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Originally published Friday, February 21, 2014 at 8:47 PM

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Transcripts show Fed failed to fully grasp unfolding 2008 crisis

The transcripts reveal the ignorance of Fed officials about economic conditions during the climactic months of the financial crisis that started in 2008.


The New York Times

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WASHINGTON — On the morning after Lehman Brothers filed for bankruptcy in 2008, most Federal Reserve officials believed the U.S. economy would keep growing despite the metastasizing financial crisis.

The Fed’s policymaking committee voted unanimously that Sept. 16 against bolstering the economy by cutting interest rates, and several officials praised what they described as the decision to let Lehman fail, saying it would help to restore a sense of accountability on Wall Street.

James Bullard, president of the Federal Reserve Bank of St. Louis, urged colleagues “to wait for some time to assess the impact of the Lehman bankruptcy filing, if any, on the national economy,” according to transcripts of the Fed’s 2008 meetings it published Friday.

The hundreds of pages of transcripts, based on recordings made at the time, reveal the ignorance of Fed officials about economic conditions during the climactic months of the financial crisis. Officials repeatedly fretted about overstimulating the economy, only to realize time and again that they needed to redouble efforts to contain the crisis.

The Fed’s chairman at the time, Ben Bernanke, was unusually clearsighted in warning of the risk of a historic recession as the nation entered into a presidential election year. But he struggled to persuade his colleagues, and at crucial junctures he did not push forcefully for stronger action.

The Fed’s current chairwoman, Janet Yellen, then president of the Federal Reserve Bank of San Francisco, was even more alarmed by the deterioration of economic conditions. She and Eric Rosengren, president of the Federal Reserve Bank of Boston, are the most forceful and persistent advocates for stronger action in the transcripts. But they, too, underestimated the downturn until the final months of 2008.

The transcripts also show Fed officials responded decisively in those final months, probably preventing an even deeper recession. By the end of 2008, the Fed had reduced short-term interest rates nearly to zero for the first time since the Great Depression, and it had become a primary source of funding not just for the global financial system but for U.S. homeowners and for companies that made food and cars.

Yellen summed up this new ethos at a Fed meeting six weeks after Lehman’s failure, telling colleagues: “Given the seriousness of the situation, I believe that we should put as much stimulus into the system as we can as soon as we can.”

The Fed releases the transcripts of its meetings annually on a five-year delay, and those from 2008 — covering eight regularly scheduled meetings and six emergency sessions — were highly anticipated because they would provide the first unvarnished view of discussions that occurred as the financial markets were in a state of near collapse.

The transcripts cover the most tumultuous period of the crisis, including the Lehman collapse, the collapse and rescue of investment bank Bear Stearns, the government takeover of mortgage giants Fannie Mae and Freddie Mac, and the bailout of insurer American International Group.

For all its aggressive steps in 2008, the transcripts show Fed officials failed at times to grasp the size of the catastrophe they were dealing with. Bernanke and his top lieutenants often expressed puzzlement that they weren’t managing to calm panicky investors.

Among the details the transcripts reveal is that while the bank’s governors discussed at length how the Fed’s actions might affect the markets, there was no discussion of what political impact those actions might have, even though a contentious presidential election was less than two months away, one that would put Barack Obama in the White House.

In normal times, the Fed is a powerful but somnolent institution, charged with keeping a steady hand on the rudder of the economy. It moves interest rates up and down to moderate inflation and minimize unemployment. But beginning in 2007, it was forced to take on a far more challenging role as the central backstop for the global financial system.

It was constrained in this new role by its reliance on economic indicators that tend to miss sharp changes in economic conditions. But the Fed’s caution in 2008 also reflected a deeply ingrained bias to worry more about the risk of inflation than the reality of rising unemployment.

As Fed officials gathered Sept. 16 at their marble headquarters in Washington, D.C., for a previously scheduled meeting, stock markets were in free fall and unemployment was spiking.

Yet most officials did not see clear evidence of a broad crisis. They expected the economy to grow slowly in 2008 and then more quickly in 2009.

The transcript for that meeting contains 129 mentions of “inflation” and five of “recession.”

Bernanke even told his colleagues it was clear the economy had entered a downturn but that he still did not favor cutting rates. “I think that our policy is looking actually pretty good,” he said.

That optimism would not long endure. Minutes after the end of that first meeting, a smaller group of Fed officials agreed to rescue faltering insurance giant American International Group, a company never before subject to Fed supervision that until then was barely on the government’s radar.

In succeeding weeks, the Fed would announce a seemingly endless series of programs to buttress the economy, leading Fed officials to joke about the resulting alphabet soup of acronyms.

In early October, a few weeks after the decision to stand pat, the Fed convened an unscheduled meeting to cut interest rates in an action coordinated with other major central banks.

“It’s more than obvious that we have an extraordinary situation,” Bernanke told colleagues.

By the end of the year, the Fed had cut interest rates nearly to zero and started to buy mortgage bonds in a further effort to stimulate the housing market and the broader economy. More than five years later, it is still pursuing both policies as the economic recovery remains incomplete.

Material from The Associated Press and McClatchy Washington Bureau is included in this report.



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