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The Subprime Lending Disaster and the Threat to the Broader Economy

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The Subprime Lending Disaster and the Threat to the Broader Economy S. HRG. 110–250 EVOLUTION OF AN ECONOMIC CRISIS?: THE SUBPRIME LENDING DISASTER AND THE THREAT TO THE BROADER ECONOMY HEARING BEFORE THE JOINT ECONOMIC COMMITTEE CONGRESS OF THE UNITED STATES ONE HUNDRED TENTH CONGRESS FIRST SESSION SEPTEMBER 19, 2007 Printed for the use of the Joint Economic Committee ( U.S. GOVERNMENT PRINTING OFFICE 38–426 PDF WASHINGTON : 2008 For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800 Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001 VerDate 11-MAY-2000 13:50 Jan 22, 2008 Jkt 038426 PO 00000 Frm 00001 Fmt 5011 Sfmt 5011 C:\JEC\38426.TXT CELINA PsN: CELINA JOINT ECONOMIC COMMITTEE [Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress] SENATE HOUSE OF REPRESENTATIVES CHARLES E. SCHUMER, New York, Chairman CAROLYN B. MALONEY, New York, Vice Chair EDWARD M. KENNEDY, Massachusetts MAURICE D. HINCHEY, New York JEFF BINGAMAN, New Mexico BARON P. HILL, Indiana AMY KLOBUCHAR, Minnesota LORETTA SANCHEZ, California ROBERT P. CASEY, JR., Pennsylvania ELIJAH E. CUMMINGS, Maryland JIM WEBB, Virginia LLOYD DOGGETT, Texas SAM BROWNBACK, Kansas JIM SAXTON, New Jersey, Ranking Minority JOHN E. SUNUNU, New Hampshire KEVIN BRADY, Texas JIM DEMINT, South Carolina PHIL ENGLISH, Pennsylvania ROBERT F. BENNETT, Utah RON PAUL, Texas MICHAEL LASKAWY, Executive Director CHRISTOPHER J. FRENZE, Republican Staff Director (II) VerDate 11-MAY-2000 13:50 Jan 22, 2008 Jkt 038426 PO 00000 Frm 00002 Fmt 5904 Sfmt 5904 C:\JEC\38426.TXT CELINA PsN: CELINA C O N T E N T S OPENING STATEMENT OF MEMBERS Hon. Charles E. Schumer, Chairman, a U.S. Senator from New York ............... 1 Hon. Carolyn B. Maloney, Vice Chair, a U.S. Representative from New York .. 4 WITNESSES Statement of Hon. Peter R. Orszag, Director, Congressional Budget Office ...... 7 Statement of Dr. Robert J. Shiller, Stanley B. Resor Professor of Economics, Yale University ..................................................................................................... 9 Statement of Martin Eakes, CEO, Center for Responsible Lending ................... 11 Statement of Alex J. Pollock, Resident Fellow, American Enterprise Institute . 13 SUBMISSIONS FOR THE RECORD Prepared statement of Senator Charles E. Schumer, Chairman ......................... 41 Prepared statement of Representative Carolyn B. Maloney, Vice Chair ............ 48 Prepared statement of Hon. Peter R. Orszag, Director, CBO .............................. 48 Prepared statement of Dr. Robert J. Shiller, Stanley B. Resor Professor of Economics and Professor of Finance, Yale University; Co-founder and Chief Economist, MacroMarkets LLC; Research Associate, National Bureau of Economic Research ............................................................................................... 71 Prepared statement of Martin Eakes, CEO, Center for Responsible Lending ... 110 Prepared statement of Alex J. Pollock, Resident Fellow, American Enterprise Institute ................................................................................................................ 141 Prepared statement of Senator Sam Brownback .................................................. 149 (III) VerDate 11-MAY-2000 13:50 Jan 22, 2008 Jkt 038426 PO 00000 Frm 00003 Fmt 5904 Sfmt 5904 C:\JEC\38426.TXT CELINA PsN: CELINA VerDate 11-MAY-2000 13:50 Jan 22, 2008 Jkt 038426 PO 00000 Frm 00004 Fmt 5904 Sfmt 5904 C:\JEC\38426.TXT CELINA PsN: CELINA EVOLUTION OF AN ECONOMIC CRISIS?: THE SUBPRIME LENDING DISASTER AND THE THREAT TO THE BROADER ECONOMY WEDNESDAY, SEPTEMBER 19, 2007 CONGRESS OF THE UNITED STATES, JOINT ECONOMIC COMMITTEE, Washington, DC The Committee met at 9:37 a.m. in Room 216 of the Hart Senate Office Building, the Honorable Charles E. Schumer, and Vice Chair Carolyn B. Maloney, presiding. Senators Present: Brownback and Schumer. Representatives Present: Cummings, Hill, Hinchey, Maloney, and Loretta Sanchez. Staff Members Present: Christina Baumgardner, Katie Beirne, Ted Boll, Barry Dexter, Stephanie Dreyer, Chris Frenze, Nan Gib- son, Colleen Healy, Marc Jarsulic, Aaron Kabaker, Israel Klein, Michael Laskawy, Zachary Luck, Robert O’Quinn, Jeff Schlagenhauf, Robert Weingart, Adam Wilson, Jeff Wrase, and Adam Yoffie. OPENING STATEMENT OF HON. CHARLES E. SCHUMER, CHAIRMAN, A U.S. SENATOR FROM NEW YORK Chairman Schumer. The hearing will come to order. I’d like to welcome my fellow Committee members, our witnesses, and guests here today for this very important hearing on the impact of the subprime mortgage meltdown on the broader economy. My colleagues and I on this Committee have been concerned for months about the dangers to the American economy as a result of widespread, unscrupulous subprime lending, and the economic news in the last 6 months has disappointedly confirmed those fears. Despite all the reassuring statements we’ve heard from the Ad- ministration that the impact of this mess would be, quote, ‘‘con- tained,’’ it hasn’t been contained but has been a contagion that has spread to too many sectors of the economy. We’ve seen it most clearly in the financial markets. This sum- mer’s credit crunch was, in large measure, attributable to the col- lapse of the U.S. subprime market. It shook Wall Street and required the emergency intervention of central banks throughout the world to restore liquidity to inter- national credit markets. (1) VerDate 11-MAY-2000 13:50 Jan 22, 2008 Jkt 038426 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 C:\JEC\38426.TXT CELINA PsN: CELINA 2 The news outside the financial markets, while not so stark, hasn’t been much better. We all saw the anemic jobs report. For the first time in 4 years, the economy actually lost jobs. Consumer spending, the engine behind much of recent economic growth, has begun to slow down. Most economists have already lowered their weak expectations about GDP growth even further, and for the first time in years, the R-word, recession, is being dis- cussed far and wide as a real possibility. And we know that the worst is still yet to come, as the riskiest subprime loans will begin to reset in a very weak housing market over the coming months. This morning we heard that housing construction fell to its slow- est pace in 12 years. The collapse in housing investment has al- ready shaved nearly a full point off of GDP growth. The inventory of unsold homes already stands at record levels. Builder confidence has sunk to record lows. In many parts of the country, real home prices have declined, on a year-to-year basis, for the first time since 1991. If there is anyone left who doubted the repercussions of the subprime mess and the risks to the economy, they should look no further than what the Federal Reserve Open Market Committee did yesterday. In March, Chairman Bernanke came before this Committee and told us that the problems in the subprime market would have little or no impact on the overall economy. Yesterday, the Federal Re- serve cut the Federal Funds Rate by 50 basis points, again, pri- marily in response to the fallout from the subprime crisis and its ramifications. When a conservative Fed drops the interest rate this much, it’s obvious they believe the economy is in trouble, and while yester- day’s rate cut is a welcome indication that the Fed realizes the real risks to our economy, it’s important to recognize that a half-point reduction will do little to get at the deeper underlying problems of our overall economic health, particularly the mortgage markets. It is a temporary solution to a bigger problem and one that must be applied infrequently and with caution. My concern, and the rea- son we’ve called this hearing, is that despite all the bad news, de- spite the sudden calls for action from those who just a few short months ago were assuring us there was little to worry about, I fear that many here in Washington still don’t appreciate the serious- ness of the problem we are facing. Our policy responses are not matching the magnitude of the risk that still lies ahead. And what, exactly, does lie ahead? An estimated 1.7 million foreclosures are predicted to occur in the next 2 to 3 years, due to adjustable-rate mortgages resetting to unaffordable rates. The Center for Responsible Lending has predicted that subprime foreclosures will lead to a net loss in home ownership and a cumu- lative loss of $164 billion in home equity. The lost property values from the spillover effects of these foreclosures could reach up to $300 billion in neighborhoods across the country, and lost property tax revenues alone could exceed $5 billion. These alarming statistics just refer to the direct impact of the crisis. The indirect consequences, such as risks to our broader eco- VerDate 11-MAY-2000 13:50 Jan 22, 2008 Jkt 038426 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 C:\JEC\38426.TXT CELINA PsN: CELINA 3 nomic growth, household wealth, the health of our financial mar- kets, and our relationship with global markets, are still unknown. I hope that today’s hearing will at least serve to clarify some of the dangers of the cloud on our economic horizon. One of the gravest dangers we face, as we will hear from Pro- fessor Shiller, is that we’re witnessing the bursting of a speculative bubble in the housing market that will impact all families, not just subprime borrowers. If, as Professor Shiller suggests, significant real nationwide hous- ing price declines are on the horizon, we face the very real possi- bility that the housing market could drag the economy down with it. Our country simply can’t afford a slowdown in economic growth. When income inequality is at historic highs, deficits are looming, and investments in critical infrastructure are drying up, economic growth is our best hope for righting past policy wrongs and getting our country back on track. Despite all of this bad news, the good news is that workable solu- tions are out there and we have time to put them in place to limit the damage.
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