Fed Members Were Torn on Response to Financial Crisis, 2008 Transcripts Show

Fed Board of Governors Meet On Volcker Rule
Bloomberg/Getty Images/Andrew Harrer Ben Bernanke and Janet Yellen in a 2013 Fed meeting.
By Jeff Cox

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 on Friday, show the depths of Fed deliberations as a crisis on Wall Street threatened to tear the global economy apart.
As policy makers rushed in to save Bear Stearns and AIG but not Lehman Brothers, then-Chairman Ben Bernanke considered the ramifications.

"There have been criticisms from the right and from the left," Bernanke said at the Oct. 28-29 meeting. "From the right, the initial criticism was that we have no business interfering with the market process. We should let them fail. The market will take care of it."

"I never took this seriously," he added. "I just don't believe that you can allow systemically critical institutions to fail in the middle of financial crises and expect it to be not a problem."

Emergency Meeting Follows Lehman Bankruptcy

The Sept. 16 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. They often appeared to be groping in the dark in trying to devise solutions to the chaos.

"Personally, I see the prospects for economic growth in the foreseeable future as quite weak, notwithstanding the second quarter's strength," 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 about 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.

A Bit of Humor From Yellen

During the otherwise-intense discussions at the September meeting, Yellen found a way to interject some levity -- though it was unclear if it was intentional -- as she described economic conditions in her district. The transcript read:

"My contacts report that cutbacks in spending are widespread, especially for discretionary items. For example, East Bay plastic surgeons and dentists note that patients are deferring elective procedures. [Laughter] Reservations are no longer necessary at many high-end restaurants. And the Silicon Valley Country Club, with a $250,000 entrance fee and seven-to-eight-year waiting list, has seen the number of would-be new members shrink to a mere 13. [Laughter]"

Yellen worried throughout the year about the economy and advocated both for aggressive asset purchases as well as knocking interest rates down to the zero-bound level, where they remain.
""It appears that the economy has stalled and may have fallen into a recession," Yellen said in April.
She noted tight credit markets as a major source of worry.

"Credit conditions have turned quite restrictive," Yellen said. "This credit crunch reflects the drying up of financing both for markets that were important sources of business and consumer credit and from banks that are contending with capital-depleting losses and illiquid assets."

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.

Misplaced Hope

Yet there was hope -- ultimately misplaced -- 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."

In October, weeks after the Lehman collapse, it became clear how bad things had gotten.
"It's more than obvious that we have an extraordinary situation," Bernanke said. "It is not a single market. It's not like the 1987 stock market crash or the 1970 commercial paper crisis. Virtually all the markets, particularly the credit markets, are not functioning or are in extreme stress. It's really an extraordinary situation, and I think everyone can agree that it's creating enormous risks for the global economy."

The Fed began cutting interest rates aggressively in January, with two cuts amounting to 1.25 percentage points, 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.

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