Federal Reserve policymakers, in a tense meeting on one of the darkest days of the 2008 financial crisis, were worried the failure of Lehman Brothers a day earlier would wreak havoc on a teetering financial system but feared cutting already low interest rates might prove an over-reaction.
Transcripts of the US central bank's meeting on September 16th of that year, released today, showed then Fed chairman Ben Bernanke flatly telling his colleagues he was philosophically torn about the collapse of the investment bank.
They also threw fresh light on a debate over whether to loosen monetary policy in the face of a crisis that was fast engulfing financial markets but which some policymakers thought would be resolved relatively quickly.
Citing the moral hazard of making such “ad hoc” decisions over whether to help failing financial institutions, Bernanke weighed taking action “versus the real possibility in some cases that you might have very severe consequences for the financial system and, therefore, for the economy of not taking action.”
“Frankly, I am decidedly confused and very muddled about this,” he said at the meeting. “I think it is very difficult to make strong, bright lines given that we don’t have a structure that has been well communicated and well established for how to deal with these conditions.”
The central bank, which is still dealing with fallout from the crisis and the 2007-2009 recession, released transcripts of all 2008 meetings of its policy-setting Federal Open Market Committee (FOMC) today after the typical five-year lag.
Looking back, the Fed was caught off guard by the severity of the crisis triggered by the subprime mortgage market. But, starting in 2008, it quickly took a series of unprecedented steps to reinforce the crumbling financial system and limit damage to the US and world economies.
It was in 2008 that the Fed flooded financial markets with emergency liquidity, began printing what would be trillions of dollars in monetary stimulus, and made the first in a series of bold promises to keep policy loose.
But on September 16th, the day the Fed Board authorised a $85 billion loan to prevent the bankruptcy of insurer American International Group, policymakers were torn: inflation was running high, but signs of economic weakness were everywhere.
People in the suburbs across the bay from San Francisco were even deferring cosmetic surgery, then San Francisco Fed chief Janet Yellen joked. Yellen succeeded Bernanke at the Fed's helm a few weeks ago.
Most of all, officials felt largely unable to gauge the effects of the crisis just one day after Lehman's bankruptcy, but Boston Fed president Eric Rosengren seemed certain of its impact.
“This is already a historic week, and the week has just begun,” Rosengren said. He was the only policymaker at the table to call for a rate cut to offset the higher borrowing costs he anticipated many firms would face following the market turmoil.
Other policymakers wanted to wait and see.
“Money doesn’t talk; it swears,” the Dallas Fed’s Richard Fisher said, quoting Bob Dylan. “When you swear, you get emotional. If you blaspheme, you lose control. I think the main thing we must do in this policy decision today is not to lose control, to show a steady hand.”
In the end, Fed officials opted to stand pat with rates at 2 per cent, counting on measures they had already taken to improve market liquidity to provide some calm, and leaving the ammunition of a rate cut in reserve for a time when the need would seem more pressing.
“We should be very certain about that change before we undertake it because I would be concerned, for example, about the implications for the dollar, commodity prices, and the like,” Bernanke told the group as he summed up the discussion.
“So it is a step we should take only if we are very confident that is the direction in which we want to go.”
