Sun, Jan 20, 2013 - Page 13 News List

Fed underestimated crisis

AP, Washington

US Federal Reserve officials in 2007 badly underestimated the scope of the approaching financial crisis and how it would tip the US economy into the deepest recession since the Great Depression, transcripts of the Fed’s policy meetings that year show.

The meetings occurred as the country was on the brink of its worst financial crisis since the 1930s.

As the year went on, Fed officials shifted their focus away from the risk of inflation as they slowly began to recognize the severity of the crisis.

Beginning in September 2007, the Fed cut interest rates and took extraordinary steps to try to ease credit and shore up confidence in the banking system. Throughout the year, the housing crisis deepened. Home prices weakened. Subprime mortgages soured.

As foreclosures rose, banks and hedge funds that had invested big in subprime mortgages were weighed down by worthless assets. The damage reached the top echelons of Wall Street.

At the Fed’s Oct. 30, 2007, policy meeting, Janet Yellen, then president of the Federal Reserve Bank of San Francisco, noted that the economy faced increased risks. However, she did not foresee anything dire.

“I think the most likely outcome is that the economy will move forward toward a soft landing,” Yellen said then.

Yellen was hardly alone in feeling more upbeat about the economy in October 2007. At the same meeting, Fed Chairman Ben Bernanke noted that housing was “very weak” and manufacturing was slowing but sounded an optimistic note.

At the same meeting, Timothy Geithner, then president of the Federal Reserve Bank of New York and now US Secretary of the Treasury, said: “Developments of financial markets on balance since the last meeting have been reassuring. The panic has receded.”

By December 2007, the economy had plunged into the recession which would officially last until June 2009.

The Fed declined on Friday to comment on the transcripts.

In many places, the transcripts illustrate what has long been known: That the Fed, like most other regulators and economists, was slow to grasp the magnitude of the housing meltdown, the financial crisis and the depth of the economy’s weaknesses.

Economic growth had slowed sharply in the first quarter of 2007 to below a 1 percent annual rate. And in August that year, employers cut jobs for the first time in four years.

The Fed declined to cut interest rate cuts at its Aug. 7, 2007, policy meeting. After that meeting, it issued a statement declaring that the threats to growth had only “increased somewhat.”

A few days after that meeting, BNP Paribas, France’s largest bank, announced that it was freezing three funds that had invested in the troubled US mortgage market. That move escalated fears in global markets.

On Aug. 10 2007, the Fed held the first of three emergency conference calls to discuss the emerging crisis.

Its policy committee took the aggressive step of announcing it would pump billions of US dollars into financial markets to try to calm turmoil on Wall Street and loosen credit.

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