Federal Reserve chairman Ben Bernanke and other top officials of the U.S. central bank missed the nation’s oncoming housing crash, believing as late as December, 2006, that the market was stabilizing, according to transcripts of policy meetings released on Thursday.
Policy makers were also far too sanguine about the potential threat housing posed to financial markets, the transcripts of the Fed’s 2006 policy meetings show.
The bursting of the housing bubble led to the deepest recession since the Great Depression and triggered a banking crisis that brought down Wall Street giants Lehman Brothers and Bear Stearns.
Yet just six months before the first cracks began to appear in the financial system, the U.S. central bank appeared largely unaware of the severity of the risks facing the economy.
“We are unlikely to see growth being derailed by the housing market,” Mr. Bernanke said in March, 2006, presiding over his first meeting as Fed chairman.
Later in the year, when home sales and prices had already extended their drop, officials appeared to believe the worst was over.
“There are some encouraging signs that the demand for housing may be stabilizing, probably assisted by recent declines in mortgage rates,” Janet Yellen said at the central bank’s December, 2006, meeting, when she was president of the San Francisco Fed. She is now the Fed’s vice-chair.
“After a precipitous fall, home sales appear to have levelled off,” she said. “In addition, equity valuations for home builders have continued to rise in the past couple of months, suggesting that the outlook for these businesses may be improving.”
At that point, U.S. existing-home sales had fallen about 10 per cent from their peak in September, 2005. In reality, it was only the beginning of a much steeper plunge. In the five-year slump that ensued, sales fell by more than half.
The Fed releases minutes of its policy making meetings with a lag of three weeks, but verbatim transcripts are only made available after five years.
A sharp drop in home prices nationwide later came to show that the one-time belief among top Fed officials that there was simply “froth” in some regional markets was misguided.
“Stabilizing house sales, recovering mortgage applications, and improving consumer attitudes toward home purchases may be the signs of a housing market beginning to find a bottom, stabilizing house sales,” said Donald Kohn, then the Fed’s vice-chair. He is now an economist at the Brookings Institution.
Even Kevin Warsh, a Fed governor who had worked as an executive at Morgan Stanley, appeared to play down the possibility of disruptions in financial markets.
“I consider the debt capital markets to be incredibly robust,” Mr. Warsh said at the December meeting. Mr. Warsh stepped down from the Fed last March.
As house prices fell further in 2007 and beyond, banks’ massive holdings of real estate-linked securities led to a sharp pullback in credit.
The Fed’s response was delayed, but potent. The central bank started lowering interest rates gradually in the summer of 2007 and slashed them more sharply as the crisis gathered steam in 2008.
By December, 2008, rates had been brought down to effectively zero, and in early 2009 the Fed embarked on its first round of unconventional policy – purchases of mortgage-backed bonds and Treasury securities known as quantitative easing, or QE.
When all was said and done, the Fed had more than tripled its balance sheet to around $2.9-trillion (U.S.). The economy did not emerge from recession until the summer of 2009, after the longest period of contraction since the 1930s.
The recovery has been unusually weak, and unemployment has come down only grudgingly. The jobless rate stood at 8.5 per cent last month, down from a peak of 10 per cent in October, 2009, but still far above the mid-4-per-cent range that prevailed before the meltdown.