In making sense of the newly released transcripts from the Federal Reserve’s 2007 policy meetings, let’s get one thing out of the way first. Prediction is hard, as Yogi Berra said, especially when it’s about the future.
That is doubly true when you add in the way things work in financial panics, in which outcomes are highly nonlinear—that’s to say, when one bank or segment of the money markets starts to experience problems, it can rapidly become a domino effect that, as we learned, can spread in unpredictable ways that bring down the entire financial system.
But here’s the thing. I really thought we would see more foresight in these transcripts than there is to be found. I was covering the Fed at the time for the Post, and subsequently reported and wrote a book that covers the events of 2007 (It comes out in April). I had the sense that even as leaders of the central bank projected public calm, and confidence that there would be no recession (let alone the near-depression that in fact materialized), that behind closed doors they saw what direction things were heading. It isn’t so.
Sure, there were hints of clear-headedness. Timothy Geithner, the New York Fed president at the time, had a consistent view that fall that the financial system was unraveling and that it was no time for policy gradualism. Eric Rosengren of the Boston Fed, Janet Yellen of the San Francisco Fed, and governor Frederic Mishkin were, by the end of the year, arguing for more interest rate cuts and seemingly pulling his hair out over their colleagues’ sanguine views of the outlook.
It should also be added that there’s not much reason to think the crisis could have been prevented if the Fed had been quicker on the draw. If you honestly believe that we would have skirted recession if the Fed had cut rates by 0.5 percentage points at the December 2007 meeting, not 0.25 percentage points, you have a distorted sense of the power of a central bank to shape the course of the economy.
But I expected to see much more evidence in these transcripts that the Fed officials had a good grasp of how the fissures that were emerging in the summer of 2007 could spiral out of control.
That’s not to say they should have been predicting the gory details of what was to come. It would have been hard to see exactly what path the crisis would take, for example that investment banks like Bear Stearns and Lehman Brothers would prove to have startlingly fragile sources of funding, or that insurer AIG had guaranteed hundreds of billions of dollars of mortgage securities that would ultimately cause the near-collapse of the company and a Fed bailout
I did expect, though, that Fed officials would show more evidence of understanding the possibility that the entire financial system had become a house of cards built on mortgage securities that were anything but secure, with all sorts of financial institutions over-levered and overly dependent on assets that were near-impossible to value. And I expected them to understand that once a problem that deep begins correcting itself, it can spiral into all sorts of dangerous directions. Which this one did.
In other words, I hoped that when Fed officials publicly dismissed the chances of a recession as late as the fall of 2007, they were acting like parents who try to keep news of a layoff from their children; that they might be fully aware of how dangerous things were becoming, but didn’t want to scare anyone.
I was wrong about that.
Theirs was, at its core, a failure of creativity. It was an inability to see how these moving pieces of an infinitely complex financial system and economy could interact to create a very bad situation. They labored mightily to separate the things they did to pump liquidity into the U.S. and European banking systems from their assessments of the U.S. economic situation. As it turns out, those were actually two sides of the same coin.
One lesson here is that our public officials, even the hard-working, highly intelligent ones, are far from demi-gods. They have the same blind spots and tendency toward analytical failures of anyone else. Secrecy allows public officials, whether in the world of monetary policy or others like national security, to create a Wizard of Oz like illusion of holding great power, of maneuvering levers with information in hand that mere mortals can only dream of. When reporters interview a high official, there is often a subtext the high official aims to convey: If you knew what I know, you would understand the supreme wisdom of my actions.
Seeing what the Fed officials were saying privately, to each other, in 2007 is a reminder that this isn’t always so, and just because a person has more information, it doesn’t mean he or she has the right answer.