Top officials at the Federal Reserve Bank of New York expressed growing but uneven concerns about the brewing mortgage-market crisis in 2007 and 2008, according to minutes of board meetings that underline how authorities failed to grasp the real dangers the economy faced at that time.
The New York Fed on Friday unveiled minutes from board meetings from 2007 to mid-2012, as part of post-crisis efforts to shed more light on internal operations at the U.S. central bank.
The heavily redacted minutes give another glimpse into how top U.S. regulators and policymakers missed or misread warning signs that emerged from the subprime mortgage market, which was headed toward a collapse that would lead to a recession that still hampers the world economy today.
As far back as January 2007, then-New York Fed President Timothy Geithner discussed the risks posed by derivatives, which ultimately proved a key conduit and multiplier of reckless bets placed by the world's biggest banks and financial institutions.
At one board meeting that month, Geithner, now U.S. Treasury Secretary, cited "substantial progress" in the regional Fed bank's efforts to identify financial market risks and to supervise banks.
According to the minutes, "initiatives" were planned on counterparty credit risk management, hedge funds, and regulatory efficiency - all pieces of the financial system that regulators continue to struggle with today.
To be sure, the Fed and other financial regulators have acknowledged missing the alarm bells of pending crisis. The massive Dodd-Frank financial reform legislation of 2010, which regulators are enforcing or implementing, aims to stop such crises from recurring.
It was back in 2006 that U.S. home prices peaked.
By 2007, lenders started to feel the pain from the brewing subprime crisis, which eventually sparked a brutal financial crisis that claimed Lehman Brothers and prompted a massive government bailout of Wall Street, before spreading globally.
IN RETROSPECT
The New York branch of the central bank is the most powerful of the 12 regional Fed banks, and it is responsible for Wall Street oversight. Minutes from its board meetings show concerns among top officials intensified as signs of the mortgage market crisis emerged.
In January 2007, Joseph Tracy, an executive vice president, discussed a surprisingly sharp contraction in housing, but noted "it was difficult to determine whether the housing adjustment had ended," according to the minutes.
Yet officials seemed unsure how worrying were the signs.
William Dudley, who would succeed Geithner as president two years later, warned in February 2007 that a further deterioration in subprime lending could result in market consolidation. But, he said, "at this point any decline was not expected to materially impact economic conditions more broadly," the minutes show.
At the same meeting, Tracy suggested the U.S. economy appeared to be poised for a soft landing.
As it happened, the United States fell into a deep recession in December 2007. The worst recession in decades ended in early 2009, but the country has yet to recover, with gross domestic product (GDP) growth still tepid and unemployment high at 7.7 percent.
In July 2007, Dudley, who at the time ran the Fed bank's market operations, said that contagion from the deteriorating subprime market "appeared to be limited," according to the minutes. By September of that year he said it had "triggered confidence issues and a contraction in the securitization of nonconforming mortgages."
'THE RECENT FINANCIAL CRISIS'
In an ironic twist, by October 2007 - one year before the worst of the financial crisis would hit and the month in which U.S. stocks hit a record high - Geithner spoke about efforts to develop "lessons learned from the recent financial crisis" to identify weaknesses in the system.
At the same meeting, Dudley noted the mortgage market had improved but that the risk of recession remained.
As it turned out that year, GDP growth in the third quarter was 3 percent and dropping sharply.
In June 2008, Richard Peach, a New York Fed senior vice president, predicted real GDP was expected to rebound in the second half of the year and that "downside risk to growth had abated somewhat over the near term."
The next month, Dudley said liquidity and funding conditions at the four largest regional banks had fallen "but that liquidity and funding conditions remained generally stable."
By October 2008, a month after the Lehman bankruptcy and the severe market contraction, Peach said that "growth prospects had been downgraded substantially and that there remained substantial downside risk to the economy."
