The Federal Reserve recently released transcripts from its meetings in 2008. Given the significant financial events that occurred in that year, it seems worthwhile to go through the transcripts in some detail.
As I work through the entire set of transcripts, in addition to a blog post I will post my comments in a new tab, entitled “Federal Reserve Transcripts 2008.” I will do the same thing for each new post – likely covering one meeting at a time.
First, a quick recap: how did 2007 end at the Fed? From my post on the released 2007 transcripts:
The Washington Post chimes in:
It was December 2007, and officials at the Federal Reserve were torn between two visions of what was in store for the nation’s economy: a mild slowdown or outright recession.
A staff presentation described a highly unlikely, worst-case scenario that included a 10 percent drop in the stock market.
The New York Daily News:
“I do not expect insolvency or near insolvency among major financial institutions,” Bernanke said at the Fed’s December 2007 meeting, as the economy was already starting to spiral into the Great Recession.
To summarize the Fed’s views at year-end 2007:
· “a mild slowdown or outright recession,” but no mention of the possibility of the greatest financial calamity to hit the United States and much of the world since the Great Depression;
· “a highly unlikely, worst-case scenario that included a 10 percent drop in the stock market,” missing the mark by just a wee bit as the S&P 500 fell by more than 50%;
· Bernanke did “not expect insolvency or near insolvency among major financial institutions,” well Lehman went belly up in the largest bankruptcy in history and the entire lot of them would have followed along had not the Fed and Treasury intervened.
With that, let’s see how 2008 unfolded through the eyes of the official Federal Reserve transcripts.
Conference Call of the Federal Open Market Committee on January 9, 2008
While reading the transcripts, keep in mind the for-public-consumption mandate of the Fed:
The Congress established the statutory objectives for monetary policy--maximum employment, stable prices, and moderate long-term interest rates--in the Federal Reserve Act.
So how does the Fed start the meeting? Bernanke opens the floor to Mr. Dudley:
Market function has improved somewhat since the December FOMC meeting. This can be seen most notably in the term funding, foreign-exchange swap, and asset-backed commercial paper markets. In addition, some of the risks of contagion—for example, from troubled SIVs and from financial guarantors to money market mutual funds or the municipal securities market—appear to have lessened slightly.
Nothing referencing the objectives of the mandate. But I can give the Fed the benefit of the doubt – efficient functioning of markets is buried somewhere in the Fed’s job description; given the risks to the financial system that had to be obvious even to the oblivious, it is at least arguable that Bernanke should start here.
As can be seen on the first page of the handout in exhibits 1, 2, and 3, term funding spreads have fallen sharply for dollar, euro and sterling rates. For example, the one-month LIBOR–OIS spread is now 31 basis points, down from a peak of more than 100 basis points in December.
The use of LIBOR as a measure of financial market health has been exposed as less than valuable – it seems the Fed may have known something about the manipulation of this self-reported rate as early as 2007:
The Federal Reserve Bank of New York may have known as early as August 2007 that the setting of global benchmark interest rates was flawed.
Dudley goes on to report improvements in various financial markets. All is not rosy, however:
Despite these positive developments in terms of market function, financial conditions have tightened as balance sheet pressures on commercial and investment banks remain intense and as the macroeconomic outlook has deteriorated. This can be seen in a number of respects.
First, large writedowns and larger loan-loss provisions are cutting into bank and thrift capital and pushing down equity prices.
Second, corporate credit spreads and credit default indexes have widened sharply in the past few months, with a significant rise registered since year-end.
Third, equity markets are under pressure. For example, as illustrated in exhibit 11, the S&P 500 index declined in the fourth quarter and, up through yesterday, has fallen about 5 percent so far this year. Moreover, the equity market weakness has broadened out beyond the financial sector. For example, as of yesterday’s close, the Nasdaq index, which has little weight in financials, had fallen 8 percent this year. Global stock market indexes have also generally weakened.
Equity prices are at issue in two of the three comments he makes.