WASHINGTON — On the morning after Lehman Brothers filed for bankruptcy in 2008, most Federal Reserve officials still believed that the US economy would keep growing despite the metastasizing financial crisis.
The Fed’s policymaking committee voted unanimously against bolstering the economy by cutting interest rates, and several officials praised what they described as the decision to let Lehman fail, saying it would help to restore a sense of accountability on Wall Street.
James Bullard, president of the Federal Reserve Bank of St. Louis, urged his colleagues “to wait for some time to assess the impact of the Lehman bankruptcy filing, if any, on the national economy,” according to transcripts of the Fed’s 2008 meetings that it published Friday.
The hundreds of pages of transcripts, based on recordings made at the time, reveal the ignorance of Fed officials about economic conditions during the climactic months of the financial crisis. Officials repeatedly fretted about overstimulating the economy, only to realize time and again that they needed to redouble efforts to contain the crisis.
The Fed’s chairman at the time, Ben S. Bernanke, was unusually clearsighted in warning of the risk of a historic recession as the nation entered into a presidential election year. But he struggled to persuade his colleagues, and at crucial junctures he did not push forcefully for stronger action.
The Fed’s current chair, Janet L. Yellen, then the president of the Federal Reserve Bank of San Francisco, was even more alarmed by the deterioration of economic conditions. She and Eric Rosengren, president of the Federal Reserve Bank of Boston, are the most forceful and persistent advocates for stronger action in the transcripts. But they, too, underestimated the downturn until the final months of 2008.
The transcripts also show, however, that Fed officials responded decisively in those final months, probably preventing an even deeper recession. By the end of 2008, the Fed had reduced short-term interest rates nearly to zero for the first time since the Great Depression, and it had become a primary source of funding not just for the global financial system but for US homeowners and companies that made food and cars.
Yellen summed up this new ethos at a Fed meeting six weeks after Lehman’s failure, telling colleagues, “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.”
In normal times, the Fed is a powerful but somnolent institution, charged with keeping a steady hand on the rudder of the economy. It moves interest rates up and down to moderate inflation and minimize unemployment. But beginning in 2007, it was forced to take on a far more challenging role as the central backstop for the global financial system.
It was constrained in this new role by its reliance on economic indicators that tend to miss sharp changes in economic conditions. But the Fed’s caution in 2008 also reflected a deeply ingrained bias to worry more about the risk of inflation than the reality of rising unemployment.
As Fed officials gathered Sept. 16 at their marble headquarters in Washington for a previously scheduled meeting, stock markets were in free fall. Housing prices had been collapsing for two years, and unemployment was spiking.
Yet most officials did not see clear evidence of a broad crisis. They expected the economy to grow slowly in 2008, then more quickly in 2009.
Bernanke even told his colleagues that it was clear the economy had entered a downturn but that he still did not favor cutting rates.
That optimism would not long endure. Just minutes after the end of that first meeting, a smaller group of Fed officials agreed to rescue faltering insurance giant American International Group, a company never before subject to Fed supervision that until then was barely on the government’s radar.
And in the succeeding weeks, the Fed would announce a seemingly endless series of programs to buttress the economy, leading Fed officials to joke about the resulting alphabet soup of acronyms.
Some Fed officials have argued that the Fed was blind in 2008 because it relied, like everyone else, on a standard set of economic indicators.