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S. HRG. 110–845 

THE ECONOMIC OUTLOOK 

HEARING 

BEFORE THE

JOINT ECONOMIC COMMITTEE 

CONGRESS OF THE UNITED STATES 

ONE HUNDRED TENTH CONGRESS 

SECOND SESSION 

SEPTEMBER 24, 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 

MEMBERS

Hon. Charles E. Schumer, Chairman, a U.S. Senator from New York ............... 1 

Hon. Jim Saxton, a U.S. Representative from New Jersey .................................. 5 

Hon. Carolyn B. Maloney, Vice Chair, a U.S. Representative from New York .. 6 

Hon. Sam Brownback, a U.S. Senator from Kansas ............................................. 8 

WITNESSES

Statement of The Honorable Ben Bernanke, Chairman, Board of Governors 

of the Federal Reserve System ............................................................................ 9 

SUBMISSIONS FOR THE RECORD

Prepared statement of Hon. Charles E. Schumer, Chairman, a U.S. Senator 

from New York ..................................................................................................... 50 

Prepared statement of Hon. Jim Saxton, a U.S. Representative from New 

Jersey .................................................................................................................... 52 

Report entitled ‘‘Government Policy Blunders Largely Caused the Global 

Financial Crisis’’ ........................................................................................... 53 

Report entitled ‘‘The U.S. Housing Bubble and the Global Financial Crisis: Housing and Housing-Related Finance’’ ............................................... 59 

Prepared statement of Hon. Carolyn B. Maloney, Vice Chair, a U.S. Representative from New York ................................................................................. 88 

Prepared Statement of Hon. Ron Paul, a U.S. Representative from Texas ........ 89 

Prepared statement of Hon. Sam Brownback, a U.S. Senator from Kansas ...... 90 

Prepared Statement of Hon. Ben S. Bernanke, Chairman, Board of Governors, 

Federal Reserve System ...................................................................................... 92 

(1) 

THE ECONOMIC OUTLOOK 

WEDNESDAY, SEPTEMBER 24, 2008 

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

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

Senate Office Building, The Honorable Charles E. Schumer (Chairman) presiding. 

Senators PRESENT. Bingaman, Klobuchar, Casey, Webb, Brownback, Sununu, DeMint, and Bennett. 

Representatives PRESENT. Maloney, Hinchey, Hill, Cummings, 

Doggett, Saxton, English, Brady, and Paul. 

Staff Present: Christina Baumgardner, Heather Boushey, Nate 

Brustein, Gail Cohen, Nan Gibson, Colleen Healy, Marc Jarsulic, 

Aaron Kabaker, Michael Laskawy, David Min, Aaron Rottenstein, 

Justin Ungson, Ted Boll, Connie Foster, Chris Frenze, Bob 

Keleher, Tyler Kurtz, Robert O’Quinn, Jeff Schlagenhauf, Christina 

Valentine, Colm Willis, and Jeff Wrase. 

OPENING STATEMENT OF THE HONORABLE CHARLES E. 

SCHUMER, CHAIRMAN, A U.S. SENATOR FROM NEW YORK 

Chairman Schumer. Let’s clear out. Okay, good morning. Our 

hearing will open. 

First, let me just make a little housekeeping note here. Because 

of the time constraints on Chairman Bernanke’s schedule, he has 

to testify in front of House Financial Services this afternoon and 

must be gone by 12:30. 

We’re going to limit opening statements today to the Chair, Vice 

Chair, Ranking Member and the Senior Senate Minority Member. 

I generally like to give everyone a chance to do opening statements, 

but, instead, what we’ve done, is given seven minutes of question 

period, instead of five, and we encourage members, if they wish to 

make—use part of that time to make a statement, to feel free to 

do so. 

We’ll also, without objection, enter all other members’ opening 

statements into the record. 

[The prepared statement of other members appears in the Submissions for the Record on page 89.] 

Chairman Schumer. Before I get into my statement, I’d like to 

acknowledge the service of one of our colleagues on this Committee, 

Congressman Jim Saxton. He’s retiring at the end of this Congress. 

Jimmy and I have been friends since he came to the House. He’s 

been a distinguished Member of this Committee for 15 years; he’s 

been chair of this Committee three times; Vice Chair three times. 

2 

Jim, thanks for your service, and we’ll miss you. 

Mr. Saxton. Thank you very much. [Applause.] 

Chairman Schumer. Okay, to begin, of course, I’d like to welcome you to this hearing, Mr. Chairman, and I’d like to thank you 

for appearing before this and the two other Committees you’re testifying in front of. 

I think we all know how grueling this can be, but it’s an important part of the process, and, frankly, sunlight is a great cleanser 

and disinfectant. 

If the Administration’s plan can’t withstand public scrutiny, we 

cannot make our case to the American taxpayers we represent, and 

I think hearings like those that began in the Senate Banking Committee, under the leadership of Chairman Dodd, and continuing in 

Financial Services this afternoon, have been important. 

Over the last 24 hours, I’ve seen greater signs of cooperation 

among my colleagues in the Congress, who, despite many of their 

well-founded reservations, recognize the magnitude of the problems 

we face and the importance of getting something done. 

So the hearings are part of this process, the so-called sausagemaking. We’re doing them under speedy circumstances this time, 

because of the worries we all have about the financial markets, but 

they’re a necessary and important part of the process, and they 

help move things along. 

As I said, I think we’re better off today in terms of getting this 

bill done, than we were yesterday, because of your and your colleagues’ testimony. 

Now, when you were last before this Committee, Mr. Chairman, 

in April—and this was a regularly scheduled hearing of the Committee, where you always appear before us twice a year, and this 

was scheduled long before the crisis—the crisis we were facing then 

was the collapse of Bear Stearns. 

And I can say that most of us thought that we had just witnessed an event that we were never likely to see again in our lifetimes, and yet here we are, six months later, and we’re discussing 

a crisis many orders of magnitude greater. 

Mr. Chairman, I believe you have been eloquent and impassioned 

in your warnings of the dangers we face, and that we must try to 

do all we can to resolve the threat to our financial system. 

And I will reiterate what I said yesterday at the Banking Committee: I do believe we must act and we must act soon. 

But let us be clear. Americans are furious. I am sure that every 

single one of my colleagues on both sides of the aisle has heard 

what I have heard from my constituents: Amazement, astonishment, and intense anger. 

And they are right to be astonished and very angry. Over the 

last eight years, we were told that markets knew best, that financial alchemy had reduced risk to an afterthought, and that we were 

entering a new world of global growth and prosperity. 

Instead, what we have learned, is that we now have to pay for 

the greed and recklessness of those who should have far known 

better. 

Unfortunately, that truth doesn’t solve the crisis that confronts 

us, and while Wall Street may have caused these problems, if we 

do nothing, Main Street will also pay a severe price. 

3 

Pension funds, money market mutual funds, and 401(k) plans 

will be negatively impacted. Credit is already tightening, which impacts households, as well as businesses large and small throughout 

the country. 

The lock down in lending has widespread consequences. I’ve 

heard from car manufacturers that it’s virtually impossible to get 

an auto loan right now, unless you have a very high credit score. 

This year alone, they are likely to sell six million fewer cars than 

they otherwise would, if credit remains as tight as it is today. 

So, even though the workers in Buffalo and Detroit and St. Louis 

are blameless, they will suffer. It’s not fair; it’s not right, but, unfortunately, that’s the world we live in today, and, to put our heads 

in the sand like ostriches and ignore it will not serve the interest 

of those workers very well. 

It’s the reality we face and I think we, on both sides of the aisle 

here in Congress, recognize it. 

I want to assure the markets once again—and I think I speak 

for all of us—that we will no be dilatory and we will not add extraneous amendments; we will not Christmas-tree this bill, and we 

will work in a bipartisan way to act and act soon. 

In the last day, it has become clear to me that with the exception 

of a few outliers on either side, there is clear recognition among 

members of both parties, that we must act and act soon. 

And it has been good to hear from both Senators Obama and 

McCain, that they believe we must act, though, like us, they believe changes must be made in the Administration plan. 

Still, as I said yesterday, as well, we must beware that in taking 

actions, we do not choose a bad solution. The markets want action; 

we understand that, but if we act so quickly that we create an ineffective solution without adequate safeguards, then we risk the plan 

failing, which would be an even worse outcome for the markets, for 

the economy, and for our country. Even on Wall Street, $700 billion is a lot of money, and none of 

the thousands of money managers would invest that sum without 

appropriate due diligence. These hearings and the discussions that 

are happening as we speak, are our Congressional due diligence, 

and we take that responsibility seriously and we will make intelligent and relevant improvements to the Administration plan. 

We owe nothing less than that to the taxpayers who have put us 

in office to safeguard their economic well being. It is a sacred trust 

and I can say that it’s a responsibility that all my colleagues, both 

Democrats and Republicans, whatever our philosophical differences, hold very dear. 

As I have said, I believe there are three essential components 

that must be part of this plan: THO, taxpayers, homeowners, and 

oversight. 

There can be no question—and this nonnegotiable—that we must 

put taxpayers first. They must come ahead of bondholders, shareholders, and executives, and we need to add to the Administration’s 

legislation those types of protections. 

I think we must consider seriously, putting this program in 

place, in tranches or installments, so that we do not limit the Secretary’s ability to act, as necessary, but are able to evaluate the effectiveness of these expenditures over time. 

4 

If the program is working, Congress will certainly ratify continuing expenditures by the Treasury, but if it’s not working, then 

we will need to review it before we once again find ourselves on the 

brink. 

I look forward to hearing your thoughts on that possibility, Mr. 

Chairman. 

Another idea I’ve proposed, is an insurance fund, modeled on the 

FDIC and paid for by the financial industry, that can defray some 

of the long-term costs of the Administration plan. 

It clearly cannot cover the entire cost, but it seems only fair that 

the industry that will receive the vast benefit of this taxpayer-funded program, pay for some share of it themselves. 

Both Secretary Paulson and you seemed positively disposed to 

that idea yesterday, and, again, I look forward to hearing further 

from you today, as well. 

Finally, on the taxpayer side, I remain puzzled by the resistance 

you and Secretary Paulson have offered to proposals that Senator 

Jack Reed and many of my colleagues have made about the need 

for equity being part of the process we are discussing. 

My constituents are asking me about it, as do many of the business people and many of your fellow economists who I’ve spoken to 

about this. 

This morning, Warren Buffett got an equity share in Goldman 

Sachs and it didn’t stop Goldman Sachs from making the deal with 

Warren Buffett. It seems only fair that we reward taxpayers, if, as 

we hope, this plan succeeds. 

We also must do something to help homeowners. Chairman 

Bernanke, you, yourself, have repeatedly stated that until we find 

a floor in the housing markets—and foreclosures are directly related to finding this floor—we will not solve the problem. 

And that affects not just those who made bad mortgages and not 

just those who will lose their homes through no fault of their own— 

the second group should be protected, the first should not—but it 

affects every homeowner. The number of foreclosures and the price 

of the average American’s home, are intrinsically related to one another and can’t be separated. 

As we’ve seen the complications of securitization, where mortgages are placed into pools and then broken up into a large number 

of securities, has created an enormous problem, it seems to me that 

any voluntary program does not work, and the only mandatory program that’s available, is bankruptcy, and I would also like to discuss that with you, as well. 

Finally, this is the last of what I call the three THO principles: 

There must be greater oversight as part of this plan. The Administration is simply asking for trust. However much we may like Secretary Paulson or you, Mr. Chairman, no sane person would put 

$700 billion in your hands on trust alone. 

I cannot in good faith, tell my constituents that ‘‘it’s fine; we 

know they’ll do the right thing.’’ Strict oversight is a sine qua non, 

and I think that this will be the easiest part of the three, taxpayers, homeowners, oversight, to accomplish. 

To close, I’d like to add a few words about something I worry has 

gotten lost in our focus on this crisis. As I have said, I do believe 

that we will fix the financial crisis we face, but that will not, in 

5 

and of itself, fix many of the other problems that continue to bedevil American families. 

The economy of the past eight years, has hammered the American middle class; their incomes have declined, their healthcare 

coverage has weakened, the price of their gas and food has skyrocketed, the value of their homes has plummeted, and now many 

of them find their jobs threatened. 

The plan the Administration has put forward, with certain modifications, will, I hope, resolve this current mess, but many other obstacles remain ahead of us. It is not enough to maintain the status 

quo. We must find a way once again to make the American economy the engine of prosperity it once was for all Americans, and not 

a casino where we let some earn extreme rewards by taking excessive risks while the rest of us get stuck with the bill. 

[The prepared statement of Senator Schumer appears in the Submissions for the Record on page 50.] 

Chairman Schumer. Congressman Saxton? 

OPENING STATEMENT OF THE HONORABLE JIM SAXTON, A 

U.S. REPRESENTATIVE FROM NEW JERSEY 

Mr. Saxton. Mr. Chairman, I’d like to join in welcoming Chairman Bernanke, and before I begin my statement, I would like to 

thank you for the kind words at the outset. 

I’ve enjoyed very much being a Member, Chairman and Vice 

Chairman of the Joint Economic Committee. It’s been a pleasure, 

and I hope that Members of Congress in both parties have benefitted from the discussions that we’ve had with the Administration, 

with regulators, and with representatives of the financial community, as well. 

I would like to say also that, little did I know, in all the years 

that I’ve been a Member and Chairman of this committee that my 

tenure would end on such a serious note. 

This is a serious problem for our economy and it’s a serious problem for Wall Street. But, most of all, my heartstrings tug when I 

get telephone calls from my constituents, and from people all across 

the country, for that matter who call and ask, what’s going to happen to their nest egg, what’s going to happen to their savings, 

what’s going to happen to their money market, what’s going to happen to their hometown bank? Those are questions that are certainly important for them to ask and for us to help solve. 

The main cause of the financial turmoil in the market, as I see 

it, is the collapse of the housing bubble, inflated by various government policies over many years. 

Government policies supported in Congress, encouraged the expansion of the subprime and other risky mortgages that fueled the 

housing bubble. I’ve been a student of housing prices over the 

years, and it was clear to me over the past three years or so, that 

as we saw the housing bubble escalate, that there was sure to be 

a correction and here it is. 

In exchange, despite warnings for many years that both Fannie 

and Freddie were excessively leveraged to a degree that was dangerous, they continued to inflate the housing bubble, undeterred by 

accounting scandals. 

6 

Now the country will have to pay a very high price for lending 

policies highly influenced by political and not economic objectives. 

Given their financial problems, created by politicization of decision 

making, Fannie and Freddie have essentially been taken over by 

the Federal Government. 

In another startling development over the last several weeks, a 

distinct investment banking industry, established by the provisions 

of the well-meaning Glass–Steagall Act, has essentially ceased to 

exist. 

The independent investment banking business model proved unable to withstand the stress in the financial markets, wracking the 

entire financial structure of our economy. 

These investment banks were highly leveraged and relied on 

short-term funds to finance longer-term investments. Unfortunately, many of these investments were mortgaged-backed securities whose value has plunged over the last year. 

The fact that the investment banking industry, created by government regulation, has proven unsound, is a reminder that government policies do not always provide effective solutions, but can, 

in fact, create problems. 

As a result, many investors are rightly concerned about the safety of their savings and their investments, and I’m not talking about 

big investors; I’m talking about mom and dad, who go to work 

every day and put some of their earnings in a savings account and 

that are now scared to death about what’s going to happen to those 

nest eggs. 

Some action by government is now needed to recapitalize the 

banks and other financial institutions, either by injections of equity 

or removal of toxic investments. 

In this financial meltdown, there is plenty of blame to go around, 

but, ultimately, the American people expect action to deal with this 

crisis. One good place to start would be guaranteeing the safety of 

transaction accounts, checking accounts, and money market accounts, that is, to assure savers and small businesses, that their 

basic financial needs can be met without disruption. 

Thank you again, Mr. Chairman, and I yield back. 

[The prepared statement of Representative Saxton appears in the 

Submissions for the Record on page 52.] 

Chairman Schumer. Thank you, Congressman Saxton. Vice 

Chair Maloney? 

OPENING STATEMENT OF THE HONORABLE CAROLYN B. 

MALONEY, VICE CHAIR, A U.S. REPRESENTATIVE FROM NEW 

YORK 

Vice Chair Maloney. Good morning. I’d first like to thank 

Chairman Schumer for holding this timely hearing to examine the 

economic outlook, especially in light of these sobering developments 

in our financial markets in recent days and months, and I want to 

welcome Chairman Bernanke. 

What started out as a subprime crisis last summer, has completely changed the face of Wall Street and created a tinderbox 

that poses a significant threat to our financial system. Treasury Secretary Paulson’s $700 billion proposal for the Federal Government to buy toxic assets, is the equivalent of one-quarVerDate Nov 24 2008 14:31 Jul 06, 2009 Jkt 045037 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 C:\DOCS\46552.TXT SHAUN PsN: DPROCT
7 

ter of the entire federal budget in 2008, more than the total 

amount we spent this year on either the defense of our country— 

and we are in two wars—or the entire Social Security system. 

American taxpayers are being asked to pour more of their good 

money after bad, while not being provided with any alternatives. 

Your Senate testimony yesterday, made the distinction between the 

market price, the fire sale price, and the higher, hold-to-maturity 

value, which is the price the government would pay under your 

plan. 

Your critics have called this a multi-billion-dollar subsidy, and I 

would like you to clarify it further. Just a fraction of this money 

could be used to help millions of Americans avoid losing their 

homes. 

I am confused by the fact that the Paulson Plan prefers government intervention instead of the private sector acquiring these assets. Yesterday, it was announced that Berkshire Hathaway intends to invest $5 billion in Goldman Sachs. Morgan Stanley sold 

a portion of their firm to the private sector over the weekend. 

One could say this is in response to government actions and a 

backstop to the markets, but also it was reported that AIG had private offers, as did Lehman. 

The idea that the private sector does not want to buy these assets, and, instead, our government should pay a premium and that 

this is somehow good for the taxpayer, seems dubious. 

Upon receiving this taxpayer money, large multinational firms 

have three choices: They can provide credit in America, they could 

invest in other countries, or they could conserve it to replenish 

their capital, which is what happened in the Japanese banking crisis. 

Some critics have said that we are taking a big chance in not 

knowing where this money will end up. 

The other issue that has been repeatedly raised, is the daisychain reaction of one firm bringing down the system. One solution 

that has been proposed, would be to allow government to seize the 

assets and do an orderly sale, before default and the ensuing need 

for taxpayer-funded bailout. 

Perhaps you can explain why this alternative is not addressed in 

the Paulson program. 

When management of so-called too-big-to-fail firms, have a liquidity crisis that could be avoided, if they’d just accept a buyout 

offer, wouldn’t it serve the public interest, if the Fed briefly guaranteed such firms’ short-term obligations, eliminating systemic risk 

and then force the auction of the firm to the highest bidder? Isn’t 

that better than effectively nationalizing the firm, as in the AIG 

case; letting it fail and damage the system, like Lehman; or worse, 

having the taxpayers buy only the very worst assets, as the plan 

proposes to do? 

These are questions that our constituents deserve to have answered. We all recognize the need to do what is best for the American economy, as a whole. We all recognize that the time will come 

for an investigation of how we came to this crisis, but any plan to 

use taxpayer funds, must require that the businesses using the 

plan, make sacrifices, just as we are asking current and future generations of Americans to do. 

8 

I look forward to your testimony. 

[The prepared statement of Vice Chair Maloney appears in the 

Submissions for the Record on page 88.] 

Chairman Schumer. Senator Brownback? 

OPENING STATEMENT OF THE HONORABLE SAM 

BROWNBACK, A U.S. SENATOR FROM KANSAS 

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

Mr. Chairman, we’re at a crossroads. We face the most monumental economic decisions in modern times. This is not the time to 

posture in pursuit of political advantage. 

Two things, I believe, are certain: Inaction is not an option, and 

we have to get this right. 

To date, we’ve dealt with symptoms of the crisis and we now deal 

with the cancer itself. The American people are angry and they certainly have every right to be. 

To most, this looks like just one more example of the government 

making them pay for someone else’s failures, and to paraphrase 

President Reagan, they want the government to walk by their side 

and stop riding on their back. 

This is, at its core, I believe, about the interaction of Wall Street 

and Main Street. Absent action, there’s a prolonged period in which 

credit stops flowing, there is a severe adverse threat to the financial conditions of every household, every American family, every 

American business, small and large. 

This is certainly not an abstract fear. I’m sure that everybody on 

this Committee has heard real-world examples of how this crisis is 

hitting the real economy of their constituents. 

For example, a major automobile seller was unable to obtain 

funding at workable rates to finance sales of its automobiles. Since 

August 2007, 87 lenders have exited or temporarily stopped making student loans backed by the Federal Government. 

If your child is counting on a student loan for next semester’s 

education, it could be tough, if this continues, tough to find. 

Sixty-seven percent of our small business owners, who are the 

engines of job creation in our economy, report that their businesses 

have been affected by the credit crunch. If we have a prolonged period in which credit flows virtually dry up, we can count on failures 

of businesses to be able to make payrolls, to employ workers, and 

to continue operations. 

Failure to act can result in severely depressed economic conditions. So I believe that it would be irresponsible to not act. 

But I also believe that we must act responsibly. Acting responsibly includes looking out for taxpayers as we consider devoting 

large amounts of taxpayer funds to resolve matters in credit markets. 

First, Chairman Bernanke, I would like you to explain in your 

testimony, what you feel would happen, if we did not act and credit 

flows remain frozen for a protracted period of time. Second, I’d like 

you to explain how you think Treasury’s proposal would find true 

hold-to-maturity prices of the distressed assets that are now being 

valued in illiquid or nonexistent markets at fire sale prices, at best. 

If Treasury pays too much for the assets, taxpayers lose. If it 

doesn’t pay enough, then banks end up taking severe write-downs 

9 

and must seek more capital and moving toward selling more assets 

at fire sale prices. 

Third, I’d like you to help me understand why it would not be 

prudent to protect taxpayers by inserting into Treasury’s plan, requirements that those who sell troubled assets, provide the taxpayers with preferred stock warrants. 

Why, for example, could we not have Treasury buy troubled assets at fire sale prices, inject capital into troubled institutions, and 

obtain preferred stock warrants? We used warrants when the Federal Government backed the Chrysler debt. 

Fourth, I’d like you to help me understand why we should con- sider Treasury’s proposal of up to $700 billion of value. Would 

there not be merit in considering an initial set of purchases of certain classes of troubled assets, in the amount of, say, $100 billion? Then we could evaluate results and move on with $100 billion of 

purchases of other classes of troubled assets. It seems to me that’s 

only prudent, that an investor wouldn’t just say, well, here’s $700 

billion, but, rather, let’s work at this in tranches, and I’d like to 

understand why we couldn’t go at it that way, as a prudent investor would go at this. 

Fifth, I’d like to know whether you believe that Treasury’s proposed plan has any room for loan modifications by the Treasury, 

on troubled mortgages. 

We have a crisis in confidence in financial markets and we have 

a crisis of confidence of the American people in their government. 

When an American family seeks to borrow money to improve 

their home or start a business, or when a small business looks to 

borrow to expand operations, they have to explain in detail, what 

they are going to do with the money, what the collateral is, and 

how they are going to pay it back. 

I don’t think the American people are unreasonable in asking the 

same questions of this proposal. 

I appreciate the help that I anticipate that you will give us and 

the country, in understanding how best to resolve the stresses in 

the financial markets that pose a very real adverse threat to our 

overall economy. 

Again, I believe it would be irresponsible not to act, but I also 

believe that we must act responsibly and get this right, including 

protecting the taxpayers. Thank you, Mr. Chairman. 

[The prepared statement of Senator Brownback appears in the 

Submissions for the Record on page 90.] 

Chairman Schumer. Thank you, Senator Brownback. 

Chairman Bernanke, the podium is yours. 

STATEMENT OF THE HONORABLE BEN S. BERNANKE, CHAIRMAN, BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM; 

WASHINGTON, DC 

Chairman Bernanke. Thank you. Chairman Schumer, Vice 

Chair Maloney, Representative Saxton and other Members of the 

Committee, I appreciate this opportunity to discuss recent developments in financial markets, and to present an update on the economic situation. 

As you know, the U.S. economy continues to confront substantial 

challenges, including a weakening labor market and elevated inflaVerDate Nov 24 2008 14:31 Jul 06, 2009 Jkt 045037 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 C:\DOCS\46552.TXT SHAUN PsN: DPROCT
10 

tion. Notably, stresses in financial markets have been high and 

have recently intensified significantly. 

If financial conditions fail to improve for a protracted period, the 

implications for the broader economy could be quite adverse. 

The downturn in the housing market has been a key factor underlying both the strained condition of financial markets and the 

slowdown of the broader economy. 

In the financial sphere, falling home prices and rising mortgage 

delinquencies have led to major losses at many financial institutions, losses only partially replaced by the raising of new capital. 

Investor concerns about financial institutions increased over the 

summer, as mortgage-related assets deteriorated further, and economic activity weakened. Among the firms under the greatest pressure were Fannie Mae and Freddie Mac, Lehman Brothers, and, 

more recently, the American International Group (or AIG). 

As investors lost confidence in them, these companies saw their 

access to liquidity and capital markets increasingly impaired and 

their stock prices drop sharply. 

The Federal Reserve believes that, whenever possible, such difficulties should be addressed through private-sector arrangements, 

for example, by raising new equity capital, by negotiations leading 

to a merger or acquisition, or by an orderly wind-down. 

Government assistance should be given with the greatest of reluctance and only when the stability of the financial system, and, 

consequently, the health of the broader economy, are at risk. 

In the cases of Fannie Mae and Freddie Mac, however, capital 

raises of sufficient size appeared infeasible, and the size and government-sponsored status of the two companies precluded a merger 

with or acquisition by another company. 

To avoid unacceptably large dislocations in the financial sector, 

the housing market, and the economy as a whole, the Federal 

Housing Finance Agency placed Fannie Mae and Freddie Mac into 

conservatorship and the Treasury used its authority granted by the 

Congress in July to make available financial support to the two 

firms. 

The Federal Reserve, with which FHFA consulted on the conservatorship decision, as specified in the July legislation, supported 

these steps as necessary and appropriate. 

We have seen benefits of this action in the form of lower mortgage rates, which should help the housing market. 

The Federal Reserve and the Treasury attempted to identify private-sector solutions for AIG and Lehman Brothers, but none was 

forthcoming. In the case of AIG, the Federal Reserve, with the support of the Treasury, provided an emergency credit line to facilitate 

an orderly resolution. 

The Federal Reserve took this action because it judged that, in 

light of the prevailing market conditions and the size and composition of AIG’s obligations, a disorderly failure of AIG would have severely threatened global financial stability, and, consequently, the 

performance of the U.S. economy. 

To mitigate concerns that this action would exacerbate moral 

hazard and encourage inappropriate risk-taking in the future, the 

Federal Reserve ensured that the terms of the credit extended to 

11 

AIG imposed significant costs and constraints on the firm’s owners, 

managers, and creditors. 

The Chief Executive Officer has been replaced. The collateral for 

the loan is the company itself, together with its subsidiaries. 

Insurance policyholders and holders of AIG investment products 

are, however, fully protected. 

Interest will accrue on the outstanding balance of the loan, at a 

rate of three-month LIBOR plus 850 basis points, implying a current interest rate over 11 percent. 

In addition, the U.S. Government will receive equity participation rights corresponding to a 79.9 percent equity interest in AIG, 

and has the right to veto the payment of dividends to common and 

preferred shareholders, among other things. 

In the case of Lehman Brothers, a major investment bank, the 

Federal Reserve and Treasury declined to commit public funds to 

support the institutions. The failure of Lehman posed risks, but the 

troubles at Lehman had been well known for some time, and investors clearly recognized—as evidenced, for example, by the high cost 

of insuring Lehman’s debt in the market for credit default swaps— 

that the failure of the firm was a significant possibility. Thus, we 

judged that investors and counterparties had had time to take precautionary measures. 

While perhaps manageable in itself, Lehman’s default was combined with the unexpectedly rapid collapse of AIG, which, together, 

contributed to the development last week of extraordinarily turbulent conditions in global financial markets. 

These conditions caused equity prices to fall sharply, the cost of 

short-term credit, where available, to spike upward, and liquidity 

to dry up in many markets. 

Losses at a large money market mutual fund sparked extensive 

withdrawals from a number of such funds. A marked increase in 

the demand for safe assets, a flight to quality, sent the yield on 

Treasury bills down to a few hundredths of a percent. 

By further reducing asset values and potentially restricting the 

flow of credit to households and businesses, these developments 

pose a direct threat to economic growth. 

The Federal Reserve took a number of actions to increase liquidity and stabilize markets. Notably, to address Dollar funding pressures worldwide, we announced a significant expansion of reciprocal currency arrangements with foreign central banks, including 

an approximate doubling of the existing swap lines with the European Central Bank and the Swiss National Bank, and the authorization of new swap facilities with the Bank of Japan, the Bank of 

England, and the Bank of Canada, among others. 

We will continue to work closely with colleagues at other Central 

Banks to address ongoing liquidity pressures. 

The Federal Reserve also announced initiatives to assist money 

market mutual funds facing heavy redemptions, and to increase liquidity in short-term credit markets. 

Despite the efforts of the Federal Reserve, the Treasury, and 

other agencies, global financial markets remain under extraordinary stress. Action by the Congress is urgently required to stabilize the situation and avert what otherwise could be very serious 

consequences for our financial markets and for our economy. 

12 

In this regard, the Federal Reserve supports the Treasury’s proposal to buy illiquid assets from financial institutions. Purchasing 

impaired assets will create liquidity and promote price discovery in 

the markets for these assets, while reducing investor uncertainty 

about the current value and prospects of financial institutions. 

More generally, removing these assets from institutions’ balance 

sheets will help to restore confidence in our financial markets and 

enable banks and other institutions to raise capital and to expand 

credit to support economic growth. 

I will now turn to a brief update on the economic situation. Ongoing developments in financial markets are directly affecting the 

broader economy through several channels, most notably, by restricting the availability of credit. 

Mortgage credit terms have tightened significantly and fees have 

risen, especially for potential borrowers who lack substantial down 

payments or who have blemished credit histories. Mortgages that 

are ineligible for credit guarantees by Fannie Mae or Freddie Mac, 

for example, non-conforming jumbo mortgages, cannot be 

securitized and thus carry much higher interest rates than conforming mortgages. 

Some lenders have reduced borrowing limits on home equity 

lines of credit. Households also appear to be having more difficulty 

of late in obtaining non-mortgage credit. For example, the Federal 

Reserve’s Senior Loan Officer Opinion Survey reported that, as of 

July, an increasing proportion of banks had tightened standards for 

credit card and for other consumer loans. 

In the business sector, through August, the financially strongest 

firms remained able to issue bonds, but bond issuance by speculative-grade firms remain very light. 

More recently, however, deteriorating financial market conditions 

have disrupted the commercial paper market and other forms of financing for a wide range of firms, including investment-grade 

firms. 

Financing for commercial real estate projects, has also tightened 

very significantly. 

When worried lenders tighten credit, then spending, production, 

and job creation slow. Real economic activity in the second quarter, 

appears to have been surprisingly resilient, but, more recently, economic activity appears to have decelerated broadly. 

In the labor market, private payrolls shed another 100,000 jobs 

in August, bringing the cumulative drop since November to 

770,000. New claims for unemployment insurance are at elevated 

levels and the civilian unemployment rate rose to 6.1 percent in 

August. 

Households’ real disposable income was boosted significantly in 

the Spring by the tax rebate payments, but, excluding those payments, real after-tax income has fallen this year, which partly reflects increases in the prices of energy and food. 

In recent months, the weakness in real income, together with the 

restraining effects of reduced credit flows and declining financial 

and housing wealth, have begun to show through more clearly to 

consumer spending. 

Real personal consumption expenditures for goods and services 

declined in June and July, and the retail sales report for August 

13 

suggested outlays for consumer goods fell noticeably further last 

month. 

Although the retrenchment in household spending has been 

widespread, purchases of motor vehicles have dropped off particularly sharply. 

On a more positive note, oil and gasoline prices, while still at 

high levels, in part reflecting the effects of Hurricane Ike, have 

come down substantially from the peaks they reached earlier this 

summer, contributing to a recent improvement in consumer confidence. 

However, the weakness in the fundamentals underlying consumer spending suggest that household expenditures will be sluggish, at best, in the near term. 

The recent indicators of the demand for new and existing homes 

hint at some stabilization of sales, and lower mortgage rates are 

likely to provide some support for demand in coming months. Moreover, although expectations that house prices will continue to fall, 

have probably dissuaded some potential buyers from entering the 

market, lower house prices and mortgage interest rates are making 

housing increasingly affordable over time. 

Still, home builders retain large backlogs of unsold homes, which 

continue to restrain the pace of new home construction. Indeed, 

single-family housing starts and new permit issuance dropped further in August. 

At the same time, the continuing decline in house prices reduces 

homeowners’ equity and puts continuing pressure on the balance 

sheets of financial institutions, as I have already noted. 

As of midyear, business investment was holding up reasonably 

well, with investment in nonresidential structures particularly robust. However, a range of factors, including weakening fundamentals and constraints on credit, are likely to result in a considerable 

slowdown in the construction of commercial and office buildings in 

coming quarters. 

Business outlays for equipment and software also appeared 

poised to slow in the second half of this year, assuming that production and sales slow as anticipated. 

International trade provided considerable support for the U.S. 

economy over the first half of the year. Economic activity has been 

buoyed by strong foreign demand for a wide range of U.S. exports, 

including agricultural products, capital goods, and industrial supplies, even as imports declined. 

However, in recent months, the outlook for foreign economic activity has deteriorated amid unsettled conditions in financial markets, troubled housing sectors, and softening sentiment. 

As a consequence, in coming quarters, the contribution of net exports to U.S. production is not likely to be as sizeable as it was in 

the first half of the year. 

All told, real gross domestic product is likely to expand at a pace 

appreciably below its potential rate in the second half of this year, 

and then to gradually pick up as the financial markets return to 

more normal functioning and the housing contraction runs its 

course. 

Given the extraordinary circumstances, greater than normal uncertainty surrounds any forecast of the pace of activity. In parVerDate Nov 24 2008 14:31 Jul 06, 2009 Jkt 045037 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 C:\DOCS\46552.TXT SHAUN PsN: DPROCT
14 

ticular, the intensification of financial stress in recent weeks, which 

will make lenders still more cautious about extending credit to 

households and business, could prove a significant further drag on 

growth. 

The downside risks to the outlook thus remain a significant concern. 

Inflation rose sharply over the period from May to July, reflecting rapid increases in energy and food prices. During the same period, price inflation for goods and services other than food and energy also moved up from low rates seen in the Spring, as the higher costs of energy, other commodities, and imported goods were 

partially passed through to consumers. 

Recently, however, the news on inflation has been more favorable. The prices of oil and other commodities, while remaining 

quite volatile, have fallen, on net, from their recent peaks, and the 

Dollar is up from mid-summer lows. 

The declines in energy prices, have also led to some easing of inflation expectations, as measured, for example, by consumer surveys and the pricing of inflation-indexed Treasury securities. 

If not reversed, these developments, together with the pace of 

growth that is likely to fall short of potential for a time, should 

lead inflation to moderate later this year and next year. 

Nevertheless, the inflation outlook remains highly uncertain. Indeed, the fluctuations in oil prices in the past few days illustrate 

the difficulty of predicting the future course of commodity prices. 

Consequently, the upside risks to inflation, remain a significant 

concern, as well. 

Over time, a number of factors should promote the return of our 

economy to higher levels of employment and sustainable growth 

with price stability, including the stimulus being provided by monetary policy, lower oil and commodity prices, increasing stability in 

the mortgage and housing markets, and the natural recuperative 

powers of our economy. 

However, stabilization of our financial system is an essential precondition for economic recovery. 

I urge the Congress to act quickly to address the grave threats 

to financial stability that we currently face. For its part, the Federal Open Market Committee will monitor economic and financial 

developments carefully, and will act as needed to promote sustainable economic growth and price stability. 

Thank you, Mr. Chairman. 

[The prepared statement of Hon. Ben S. Bernanke appears in the 

Submissions for the Record on page 92.] 

Chairman Schumer. Thank you, Mr. Chairman. I appreciate, 

once again, your erudite testimony. 

All right, now, as you know, yesterday, because you were sitting 

there, I asked Secretary Paulson why this entire plan needed to be 

implemented at once, why we couldn’t provide the authority for 

some portion of that, say, $150 billion now, and authorize the rest 

later. 

He said he was strongly opposed, but he didn’t really give the 

reasons why. Authorizing this money in installments will give the 

Secretary the ability he needs to deal with this financial crisis, and 

15 

$150 billion, is a lot of money, still. Who would have thought we 

would think of it as a very low amount, a couple of weeks ago? 

But it would also ensure that taxpayers’ interests are being protected, and allow us in Congress to evaluate the effectiveness of 

these expenditures over time. 

Clearly, we have a financial crisis, but if the program is working, 

Congress can certainly continue ratifying expenditures by the 

Treasury, and if it’s not working, then we’ll need to review it before, once again, we find ourselves on the brink. 

So I want to ask you, Mr. Chairman, what are your thoughts on 

this idea, and I want to stress that this is just an idea, one of many 

that we in Congress are considering, as we try to responsibly respond to this dire situation, of providing this money in tranches or 

installments—some money now, some money later. 

In your estimation, do you need all of this money now, how much 

do you need right now, can you explain why, if you disagree with 

this idea, why $700 billion is needed immediately? 

And just let me say that I called up some people with knowledge 

of the markets, and most of them thought—they said to me, well, 

there might be greater confidence with $700 billion, but they didn’t 

see—the consensus—and I only spoke to a handful of people—was, 

it wasn’t essential, in other words, providing $150 billion with 

Congress’s commitment to come back and continue this, if the program is working, would deal with the problem, certainly more than 

adequately. 

Chairman Bernanke. Mr. Chairman, first—and this would 

apply to the whole hearing—as you know, I’m neither part of the 

Executive Branch nor the Legislative Branch, and so I have no 

standing to negotiate this proposal—— 

Chairman Schumer. Correct. I’m just asking your opinion. 

Chairman Bernanke [continuing]. And, therefore, I’m just giving views. 

I think the concern is that the markets need to have confidence 

that this problem will be attacked with sufficient force and addressed. Insufficient measures could be perceived as drips and 

drabs and may not have the sufficient force to address the confidence issue. 

That being said, I think this is an issue you should take up with 

Secretary Paulson. One alternative, of course, would be to have 

close and continuous oversight of what’s happening, and, of course, 

if things are not working well, then, the Congress can always intervene at an intermediate junction, if it’s really felt that things are 

not working. 

Chairman Schumer. But just from your knowledge as an economist, you’re not going to use the full $700 billion in the first three 

months or six months, and, by definition, if the President’s proposal passes, there certainly is Congress’s agreement, acquiescence, 

maybe, to go along with it, we’re not going to pull it back for no 

reason. 

But I think it would assure the American people and we, as their 

representatives, that there would be a constant eye on this, that 

there wasn’t such a huge outlay at once, which is a huge pill for 

people to swallow. 

16 

So let me ask you the question just one other way: Even if $700 

billion would be advisable and probably a trillion would be better 

than $700 billion, do you think that $150 billion is insufficient to 

assure the markets that Congress is serious and the government 

is serious about addressing this problem? 

It certainly gives you what you need in the first several months. 

Chairman Bernanke. Senator, you ask me my opinion as an 

economist, but, unfortunately, this a matter for psychology. 

Chairman Schumer. Right. 

Chairman Bernanke. And the question is, what signal, what 

information would the market get about the government’s commitment to addressing this problem, and the details of what the commitment really was. Therefore, I would urge you to discuss that 

with Secretary Paulson. 

This is a very big problem. As I mentioned yesterday, just to take 

one metric, the outstanding U.S. mortgages in commercial real estate and residential, is about $14 trillion. 

Chairman Schumer. Right. 

Chairman Bernanke. Therefore, $700 billion, which is, of 

course, an enormous amount of money, is about five percent of that 

amount outstanding, and so it is a very big problem and we don’t 

want to undershoot. 

Chairman Schumer. Understood, and let me just say, obviously, if we’re convinced it’s not sufficient, this proposal will not 

stand. I would say this, that $550 billion is an awful lot for psychological reassurance, when $150 billion is a pretty good amount. 

Let me go to my second, and, I guess, my last question: At yesterday’s hearing, I also brought up the idea of a fund. These are 

all aimed with trying to limit the involvement of the taxpayers, at 

least protect the taxpayers as much as we can. 

This would be a fund like the FDIC’s Deposit Insurance Fund. 

It would collect, over time, fees, from large financial institutions, 

those maybe that might be too big to fail, across the board, not just 

banks, but all of them. They are all going to benefit from this, 

being financial institutions, and it would offset some of the costs. 

That would serve the purpose of assuring the taxpayer that the 

financial institutions, which are at the eye of the storm here, are 

shouldering some of the burden, and it’s not, hey, we make the 

mistakes, you pay the bill. 

So, let me—yesterday, both you and the Secretary thought this 

would be a good idea. We are beginning to explore it with the 

Banking Committees here, both sides of the aisle, and Treasury. 

You’ve had a little time to sleep on it. Can you elaborate on your 

thoughts on whether this might make some sense? 

Chairman Bernanke. Well, again, I think it should be on the 

list of things that are discussed with the Administration and with 

the Congress. Let me make a couple of comments about it, in two 

contexts: 

The first is—and I recognize that this doesn’t address your problem—we don’t want to impair, in the near term, the earnings and 

capital of financial institutions, to the extent that it affects their 

lending and capacity to support the economy. So, perhaps doing 

something with a longer horizon, might be worth considering. 

The other—and, again, I’m not negotiating for the Secretary. 

17 

Chairman Schumer. Understood. I just want your opinions. 

Chairman Bernanke. The second point, I think, is something 

which I really would like the Committee to take away, which is 

that the Federal Reserve and the Treasury have engaged in a number of extraordinary activities over the last year, with Bear Stearns 

and AIG and so on, and this takes us very far, of course, as you 

know, from the Federal Reserve’s main mission, and was done with 

great reluctance. 

The reason we undertook these events was because we felt that 

the institutions involved were too big to fail, in the sense that their 

failure would have significant implications for the world economy. 

The problem is that, unlike banks, for these non-bank institutions, there was no clear set of resolution rules, regimes, and so on, 

to address this problem. 

I think, going forward, there are a lot of ways to address it. First, 

it’s important to have a resolution regime that we can use in nonbank situations. 

Secondly, that resolution regime needs financing, and that might 

involve some kind of deposit insurance type payments. 

But, thirdly, we also—and I think this is very important—we 

were shocked, given the context of this financial stress, that toobig-to-fail widened. The number of firms in that net widened more 

than we would have anticipated, and we need to take a number of 

steps—and I have suggested some in other contexts—to reduce the 

number of firms in that category and to make it possible for a large 

firm to fail without huge adverse consequences to the whole system. 

Chairman Schumer. Right. Well, thank you for that, and I’m 

glad that you’re open to this idea. I think this could help a great 

deal in gaining passage of the legislation. 

Congressman Saxton? 

Mr. Saxton. Thank you, Mr. Chairman. Mr. Chairman, asking 

Congress to authorize the expenditure of $700 billion, is, I think, 

by anyone’s account, a heavy lift. 

It’s almost five percent of GDP to bail out financial institutions, 

to use this money to bail out financial institutions, is controversial, 

to say the least. 

It would be nice if we could go down to Treasury and there was 

a big safe down there with $700 billion in it and we could take the 

money and use it for this worthwhile plan. However, Treasury 

doesn’t have $700 billion in a big old safe, and we have to go borrow it, and that has raised concerns on the part of many lawmakers in both houses. 

But relieved of the burden, financial institutions would be able 

to get back in business, and if Treasury were to acquire the impaired financial assets that are a result of subprime mortgages, 

based on what is called mark-to-market accounting, which means 

these assets are discounted, the Treasury may be able to repay this 

debt and perhaps even earn a profit for the taxpayers as we dispose of these assets down the road. 

On the other hand, if we reject the Administration’s plan, the 

Treasury will not borrow $700 billion, not immediately, anyway, 

because, if we don’t do something to solve this problem, it will inVerDate Nov 24 2008 14:31 Jul 06, 2009 Jkt 045037 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 C:\DOCS\46552.TXT SHAUN PsN: DPROCT
18 

tensify the probability of triggering a deep and perhaps long recession. 

If a recession were to occur, countercyclical outlays and lower tax 

receipts would boost the federal budget deficits and Treasury would 

have to borrow money to meet those needs. So, my question is, 

would you walk us through your assessment of the costs and risks 

we face, if we approve the plan, and could you talk to us also about 

the likely consequences, if we disapprove it? 

Chairman Bernanke. Yes, Congressman, thank you. 

First, let me address the question of prices. Vice Chair Maloney 

asked me about this, as well, and I think my comments yesterday 

might have been slightly misunderstood. Let me try to address 

that: 

Many of these assets are now currently being sold only under 

distressed circumstances to illiquid markets, and that leads to very 

low pricing, pricing which I refer to as fire-sale pricing. It’s that 

fire-sale pricing and the markdowns it creates for banks that is one 

of the sources of why capital is being reduced and why banks are 

unable to expand credit. 

A big part of the program that the Treasury is proposing would 

involve the Federal Government going out, and, through various 

market-based mechanisms, buying some of these assets from various financial institutions. 

Now, the presence of a large buyer would obviously raise prices 

above the fire-sale level. However, I am not advocating that the 

government intentionally overpay for these assets; rather, it’s possible for the government to buy these assets, to raise prices, to benefit the system, to reduce the complexity, to introduce liquidity and 

transparency into these markets, and still acquire assets which are 

not being overpaid for in the sense that under more normal market 

conditions and if the economy does well, most all of the value could 

be recouped by the taxpayer. 

So, again, I do think that the program will involve increases in 

the prices from the current fire-sale values, but not necessarily increases above levels which would be sustainable in a more normal 

market and economic environment. 

With respect to the fiscal implications, you’re absolutely right 

that $700 billion is an enormous amount of money, but it’s not an 

expenditure; it is an acquisition of assets that does expose the taxpayer to significant risk. 

We don’t know exactly what the long-term cost or benefit may be, 

but it is certain, to my mind, that if there is a loss, it will be much, 

much less than $700 billion; it will be some percentage of that. 

And with respect to the fiscal effects, again, you’re exactly right, 

that people have been concerned of what about the effects on the 

government budget, and I think those concerns are very serious. 

But it’s really a question of alternatives. If we don’t act and we 

have a more severe and protracted downturn in the economy, that 

will obviously affect tax revenues and increase government expenditures to address the problems that that will bring. 

And so both approaches have fiscal implications, and my view is 

that to protect the economy from what otherwise might be a much 

more severe episode, that it’s important that we take steps to significantly address this financial situation. 

19 

Mr. Saxton. Thank you. Mr. Chairman, over last weekend, Secretary Paulson announced two changes to the initial plan: One is 

that foreign-based financial institutions with substantial U.S. operations, would be eligible to participate, and, second, the Treasury 

would be authorized to purchase other impaired financial assets, 

not just impaired mortgages and mortgage-related securities. 

Can you help us with why these changes were made and whether 

you think they’re appropriate? 

Chairman Bernanke. Yes, I’ll give you the logic. Again, I think 

it’s very important to distinguish what is the primary goal of the 

plan that the Treasury Secretary has talked about, which is to restore normal functioning to markets, by providing liquidity to those 

markets, and helping to establish prices for these impaired assets. 

You asked a moment ago about how the Treasury would set 

prices and how we would be assured of not overpaying. Clearly, the 

more competitors we have offering these assets, competing with 

each other to sell those assets to the Treasury, the better the protection that the Treasury has against overpaying. 

And so for the purpose of trying to introduce liquidity into markets, the wider the range of participants we have in the auction or 

the other mechanism, the better the chance that the Treasury will 

get a good price and the better the chance that the market’s functioning will be improved by these activities. 

That’s very different from a situation where an institution is failing, the government comes in and injects capital, and wipes out the 

shareholders—all those sorts of steps, like we did with Fannie and 

Freddie, for example. That’s not what we’re contemplating, at least 

for the biggest part of this program. 

The biggest part is to try to improve market functioning rather 

than to help individual institutions. Which is why it’s a mistake, 

I think, to punish or single out those firms which sell the assets, 

because all firms will be benefitting, even if they don’t sell the assets, if they hold those or similar assets. 

Chairman Schumer. Vice Chair Maloney. 

Vice Chair Maloney. Thank you. Before the Senate Banking 

Committee yesterday, you testified that under this plan, and I 

quote, ‘‘Liquidity should begin to come back to the markets when 

the credit markets unfreeze. New credit will become available.’’ 

Moving forward, is it more important that the plan focuses on 

buying up existing assets, or should we focus on creating new credit? Some critics have argued that our involving a middle man and 

risk, when we could directly inject credit into the economy with 

new mortgages, new loans, new auto loans and other sluggish 

areas in our economy. 

Chairman Bernanke. Well, two comments, Vice Chair: First, 

the intermediaries, the financial intermediaries, need to be able to 

make new credit available, and if their balance sheets are so 

gummed up that they can’t attract capital, they can’t even attract 

funding because counterparties don’t know what they’re worth, 

then that’s a problem. 

So this program would help to try to create more transparency 

and less uncertainty about those balance sheets, giving institutions 

a chance to make new capital and new credit available. 

20 

But let me also say that I agree with you that there is some 

scope for supporting new lending, and, in particular, one example 

of that is the initiative by the Treasury to use both Fannie and 

Freddie and the Treasury’s authorities to buy new mortgagebacked securities, which would support the new mortgage market 

and help create mortgage credit for home buyers. 

Vice Chair Maloney. Returning to the pricing argument, some 

economists suggest that a preferred stock option would avoid the 

pricing challenge, which is really huge in some people’s minds, and 

protect taxpayers by putting them in a senior position, relative to 

the financial institutions we’re helping. 

What’s your position on preferred stock as a better choice than 

just common stock? It wouldn’t dilute the common stock value, so 

the companies can raise capital and the government gets paid first. 

Chairman Bernanke. Vice Chair, so the preferred stock or capital injection approach, has, in fact, been one of the favorite approaches in previous bank crises, like the S&L crisis, or the Japanese or Scandinavian crises and others. 

Those were situations, however, where the government was dealing with institutions on the brink of failure, or had already failed. 

In that case, the only way to keep the institution going—if it’s 

viewed as being appropriate to do so, for systemic or other reasons—is to inject capital, wipe out the existing shareholders, and 

impose many conditions on the firm. 

We’re facing a somewhat different situation, which is, firms that 

are valid, going concerns. While we may have a few companies in 

trouble, which might be addressed in the way you describe, companies that are strong, going concerns, we don’t want to take the risk 

that if the private markets perceive the government injecting capital into these ongoing concerns is going to wipe out other shareholders or take over the firm or otherwise make it difficult for them 

to raise new capital. 

Now, all different kinds of options should be discussed, and I 

don’t want to negotiate for the Treasury. You should discuss lots 

of different ideas, but I think that is one concern, that putting capital into healthy or at least reasonably functioning banks might 

frighten off private money that could come in, if we were just able 

to clean up their balance sheets enough that private investors 

could understand the risk/reward return better. 

Vice Chair Maloney. Could you walk us through how you and 

Secretary Paulson arrived at the $700 billion figure? How will 

these funds affect the real economy? Will this act as a large infusion of cash and affect future inflation? 

Chairman Bernanke. Well, it’s not science to figure out how 

much is going to be needed to stabilize the firms and the markets, 

but there are various metrics one can use, and one that I mentioned yesterday, which I think is useful, is to note that there’s 

about $14 trillion outstanding of residential and commercial mortgages, so $700 billion is about five percent of that amount, which 

is similar to some of the loss rates we’ve seen in some of these categories. 

Likewise, the assets of U.S. commercial banks are in a similar 

$10 to $12 trillion category, again, so it seems an appropriate size, 

relative to the scale of the problem. 

21 

One could argue for slightly different numbers, but, clearly, we 

need a strong response. 

Vice Chair Maloney. But the real question is, will this affect 

inflation, and do you think the Fed will have to raise interest rates 

in order to float so much new debt? 

Chairman Bernanke. No, this is not a fiscal stimulus; this is 

not going to directly serve like a stimulus plan, for example. If it 

does, in fact, strengthen the financial markets, increase credit extension, and help the economy grow, then the Fed would have to 

respond perhaps sooner raising rates than otherwise, perhaps, but 

that would be part of the normal process of recovery, as the economy goes back to a normal growth pace, and then the Fed would 

want to return interest rates back to a more normal level. 

Vice Chair Maloney. And the effect on inflation? 

Chairman Bernanke. I don’t expect any effect on inflation, 

other than the fact that we just want to stabilize the overall economy. 

Vice Chair Maloney. Okay, great. My time has expired. 

Chairman Schumer. Thank you, Vice Chair Maloney. Senator 

Brownback? 

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

Chairman Bernanke, I want to take you back to this preferred 

stock issue and the warrants, because you were discussing this. 

I think this is a key point in the discussion. Why couldn’t you 

condition the entry into this program upon the financial institutions’ willingness to put up preferred stock as a way of saying to 

them, you know, you’re getting rid of this bad paper, this toxic 

paper, and the taxpayers deserve to be in on the up side, if there 

is some up side, so we have less exposure? 

And couldn’t you condition it such that if we’re not losing money 

on what we’re buying from you, we’re not taking the stock, but if 

we do and you’re surviving, we are taking the stock? That seems 

to me to be a fair offer in the type of situation we’re going into, 

one that’s so extraordinary and where we’ve got to protect the taxpayer at the same time we’re trying to get these institutions working again? 

Chairman Bernanke. Senator, again, I think it’s important to 

distinguish two situations: The first is a situation where a bank is 

failing and it needs injection of capital to continue to operate, and 

the government decides that, for various reasons, it wants the bank 

to continue to operate. 

In that case, the injection of capital, taking warrants, every other 

condition, is entirely appropriate. In the second situation that I described, we’re trying to return liquidity to these markets. 

As I mentioned to Congressman Saxton, if you want to have auctions or other mechanisms to purchase these assets, to protect the 

taxpayer, you want as wide a participation as possible. 

And, in fact, if you do succeed in making these markets more liquid and raising prices in those markets, you’ll be benefitting everyone who holds that mortgage or that asset, not just those who participate. 

So, if you impose that condition, you have the risk of just no one 

will want to participate, but will say, well, let somebody else do it 

and I’ll benefit indirectly from the higher prices. 

22 

Then no one will participate, there will be no competition in the 

auction, and this won’t work. 

Now, as I said, you may wish, if you prefer to do other approaches, like injecting capital, that’s a different matter, but this 

approach to bidding up for assets, requires a broad participation. 

Senator Brownback. It just seems to me that we’re all talking 

about trying to protect the taxpayer, and here is a way to better 

protect that taxpayer. I recognize you’re saying that it may not 

have as broad of an effect on the economy, but I think, you know, 

we’ve got to look towards the taxpayer, who is just very mad about 

this overall situation. 

Chairman Bernanke. Another way to protect the taxpayer, is 

to pay a lower price, a better, more reasonable price. 

Senator Brownback. There’ve been proposals pushed about 

that we should reform the bankruptcy code to allow bankruptcy 

judges to reset the financial—reset home mortgages. 

In looking at this, this seems like to me, that this would actually 

raise mortgage rates on individuals. Do you have a thought on that 

particular piece of a proposal that’s been out there? 

Chairman Bernanke. Senator, I agree that the implications of 

that change are very hard to know. They could be very complex, 

they could be beneficial or they could restrict credit. 

The Federal Reserve did not take a position on the bankruptcy 

reform a couple of years ago, and we’ve tried not to take a position 

on this one, because we do view it as a very complicated issue and 

one that we are not comfortable predicting the outcome. 

Senator Brownback. Could it have the potential of raising 

mortgage rates? 

Chairman Bernanke. It could, it’s possible, yes. 

Senator Brownback. It looks like to me, with what you’ve described as the current financial situation that we’re looking at a 

very tough quarter right now, with the good possibility even of a 

negative quarter that we’re in already and maybe even substantially, from what I heard you say based on the current numbers 

you’re getting back. 

I would hope the Fed wouldn’t be looking at raising interest 

rates, and, if anything, would look at cutting interest rates, moving 

forward. Exports have been one of our key drivers. Low interest 

rates are important for to be able to be competitive internationally 

as much as we can, even in a slowing global marketplace. 

So, I thought, on the current conditions, you sure wouldn’t want 

to raise interest rates, you’d sure want to be taking those down. 

Chairman Bernanke. Well, the Fed has to look at both its 

mandate to maximize employment, as well as its mandate for price 

stability, and we’ll have to continue to evaluate how those two factors evolve. 

I do think that a sine qua non for a health recovery would be 

trying to stabilize the financial situation. I think that’s very important. 

Senator Brownback. I think that’s far more important than an 

inflationary concern at this point in time. 

Chairman Bernanke. Well, again, Senator, you know, we will 

look at the risks and the expectations on all aspects of this, including both growth and inflation. 

23 

Senator Brownback. Finally, you’re a student of the Great Depression and a scholar on that. When you back up and look at this 

situation, versus your knowledge of what led into that, what circumstances, just as you overview it, cause you the most pause of 

what we’re entering into in this phase right now, with your knowledge as a scholar on that period of U.S. history? 

Chairman Bernanke. Well, Senator, certainly there are very 

marked differences in terms of the underlying size and sophistication and diversification of our economy. I would also say that someone from 1929 would not recognize our financial system. It is enormously more sophisticated and interconnected and complex than it 

was in the 1930s, when basically it was just banks and bonds and 

stocks. I mean, essentially, that was all there was. 

I think the one lesson I would draw from that experience, but 

also from other international experiences, is that when there are 

major dislocations in the financial sector and in the credit creation 

process, it can have significant effects on growth and employment 

in the economy, and that’s been true, not just in the United States, 

but in a number of other countries, both emerging-market and industrial countries, and that would be the main lesson I would take 

from that experience. 

Senator Brownback. Thank you. 

Chairman Schumer. Thank you, Mr. Chairman. I know we 

have a lot of people here, and I know your time constraints, so I’m 

going to try to get everybody in, and that’s why I’m going to try 

to stick to the seven minutes. I’m just going to read the order, so 

people can plan their schedules. 

This is an order of people coming in: Congressman Cummings, 

Senator Sununu, Congressman Doggett, Congressman Paul, Senator Klobuchar, Congressman Brady, Senator Bingaman, Senator 

DeMint, Congressman Hinchey, Congressman English, Congressman Hill, Senator Bennett, Webb, and Casey, and Congresswoman 

Sanchez. 

Congressman Cummings? 

Mr. Cummings. Thank you very much, Mr. Chairman. Chairman Bernanke, it’s good to see you again. 

As I sit here and I listen to my colleagues, I’m reminded of something that my mother used to say, that we have to be careful that 

we don’t have motion, commotion, emotion, but no results. 

And as I think about what has happened here, I realize that 

there’s a very—there is something that seems to be going through 

all of us, and definitely, the people on Main Street where I live, 40 

miles away from here in Baltimore, and that is whether the—and 

it goes to the question of trust. 

People are beginning to get a bit upset as they see their money 

being spent, and they’re trying to figure out what that has to do 

with them. They see estimates of various things, that the government is spending money on, but then later on, they find out that 

it’s going to cost a lot more. 

As I listened to the hearings yesterday, the Senate hearings, I 

know that there is a question up in the air, as to how much this 

is going to eventually cost. I know we’re talking about $700 billion 

today, but the reports are saying—I mean, you hear on the news 

it could be $1.3 trillion. It’s questionable as to what—how much 

24 

success we will have with all of this, but I, for one, am convinced 

that we must do something; I’ve got that. 

But I also believe that we have to do something with regard to 

make sure that we are not just shoring up the market and what 

have you, but do some things with regard to Main Street. 

And so I want to just ask you a few questions on that. Clearly, 

the housing bubble, in my opinion, has burst. In my home state of 

Maryland, it currently has approximately 21,500 vacant homes this 

year, and 431 homes in Baltimore City that have been subjected to 

foreclosure filings. 

And can you tell me the types of conditions that would imply 

that we have reached the bottom? Are we seeing the upturn in the 

housing market? Again, because people are—the experts are telling 

us that this housing market has a lot to do with what is taking 

place today. 

Chairman Bernanke. That’s absolutely correct. The housing 

market has been central to this whole situation. 

As I said in my testimony, there are a few signs of some stabilization in the demand for housing, although I would say that’s 

quite tentative, because, particularly if the credit markets freeze 

up and mortgage availability declines, that would take a big chunk 

out of what demand there is for housing. 

I do think that we will see, reasonably soon, some bottoming out 

of the construction, it has come down so much already, we’re getting to the point that we will see some at least slower decline in 

residential construction. 

The issue which I think remains uncertain is house prices. 

There are large inventories of homes, both new and existing, in 

foreclosure, as you know. Those inventories put downside pressure 

on house prices. As prices fall, we see both a weakening economy 

because consumers have less equity in their homes, and because 

firms, banks have weaker balance sheets and therefore less willingness to extend credit. So I think house prices are an important 

issue. 

This I think is a bread-and-butter point that I would make, 

which is that if the financial system freezes up and mortgage credit 

and other kinds of credit are not available to Main Street, one of 

the many adverse consequences would be a longer and deeper decline in house prices and in housing activity, which would be obviously a real effect on people. 

Mr. Cummings. Now I notice, I note that when you were here 

only a month prior to the passage of our stimulus package I asked 

you specifically what recommendations you had for us with regard 

to a stimulus package. 

The reason why I bring up the stimulus package is that the stimulus package affects—I mean this bailout affects my constituents, 

but the stimulus package was direct. It is an immediate effect. It 

has an immediate effect on them. And indeed it was at that time 

that I pressed that an economic stimulus be equated to rebuilding 

our infrastructure, boosting food stamp support, increasing tax 

credits to families that have children in college or daycare, extending Medicaid funding to states that continued to be overburdened 

by increasing Unemployment benefits well beyond those offered in 

the original package back then. 

25 

Mr. Chairman, a bailout on Wall Street must also bring with it 

a safety net to those on Main Street. You have this opportunity, 

and you will be before the Financial Services Committee in the 

House in a few minutes, and I am just wondering what you—and 

I have said it before; I have a tremendous amount of respect for 

you and Secretary Paulson. I say you are the super star experts. 

That is what the taxpayers pay you to do. 

The question is: How do you say to the people on Main Street, 

the ones that are looking at you right now looking for some comfort, just as the Stock Market folks are looking for comfort to be 

able to invest, what do you say to them, regular mom and pop that 

got up—they may not be watching because they got up at five 

o’clock this morning to go to work and they will not get home until 

this evening, but they will catch you on the news—what do you say 

to them, the super star that you are, what effect will this have on 

them? 

Because that is why counts. And that is who is going to vote for 

all these people who are sitting up here. 

Chairman Bernanke. Yes, sir, you are absolutely right. 

The effects I think are very direct. If the credit markets remain 

in their current condition, or if they worsen, then increasingly credit conditions which are already very tight are going to worsen as 

well, which means that small businesses that want to get a loan 

and create jobs in the community will not be able to do so; people 

who want to buy a car—and we have already seen a drop in auto 

financing—will not be able to get a loan to do so. That means also 

the auto workers will not have as much employment. 

The housing market, as I mentioned, will continue to come under 

stress. House prices will continue to fall. So these things will affect 

jobs. They will affect housing and house prices. They are going to 

affect small business creation. 

The credit system is like the plumbing. It permeates throughout 

the entire system, and our modern economy cannot grow, it cannot 

create jobs, it cannot provide housing without effectively working 

credit markets. And my only concern here today is to try to find 

a solution that will stabilize the credit markets so that they can 

do their job, which is to support our economy and help us get back 

into a strong growth path that the underlying strengths of our 

economy would otherwise support. 

Mr. Cummings. Thank you, Mr. Chairman. 

Chairman Schumer. Senator Sununu. 

Senator Sununu. Thank you. 

Chairman Bernanke, you described the most important function 

of this Treasury proposal as restoring a normal functioning to the 

credit markets. And I agree very much with the point you just 

made, that the most important aspect of it is restoring normal operation to the credit markets that consumers depend on because 

that is such an important part of our overall economy: student 

loans, home loans, automobile loans. Those are the pieces of the 

credit market, whether you are a family in New Hampshire, or a 

small business anywhere in America, that is what keeps our economy going. 

But it is unclear I think to a lot of people who do not have your 

experience what the relationship is behind the mortgage-backed seVerDate Nov 24 2008 14:31 Jul 06, 2009 Jkt 045037 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 C:\DOCS\46552.TXT SHAUN PsN: DPROCT
26 

curities that would be the principal securities purchased under this 

Treasury Fund, and these consumer credit markets. 

I think it is important, and it would be very valuable for you to 

describe in as much detail as you can how it is that $10 billion, 

or $20 billion of mortgage-backed securities that are held in a firm 

today—it might be a Wall Street firm, it could be a bank, it could 

be a savings and loan—affect the consumer credit markets for 

school loans, auto loans, and home mortgages that people across 

America are really worried about today? 

Chairman Bernanke. Senator, an excellent question. 

Our system is a very large and complex one, but our banks, commercial and investment banks still play a very central role in our 

credit markets, either by making direct loans, by originating loans, 

by supporting other markets like the commercial paper market, 

and so on. 

So banks are critical to the health of the overall credit system. 

Now banks, in order to make loans, must have capital. They have 

to have some net worth that allows them to expand, make loans, 

and extend credit to average people and to businesses. 

These losses from mortgage delinquencies and foreclosures have 

caused global financial institutions to write down their capital on 

the order of $500 billion. So that capital has shrunken very considerably and has only been partially replaced by raising new capital 

in the private sector. 

If banks do not have enough capital, they do not have the capacity to increase their lending. In fact, what they have to do is contract their lending. They have to try to get rid of the loans they 

have, and they certainly are not going to be interested in making 

new loans to individuals or businesses. 

So we need to find a way for banks to have more capital so that 

they can make more loans to the economy. Now the way this works 

to create more capital is a couple of ways. 

First of all, by taking these assets off the balance sheets, it takes 

some of these loans off, that burden capital and gives more space 

for banks to make loans. 

But more importantly, by getting these markets moving again, 

by figuring out what the prices should be of these complex securities, it is going to reduce considerably the uncertainty about the 

value of these banks. And if that uncertainty is reduced, then private equity will come in and increase the capital and allow those 

banks to make more loans. 

I realize that is a very complicated story. The bottom line, 

though, is that banks are holding all of these complex, hard-tovalue securities and their capital is low. Those two things together 

do not allow them to make adequate loans. We need to address 

that problem, and this approach is one way to address that problem. 

Senator Sununu. Thank you. It is a complicated story, but it 

is a direct relationship and it is one that I think is very important 

for you to describe as much as you can, as clearly as you can, not 

just to the Committee but to the American people, because they are 

the ones that are going to be affected and hopefully benefit by any 

action that we might take. 

27 

Along those lines, you have talked about protecting the taxpayers’ interests. Many Members of the Committee have talked 

about the importance of putting taxpayers first, and I very much 

agree with that priority. 

We can do that by adding strong oversight measures, which you 

referred to, and I think we should do that. I think it is important 

that we make sure that this is a temporary facility; that it is not 

going to be a permanent part of our bureaucracy. 

I think we should add provisions to make sure that if there are 

any taxpayer gains from any of these programs we use that money 

to pay down debt, not to increase the size of government spending. 

But you mentioned one additional way that we can protect the 

taxpayer, and that is by making sure that the government, or the 

Treasury, ultimately pays an appropriate price. 

You describe the fire sale price where distressed firms have been 

selling some of these securities recently, and you have previously 

described a hold-to-maturity price which is the value that would be 

received if these securities were held to the point where all the 

mortgages have either been paid or dispensed with. 

We want to make sure that the facility purchases at an appropriate price. If the taxpayers, through the actions of the Treasury 

pay above the hold-to-maturity price, we lose. 

Now some people have said, well look, no one is going to participate unless you are buying at or above the hold-to-maturity price, 

and that would mean that the taxpayer loses money. 

My question is: Are there participants in the marketplace that 

would be willing to sell their securities at a price below the holdto-maturity price? Would they find benefit from that transaction, 

even if they thought it was less than the hold-to-maturity price, 

would they still make the sale to the Treasury facility? 

Chairman Bernanke. Certainly if they have assets on their 

books at fire sale prices then they are better off. And indeed in 

some kind of auction or market-based mechanism, which is one approach and you can combine it with other kinds of safeguards and 

checks—we would be sure that we would be able to get the prices 

between the hold-to-maturity price and the fire sale price. 

There are very good ways to make sure that you are not overpaying for that. 

Senator Sununu. Would there be firms that even had an incentive to sell if the price that was being offered was below the price 

that they held it on their books? Even if it meant an additional 

write down, would there be market participants that would even 

find that price beneficial to the way they operate in the marketplace? 

Chairman Bernanke. Well some would be worried about the 

accounting issue, that’s right, because they would have to mark 

down. But even so, from an economic perspective they look at the 

economics and over time there is no way to hide the real value of 

an asset. If it is really impaired, that is going to show up at some 

point in reserves or elsewhere. 

I think many institutions would be willing to sell to get it off 

their books and to get a reasonable price. 

28 

Senator Sununu. That would allow them to raise more capital. 

That would then obviously help restore confidence in their structure? 

Chairman Bernanke. That’s the idea. 

Chairman Schumer. Thank you. Congressman Doggett. 

Mr. Doggett. Thank you, Mr. Chairman. 

Mr. Chairman, am I correct that the first time that you and Secretary Paulson brought your bailout needs to the attention of the 

Congressional leadership was last Thursday evening in the United 

States Capitol? 

Chairman Bernanke. I believe that is correct. 

Mr. Doggett. When did you first bring it to President Bush’s attention? 

Chairman Bernanke. That afternoon. 

Mr. Doggett. In any of the visits with President Bush or any of 

the discussions that you have had with Secretary Paulson, any of 

these negotiations, at any point along the way right up until today 

has anyone asked the question: Who is going to pay for this? Is 

there any way to pay for it other than taking the standard approach of the Bush Administration which is, borrow and spend? 

Have there been any other alternatives considered? 

Chairman Bernanke. Well we have discussed a variety of alternatives. The Secretary worked with a private-sector approach early 

on. 

Mr. Doggett. Oh, I understand you looked—but once you went 

public, the only approach that this Administration has considered 

is to borrow all the money that you need and increase the debt ceiling, right? 

Chairman Bernanke. The only one considered? No. We have 

looked at all kinds of alternatives throughout, and we have tried 

to do our best using all the powers we have to try to keep the markets functioning and to try and maintain stability. 

Mr. Doggett. I am just focusing—I understand, and I applaud 

your efforts to do that. I agree with much of what you have done 

in the past. But in terms of how to finance this massive bailout, 

you concluded, or the Secretary and President Bush concluded that 

the way to pay for it was to borrow all the money to do it, right? 

That’s what you have asked Congress to do, is raise the debt ceiling and borrow the money? 

Chairman Bernanke. That is what we have asked Congress to 

do, that’s correct. 

Mr. Doggett. You know, it wasn’t that long ago that we were 

trying to see that children in this country got health insurance in 

a comprehensive way. And if you look at the President’s web site 

today, or at least last night, you will see that he rejected the notion 

of $35- to $50 million over five years because it just costs too much 

to do that. 

And yet, over night—not over five years—we are asked to come 

up with $700 billion. You testified not just in answering my questions in front of the House Budget Committee but in numerous 

other places about the dangers of soaring national debt. 

We have added $3 trillion, I think even before this we were on 

the way to $4 trillion, money borrowed, more money borrowed from 

29 

overseas, foreign creditors by President Bush than all the Presidents in American history put together. 

We were headed up before this request, but now you are going 

to add even more debt on top of that. At some point doesn’t there 

become a limit where the dollar continues to decline, the price of 

oil continues to go up, and we jeopardize and mortgage the future 

of this country from over-borrowing? 

Chairman Bernanke. Well, first of all, this is a very bad situation, and I very much regret being the bearer of bad news in this 

situation. 

From a fiscal perspective, just a couple of comments. I understand and share your concern. The first is that the net fiscal cost 

to the taxpayer will certainly be much less than $700 billion. This 

is an acquisition of assets—— 

Mr. Doggett. Just to be sure, you’ve asked us to raise the debt 

limit, once again as this Administration has done so often, a full 

$700 billion. Right? 

Chairman Bernanke. That’s correct, but I think that the debt 

markets will recognize that much of the $700 billion is being offset, 

or all of it is being offset by acquisition of financial assets. So it 

is quite a different situation from a pure expenditure of $700 billion. 

Mr. Doggett. But these are assets you are acquiring because 

we’ve been told they are toxic and no one really knows what their 

value is, so that is why we are having the taxpayer buy them. 

Chairman Bernanke. Well the objective would be to buy them 

at prices that are consistent with their economic value in a more 

normal market. 

The other comment, if I may, very quickly—— 

Mr. Doggett. Surely. 

Chairman Bernanke [continuing]. Is simply, what is the fiscal 

implication of doing nothing? It is my belief that if we do nothing—— 

Mr. Doggett. I don’t want to interrupt you, but I will because 

I understand you want to talk about inaction. I think all of us want 

to take responsible action to address this problem. 

My questions have focused on how we pay for it, and the dangers 

of adding another $700 billion to the debt limit. You know, as I 

look over the work you have done just in the last few weeks, I 

think Bear Stearns was about $30 billion of public money, Fannie 

Mae and Freddie was about $200 billion, AIG is about $85 billion. 

And now $700 billion more. About $1 trillion. I think it works out 

to about $3000 for every man, woman, and child in this country or, 

with my limited math, $12,000 for a family of four. 

That is a tremendous expenditure, all on borrowed money once 

again. The solution that this Administration used to finance the 

War in Iraq, the solution it uses for every fiscal challenge, every 

public challenge is borrow more money. 

You know, if you look back even to the savings and loan debacle, 

if you look at the history of that we at least asked the Federal 

Home Loan Banks—and they are still paying—to pay 20 percent of 

the interest on bonds that were issued to finance the recovery. 

Why isn’t it reasonable to ask Wall Street to pay for a little bit 

of the cost of cleaning up the mess that the Bush Administration 

30 

policies permitted Wall Street to engage in instead of shifting all 

that cost to future generations of Americans who did not have anything to do with this? 

Chairman Bernanke. I think you ought to raise those questions with Secretary Paulson. 

Mr. Doggett. Well I certainly plan to do so, and that is one of 

the reasons why we want to move expeditiously. We do not want 

to move overnight. This notion that we would approve this bailout, 

$700 billion, today or tomorrow is irresponsible. And we need to 

move expeditiously, but we need to look carefully at this question 

of why we would shift all the cost to the people that weren’t at the 

party. 

I think President Bush did properly diagnose it down in Houston 

at a fund raiser a few months ago when he said the problem was 

Wall Street got drunk and has a hangover. 

The problem is, the people that are asked to clean up all the broken furniture, they didn’t get invited to the party. And I think that 

is why so many of the people that are contacting me—and I expect 

it is true of every one of my colleagues—are not just against this 

bailout, they are very angry they are even being asked to contribute to the bailout. 

Let me just say in my concluding eight seconds, in Texas we 

would say that the chickens have come home to roost. This is not 

the result of just bad luck, it is the result of bankrupt ideology. 

In this case the vultures have come home to roost, and I think 

we need to look very critically at this giant bailout before we place 

all the burden on the people who did not benefit from what went 

wrong here. 

Thank you for your service. 

Mr. Saxton. Mr. Chairman—— 

(The chairman bangs the gavel.) 

Mr. Saxton. Early in the—— 

Chairman Schumer. Congressman, if we are going to let everyone get a chance—— 

Mr. Saxton. No, no—— 

Chairman Schumer.—we cannot have a dialogue. 

Mr. Saxton. He asked the Chairman a question, and the Chairman never got a chance to answer the question. Could Chairman 

Bernanke just speak for a moment about the fiscal implications of 

not doing a program? I think it is a very important point. 

Chairman Bernanke. If we do not do it, then the economy will 

do worse and tax revenues will be significantly affected. And so it 

is not evident that it is more expensive to take action than not to 

take action. You said of course you want to take action, so I understand that, and I appreciate it. 

And let me just say that I think that this program ought to meet 

three criteria: 

First, it has to be big enough and aggressive enough to solve this 

problem which is threatening our economy. 

Second, it needs to protect the taxpayer as well as possible. 

And third, it should not benefit anybody unduly who was involved in creating the problem. 

So I think those are some principles we might try to take as we 

design this program. 

31 

Chairman Schumer. Thank you. Congressman Paul. 

Mr. Paul. Thank you, Mr. Chairman. 

I appreciate the comments by the gentleman from Texas, but actually you have confused me a little bit because now I do not know 

who the conservatives are and who the liberals are. [Laughter.] 

Mr. Doggett. It is hard to tell here sometimes. [Laughter.] 

Mr. Paul. Anyway, I am going to keep trying to figure it out, but 

we obviously have a serious problem on our hands, and it is something that I have been talking about for quite a few years. 

Earlier on the Senator brought up the subject of the Depression, 

and you did allude to the fact that dislocations and credit creations 

are a problem and can add fuel to this fire. But at times I don’t 

think you follow those rules very well. 

I mean, even though you recognize that is the case, because I 

think, understanding the Depression is one of our problems, or the 

lack of understanding of the Depression. Because generally most of 

what people are taught these days is that it was a lack of credit 

in the 1930s that caused the prolongation of the Depression. They 

never talk about the excessive credit and the misallocation and the 

malinvestment of the 1920s that precipitated the bubble that had 

to be corrected. 

Then in the Depression what did we try to do? We tried to fix 

prices, which is exactly what we are doing now. We would not in 

the Depression allow wages to go down, and we said the price of 

farm products has to stay up. So in doing that, we plowed crops 

under and people were starving. 

And I do not think we have gained a whole lot of wisdom since 

we were plowing under crops to keep prices up, because now we 

are talking about illiquid assets, and we are talking about price fixing, and we are talking about somebody in the government, in the 

Federal Reserve and Treasury, who does prices. 

Now the Austrian School of Economics, which has been around 

a long time—they predicted the Depression, they predicted the 

1970s, the breakdown at Bretton Woods, they predicted all that is 

happening today—their key point is: Do not mess around with 

prices. Because if you do you become socialistic. 

This is why Mises predicted the failure of socialism, and why it 

did fail. But here we are in price fixing again. You say that part 

of your mandate is price stability. But I hardly think price stability 

comes by price fixing. 

But the idea of you taking illiquid assets, for the most part illiquid assets are illiquid because they are not worth anything. And 

if somebody has a house that they bought for $4 million and it goes 

up to $5 million and he wants to sell and nobody buys it, that is 

really not an illiquid asset. If he takes it down to $1 million he 

might sell it. 

But people are not smart enough. The Federal Reserve is not 

smart enough. Treasury is not smart enough. Congress is not 

smart enough. To know what prices are. So I think that is the 

greatest danger of what we are doing here, is we are price fixing 

and that is what I am convinced that prolonged the Depression in 

the 1930s because we got into that. 

This whole idea of credit creation. We have already created $700 

billion worth of credit because of the interference and the involveVerDate Nov 24 2008 14:31 Jul 06, 2009 Jkt 045037 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 C:\DOCS\46552.TXT SHAUN PsN: DPROCT
32 

ment in the markets, and here we are coming along with another 

$700 billion. The real question is: Where does it come from? We are surely not going to tax the economy $700 billion. Nobody 

would even consider this. But are we going to borrow it? Well, we 

could go to our bankers, our friends in China, they might come up 

with $700 billion and loan it to us, but I doubt it. 

But where will it come from? They are going to come to you. 

They are going to come to you to create credit. But I don’t even 

know where you get the authority to create credit out of thin air. 

There is certainly no authority in the Constitution for you to have 

endless authority to create money and credit out of thin air, which 

is the basic problem that we have. 

This is why we are here today, that we have not understood that. 

All the blame is put on the fact that there is a downturn in housing. Well that means they were overpriced. So all our efforts right 

now are to keep the prices up, but the prices should come down. 

That is what the market is saying. But to fix prices at a higher 

level than they should be I think just compounds our problem. 

But I would like to just see if I can get an opinion from you on 

where all this authority comes from. My estimation now is that 

there are probably only about 15 percent of the people in this country who really care about the Constitution and the rule of law. 

Sometimes I think there are less here in Washington. 

But where does this authority come from for this unlimited amount of money? At least the $700 billion is being appropriated 

on this new, but the other is not. But you are going to have to monetize a bunch of this, and quite frankly I would have trouble finding anything in the Constitution that said, ah, this is it. You know, 

this particular paragraph says, oh, the Congress has the right to 

buy up illiquid assets. 

Could you comment on this authority and the basic fundamentals 

of when we are going to address this? If we do not, we cannot solve 

the problem of inflation with more inflation. 

Chairman Bernanke. Thank you, Congressman. 

First of all, I actually agree with you about the price fixing in 

the Depression. I think there is a pretty wide consensus that the 

National Recovery Act and the fixing of wages and prices was a 

counterproductive step, and I agree with you there. 

On whether prices are being fixed for these securities, the intention is to use market-based mechanisms, auctions and other things, 

to try to discovery what the true prices are, or at least something 

approximating a market price. It is not going to be price setting in 

that respect, as I understand it. 

I would note about the Depression that one has to balance concerns about intervening in financial markets with concerns about 

macroeconomic stability. In the case of the Depression, the Federal 

Reserve essentially took no action as the banking system collapsed. 

About a third of the banks in the country failed. 

The Fed, following the advice of Secretary Mellon, liquidated the 

banks, liquidated labor, and so on, and that did not work out so 

well. 

With respect to your other questions—and I want to respond also 

again to Vice Chair Maloney. There is no need for the Federal Reserve to monetize any of this borrowing. The Federal Reserve has 

33 

independent instrument, its management of monetary policy. I do 

not expect additional inflationary consequences from this. 

As to our authority, of course the Constitution gives the Congress 

the right to coin money and regulate the value thereof—— 

Mr. Paul. ‘‘Coins.’’ 

Chairman Bernanke. And that has been delegated to the Federal Reserve through the Federal Reserve Act, and everything we 

have done is directly based on that Act. 

Now if you disagree with the Act, that is a different issue, but 

we certainly have the authority from Congress. 

Chairman Schumer. Senator Klobuchar. 

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

I said the other day, Chairman Bernanke, that basically my view 

of this is that the Administration has allowed Wall Street to operate like a casino, and unfortunately for you, you and Secretary 

Paulson have been called in as the house managers at the 11th 

hour to shut it down. 

My concern, as you look at changing this and restructuring it, 

and as we look at longer term regulations that need to be put in 

place, that we minimize the exposure to the taxpayer. 

I want to follow up on Congressman Doggett’s questions about 

the debt and the deficit. I know last time you appeared before us 

in April I asked you about the danger of one out of every twelve 

dollars of our federal tax money is to go pay interest on the debt 

for individual taxpayers, and you responded that it is crucial that 

we get control of the deficit and that we find solutions before it gets 

so imminent that it becomes very, very difficult to balance the 

budget. 

Well this week a columnist named Nick Coleman in the Minneapolis Star Tribune wrote an article about the share of the debt, 

not just the increase that Congressman Doggett was talking about, 

but if our debt is in fact raised to $11.3 trillion according to him 

every man, woman, and child would carry about $38,000 of that 

debt, and in his case for a family of five $190,000. 

How will this hurt our long-term economy? 

Chairman Bernanke. Well not to get into the weeds here too 

much, but the $1.3 trillion includes lots of things like debt held by 

the Federal Reserve, which is not really net debt to the government. 

That being said, I agree that it is critically important that we 

have a stable, sensible, responsible fiscal plan going forward. We 

have a lot of implicit obligations, for example, to entitlements, to 

Medicare and Social Security, which are not fully funded. The 

GSEs were not fully funded. That was always an issue that the 

Federal Reserve pointed out. 

I think that our economy will be fine. I think it will be a strong 

economy in the medium term. I am obviously very unhappy about 

the fiscal implications of this. I bring it to you because I think the 

alternatives are even worse. But if your complaint is that this will 

have adverse fiscal consequences and make it harder to balance the 

budget and address other needs, you are absolutely right and I 

agree with you on that. 

Senator Klobuchar. What I am trying to search for here, along 

some of the comments that Senator Schumer made and others, is 

34 

ways to pay for this that we can look at besides putting it on the 

backs of the middle class. Because you know how their wages have 

gone down $2000 a year average in the last eight years, and their 

expenses have gone up $4500. 

One of the issues that Senator Schumer raised was some kind of 

charge on Wall Street, or some kind of charge that could be made 

there. There has also been a proposal to put some kind of surcharge on people that make over a million dollars a year, and I 

would personally not really have proposed something like this, but 

you keep talking about how we are in such an extraordinary time 

and such an extraordinary crisis. 

Why couldn’t we actually be open to doing something like that? 

What would the fiscal implications be? Because it could collect like, 

there’s one proposal, 10 percent on people making over a million 

dollars a year, that could collect $300 billion and we would not be 

putting it on the backs of the middle class. 

Why couldn’t we do something like that? And what would the fiscal implications be if we did? 

Chairman Bernanke. $300 billion over what—— 

Senator Klobuchar. Over the time of this thing. It is just trying to get at some kind of help and backing for this, aside from on 

the backs of the people who have been suffering for so long. 

Chairman Bernanke. You know, I think that Congress needs 

to make decisions about how it wants to manage its spending and 

its taxing, and I am not going to tell you ‘’yes’’ or ‘‘no.’’ It is your 

decision to make. 

I would say this—and here I intrude very slightly, I hope into 

your legislative decision-making, since I think it is very important 

that we address this issue in some way relatively soon and in particular before Congress leaves town—I hope that it will not be involved in a whole list of other issues that will prevent something 

from being done. That is my main concern. 

But in terms of the fiscal issues—taxes, spending programs, all 

those things—that is Congress’s job and that is your decision. The 

point I have made is that we need sane fiscal programs. And again 

I am very unhappy about this development. 

Senator Klobuchar. And Secretary Paulson has not been very 

open to this idea of doing something about executive pay. Here the 

idea is, because these people who have benefitted directly from this 

and gotten these huge severance packages, $20 million, $40 million, do you understand why we would want to structure something 

in this deal where, if they are taking money, a company is taking 

money, a firm is taking money, that the government then can get 

something in return to say there has to be some limits about what 

you can make when you are taking our money? 

Chairman Bernanke. There are obviously legitimate issues. 

Those include executives who walk away from companies with 

large golden parachutes even though they did not perform well. 

They include issues of corporate governance. Are the shareholders 

in fact being appropriately represented? 

There are issues of incentives for risk taking. I think it may be 

a supervisory issue to ask whether these packages are structured 

in a way that leads to excessively risky decisions. So there are a 

35 

lot of legitimate issues here, and I agree with you about that, and 

there are tax issues, too, as you already mentioned. 

But one thing I would strongly ask you to consider. For this to 

work we need very wide participation from a range of financial institutions. This is not a handout to individual institutions. This is 

trying to make the market as a whole work by getting many institutions to participate in auctions and other market-based processes. 

If you particularly stigmatize the individual institutions that 

participate, you are going to guarantee no participation. So you 

should think about this as part of a longer term reform for the 

overall system, not just for the individual firms that are participating. 

Senator Klobuchar. Okay, one last question. I know you are an 

expert on the Depression and those things. Norman Ornstein has 

suggested this week this idea of using the whole idea that they had 

during the Depression when they bought the mortgages that were 

going under, and I think they ended up for the mortgages in default getting like 46 percent of them they rejected, they got the 

rest, it went over 18 years, and it worked for the most part. 

Have you thought about doing something like that here? 

Chairman Bernanke. Well this is related in some ways, but 

there are some important differences. One is the HOLC took mortgages off failed institutions, not buying them in the market, as we 

are discussing here. 

Secondly, those were simple mortgages, not these complex securities that are creating such a problem in the markets today. So I 

do not think it is exactly analogous, although I would point out, as 

others have, that the HOLC made a profit over time. Though I certainly do not guarantee anything like that here, and there is a lot 

of risk being taken here which we need to minimize, it does not 

mean that $700 billion of taxpayer money is going to disappear. 

I mean, there are risks but certainly a very substantial part of 

it will be recouped as these assets are sold, and as the economy recovers. 

Senator Klobuchar. Thank you, very much. 

Chairman Schumer. Congressman Brady. 

Mr. Brady. Thank you, Mr. Chairman. 

Can you be more specific about the economic consequences if 

Congress does not act? 

Chairman Bernanke. Yes. I see the financial markets as already being quite fragile. The credit markets are not working normally. For example, there has already been a tightening up of lending. Corporations are not able to finance themselves through commercial paper. 

The money market mutual funds and other parts of the financial 

system are not performing in the normal way. I would think that 

even if the situation stayed about where it is today that it would 

be a significant drag on the economy because of the effects both on 

savers through asset values, but also on the broad economy 

through the availability of credit. 

If credit is not available for small businesses to create jobs, for 

companies to finance their payrolls, for people to buy cars, that in 

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36 

gages—which is affecting the housing market and house prices—all 

those things. If those things are all cut back and unavailable, it is 

going to have significant adverse effects on our economy. 

Now what I said was, if there was no change. I think without 

any action it is very possible that we might see a significant deterioration in financial conditions from here, which would make the 

problems for the broader economy even worse. 

So I do think that this is quite consequential. I think that this 

is the most significant financial crisis in the post–War period for 

the United States, and it has in fact a global reach. So it has implications for other countries, as well. So I do think it is extraordinarily important that Congress take action. 

I understand how difficult this is, and how complex, and I hope 

that you will take the time to think through your options and consider all the issues, but I do believe it is very important to take 

action. 

Mr. Brady. Look forward, do you have a range of what that loss 

of GDP or increase in unemployment—the range. Obviously you 

are having to eyeball that. But do you have a range? 

Chairman Bernanke. It is very difficult. But if you look at historical examples, in many cases it has been quite significant. The 

case of Japan was a case where growth was suboptimal for a decade. 

In Scandinavia, they acted relatively quickly to restore capital to 

the banking system, and they still had a fairly severe recession 

after that. 

So there have been very few cases where you have had this kind 

of financial disruption without a significant effect on the economy. 

We have already seen a lot of that effect, and I am just trying to 

argue that we should do what we can so it does not get worse. 

Mr. Brady. The reason I asked that is I think it is important 

in this debate. A lot of us are being asked to walk away from every 

principle we have had on government control and free markets. 

We understand the severity of the crunch we have today, but 

when we listen to folks back home—and I do not think we always 

give our constituents the credit for the smarts they have as we 

should—and their point is simply that they do not want to reward 

this risky behavior. 

The feeling many of them have is, and I agree to a great extent, 

why don’t we allow the free market system to correct itself and accept the consequences to avoid that risky behavior in the future? 

I think there is a general sense that we are living in a financial 

house of cards; that action like this may only be a temporary solution to it; that we need to return to firmer, less complex, more financially sound, so that in the long run those consequences are 

better for taxpayers. 

How would you talk directly to them? 

Chairman Bernanke. My response is that the pain would be 

very significant. It would be very difficult for Main Street if this 

credit system broke down. It would be very costly to average people. 

Here is a better solution: A better solution is to recognize that 

things went wrong. We have a problem now that we can solve if 

37 

we address it with enough force. We can protect taxpayers in doing 

that. 

The second part of the program, though, is we need to come back 

and look at our financial regulatory system, and look at our financial markets, and ask, how could this have happened? How can we 

make sure it does not happen again? 

That is a much better way to prevent recurrence than by letting 

things fall apart and letting that serve as an object lesson to future 

market participants. 

Mr. Brady. Thank you. Let me conclude with this. Are there 

some other things Congress ought to be looking at to increase capital flows in the United States? They are focused on credit. Capital 

is important, too. Such as a holiday on the capital gains tax might 

unlock some of those assets in the country. 

Or Mr. English’s proposal that I had the opportunity to work 

with three years ago to temporarily lower the repatriation roadblock that we have some estimated $350 billion of U.S. profits 

stranded overseas that are simply too expensive to bring back 

under the current tax rate. 

When we lowered that barrier temporarily three years ago, it brought in just about $300 billion. Is it time for Congress—and it 

does not make sense at this point to be blocking any of those capital inflows into the United States—should Congress also be examining, in conjunction with this, or parallel to this, some of those actions to increase, to raise that capital flow? 

Chairman Bernanke. Well there are ones that could be positive. I think as I responded to Ms. Klobuchar that that is 

Congress’s determination to make. I would make the assessment 

that by themselves those kinds of actions would not address the 

larger problem that we are currently facing. 

Mr. Brady. But in conjunction they might be helpful? 

Chairman Bernanke. Congress certainly obviously can discuss 

those issues and come to its own determination. 

Mr. Brady. Thank you, Mr. Chairman. 

Thank you, Mr. Chairman. 

Chairman Schumer. Thank you, Congressman. 

Senator Bingaman. Thank you, very much. 

Thank you, Mr. Chairman, for your service at this very difficult 

period. Let me just state a broad concern that occurs to me. 

I have heard your testimony that what is needed to get credit 

markets functioning again is to get more capital into these financial institutions. And the proposal that we have been given by the 

Secretary of the Treasury is that the way to do that is to essentially have the government come in and take these so-called troubled assets off the books of these companies by buying them up at 

whatever price, and that will allow these companies to then be in 

a better position to perform the function they need to perform in 

providing credit and otherwise assisting the economy. 

I am struck with the other way, the other obvious way, in which 

capital is provided to these financial institutions. When Warren 

Buffet invests $5 billion and gets preferred stock in Goldman 

Sachs, or when Mitsubishi invests a little over $8 billion and gets, 

I’m not sure exactly, I assume some type of preferred stock in Morgan Stanley, that is seen as a good thing for those firms. It is an 

38 

infusion of capital. It is welcomed by the stockholders of those 

firms, presumably. 

It is not wiping out the stockholders; it is helping the stockholders of those firms. And it is a good investment for Warren Buffet and for Mitsubishi, presumably. 

So I guess my concern is that the way this thing is being characterized and presented to the Congress, we are being asked to endorse a bailout where we basically take the assets that these companies, these firms cannot otherwise dispose of at a reasonable 

price and take them off their hands, instead of us, instead of being 

characterized as a recapitalization of these firms. 

If instead of a Resolution Trust Corporation, which we had in the 

S&L crisis, we—at this point we are talking about a Recapitalization Trust Corporation—where the taxpayer was essentially putting up funds, or committing whatever number, hundreds of billions of dollars of taxpayer money, but it was for purposes of recapitalizing the financial sector so that the financial sector can 

once again perform the function it needs to, and the taxpayer 

would come away from that presumably just like Warren Buffet 

does or Mitsubishi does with some ownership and some ability to 

benefit once the financial sector is back on its feet. 

It seems to me that is a much better way to characterize things. 

It gets you somewhere to the same point. It gets the money into 

the system. It is much better for the taxpayer. But for some reason 

this thing has been described and structured as the taxpayers’ job 

is to buy the assets that these firms no longer want. 

That is the reason there is so much pushback on this thing. I 

think you get much better support, or much better acquiescence at 

least by many of the folks I represent if they thought that the government was going to go ahead and have something in the way of 

an investment here once the dust settled. 

So what is your reaction to that? Am I not thinking about this 

right? 

Chairman Bernanke. No, it is a very good comment. As I mentioned before, perhaps this is not a completely compelling objection. 

There is a concern that investors might view this as a prelude to 

forcible capital injections that would, as in the case of Fannie or 

Freddie, wipe out common shareholders, or at least put them at 

some risk in that respect. 

I think that is one of the concerns that is underlying that approach. But if it were possible to convince the markets that in fact 

the government were going to act like Warren Buffet and make investment banking deals based on negotiations and approval by the 

common shareholders and the board, et cetera, I think that is 

something that is probably worth discussing with the White House 

to see if they see any benefit in that. 

But, again, the concern that I have heard from a number of people is: Does this open the door to effective nationalization, as opposed to simply putting capital into the banks? 

Senator Bingaman. Well what if we were to say, okay, we are 

going to set up this Recapitalization Trust Corporation. We are 

going to start with a tranche of a couple hundred billion dollars, 

and we are going to have a board that will operate this, and we 

will ask Warren Buffet to volunteer his services to head the board. 

39 

Now what is wrong with something like that, where he would 

have clear instructions that we are looking out for the taxpayer 

here but we also want to get this system functioning again and get 

these financial institutions operating? 

Why would that not be a much more politically and substantively 

preferable course than this idea of us just buying these troubled assets? 

Chairman Bernanke. Well you are a better judge of the politics 

than I am. I do not know whether that would be more popular or 

not. I told you what I think is viewed as the concern about it, but 

I certainly think that there is nothing wrong with discussing this 

option with the Treasury. 

Again, I am not empowered to negotiate for the Treasury. 

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

Chairman Schumer. Thank you. 

Congressman Hinchey. 

Mr. Hinchey. Thank you very much, Mr. Chairman—— 

Mr. Saxton. Mr. Chairman—— 

Chairman Schumer. Well Hinchey came in before English, but 

we usually try to go back and forth, so we will go to English and 

then Hinchey. 

Mr. English. Mr. Chairman, it is always a privilege to have a 

couple of New Yorkers deferring to me. Thank you, sir. [Laughter.] 

Mr. English. Mr. Chairman, following up actually on a point 

that Senator Bingaman made, and maybe approaching it from a 

different angle, one of the concerns that I have is that the architecture that has been outlined here gives extraordinary power to the 

Treasury, to people who are unelected, to make extraordinary 

interventions in the economy. And I do not think that we can contemplate this without considering the political implications. 

Secretary Paulson has reportedly agreed that the Treasury would 

be authorized to take an equity stake in financial institutions that 

sell impaired financial assets to the Treasury. 

I have to wonder, Mr. Chairman, do we risk politicizing credit 

decision making by giving the Federal Government equity stakes 

in a whole array of banks and other financial institutions? 

And as a couple of commentators have gestured at, is there a 

real danger here that we go down the path to crony capitalism? 

Chairman Bernanke. Well your question comes after Senator 

Bingaman’s question, which was on the other side of the same 

issue. 

I am not aware that the Treasury Secretary has agreed to what 

you just indicated for the reasons I said before, that we do not 

want to stigmatize those who participate in the asset sales. 

It would be a different matter if a firm was failing and obviously 

needed some infusion of cash in that respect. I may just be behind 

the discussions, but I am not aware that that has been agreed to. 

In any case, let me just say that I think it is very appropriate, 

indeed essential, for Congress to have very tough oversight over 

this program, and that there be a set of principles under which the 

program operates, and that there be close oversight by however 

Congress sees fit to structure that. 

40 

And I think that should give some comfort to taxpayers and to 

others that indeed this program is being run in a serious and fair 

way. 

I think what would create some concern would be if too much of 

the details of how this would be done, whether there is an auction 

mechanism or something else, is written into the legislation, then 

that would take away the flexibility that might be necessary to 

deal with unexpected circumstances. So that is a concern. 

But from an oversight perspective, I absolutely agree with you. 

Mr. English. Very good. As we look at the recent market turbulence, one of the things I have been concerned about is the presence of new and unusual products of the market that may have 

contributed to it. 

It has been suggested that the value of complex derivatives related to mortgages and credit fell further and faster than investors 

and bank regulators thought likely. How does the Fed view the role 

of these derivatives in contributing to the turmoil recently in financial markets? 

Chairman Bernanke. Well I think they played an important 

role. Many factors have been involved—not just the housing market, but the structure of financial markets, the structure of financing, the structures of risk transfer such as these derivatives that 

you are referring to. 

I think at the time the argument for them was, by putting all 

these things together and chopping them up different ways we 

would spread risk more effectively. What we learned instead was 

that, first, that risk was not always spread as well as was thought, 

and that banks did not always realize what their exposures were 

to different types of assets. 

But secondly, transparency is a big issue. And investors are not 

going to come in and buy incredibly complex instruments at a time 

of serious financial stress because they have essentially no way to 

value them under these circumstances, which is one of the reasons 

for trying to get the market going again. 

But I agree that the opacity and complexity of these instruments 

has been a factor, and that that needs to be addressed going forward, as does the role of the credit rating agencies who would bless 

them, and then investors did not have to look at what was inside 

because they had a AAA rating. 

So both of those things need to be looked at as a part of the reform. 

Mr. English. Where do you see the current failure of transparency? Is this a case where our existing oversight entities do not 

have the competence, or the resources, or perhaps the focus to pursue these particular products? Or is this a case where you mentioned the rating agencies, have the rating agencies been from your 

perspective too casual in making their assessments? 

Where does the blame fall? Is this a regulatory failure? Is this 

a—since we throw around a lot of blame right now—is this a failure of Congressional oversight? Where do you see the most immediate failings here? 

Chairman Bernanke. Well I think there is a lot of blame to go 

around. There have been a number of international and domestic 

studies of the crisis that have tried to diagnose it and point to difVerDate Nov 24 2008 14:31 Jul 06, 2009 Jkt 045037 PO 00000 Frm 00044 Fmt 6633 Sfmt 6633 C:\DOCS\46552.TXT SHAUN PsN: DPROCT
41 

ferent aspects or causes of the crisis, and all the things you mentioned are in the list. 

The credit rating agencies which did not really anticipate the decline in housing prices, or that possibility, and had problems with 

their methodologies, which have been discussed, and they are trying to improve those now. 

Secondly I think the regulators were not sufficiently attentive to 

the risks of these derivative instruments, or off-balance-sheet instruments in general, and we and our fellow regulators are trying 

to remedy that. But I think that was an issue. 

And third I think the private sector in its zest for financial innovation under-estimated the problems that might arise in a situation of financial distress. Why it is hard to value these assets at 

this point is really for two reasons. One is simply that they are extraordinarily complex. But also, there is an awful lot of uncertainty 

about the economy. We just do not know where house prices are 

going to end up, where the economy is going to end up, and that 

would make even a simple security harder to value. Those two reasons affect the securities’ valuation. 

Mr. English. Thank you, Mr. Chairman. 

Chairman Schumer. Congressman Hinchey. 

Mr. Hinchey. Thank you very much, Mr. Chairman. 

Thank you very much, Mr. Chairman, for being here, for your 

testimony, and for the very direct and honest answers I think you 

have given to the statements that have been made and the questions that have been asked. So I very much appreciate what you 

are doing. 

You said that you and the Secretary of the Treasury went to the 

White House and spoke to the President on Thursday. I can imagine, however, that both your operation and the Treasury operation 

were focused on this issue for a lot longer than just Thursday. 

I wonder if you would kindly tell us how long that has been, and 

what you have been doing together or independently to try to deal 

with this situation up until Thursday? 

Chairman Bernanke. Well as you may know, both the Treasury and the Fed have been extraordinarily active over the last year 

through a wide range of mechanisms—discount window lending, 

the creation of new lending facilities, international swaps, and a 

whole other range of activities that we have done—to try to stabilize markets and to maintain as much stability in the financial 

system as we can. 

Our hope was that the actions that we took, together with the 

natural healing process some stabilization in housing, would allow 

us to get through this difficult period without any extraordinary 

intervention from Congress. And we certainly did not want to come 

to Congress prematurely and say do something large when it was 

not yet evident that action was necessary. 

However, in recent weeks market conditions have deteriorated 

quite significantly. We are continuing to do what we can to support 

markets, to increase liquidity, and so on, but our judgment at this 

point is that Congress needs to act, and only Congress can take the 

actions necessary to stabilize the financial system. 

Mr. Hinchey. Well I think there is no question you are absolutely right. Congress needs to act, and the financial system needs 

42 

to be stabilized, but there are other elements of this economy that 

need to be dealt with as well. Not just the financial system. 

In other opportunities that you and I have had to be together we 

have asked questions and talked about the way in which the economy was working. The last time that you were here before this 

Joint Economic Committee in April, I believe it was, the general response to the question was that everything was going to be okay; 

that the economy was generally strong, and everything was running fairly well. 

I was very skeptical about that, and I think that there was very 

good reason for it. It was very interesting in a question that I 

asked Secretary Paulson, his answer was that our economy was 

growing, unemployment levels were fine, there was housing downturn and turmoil in capital markets, but all major institutions are 

fundamentally healthy. 

The fact of the matter is that that was not true. And I understand that that did not mean that he might have been focused on 

trying to deal with the issue, but I think that there was some motivation here to try to keep this under cover and try to present that 

the kind of things that were going wrong were not really happening. 

I understand the situation that we have been talking about mostly here with regard to the mortgage market, but we are also seeing 

something here about the way in which the mortgage market has 

been manipulated; how it has been twisted and distorted in order 

to engage in speculation, and the desire there, the objective there 

is to make larger profits, and that has been for a lot of people very 

successful. 

Isn’t that some aspect of this problem that we have to deal with? 

Chairman Bernanke. Thank you for the question. A couple of 

comments. First, I do not recall exactly what I said in April, but 

in January we made a number of sharp interest rate cuts, and I 

think that was indicative of the fact that at that point I was certainly, and the FOMC was quite concerned about the economy. I 

think, looking back, that policy was justified. 

On your second question, you are absolutely right. There are a 

lot of problems, a lot of issues. I believe that the Congress ought 

to look at a substantial reform of our regulatory structure and of 

the financial markets to try to assure that these kinds of problems 

do not occur again. 

I think that is very important. You could think of this as a onetwo punch. First, stabilize the situation. Secondly, fix it so it does 

not happen again. 

My only concern is that, just given the realities of the Congressional schedule and so on that doing the complete regulatory reform is going to take awhile. It is going to take a lot of thought, 

and hearings, and discussions, and so my advice and my request 

is that you take step one today, but with a strong promise for step 

two. 

Mr. Hinchey. Well I appreciate that, and I am still skeptical 

about engaging in it in that way because I think that the situation 

has to be addressed more broadly. But I understand that the main 

focus of your attention, because of your responsibilities, has got to 

be on the financial market. And I very much appreciate that. 

43 

I think that that is true, but there is a lot more to deal with 

here. There is a lot of concern that a lot of people have with the 

general operation that is going on, the way in which this economy 

has been going down for more and more people. 

When I talk to you I can’t help but remember what an authority 

you are on the Great Depression, and it seems to me that there are 

so many aspects of this economic situation that we are confronting 

today which are so similar to the situation that we confronted during the Great Depression, I know that the financial markets are 

much more complex, much more different than they were back 

then, but in terms of that complexity there’s a lot more openness 

in terms of manipulation as well within the financial markets. 

But now you have a situation where you have a greater concentration of wealth in the hands of fewer and fewer people that 

we have had since 1929. You have an increase in poverty. You have 

a shrinking of the middle class. You have a downgrading of the 

Gross Domestic Product because the income of working people is 

going down, going down particularly with regard to the cost of living that is going up. 

Aren’t these things that this Congress must focus its attention 

on, as well? 

Chairman Bernanke. I would hope Congress would be focusing 

attention on those issues on an ongoing basis. The things you mention are related, for example, to education and workplace skills, energy, a whole set of issues, and I assume the Congress would be 

looking at those. 

Mr. Hinchey. Some of us in Congress have been for some time 

looking at these things. And what I am thinking about, as you and 

I are talking now, is you might have an opportunity to go back to 

the White House and say to the President: Maybe you, Mr. President, need to focus on these aspects of the economic circumstances 

that we are confronting, because he has been adamantly opposed 

to any increase in spending for domestic investment, infrastructure, health care, education, all the things that are needed across 

this country have been rejected by this Administration because 

they did not want to spend the money. But they are very happy 

to spend $700 billion now to deal with the circumstances in the financial market. 

That inconsistency just does not make any sense. 

Chairman Schumer. Congressman Hill. 

Mr. Hill. Thank you, Mr. Chairman. 

Chairman Bernanke, in this town it is hard to get the facts, and 

it is very difficult to determine what reality is. I want to take you 

through the last seven days in my life as a Member of Congress, 

and then return to a question that Congressman Cummings asked, 

because I thought it was very significant, your answer. 

Last week I was under the impression that the Administration 

felt like the economy was fairly strong. I disagreed, of course, but 

that was the message that was coming to me and other Members 

of Congress before Thursday. 

And then Thursday we adjourn, and suddenly we have a crisis 

on our hands. I learn over the weekend that we are going to be 

asked to appropriate $700 billion to try to get us out of this jam. 

44 

I am wondering, at the time that I heard all of this over the 

weekend, where have people been? Why is this suddenly a crisis? 

What has triggered all of this? 

I get back here on Monday and we are now discussing it among 

ourselves as Members of Congress, and there is great angst out 

there among Members of Congress about whether or not we should 

be doing this. 

In the last couple of days I have received over 200 telephone calls 

telling me: Don’t do it. 

Now, I, as a Member of Congress, am trying to make a determination of whether or not we should be doing this or not. But I 

will have to be quite frank with you—your answer to Congressman 

Cummings’ question of how this affects the Main Street people, our 

constituents back home, was rather stunning. 

Because what you are in fact asking us to do is to appropriate $700 billion to make car loans more accessible, and for small business people to have better credit. And quite frankly, if I went home 

and had a town hall meeting and told my constituents that we had 

to bail out Wall Street to the tune of $700 billion so they could find 

an easier time to get a car loan, or for small business people to get 

better credit so they could build their businesses, they would laugh 

me out of that town hall meeting, Mr. Chairman. There has got to 

be a better answer than just that. 

Can you give a better answer? 

Chairman Bernanke. Yes, sir, I can try to give you an answer 

on two fronts. 

The first is, I recognize that this is always viewed as a $700 billion program, but again the fiscal cost of it is going to be much, 

much less than that because it is an acquisition of assets which 

will be resold. So I think that needs to be kept in mind. 

With respect to the second part, which is very important, in the 

first instance credit will be restricted further for home ownership, 

for small business, for individual consumers and so on, but that is 

not just an inconvenience. 

What that is going to do is affect spending and economic activity, 

and it will cause the economy as a whole to decline and be much 

weaker than it otherwise would be. It will affect the unemployment 

rate. It will affect job creation. It will affect real incomes. It will 

affect everybody’s standard of living. 

So it is much more than car loans. It is really about the overall 

performance of the U.S. economy over perhaps a period of years. 

So I think it is extraordinarily important to understand that, as we 

have seen in many previous examples of different countries and different times, choking up of credit is like taking the lifeblood away 

from the economy. The economy will not function in a healthy way 

without availability of credit for business creation, job creation, and 

the like. 

Mr. Hill. But are we talking about the threat of a depression 

here? I talked to two economists yesterday who said, yes, we are 

talking about a depression. Today, I am getting a different feel for 

what the results are if we do not do anything. 

Warren Buffett invested $50[sic] billion yesterday, and I read in 

the paper from several economists who say Congress would be 

crazy to do this. 

45 

Chairman Bernanke. Warren Buffett said on the TV this 

morning that he did it because he thought Congress was going to 

do the right thing, and if Congress didn’t act that we would go over 

a precipice, quote, unquote. 

So I think that it is important to do something. I don’t want to 

make comparisons to the Depression. That was an extraordinary 

event. It lasted for many years. It was a different time and place. 

But certainly there are going to be very negative implications for 

our economy if the credit markets are not functioning. 

Mr. Hill. Is it fair to tell my Main Street people back home that 

their stock portfolios are going to decrease dramatically? 

Chairman Bernanke. Very likely. 

Mr. Hill. And their 401Ks, and retirement programs? 

Chairman Bernanke. Very likely. 

Mr. Hill. Okay. I yield back, Mr. Chairman. 

Chairman Schumer. Thank you, Congressman Hill. 

Senator DeMint. 

Senator DeMint. Thank you, Mr. Chairman. 

I appreciate, Mr. Chairman, you being here today. I know you 

are doing what you think is best for our country, and I think you 

know it is our job to question that, particularly something of this 

significance. 

You just indicated that the $700 billion is for stopping a shortterm problem, and that we need to get about really fixing the problem afterwards. And it seems you are suggesting that fix includes 

a lot more regulations. 

My biggest concern at this point is that the casualty of all of this 

is going to be our belief in the free enterprise system, and that unbridled capitalism is being blamed for this problem. 

I learned after 25 years in business that you really cannot solve 

a problem unless you understand the root causes. It is hard for me 

to look at this and trace it back over the years without recognizing 

that this is a problem that was clearly caused by government. 

Obviously, easy and cheap money from the Fed, government requirements that banks make subprime loans, the implied government guarantees behind Fannie Mae and Freddie Mac which everyone, with a ‘‘wink and a nod’’ knew was an explicit government 

guarantee. 

Essentially what we did by trying to use the markets to put more 

people in houses is we removed the accountability of risk from the 

free enterprise system. And it only works when there is a good balance between risk and reward. 

I do not think anyone could question that that is what the government did. We created a low risk, big reward environment in 

which to sell a lot of these mortgages and move them around as 

securities. Now they are embedded in all areas of our credit market, and free markets are being blamed for this without any criticism of bad government policies. 

Now my question to you is—and I said this on a conference call 

the other day and I am not sure I have gotten a straight answer— 

Do you believe this is a failure of the free enterprise system, or another example of how government intervention destroys the dynamics of a free market system? 

46 

Chairman Bernanke. Well, we can discuss the origins of the 

situation. I think there are different points of view on that. I think 

that there were elements of the financial system—and let me amplify in just a second—such as the inadequate risk management 

and other things that amplified the problem and have created the 

crisis we see now. 

Historically, precisely because the financial system has such a 

critical function in the economy, and because of the too-big-to-fail 

problem, and the problem of runs on banks, and those sorts of 

things, there has always been Deposit Insurance, supervision, some 

regulation of the financial system. 

What I was saying, I don’t think I used the word ‘‘heavier regulation’’ or anything like that. What I had in mind was reform. I think 

our regulatory system now is a patchwork system. It is not well 

structured. In some places it is too heavy, and in other places it 

is nonexistent. 

So I do think the financial system needs to be regulated, and 

there are deep historical and economic reasons for that. But it is 

important that it be done in a way which on the one hand protects 

the safety of the economy and avoids crises of the type we are currently having, but on the other hand allows for innovations and the 

contributions that the financial sector can make to growth and diversification of the economy. 

So I think there is a lot of blame to go around, to make a long 

story short, but I do think that part of the problem is that the regulatory system we have is needing of reform, which may involve in 

some cases less regulation but smarter regulation. 

Senator DeMint. I am not suggesting we do not need a good 

regulatory structure for our financial markets. It just is very clear 

to me that the accountability of risk was removed, and the too-bigto-fail was primarily the government-created entities of Fannie 

Mae and Freddie Mac. They were major players in all of this. 

I am concerned that that is being left out of a lot of the word 

coming from the Administration and the Federal Reserve. None of 

these proposals would actually support more free market activity, 

and seemed to have actually taken the burden of taxes and regulations off of our economy. 

It would seem the Administration, while looking short term with 

this immediate bailout, would insist on some long-term changes in 

tax structure such as lowering our corporate tax rate, or eliminating the capital gains. 

We created this Sarbanes-Oxley monster in order to tell us when 

Bear Stearns was going to go out of business but it didn’t. It didn’t 

do anything it was supposed to do, but we know it chased capital 

offshore. However, there’s not advocacy from the White House or 

the Federal Reserve that we need to fix these things that are running capital out of our markets. 

And so it is very frustrating for me, as someone who believes in 

free markets and free enterprise, that the blame of all this is being 

laid at the fact that we didn’t have enough regulation and oversight. As somebody who has been in business, I know there is no 

amount of government regulation that can stop the corruption in 

a system if you take the risk out of it. 

47 

Chairman Bernanke. Senator, first of all, on Fannie and 

Freddie the Federal Reserve has long raised the issue of the systemic risk there. And I think you are absolutely right on that case. 

With respect to regulatory reform, the Federal Reserve contributed to, but of course Treasury took the lead in the presentation 

of the blueprint that Secretary Paulson presented before the crisis 

began, and that was in response to this issue of capital moving offshore, as you put it. 

His objectives in that blueprint were to try to simplify the system, remove redundancies, reduce costs, and make the regulatory 

system more industry friendly in that respect. 

So again I reiterate that I am not sure that what is needed necessarily is heavier, more regulation, but better, cleaner, more efficient regulation. 

Senator DeMint. Do you agree that insulating the market from 

natural risk creates a problem? 

Chairman Bernanke. Well what we have is a problem where 

the financial system, because of too-big-to-fail, or just because of 

other instabilities like runs on banks, historically has had the potential to have very widespread effects on the rest of the economy 

if it becomes unstable, more so than other industries. 

And so there has been a view—back to the introduction of deposit insurance, or before—a long-term view that some regulation 

is needed of the financial system. And given that, and you said 

yourself that it is needed, I think we just need to do it as well as 

possible. 

Senator DeMint. Thank you, Mr. Chairman. 

Chairman Schumer. Well thank you, Mr. Chairman. 

We said we would try to get you out at 12:30, and we went 

through a lot of questions. We very much appreciate your calm nature here, but also the knowledge that you have. I think most of 

us on either side of the aisle believe you look at these things dispassionately without a particular axe to grind. 

I just want to say, in conclusion, that the hearing reinforces my 

view of two things: 

That we do have to act, and act relatively quickly. And at the 

same time we need some changes in the legislation proposed, and 

I am glad to hear that you are open to the kinds of changes that 

I have talked about on reducing the burden to the taxpayers. 

Thanks for being here. 

Chairman Bernanke. Thank you, Mr. Chairman 

Chairman Schumer. The hearing is adjourned. 

(Whereupon, at 12:34 p.m., Wednesday, September 24, 2008, the 

hearing was adjourned.) 

(49) 

SUBMISSIONS FOR THE RECORD 

50 

PREPARED STATEMENT OF SENATOR CHARLES E. SCHUMER, CHAIRMAN

To begin, I’d like to welcome you this hearing Mr. Chairman. And I’d like to thank 

you for appearing before this and the two other committees you are testifying in 

front of. I know how grueling this can be. But like it or not, it is important part 

of the process. If the Administration plan cannot withstand scrutiny, we cannot 

make our case to the American taxpayers we represent. 

I think these hearings—beginning in the Senate Banking committee yesterday 

under the leadership of Chairman Dodd and continuing in the House Financial 

Services Committee this afternoon under Chairman Frank, have been important. 

Over the last twenty-four hours, I’ve seen signs of greater cooperation from my colleagues in Congress, who, despite many of their well-founded reservations, recognize 

the magnitude of the problems we face and the importance of getting something 

done. 

When you were last before this committee, in April, the crisis we were facing was 

the collapse of Bear Stearns, and I can say that most of us thought we had just 

witnessed an event that we were likely never to see again in our lifetimes. And yet, 

here we are, only six months later, and we are discussing a crisis many orders of 

magnitude greater. 

Mr. Chairman, I believe you have been eloquent and impassioned in your warnings of the dangers we face, and that we must try to do all we can to resolve the 

threat to our financial system. And I will reiterate what I said yesterday, I do believe we must act and we must act soon. 

But let us be clear—Americans are furious. I am sure that every single one of my 

colleagues has heard what I have heard from my constituents—amazement, astonishment and intense anger. And they are right to be astonished and very angry. 

Over the last eight years, we were told that markets knew best, that financial alchemy had reduced risk to an afterthought, and that we were entering a new world 

of global growth and prosperity. Instead, what we have learned is that we now have 

to pay for the greed and recklessness of those who should have known far better. 

Unfortunately that truth does not solve the crisis that confronts us. While Wall 

Street caused these problems, if we do nothing, Main Street will also pay a severe 

price. Pension funds, money market mutual funds, and 401(k) plans will be negatively impacted. Credit is already tightening, which impacts households as well as 

businesses large and small throughout this country. The lock down in lending has 

widespread consequences. I’ve heard from car manufacturers that it is virtually impossible to get an auto loan right now unless you have a very high credit score. This 

year alone they are likely sell six million fewer cars than they otherwise would. So 

even though the workers in Buffalo, Detroit and St. Louis are blameless, they will 

suffer. It’s not fair, it’s not right, but that’s the world we live in today. 

That is the reality we face, and we in Congress recognize it. I want to assure the 

markets once again—and I think I speak for all of us—that we will not be dilatory 

and we will not add extraneous amendments. We will not Christmas tree this bill. 

And we will work in a bipartisan way to act, and act soon. In the last day it has 

become clear to me, that, with the exception of a few outliers in either party, there 

is a clear recognition among members of both parties that we must act and act soon. 

And it has been good to hear from both Senators Obama and McCain that they concur we must act, though like us, they believe changes must be made to the Administration plan. 

Still, as I said yesterday as well, we must beware that in taking actions, we do 

not choose a bad solution. The markets want action. We understand that. But if we 

act so quickly that we create an ineffective solution, without adequate safeguards, 

then we risk the plan failing, which would be an even worse outcome for the markets, for the economy, and for our country. 

Even on Wall Street, $700 billion is a lot of money, and none of the thousands 

of money managers would invest that sum without appropriate due diligence. These 

hearings, and the discussions that are happening as we speak, are our Congressional due diligence, and we take that responsibility seriously and will make intelligent and relevant improvements to the Administration’s plan. We owe nothing less 

than that to the taxpayers who have put us in office to safeguard their economic 


42773.001
51 

well-being. It is a sacred trust, and I can say that it is a responsibility that all my 

colleagues, both Democrats and Republicans, whatever philosophical differences, 

hold very dear. 

As I have said, I believe there are three essential components to that must be part 

of this plan—T H O—taxpayers, homeowners, and oversight. There can be no question—and this is non-negotiable—that we must put taxpayers first. They must come 

ahead of bondholders, shareholders and executives and we need to add to the Administration’s legislation those types of protections. I think we must seriously consider putting this program in place in tranches, or installments—so that we do not 

limit the Secretary’s ability to act as necessary, but are able to evaluate the effectiveness of these expenditures over time. If the program is working, the Congress 

will certainly ratify continuing expenditures by the Treasury. But if it is not working, then we will need to review it before we once again find ourselves on the brink. 

I look forward to hearing your thoughts on that today, Mr. Chairman. 

Another idea I’ve proposed is insurance fund modeled on the FDIC and paid for 

by the financial industry that can defray some of the long-term costs of the Administration plan must also be part of this legislation. It clearly cannot cover the entire 

cost. But it seems only fair that the industry that will receive the vast benefit of 

this taxpayer-funded program pay for some share of it themselves. Both Secretary 

Paulson and you seemed positively disposed towards that idea yesterday, and again, 

I look forward to hearing further from you today on this as well. 

I remain puzzled by the resistance you and Secretary Paulson have offered to proposals that Senator Jack Reed and many of my colleagues have made about the 

need for equity being part of the process we are discussing. My constituents ask me 

about it, as do many of the business people and many of your fellow economists who 

I’ve spoken with about this. It seems only fair that we reward taxpayers if, as we 

all hope, this plan succeeds. 

We must also do something to help homeowners. Chairman Bernanke, you yourself have said repeatedly until we find a floor in the housing markets—and foreclosures are directly related to the housing markets—we will not solve this problem. 

And that affects not just those who made bad mortgages, not just those who will 

lose their homes through no fault of their own, but every homeowner. The number 

of foreclosures and the price of the average American’s home are intrinsically related to one another and cannot be separated. As we’ve seen, the complications of 

securitization—where mortgages are placed into pools and then broken up into a 

large number of securities, has created an enormous problem. Unlike in the old 

days, homeowners can no longer go the local bank, where they got their mortgage, 

to try to negotiate terms beneficial for both sides. Instead, since their mortgage has 

been sold into a pool with others, they find themselves trapped by servicing agreements they were never party to in the first place. And that’s to say nothing of the 

complications presented by second lien holders, who can often hold entire pools of 

mortgages hostage because they have nothing to lose by not co-operating. I remain 

convinced that judicial loan modifications, which would allow judges leeway in helping homeowners facing foreclosure, are an essential step that we must consider to 

resolving these problems, and the housing crisis. 

Finally—this is the last of what I call the three THO principles—there must be 

greater oversight as part of this plan. This Administration is asking simply for 

trust. However much we may like Secretary Paulson or you, Mr. Chairman, no sane 

person would put 700 million dollars in your hands on trust alone. I cannot in good 

faith tell my constituents that ‘‘it’s fine, we know they’ll do the right thing.’’ Strict 

oversight is a sine qua non. And when we return next year, we must develop a regulatory system that fits today’s financial system. While we cannot do that this week, 

it has become crystal clear that our system of regulation is broken and must be repaired, if not entirely replaced. 

To close, I would like to add a few words about something that I worry has gotten 

lost in our focus on this crisis. As I have said, I do believe we will act, and I do 

believe we will fix the financial crisis we face. But that will not in and of itself fix 

many of the other problems that continue to bedevil American families. The economy of the past eight years has hammered the American middle class. Their incomes have declined, their healthcare coverage has weakened, the price of their gas 

and food have skyrocketed, the value of their homes has plummeted, and now many 

of them find their jobs threatened. The plan the Administration has put forward, 

with certain modifications, will, I hope, resolve this current mess, but many other 

obstacles remain ahead of us. It is not enough to maintain the status quo. We must 

find a way to once again make the American economy the engine of prosperity it 

once was for all Americans, and not a casino where we let some earn extreme rewards by taking excessive risks while the rest of us get stuck with the bill. 

52 

PREPARED STATEMENT OF REPRESENTATIVE JIM SAXTON

I would like to join in welcoming Chairman Bernanke before the Joint Economic 

Committee this morning. Given the recent financial turmoil, his testimony comes at 

a critical juncture in economic policy. 

The main cause of the financial turmoil is the collapse of the housing bubble inflated by various government policies over many years. Government policies supported by many in Congress encouraged the expansion of subprime and other risky 

mortgages that fueled the housing bubble. Strong Congressional support of Fannie 

Mae and Freddie Mac depended on their investment in high risk mortgages for their 

own investment portfolios. 

In exchange, both Fannie Mae and Freddie Mac showered their Congressional patrons with generous campaign contributions that seriously corrupted the political 

process. Despite warnings for many years that both Fannie and Freddie were excessively leveraged to a degree that was dangerous, they continued to inflate the housing bubble undeterred by their accounting scandals. Now the country will have to 

pay a very high price for lending policies highly influenced by political, not economic, objectives. Given their financial problems created by a politicization of decision making, Fannie and Freddie have essentially been taken over by the federal 

government. 

In another startling development, over the last several weeks a distinct investment banking industry, established by the provisions of the well-intended GlassSteagall Act, has essentially ceased to exist. The independent investment banking 

business model proved unable to withstand the stress of the financial market instability wracking the entire financial structure. These investment banks were highly 

leveraged and relied on short-term funds to finance longer term investments. 

Unfortunately, many of these investments were mortgage backed securities whose 

value had plunged over the last year. The fact that the investment banking industry, created by government regulation, has proven unsound is a reminder that government policies do not always provide effective solutions, but can in fact create further problems. As a result, many investors are rightly concerned about the safety 

of their savings and investments. 

Some action by government is now needed to recapitalize the banks and other financial institutions either by injections of equity or removal of toxic investments. 

In this financial meltdown there is plenty of blame to go around, but ultimately the 

American people expect action to deal with the crisis. One good place to start would 

be guaranteeing the safety of transactions accounts to assure savers and small businesses that their basic financial needs can be met without disruption. 

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88 

PREPARED STATEMENT OF REPRESENTATIVE CAROLYN MALONEY, VICE CHAIR

Good morning. I would like to thank Chairman Schumer for holding this timely 

hearing to examine the economic outlook, especially in light of the sobering developments in our financial markets in recent days and months. I want to welcome 

Chairman Bernanke and thank him for testifying here today. 

What started out as a subprime crisis last summer has completely changed the 

face of Wall Street and created a tinderbox that poses the greatest threat to our 

financial system and our economy since the Great Depression. 

Despite a series of increasingly aggressive and unprecedented actions by the Federal Reserve and Treasury Department, continuing asset losses and deleveraging 

have continued to undermine confidence in financial institutions, choked off the 

availability of credit, and led to worrisome concerns about a domino effect from the 

interlocking relationships between thousands of investors and banks worldwide. 

Americans’ economic security, indeed our future, depends on a swift resolution of 

this problem. I am hopeful that we can work in a bipartisan manner to stabilize 

our economy, but there will be no blank check for the Administration. 

Treasury Secretary Paulson’s $700 billion proposal for the federal government to 

buy toxic assets is the equivalent of one-quarter of the entire Federal budget in 

2008—more than the total amount we spent this year on either the defense of our 

country or the entire Social Security system. 

American taxpayers cannot be asked to pour so much of their good money after 

bad. Proper oversight of the Treasury’s proposed facility is imperative, so we are 

amending the proposal to include a system that instills accountability. In addition, 

it would be inappropriate to have CEOs collecting ‘‘golden parachute’’ compensation 

packages as they leave their jobs, when taxpayers are on the hook for their mistakes. We are also pressing for an equity stake in firms in exchange for bailing them 

out. 

Clearly, the distressed balance sheets of our elite financial institutions threaten 

our economic well-being and require government action. But rising unemployment, 

continued income stagnation, and the bursting of the housing bubble are driving 

household balance sheets deep in the red at the same time. The housing wealth that 

consumers once relied on to fuel their spending—and the economy relied on to 

grow—is quickly evaporating as house prices continue their downward spiral. That’s 

causing consumer spending to drop and sending foreclosures to record levels—a 

major source of the problems on Wall Street. 

Ordinary homeowners also deserve some direct assistance. We need to help them 

renegotiate their bubble-inflated mortgages so they can stay in their homes and provide further economic stimulus to avoid a deep downturn. By providing aid to the 

states, we can preserve families’ health insurance, extend unemployment benefits, 

provide energy assistance, and invest in crumbling infrastructure to create good jobs 

at good wages. 

We are also working to help protect families on Main Street facing unfair practices from the credit card industry. Yesterday, the House passed the Credit Cardholders’ Bill of Rights (HR 5422), to provide crucial protections against unfair, but 

all too common, credit card practices. 

Finally, our regulatory system is in serious need of renovation because financial 

innovation has surpassed our ability to protect consumers and hold institutions accountable. In order to prevent this sort of crisis from happening again, the next 

Congress and the next President will have to rethink our fragmented system and 

correct the systemic risk that we have witnessed. 

Mr. Chairman, thank you for holding this hearing and I look forward to Chairman 

Bernanke’s insights on the best policies for strengthening the economy. 


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89 

PREPARED STATEMENT OF REPRESENTATIVE RON PAUL

Mr. Chairman, I believe that our economy faces a bleak future, particularly if the 

latest $700 billion bailout plan ends up passing. We risk committing the same errors 

that prolonged the misery of the Great Depression, namely keeping prices from falling. Instead of allowing overvalued financial assets to take a hit and trade on the 

market at a more realistic value, the government seeks to purchase overvalued or 

worthless assets and hold them in the unrealistic hope that at some point in the 

next few decades, someone might be willing to purchase them. 

One of the perverse effects of this bailout proposal is that the worst-performing 

firms, and those who interjected themselves most deeply into mortgage-backed securities, credit default swaps, and special investment vehicles will be those who benefit the most from this bailout. As with the bailout of airlines in the aftermath of 

9/11, those businesses who were the least efficient, least productive, and least concerned with serving consumers are those who will be rewarded for their mismanagement with a government handout, rather than the failure of their company that is 

proper to the market. This creates a dangerous moral hazard, as the precedent of 

bailing out reckless lending will lead to even more reckless lending and irresponsible behavior on the part of financial firms in the future. 

This bailout is a slipshod proposal, slapped together haphazardly and forced on 

an unwilling Congress with the threat that not passing it will lead to the collapse 

of the financial system. Some of the proposed alternatives are no better, for instance 

those which propose a government equity share in bailed-out companies. That we 

have come to a point where outright purchases of private sector companies is not 

only proposed but accepted by many who claim to be defenders of free markets 

bodes ill for the future of American society. 

As with many other government proposals, the opportunity cost of this bailout 

goes unmentioned. $700 billion tied up in illiquid assets is $700 billion that is not 

put to productive use. That amount of money in the private sector could be used 

to research new technologies, start small business that create thousands of jobs, or 

upgrade vital infrastructure. Instead, that money will be siphoned off into unproductive assets which may burden the government for years to come. The great French 

economist Frederic Bastiat is famous for explaining the difference between what is 

seen and what is unseen. In this case the bailout’s proponents see the alleged benefits, while they fail to see the jobs, businesses, and technologies not created due to 

this utter waste of money. 

The housing bubble has burst, unemployment is on the rise, and the dollar weakens every day. Unfortunately our leaders have failed to learn from the mistakes of 

previous generations and continue to lead us down the road toward economic ruin. 

90 

PREPARED STATEMENT OF SENATOR SAM BROWNBACK

Mr. Chairman, we are at a crossroad. We face the most monumental economic decisions in modern time. This is not the time to posture in pursuit of political advantage. Two things are certain: Inaction is not an option, and we have to get this 

right. To date, we have dealt with symptoms of the crisis. We must now deal with 

the cancer itself. 

The American people are angry. They have every right to be. To most, this looks 

like just one more example of the government making them pay for someone else’s 

failures. To paraphrase President Reagan, they want the government to walk by 

their side and stop riding on their back. 

This is at its core about the interaction of Wall Street and Main Street. Absent 

action, if there is a prolonged period in which credit stops flowing, there is a severe 

adverse threat to the financial conditions of every household, every American family, and every American business, small and large. 

This is not an abstract fear. I am sure that all of us on this committee have heard 

real world examples of how this crisis is hitting the real economy from our constituents and colleagues. For example, a major automobile seller was unable to obtain 

funding at workable rates to finance sales of its automobiles. Since August 2007, 

87 lenders have exited or temporarily stopped making student loans backed by the 

Federal government. If your child is counting on a student loan for next semester’s 

education, it could be tough to get if things continue the way they have been going. 

67% of small business owners, who are the engines of job creation in our economy, 

report that their businesses have been affected by the credit crunch. If we have a 

prolonged period in which credit flows virtually dry up, we can count on failures 

of businesses to be able to make payrolls, employ workers, and continue operations. 

Failure to act can result in severely depressed economic conditions. 

So, I believe that it would be irresponsible to not act. But, I also believe that we 

must act responsibly. Acting responsibly includes looking out for taxpayers as we 

consider devoting large amounts of taxpayer funds to resolve matters in credit markets. 

First, Chairman Bernanke, I would like you to explain what you feel would happen if we did not act and credit flows remained frozen for a protracted period. 

Second, I would like you to explain how you think Treasury’s proposal would find 

true ‘‘hold to maturity’’ prices of the distressed assets that are now being valued in 

illiquid or non-existent markets at ‘‘fire sale’’ prices, at best. If Treasury pays too 

much for the assets, taxpayers lose. If it doesn’t pay enough, then banks end up taking severe write-downs, must seek more capital, and are moved toward selling more 

assets at fire sale prices. 

Third, I would like you to help me understand why it would not be prudent to 

protect taxpayers by inserting into Treasury’s plan requirements that those who sell 

troubled assets provide the taxpayers with preferred stock warrants. Why, for example, could we not have Treasury buy troubled assets at fire sale prices, inject capital 

into troubled institutions, and obtain preferred stock warrants? We used warrants 

when the Federal government backed Chrysler debt. 

Fourth, I would like you to help me understand why we should consider Treasury’s proposal of up to $700 billion of value. Would there not be merit in considering 

an initial set of purchases of certain classes of troubled assets in the amount of, say, 

$100 billion? Then, we could evaluate results, and move on with $100 billion of purchases of other of classes of troubled assets. Why would it not be useful to attack 

the problem in a sequence of moves, rather than just one very large authorization? 

At the very least, we must be sure that there is adequate transparency and oversight in whatever Treasury ends up doing. 

Fifth, I would like to know whether you believe that Treasury’s proposed plan has 

any room for loan modifications by the Treasury on troubled mortgages. The root 

cause of problems in credit markets and in the economy seems to be declining home 

prices. And, to help stabilize those prices, wouldn’t it be advantageous to have 

Treasury get into the mortgage-backed securities, separate out the troubled loans 

and work out those that can be worked out. It seems to me that that would help 

reduce foreclosures, meaning fewer properties placed on an already over-supplied 

market, and thereby help arrest declines in home prices. 

We have a crisis in confidence in financial markets. And we have crisis of confidence of the American people in their government. When an American family 

seeks to borrow money to improve their home or start a business or when a small 

business looks to borrow to expand operations, they have to explain in detail what 

they are going to do with the money, what the collateral is, and how they are going 

to pay it back. I don’t think the American people are unreasonable in asking the 

same questions of this proposal. 

91 

I appreciate the help that I anticipate you will give me in understanding how best 

to resolve the stresses in financial markets that pose a very real adverse threat to 

our overall economy. Again, I believe that it would be irresponsible not to act. But, 

I also believe that we must act responsibly and get this right, including protection 

of taxpayers who we are putting at risk. 

92 

1Specifically, the loan is collateralized by all of the assets of the company and its primary nonregulated subsidiaries. These assets include the equity of substantially all of AIG’s regulated 

subsidiaries. 

PREPARED STATEMENT OF BEN S. BERNANKE

Chairman Schumer, Vice Chair Maloney, Representative Saxton, and other members of the committee, I appreciate this opportunity to discuss recent developments 

in financial markets and to present an update on the economic situation. As you 

know, the U.S. economy continues to confront substantial challenges, including a 

weakening labor market and elevated inflation. Notably, stresses in financial markets have been high and have recently intensified significantly. If financial conditions fail to improve for a protracted period, the implications for the broader economy could be quite adverse. 

The downturn in the housing market has been a key factor underlying both the 

strained condition of financial markets and the slowdown of the broader economy. 

In the financial sphere, falling home prices and rising mortgage delinquencies have 

led to major losses at many financial institutions, losses only partially replaced by 

the raising of new capital. Investor concerns about financial institutions increased 

over the summer, as mortgage-related assets deteriorated further and economic activity weakened. Among the firms under the greatest pressure were Fannie Mae 

and Freddie Mac, Lehman Brothers, and, more recently, American International 

Group (AIG). As investors lost confidence in them, these companies saw their access 

to liquidity and capital markets increasingly impaired and their stock prices drop 

sharply. 

The Federal Reserve believes that, whenever possible, such difficulties should be 

addressed through private-sector arrangements—for example, by raising new equity 

capital, by negotiations leading to a merger or acquisition, or by an orderly winddown. Government assistance should be given with the greatest of reluctance and 

only when the stability of the financial system, and, consequently, the health of the 

broader economy, is at risk. In the cases of Fannie Mae and Freddie Mac, however, 

capital raises of sufficient size appeared infeasible and the size and governmentsponsored status of the two companies precluded a merger with or acquisition by 

another company. To avoid unacceptably large dislocations in the financial sector, 

the housing market, and the economy as a whole, the Federal Housing Finance 

Agency (FHFA) placed Fannie Mae and Freddie Mac into conservatorship, and the 

Treasury used its authority, granted by the Congress in July, to make available financial support to the two firms. The Federal Reserve, with which FHFA consulted 

on the conservatorship decision as specified in the July legislation, supported these 

steps as necessary and appropriate. We have seen benefits of this action in the form 

of lower mortgage rates, which should help the housing market. 

The Federal Reserve and the Treasury attempted to identify private-sector solutions for AIG and Lehman Brothers, but none was forthcoming. In the case of AIG, 

the Federal Reserve, with the support of the Treasury, provided an emergency credit 

line to facilitate an orderly resolution. The Federal Reserve took this action because 

it judged that, in light of the prevailing market conditions and the size and composition of AIG’s obligations, a disorderly failure of AIG would have severely threatened 

global financial stability and, consequently, the performance of the U.S. economy. 

To mitigate concerns that this action would exacerbate moral hazard and encourage 

inappropriate risk-taking in the future, the Federal Reserve ensured that the terms 

of the credit extended to AIG imposed significant costs and constraints on the firm’s 

owners, managers, and creditors. The chief executive officer has been replaced. The 

collateral for the loan is the company itself, together with its subsidiaries.1 (Insurance policyholders and holders of AIG investment products are, however, fully protected.) Interest will accrue on the outstanding balance of the loan at a rate of 

three-month Libor plus 850 basis points, implying a current interest rate over 11 

percent. In addition, the U.S. government will receive equity participation rights 

corresponding to a 79.9 percent equity interest in AIG and has the right to veto the 

payment of dividends to common and preferred shareholders, among other things. 

In the case of Lehman Brothers, a major investment bank, the Federal Reserve 

and the Treasury declined to commit public funds to support the institution. The 

failure of Lehman posed risks. But the troubles at Lehman had been well known 

for some time, and investors clearly recognized—as evidenced, for example, by the 

high cost of insuring Lehman’s debt in the market for credit default swaps—that 

the failure of the firm was a significant possibility. Thus, we judged that investors 

and counterparties had had time to take precautionary measures. 

While perhaps manageable in itself, Lehman’s default was combined with the unexpectedly rapid collapse of AIG, which together contributed to the development last 

93 

week of extraordinarily turbulent conditions in global financial markets. These conditions caused equity prices to fall sharply, the cost of short-term credit—where 

available—to spike upward, and liquidity to dry up in many markets. Losses at a 

large money market mutual fund sparked extensive withdrawals from a number of 

such funds. A marked increase in the demand for safe assets—a flight to quality— 

sent the yield on Treasury bills down to a few hundredths of a percent. By further 

reducing asset values and potentially restricting the flow of credit to households and 

businesses, these developments pose a direct threat to economic growth. 

The Federal Reserve took a number of actions to increase liquidity and stabilize 

markets. Notably, to address dollar funding pressures worldwide, we announced a 

significant expansion of reciprocal currency arrangements with foreign central 

banks, including an approximate doubling of the existing swap lines with the European Central Bank and the Swiss National Bank and the authorization of new swap 

facilities with the Bank of Japan, the Bank of England, and the Bank of Canada, 

among others. We will continue to work closely with colleagues at other central 

banks to address ongoing liquidity pressures. The Federal Reserve also announced 

initiatives to assist money market mutual funds facing heavy redemptions and to 

increase liquidity in short-term credit markets. 

Despite the efforts of the Federal Reserve, the Treasury, and other agencies, global financial markets remain under extraordinary stress. Action by the Congress is 

urgently required to stabilize the situation and avert what otherwise could be very 

serious consequences for our financial markets and for our economy. In this regard, 

the Federal Reserve supports the Treasury’s proposal to buy illiquid assets from financial institutions. Purchasing impaired assets will create liquidity and promote 

price discovery in the markets for these assets, while reducing investor uncertainty 

about the current value and prospects of financial institutions. More generally, removing these assets from institutions’ balance sheets will help to restore confidence 

in our financial markets and enable banks and other institutions to raise capital 

and to expand credit to support economic growth. 

I will now turn to a brief update on the economic situation. 

Ongoing developments in financial markets are directly affecting the broader 

economy through several channels, most notably by restricting the availability of 

credit. Mortgage credit terms have tightened significantly and fees have risen, especially for potential borrowers who lack substantial down payments or who have 

blemished credit histories. Mortgages that are ineligible for credit guarantees by 

Fannie Mae or Freddie Mac—for example, nonconforming jumbo mortgages—cannot 

be securitized and thus carry much higher interest rates than conforming mortgages. Some lenders have reduced borrowing limits on home equity lines of credit. 

Households also appear to be having more difficulty of late in obtaining nonmortgage credit. For example, the Federal Reserve’s Senior Loan Officer Opinion Survey 

reported that as of July an increasing proportion of banks had tightened standards 

for credit card and other consumer loans. In the business sector, through August, 

the financially strongest firms remained able to issue bonds but bond issuance by 

speculative-grade firms remained very light. More recently, however, deteriorating 

financial market conditions have disrupted the commercial paper market and other 

forms of financing for a wide range of firms, including investment-grade firms. Financing for commercial real estate projects has also tightened very significantly. 

When worried lenders tighten credit, then spending, production, and job creation 

slow. Real economic activity in the second quarter appears to have been surprisingly 

resilient, but, more recently, economic activity appears to have decelerated broadly. 

In the labor market, private payrolls shed another 100,000 jobs in August, bringing 

the cumulative drop since November to 770,000. New claims for unemployment insurance are at elevated levels and the civilian unemployment rate rose to 6.1 percent in August. Households’ real disposable income was boosted significantly in the 

spring by the tax rebate payments, but, excluding those payments, real after-tax income has fallen this year, which partly reflects increases in the prices of energy and 

food. 

In recent months, the weakness in real income together with the restraining effects of reduced credit flows and declining financial and housing wealth have begun 

to show through more clearly to consumer spending. Real personal consumption expenditures for goods and services declined in June and July, and the retail sales 

report for August suggests that outlays for consumer goods fell noticeably further 

last month. Although the retrenchment in household spending has been widespread, 

purchases of motor vehicles have dropped off particularly sharply. On a more positive note, oil and gasoline prices—while still at high levels, in part reflecting the 

effects of Hurricane Ike—have come down substantially from the peaks they 

reached earlier this summer, contributing to a recent improvement in consumer conVerDate Nov 24 2008 14:31 Jul 06, 2009 Jkt 045037 PO 00000 Frm 00097 Fmt 6601 Sfmt 6621 C:\DOCS\46552.TXT SHAUN PsN: DPROCT
94 

fidence. However, the weakness in the fundamentals underlying consumer spending 

suggest that household expenditures will be sluggish, at best, in the near term. 

The recent indicators of the demand for new and existing homes hint at some stabilization of sales, and lower mortgage rates are likely to provide some support for 

demand in coming months. Moreover, although expectations that house prices will 

continue to fall have probably dissuaded some potential buyers from entering the 

market, lower house prices and mortgage interest rates are making housing increasingly affordable over time. Still, home builders retain large backlogs of unsold 

homes, which should continue to restrain the pace of new home construction. Indeed, single-family housing starts and new permit issuance dropped further in August. At the same time, the continuing decline in house prices reduces homeowners’ 

equity and puts continuing pressure on the balance sheets of financial institutions, 

as I have already noted. 

As of midyear, business investment was holding up reasonably well, with investment in nonresidential structures particularly robust. However, a range of factors, 

including weakening fundamentals and constraints on credit, are likely to result in 

a considerable slowdown in the construction of commercial and office buildings in 

coming quarters. Business outlays for equipment and software also appear poised 

to slow in the second half of this year, assuming that production and sales slow as 

anticipated. 

International trade provided considerable support for the U.S. economy over the 

first half of the year. Economic activity has been buoyed by strong foreign demand 

for a wide range of U.S. exports, including agricultural products, capital goods, and 

industrial supplies, even as imports declined. However, in recent months, the outlook for foreign economic activity has deteriorated amid unsettled conditions in financial markets, troubled housing sectors, and softening sentiment. As a consequence, in coming quarters, the contribution of net exports to U.S. production is 

not likely to be as sizable as it was in the first half of the year. 

All told, real gross domestic product is likely to expand at a pace appreciably 

below its potential rate in the second half of this year and then to gradually pick 

up as financial markets return to more-normal functioning and the housing contraction runs its course. Given the extraordinary circumstances, greater-than-normal 

uncertainty surrounds any forecast of the pace of activity. In particular, the intensification of financial stress in recent weeks, which will make lenders still more cautious about extending credit to households and business, could prove a significant 

further drag on growth. The downside risks to the outlook thus remain a significant 

concern. 

Inflation rose sharply over the period from May to July, reflecting rapid increases 

in energy and food prices. During the same period, price inflation for goods and 

services other than food and energy also moved up from the low rates seen in the 

spring, as the higher costs of energy, other commodities, and imported goods were 

partially passed through to consumers. Recently, however, the news on inflation has 

been more favorable. The prices of oil and other commodities, while remaining quite 

volatile, have fallen, on net, from their recent peaks, and the dollar is up from its 

mid-summer lows. The declines in energy prices have also led to some easing of inflation expectations, as measured, for example, by consumer surveys and the pricing 

of inflation-indexed Treasury securities. 

If not reversed, these developments, together with a pace of growth that is likely 

to fall short of potential for a time, should lead inflation to moderate later this year 

and next year. Nevertheless, the inflation outlook remains highly uncertain. Indeed, 

the fluctuations in oil prices in the past few days illustrate the difficulty of predicting the future course of commodity prices. Consequently, the upside risks to inflation remain a significant concern as well. 

Over time, a number of factors should promote the return of our economy to higher levels of employment and sustainable growth with price stability, including the 

stimulus being provided by monetary policy, lower oil and commodity prices, increasing stability in the mortgage and housing markets, and the natural recuperative powers of our economy. However, stabilization of our financial system is an 

essential precondition for economic recovery. I urge the Congress to act quickly to 

address the grave threats to financial stability that we currently face. For its part, 

the Federal Open Market Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and 

price stability.