Too Little, Too Late: The Fed's Reaction to the Subprime Crisis in 2007

by Rick Roque21 Jan 2013

Hindsight may always be 20/20, but at a Federal Open Market Committee (FOMC) meeting in August of 2007, Federal Reserve Bank officials could have moved proactively to avoid the worst of the subprime mortgage meltdown of 2008. According to recently released transcripts, Fed Chairman Ben Bernanke talked about the resilience of the United States economy to withstand what the looming crisis, but even by late 2007 he was not keen on intervening with rescue measures such as the bailouts that were later implemented anyway.

According to the Wall Street Journal, Vice Chairwoman Janet Yellen showed more concern and alarm than her Fed peers with regard to the growing turmoil in the secondary mortgage markets. She wanted the Fed to make a move at that time, despite intervention being an unpopular opinion at the time. Even Treasury Secretary Timothy Geithner was not convinced that the situation would turn into an economic emergency for the U.S. Ms. Yellen is now one of the top candidates to assume Mr. Bernanke’s position. 

That August 2007 FOMC meeting can now be seen as missed opportunity. The Fed could have moved to cut interest rates at that moment, but failed to do so. The financial markets reacted in panic days later, and by the following week even the European Central Bank was considering making cash available to commercial banks as an emergency measure. 

In retrospect, the Fed was looking at various reports that could have signaled the impending disasters, although the signals were unconventional. One such report came from a Wal-Mart executive who remarked on his observation of sharply decreased remittances from Mexican workers in the U.S. to their families back home. Years later, many of those migrant workers would leave the U.S. altogether. 

Ms. Yellen actually used the terms credit crunch and recession at the December 2007 FOMC meeting. A review of the 2007 transcripts by an analyst from the Cato Institute indicates that Fed officials were far too complacent with regard to what should have appeared as writing on the wall to them; namely the performance of funds comprised of subprime mortgage-backed securities managed by major Wall Street investment banking firms Bear Stearns and Lehman Brothers. Both firms eventually collapsed and created a domino effect that rippled across global economies.



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