Bernanke Says Fed Failed to See Broader Risks From Housing
Federal Reserve policy makers failed to foresee a threat to the financial system from the housing market in 2005 in part because central bank economists didn’t find major risks, Chairman Ben S. Bernanke said.
At one Federal Open Market Committee meeting in mid-2005, Fed governors and regional presidents heard staff briefings suggesting that the U.S. mortgage system “might bend but would likely not break” from a large home-price drop, and that the market may rest on “solid fundamentals,” Bernanke said in a Dec. 21, 2010, letter to the Financial Crisis Inquiry Commission, providing his views and revealing new details on FOMC meetings from 2005 to 2008.
“Given these and other analyses, it was hard for many FOMC participants, in the summer of 2005, to ascribe substantial conviction to the proposition that overvaluation in the housing market posed the major systemic risks that we now know it did,” Bernanke said in the letter, posted on the FCIC’s website.
The FCIC, the congressionally appointed panel assigned to probe the origins of the 2008 credit crisis, heaps blame on “reckless” Wall Street firms and “weak” federal regulators and concludes that the meltdown could have been averted. Some points from Bernanke’s letter are included in the commission’s a 545-page report, released today.
The 2005 presentations were made public this month as part of transcripts of that year’s FOMC meetings. The Fed, which has a policy of giving out FOMC transcripts with a five-year lag, hasn’t published any records from 2006 or later.
Change for ‘Worse’
While most participants at a June 2005 Federal Open Market Committee meeting agreed that “the probability of spillovers to financial institutions from lower housing prices seemed moderate, they recognized that circumstances could change for the worse,” and several officials raised concerns about subprime lending and mortgage-backed securities, Bernanke said in the letter.
In 2006, Fed officials “expressed nervousness” about some practices in the mortgage industry, said Bernanke, who became chairman in February of that year. He said he “had in mind increased regulatory oversight” and “increased vigilance” for the implications of housing on interest-rate policy.
FOMC members were briefed in June 2007 about the liquidation of subprime securities at two hedge funds sponsored by Bear Stearns Asset Management, Bernanke said. Some Fed officials were concerned that the Fed didn’t understand “the scope of the problem” because the central bank couldn’t “systematically collect information from hedge funds,” which were outside the Fed’s jurisdiction, he said.
Extent of Threat
In August 2007, as turbulence in the subprime-mortgage market rose to a “considerable” degree, policy makers at an FOMC meeting disagreed over the extent of the threat to the economy, Bernanke said.
“One participant, in a paraphrase of a quote he attributed to Churchill, said that no amount of rewriting of history would exonerate us if we did not prepare for the more dire scenarios discussed in the staff presentations,” the Fed chairman said.
At that meeting, Bernanke and his colleagues judged that inflation was their “predominant” concern and left their benchmark interest rate at 5.25 percent. Within two months, they had scrapped that view and begun cutting rates. That December, the worst recession since the 1930s began, and a year later, the federal funds rate was cut almost to zero.
In September 2008, FOMC members briefed on the failure of Lehman Brothers Holdings Inc. were divided on what the government should do in such a situation. Some wanted the government to have no role in a rescue, while others sought capital injections instead of central bank liquidity or monetary policy interventions, Bernanke said.
“My own view at the time was that only a fiscal and perhaps regulatory response could address the potential for wide-scale failure of financial institutions during that period,” Bernanke said. “Such an approach would involve tools such as a robust resolution authority and a capital injection program, neither of which was authorized at that time.”
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