The Bubble

Steel also telephoned Lewis Ranieri, a pioneer in mortgage-backed securities. Ranieri told the Treasury official that many of the securities were actually in good shape but banks couldn't unload them because of the perception that they had no value.

Fed officials, in a state of growing alarm by late August, maintained an outward calm at their annual symposium at Jackson Hole, Wyo. But secretly, Bernanke and other top Fed officials met several times a day in a makeshift war room where they had installed secure telephone lines.

Bernanke, a former Princeton University professor, employed the Socratic style, going around the table, asking his Fed team how the central bank should respond to the crisis, according to some of those present. How aggressive should the Fed be in using its influence on interest rates -- a broad sword that affects the entire economy? What risk did the credit problems pose to average Americans?

After one long discussion, the Fed officials went downstairs to the public conference, where one economist, John Taylor of Stanford University, was criticizing the Alan Greenspan regime for having kept interest rates so low for too long.

Gramlich, too sick to attend the conference after being diagnosed with leukemia, had his speech read by a colleague: "The subprime market, for all its warts, is a promising development, permitting low-income and minority borrowers to participate in credit markets." But, he added, "a majority of loans are made with very little supervision."

In the coming weeks, the Fed began aggressively cutting interest rates to encourage banks to lend. In October, the Bush administration announced a Gramlich-style idea, Hope Now, an alliance of counselors, lenders and other industry participants who would work to help borrowers avoid foreclosure by renegotiating mortgage terms. But it was clear that the trouble was not over when some of the nation's biggest banks began reporting unexpectedly large losses: Morgan Stanley, $3.7 billion. Merrill Lynch, $8.5 billion. Citigroup, $11 billion.

In his final weeks, Gramlich followed the unfolding financial crisis from his home near Dupont Circle, sitting in a white easy chair at a window overlooking Connecticut Avenue. He was resigned to the fact that he couldn't play a larger role. Five days after his speech was read in Jackson Hole, he died.

Staff writers David Cho and Neil Irwin and staff researchers Richard Drezen and Rena Kirsch contributed to this report.