Federal Reserve releases transcripts of unfolding 2008 financial crisis

3:05 PM, Feb 21, 2014   |    comments
Then-Fed chief Ben Bernanke speaking at the Brookings Institution in Washington on Jan. 16.
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(USA TODAY) Five years after the 2007-2008 financial crisis, the Federal Reserve is providing an inside glimpse of how it kept financial markets from collapsing, averting the worst economic crisis since the Great Depression.

The Federal Reserve on Friday released transcripts of more than a dozen policy meetings beginning in January 2008, when then-Federal Reserve Chief Ben Bernanke and other Fed officials candidly expressed fears that the economy was continuing to slide, investment banks remained at risk of failing, and the financial fallout was spreading from financial sector stocks to global markets and economies.

The transcripts, which cover Fed discussions through December 2008, are the most intimate look at how Fed officials were dealing with the crisis in real time, debating how best to help investment banks and protect the economy - from continued cuts in interest rates to bailouts of troubled investment banks, such as Lehman Bros. It's also clear from hundreds of pages of Fed transcripts that officials faced a crisis that may have been deeper, more widespread and more problematic to solve than previously disclosed.

"The data have been on the whole negative,'' Bernanke said at a Federal Open Market Committee conference call. "The markets in part are suffering from just simple uncertainty about whether the Fed is willing to be proactive in addressing downside risks."

William Dudley, head of the Fed's Bank of New York, said financial markets, already roiled the previous quarter, feared that risks "remain severe and may have even intensified."

"Put simply, market participants believe that the macroeconomic outlook has deteriorated significantly and financial asset price movements broadly reflect that shift in expectations,'' Dudley said.

"Balance sheet pressures on commercial and investment banks remain intense as the macroeconomic outlook has deteriorated,'' he said.

The crisis was rooted in the August 2007 collapse of the housing market, when consumers who had bought homes with low-interest loans from subprime lenders could not keep up with higher payments as loan rates rose.

That led to massive loan defaults and a meltdown among subprime lenders. That spread to investment banks and hedge funds, which had repackaged loans in secondary markets for other financial instruments, allowing them to heavily leverage investments.

The Fed and other central banks began slashing interest rates in 2007 and also provided emergency funding for investment banks to keep them from collapsing. Lehman Brothers wound up filing for bankruptcy, Bear Stearns was acquired by JP Morgan Chase, Merrill Lynch was acquired by Bank of America, while lenders Fannie Mae and Freddie Mac were put under government control.

Minutes from a crucial Sept. 16, 2008, FOMC meeting underscored continued worries.

Caught between stormy financial markets, building inflation and weak economic conditions, they debated whether to again lower interest rates.

"Either the financial system is going to implode in a major way," which would lead to lower interest rates, "or it is not," Dudley said.

Atlanta Fed chief Dennis Lockhart said he sensed a "quite weak" economy. "I am concerned that the downside risks to growth may be gathering force," he said.

The Fed left interest rates unchanged at that meeting. But they were intent on making a dramatic statement to markets to ease widespread fears, according to the transcripts.

"In a crisis you need enough force - more force than the market thinks is necessary to solve the problem," Dudley said.

Fed officials at that meeting were also worried that lenders were pulling away from a critical financing source for the banking system known as "tri-party repos."

"That is a frightening scenario," Richmond Fed President Jeffrey Lacker said.

Fed officials also discussed their efforts to keep American International Group from collapsing. AIG had sold derivatives called credit default swaps designed to cover loan defaults but was on the hook for billions of dollars.

"AIG is in a situation in which (the parent company) is basically going to run out of money - today, tomorrow, Thursday or very, very soon,'' Dudley said at the Sept. 16 FOMC meeting.

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