Courtesy of Larry Doyle.
If anybody thinks that the governors of the Federal Reserve have any degree of foresight on the economy, the following transcripts from 2007 are a MUST read. One governor, (yes one and it was not Ben Bernanke), displayed real foresight and expressed real concern on what likely lay ahead on our economic landscape. Who was it? The one I recently highlighted as calling for the breakup of our TBTF megabanks. That would be Dallas Fed governor Richard Fisher.
After reading this release provided by the WSJ, you may doubt the Fed’s collective capability in managing the economy.
Fed meeting transcripts are released with a five year lag. Here is a look at the three key periods of 2007, and what central bank officials were saying during this period:
I) PRELUDE, BEFORE THE CRISIS, January-May:
Jan. 30-31 Fed Chairman Ben Bernanke: “The housing market has looked a bit more solid, and the worst outcomes have been made less likely.
But given that we have the breathing space to observe how that evolves, I think that waiting a bit more would be wise.”
Jan. 30-31 Janet Yellen, San Francisco Fed President. “I think we should maintain the current stance of policy because it is likely to foster an economy that gradually moves toward a soft landing… Housing remains a concern, but I think the prospects for a really serious housing collapse that spreads to consumer spending have diminished substantially.”
Jan. 30-31, New York Fed President Timothy Geithner: “The most important thing for us to do today, and it’s really the only thing we need to do, is to convey a sense that, on the basis of recent data, we see somewhat less downside risk to growth and maybe somewhat less upside risk to inflation.”
Jan. 30-31, William Dudley, Manager, System Open Market Account on subprime risk: “The most recent 2006 vintage of subprime mortgages is showing a much more rapid rise in delinquencies than earlier vintages showed … I see some risk of a vicious cycle … Fortunately, to date the news is still fairly favorable … the economics of making such loans and securitizing them into the capital markets still work.
Jan. 30-31, Mr. Geithner, questioning Mr. Dudley on subprime: “Remind us what share of the total outstanding stock of mortgages consists of subprimes or what share of the housing stock do we think is financed at the subprime level? My recollection is that the share is still small even though it has been a large part of the recent flows.”
Dudley responds: “It’s quite a bit smaller share of total outstanding.”
March 20-21, Mr. Bernanke “The central scenario that housing will stabilize sometime during the middle of the year remains intact…The effects of the decline in subprime lending may have already been mostly seen, since that has slowed from last fall.”
March 20-21, Ms. Yellen: “The extraordinary run-up in house prices in recent years led to construction and sales booms that couldn’t last. So far the adjustments to more-sustainable levels of housing starts and sales have been relatively orderly.
May 9, Mr. Bernanke: “We’re not blind to current economic developments. Nevertheless, we have good fundamental reasons to think that growth will be moderate.”
May 9, Ms. Yellen: “Much of the first-quarter weakness, of course, was due to housing, and I really don’t see that sector starting to turn around at this point.”
May 9, Richard Fisher, Dallas Fed President: “On the housing front, I have been bearish—more bearish than anybody at this table…I am more concerned than I was before. We can go through the numbers, but I think it is best expressed by the CEO of one of the five big builders, who said that in March he was arguing internally with his board that the headlines were worse than reality and now reality is worse than the headlines.”
May 9, Mr. Bernanke advocates to remain steady on policy: “I just want to make the observation that for almost a year now we have taken a very steady approach…During the period, the markets and the general view have gone up and gone down, and we have maintained a pretty even keel. That increases confidence in the institution, and unless we have a reason to change our view, we should continue to stay on a steady path.”
May 9, Mr. Bernanke: “I think we have the market in sync with our views, and therefore I would be very reluctant to go through that again to change the assessment of risk. So I’m going to demonstrate a very conservative perspective today, which probably won’t surprise you.”
II) A CRISIS EMERGES, June-August
June 27-28, Mr. Geithner on problems emerging at a Bear Stearns hedge fund: “Direct exposure of the counterparties to Bear Stearns is very, very small compared with other things.”
June 27-28, Dallas Fed President Richard Fisher: “I was once a hedge fund manager—I know all the tricks that are played there, including, by the way, the valuation of underlying securities—in a day when the business was less sophisticated than it is now. I don’t feel I understand this issue … I don’t think the issue is contained. I do think there is enormous risk.”
June 27-28, Richmond Fed President Jeffrey Lacker: “I agree with Vice Chairman Geithner—there’s a certain danger of our commenting on stuff like this and leading people to believe that we feel some responsibility for damping or otherwise minimizing the effects of changes in market prices on the changes in other market prices.”
June 27-28, Ms. Yellen on the economy: “In terms of risks to the outlook for growth, I still feel the presence of a 600-pound gorilla in the room, and that is the housing sector. The risk for further significant deterioration in the housing market, with house prices falling and mortgage delinquencies rising further, causes me appreciable angst.”
June 27-28, Mr. Bernanke: “A a bit of cooling in the financial markets might not be an entirely bad thing … We need to be very careful, just the same as with inflation, about declaring victory too soon on the housing front … there is the potential for some trigger to lead to what would amount to an effective tightening in financial markets, which would affect not only housing but also potentially, for example, corporate credits.”
Aug. 7, Mr. Dudley: “We’ve done quite a bit of work trying to identify some of the funding questions surrounding Bear Stearns, Countrywide, and some of the commercial paper programs. There is some strain, but so far it looks as though nothing is really imminent in those areas. Now, could that change quickly? Absolutely.”
Aug. 7, Ms. Yellen: “We seem to be repeatedly surprised with the depth and duration of the deterioration in these markets; and the financial fallout from developments in the subprime markets, which I now perceive to be spreading beyond that sector, is a source of appreciable angst.”
Aug. 7, Mr. Fisher: “No amount of rewriting of history will exonerate us if we are not prepared for the more-dire scenarios that were presented by the staff. I would ask that we do some scenario preparation in terms of, should we encounter increased financial market turbulence, what actions we might take to deal with it. “
Aug. 7, Mr. Geithner: “These developments in financial markets, even though they represent a necessary adjustment, a generally healthy development, have the potential to cause substantial damage.”
Aug. 7, Mr. Bernanke: “I think the odds are that the market will stabilize. Most credits are pretty strong except for parts of the mortgage market.”
III) PUTTING OUT FIRES, September-December
September 18, Mr. Dudley: “Clearly, the adjustment process is far from over. Asset-backed commercial paper programs are still being rolled up, and there is considerable uncertainty about how difficult it will be to roll some of this paper over quarter-end….The good news, of course, is that as time passes, the uncertainty about bank balance sheet pressures and funding requirements should lessen.”
September 18, Mr. Fisher: “Already we’re seeing signs of returning stability. I’m trying to differentiate between what we had earlier—serious counterparty risk and phobias—and what we have now—which seems to be concerns about balance sheet risk.”
Sept. 18, Mr. Dudley on the health of U.S. banks: “The problem they have right now is that they can’t really size with any accuracy how much will be coming onto their balance sheets over the next few months through asset-backed commercial paper, through bank conduits, and through other things for which they may be on the hook that they didn’t expect to be on the hook for….The analysis that has been done has suggested that the banks are well capitalized and should, with one or two exceptions, be able to handle this balance sheet expansion reasonably well; but they can’t say that with absolute certainty.”
Sept. 18, Mr. Bernanke remarks on a shortage of U.S. dollar funding for foreign banks that would later become worse: “One complexity in this whole period is that there is a surprisingly large demand for dollars in Europe…”
Sept. 18, Philadelphia Fed president Charles Plosser: “The national economy looks more vulnerable to me than it did six weeks ago, but it would be a mistake … to count out the resiliency of the U.S. economy at this early stage….On balance, I believe that within the forecast period we can see a return to trend growth.”
Sept. 18, Ms. Yellen: “The downside risks to this forecast are substantial and worrisome…A big worry is that a significant drop in house prices might occur in the context of job losses, and this could lead to a vicious spiral of foreclosures, further weakness in housing markets, and further reductions in consumer spending. …So at this point I am concerned that the potential effects of the developing credit crunch could be substantial … I think we should be taking a forward-looking approach and trying to forestall damage.”
Sept. 18, Boston Fed President Eric Rosengren: “So we have a situation of a very weak housing sector, some evidence of slowing employment growth, and a period of extended illiquidity that may get worse before it gets better.”
Sept. 18, Cleveland Fed President Sandra Pianalto: “I believe that the risks to the outlook, given no change in our policy, have shifted decisively toward potential rapid deterioration in the real economy. “
Sept. 18, Mr. Geithner: “I believe the arguments work in favor of doing more now rather than less. Policy needs to provide a convincing degree of insurance against a more adverse outcome. “
Sept. 18, Mr. Bernanke: “As the central bank we have a responsibility to help markets function normally and to promote economic stability, broadly speaking. We are not in the business of bailing out individuals or businesses.”
Sept. 18, Mr. Bernanke summarizing Fed officials’ assessments of the economy: “There is a general view that downside risks to output have increased with some very bad scenarios at least conceivable … there has been some discussion about the fact that in 1998 there was very little effect of the financial markets on the real economy. There was no obvious channel of effect in that episode. In this case, there is, I think, a pretty clear channel of effect through mortgage lending, and we have already seen changes in availability of mortgages and changes in cancellations, sales expectations, and the like. I think there is potential for a negative feedback cycle, which is of some concern.”
Dec. 11, Ms. Yellen, “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. The bad news since our last meeting has grown steadier and louder, as strains in financial markets have resurfaced and intensified and as the economy has shown clear signs of faltering … I am particularly concerned that we may now be seeing the first signs of spillovers from the housing and financial sectors to the broader economy … Thus, the risk of recession no longer seems remote, especially since the economy may well already have begun contracting in the current quarter … I believe that the most likely outcome is for the economy to slow significantly in the near term, flirting with recession, and I view the risk to that scenario as being weighted significantly to the downside”
Dec. 11, Mr. Rosengren: “I think I took the same pessimism pill as President Yellen this morning … with core inflation a little below 2 percent, and future reductions in labor market pressures likely, we have the flexibility to respond aggressively to slowing economic growth and the ongoing financial turmoil. This seems to be the appropriate time to take significant further action.
Dec. 11, Mr. Geither: “We now think it’s likely that the Committee will reduce the target rate to 3.75 percent over the next few quarters, and this puts our real and our nominal fed funds rate assumption for ’08 a bit under the new path in the Greenbook. We’d raise it back in ’09.”
Dec. 11, Mr. Bernanke, deliberating over whether to cut short-term interest rates 0.25 percentage points or 0.50 percentage points. He decided on 0.25: “If the choice were between 0 and 50 basis points, I would be very tempted to do 50 basis points. I think it would move us more toward accommodation … that said, I think there are some risks to going with 50 basis points. I acknowledge what others have said, which is that it is not just about the rate but also about what the message is … If we do 50, we may be saying to the market that we are willing to do even more than you currently expect. I think that poses some risks to inflation expectations and poses some risks to the dollar, which is a little fragile right now. You can imagine it even having reverse effects with respect to the economy—for example, if it caused oil prices to jump or if it caused nominal interest rates to rise, thereby raising nominal mortgage rates. The other concern I have is that, for better or worse, given our communications and market expectations, at this point a 50 basis point cut would be viewed as something of a lurch and might signal, as others have suggested, more concern or private information about the economy that we in fact don’t necessarily have. You can tell that I am quite conflicted about it, and I think there is a good chance that we may have to move further at subsequent meetings.”
Most of these ‘savants’ are still running the economy. Rut-ro.
Larry Doyle
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I have no business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.
