Fed slow to abandon optimism even as a few sounded alarm, 2007 transcripts show

Correction: A previous version of this article incorrectly referred to Eric Rosengren as being a member of the Federal Reserve Board of Governors at the time. Rosengren has never been a Fed governor; as president of the Federal Reserve Bank of Boston, a title he still holds, he was serving a one-year term on the Federal Open Market Committee in 2007. This version has been corrected.

January 18, 2013

It was December 2007, and officials at the Federal Reserve were torn between two visions of what was in store for the nation’s economy: a mild slowdown or outright recession.

They opted to believe in a slowdown. They were wrong.

Economists would later pinpoint that month as the official start of the Great Recession that wiped out nearly 9 million jobs and 40 percent of American households’ wealth. But transcripts released Friday of the Federal Reserve’s policy­making meetings in 2007 show officials were slow to abandon the optimism of the boom years even as a few officials began to sound the alarm.

That model of a slow-growth future restrained the Fed’s earliest efforts to prop up increasingly tumultuous financial markets and created new divisions in an institution that for decades had been marked by strong consensus.

According to the transcripts, the word “recession” wasn’t spoken until the summer. A staff presentation described a highly unlikely, worst-case scenario that included a 10 percent drop in the stock market. That still would not be enough to force the economy to contract, the staff assured senior Fed officials. Even later, officials were hesitant to deploy what one called “the R word.”

Some worried that the Fed could worsen market panic by appearing overly concerned by the volatility.

“The best guidance would be that we must not ourselves become a tripwire,” Dallas Fed President Richard Fisher said in an August meeting. “I rather liked the reference to the Hippocratic oath earlier, ‘Do no harm.’ ”

But an increasingly vocal minority began pushing for the Fed to show it was staying ahead of the bad news.

“I believe the arguments work in favor of doing more now rather than less,” Timothy F. Geithner, then president of the New York Fed and now Treasury secretary, said in a September meeting. “A gradualist, tentative response would be more disconcerting than encouraging. The risk of under­doing it now is that we will ultimately be forced to do more.”

That month, the Fed began taking action by cutting its target for the federal funds rate — a key interest rate that is the basis for business and consumer lending — by half a percentage point to stimulate lending and encourage spending. It followed up with a smaller cut in October.

Some argued for even more aggressive measures as their economic forecasts turned darker. By December, then-San Francisco Fed President Janet Yellen said her hope that the nation could escape serious financial damage was “severely shaken.” She cited the shutdown in the market for complex securities, the decline in housing prices and growing consumer delinquencies as justification for cutting the federal funds rate by another half a percentage point.

Eric Rosengren, president of the Federal Reserve Bank of Boston, backed her, joking that the two of them had taken a “pessimism pill.” Even typically optimistic Fed Governor Frederic Mishkin, who is now at Columbia University, said that he had become “very, very worried.”

“Any more bad news could put us over the edge,” said Yellen, now vice chairman of the Fed. “I think it argues for doing so now rather than taking a ‘wait and see’ approach and lowering [the interest rate] only grudgingly.”

But Fed officials ultimately decided to do just that, voting in favor of a more measured quarter-percentage-point rate cut. The transcripts show Fed Chairman Ben S. Bernanke grappled with the decision, saying he was “tempted” by a bolder move but worried about overshooting.

“You can tell that I am quite conflicted about it, and I think there is a good chance that we may have to move further at subsequent meetings,” he said. But such a large cut could signal “more concern or private information about the economy that we in fact don’t necessarily have.”

Bernanke was correct in predicting that more cuts lay ahead: Over the next year, the Fed would cut its target interest rate an unprecedented seven times, bringing it close to zero for the first time in the central bank’s nearly 100-year history. The next year, the financial crisis would be in full swing, economic output would plummet and the unemployment rate would skyrocket.

The transcripts of the Fed’s policy­making committee meetings are released after a five-year delay. Since 2007, Bernanke has acknowledged that he was slow to understand how severe the economic downturn would be. During an appearance last week at the University of Michigan, he was asked what surprised him most about the financial crisis.

Without missing a beat, Bernanke responded, “The crisis.”

Neil Irwin, Jim Tankersley, Zachary A. Goldfarb and Dylan Matthews contributed to this report.

by Ylan Q. Mui

It was December 2007, and officials at the Federal Reserve were torn between two visions of what was in store for the nation’s economy: a mild slowdown or outright recession.

They opted to believe in a slowdown. They were wrong.

Economists would later pinpoint that month as the official start of the Great Recession that wiped out nearly 9 million jobs and 40 percent of American households’ wealth. But transcripts released Friday of the Federal Reserve’s policy­making meetings in 2007 show officials were slow to abandon the optimism of the boom years even as a few officials began to sound the alarm.

That model of a slow-growth future restrained the Fed’s earliest efforts to prop up increasingly tumultuous financial markets and created new divisions in an institution that for decades had been marked by strong consensus.

According to the transcripts, the word “recession” wasn’t spoken until the summer. A staff presentation described a highly unlikely, worst-case scenario that included a 10 percent drop in the stock market. That still would not be enough to force the economy to contract, the staff assured senior Fed officials. Even later, officials were hesitant to deploy what one called “the R word.”

Some worried that the Fed could worsen market panic by appearing overly concerned by the volatility.

“The best guidance would be that we must not ourselves become a tripwire,” Dallas Fed President Richard Fisher said in an August meeting. “I rather liked the reference to the Hippocratic oath earlier, ‘Do no harm.’ ”

But an increasingly vocal minority began pushing for the Fed to show it was staying ahead of the bad news.

“I believe the arguments work in favor of doing more now rather than less,” Timothy F. Geithner, then president of the New York Fed and now Treasury secretary, said in a September meeting. “A gradualist, tentative response would be more disconcerting than encouraging. The risk of under­doing it now is that we will ultimately be forced to do more.”

That month, the Fed began taking action by cutting its target for the federal funds rate — a key interest rate that is the basis for business and consumer lending — by half a percentage point to stimulate lending and encourage spending. It followed up with a smaller cut in October.

Some argued for even more aggressive measures as their economic forecasts turned darker. By December, then-San Francisco Fed President Janet Yellen said her hope that the nation could escape serious financial damage was “severely shaken.” She cited the shutdown in the market for complex securities, the decline in housing prices and growing consumer delinquencies as justification for cutting the federal funds rate by another half a percentage point.

Then-Fed Governor Eric Rosengren backed her, joking that the two of them had taken a “pessimism pill.” Even typically optimistic Fed Governor Frederic Mishkin, who is now at Columbia University, said that he had become “very, very worried.”

“Any more bad news could put us over the edge,” said Yellen, now vice chairman of the Fed. “I think it argues for doing so now rather than taking a ‘wait and see’ approach and lowering [the interest rate] only grudgingly.”

But Fed officials ultimately decided to do just that, voting in favor of a more measured quarter-percentage-point rate cut. The transcripts show Fed Chairman Ben S. Bernanke grappled with the decision, saying he was “tempted” by a bolder move but worried about overshooting.

“You can tell that I am quite conflicted about it, and I think there is a good chance that we may have to move further at subsequent meetings,” he said. But such a large cut could signal “more concern or private information about the economy that we in fact don’t necessarily have.”

Bernanke was correct in predicting that more cuts lay ahead: Over the next year, the Fed would cut its target interest rate an unprecedented seven times, bringing it close to zero for the first time in the central bank’s nearly 100-year history. The next year, the financial crisis would be in full swing, economic output would plummet and the unemployment rate would skyrocket.

The transcripts of the Fed’s policy­making committee meetings are released after a five-year delay. Since 2007, Bernanke has acknowledged that he was slow to understand how severe the economic downturn would be. During an appearance last week at the University of Michigan, he was asked what surprised him most about the financial crisis.

Without missing a beat, Bernanke responded, “The crisis.”

Neil Irwin, Jim Tankersley, Zachary A. Goldfarb and Dylan Matthews contributed to this report.

Ylan Q. Mui is a financial reporter at The Washington Post covering the Federal Reserve and the economy.
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