising from financing such 

stimulus, such as the crowding out effects of higher spending that manifests itself 

through higher interest rates, inflation rates, and/or taxation. There are no free 

lunches, and the funding of stimulus packages inevitably would have adverse effects. Raising taxes to fund economic stimulus would be particularly foolhardy, as 

the disincentive effects of taxation could cause further damage to the real economy. 

The creation of an infrastructure construction bureau within the government was, 

of course, what the Works Progress Administration, or WPA, was all about during 

the Great Depression. This became the largest New Deal agency before World War 

II, and at its peak in November 1938 the WPA employed 3.3 million persons. RelatVerDate Nov 24 2008 10:43 Aug 04, 2009 Jkt 045037 PO 00000 Frm 00110 Fmt 6601 Sfmt 6621 C:\DOCS\48279.TXT SHAUN PsN: DPROCT
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ing to the timing issue previously mentioned, it is interesting that it took over 3 

and one-half years to get to that level of activity, and that was in the era before 

we had environmental impact and affirmative action requirements that inevitably 

delay construction. It is noteworthy that the unemployment rate when the WPA hit 

its peak size was 17.7 percent, only slightly less than the 18.7 percent rate prevailing in April 1935 when the agency was created. Relative to leading European 

countries like Britain or Germany, our recovery in this period was anemic. It is fairly clear that the WPA was not a big success in creating jobs, and it was formed 

at a time when the federal budget deficit as a percent of GDP was smaller than 

today but when unemployment in those days was greater than today, meaning that 

the crowding out problems implicit in funding stimulus packages are probably even 

greater today than it that era. 

Conclusions 

In conclusion, I urge you not to panic. The Federal government has taken the 

most aggressively interventionist position ever taken to deal with a crisis of investor 

confidence. For example, your legislative actions have made the government stockholders in vast portions of our financial system. You seem to be poised to provide 

massive aid, totally inappropriately in my judgment, to the automobile industry, 

substituting your judgments for that of consumers and producers operating through 

markets. You have authorized a vast potential unfunded liability through the radical expansion of deposit insurance, which I think I can assure you Franklin D. Roosevelt would have opposed if somehow he could have come back to life for a day. 

By the way, I personally do believe some expansion in deposit insurance probably 

was justified, but it needs to be funded, and that is not without its problems, and 

raises the moral hazard issue and the possibility that unsound banking practices 

will be subsidized rather than discouraged. You have already muted the important 

signals that markets give off that lead to what on the whole are growth-inducing 

reallocations of resources. The impact of all of this may be to prevent an imminent 

collapse of the financial system, but only at the possible price of future stagflation, 

declining income and wealth, and a rise in national malaise reminiscent of the 

1970s if not 1930s. You have done enough for now, probably more than enough. 

Relax and recover from your labors and allow the healing properties of markets to 

be asserted again. 

Thank you for your attention. 

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PREPARED TESTIMONY OF VINCENT DEMARCO, PRESIDENT, MARYLAND CITIZENS’ 

HEALTH INITIATIVE

Thank you, Chairman Schumer, Vice-Chairwoman Maloney, and Members of the 

Committee for this opportunity to testify before you. I am Vincent DeMarco, President of the Maryland Citizens’ Health Initiative, a nonprofit advocacy organization 

working to achieve quality, affordable health care for all Marylanders. Over a thousand faith, community, labor, business and health care groups are part of our 

Health Care For All! Coalition (www.healthcareforall.com). We, like you, have been 

inspired by Dr. Martin Luther King, Jr., who taught us that, ‘‘Of all the forms of 

inequality, injustice in health care is the most shocking and inhumane.’’ 

It is particularly an honor to be before the Honorable Elijah Cummings, who prior 

to joining your ranks was a courageous leader of the Maryland House of Delegates, 

and who then, as now, makes sure that we all do what is right for the people who 

need help the most. 

I greatly appreciate the chance to talk with this Committee about how the economic downturn is harming health care for Marylanders and how this harm would 

get increasingly worse without some help from the US Congress. I will describe 

what is happening in Maryland and present some ideas of how Congress can help 

us. Most importantly, we ask that you increase our state’s Federal Medical Assistance Percentage (FMAP) to help us fund our very important new Medicaid expansion. 

Over the past two years, under the leadership of Governor Martin O’Malley, the 

State of Maryland has made great progress in expanding health care access. This 

includes allowing young people up to age 25 to stay on their parents’ health care 

and helping seniors afford their prescription drugs. Most important was the Governor’s Working Families and Small Business Health Care Coverage Act of 2007 

which, over the next three years, is designed to provide health care coverage for 

over 100,000 uninsured Marylanders by expanding Medicaid eligibility and providing grants to small businesses. The law increased Medicaid eligibility to 116% 

of the federal poverty level for custodial parents on July 1, 2008, and will expand 

benefits for adults without children on July 1, 2009. 

Because of Governor O’Malley’s initiative, and after careful balancing of State 

Budget priorities, Maryland went from 44th in the country to 21st in providing Medicaid coverage to adults. We have been working hard since it took effect to inform 

Marylanders about this new law. Our outreach efforts include a media campaign we 

funded featuring Governor O’Malley and prominent Baltimore Ravens players such 

as Ed Reed. As a result, in just three months, over 16,000 uninsured Marylanders 

have signed up for coverage, demonstrating the great need for this expansion. 

On July 7, Governor O’Malley gave the first new Medical Assistance for Families 

card to Alanna and Adamantious Boulis. As you can see from the front page article 

in The Baltimore Sun that is attached to my written testimony, both of the Boulis’ 

had several health issues, including colon cancer and diabetes. They were only able 

to receive the treatment they needed for these illnesses because of Maryland’s new 

law. Because they now can address these health issues, the Boulis will not have to 

wait until they get so sick that they are forced to go to the emergency room for costly critical care. This will reduce the amount all Marylanders now pay through higher insurance premiums for the hospitalization of the uninsured. 

Now, the health care coverage of the Boulis’ as well as the coverage for tens of 

thousands of other Marylanders is directly threatened by the current economic crisis. As you know, the downturn is dramatically lowering states’ tax revenues, forcing them to re-evaluate priorities, and make necessary cuts to important programs. 

Right now Maryland is among those states—facing a deficit of hundreds of millions 

of dollars, despite having recently taken aggressive measures to deal with a structural budget problem. Governor O’Malley is to be commended for doing all that he 

can to deal with this deficit in a creative way that has not yet significantly reduced 

the Medicaid program or health care coverage. But, as the national economy keeps 

getting worse, the dire need for federal help continues. 

We know that many of the people who would be hurt if Maryland’s new Medicaid 

expansion is curtailed are in particular need of health care coverage now because 

of the economic downturn. Among the people who are eligible for the new expansion 

are a plumber on the Eastern Shore and a single mom in Prince George’s county. 

Both of them had health care coverage through their jobs until recently but both 

of them lost their jobs and their coverage this year due to workforce cuts made by 

their employers necessitated by the economic downturn. Now, thanks to the new 

Medicaid expansion made possible by the State, they can at least have health care 

coverage while they try to find new jobs. 

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The impact of people not having health care coverage can be devastating. We all 

know the statistics that many bankruptcies and foreclosures are caused by 

unaffordable health care bills and that health care costs are rising much faster than 

wages. But these statistics translate directly into human disaster. 

There is, for example, the very sad story of Mr. William Paul from Fruitland, 

Maryland, who worked every day of his life at odd jobs trying to make ends meet. 

He had a tough family life, and though he graduated from high school and spent 

some time in the armed service, he was never able to find more than odd jobs in 

restaurants and yard work to make ends meet. He was diabetic. He also found out 

from a free clinic at the local health department that he needed to see a cardiologist, 

but no doctor would see him because he didn’t have health insurance. The next day, 

he died of a heart attack, while mowing someone’s lawn. 

Because he died in the yard alone, it was considered to be an unattended death. 

In Maryland, corpses under those guidelines must be sent to Baltimore for autopsy 

but there is a charge for this ‘‘service’’ which cleaned out Paul’s meager savings and 

life insurance policy benefits that would have been passed along to his companion 

Joanne. There was no money for a memorial service, but thankfully a friend donated 

a plot of land in the local cemetery. The widowed companion still mourns that she 

will not be able to be buried beside her beloved because she can’t afford it. She lives 

on $660 monthly social security check, food stamps, and the invaluable friendship 

of neighbors in their small community. Paul was described as a man who ‘‘never 

had any luck in his life’’ but someone who would ‘‘help ANYBODY in the world; it 

didn’t matter who they were or what they were going through. If he could help you 

out, he did.’’ He is sorely missed. And it is unfortunate that if he had been able 

to see the doctor, he might still be with his friends and family. 

And, there is the sad story of the 54-year-old brother of Ms. Judith Campbell of 

Baltimore City. As Ms. Campbell told us, ‘‘My brother took his life earlier this year 

because he found out he had treatable but potentially fatal cancer and was turned 

down by the state for health care assistance. He worked as a security guard for 

$8.49/hr and his company did not offer health insurance.’’ 

Both Mr. Paul and Mr. Campbell would have been eligible under Maryland’s new 

Medicaid expansion. It would be very sad if the economic downturn prevented us 

from fully implementing this expansion and saving many other Marylanders from 

the economic distress, health care woes and possibly even death that can result from 

the lack of health insurance. But the current economic trend makes it much harder 

for states to sustain this kind of program. 

It is not just the Medicaid expansion that is threatened by cuts forced by the state 

of the national economy. Under Governor O’Malley and Maryland Secretary of 

Health John Colmers, our Health Department has done much to make sure that 

other health programs work well. For example, they put additional money into dental services to make sure that children in Maryland’s Medicaid program get the dental care to which they are entitled. This will prevent the kind of tragedy that occurred a couple of years ago when a young boy in Prince George’s County died because he did not get proper dental care. Congressman Cummings has spoken often 

and eloquently about the circumstances that led to the death of Deamonte Driver 

and we hope that the progress we have made to prevent such deaths will not be 

rolled back due to more forced cuts. 

We strongly urge that Congress and the next Administration move quickly to 

enact an additional economic stimulus package that would directly help states like 

Maryland pay for critical health care needs. Specifically, we ask that a new stimulus 

package include an increase in our state’s Federal Medical Assistance Percentage 

(FMAP). Additional federal Medicaid dollars would help forestall significant cuts in 

the Medicaid program. As you can see from the attached letter to the US Congress 

from Governors Edward G. Rendell and James H. Douglas, the National Governors’ 

Association is calling for an increase in FMAP as part of an economic stimulus package. Increasing the FMAP would help us in Maryland in two important ways. 

First, the stimulus package would spur economic growth which would generate 

more revenue for our state and thereby help prevent cutbacks in our Medicaid program. According to Families USA’s well-documented Medicaid Multiplier Effect 

analysis, for every $1 million in additional Medicaid funds that Maryland would receive, there would be $2.2 million in additional business activity, including 20 new 

jobs and $765,000 in additional wages. So, if you enact a measure like S. 2819, 

which unfortunately did not pass in the 110th Congress, Maryland would receive 

an additional $118.5 million in federal dollars which would generate $210.6 million 

in additional business activity, or 1800 new jobs and $72.4 million in additional 

wages. In addition to putting people to work, this new business activity would translate into substantial new tax revenues for the state which would help fund our MedVerDate Nov 24 2008 10:43 Aug 04, 2009 Jkt 045037 PO 00000 Frm 00116 Fmt 6601 Sfmt 6621 C:\DOCS\48279.TXT SHAUN PsN: DPROCT
113 

icaid expansion. Attached for you are charts done by Families USA on the economic 

impact on the states of both S. 2819 and the similar House passed H.R. 7110. 

Second, of course, the FMAP increase would put money directly into our Medicaid 

program, making funding of our expansion much easier. As described above, the expansion for custodial parents has already gone into effect but the expansion for nonparents is not set to take effect until July 1, 2009. There is already some pressure 

to delay the non-parental expansion because of the budget deficit. Additional federal 

money added to the Medicaid program would help us ensure that the rest of the 

expansion takes effect on July 1, 2009 as planned. This would keep tens of thousands of Marylanders healthy and out of economic distress, and even save some 

from an early, preventable death. 

In addition to the critically necessary FMAP increase, there are two other ways 

that the United States Congress can help Maryland and other states expand health 

care access in these tough economic times. First, we urge you to pass as soon as 

possible an expanded State Children’s Health Insurance Program—or SCHIP—extension like the one which you passed and President Bush unfortunately vetoed earlier this year. Passage of this legislation is vital to our ability to keep our Maryland 

Children’s Health Insurance Program fully funded. We strongly support the tobacco 

tax increase funding mechanism that you included in the SCHIP bill. We passed a 

$1 per pack tobacco tax increase in Maryland in 2007 which experts estimate will 

save 50,000 Maryland children from smoking. Tobacco tax increases are a great way 

to fund health care expansion while at the same time saving lives from tobacco 

which will in the long run greatly reduce health care costs. 

Second, we ask your help in removing federal obstacles to health care expansion 

at the state level. Although we will work closely with you to achieve our common 

goal of a federal law that guarantees quality, affordable health care for all Americans, we hope you agree with us that the federal government should not stand in 

the way of states’ efforts to expand health care while we are working toward that 

goal. Specifically, we are here asking your help in removing two federal obstacles 

to health care expansion in Maryland and across the country. 

In 2005, Maryland enacted a landmark measure that was unanimously approved 

by the Maryland General Assembly that would significantly reduce prescription 

drug prices for hundreds of thousands of lower income Marylanders by allowing 

them to get the same drug discounts that the State’s Medicaid program gets. Unfortunately, the Bush Administration denied a waiver request that our state submitted 

to allow it to implement this measure. We strongly urge the Members of this Committee and your colleagues to support legislation introduced by Congressman Chris 

Van Hollen, The Voluntary State Discount Prescription Drug Plan Act—or H.R. 

3309—that would allow states to implement such measures. 

In 2006, Maryland enacted another landmark law which would have required 

large companies to pay their fair share of the state’s health care costs. Unfortunately, the Fourth Circuit Court of Appeals ruled that our Fair Share Health Care 

Law was preempted by ERISA. We were encouraged by the Ninth Circuit’s recent 

decision upholding a similar San Francisco measure. We urge Congress and the next 

Administration to amend ERISA to allow states to enact measures that would make 

sure that all employers, particularly large ones, pay their fair share of the rising 

costs of health care. By doing so, you will help us expand health care access in our 

state and reduce the burden of paying for the hospitalization of the uninsured now 

borne by employers who provide full health care coverage for their employees. 

Thank you again so much for giving me this opportunity to share with you the 

harmful and very real effects that the economic downturn has on the health of 

Marylanders and how we think the United States Congress can help us. We look 

forward to working with you to enable states to alleviate the health care injustice 

Dr. King warned us about by achieving quality, affordable health care for all Americans. I would be happy to answer any questions you may have. 

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PREPARED STATEMENT OF DONALD C. FRY, PRESIDENT AND CEO, THE GREATER

BALTIMORE COMMITTEE

Mr. Chairman, and Members of the Committee, my name is Donald C. Fry. I am 

the President and Chief Executive Officer of the Greater Baltimore Committee 

(GBC). The GBC is the leading business organization serving Baltimore City and 

Anne Arundel, Baltimore, Carroll, Harford and Howard counties in the State of 

Maryland, a region with a population of approximately 2.6 million residents. The 

GBC is a fifty-three year old private sector membership organization with a rich legacy of working in collaboration with government to find solutions to problems that 

negatively affect our competitiveness and viability as a region. It is an organization 

that prides itself on advocating for changes in public policies that strengthen the 

business community while improving the quality of life in the region. 

First of all, I want to thank the Joint Committee for the foresight and initiative 

to pursue an aggressive agenda to achieve economic recovery. By highlighting infrastructure needs, you definitely are keyed in to a vital means of sustained employment and of moving our country forward. 

I am pleased to be here today to discuss the need for economic stimulus and how 

the current economy is affecting business. I plan to discuss specifically the need to 

invest in infrastructure, particularly transportation infrastructure. While I am prepared to address some projects that would benefit from such a stimulus, it must be 

noted that as a business advocacy group we are not directly involved in decision 

making regarding project delivery from the State of Maryland’s perspective. We 

have, been on the forefront, however, with respect to spurring the advocacy of the 

business community for increased investment in transportation projects and the 

need for a substantial increase in transportation funding. I am happy to lend my 

voice to the efforts to move our country forward in meeting its infrastructure and 

transportation needs. 

Our transportation systems are under stress. If infrastructure does not keep pace 

with growth and changing patterns in population and employment, as well as associated development trends, the consequences will be enormous. Already, we are seeing intolerable congestion, stifling of growth and economic development in cities, 

towns, and older suburbs, more sprawling development, more demands for public 

water, sewers, schools, and transportation, detrimental environmental impacts, and 

an overall degradation of our quality of life. 

Nationally, our transportation infrastructure is deteriorating from insufficient investment. Just last year, the Urban Land Institute and Ernst & Young reported in 

Infrastructure 2007: A Global Perspective that the emerging crisis in mobility will 

significantly affect the United State’s ability to compete on the international stage. 

A report by the American Society of Civil Engineers expressed strong concern with 

not only the condition of our transportation infrastructure but also the electricity 

power grids, water and wastewater systems. The price tag placed on the needed repairs to our nation’s infrastructure was $1.6 trillion. Further, the National Surface 

Transportation Policy & Revenue Study Commission examined the nation’s surface 

transportation modes and concluded that an annual investment of 3-4 times in excess of the current annual capital investment was needed to sufficiently address the 

investment gap existing in surface transportation. 

The primary cause for our failure to invest in infrastructure is lack of money. I 

would suggest that another significant factor has been our failure to appropriately 

recognize infrastructure investment as a public policy priority essential to our economic growth. 

In Maryland, the state’s 6-year Consolidated Transportation Plan (CTP) includes 

over 90 transportation projects in the planning cycle. These are projects that have 

been identified as meritorious by elected officials and transportation officials. None 

of these projects have a single dollar allocated for future construction. The current 

cost to construct those projects falls in the range of $40 billion to $60 billion. 

Just a few months ago, Maryland deferred $1.1 billion in transportation projects 

in its current six year CTP, each of which is desperately needed. Maryland’s Transportation Secretary cited lagging revenues to the state’s Transportation Trust Fund 

and uncertainty over federal funding as the primary reasons for deferring budgeted 

spending. 

This action directly affects 100 state projects in the state’s six year transportation 

plan. Some of the more pronounced projects affect our transit systems. These result 

in deferral of funds for light rail and Maryland Commuter Rail, or MARC, maintenance projects, including station rehabilitations and parking improvements. Moreover, just recently, the State has announced further cuts to its transit system, primarily to commuter bus routes, and eliminating several trains from MARC’s Penn 

Line and Brunswick services. Such actions come at a time when the Baltimore 

117 

area’s transit needs were already stressed with increased ridership that grew significantly due to spiking fuel costs. 

It should be noted that Maryland, like many states in the country, as well as the 

federal government, relies heavily on motor vehicle related charges such as gasoline 

taxes, vehicle registration fees, sales tax on motor vehicles, and similar assessments 

to fund its Transportation Trust Fund. The sharp increase in the price of oil combined with the downturn in the economy significantly reduced the amount of funds 

available for transportation projects resulting in the decimation of the state’s six 

year transportation plan. This deferral of transportation projects occurred despite 

the Maryland General Assembly enacting a series of funding increases in November 

2007 that added close to $400 million per year to its Transportation Trust Fund. 

This dynamic highlights the need for Maryland and other states to alter transportation funding formulas to address growing transportation needs without a reliance 

on motor vehicle related taxes and assessments. To address this challenging issue, 

the Greater Baltimore Committee has formed a private sector task force to study, 

evaluate and recommend alternative revenue sources or formulas that are inflation 

sensitive and are capable of meeting ever expanding transportation needs and demands. 

Just yesterday, Maryland’s Transportation Secretary John Porcari stated in testimony before the House Transportation and Infrastructure Committee that nearly 

three dozen projects have been identified with a cost of about $150 million that 

could be obligated within 120 days should federal funds be made available. Of these 

three dozen projects, approximately 80 percent are in urban/metropolitan areas with 

the balance located in the rural areas of the state. The fact remains that as these 

projects are deferred, the needs continue to grow and the price tag only escalates 

due to increased deterioration of roadways and inflationary material and construction costs. In order to avoid such circumstances the need is there to act now to effectuate these long sought repairs and construction plans. 

On August 1, 2007, our country was shocked at the vivid pictures of a critical 

bridge failure as the bulk of the I-35 bridge in Minneapolis, Minnesota, collapsed 

killing seven people and injuring 59. Similarly, the Chesapeake Bay Bridge connecting the eastern and western shores of Maryland, one year later, experienced a 

deadly crash as a swerving car sent a tractor trailer banging against both sides of 

the bridge until it punched a ten foot opening in the bridge’s concrete railing. Subsequent examination by the State of Maryland’s bridge experts revealed a previously 

undisclosed failure in the bolts that are critical to the structure. There was understandable public concern over each of these sad events. Yet, we inevitably go back 

into our torpor until the next tragedy. Mr. Chairman, something must be done, and 

soon, to avert similar catastrophes. 

Inasmuch as Baltimore is on the Northeast Corridor which is utilized by both our 

local commuter service and interstate passenger rail, I would like to emphasize two 

projects that have been lingering for many years without attention. They are the 

two tunnels—one northeast of Penn Station, the Union tunnel, and one southwest 

of Penn Station, the Baltimore & Potomac Tunnel. Both of these structures are well 

over one hundred years old and are in dire need of rehabilitation, or replacement. 

Legislation recently passed by Congress and signed into law by the President has 

authorized over $14 billion in railway improvements across the nation, with $60 

million dedicated for attention to the Baltimore tunnel choke points. A stimulus 

package focused on infrastructure investment could very well move this project and 

other rail programs forward. 

One key statistic that has been noted in recent reports suggests that every one 

billion dollars in federal transportation investment supports approximately 35,000 

jobs and $1.3 billion in employment income. An investment in infrastructure would 

be significant to the construction industry sector as the housing decline and tight 

credit market has caused many construction workers to join the ranks of the unemployed. 

The Bureau of Labor Statistics estimates a loss of more than 600,000 jobs in the 

construction industry sector from 2007–2008. The time appears ripe to ‘‘jump start’’ 

the construction industry. An investment in infrastructure will buttress the construction industry’s sagging employment levels while simultaneously investing in 

our weakening infrastructure. 

An infusion of money for needed infrastructure projects can also benefit small 

businesses and minority and woman owned businesses. Urging, and perhaps establishing incentives for equity relationships between majority and minority and 

woman-owned businesses, beyond the customary MBE/WBE requirements, can result in the creation of opportunities for minority and woman-owned companies to 

significantly participate in infrastructure projects thus expanding their capacity to 

compete for future project awards. 

118 

Congressional efforts should be directed toward creating both short term jobs, as 

well as creating lasting value for our country by investing in infrastructure that can 

help the nation compete in a global economy, achieve energy independence, and provide capacity for the projected population growth that the United States will experience by 2050 and the threefold increase in GDP that will ensue over the same time 

period. 

As part of any stimulus package, I urge Congress to develop an Infrastructure Investment Plan that would invest in intercity and high-speed rail networks, invest 

in goods movement and seaports, strengthen the electrical grid and its technology, 

extend broadband communication to rural areas, repair aging and ailing water and 

sewer infrastructure systems of our nation’s metropolitan areas, and retrofit the nation’s existing energy systems so that they are more energy efficient. 

If Congress were to enact such a plan it would create new jobs in engineering and 

construction, would move goods and people more efficiently thereby reducing costs 

to business, and would provide the necessary infrastructure to move to a renewable 

energy economy. 

I offer these points in the hopes that you and your colleagues can unite to pass 

legislation that will truly begin to restore the quality of our nation’s infrastructure 

while strengthening our position in this competitive global economy. 

119 

PREPARED STATEMENT OF JOSEPH HASKINS, JR., PRESIDENT AND CEO, HARBOR

BANKSHARES CORPORATION

Good Morning, Chairman Schumer, Vice Chair Maloney and Members of the Committee. Thank you for the opportunity to address the Committee. 

I am the Chairman, President and CEO of Harbor Bankshares Corporation that owns a $300 million dollar bank (The Harbor Bank of Maryland) headquartered in 

Baltimore, Maryland. My market is Main Street America. 

I recognize that the U.S. Government has taken extraordinary steps over the 

course of the last few months to address the monumental problems we are experiencing in our credit markets and the erosion of public confidence in our financial 

institutions. 

While many, if not all, of these actions were necessary and went a long way to 

insure that our country did not fall into a deep recession or worse, these actions, 

by and large, were designed to aid and assist the larger financial institutions in the 

United States and, thus far, have done little to directly assist smaller financial institutions such as my bank, The Harbor Bank of Maryland (Harbor Bank). 

I am pleased to share my experiences and thoughts on the state of the economy 

from a community banker’s perspective. I have five (5) points to make. 

First, I am fortunate to have avoided the subprime crisis. Senior Management of 

Harbor Bank decided four (4) years ago to get out of the market. Our decision was 

made based on increasing errors, misrepresentations, and in some cases out right 

fraud that we found on residential mortgage applications. Incomes were inflated, 

work histories were altered, and credit scores were changed. 

Harbor Bank and other small community banks for the most part did not participate in the subprime mortgage loan debacle but because of the misdeeds and bad 

judgments of many larger institutions have nonetheless suffered tremendously. 

These smaller financial institutions did not participate in making loans to people 

who could ill afford them. They did not package them up and sell them to 

unsuspecting investors all over the globe. 

These problems in part help to lead to a FDIC Insurance costs increase for all 

banks. 

Second point, when the major financial organizations continued to stumble and 

show large losses, a heightened level of concern spread throughout the deposit base 

of smaller banks. In particular, a major event that panicked the bank customers 

was watching television and seeing depositors attempting to get their money out of 

a failing bank. 

Shortly thereafter, Harbor Bank lost deposits as customers feared for the safety 

of their money. Many customers moved their money to larger banks as they believed 

they would be better protected. Fortunately, the increased FDIC coverage has allowed us to reclaim some of the lost deposits. 

Third point, the current negative economic conditions have led to increased delinquencies in our loan portfolio across all sectors. We have record leveled loan chargeoffs (the 2008 level is 2.5 times higher than the highest previous years). Earnings 

have been substantially reduced as additional funds have been allocated to the Allowance for Loan Loss Reserves to protect against anticipated losses associated with 

residential development. Harbor Bank and other small banks have experienced 

eroding capital and reduced earnings. 

Harbor Bank and many other smaller Banks need the Treasury to make capital 

available. Smaller financial institutions are much more dedicated to the concept of 

using these capital infusions as a stimulus for additional lending in their communities. Some of the larger institutions are using the additional capital to purchase 

other institutions to gain market share or to make themselves more attractive takeover candidates instead of using this capital to support the banking footprint they 

serve. I am not suggesting that this additional capital should not be used to merge 

troubled institutions into healthier ones but I do feel that smaller institutions will 

be more prone to put the additional capital to work in the communities they serve. 

Even if smaller banks are allowed to participate in the capital assistance program 

from the Treasury and they use some of these proceeds to acquire troubled institutions in their trade areas, these combined institutions for the most part will remain 

small by comparison to the regional banks and major financial institutions that 

have already accessed capital from the Treasury. These combined or merged small 

banks will still be more prone to put the money out to small businesses and individuals residing in their banking territories. 

Fourth point, smaller banks need the opportunity to have the government buy out 

its problem loans and unmarketable mortgage backed securities and/or preferred 

shares with Fannie Mae or Freddie Mac. This will create more liquidity and free 

management from heavy loan monitoring and collection activities. 

120 

Fifth point, I would like to address is the plight of small broker-dealer firms that 

service small municipalities and counties in this country. Our bank also has a small 

broker-dealer subsidiary. It has struggled mightily under the strain of the locked 

up public debt markets. Our broker-dealer subsidiary underwrites investment grade 

public debt primarily for small municipalities comprised mostly of low income individuals and minorities. Most large broker-dealers do not seek or want this business 

because for them it is not profitable. It is a segment of the market that is often ignored by Wall Street. These small communities are suffering much more than larger 

cities and counties in the country. The tax base in these areas is much more limited 

but they are not immune from the foreclosure rates or job losses haunting larger 

areas. Their problems have become exacerbated with the virtual exit of insurance 

companies who historically have provided low cost guarantees of their bonded indebtedness. As a result, many public improvement projects such as schools, jails, infrastructure improvements, and the like are going unfunded. Our broker-dealer subsidiary has seen its capital diminish significantly due to the lack of business activity 

in the small municipal markets it has traditionally served. Also, securities issued 

by these small municipalities have been disproportionately devalued in the credit 

markets. Our firm has experienced maintenance calls due to haircuts assigned to 

the public debt of these small issuers of public debt resulting in the erosion of capital in our broker-dealer subsidiary. Our firm underwrites only investment grade 

municipal bonds which are being treated by clearing firms as junk bonds. The 

Treasury capital assistance program should be extended to include small brokerdealers who specialize in serving the under-served communities in our country. 

They are federally regulated just as banks are and serve a purpose in helping to 

unlock the credit markets in this country. Bolstering the capital base of the large 

banks will do nothing to help those municipalities and counties that are not heavily 

populated and do not have a large industrial base to provide jobs and a larger tax 

base. The default rate on bonds issued by these small towns and counties is practically non-existent but their access to the credit markets has completely dried up 

and they do not have investment banks willing to underwrite their debt. 

In closing I would like to reiterate one major point which I think deserves immediate attention. Small community banks and small broker-dealer firms should be allowed to access the capital assistance program being sponsored by the Treasury. The 

preferred stock purchased by the Treasury from these smaller institutions should 

be less costly than the coupon rate currently being charged to the large institutions 

who were in large part responsible for the problems we are facing today. This will 

help to insure that the bailout program, which has thus far been limited and directed at only the large financial institutions, is expanded to assist those underserved borrowers who are customers of community banks and also small municipalities and counties which in the present credit crunch environment have been forgotten and neglected but are just as important to the economic recovery of our nation 

as the big banks and investment banking houses on Wall Street. 

Times are tough on Main Street and the best way to improve the economy is to 

get stimulus funds in the hands of community based financial services companies. 

Æ