They Didn't See it Coming

The Federal Reserve recently released transcripts of its meetings in 2007.  This was during the time of the first visible signs of the ongoing financial calamity.  I say the first visible signs, because there were a few economists and investors who understood this issue well before 2007, most of these students of the Austrian Business Cycle Theory.

But none were to be found at the Fed.  The New York Daily News summarizes the transcripts:

They didn't see it coming.

Federal Reserve officials were largely blindsided as the financial crisis hurtled toward the U.S. economy like a freight train in 2007, according to newly released transcripts. [1]

The Wall Street Journal is slightly less blunt:

Federal Reserve officials in 2007 appeared to underestimate the sickly condition of U.S. financial markets before shifting to a state of growing alarm, according to 1,566 pages of newly released transcripts from the central bank's meetings that year.

During most of the year, Fed Chairman Ben Bernanke embraced only reluctantly the interventionist stance that has defined his stewardship of the central bank. [2]

Yes, Bernanke really didn’t want to intervene.  The markets made him do it.

I am quite certain Bernanke’s reluctance was never a concern to those who placed him at the helm.  They knew he was “Helicopter Ben,” and they knew where his instincts would lead him when the time was right.

The whirlwind that hit the global economy in late 2008 outstripped even the direst forecasts in the transcripts. The new record provides ammunition for the Fed's critics—both those who say it was too slow to act and those who say it was too aggressive in intervening in financial markets. [2]

It gives the most ammunition to those who say the Fed shouldn’t even exist.  There is no economically rational argument for central planning of any commodity (meaning any good or service); why is this ignored when it comes to the most important commodity in a sophisticated division-of-labor economy?

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.

I guess they didn’t consider a third possibility.

They opted to believe in a slowdown. They were wrong. [3]

They weren’t just wrong in their choice; they were wrong by limiting themselves to these two possibilities.  It seems they didn’t even consider the third possibility, and the one that actually came to pass: the most severe economic catastrophe since the Great Depression, one that has lasted for five years with few signs of abating, and no signs of return to anything approaching pre-catastrophe levels.

A staff presentation described a highly unlikely, worst-case scenario that included a 10 percent drop in the stock market. [3]

They missed that forecast by just a bit, as the S&P 500 would fall more than 50%, from above 1500 in the summer of 2007 to below 700 by March 2009.

The transcripts mention the word “recession” four times in January, three times in June, once in August, and 27 times in December. [4]

According to the National Bureau of Economic Research (NBER), the recession began in December, 2007.  Good catch there by the Fed, to even begin to seriously discuss the possibility of recession all the way back in…wait a minute, let me double-check that…December, 2007.  Way to look out into the future and guide the ship.  The best macro-economists money can buy.

Central banking, like all macro-economic disciplines based on math and formulas (as opposed to human action) is quackery, and these transcripts demonstrate this unavoidable fact once again – as if we need more evidence.

Here are some of the lowlights of the minutes, gleaned from several sources that have reported on the subject:

January

The year had kicked off on a relatively high note, with one Fed official noting in January that the “risk of recession has become much slimmer.” [1]

In January 2007, [Bernanke] said the "worst outcomes" for housing had become less likely. [2]

In January 2007, [Geithner] said the subprime-mortgage market, which would later emerge at the core of the crisis, was small as a share of the overall mortgage market—a commonly held view at the time. [2]

Participants at the first FOMC meeting of 2007, on Jan. 30- 31, saw signs the economy was improving and recession risk diminishing. [4]

Yellen said at the January 2007 meeting that “prospects for a really serious housing collapse that spreads to consumer spending have diminished substantially.” [4]

Can we afford to give a mulligan to the group that is in complete control of central economic planning?

May

That May [Bernanke] said he saw "good fundamental reasons to think that growth will be moderate." [2]

Does negative growth fit into the category of “moderate”?

June

Bear Stearns broke wide open in June, with the collapse of two funds:

On June 22, 2007, Bear Stearns pledged a collateralized loan of up to $3.2 billion to "bail out" one of its funds, the Bear Stearns High-Grade Structured Credit Fund, while negotiating with other banks to loan money against collateral to another fund, the Bear Stearns High-Grade Structured Credit Enhanced Leveraged Fund. Bear Stearns had originally put up just $35 million….

From $35 million to $3.2 billion: a 91-fold miss in the capital required behind these funds.  You might think that this would light a match under Bernanke and members of the Fed.  Is it possible that only Bear Stearns made such a mistake?  Was Bear Stearns the only firm that invested in these securities and markets?

Fed Bank of Dallas President Richard Fisher in June cautioned that Bear Stearns’ troubles could mean “enormous risk,” but others brushed off his concern. That month, then-San Francisco Fed President Janet Yellen called the housing market’s troubles the “600-pound gorilla in the room.” [1]

Richard Fisher has long been the “hawk” in the room (a relative term, given the Fed’s charter).  Janet Yellen, both in this text and others in the reports comes across as the most prescient of the bunch.  Of course, that suggests two things, the first seems certain and the second a reasonable guess: 1) Her foresight would only lead to actions that make Bernanke look like Jim Grant, and 2) she may be the choice of the oligarchs to replace Bernanke.

Meanwhile, it seems no one else was overly concerned:

In June 2007, [Geithner] played down problems at two hedge funds controlled by investment bank Bear Stearns…."Direct exposure of the counterparties to Bear Stearns is very, very small compared with other things," Mr. Geithner said. [2]

What about “direct exposure” of other financial institutions to the exact same type of financial products as these that impacted Bear Stearns?

August

William Poole, president of the Federal Reserve Bank of St. Louis, echoed his sentiments at the meeting, saying, “My own bet is that the financial market upset is not going to change fundamentally what’s going on in the real economy.” [1]

But then why is the Fed today after propping up the market in order to “change fundamentally” what is going on in the market?

In August 2007, [Bernanke] sought to cast market turmoil in an optimistic light. While there was a risk that a twin housing and credit squeeze could become "difficult to deal with," he said, he thought "the odds are that the market will stabilize." [2]

Certainly long odds.  Very long odds, it turns out.  Do you feel better knowing that this is all one big craps game for PhDs?

A few days later, in an emergency meeting, [Bernanke] said: "My own feeling is that we should try to resist a rate cut until it is really very clear from economic data and other information that it is needed. I'd really prefer to avoid giving any impression of a bailout." [2]

An emergency.  In a few days. 

Instead of giving the impression of a bailout he would rather give actual bailouts.  That way no one will have any doubt about the true role of the Fed.

“Well-capitalized banks and opportunistic investors will come in and fill the gap, restoring credit flows to nonfinancial businesses and to the vast majority of households that can service their debts,” Donald Kohn, then vice chairman of the board, said in Aug. 2007…. [4]

After $700 billion of TARP, $1 trillion a year or more of annual federal deficits, a $2 trillion increase in the Fed’s balance sheet, and unknown trillions in backstops and other support provided by the Fed to international money center banks, we are still looking for those well-capitalized banks.

On Aug. 10 and Aug. 16, the FOMC held emergency meetings by conference call as money markets began to tighten. Just nine days after their regular meeting they ripped up their previous outlook and said, “downside risks to growth have increased appreciably.” [4]

Nine days!  Their previous outlook couldn’t survive nine days?

August 2007 stands out as one of the biggest policy flip- flops in Chairman Ben S. Bernanke’s tenure and shows the policy inertia on the FOMC. [4]

It isn’t policy inertia.  It is the impossibility of central planning.  They don’t get it right because they cannot get it right.  It is impossible for a few people surrounded by computers to plan any commodity, let alone the single most important commodity: money.

September

In September, [the Fed] began cutting interest rates, slashing them to near-zero by December of the following year. [1]

Even so, Bernanke seemed reluctant to move too quickly. At the September 2007 meeting he declared that, “We are not in the business of bailing out individuals or businesses.” [1]

Oh, just give Ben some time.  The oligarchs knew when they placed him in the job that under that thin veneer of a market-disciplinarian lurked a helicopter-piloting-enabler.  Bernanke could talk tough, but when push came to shove he would offer bailouts by the bushel.

December

“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. [1]

I think he meant to add “this calendar year.”  As the meeting was in December, that was a safe bet.  Just wait until 2008, Ben; just wait.

In December 2007, [Bernanke] said he was "quite conflicted" about whether to cut interest rates sharply. [2]

Why is the fate of the world’s markets and economies dependent on one person’s inner conflicts?

"At the time of our last meeting, I held out hope that the financial turmoil would gradually ebb and the economy might escape without serious damage. Subsequent developments have severely shaken that belief," [Yellen] said in December. [2]

Hope and belief.  Is this any better than Bernanke playing the odds?  This, it would seem, is what will differentiate the Yellen chairmanship from the Bernanke chairmanship.

I find it difficult to summarize this post any better than words offered by the chairman himself, Ben Bernanke:

Since 2007, Bernanke has acknowledged that he was slow to understand how severe the economic downturn would be. During an appearance last week at the University of Michigan, he was asked what surprised him most about the financial crisis.

Without missing a beat, Bernanke responded, “The crisis.” [3]

Of course, he isn’t so surprised as to go about seeking advice from the people who got it right all along.  I will give a hint.

1)      New York Daily News

2)      Wall Street Journal

3)      The Washington Post

4)      Bloomberg