Paul Volcker statement beore the Joint Economic Committee

[RedEarth]

TATEMENT OF PAUL A. VOLCKER
BEFORE THE JOINT ECONOMIC COMMITTEE
WASHINGTON, DC FEBRUARY 26, 2009

Madame Chairwoman and Members of the Joint Economic Committee:

It is no secret that we are living in a difficult time for the economy, with unprecedented complexities,
complications and risks for financial markets and financial institutions. You have entitled this hearing “Restoring the Economy: Strategies for Short-term and Long-term change”.

I appreciate the invitation to address those issues, but I am sure you understand that any brief statement may elicit as many questions as answers. In the circumstances, I will proceed by making a few points that I consider highly relevant in the effort to achieve recovery, greater stability, and protection against a future financial crisis. We must not again leave the markets so vulnerable that a breakdown will again threaten the national and world economies.

1. My first point is to emphasize an essential longer-term reality.

The present crisis grew out a serious andunsustainable imbalance in the United States and world

economies. Specifically, over recent years, until theoutset of the recession, Americans spent more than ourcountry produced or was capable of producing at fullemployment. That spending, reflected in exceptionally highlevels of consumption generally and in housing inparticular, was made possible by a high level of imports, acollapse in personal savings, and large trade and currentaccount deficits. The consequence was the nation becamedependent on borrowing abroad hundreds of billions ofdollars a year.

For a while it was all quite comfortable. Imports fromChina and elsewhere satisfied our strong consumption proclivities without inflationary pressures. China, Japanand other countries were eager to export and willing toacquire and hold trillions of U.S. dollars, keeping ourcurrency strong and helping to keep our interest rates low.

The trouble was it could not last. The process came tobe dependent upon an enormous build-up of domestic as well as international debt, facilitated by the low interest rates and sense of “easy money”. The bulk of that debt came to be mortgage-related. It was supported by the strong increase in housing prices, giving the illusion of wealthcreation. When housing prices leveled off and then declined, the weakest mortgages – so-called subprime – cameunder pressure, and the highly engineered over-extended financial structure began to unravel. As the financialcrisis broadened, the recession was triggered.

I repeat that story because the first and most fundamental lesson of the crisis is that future policy should be alert to, and take appropriate measures to dealwith, persistent and ultimately destabilizing economic imbalances. I realize that is a large and continuing challenge of international as well as domestic proportions, but it is the essence of prudent economic management.

2. Secondly, I turn to the problem in financialmarkets. The rising debt, particularly mortgage credit, wasfacilitated and extended by the modern alchemy of financial

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