WASHINGTON -- When the financial crisis deepened in September 2008, Federal Reserve leaders initially viewed it as a problem that would reverse itself. Janet Yellen, now the new Fed chair, was the earliest voice for aggressive action, transcripts released Friday show.
Like her colleagues, Yellen didn’t foresee the huge spike in unemployment or a profound recession around the corner in the aftermath of the bankruptcy of Lehman Brothers, the event that triggered the economic crisis of 2008. But within weeks, she recognized that the threat as more than storm clouds and became the most forceful advocate of what would become efforts to stimulate the economy through unconventional means.
The legacy of those efforts remains today, as it falls to Yellen to pull back on the massive bond-buying program that was used to drive interest down in an effort to spur more consumption and lending. That program is still unfolding at a pace of $65 billion a month, and Yellen must find a way to rein it in that’s least disruptive to nervous financial markets. It’s a fitting challenge, since the transcripts of the Fed’s 2008 meetings show her as a vocal advocate for an aggressive approach almost from the outset.
The Fed releases the transcripts of its meetings annually on a five-year delay, and those from 2008 were highly anticipated, since they would provide the first unvarnished view of discussions that occurred as the financial markets were in a state of near collapse.
Among the details the transcripts reveal is that while the bank’s governors discussed at length how the Fed’s actions might affect the markets, there was no discussion of what political impact those actions might have, even though a contentious presidential election was less than two months away, one that would put a little-known senator from Illinois, Barack Obama, in the White House. That’s likely to prove meaningful in the current congressional debate over whether to audit the Fed’s monetary policymaking meetings.
When the interest-rate setting Federal Open Market Committee, a rotating panel of Fed bank presidents and governors, met on Sept. 16, 2008, a day after investment bank Lehman Brothers filed for bankruptcy and the very day the Fed rescued insurance behemoth American International Group, there were worries about market turmoil but no predictions of the deep economic downturn that followed.
Yellen was then president of the San Francisco Federal Reserve; she’d become Fed vice chair in 2010 and then the first woman to lead the Fed this month. She argued forcefully against cutting interest rates, predicting the economy would show “a little more strength in 2009” after a slowdown in the second half of 2008.
Some Fed governors were less optimistic. Kansas City Fed President Thomas Hoenig predicted that “we are going to have many lessons from this. Part of the problem has been very lax lending and, obviously now, weakness in some of the (regulatory) oversight.”
Elizabeth “Betsy” Duke, a Fed governor and former private-sector banker, seemed the most aware of what would follow. Talking about the housing market, she noted that loans originated by mortgage brokers, instead of banks themselves, “are 100 percent loss (sic).” Of states that’d later be the epicenter of the housing crisis, she said, “Florida is a bottomless hole – speculation combined with insurance problems. In Arizona, so much land was available that they can’t find a bottom there.”
Then-Fed Chairman Ben Bernanke, hailed for his leadership during the crisis, closed that meeting by suggesting it was likely that the economy was already in recession. But he argued against another interest rate cut, and the rate stayed at 2 percent.
That all changed just three weeks later, when the Federal Open Market Committee met on a conference call Oct. 7. The members were asked to get behind a plan in which the Fed, the European Central Bank and four other central banks would announce a surprise coordinated drop in lending rates, a positive shock for markets and the economy.
By then, Bernanke had determined it was “more than obvious that we have an extraordinary situation,” adding that virtually all markets “are not functioning or are in extreme stress.” The deteriorating conditions demanded a rate cut, he said.
“I should say that comes as a surprise to me. I very much expected that we could stay at 2 percent for a long time,” he told the other members of the committee.
During the call, Yellen emerged as the committee’s strongest voice for even more action.
“In my opinion, a larger action could easily be justified and is ultimately likely to prove necessary,” she said.
Three weeks later, at a regularly scheduled two-day meeting, members for the first time began discussing quantitative easing, the controversial program under which the Fed purchased government and mortgage bonds in an attempt to simulate what would be negative interest rates.
Jeffrey Lacker, the president of the Federal Reserve Bank in Richmond, Va., raised the issue, asking if the Fed might soon be at the point where that step would need to be taken. Bernanke answered, “We’re pretty close, yes.”
Yellen again she repeated her call for more aggressive action.
“Given the seriousness of the situation, I believe that we should put as much stimulus into the system as we can, as soon as we can,” she concluded.
Bernanke offered a gloomy outlook. He told colleagues that the post-World War II record for recessions was 16 months in 1980-81, and “I think we have a reasonable chance to break that record.” He also said the largest swing ever in the unemployment rate was 3.6 percentage points and “I think we have a chance to come close to that number.”
The Great Recession’s swing was actually a record 6.4 percent points from peak to bottom. It would last officially 19 months.
Before a vote to cut rates further, the chairman spelled out what historians may come to call the Bernanke doctrine.
“We do have to continue to be aggressive. We have to continue to look for solutions,” the Fed chief said. “Some of them are not going to work. Some of them are going to add to uncertainty. I recognize that critique. I realize it’s a valid critique. But I don’t think that this is going to be a self-correcting thing anytime soon.”
In November, the Fed began aggressively buying mortgage bonds, the precursor to what later was trillions in government and mortgage bond purchases.
Then in December, the Fed cut its closely followed lending rate to zero, where it remains more than five years later.