The leaders of the Federal Reserve went around the room saluting Alan Greenspan during his last major meeting as chairman of the central bank Jan. 31, 2006. Timothy F. Geithner, at the time the president of the Federal Reserve Bank of New York and now Treasury secretary, made a prediction.
“I’d like the record to show that I think you’re pretty terrific, too,’’ Geithner told Greenspan. “And thinking in terms of probabilities, I think the risk that we decide in the future that you’re even better than we think is higher than the alternative.’’
Greenspan’s record - sterling when he left the central bank after 18 years - now appears much more mixed. Many economists and analysts say a range of Fed policies contributed to the financial crisis and resulting recession. These included keeping interest rates low for an extended period, failing to take action to stem the bubble in housing prices, and inadequate oversight of financial firms.
The release yesterday of transcripts of Fed meetings in 2006 shows that top leaders of the Fed - several of whom continue to hold key positions today - had a limited awareness of the gravity of the threat that the weakness in the housing market posed to the rest of the economy.
In his first meeting as Fed chairman, Ben S. Bernanke noted that the housing market was causing some uncertainty, but that he “was reassured to hear that most participants think that a decline in housing will be cushioned by strong fundamentals in terms of income, jobs, and continuing low interest rates.’’
Bernanke made light of the questions surrounding Iceland, which was causing some early waves in financial markets after borrowing heavily.
After a Fed economist gave a presentation that noted those trembles, Bernanke said, “We’d like a full report on the Icelandic,’’ before being interrupted by laughter. Later, the explosion of Iceland’s financial markets led to that nation’s banks defaulting on debts, which fed the financial crisis.
‘Strong fundamentals support a relatively soft landing in housing.’
The year 2006 began with adulation all around for Greenspan.
Janet Yellen, then president of the Federal Reserve Bank of San Francisco and now the Fed’s vice chair, told Greenspan “the situation you’re handing off to your successor is a lot like a tennis racquet with a gigantic sweet spot.’’
A Fed economist reported in a 2006 meeting that “we have not seen - and don’t expect - a broad deterioration in mortgage credit quality.’’ That turned out to be incorrect.
At the end of the year, there was growing awareness that problems in housing, with prices declining, could lead to some slower growth in the overall economy. But officials were still somewhat optimistic.
“The current weakness in the economy still seems principally to stem from the direct effects of the slowdown in housing on construction activity,’’ Geithner said in December 2006. “As things now stand, the softer-than-expected recent numbers don’t argue, in our view, for a substantial reassessment of the risks in the outlook.’’