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Economy

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Records show Fed misread severity of ’07 crisis

– Federal Reserve officials in 2007 badly underestimated the scope of the approaching financial crisis and how it would tip the 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 more upbeat about the economy in October. At the same meeting, Chairman Ben Bernanke noted that housing was “very weak” and manufacturing was slowing but sounded an optimistic note.

“Expect for those sectors, there is a good bit of momentum in the economy,” Bernanke said.

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