The Federal Reserve on Friday released transcripts of 14 policy and emergency meetings beginning in January 2008, when then-Federal Reserve Chief Ben Bernanke and other Fed officials candidly expressed fears that the economy was continuing to slide, investment banks remained at risk of failing, and the financial fallout was spreading from financial sector stocks to global markets and economies.
The transcripts, which cover Fed discussions through December 2008, are the most intimate look at how Fed officials were dealing with the crisis in real time, debating how best to help investment banks and protect the economy – from continued cuts in interest rates to bailouts of troubled investment banks, such as Lehman Bros. It's also clear from hundreds of pages of Fed transcripts that officials faced a crisis that may have been deeper, more widespread and more problematic to solve than previously disclosed - and that officials frequently struggled in the wake of conflicting economic signals, lagging data and the potential fallout on Wall Street and Main Street.
"The data have been on the whole negative,'' Bernanke said at Federal Open Market Committee conference call in January, a month in which the Dow Jones Industrial Average was being pummeled. "The markets in part are suffering from just simple uncertainty about whether the Fed is willing to be proactive in addressing downside risks."
William Dudley, head of the Fed's Bank of New York, said financial markets, already roiled the previous quarter, feared that risks "remain severe and may have even intensified."
"Put simply, market participants believe that the macroeconomic outlook has deteriorated significantly and financial asset price movements broadly reflect that shift in expectations,! '' Dudley said.
With stocks continuing to plunge, continued credit woes and recession fears swelling, Bernanke pressed fellow Fed officials for a big, bold interest rate cut during an emergency conference call Jan. 21, according to Fed transcripts, urging that the Federal Funds rate be lowered to bring benchmark lending rates down to 3.5% from 4.25% a week ahead of the Fed's normally scheduled meeting.
"There are times when events are just moving too fast for us to wait for the regular meeting," Bernanke said. "I know it is only a week away, but seven trading days is a long time in financial markets."
Bernanke wasn't sure if the surprise rate cut would help, but argued that not acting would be worse. "We have to address this crisis. We have to try to get it under control. If we can't do that, then we are just going to lose control of the whole situation," he said.
Then Vice chairman Tim Geithner backed the move, hinting that more accommodation would be needed. The Fed's rate cutting would eventually extend into December 2008. In all, the Fed cut rates eight times in 2008.
The financial crisis was rooted in the August 2007 collapse of the housing market, when consumers who had bought homes with low-interest loans from subprime lenders could not keep up with higher payments as loan rates rose.
The collapse led to massive loan defaults and a meltdown among subprime lenders. That spread to investment banks and hedge funds, which had repackaged loans in secondary markets for other financial instruments, allowing them to heavily leverage investments.
The Fed and other central banks began slashing interest rates in 2007 and also provided emergency funding for investment banks to keep them from collapsing. Lehman Brothers wound up filing for bankruptcy, Bear Stearns was acquired by JP Morgan Chase, Merrill Lynch was acquired by Bank of America, while lenders Fannie Mae and Freddie Mac were put under government control.
Minutes from a crucial Sept. 16, 2008, FOMC! meeting ! underscored continued worries.
Caught between stormy financial markets, building inflation and weak economic conditions, they debated whether to again lower interest rates.
"Either the financial system is going to implode in a major way," which would lead to lower interest rates, "or it is not," Dudley said.
Atlanta Fed chief Dennis Lockhart said he sensed a "quite weak" economy. "I am concerned that the downside risks to growth may be gathering force," he said.
Fed Chair Janet Yellen, then chief of the San Francisco Fed, was perhaps the most prescient in the group. "Recent data also suggest that labor markets are weakening across the board-- a development that will cast a pall on household income and spending," she said.
But other Fed officials were far more concerned about the budding risks of high inflation.
"At some point, before the unemployment rate begins to improve substantially, I believe this committee will need to raise rates in order to deliver on our inflation objectives," says Charles Plosser, president of the Philadelphia Fed.
Bernanke, for his part, expected the economy to weaken further but didn't anticipate the recession. "I think that we are in for a period of quite slow growth," he said.
The Fed left interest rates unchanged at that meeting.
Fed officials at that meeting were also worried that lenders were pulling away from a critical financing source for the banking system known as "tri-party repos."
"That is a frightening scenario," Richmond Fed President Jeffrey Lacker said.
Fed officials also discussed their efforts to keep American International Group from collapsing. AIG had sold derivatives called credit default swaps designed to cover loan defaults but was on the hook for billions of dollars.
"AIG is in a situation in which (the parent company) it is basically going to run out of money – today, tomorrow, Thursday or very, very soon,'' Dudley said.
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