Lehman Brothers, the giant investment firm, declared bankruptcy in September 2008. The next day, the Federal Reserve’s policy-setting committee convened for a regularly scheduled meeting as markets wondered just how far Lehman’s collapse would ripple through the financial system.
Ben Bernanke, then Fed chairman, said he was “grappling” with the necessity of making ad hoc decisions about “moral hazard,” according to transcripts from the 2008 meetings, released Friday after a five-year lag.
“In each event, in each instance, even though there is this sort of unavoidable ad hoc character to it, we are trying to make a judgment about the costs — from a fiscal perspective, from a moral-hazard perspective, and so on — of taking action versus the real possibility in some cases that you might have very severe consequences for the financial system and, therefore, for the economy of not taking action,” Bernanke said at the Federal Open Market Committee’s Sept. 16 meeting.
“I am decidedly confused and very muddled about this,” he said.
Although we know now that the economy was going to continue its downward spiral, most FOMC members — including then-San Francisco Fed President and now-Fed Chair Janet Yellen — thought it was too soon to provide monetary accommodation in the form of further interest-rate cuts at that September meeting.
“My policy preference is to maintain the federal-funds rate target at the current level and to wait for some time to assess the impact of the Lehman bankruptcy filing, if any, on the national economy,” said St. Louis Fed President James Bullard. “I think we should be seen as making well-calculated moves with the funds rate, and the current uncertainty is so large that I don’t feel as though we have enough information to make such calculations today,” said Charles Evans, the Chicago Fed president.
Like Bullard and Evans, Eric Rosengren, president of the Boston Fed, wasn’t a voting member at that September meeting. But he had a different take. “This is already a historic week, and the week has just begun”¦. The degree of financial distress has risen markedly,” Rosengren said. “Given that many borrowers will face higher interest rates as a result of financial problems, we can help offset this additional drag by reducing the federal-funds rate.”
The FOMC’s voting members unanimously stood pat at that September meeting’s conclusion, leaving the federal-funds rate at 2 percent. As the economy continued to unravel over the coming months, the Fed opted to act, cutting the rate to near zero when it met in December and ushering in a new era of monetary policy as the Fed turned to unconventional tools — like the three bond-buying programs it has since launched — to boost the economy.
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