U.S. Fed Underestimated 2007 Financial Crisis
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Even as warning signs of a looming global financial crisis appeared, Federal Reserve officials were confident that the U.S. economy would be able to withstand the subprime mortgage crisis, grossly underestimating the severity of the current economic slump, released transcripts from 2007 meetings show.
The transcripts, made public last Friday after a customary five-year lag, provide fresh insight on the central bank’s decision making process even as it was on the brink of historic economic crisis.
Even as warning signs of a looming global financial crisis appeared, Federal Reserve officials were confident that the U.S. economy would be able to withstand the subprime mortgage crisis, grossly underestimating the severity of the current economic slump, released transcripts from 2007 meetings show.
The transcripts, made public last Friday after a customary five-year lag, provide fresh insight on the central bank’s decision making process even as it was on the brink of historic economic crisis.
The 1,566 page document revealed that Fed governor Ben Bernanke in 2007 wanted to hold off from addressing rising panic in the markets as he did not “expect insolvency or near insolvency among major financial institutions.”
Other Fed officials also believed that rough economic times would be short-lived and moderate. Current U.S. Treasury Secretary Timothy Geithner, who was in 2007 the president of the New York Federal Reserve Bank, said:
[quote] We have no indication that the major, more diversified institutions are facing any funding pressure. In fact, some of them report what we classically see in a context like this, which is that money is flowing to them. [/quote]
Although the financial crisis started in the U.S. as a result of the sharp downturn in the country’s housing market, it quickly spread around the world as U.S. mortgage debt had been repackaged and sold to banks and other financial institutions around the globe.
With most of Wall Street lenders, including Goldman Sachs and Morgan Stanley, discovering billion-dollar losses linked to toxic debt as the U.S. housing market collapsed, investment banks such as Bear Stearns received huge government bailouts while another, Lehman Brothers, was declared bankrupt.
In 2008, the U.S. government also took control of mortgage giants Fannie Mae and Freddie Mac.
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As the year went on, Fed officials started to shift their focus away from inflationary risks as they slowly began to recognise the severity of the crisis. That realisation prompted Bernanke to test some unconventional recession-fighting tools which include bringing benchmark interest rates to near zero, as well as purchasing more than $2 trillion in mortgage and Treasury securities in an effort to bring down long-term borrowing costs.
Last month, the Fed decided to expand its bond purchase at a rate of $85 billion a month. But with weak economic and job recovery, there are growing doubts within the central bank about the efficacy and possible risks of unorthodox monetary policies.
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