Fed missed warning signs in 2007 as crisis gained steam

Fri Jan 18, 2013 5:23pm EST
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WASHINGTON (Reuters) - Top policymakers at the Federal Reserve felt for most of 2007 that problems in housing and banking were isolated and unlikely to tear down the U.S. economy as they ultimately did.

Even as crisis signals started flashing red with the freezing of credit markets during the summer, Fed officials believed the troubles would be moderate and short-lived, according to transcripts of the 2007 meetings released on Friday after the customary five-year lag.

U.S. Treasury Secretary Timothy Geithner, then president of the New York Federal Reserve Bank, said during an emergency telephone call on August 10 of that year that most of Wall Street was still doing fine.

"We have no indication that the major, more diversified institutions are facing any funding pressure," Geithner said according to the transcripts, which total 1,370 pages. "In fact, some of them report what we classically see in a context like this, which is that money is flowing to them."

Similarly, Fed Chairman Ben Bernanke underestimated the risks of a looming financial blow-up.

"I do not expect insolvency or near insolvency among major financial institutions," he said in December 2007.

By then, the Fed had already launched emergency liquidity measures and begun cutting interest rates, which by December of 2008 would be brought all the way down to effectively zero.

Eventually, the financial meltdown would come to threaten all of Wall Street's powerhouses, including Goldman Sachs Group Inc (GS.N: Quote) and Morgan Stanley (MS.N: Quote). It led to the failure of Lehman Brothers, the massive bailout of insurer American International Group Inc (AIG.N: Quote) and the government takeover of mortgage giants Fannie Mae FNMA.OB and Freddie Mac FMCC.OB.

The combined effects of the housing crash with the credit crunch helped push the country into its worst recession since the Great Depression, with output shrinking during 2008 and the first half of 2009.   Continued...

A view shows an eagle sculpture on Federal Reserve building, on the day it will release minutes of Federal Open Market Committee from August 1, 2012, in Washington August 22, 2012. REUTERS/Larry Downing