Fed at crossroads: Transcripts detail crisis

Keith Lew | Flickr Vision | Getty Images September 15, 2008, the day the 150 year old Lehman Brothers declared bankruptcy.

Keith Lew | Flickr Vision | Getty Images
September 15, 2008, the day the 150 year old Lehman Brothers declared bankruptcy.

Even for an entity used to doing heavy lifting when it comes to supporting the U.S. economy, 2008 was a historic year for the Federal Reserve.

The central bank was left to grapple with the worst downturn since the Great Depression, and was challenged to come up with innovative tools to get the economy back on its feet.

Transcripts from that year’s meeting, released in a massive document dump Friday, show the depths of Fed deliberations as a crisis on Wall Street threatened to tear the global economy apart.

The September emergency meeting, which came the day after Lehman Brothers filed for bankruptcy, showed officials grappling with the full scope of the problem and trying to anticipate the landscape ahead.

“Personally, I see the prospects for economic growth in the foreseeable future as quite weak, notwithstanding the second quarter’s strength,” then-Chairman Ben Bernanke said. “I think what we saw in the recent labor reports removes any real doubt that we are in a period that will be designated as an official (National Bureau of Economic Research) recession.”

Current Chair Janet Yellen saw things much the same way as she ruminated over the problems in housing and employment.

“The interaction of higher unemployment with the housing and financial markets raises the potential for even worse news—namely, an intensification of the adverse feedback loop we have long worried about and are now experiencing,” she said from her position then as leader of the San Francisco Fed. “Indeed, delinquencies have risen substantially across the spectrum of consumer loans, and credit availability continues to decline.”

Interestingly, Yellen advocated for no change in the funds rate, which was at 2 percent then. The Open Market Committee followed that meeting with successive cuts of 50 basis points at two October meetings and another 75 basis points in December.

The year began with a drop in the red-hot housing market and the crumbling of the subprime mortgage industry that helped blow up the real estate bubble.

Yet there was hope at the Jan. 29-30 meeting that a recession would be avoided altogether.

“We are not forecasting a recession,” board member Dave Reifschneider said. “While the model estimates of the probability of recession have moved up, they are not uniform in their assessment that a recession is at hand.”

By the time the year was over, the Great Recession left some of the Street’s most venerable names in the dust: Lehman Brothers, Bear Stearns, Merrill Lynch, Washington Mutual and a host of other financial powerhouses.

The Fed began cutting interest rates aggressively in January and by year’s end had taken the policy rate down to nearly zero. It also began a bond-buying program that ultimately would take the central bank balance sheet past the $4 trillion mark.

In the transcripts there are detailed descriptions of the deliberations that helped the Open Market Committee make history.

Fed members clearly were torn over how to respond to the crisis.

With liquidity freezing up due to the Lehman collapse, members lobbied for interest rate cuts as well as the general policy easing that would come in November in the form of quantitative easing. Not all members, though, were on board with the Fed taking extreme measures.

“I would say to you, in dealing with that stress, I am fully supportive of the actions that we take in terms of liquidity—the (Term Auction Facility) and the other efforts to provide liquidity into the market,” Kansas City Fed President Thomas Hoenig said at the September meeting. “These are tools that we can and should use for these kinds of shocks in a short-term context. On the other hand, I would encourage the Committee to resist the impulse to ease policy in a sense of doing something. The issue is not the level of our policy rate at this time. It is the dysfunctioning of the markets that we hope our liquidity efforts will help address.”

(Read the full transcripts here.)

—By CNBC’s Jeff Cox. Follow him on Twitter @JeffCoxCNBCcom.

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