“The odds are that the market will stabilize,” U.S. Federal Reserve chairman Ben Bernanke told the Federal Open Markets Committee in Aug. 2007. “This restrictive effect could come in various magnitudes. It could be moderate, or it could be more severe, and we are just going to have to monitor how it adjusts over time.”
With the benefit of hindsight from the other side of the worst global financial crisis since the Great Depression of the 1930s, we now know the magnitude of what would come. The newly released transcripts of the committee’s meetings for 2007 make embarrassing reading for many policymakers, and not only the Fed chairman who has spent the intervening time doing a lot more than just monitoring the situation.
Yet there is no escaping the fact that the transcripts show the Fed’s slow grasp of the implications of the souring of billions of dollars in low-quality housing assets that had been securitized into bonds and sold to banks and investors worldwide, and the devastation that would cause as it spread like acid through global markets. Capital losses from toxic mortgage securities would freeze interbank lending markets and trigger runs against big investment banks. In March 2008, the Fed and JPMorgan Chase would have to rescue Bear Stearns. In September, Lehman Brothers would collapse into bankruptcy. Goldman Sachs and Morgan Stanley — storied names in investment banking — converted to bank holding companies to access backup funding from the Fed’s discount window.
Yet for most of 2007, these transcripts show, the Fed felt problems in housing and banking would be moderate and short-lived. Though many, no doubt, will use these records to say that the imminent crisis was there for all to see, at the time few had a desire to look, let us not forget. Animal spirits were abroad in plenty. The loose, frenetic ways and swashbuckling language to be heard inside the banks in those days is in stark contrast to the measured, technocratic tones of the policymakers revealed in the FOMC transcripts.
Doomsayers were a minority, yet to multiply into the numbers they would retrospectively become. And the transcripts show how much difficulty the Fed had in understanding the scope of the problem that was unfolding in front of them as a problem with subprime housing became a run on the shadow banking system, and a liquidity problem in the credit markets became a capital problem in the banking system.
As late as the December 6, 2007 FOMC conference call, the Minneapolis Fed’s Gary Stern was saying, “my sense is that this is more of a capital, balance sheet, credit loss problem than a liquidity problem per se, and we haven’t even talked about the capital position of some of the major institutions, which presumably we are concerned with here.”
Less than nine months later two of Wall Street’s famed names (Bear Steans and Lehman Brothers) would be gone, and U.S. taxpayers would be starting to hand over over $700 billion to bail out America’s banks. What these transcripts can’t answer is whether, had the Fed reacted more quickly, those taxpayers would have suffered a less severe recession. But they will certainly prompt the question.