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U.S. Federal Reserve Board chairman Ben Bernanke.


Federal Reserve policy makers watched all the signs of the pending housing apocalypse develop over the course of 2006, but disastrously failed to grasp the implications.

Newly released transcripts of all the Federal Reserve policy meetings in 2006, Ben Bernanke's first year as chairman, show that the Fed was getting increasingly dire signals about the housing market - right down to anecdotes of builders giving away cars to try to draw reluctant buyers. But the economists around the table were consumed by trying to estimate what (small) percentage of consumer spending that would affect, missing the tremendous structural upheaval that a housing price decline would go on to create, with banks failing, the financial system seizing and job losses soaring.

Instead, there was a preoccupation with inflation and rising oil prices.

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Surprisingly, from the regulator of the banking system, there was next to no discussion of the world of credit derivatives based on housing, nor of weak lending standards. In fact, quite the contrary, policy makers reported that bankers were telling them credit quality was quite good.

Dallas Fed president Richard Fisher, in particular, comes off as way out of touch with reality, at one point summing up the U.S. economy as "something like a 2006 BMW Z4 Roadster - Bluetooth-enabled, by the way. It's complex, it's highly integrated, it's a technically advanced machine that apparently cannot help itself from exceeding the speed limit."

The transcripts show that those in the room laughed. Of course, six mostly painful years later, we know who the joke was really on.

There are also some excruciating-in-hindsight tributes to departing chairman Alan Greenspan at the first meeting of the year - his last before retiring.

Read on for highlights. If you can call them that.

JANUARY MEETING (Mr. Greenspan's last)

The meeting is dominated by a generally good feeling about the economy, only slight worry about housing, and a round of tributes to Mr. Greenspan. Some of the most effusive came from then-Vice Chairman Timothy Geithner and San Francisco Fed head Janet Yellen.

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However, early warnings of housing doom are already coming, noted by Atlanta Fed boss Jack Guynn.


VICE CHAIRMAN GEITHNER: Mr. Chairman, in the interest of crispness, I've removed a substantial tribute from my remarks. [Laughter]

CHAIRMAN GREENSPAN. I am most appreciative. [Laughter]

VICE CHAIRMAN GEITHNER. I'd like the record to show that I think you're pretty terrific, too. [Laughter]And thinking in terms of probabilities, I think the risk that we decide in the future that you're even better than we think is higher than the alternative. [Laughter]

With that, the economy looks pretty good to us, perhaps a bit better than it did at the last meeting.

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YELLEN: So as I look at the total picture, I would say that the overall outlook is quite positive. The economy is near full employment with real GDP tending toward trend-like growth. Core inflation is within a reasonable range but a bit on the high side. Needless to say, it's fitting for Chairman Greenspan to leave office with the economy in such solid shape. And if I might torture a simile, I would say, Mr. Chairman, that the situation you're handing off to your successor is a lot like a tennis racquet with a gigantic sweet spot. [Laughter]


GUYNN: we're now beginning to see some signs of downward pressure on prices - in some cases in the high single digits, but in a few markets substantially higher than that. As an example, we heard one report that in the Panama City area of Florida, condos that had been going for $600 a square foot are now being priced at $450 a square foot. That's a 25-per-cent correction. I think we have to view these corrections that are taking place as healthy.


By the March meeting, the housing picture is darkening. But nobody's overly worried. The focus remains on inflation and whether to raise rates.

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The policy makers laugh off signs of trouble in Iceland. Of course, Iceland was embarking on an epic collapse from a high that was fuelled by the same cheap credit that was feeding the U.S. housing market.

The Fed's trading desk, represented at the meeting by Dino Kos, raises questions about just where money is flowing, such as Iceland, and whether that can be sustained. Later, new chairman Mr. Bernanke cracks a joke that the Fed would like a "full report" on Iceland, drawing laughter.

David Stockton, the Fed's director of research, lays out a prophetic forecast for housing that's darker than most of what the policy makers go on to state. For example, Atlanta's Mr. Guynn doesn't believe that a pullback would be a big deal. And when Richard Fisher, head of the Dallas Fed, makes a joke about condos being akin to casinos, the foreshadowing is dead on.

STOCKTON: I'm afraid that there is still plenty of scope for surprise in the housing sector ... Right now, it feels a bit like riding a roller coaster with one's eyes shut. We sense that were going over the top, but we just don't know what lies below.


GUYNN: I don't mean to imply that a major pullback in real estate would cause a precipitous drop in economic growth - that would be inconsistent with most of our simulations and analyses.

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GEITHNER: We believe that, absent some large, negative shock to perceptions about employment and earned income, the effects of the expected cooling in housing prices are going to be modest. Of course, this view may prove optimistic.


POOLE: To give you some examples, there's $930-million worth of casino projects, including casinos and some casino hotels. So we're building casinos. I guess in Dallas they're building condos.

PRESIDENT FISHER. Same thing. [Laughter]


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BERNANKE: Housing is the crucial issue. To get a soft landing, we need some cooling in housing. So far there is a good bit of evidence that there has been a peak, but we do not know a great deal more than that. So obviously we are going to have to watch carefully. The range of possible outcomes is quite wide. I agree with most of the commentary that the strong fundamentals support a relatively soft landing in housing.


Skipping ahead to the December meeting, the possibility of a big housing collapse is beginning to dawn on some members of the FOMC, but clearly not all.

YELLEN: I have to admit that this time around I found it pretty challenging to read the tea leaves on economic activity. The data are providing distinctly contradictory signals.

The correction in the housing sector has continued, even sharpening somewhat compared with our expectations. Still, there are some encouraging signs that the demand for housing may be stabilizing, probably assisted by recent declines in mortgage rates.


LACKER: This is notable because one way the housing downturn could spread to the remainder of the economy is through a wealth effect. So far I'm not persuaded by this gloomy view, and I think there are good reasons to doubt it. Household net worth looks pretty strong, and equities continue to advance.

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