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Bernanke and Federal Reserve Totally Oblivious to Looming Housing Crisis, Transcript Reveals

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Though there were signed that the US housing market was overheating in 2006, Federal Reserve chairman Ben Bernanke was not worried about a housing bubble bust.
“So far we are seeing, at worst, an orderly decline in the housing market,” Bernanke replied to a Fed governor who raised concerns about the mortgage market.
Bernanke made that remark at his second meeting as chairman of the Fed in May 2006. On Thurdays, some 1,197 pages of transcripts from closed-door Fed Open Market Committee meetings that year were released in accordance with the usual five-year lag. The transcripts reveal how most of the leading officials at the central bank did not have a clue that the US economy and global financial system were about to be wrecked.
"We believe that, absent some large, negative shock to perceptions about employment and earned income, the effects of the expected cooling in housing prices are going to be modest," said Tim Geithner, the current Treasury secretary, who then was president of the Federal Reserve Bank of New York, at Bernanke’s first meeting as Fed chairman in March, the Los Angeles Times reports.

When Geithner was finished, Bernanke asked, to a round of laughter, "Anything to report on co-op prices in Manhattan?"

"As in many cases, I am not sure what you can take from the anecdote, but I guess some people say that you see a little of the froth dissipating," Geithner replied. "But I don't think the adjustment is acute.

"If you see hiring at the New York Fed go up substantially in the market, that will be a good leading indicator of housing prices reverting somewhat," he said, prompting more laughter.

 According to the transcripts, the Fed failed to see the danger posed by the connection between the housing boom and the mortgage-backed securities traded by the likes of Goldman Sachs (GS), Morgan Stanley (MS), Merrill Lynch, which was later acquired by Dow Jones (^DJI) component Bank of America (BAC), and the now defunct Lehman Brothers and Bear Stearns. In a May meeting, Bernanke said the slowdown of the housing market was a "healthy thing" while a June 2006 Fed report noted that the central bank had “not seen—and don't expect—a broad deterioration in mortgage credit quality.”
When asked by the Wall Street Journal, Bernanke declined to comment on the transcripts, but he has admitted in the past that his agency failed to heed the warning signs before it was too late.
Richard Fisher, president of the Dalls Fed, however, told the Journal that "the Fed did react to the crisis in a most effective way. That has now been proven. Whether we were, as a group, late to get on the stick is of course debatable."

Another potentially embarrassing detail one can gleam from the transcripts was how Fed officials offered effusive praise to outgoing chairman Alan Greenspan in his last meeting in January 2006.
"Needless to say, it's fitting for Chairman Greenspan to leave office with the economy in such solid shape," said Janet Yellen, then the president of the San Francisco Fed and now the Fed's vice chair.

"And if I might torture a simile, I would say, Mr. Chairman, that the situation you're handing off to your successor is a lot like a tennis racquet with a gigantic sweet spot," she added to much amusement.
Greenspan, of course, was slaughtered after the financial crisis by critics who said that he kept interest rates too low for too long, fueling the credit bubble that originated the crisis. He was also slammed for not having protected consumers from predatory lenders.
"This reads like a broken record," Allan Meltzer, an economist and also a Fed historian, told the Journal.  "[The Fed], one, gives too much weight to short-term forecasts; two, never discusses the medium-term consequences of its decisions; and three, ignores without any discussion warnings such as those that others tried to bring up."
POSITION:  No positions in stocks mentioned.