Excerpt from 2/14/08 testimony before the Senate Banking Committee by Federal Reserve Chairman Ben S. Bernanke and US Treasury Secretary Henry M. Paulson Jr.: Let me begin, if I can, with our witnesses. When this problem first began to emerge, of course, I think it was expressed by some of you here at the witness table, I think many people certainly hoped that this problem would be contained within the housing sector -- be limited to that. DODD: Obviously, we're learning, as each week and month goes by, that this problem is spreading. And I think your testimony this morning reflects the recognition of that. It's been deeply troubling, just -- and I'm sure my colleagues from New York and New Jersey are going to want to focus on this as well -- but I couldn't help but note yesterday the lead story in the Wall Street Journal, talking about how this credit crunch issue now could affect student loans; that some number of colleges in the state of Michigan may be adversely affected as a result of the lack of availability of credit, forcing families to rethink how they're going to finance their children's education. The decline in home value, certainly -- we've seen the -- as I mentioned in my opening comments -- the first time since the Great Depression we've had nationally a decline in values occurring. And the predictions of where those values may go, literally, as people are watching their values are declining, that equity they have built up over the years, with the hopes of utilizing that equity, for many different ideas, certainly not the least of which is possibly to finance their children's higher education, is certainly disappearing. So that pressure is mounting here, both the availability of credit and the lack of equity in homes. Then this morning's news about the headline, "Train Pulls Out of New Corner of Debt Market," talking about the Port Authorities of New Jersey and New York, that increase from 4.2 percent to 20 percent, raising the interest -- weekly interest rates to something around $300,000. This is one example. I presume there are many more around the country that just, once again, highlight how this is expanding, this problem, beyond just a housing issue. And so my first basic question is, what are you going to do about it? I mean, this is a -- what are we going to do about it? What are we going to do about it? This is not an issue that can -- we can discuss it, and the details of it, but this is growing. Should parents, for instance, be thinking about alternative means of financing their children's education, as a result of this credit crunch and student loan availability? Is it that serious, here? And I'd be very interested in hearing some response as to what you think else can be done, what actions Congress should or should not be taking, what steps further the administration could be taking, and what admonitions or warnings should be given to the American public? As we try to rebuild that confidence, it's also important, I think, at hours like this, that we express to them the steps they ought to be thinking about, in light of some of these facts we're seeing. BERNANKE: Mr. Chairman, the examples that you're referring to illustrate the complex chains of causality that we're seeing promulgating throughout the financial markets at this point. The sequence in this event is that the losses in housing affected the value of CDOs, which in turn has hurt the bond insurance corporations, which in turn has reduced the value of their guarantees for these particular securities that make up municipal bonds and student loans, and has disrupted that market, as you point out. So there's this very complex chain. I think, with respect to municipal bonds and student loans, the good news is that the underlying quality of those credits is generally very good. No one is really doubting that the Port Authority's credit quality is any worse than it was before -- thinking that it was worse than it was before. So I don't think that this is a long-term situation. I think it's going to require some adjustment, some rethinking, in terms of how best to market these securities in ways that will be attractive to investors. So it illustrates, though, the unexpected effects and consequences. I think the best thing we can do -- there are a whole number of measures that we can do, but, from the Federal Reserve's point of view, one of the best things we can do, of course, is to try and maintain a strong economy that will help cause, eventually, stabilization in the housing market, stabilization in the credit markets. And that will allow these unexpected consequences to reverse themselves. DODD: Mr. Secretary? PAULSON: Yes, I very much agree with that. And just make a couple of additional points here. What we're seeing is, as -- although it was subprime that maybe produced the spark that created -- that got this going, that we had a dry forest out there, because for some time we had a lot of -- we had seemingly excess liquidity, low levels of inflation around the world, and investors reached for yield and mispriced risk in a number of markets. And so now what we're seeing is a reaction, and the areas of the market that are under the most stress today are those that are the most complex products or, you know, auction products for municipals, preferreds and so on. The example you've given is one that will resolve itself pretty easily, because, you know, the Port Authority will refinance, they won't pay 20 percent interest rates. But it's indicative of a broader problem. And, to me, in addition to what the chairman said, the other thing that needs to be done is we need to keep encouraging our financial institutions to recognize their losses, let the market work, and raise capital. And if there's any doubt they need capital, they need to go and raise capital, recapitalize, so that they've got the capital base they need so they will -- we don't want to see them shrink their balance sheets and pull back from doing the things they need to do in the economy. So, again, as risk is being repriced, these things aren't pretty while you're going through them, but these adjustments are necessary. And I believe the markets are going to work. But, again, if we do anything, it's encouraging institutions to recognize the losses, realize the losses, raise capital. DODD: What about the student loan issue here? Is it the same answer -- would you have the same answer regarding the availability of student loans? PAULSON: I would say, Mr. Chairman, believe it's the same answer, but this is something we're looking at carefully. I mean, this is -- this is -- I think the underlying credits -- I agree with the chairman -- are good. PAULSON: But there have been a number of changes, regulatory changes, others, that have impacted some of these companies. They've got reduced profit margins. There are a number of things working here. And so, this is something that, you know, we at Treasury are going to look at very carefully in the next couple of months. But I agree with the chairman's general comments. DODD: Is it a legitimate matter of concern, however, in light of what we've said here? PAULSON: Of course. Of course. You know, all of these -- every one of these issues, as we work our way through the markets, impact real people. So we're talking about them in terms of the institutions and the markets, but they impact real people. And even when we're talking about things like some of these auction preferreds and municipal auctions, that a -- if the auction fails and there's a 20 percent interest rate, then there will be a refinancing. There will be some auctions that may fail where there's a lower interest rate, there won't be a refinancing, and individual investors will end up losing money. So, yes, they're all legitimate concerns, and student loans is something that we need to watch very carefully.