Saturday January 19, 2013

WASHINGTON -- Federal Reserve officials in 2007 badly underestimated the scope of the approaching financial crisis and how it would tip the U.S. economy into the deepest recession since the Great Depression, transcripts of the Fed’s policy meetings that year show.

The meetings occurred as the country was on the brink of its worst financial crisis since the 1930s. As the year went on, Fed officials shifted their focus away from the risk of inflation as they slowly began to recognize the severity of the crisis.

Beginning in September 2007, the Fed cut interest rates and took extraordinary steps to try to ease credit and shore up confidence in the banking system. Throughout the year, the housing crisis deepened. Home prices weakened. Subprime mortgages soured.

As foreclosures rose, banks and hedge funds that had invested big in subprime mortgages were weighed down by worthless assets. Many had trouble getting credit to meet their expenses. The damage reached the top echelons of Wall Street. Fears rose that the U.S. banking system could topple.

At the Fed’s Oct. 30 policy meeting, Janet Yellen, then president of the Federal Reserve Bank of San Francisco, noted that the economy faced increased risks. But she didn’t foresee anything dire.

"I think the most likely outcome is that the economy will move forward toward a soft landing," Yellen said then.

Yellen was hardly alone in feeling hopeful about the economy in October.


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At the same meeting, Chairman Ben Bernanke noted that housing was "very weak" and manufacturing was slowing but sounded an optimistic note.

"Except for those sectors, there is a good bit of momentum in the economy," Bernanke said.

Earlier that October, the Dow Jones industrial average closed at an all-time high of 14,164 -- nearly 4 percent above where the Dow stands now.

At the October meeting, Timothy Geithner, then president of the Federal Reserve Bank of New York and now Treasury secretary, said: "Developments of financial markets on balance since the last meeting have been reassuring. The panic has receded."

By December, the economy had plunged into the recession, which would officially last until June 2009. Five years later, the economy has yet to fully recover.

The Fed declined Friday to comment on the discussions revealed by the transcripts.

In many places, the transcripts illustrate what has long been known: That the Fed, like most other regulators and economists, was slow to grasp the magnitude of the housing meltdown, the financial crisis and the depth of the economy’s weaknesses.