WASHINGTON — Federal Reserve officials in 2007 underestimated the scope of the approaching financial crisis and how it would tip the U.S. economy into the worst 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 the 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.
During 2007, the Fed began to cut interest rates and took extraordinary steps to ease credit and shore up confidence in the banking system. Throughout the year, the housing crisis deepened. Banks and hedge funds that had invested big in subprime mortgages were left with worthless assets as foreclosures rose. The damage reached the top echelons of Wall Street.
At the Fed's Oct. 30 policy meeting, Janet Yellen, then-president of the Federal Reserve Bank of San Francisco, said the economy faced increased risks. But she hardly predicted anything dire.
I think the most likely outcome is that the economy will move forward toward a soft landing, she said.
Chairman Ben Bernanke noted that housing was very weak and manufacturing was slowing.
But expect for those sectors, there is a good bit of momentum in the economy, he said. Bernanke did acknowledge that there was an unusual amount of uncertainty surrounding the Fed's economic forecasts.
In the aggregate data, there is yet no clear sign of a spillover from housing, Bernanke said in summing up the views of the committee.
By December, the economy had plunged into the recession, which would last until June 2009. Five years later, the economy has yet to fully recover.
The Fed did take action in 2007, although investors seemed to think it waited too long. Markets were disappointed when the Fed refused to cut interest rate cuts at its Aug. 7 meeting. After the meeting, the Fed issued a statement declaring that the threats to growth had only increased somewhat.
At the meeting, various Fed officials signaled their belief that the biggest threat facing the economy was inflation – not slower growth, the transcripts show.
Days later, BNP Paribas, France's largest bank, announced that it was suspending withdrawals from three investment funds, a move that jolted financial markets around the world.
Still, the transcripts showed the central bank struggled through the year to develop a clear sense of how serious the unfolding crisis could be and what harm it might do to the U.S. economy.