Transcripts show Fed shock at '08 collapse

Transcripts show Fed shock at '08 collapse
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Transcripts released Friday of Federal Reserve meetings held throughout 2008 suggest the Fed was caught off guard by the suddenness and severity of the financial crisis that year.

The financial crisis and resulting recession has widely been referred to as the worst economic downturn since the Great Depression, but it was not immediately clear to the Fed's economic stewards just how much trouble the nation was in during the immediate aftermath of the Lehman Brothers bankruptcy, which kindled the collapse. 


At a September meeting held one day after Lehman went bankrupt, some Fed officials speculated the economic impact could be muted, and would perhaps be restricted to New York City or the financial sector.

Others argued it was a positive thing that the government did not step in to rescue Lehman, sending a message to markets that the government would not provide a safety net.

Still others, including Chairman Ben Bernanke, said it was too soon to make that call.

“We may have to wait for some time to get greater clarity on the implications of the last week or so,” he said at the Sept. 16 meeting.

Fed officials noted their concerns, but expressed hope that the housing market, which had long driven the decline, could turn around soon and pick the economy back up.

With that in mind, the Fed wrapped that meeting by deciding to keep interest rates at 2 percent.

“Overall I believe that our current funds rate setting is appropriate,” said Bernanke at the time. “I don’t really see any reason to change.”

It turned out that “some time” would be just a few weeks. The bankruptcy of Lehman exacerbated concerns about other major Wall Street banks, as several major institutions teetered on the brink of insolvency or had to be taken over by competitors to remain afloat.

A little over two weeks after the Fed held steady, Congress agreed to pass the massive Troubled Asset Relief Program, giving the government the power to pump hundreds of billions of dollars into the financial sector.

And just days after that, the Fed convened for a rare, phone-in, unscheduled meeting to cut rates by half a percentage point. By December, rates would fall to near-zero, where they currently remain.

Roughly a month and a half after the Fed adopted a “wait and see” approach, they were confident the verdict was in.

“It is becoming abundantly clear that we are in the midst of a serious global meltdown,” said Janet Yellen, then the vice chairwoman of the Fed and now its current head, at an Oct. 28-29 meeting. “The deterioration in overall financial conditions since the September ... meeting is truly shocking.”

By the fall of 2008, the Fed had spent most of the year helping the U.S. government battle an economic downturn. The subprime mortgage crisis had enveloped housing giants Fannie Mae and Freddie Mac, necessitating their government takeover in the summer. And in March, the Fed announced plans to provide direct liquidity to financial institutions like JPMorgan.

And Fed officials, including Bernanke and Yellen, were aware of the risks of a recession. In January, Yellen warned that the housing downturn had placed the U.S. “if not beyond, at the brink of recession.”

By the end of the year, the transcripts reveal that Fed officials were deeply concerned about the trajectory of the economy, and had no idea how far it could sink before turning it around.

With that backdrop in mind, Bernanke pressed his colleagues to prepare to take aggressive, and perhaps unprecedented, action to right the economy.

“We do have to continue to be aggressive. We have to continue to look for solutions. Some of them are not going to work. Some of them are going to add to uncertainty,” he said at the Oct. 28-29 meeting. “I recognize that critique. I realize it’s a valid critique. But I don’t think that this is going to be a self-correcting thing anytime soon. I think we are going to have to continue to provide support of all kinds to the economy.”

In November, the Fed announced it would begin buying mortgage bonds directly from Fannie Mae and Freddie Mac in its first round of “quantitative easing.”

Since then, the Fed has gone through three rounds of easing, accumulating trillions of dollars' worth of securities in its portfolio.

The central bank has faced ample criticism from Republicans over the approach, but the Fed is still buying bonds, albeit at a slower pace. Bernanke announced in his final press conference at the end of 2013 that the Fed will begin shrinking the size of its purchases, and continue to do so so long as the economy continues to improve.