Inside the Fed in 2008: What were its worries amid economic collapse?

Now-Chair Janet Yellen fretted about wrong incentives created by Wall Street pay structure. Many underestimated the effect of the Lehman Bros. failure. These and other insights come from Fed meeting transcripts, released Friday, of that tumultuous year.  

Mary F. Calvert/Reuters
Federal Reserve Chair Janet Yellen testifies before a House Financial Services Committee hearing on 'Monetary Policy and the State of the Economy' at the Rayburn House Office Building in Washington last week.

Newly released transcripts from Federal Reserve meetings during 2008 – a very bad year for the US economy, to say the least – paint a detailed picture of how the US central bank struggled in its efforts to contain a spreading financial crisis, including the controversial provision of bailouts to troubled firms.

The transcripts show a group of policymakers working intensely in the midst of a historic economic collapse, but they also expose the Fed – which doesn't exactly rank high in Main Street popularity contests – to a fresh round of scrutiny for steps it took (or failed to take) at various points during that tumultuous year.

On Sept. 16, 2008, for example, the Fed’s policy committee apparently gave little consideration to the possibility of lowering short-term interest rates, the day after markets had reacted in a sharply negative way to the bankruptcy of Lehman Bros. By a unanimous vote, the committee led by Chairman Ben Bernanke opted to hold its short-term lending rate steady at 2 percent.

Among hundreds of pages in the transcripts, largely professional dialogue is interlaced with comments that also show anxiety, self-doubt, dark humor, and occasional bursts of frustration. The Fed released the transcripts Friday under the tradition of making them public after five years have passed.


Here are some notable excerpts from the transcripts, each preceded by a descriptor based on 20/20 hindsight:

Well, duh! “We postponed the special presentations on inflation,” Mr. Bernanke said at an October meeting, when post-Lehman chaos had pushed inflation to the periphery of Fed concerns.

Let's not jump to any conclusions. “I don’t think we’ve seen a significant change in the basic outlook,” Fed economic forecaster Dave Stockton said right after Lehman’s failure. “We’re still expecting a very gradual pickup in GDP growth over the next year.” It wasn’t obvious then, but the outlook deteriorated rapidly after that.

In the dark. Fed Vice Chairman Timothy Geithner said at a January meeting that the New York insurance commissioner had little information to share about a key issue: “to whom [certain insurers] sold credit protection and on what.” Some insurance firms were in serious trouble, but the Fed had no direct supervisory insight. 

Wall Street pay and bad behavior. Also in January, Janet Yellen (now the Fed chair and then head of its San Francisco regional bank) talked about the way banker bonuses might have caused reckless behavior that was harming the economy. “I don’t know what the answer is in terms of changing these practices,” she said. “Maybe the market will attend to them, but it seems to me that we have had an awful lot of booms and busts in which this type of incentive played a role.”

Mr. Geithner, later appointed by President Obama to be the US Treasury secretary, pushed back, arguing that it’s hard to affect banker behavior through regulation of pay.

He who laughs, lasts. Amid the sobering circumstances, Fed officials managed to inject some levity, even if of the dark variety, into their discussions. At the December meeting, Richard Fisher of the Dallas Fed talked about how the crisis was even affecting divorce proceedings. “One woman whom I know summarized it this way: ‘This is the divorce from hell. My net worth has been cut in half, but I am still stuck with my husband,’ ” Mr. Fisher explained, drawing laughter from colleagues.

That Lehman hot potato. Bernanke has said the Fed had no choice but to allow the investment bank Lehman Bros. to fail, because the Fed was allowed to extend help only if a firm could provide some assets as collateral. During the September Fed meeting after Lehman collapsed, some regional officials (who had not been involved in Lehman-related decisions) expressed diverging views.

Eric Rosengren of the Boston Fed said that “we had no choice,” but that the Lehman bankruptcy “may not look nearly so good” if credit markets for short-term financing shut down. (They nearly did.) James Bullard of the St. Louis Fed made the so-called "moral hazard" argument that the Lehman failure sent a helpful tough-love message. “By denying funding to Lehman suitors, the Fed has begun to re-establish the idea that markets should not expect help at each difficult juncture,” he said. “Changing [interest] rates today would confuse that important signal.” 

Can't we all get along? At one meeting in July, various Fed officials bantered about the challenge of ensuring that the central bank – in its worthy efforts to prop up a fragile banking system – didn’t extend credit too easily to banks on the brink of failure. “In this instance [of failed California bank IndyMac], I think it is outrageous that the OTS [the US Treasury’s Office of Thrift Supervision] downgraded them and didn’t inform the San Francisco Fed,” Jeffrey Lacker of the Richmond Fed said.

"I told you so." While some lines in the transcripts hint at Fed officials being slow to grasp financial-sector risks to the economy, others suggest alertness. In January, when it was still unclear to many economists that a recession was brewing – and when many forecasters expected any downturn to be mild – Bernanke worried aloud that a recession “might morph into something more serious” due to the behavior of financial markets.

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