previous directive and issuing a directive to increase it to 10%. i guess the first question is if we've already studied it, why are we studying it again? >> well, i don't think we should ever stop evaluating issues. i was not a party to the study that was done before. we obviously are taking that study and any conclusions that it reached into account and reaching our conclusion but we've been very transparent in

seeking input about how these gdps should be set, what criteria should be applied in setting the gdp. should it be just about protecting against the risk that we are -- that fannie and freddie are assuming, should it be about capital formation, should it be about attracting private capital? the process has been very transparent, and -- >> so you decided to study it again. >> yes. >> the process that the gentleman from new jersey brought is an issue i'm interested in as well. in fact, i had conversations with your predecessor in that there are some states that have very very stringent foreclosure procedures that in many cases

keep the people who are in good faith, gets them not much for the property sometimes years. that is a higher risk to those entities and those foreclosure rules are very consumer oriented. i'm not opposed to those states deciding that, i think that's their right. but i think what they have to also understand is when you make it so consumer oriented in that you penalize the people that are loaning the money and causing losses. what we've seen in many of those states where it's very difficult to get your property back, those properties were stripped of windows and sinks. so i just want to say to you that i think pricing your gps on risk is important. now, one of the things that you were -- what you allude to in your report -- i mean your written testimony and you brought it up as well is you've been doing some risk

transferring. so i guess the question is, if you're not taking a risk you don't have to transfer it. but i wondered if you could give the committee some idea of how many basis points it's costing to transfer that risk? what is the pricing on those transactions that you're doing that would -- if you could give us some idea of what it's costing to reinsure those risks. >> i can't tell you in basis points, but i can tell you that one of the criteria that is always applied is that a risk transfer must be done in a commercially reasonable manner, and it can't be just giving away assets because that would be inconsistent with our conserve and preserve mandate under the

conservative aspect. >> fannie and freddie need to make a profit, but there is really no market, forces in place there to determine what the value of these entities are. and so the question is if you are transferring that risk, it would be helpful for us to know that, because that should also influence what your gp price is going to be. >> we have that information. i don't mean to suggest that we don't have that information, we have the information on every risk transfer transaction that has been undertaken, because what the model says the value was, what fannie and freddie made on the transactions, we have that information but you're asking me what are the number of basis points. that's information i wouldn't have off the top of my head but we can provide more information to you if that's what you need. >> i would like that. final point i would make is that on the down payment, i think

it's kind of ironic -- maybe erroneous, too but it's ironic that we made fha go down to 5% and the two of you seem to be wanting to see how much market share you can get so you have fha going to 3% down payment when they have a 3.5% down payment. >> first of all, we are not in competition with fha. >> sure, you are. >> we're not. the market is going to go to whoever gives them the best deal, we know that, but we're not competing with fha we're trying to provide liquidity in the market, which is what our mandate says we're supposed to do. >> the time for the gentlemen has expired. the chair now recognizes the gentleman from georgia, mr. scott. >> thank you mr. chairman, and

welcome welcome. i feel good and i feel proud to see you sitting where you're sitting and doing what you're doing for the people of this nation. congratulations. i think you're doing a great job. i would like to talk first about the national housing trust fund. i'd like to clear up some things so that folks will understand. first of all, both you and i were here sitting on this committee when none other than george w. bush authorized. he authorized the housing trust fund. and if you recall when he authorized it he said that this is perhaps the best tool that we could use to help get housing for our most vulnerable

population. so i want to set the record straight that this is both a democratic and a republican initiative. and secondly you have moved to reinstate the payment largely following the orders of us in congress. because we -- during the economic recovery we put three criteria in for spending it. those criteria now no longer exist for the gses, so you are operating on this trust fund within the authority, first of all, that president george bush gave you, and secondly what the congress of the united states reinforced. i just want to make sure that is

clear. now i want to talk about one other thing because i think it's very important and that is principal reduction. that is really at the core of helping people and all the evidence is in that that is the case. recently you went to -- and that's another thing i want to commend you for, because you go out where the problems are. you've been out in the nation. you've been to atlanta, and we certainly appreciate that you're there with the heart program. but you went to detroit where this problem is very pronounced. and i think you articulated there your concern about being able to use the necessary tools for principal reduction. i think that that is the core of

it. would you mind addressing that within the light of what you said and how important principal reduction is? >> well, allow me to go back to a point i made with representative nugenbotham. this is one of those issues i've received a lot of second guessing about, because there was a study done about principal reduction before i got the fo fhfa also. i haven't done principal reductions, either. we're still studying that issue just like we're still studying the gp issue. what we're trying to do on principal reduction is find a place where it is beneficial to borrowers and not negatively net presence value to fannie and

freddie, all right? and there are some instances in which that is the case. it's beneficial to borrowers and not negative to fannie and freddie, and when we find that niche, that's when we're going to make a decision about this. now, in detroit, we are under the neighborhood stabilization initiative testing some things there to see where that sweet spot is because if you have a whole neighborhood that's sitting there with vacant properties, half of the properties vacant, it pulls down the value of the other properties in that neighborhood.

so we're trying to find something that will work for the enterprises and for bordtthe borrowers. >> the time for the gentlemen has expired. the chair now recognizes the gentleman from missouri. >> thank you for being here. we're glad you're here today. to follow up on a couple comments with regards to the capital that you have in your gses and the ability to provide stability. you know one of the things i'm looking at here as i read through this is, you know your past dues in fannie mae and freddie mac right now is less than 2% for both of them, so that's good. is my microphone not on?

>> i hear you, but i'm having a little trouble picking up all of you. >> i'll hold the microphone closer. i apologize. your past dues for fannie and freddie is a little under 2% right now, which is very good but your capital is at .4%. you're supposed to be at 2. so i guess my question is -- in your testimony you say enterprise does not have the ability to build capital internally and maintain a con conservatorship. do you have any assets coming in? how do you solve the problem of having enough capital to absorb the loss is my question. >> we can't build up capital because we are operating under a preferred stock purchase agreement with treasury in con

conservatorship that sweeps all the profits fannie and freddie make to profits. that was to keep fannie and freddie from going into bankruptcy. >> when bad debt losses occur where do you take those losses? do you eventually go to the treasurer and ask them to write a check? >> that's what would happen under the preferred stock purchase agreement. basically the taxpayers are backing fannie and freddie, and they will be until gse reform and we don't do gse reform. >> in my income figures, i assume part of that is also the settlement of lawsuits from

different entities? what's >> what's pending now, there are two more lawsuits pending -- >> when you win those lawsuits, will the dollars go to the capital account or to the treasury? >> they will go into freddie and fannie's account, and if at the end of the year, there are profits, they will be swept to treasury, yes. >> very good. one of the concerns that i have also is with regards to the way that you're pricing things and the way that you are changing some of your rules and regulations. having been loaning money for 35 years, i can tell you there are certain tenets of lending you can't get away from no matter how much you want to do it. it's a risk, just that simple. people can say i can tweak here, tweak there. i'm sorry, it doesn't work. after 35 years stumbling over

there, there are certain tenets that have to be there, that's it. my concern is when we change these things and we loosen rules up, as you've seen over the last six years fannie and freddie have had a resurgence. they are actually now turning a profit. so why in the world do you go back now? i want to change those to loosen it up and head down the same path you were on before. >> you're absolutely right. we are in the risk business and there is no way to get away from risk. you can make any loan at some point can become risky. so what you do on every loan that you -- that we back we try to set what other risks are associated with this loan and we try to minimize those risks? now, you can't eliminate risk -- >> with all due respect i have one more question and i see my

time is about up here. in your testimony, you also want to try to move a lot of stuff to the private sector and i think that that's laudible. that's a thing we need to be doing. my concern is, though, if you continue to compete with the private sector by lowering guarantees, by loosening lending standards, it makes it more difficult for the private sector to step in and do that. would you agree with that statement? >> i agree with it generally, but at the same time our responsibility is to assure a liquid housing market in the interim. we are balancing risk and availability of housing finance which is what i said in my opening statement. >> the time of the gentlemen has expired. the chair now recognizes the gentleman from texas.

>> thank you mr. chairman. it's been a privilege to serve with you over a decade in congress. you are always the voice of reason, and i see you continue to be that voice of reason. i would like to talk to you about a fico score that the gses are required to adhere to. other than current fico standards, we have a circumstance that allows bad credit for utility and rental payment to be utilized when ascertaining a score but the good credit one has for the very same utilities and rental payments is not utilized. i'm mentioning this to you because i think we need a more inclusive model. i'm not talking about doing anything that would in any way impair or prevent a good fico

score from being developed, i just think it's fair we use this term fairness this morning, it seems fair to me that if you're going to use the adverse information that we should use that information in a positive way when it is available for a score. these fico scores, as you know, are everything when it comes to getting a loan. could you please just give me a bit of intelligence on this in terms of how we might work with your office to try to expand and have a more inclusive credit scoring model? >> director, is your microphone on? >> did it go off? >> if you could pull it a little closer to you, please. >> would you add 30 seconds of my time, please? >> i'll consider it.

thank you, mr. chair. there are alternative credit scoring models that are beginning to be out there now. fico is updating its credit scoring model, vantage has a credit scoring model. there are several. and what we've done in this year's 2015 scorecard is we've instructed fannie and freddie to evaluate these alternative credit score models to see if we can get to a better place in this area. not a race to the bottom. we don't want credit scores that get more people the ability to get loans and are not reliable so we asked them to evaluate the reliability of it. we asked them to evaluate the

operational challenges that would go with implementing alternative credit scoring models. so this is an area that we're working aggressively on this year. we started last year in response -- well, not in response, but a number of people on this committee have written to me about alternative credit scoring models both on the republican side and the democratic side. it's not a partisan issue. so we're trying to figure out how we can do this but do it in a reliable way and in a way that operationally doesn't create angst in the entire market. because what we do in this space could have some significant implications. >> well, thank you for exploring the possibility, because i concur with you, there are alternative models that seem to indicate that we had some opportunity.

let me move quickly to the housing trust fund, because i think it's important for us to explain that when we -- and you were here when we developed the formula, if you will we put a trigger in. and that trigger was placed there to prevent a person who might be in your position who might have opinions that would vary from what we thought the law should require. so the trigger requires that we not fund because of circumstances, and then it requires that we do fund because of circumstances. it allows circumstances to dictate the actions of the director as opposed to the will of the director. i think it was a pretty good idea then. it seems like it's a pretty good idea now to take the director to the extent that you can, out of play and this is no disrespect to you, it's just that we were trying to protect the process that could help people that i have seen

represented, people who don't have the same asset liquidity as others. >> a brief answer, please. >> i'm happy to follow the policy that was written, and that's exactly what we've done. and i stand by that. >> the time of the gentlemen is expired. the chair now recognizes the gentleman from california mr. royce. >> director, congratulations. good to see you again. >> thank you. good to see you again. >> as you know, my concerns have always gone to these issues of moral hazard and overleverage, whether it was a republican administration or a democratic administration. but i think until 2007 we probably could have considered some of my concerns hypothetical or philosophical. but after '07 i think that overleverage issue sort of proved a point. and looking at the headlines

the headlines read government keeps pushing mortgage guarantees as risk index rises. here's another headline. fhfa orders gses to start supporting affordable housing trust fund. surprisingly the year here is not 2005, it's 2015. and so we find the fha today engaged in this race with fannie and freddie to see who can more swiftly crowd out the private sector, who can assume more risk on behalf of the american taxpayer. and i would just point out that in my view this is kind of a frightening race. we've seen it before. the fha has joined sort of a moral hazard problem here, and in december, you announced that the gses should begin to put more money into the coffers of

advocacy groups through the housing trust fund established under the housing and economic recovery act and you made this move despite the fact that fannie and freddie have yet to repay a lot of the money through the american people. we can argue about whether it's 200 billion or -- but there was a lot of money lost at the end of the day because of overleverage. so it is difficult to see how you can argue that as it is required by law, the gses are financially stable enough to begin the transfer of money to housing groups. let me show you the ratios here and i think this was pointed out earlier. fannie mae leveraged at 341 to 1. that's a capital ratio of 2.9%. freddie mac, 153 to 1 and an equally concerning leverage ratio of 4.56%.

a decade ago i was arguing about 100 to 1 ratios this is in excess of that. you said earlier in this hearing the leverage ratio is not something the statute requires you to look at when suspending allocations. i've got a different reading of that statute that i'll share with you. what the statute requires is that you shall expand allocations, not may. the statute reads, shall suspend allocations if they would contribute to the financial instability of the enterprise or would cause the enterprise to be classified as undercapitalized. so in reality, the statistics cited earlier do come into play, so director how can the enterprises be in this state with these leverage rash oedstiosratios, in one case 343 to 1, and not be deemed unstable and

undercapitalized? that's my question. >> first of all, we put in place provincial stops if circumstances go in the other direction. if we ever have a draw on the treasury, that would automatically stop funding of the housing trust fund. >> but it's already undercapital undercapitalized undercapitalized, is the point i'm making. >> well, when fannie and freddie were put into conservatorship and the preferred stock agreements were entered into with treasury, that suspended the capital of fannie and freddie. now, if we were building up capital, i understand exactly what you're saying. but those two criteria don't apply anymore because they are in conservatorship, every dime

is going to the taxpayers if there is a profit. >> there is statutory language here that requires an end to the allocations. i think it's very straightforward, but i'll close with this. today i, along with many of my republican colleagues will reintroduce the payback to taxpayers act, and this bill will ensure that money coming in from the gses will go to the taxpayers. in other words, will go to address this issue instead of being diverted to the housing trust fund. but thank you, director. good to see you again. >> the time of the gentleman has expired. the chair now recognizes the gentleman from missouri mr. cleaver, ranking member of our housing subcommittee. >> thank you, mr. chairman. thank you for being here, mr. watt. there's been a lot of discussion about the 3% down and i'm not

sure if the suggestion is that 3% down is reckless. i was looking at a study. the va had a 0% down and a lower foreclosure rate than the prime lenders. so is there any evidence that 3% is going to cause more foreclosures if 0% is not causing foreclosure, and what is it about 0 to 3 that creates this problem? >> i think, representative cleaver, the challenge is to look at lenders. when the down payment is lower there is potential it could be a risky loan. but when you pair that with other compensating factors which this product does you

offset that additional risk. and that's exactly what we've done. lending is about assessing the ability of people to pay. and what most people don't realize, even probably 90% of the people who are under water have no equity in their mortgage at this point are continuing to pay their mortgages, right? that's not a criteria whether somebody is going to pay whether you've got 3% 10% -- you know. it's about whether you want to have a home that you own, right? and so you assess those criteria and there are substantial studies that confirm that home ownership counseling makes people better borrowers, more

reliable borrowers. this program -- that's one of the compensating factors. and if all else fails you've got to have private mortgage insurance to back the loan. so it's not as if we've created a risk in situations, these are not the loans that have no documentation, no -- you know recess after 90 days or three years. these are not risky loans and we have made that assessment based on research. not based on politics, based on research we have made that assessment, and i stand behind this decision. that's why i'm happy to come here and have the opportunity to talk about the prudential

compensating factors we have put around this thing to make sure you all understand that my philosophy has not changed. if somebody cannot pay a loan, they shouldn't be given the loan. if you look down there and say, this person can't pay this loan it would be irresponsible for us to say that we should be making loans to those people or that fannie and freddie should be backing those loans. >> i think i heard you clearly. quick question. let's remove the philosophical issues if people want to connect that to the loan. the economy is not healing for some people. we still have stagnant wages. in fact, hourly wages are actually ticking down in terms of keeping up with inflation. so if we are having stagnant

wages and we're trying to heal the economy, and housing is a significant part of healing the economy, having a housing market that's healthy, does it make sense, then, for us to put interest rates and down payments high when we're trying to get the housing industry healed? can we heal the housing industry without getting more people to buy houses people who qualify, creditworthy people? is there any other way to do it, to get people to buy more housing without making it affordable? >> congress has given us a mandate. do lending back loans that are safe and sound and provide liquidity in the market. we are constantly balancing those two objectives. that's what we're in business to do and that's what we plan to continue. >> the time of the gentleman has

expired. the chair now recognizes the gentleman from michigan monetary and trade policy committee. >> thank you mr. chairman, and welcome back to a prior home turf while ours is in much needed repair. almost two years ago, i had a chance to ask your predecessor, mr. demarco, did fhfa's intentions as it related to new regulations in the lender place insurance market, the lpi market and i urged director demarco to make sure any recommendations met an open marketplace for providers of lpi, and for, more importantly the consumers which in turn would produce potentially lower prices for these consumers. can you please provide the committee with any kind of update in this particular area that has gone on? i know at that time he was looking at the rule.

>> first of all, acting director demarco is to be commended and fhfa is to be commended for getting into this phase because there was a lot of abuse going on. there were virtually no controls controls, and fhfa addressed some of those inappropriate practices by directing the enterprises to prohibit servicers from receiving compensation in the form of commissions for placing insurance, because there was a financial incentive for placing insurance in these circumstances with affiliates or people who were paying commissions. and we've formed a working group

because this is an issue that is not only an fhfa issue, it impacts everybody who has a mortgage in this country. and we've set up a regulatory working group consisting of 14 insurance regulators the national association of insurance commissioners and eight federal regulatory agency representatives to try to figure out how best to attack this problem. >> and when was that formed? >> i beg your pardon? >> when was that formed? >> that was formed in 2013. >> and is there a status update? >> they've had seven -- eight -- seven meetings up to this point, and in the meantime things have improved because of these interim requirements we imposed

on fannie and freddie, but we are continuing to work on a set of guidelines that would apply across the whole -- >> do you have a timeline of when that would be completed? i think anything that's in limbo like that probably needs to get wrapped up. >> it's hard to set a time frame on a lot of these things as you've noticed. but we're going to do it. as soon as they come out with a set of regulations. we're vaultevaluating those. >> they have not come up with those recommendations as of yet? >> it's in the 2014 scorecard, so we expect that to happen sometime during this year. >> all right. we'll follow up on that. i'm going to ask you a question as i was going back over some of the testimony. i'm going to ask you a question that i asked mr. demarco as

well. is a 30-year mortgage necessary and why? >> now you got me into congressional territory. i think that's a decision that really is more appropriately made. i can tell you that demographics are changing. people are a lot more mobile than they used to be. and a 30-year mortgage would help people pay for the same place for 30 years and it would help you get a lower payment. there are a lot of factors that go into that, but that's not a decision that fhfa is going to make, that's a decision more appropriately made in the

legislative context. >> personally, i think it might be the private marketplace. i don't know if you're aware of this but i'm going to quote this. the methuselah of home prices has arrived. that makes me nervous. thank you. >> we don't allow freddie and fannie to back those mortgages. 30 years is our limit. >> that's one of the first times i agree with you. i was about to give you more time. instead we will turn to the gentleman from texas recognized for five minutes. >> thank you mr. chairman. i was in another committee where we were reorganizing. i will say good morning and welcome to my fellow colleague,

mr. mel watt, for giving us an update on the changes to the housing finance system and fhfa's role going forward. i believe that fannie mae and freddie mac share very important goals such as ensuring liquidity in the mortgage market and promoting home ownership. however, due to their financial trouble in recent years, we have seen attempts to not just refund them but wind them down completely and i don't agree with that. i would like to go right into the questions and director watt last year to president obama made remarks that he would like to see freddie mac and fannie mae wind down and we be backed by insurance. could you tell us where we stand on that proposal, and do you think that would positively or negatively affect the home buying market?

>> that is a subject that i am not going to express an opinion about. that's a legislative, congressional decision, and to just kind of put it in perspective, when i got to fhfa, there were multiple issues abused about gse reform. i kind of took fhfa out of that discussion because we were sending mixed messages. it wasn't part of the statutory mission that fhfa has, which is to, in the present, guarantee liquidity and safety and soundness in the market. that is a congressional decision, not an fhfa. >> i respect your answer but i want to commend you because if fhfa is a conservotorship for

freddie mac and fannie mae, and we thank you for your leadership in being able to make those improvements. i especially like the $38 billion in extra funds that you gave our nation's treasury. i have another question. late last year fannie mae and freddie mac announced new lending outlines designed to help more low income and first time buyers afford homes as well as minimize the reduction of the down payment of a home from 5% to 3%. what other proposals is fhfa looking at to encourage first-time home buyers and how is the agency making people aware of these initiatives that i have mentioned? >> well, we have a number of things already on the books. i don't know that we're looking at any new proposals that i would indicate to you, but we

have homeowner modification programs, we have the program for people who are under water but have been regularly paying their mortgage. and the 97% loan product i think what we've asked fannie and freddie to do is, in this space, evaluate how we can make credit available to creditworthy people and that part of the 2015 scorecard, it was part of the 2014 scorecard. they operate in this area regularly. we evaluate what they propose.

it is all research based and we try to make good, prudent decisions in the interest of safety and soundness and the interest of liquidity in the market. >> i want to make my last question. what steps if any has fhfa taken to ensure that private capital is reentering the market? because i can see some months where the numbers -- the people who are buying new homes or used homes have been going up and suddenly they went down. this is important to be on the private capital reentering the market. >> well, the major way is that we are doing aggressive risk transferring to the private sector. we're not holding on to these loans, we're transferring that risk back into the private sector and we've tripled, quad

rupe rupled the risk transfers since i've been there. >> the chair recognizes the gentleman from wisconsin. >> thank you, mr. chairman and welcome again mr. watt. over the course of your testimony, you have indicated that you're following the law and following the statute, which we appreciate that because we don't always think that laws and statutes are being followed. i want to follow up on mr. royce's line of questioning, like in regard to the funding of the housing trust fund. you're obviously aware of section 2737, and basically we have a discussion about how the gses are capitalized. if they're undercapitalized, you

can't really have a housing trust fund? >> if they're not making capital, i absolutely agree with you. capital is a whole different issue that basically, when the fannie and freddie were put into conservatorship, the capital considerations went away, because basically we don't have necessary capital at this point. >> one of the drawbacks of capital is you don't get to split hairs. you would agree that the language in the statute requires that the gses are well capitalized, not undercapitalized correct? >> before you can fund the housing trust fund you have to find that the gses are not undercapitalized, correct? >> i don't think that's the case. i can't make a decision that would cause the enterprises to

be classified as undercapitalized, but the decision about capital was not on my plate. that was in the letter i wrote that reinstated the contributions. i specifically said that that provision, nor the third provision, was applicable anymore because they were in conservatorship. it was only the first provision that was applicable to my decision. >> can you direct me to the section of the statute that says, unless the gses are in conservatorship? >> well, there is nothing in there that says unless they're in conservatorship. >> where do you come up with that? >> the conservatorship statute tells us what we have to have.

>> is it in section 37b? >> i think the purchase staff agreement trump b2. 1337b doesn't really apply and you have the authority to how's the housing trust fund? >> if i hadn't concluded that, i wouldn't have done it. >> would you mind sending me the legal analysis on that because the statute has been pretty clear and we want to follow the statute for your testimony. if you would help me out, that would be wonderful. just quickly, in regard to the housing trust fund, how is that going to be funded? how is it going to be funded? >> how is it going to be funded? out of the profits of fannie and freddie. >> where do those profits come from? is there any type of surcharge or tax? >> no. in fact, the statute says there cannot be a surcharge to how's

the -- house the housing trust fund, and we have put out a rule that ensures that that does not happen. >> will it guess the fox, do you think r of home purchaseer. we're not allowed to increase the cause to the borrower. >> statutes say a lot of things. sometimes it's applicable, sometimes it's not. >> all the time we try to follow the statute. >> i appreciate that. we sent you a letter with regard to the gses lobbying. this was sent on december 11 and we haven't received a response from you yet. did you receive that letter? >> yes, sir, i did. >> can you expect a response? >> yes, sir, you can. you might have gotten it yesterday, but i thought you all were saying we were doing it just in response to the hearing. we take every inquiry we get

seriously and we try and go and get to the bottom of whatever -- but we will respond. >> are you going to continue the ban on gse lobbying? >> i beg your pardon? >> are you going to continue the ban on gse lobbying? >> absolutely we're going to continue the ban on gse lobbying. >> i yield back. >> the chair now recognizes mr. clay. >> thank you, mr. chairman. welcome back. how is it the family? >> the family is good. >> good, good. thank you. >> it's going to grow. >> thank you for being here. although there are operational costs involved in requiring the gses to update the credit scoring model that they use in their seller service guidelines, the gses are still using the

pricing molgds despite the fact that newer versions, including cycle '08 and '09 are apparently available in the that the failure to compel the gses to use their most updated credit scoring models and their seller service guidelines may not be given the gses the best available assessment of whether a borrower is a good credit risk, and may be unnecessarily restricting credit to eligible borrowers? >> well, your question illustrates the difficulty of this, because to move from fico classic to fico-8 or 9 is the same challenge that we have to move from fico classic to vantage, or some other credit scoring model. so what we've done is in the 2015 scar board, we've

instructed fannie and freddie to evaluate both the feasibility and the operational complexity challenges related to using updated or alternative scoring models. now, feasibility is are these credit scoring models better than the ones that -- fico classic? we think they are. but we have to document that. and then operational feasibility relates to what would it take to change not only fannie and freddie, but the industry to using alternative credit scoring models, because, you know turning that ship is a major task.

>> credit scoring agencies, have they been receptive or have they pushed these new aversions? >> yes, they have. both fico has updated its credit scoring model. and vantage, and others are -- we're regularly talking to them about this. >> i see, all right. let's move over to harp. director watt fhfa recently launched an interactive map showing that there are more than 722,000 eligible households nationwide that could still benefit from harp program that allows certain homeowners with gse backed loans to refinance into mortgages with lower interest rates, thereby reducing their payments by as much as 200 per month while also reducing risk. to the taxpayer by reducing

their likelihood to default on their mortgages. what are you -- what is your agency doing to assure that households are aware of this refinancing program? >> well first of all, we are very proud of that map because it gets you to the people who are eligible for harp refinancing. 3.2, 3 in3 million people have already taken advantage of harp. there are over 700,000 who would still be eligible for it that would get an advantage of taking advantage of it. and we're trying to get to those people. now, let me just emphasize that these are people every single one of them, all 3.3 million of them, have no equity in their homes. their homes are under water. and they have been continuing to

pay their mortgage, despite the fat that they are under water. that takes us back, you know this notion that you got to have a down payment you got to have equity in a house for people to continue to be reliable homeowners and borrowers is just in the face of all of that. so, we're trying to get to those people. we've done a series of meetings around the country and the highest concentrations where those people are and trying to get them to take advantage of the harp refinance program. >> thank you. >> time of the gentleman has expired. the chair now recognizes the gentleman from south carolina, mr. mulvaney. >> thank you. i also appreciate your dedication to following the law, and following statutes of limitation. an example you can set for the rest of the administration. regarding the statutes, i think we've talked a little bit about the statute regarding the suspension. what statute did you rely on in ending the suspensions?

>> the housing trust fund statute. the affordable housing allocations. that's in error. it was reauthorized by congress in error >> correct. okay. >> but that's the statute that says when to suspend correct? there is no statutory guidance for you on how to end a suspension. >> it says the director shall temporarily suspend, i would assume that the word temporarily has an inverse that says you can unsuspend. you know you're technically you may be right that there's no statute that specifically says -- >> let's walk through it. >> but to do this if you unsuspend, but you apply the same criteria to suspend and unsuspend unsuspend, and that's what we did. >> i think that's fair. but by the same token, the mandate to suspend is not -- there's no discretion there. you shall suspend if you find one of these three conditions

correct? >> yeah. and i interpret it the same way. you shall unsuspend if you find that these three things don't apply anymore. >> don't apply. then let's walk through them. it says that they contribute to the financial instability of the enterprise causing undercapitalized or preventing them from doing their capital restoration plan. i heard you say something to mr. duffy earlier which is new, which is reference to the fannie and freddie making a profit. that's not in the statute, right? that's not one of the factors you can consider in making a decision to suspend or end the suspension, is it? >> well number one says are contributing or would contribute to the financial instability of the enterprises. if you are awaiting the financial stability or instability of the enterprises -- >> is fannie stable? >> the primary factor you're looking at is whether they're making money or not. >> oh, really? so whether a bank is making money is the only issue we look at as to whether or not they are

stable. is that what you're saying? if bank of america is making a profit then therefore they must be stable? >> i don't make decisions about bank of america. i'm following the statute was written that applies to the -- on that. >> to the federal housing -- >> is fannie stable? >> we think it is and we built in to the decision to reverse the suspension prudent reasonable safeguards in the event that they go back in the other direction. >> -- will suspend payment i get that. not in the statute, is it? the protection you supposedly put in the letter is not part of the statutory consideration. i hear what you're saying mr. watt. i think it's a good why the but it's not statutory. you can't take the position you're following the statute and go really what we're considering is profitability and don't worry because we put something in the letter that says if we ever have to go back to treasury we'll stop. you're rewriting a law, aren't you? >> well, i'm following the conservatorship statute, representative mulvaney.

>> number two regarding the undercapitalized. i think you've taken the position several times that your agreement with the treasury moots this section. is that fair? >> yes. >> my understanding, again, new to this, is that your agreement with treasury is an agreement, right? >> that's correct. >> how does an agreement trump the law? >> well i think the law got trumped, then we went into a conservativeship, then the taxpayers have to ante up 187 billion dollars, and there has -- and so an agreement was made. that was before i got there. i didn't negotiate the agreement. >> you would agree -- >> the agreement was in place when i became the director -- >> an agreement between one agency and another department of government cannot trump the law. you can't get around the law. >> i absolutely agree with that. right. >> so if the conservativeship

statute doesn't explicitly repeal section b-2, then section b-2 is still valid law. >> i don't agree with that. i mean i understand what you're saying. i just disagree with you. >> if the conservatorship statute doesn't speak to b-2 why is b-2 still not resolved? >> well, it just doesn't apply. we're engaging in a legal argument here that -- >> that's what we're supposed to do though, isn't it? >> if you all didn't want to fund the housing trust fund, you have the authority to stop the funding of the housing trust fund. but don't expect me to disregard the law and do it for you. if you want to do that i mean, that's -- >> we did just that under these certain circumstances we don't think we should be funding the trust fund and all we're asking you to do is follow the law. if you believe it's

undercapitalized or you believe it's unstable then you should stop the payments. i yield back. >> gentleman yields back. chair now recognizes the gentleman from california, mr. sherman, for five minutes. >> -- do you think we could take a two-minute break? >> the chair declares a five-minute recess. we'll go live now to the brookings institution here in washington for a discussion this morning on the rise of china's military and economy, and its implications for u.s. national security and defense spending. foreign policy and military analysts this morning are expect expected to discuss these issues in the context of president obama's so-called rebalanced strategy to the asia pacific region. this is live coverage on c-span3.

good morning, everyone. thank you for coming. i'm mike o'hanlon with brookings center on security and intelligence. we'd like to welcome you to an event on china's rise and its implications for america's strategy and the u.s. defense budget. and i'm joined by a very, very capable and accomplished panel that has different elements of expertise on different aspects of the question. i also see a lot of expertise in the audience. i have no doubt once we get to you we'll have some excellent thoughts and questions from you, as well. our plan for today after i introduce a little bit more about the subject, and my distinguished colleagues here on stage is to have a little bit of a conversation without formal presentations. but beginning by trying to think through the questions that we've put on the table, and then involve you about halfway through, as well. the basic question here that we're trying to get at of

course, is where is china's military today. where is china's military headed in the future? how is china employing its military? more generally, what is china's foreign policy all about? and then once we get some of those pieces on the table, what does it all mean for us in terms of american policy and american strategy, and american defense spending. and, at that latter point i may weigh in a little bit as well as a speaker. but in the first few questions i want to get through some questions, and pose them to my panelists. starting next to me, we have professor bud cole of the naval -- excuse me the national war college but his distinguished career was in the u.s. navy when he was in the armed forces of the united states. he retired as a captain after 30 years of service. he was largely, not exclusively, in the pacific theater, and on surface ships. so he has a great deal of operational experience, but for a couple of decades now, it seems, it's impossible to put all this into one short career but he's done it.

he's been an amazing and prolific author on many aspects of china's military, starting with not only its navy but really more generally its entire force structure. so we're going to look to him for a lot of thinking about where is china's military today and where is it headed. next to him is my good friend and colleague richard bush. who runs our east asia policy center here at brookings. and as many of you know, is a long-standing expert on east asia policy both as a practitioner in the u.s. government, used to work on capitol hill for congressman steve solars. he then worked in the u.s. government largely on taiwan issues for many years, and he's been here at brookings for about 15 years now, working on east asian security. he's just one of the most prolific but also one of the most rigorous and careful and thoughtful scholars on the entire region. so i'm delighted to have him on the panel as well. and next to him is david dollar from our john thornton center on china studies. and david is a former u.s. government official who was based in beijing for a number of years with the u.s. treasury.

is our lead economics and finance person there. prior to his service in the u.s. government, he worked for the world bank, including a long stint on and in china with the world bank, as well. so he will be particularly helpful in thinking through the question of where is china headed in terms of its economy. which, of course is the foundation for national power for military capability for high technology production of weaponry, and for the sense that china's rise creates throughout the region of the world of just where is this country headed and to what extent is it potentially rivalling the united states. the broader perception of china's power and what that does to the diplomatic aspects as well as the military and economic aspects of the region, and how all these things fit together. so, without further ado, what i'd like to do then is walk through a couple of these questions one by one, beginning with dr. cole and asking him just for the few minutes of thought on how you see china's military today. i'll just add, as i think many

of you know, china's military budget, even though it's not denominated in dollars, is estimated at being the equivalent of roughly $150 billion a year. plus or minus let's say 25% to 50% depending on who you're talking to and which methodology you're employing. and in that almost regardless of where in that range it might actually be most properly located, it's easily the world's number two military power behind the united states now by spending. we are certainly in no -- if all of the power were about just spending levels we'd be in no imminent danger of losing our position. because the united states is still spending some $550 billion to $600 billion a year, three to four times china's amount. but, of course much of what we're thinking about is how this all comes together in the western pacific theater specifically. which is china's main focus of its military activities and only one of ours. and so it's a little more complicated than just comparing defense budget levels. so, with that as prelude, dr. cole thank you for being

here. i just love your sense of how you see china's military condition, position, capability, today, and where you think it's headed in the coming years. >> well, thanks very much. i'm delighted to be here this morning. especially to see such a large turnout. the way i usually characterize china's military modernization, which has certainly been significant over the last quarter century is that they're improving at a moderate pace. i don't see any big crash program going on with people's liberation army. having said that, as mike said, where the u.s. military responsibilities are global in nature, china so far has been able to focus primarily on the western pacific, and on asia. and what we have seen in a significant shift is away from an historic chinese concern about threats from mainland asia, to now being able to focus on the maritime realm off the coast of the east and to a certain extent to the southeast. one of the remarkable things about chinese diplomacy in the last quarter century or so is

the way they have resolved their border disputes with everybody except india, really. the land border with vietnam is still a little bit iffy perhaps but it's formally been resolved. so i think what has happened in the chinese military, and most significantly in the last oh, four or five years is a shift in emphasis from the army being the chief beneficiary of budget increases to the navy air force and second artillery. that is the chinese missile forces, receiving the most emphasis in the budget councils. this is a little bit of an interesting situation, because if we look at the command and control of the people's liberation army, it's still very much centered on the army. whereas most of the budget emphasis seems to be shifting to the other services. i think this indicates a shift in the national attention and concern to not only the maritime element, but also the ability to maintain a certain minimum level of nuclear deterrence.

>> if i could ask you how you see what you could have predicted for 2015 if i ask you the same question in 2005 one of the big questions and it affects perception, it's not only how fast are they improving and how good are they today but how does they compare with expectations? the up and down on that was what shapes people's perception. how would you compare where they are today to what you would have predicted five or ten years ago? >> i don't think we should be surprised what we see in china. the large military budget increase has come not so much in my view from a shift in emphasis of national spending from other sectors of the military but rather simply from the fact that the chinese economy has been expanding so impressively that there's simply more money available to the votes in the military. it's within the military that i think we've seen some resource allocation changes. if we look back at history at the rise of various other great powers, i think we should expect

china to be devoting more and more resources to a modern military, in this case a 21st century capable military. >> now, when admiral willard was the head of pacific command he made a statement, i think about 2009, in which he said that china's improvement in its military has exceeded our expectations almost in every category. it sounds like you're a little more restrained in that assessment. am i reading that correctly? >> in general terms, yes. i'm sure if we looked at specific systems or specific capabilities, for instance i'm a little bit surprised at how efficiently they progressed apparently in the area of cruise missiles. but in general terms, i don't think i would sign up for that. >> one last question, which is as you well know the estimate is whatever china's actual military spending level might be most people seem to agree that it's about 2% of their gross domestic product. david may want to comment on this later, as well. do you agree with that number? and then secondly do you see

that as maybe reinforcing your argument that we should interpret their buildup as gradual? because 2% is less than ours. we're at 3.5% still. and it's not particularly big number by historical standards for great powers. >> well the number game is too hard for me to play, frankly. even if we -- even if we know the accurate figures coming out of china on defense spending which we don't, i don't think, again i think that there's still spending at a relatively moderate rate and i think they're doing that deliberately because they're focusing not on trying to match the u.s. for instance missile or missile or shift or shift or tank for tank but they're focusing i think on specific strategic situations. taiwan for instance, as well as the east china sea south china sea, other topics we'll probably get into. >> okay so we'll come back to that in a little bit. richard, please, would love your thoughts on any of what we've been discussing already but especial his on the question of how you see china's behavior in recent years and what we should therefore be taking stock of

ourselves as we think about american policy. >> thank you very much. and i agree with everything that bud has said. let me comment a little bit on military budget. i think specialists believe, first of all that gradually things that have been off budget, or not publicly announced are going on budget. second, the pla was for many many years starved of resources. the regime did not have the resources to give to it. so a lot of this is campup, particularly in the area of pay. third, although we talk about double digit growth, the real growth rate has declined. the best estimate i've seen is from about 11.4% in 2003 to 8.3% in 2012. the defense budget as a share of

gdp in real prices has interestingly stayed in a range of 1.2 % to 1.45% over the last decade. and finally, the share o8 the military budget as a share of state expenditures has declined. now, -- what's important for the united states is the military budget as a share of state expenditures has declined. now, -- what's important for the united states isf the military budget as a share of state expenditures has declined. now, -- what's important for the united states is how these resources are used and what's the effect on our nation ol security and interests. again i think some context is important. first of all we have to recognize objectively that for decade decade a militarily weak china lived in a state of fairly profound insecurity. the united states was there on its doorstep we fought a war in korea, we almost fought in

vietnam, and i think the primary and underlying goal of current defense policy is to reduce that insecurity. not all of china's fears are well-founded. there's an intention -- there's a tendency to misread the intentions of adversaries. there's a tendency to want the other guy to make all the concessions. but the fears have enough of a basis in reality to compel responses, and i think that's what we're seeing. i agree with bob that the primary motivation and focus of china's military buildup since the late 1990s was taiwan. and dealing with what they perceived as the threat of separatism. taiwan independence. and that has given a focus to what they've done. of course, military capabilities are dual use.

and what you can use for title one you can use for other purposes. i think there is a strategic, larger strategic focus to what china is doing. and that is to create more of a strategic perimeter, more strategic depth. china for many years had to think about defending against the united states at the coast. that's a terrible place to have to defend your country. and so, if i were a chinese defense planner i would want to be doing exactly what they're doing. the problem is of course, that space is already occupied. we're there, japan's there, southeast asian countries there. and that's the reason that we will -- we have frictions with

china, and we will continue to have them. then you have natural resource competition, as well. now i don't -- the current worry on everybody's mind, of course, is what's happening in maritime east asia. and as china's military capabilities and law enforcement capabilities have grown it has grown somewhat more aggressive in its actions in the maritime domain. putting japan on the defensive around the senkaku islands, and establishing its presence and strengthening its presence in the various land forms in the south china sea. my own view is that conflict is not inevitable.

how you respond to each little move on china's part is not easy. but, there are other ways to deal with these problems. there is diplomacy in what we've seen in the last six months i think, is a shift away from more coercive actions to more diplomatic ones. including talk about some kind of cvm regime around the senkaku islands. talk about a binding conduct in the south china sea. i think china has realized that its recent behavior has created a great deal of anxiety among its neighbors that's not in china's interest. it's not in china's interest to take on the united states at this point in its development. and so they're backing off. how long this will last? nobody knows. but, you know it is possible

that it will last. and that the military will be kept in the background as a tool of national power. >> if i could follow up with a couple of other questions before i go on to david. one, because we're going to talk about u.s. policy, questions and thoughts from all of you, i'm just trying to establish a good military baseline and you both contributed already to understanding that. but, you both talked about improved capabilities. could you give us a little bit of a sense of some new capability that china has now that it didn't have before in strategic terms? so bud mentioned missile capability, much more precise, much more numerous. what does that mean for china? to what extent could china more effective threaten taiwan than it might have 10 or 15 years ago. do you see a qualitative change that's important strategically? >> toyaiwan is a place where we have seen a change. china's development of long-range precision strike capabilities, particularly ballistic missiles, but also

cruise missiles, and more advanced fighter aircrafts has changed the military calculus across the taiwan strait, it has created a much more formidable deterrent against any effort to separatism. moreover, i think the improvement of china's air and naval capabilities is such that some experts at least, believe that it -- it would be difficult for taiwan to defend itself with what i think was the traditional strategy of trying to establish air and sea control over the taiwan strait.

that would be the preferable strategy, but that may not be possible anymore because of the pla's growing capabilities. >> just one more thing if i could on this before i go on to david, in thinking about china's underlying economic strength and power. you gave a somewhat bear in mind as is characteristic of you, a fair-minded interpretation of why china is building up a military. but i know you also probably have concerns about certain aspects of their behavior, and you hinted at a couple of those. but if i could ask you since we're thinking about what this might mean for u.s. strategy and the u.s. defense budget and so forth, are there any particular areas of chinese behavior that you wish had been different, or particularly concerned about or tread lines that you think we might have to factor in specifically, as we anticipate where american strategy may have to go. >> well the one i worry about the most right now, and i don't worry as much today as i did maybe eight months ago, is the

way in which china rather coercively promotes its claims, both in the east china sea, and south china sea. it's not that i fear that china is going to take the senkaku islands. because once you take them, they're damn hard to hold. and i think the japan's self-defense forces would do a good job in defending them. what i worry about more is a modest clash between the law enforcement cape ands of the two countries, but then spins out of control. because of bad crisis management. because of domestic nationalism. and so something that shouldn't have happened, and shouldn't have been a big deal then becomes a big deal.

and we become involved. >> so in that point, last question, i promise, is to clarify that. i think it's important to make this vivid as we think about where american policy may have to respond you referred to the confidence building measures the cbms, that president obama and president xi worked on in their summit. i want to check with both of you on this point, make sure we get this clear and make sure i'm understanding correctly, as welcome as that is nonetheless it applies to the united states and china, not necessarily japan. and also it applies to navies not necessarily coast guards or the equivalent. and those are really the instruments that have been most involved in the senkaku. do you see those same limitations, both of you? >> i think that china has a very poor record of calculating what a u.s. response would be whether one of the taiwan strait crisis going back to 1950 or what's going on in the south china sea and east china sea. and i worry that the chinese military, maybe even the national command authority in beijing, believes they have the

ability to contain or prevent unintended escalation of the military conflict, military clash. whether it be with the united states or japan. i think that should be a major concern. >> i agree with that. there have been discussions, very recently, between china and japan on various kinds of measures to reduce the risk of the situation in the senkakus. and those, as i understand it, will include coast guards. it's still very much a work in progress. certainly for us but especially for japan and china. but, drawing in china to this kind of discussion is a really good thing. >> so david, i think we're all curious about where china's headed, as well. and we all know whatever it might want to do with its military budget, it's the economy that ultimately provides the foundation, not only for the

size of the budget but for the high technology capacity of the armed forces, just weaponry, and then, of course, it's the progress in the chinese economy that largely shapes the perception in the region and the world of whether china is the rising super power that perhaps relatively speaking or whether this is something that's going to level off. so just welcome your thoughts on the strength of china's economy and where you think it's headed. >> okay thanks. first it's a great pleasure to be here. be the economist listening to this interesting discussion. you probably saw the announcement earlier this year from the imf that in purchasing power and parity terms china has already passed the united states as the biggest economy in the world. and that purchasing power parity calculation is essential if you want to compare living standards across countries. but if you're talking about weight in the world economy i argue you want to measure market exchange rates. on that basis the u.s. economy right now is about 70% bigger

than the chinese economy. right now the numbers are relatively simple. chinese economy is about $10 trillion. u.s. economy is $17 trillion. so u.s. is about 70% bigger. now that gap will certainly narrow. in the near future. chinese growth is slowing down. it's not going to be 10% in real terms as it's been. but i think most analysts accept that if china follows through on reform it has the potential to continue to grow in six or seven segments up to about 2030. a lot of uncertainty. there are downside scenarios. also up and down scenarios for the u.s. many people think the u.s. growth rate. i think the u.s. has the potential to grow at about 3% in real terms. hat all that adds up to is most likely scenario by 2030 china

will be about the same size china's economy will be about the same size as the u.s. economy. 2030. that's a useful way to think about the near future. some people extrapolate the high growth rates further and argue china will be several times bigger than the u.s. economy. personally i think that's very unlikely. i think there are a number of reasons why china's economy is likely to slow down after 2030 even if it's doing well. it's got a lot of challenges, and let me just emphasize one. it's got very severe demographic challenges. so the working-age population has already peaked in china and started to decline. urban labor force will keep growing for awhile because of migration. that's why china will continue to grow well. but after 2030, the population is going to start declining the labor force is going to decline very sharply. between 2030 and 2050, the labor force is projected to decline by 120 million people. so it's quite difficult to

continue to grow well when your labor force is shrinking. all economies need to be adjusting all the time. it's easier if your labor force is growing. the united states is the only advanced economy where the labor force will continue to grow at a healthy rate throughout the century, primarily because of immigration. so after about 2030, it's not obvious to me that the chinese economy will be growing faster than the u.s. economy. you know a lot of uncertainty, a lot depends on what each of these countries, these societies do. but i think looking out further, just as likely the u.s. economy will re-emerge as the biggest economy in the world, later in the century. i think that this is likely as china being the largest economy later in the century. >> quite a remarkable prognostication or at least possibility. >> emphasize a lot of uncertainty. so we're talking about scenarios. >> i want to say, it's nice to be on the panel with you. the last time i was on a panel with you was in taiwan except

you weren't there because you had knee surgery. so richard has to do a vtc and you were about 30 feet high in the room. even when you're not 30 feet high your ideas seem like they are. thank you for that crisp explanation. what i'd like to do now is really just go down the row and ask the second main question. this one is simpler and it's the same for all of you. which really is get the conversation started. the conversation that i know we're going to have with all of you in a few minutes, as well. what should the united states do about the current situation that we see in china. and you've all laid out a number of aspects, military modernization. foreign policy behavior. economic future. prospects for china's long-term growth. what does this mean about the near-term american response? and as you all know the congress and the presidents here on this side of the pacific are going to have to cope with the question of do we tolerate the possibility of a defense budget either being sequestered or held to the sequestration levels which is looming again for fiscal year 2016? 2016 is now only nine months

away in fiscal terms, and regardless of whether we go to sequester or not we're going to still be three times as well endowed in our military budget as the chinese. but the trend lines are getting interesting. and you can now sort of see these two countries' military budgets on the same ground in a way that wasn't so hesitant before. and as david said if people extrapolate far enough out they can make interesting things happen with lines crossing the defense budget maybe even sooner than with gdp depending on who spends more. right now we're spending more than 3% of gdp. richard and david have pointed out, richard particularly, maybe it's more like 1.5% in china. you do the math on the number i gave before, $150 billion divided by the $10 trillion economy that's also 1.5%. so it's much less than ours. but if china's budget were to grow as a percent of gdp and ours continues to decline these could begin to converge to some extent. so the question i really want to

ask all of you is what, if anything, should we do about it in the u.s. defense budget context in the short-term? maybe -- >> can i go first? >> yes, i think you should. >> so i'm not a military strategic kind of person at all. but just thinking intuitively, the most important issue for the u.s. in order to continue to be a leading force in the world is to maintain u.s. share of global gdp. you know there are a lot of reasons why developing countries are growing faster than rich countries. so the u.s. share has a tendency to decline. but that can be very slow. so i just want to make the point that whether the u.s. growing at 2% or 3% may sound like a small difference but if you're looking out toward 2030, 2050, it makes a huge difference. so just briefly things like investing in infrastructure. strengthening education and then immigration is a key factor in u.s. growth and we could reform our immigration policy to make it more rational. so all these smart students who come to the u.s. from around the world, we should make it easy for these people to say if they

want to be entrepreneurs and be productive people. so we can influence our economic growth rate fairly significantly and out 20 30 years it's going to make a huge difference whether the u.s. grows at 2% or 3%. >> if i could link that before going to richard, if i could link that to the u.s. defense debate but also the u.s. budget debate more generally that we're having right now sounds like you're not all that super worried about whether u.s. military budget for 2016 are going to be leaving aside the war supplements are going to be $500 billion or $550 billion. you might be equally concerned about whether we sequester the domestic investment account that you talk about is important for our long-term future. >> just briefly. if there's some kind of -- the u.s. has got a short-term fiscal situation in good shape. so we can afford to spend more money. i'm not a security person but if the compromise is to spend more money on infrastructure, education and defense, within a sustainable fiscal framework, that would be a good compromise. >> i'll say for those of you who

aren't following this in great detail that as you all know this is budget week. it's the friday of budget week and the president put out his budget on monday and alluded to in the state of the union address earlier as i think many of you know what he's trying to do is to increase spending on both domestic and defense discretionary accounts. about 35 billion each. relative to what that budget control act and sequestration level would require if we can't get around that, you know, in existing law. so it's treeing to do what you're suggesting. but of course, the controversy comes in as to how do you pay for it. with defense you always have a safety valve that says you can put more things into the war supplemental and they're not subject to the other tax. and you can play that game to some extent. with nondefense you don't really have that safety valve. so it remains to be seen if the president and congress can agree on a way to pay for these investments that you're calling for. richard over to you.

just love your thoughts of how you feel the u.s. defense debate should reflect all these concerns. >> let me start with the pivot and i think that the pivot isn't a new policy. it's an adaptation of a very old policy. to new circumstances. i think our policy toward asia has been based for decades on an active military economic diplomatic and political presence in the region so that we set the context in which our friends, allies, and potential adversaries make their national defense decisions. we have been in a way the cop on the beat that creates peace in the neighborhood. it's very important for us in the region that we continue to be able to do that.

and so i see sequestration on defense as a critical challenge. and there seems to be a growing consensus the president and republicans on the hill that we need to find some way around it. experience over the last four years, does not make me terribly optimistic that we can get to the goal that we want to achieve. i agree very much with david that we need to strengthen the national power that allowed us to emerge in the 20th century, as a force for peace and stability and pros bertie around the world. within east asia, i think the

most difficult challenge is calibrating our responses to chinese moves in the east china sea and the south china sea so that it, in a way that encourages restraint on china's part and doesn't feel that they can constantly nibble away at the -- nibble away at the current status quo. we may have a bit of a challenge coming up, because taiwan is having an election. about this time next year and that may bring about some changes at least in how china perceives the situation. but i think in summary that we have the capacity to continue to play the kind of role that we have played in the past, and that would be a good thing. whether we have the will to do so and the political system to

express that will is another question. >> to clarify one thing in my understanding, very well stated but i want to make sure i understand one of your messages if sequestration would occur and you're against it but if it were to occur your greater concern might be the signal that it would send about our inability to function effectively as the government and carry out policies that we'd already decided and promised to effect. and maybe less so again i'm trying to be provocative to clarify, maybe less so what it means for specific military programs but more for the sense of our leadership. >> sorry i wasn't clear. it's very important what the signal is. and it is certainly that. both to our friends, and allies, but also to china because that changes the risk calculation of all of us. but i do think that sequestration, if it were continued over an extended period of time the rest of the

whole ten years, it would have an important impact on our ability to continue the policy of forward deployment. which really is the basis of peace and security in the region. sometimes our friends in asia complain that the president of the united states has not shown up at a major meeting. and i understand that. i think it's far more important that the aircraft carrier battle groups show up. if we can't do that, then we're living in a very different world. >> thank you. >> bud over to you. very curious where you think u.s. strategy and budget have to go? >> to expand on something richard said the recent chief of naval operations said if sequestration takes full effect the u.s. navy would no longer be able to maintain the constant presence, the constant series of six to nine month deployments that we followed since roughly i suppose the korean war. but instead, that the battle

groups, the carriers were be home port in the united states, possibly in hawaii one hosted in japan, would only be able to steam out in times of crisis, which of course changes the whole time line and the whole paradigm of how you respond to a crisis. i think that the most likely areas and i'm stealing a page from something ambassador roy and i said a couple years ago, the area of most concern right now and the foreseaable feature are the three seas, the yellow sea, the east china sea and the south china sea. these are areas i believe beijing believes are vital national interest areas to china. and of course the other side of that coin is we have defense agreements with south korea, japan and the philippines. we have a special relationship with taiwan and with singapore and of course we have the treaty with australia. so this is the area that seems to be of most likely conflict. and this is the area where hopefully we can use diplomacy

instead of aircraft carriers to resolve our differences. i think china to a certain extent is planning a a risky game, particularly in the south china sea. and that is when i talk to counterparts out in u.s. military who are stationed in the pacific, they wonder where the threshold is. in other words what were it take china to do in the south china sea to evoke a u.s. military response? i don't know where that threshold is. i'm not privy to that. but it's a relatively dangerous situation and i think it goes back to what i said earlier about beijing's historic inability to accurately calculate the u.s. response of the pacific crisis situation. let me talk just for a minute, though about a difference i think in chinese behavior in the eastern south china sea. it seems to me in the east china sea given the nature of the u.s. commitment to the maintaining japan's claims to the senkakus, which is not one of pfaff winty but one of administrative

control that china is trying to demonstrate that the administrative control by tokyo does not in fact, exist. but in the south china sea on the other hand given the multiplicity and timing i think china is simply moving ahead, building artificial islands simply using military power as they did against the philippines, and i suppose there's a benefit to using ships that the people's liberation army navy ships but the end result is the same. it's usually armed force to enforce your claim. and in the case of the philippines, it's simply the philippines can't object to it at sea. as far as u.s. future strategy is concerned i think our strategy has remained fairly consistent. although i'd argue that the u.s. military strategy has not been clearly delineated as well since perhaps 1986 when the navy came

out with new maritime strategies. i think that's understandable. it's hard to generate a meaningful military strategy when you don't have a very specific single opponent in mind. it was easy to define a military strategy against japan. it was easy to define a military strategy against the soviet union in the cold war. it's not easy to do that now. what the u.s. military is facing right now in the post-iraq and afghanistan years is defining the end, i think, that they want. and what means do they need to reach those ends. it's not an easy solution and in the era of the declining budget, not to mention possible full sequestration, it's a difficult problem to solve. so let me ask one last question about the south china sea, you mentioned in your answer, something michael and others have thought about a great deal so i know this is going to have a lot of participation very soon on this and other questions but this is a good place to i think bring it all together as we wrap up this phase of the event.

what's the u.s. role in the south china sea? because, you've all talked about, especially richard and bud, you talked about u.s. presence being enforced. you haven't talked about i think you probably don't hope for a direct u.s./china conflict. you're not necessarily engaging the u.s. military in terms of how do we make sure we can win the all-out war. maybe that's a consideration but it doesn't sound like it's your main consideration. how do we think about the u.s. role in the south china sea? what is our military and our diplomacy trying to do there? just you know in terms that we can latch onto here as we have the rest of the conversation. >> we do have a defense treaty with the philippines but since it was signed before the philippines laid claim to some of the islands in the south china sea some of the islands i don't believe the u.s. government has ever forthrightly said that we agree with the philippines sovereignty claims to those islands. once requested frankly why in

2015 we need -- since the cold war is long over so we've been playing a very careful diplomatic game i think in the south china sea. u.s. policy as i understand it is very straightforward. we don't back any nation's claims for sovereignty over the land features in the south china sea. we urge everybody to resolve their differences peacefully but we will not stand by and accept any attempts by any of the claimants to interfere with freedom of navigation by u.s. or other ships through the south china sea. so the danger is, you know the well known dash line that china has published beginning as possibly as early as 1922 beijing has never defined what they mean by that. they keep saying they claim the land features and associated waters. if we would get into convention on the sea just defining associated waters would take the

rest of the day. there's a lot of uncertainty with respect to that. i think the bottom line u.s. concern in the south china sea is that there would be no constraints imposed on the free come of ships transferring those vital sea lanes. >> richard? >> i agree with all of that. i would only add that china's ability to incrementally improve its presence in the land farms of the south china sea can't have an important psychological effect on how the united states is perceived. and how our friends and allies assess our results. but it's really hard to figure out exactly what you want to do as each little action takes place. >> david any thoughts on -- >> thank you very much everyone. i think we have a lot on the table, and a lot of thoughts and

expertise among you so let me please ask you to once the microphone comes to you, to state your name clearly, and to pose a question i'm going to take two at a time to start. and if you can direct your question primarily to one person i'd prefer it. if it doesn't work out that way, that's fine, too. but if you have any ability why don't we start here in the front with these two gentlemen for round one. >> thank you all very much. >> please identify yourself. >> michael formerly from the london school of economics, and now the george washington university. it seems to me that there are two elements in what we said. one is that there is quite a lot of continuity in u.s./china relations. and also in terms of -- emergent and continuing emergent path.

i think one element that constitutes a major change especially for the united states, is the relationship -- or combining the relationship with china with the relationship with allies in ways that hasn't happened before. in the sense that china's immediate challenge is not directed at the united states, it's directed in its nato group, and its leader has articulated the vision of the nation order in which it's very difficult to see where america fits in from that point of view. so, for the united states, obviously, the approaches to east asia centers on china. but the challenges are going to be much more in terms of relation with allies. so in one sense the united states has to demonstrate to its allies and partners that the united states has sufficient resolve, sufficient capabilities

to deal with the threat that exists to them as far as they perceive. on the other hand the united states does not want them to be in quotation marks provocative regarding china. what is provocative of course, depends very much on perception and so on. and the -- in this sense, it seems to me, that the united states is facing the kind of systematic challenge which it has not had before. and this is going to raise all kinds of different -- difficulties. one is what extent can the united states coordinate all the different elements of its policy as richard bush indicated. the economic, political, the military and so on, so forth. so to what extent do you think we are here beginning to think

creatively as to how to deal with this challenge? >> thank you. and here in the front row, please. >> my name is arnold reitland i've been teaching in china. i think david might be the first one to respond to my question. i'm wondering if it's possible to compare u.s. and china military spending on a pcp basis in so much as cost in china in some sectors are much less. >> david want to start? >> so i'm not an expert on the chinese military budget. since when you make a general ptc correction you're basically raising chinese gdp by more than 50%, actually by 70% would be the current estimate. so you know, one initial thought would be take that 150 billion dollar rough estimate of

chinese military spending at market exchange rates and just raise that by 70%. it would of course be the same share of gdp, right? but it would be 70% higher. now i think in terms of thinking about the soldiers that probably makes sense, you know, if you can hire an equivalent soldier in china for a lot less than in the united states then it makes sense to do that price correction. but if you look in the details of the pcp calculation you know, price is an advanced machinery tend to be the same in the two economies. right? so i don't know how much of the chinese military budget goes to equipment, versus paying for soldiers. but if there's a lot of the budget is going to equipment, then it would be a mistake to make the ppp correction. basically, you know, the price and equivalent quality piece of weaponry may very well be similar in china and the united states. that's what you would find for advanced equipment in the nonmilitary sector. so you know, probably the answer is, you wouldn't want to make the full 70% adjustment.

you know but in thinking in real time gdp you'd want to make some adjustment. >> if i could speak to michael's question, it's a very good question. my response would be that this is not a completely new problem it's a new version of an old problem. because, we have had to reassure our allies about our resolve ever since those alliances were created. we have had to worry about independent action by our allies. for example i think one purpose of the u.s. mutual defense treaty with south korea was to make sure that south korea didn't go north. that's not a concern today but it was a concern earlier on.

similarly, our mutual defense treaty with the republic of china, you know, there were understandings at the time that if the republic of china was and there were a series of incidents where a lot of argument over what's a major initiative and what's not. i think what makes this more complicated today, obviously is china's greater power and its greater ability to expand its, expand its power and influence in the region, which is the first and principal area of competition. more over, another new development is national israel in all the countries which

greatly complicates how national leaders, including in china, i success threats to their national security and respond to those threats. >> folks like me who tend to concentrate on the chinese military have to remind ourselves of the relationship is much broader than that and if the economic relationship, particularly economic, is extremely important several years ago, when mike mullen was the chairman of the giant chiefs of staff he called a bunch of folks together and said we need to get away from look at a military relationship and look at the government approach. deals with chinese counterparts.

i'm not aware frankly as much of that, but that was his idea. he was also the chairman that said the problem was economics, not some sort of military balance. also note that the overall strategic situation is based on geography. jogty rarely changeds much. we can come up with some instances of it, like the yellow rifl shifting but geography matters and if you're sitting in singapore or seoul or tokyo or taipei, you have to pay attention to that and i once suggested to the deputy minister of defense from south korea that perhaps before the end of this century, that a trade would be made. south korea would give up the mutual defense alliance with the united states to emerge as the governing body of the entire peninsula. i didn't get a response. but thinking long range, i think

those sorts of thoughts need to be considered. >> i'm just going to toss in one thought on this question, on u.s. korea relationship. as many here remember and in some cases know much better than i, in the mid 2000s, the bush administration administration asked i'll be simplistic. we meant we would like to have to some extent advanced permission to be able to use the forces normally based in korea for other contingencies in the region and the relationship between president no and some parts of the bush administration wasn't so strong in the president and president no even though i was not a big fan overall of his tenure in south korea, but he had a very reasonable response. he said, you mean you want to be able to use forces in korea about the taiwan problem or some other area of east asia. i got to live here with the chinese for the rest of eternity and i would rather have some say.

obviously, if you want to take your forces move them, that's your prerogative but if you want to use my country as a staging base, maybe i should have a say when the actual crisis occurs. at which point, the bush administration i think essentially stood down the request, which i think was the right way to go athey shouldn't have asked them frankly. jim steinberg and i did a book on u.s. china relations last year and spent a lot of time on korea, thinking about a possible korea contingency and a lot of our focus was on how the united states and rok might want to work with china to involve china in managing that kind of a crisis rather than just assuming china would or should stay out. this was an area where we thought for a number of reasons in including those you were getting at, a collaboration. even though it would have some risks, would be more pru dent than having to keep china at arm's length. any way, enough on that. we've got a couple of friends

here. let me take these two. either way. >> earlier you asked the question about china's focus on military development as a surprise to you. there is one surprise, at least for me. over the last 18 months, two years, china has announced the avowed goal to become a maritime power. that's not just a navy but it is a navy, coast guard, shipbuilding, merchant marine, fishing industry. it's their ports et cetera, the infrastructure. it's an elaborate vision. i had been looking into that and i guess one related surprise is in terms of the navy, for the

strategy that would have been discussed, essentially, keeping the united states away from the coast of china, the navy only needed submarines and then of course the rest of the pla had missiles and airplanes to deal with it. what we see happening now is the surface ship part of the chinese navy is growing. to the point where by my calculations in the five or six years, china is going to have the second most powerful balance navy in the world. they're going to be a global power. it's interesting. >> allen roberts. it's great panel. thank you very much.

i guess my question in the first instance goes to richard. that has a strategic vision to mention to it. i perhaps overly sim plisically i would say that one reason china has behaved as assertively as it has in the region in recent years is because it can. and so my question is whether going forward, you can in doing the things that china feels will be in its interest to do will leave it will have it behave in what we would interpret as assertive a manner. particularly in the region in this case. or whether they will feel confident they can protect their claims and all the rest of that in the way you were describing, which also was what they did a

few years ago when they overstepped and thought they hurt their interests. whether this more moderate approach will be something we should expect to see or whether the strategic vision is such that china feels it needs to expand its influence, not necessarily its physical claims but in ways which will lead it to use its military capabilities in ways which are challenging to us. >> china's focus until maybe ten years ago was pret it much strictly on taiwan. if you look at modernization in china, you can see the great emphasis in the last 15 years on building submarines. and i think this was done deliberatery because they felt they could -- very much slow

down any u.s. intervention in the taiwan scenario. i think now, they're going back to a three-phase strategy. the third was to have a global aircraft based navy. second island chain through the bonnen islands, mary islands, pa lou and around through indonesia is certainly very efficient. extends out about 1800 nautical miles from the coast of china. whether or not they could achieve by 2015 is still an open question. they have been able to make great progress in achieving the earlier step which is asseting sea patrol in the first chain,

taiwan and philippines and then around the indonesia. by not only submarines and naval ships, but by virtue of land based missiles and air force capabilities. i think that the chinese military believe that is taiwan is no longer a problem. from any sort of balance measurement. by gaining control, i think beijing wants to be able to prevent events from happening of which it does not approve within those three cs. what we have seen and this may actually have been become an unexpected nature to the chinese military as mike mentioned, they're building not just to deploy these three ship formations to exert counter pie ra sy, they go beyond that. especially terroring into the mediterranean