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The Fed Was Hopelessly 'Behind The Curve' During The Financial Crisis, New Transcripts Show

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BERNANKE 2008
MANDEL NGAN via Getty Images

Federal Reserve policy makers were repeatedly caught by surprise as the economy and financial markets collapsed around them in 2008, according to newly released transcripts of their meetings from that year.

If you believe, for some reason, that the Fed has special fortune-telling abilities, these records should disabuse you of that notion pretty quickly.

Repeatedly throughout that crisis year, the Fed took relatively hopeful views of the economy's fate, only to play catch-up when the situation got much worse than they expected, sometimes in a matter of just weeks or days.

To be fair to the Fed, the unfolding economic collapse took a lot of people by surprise. And the Fed did act fairly aggressively when it got around to acting. But these records are reminders that the human beings pulling the strings of the world's largest economy are no better than most other economists at predicting the future.

"We were seriously behind the curve in terms of economic growth and the financial situation," then-Fed Chairman Ben Bernanke said during an emergency conference call on Jan. 21, 2008. It would not be the last time.

The Fed decided on that call to slash its key interest rate by three-quarters of a percentage point, a shockingly bold move after it had decided not to cut rates during another emergency call just 12 days earlier.

Even with the large cut on Jan. 21, the Fed knew it hadn't done enough. Bernanke suggested that it should have cut by a full percentage point or more. Instead, it waited just nine days and slashed another half-percentage point from its target rate on Jan. 30.

Repeatedly throughout the first month of 2008, Fed officials described themselves as "behind the curve." And yet they seemed to forget that lesson later in the year.

The most egregious example came during its policy meeting on Sept. 16, 2008, when the Fed decided not to cut interest rates to help the economy, even though Lehman Brothers had just collapsed and insurance giant AIG was in the grips of a crisis that threatened to bring down the whole financial system.

At that time, many Fed officials were far more worried about inflation risks than about the risk of an economic collapse and depression. The word "inflation" occurs 129 times in the Sept. 16 transcript; the word "recession" was uttered just five times. ("Laughter" is noted in the transcript 22 times.)

Even current Fed Chair Janet Yellen -- who was then the president of the San Francisco Fed and had frequently been prescient about the growing risks to the economy -- argued for standing pat on Sept. 16. She did so despite the fact that she still saw signs of growing economic weakness, including a slowdown in demand for plastic surgery in wealthy San Francisco neighborhoods.

Financial markets kept deteriorating in the days after that meeting, prompting an emergency Fed conference call on Sept. 29. Amazingly, the Fed again decided to take no action.

It wasn't until Oct. 7 that the Fed finally got around to cutting interest rates. Even then, some Fed policy makers wanted to quibble about the Fed's outlook for inflation, refusing to believe that the economy had tipped into a deep hole.

As late as Oct. 29, the Fed still expected unemployment to peak no higher than 7.6 percent in 2009. It hit 7.8 percent just three months later, and surged all the way to 10 percent by late 2009.

Between January and October, the Fed often failed to appreciate what was happening to the economy and the financial system. In April, for example, not long after the collapse of Bear Stearns, Bernanke gave himself a gentle high-five.

"Let me first say that I think we ought to at least modestly congratulate ourselves that we have made some progress," he said. "Our policy actions, including both rate cuts and the liquidity measures, have seemed to have had some benefit. I think the fear has moderated. The markets have improved somewhat."

The Fed did cut its target rate by a quarter-percentage point at that meeting, but made no change at its next meeting in June, even after the collapse of mortgage lender Countrywide Financial.

By mid-July, government-backed mortgage companies Fannie Mae and Freddie Mac were under constant assault in financial markets. Astoundingly, Fannie and Freddie were mentioned only once at the Fed's June policy meeting, and got no mention at all during a July conference call.

At least the Fed's private discussions were consistent with its public statements: In July, Bernanke declared to Congress that Fannie and Freddie were "adequately capitalized" and "in no danger of failing."

Both failed and were taken over by taxpayers less than two months later.

Fannie and Freddie did get 12 and 13 mentions, respectively, at the Fed's August meeting, when the end was near. But the Fed was not overly concerned about the broader implications, holding its policy steady at that meeting. The Fed still expected inflation (mentioned 322 times in that transcript) to rise in the second half of the year.

At least the Fed seemed aware of its own limitations. At that fateful Sept. 16 meeting, one Fed economist said:

"We did receive a great deal of macroeconomic data since ... last Wednesday. We didn't seem to get any of it right, but it all netted out to just about nothing."

And everybody had a good laugh.

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