On the precipice of financial meltdown in 2007, the Federal Reserve was groping in the dark according to transcripts of Fed policy meetings released Friday. The very same month the U.S. fell into the worst recession in recent history, a December policy meeting saw the Fed forecast the the U.S. would avoid recession altogether. In a similar meeting in August of that year, the officials remained officials were still skeptical that foreclosures could cause a financial crisis.
As Wonkblog notes on the transcripts:
In December 2007, the month that the recession is now known to have begun, Fed officials were working from economic projections that would prove wildly inaccurate. They forecast sluggish but sustained growth in 2008 followed by a bounceback in 2009. Staff economist Dave Stockton acknowledged that his was a more optimistic view:
“Our forecast could admittedly be read as still painting a pretty benign
picture: Despite all the financial turmoil, the economy avoids recession and, even with steeply higher prices for food and energy and a lower exchange value of the dollar, we achieve some modest edging-off of inflation.”
Stockton joked that new drug tests introduced for the senior Fed staff would mean their projections could not be read as drug-induced mistakes. "No, we came up with this projection unimpaired and on nothing stronger than many late nights of Diet Pepsi and vending-machine Twinkies." Five years later a recourse to mind-altering drugs as an excuse might seem preferable to hubris.
Timothy Geithner, then-president of the Federal Reserve Bank of New York, did express concern in September 2007 that the Fed should do more to stem a possible spiraling situation. "I believe the arguments work in favor of doing more now rather than less. Policy needs to provide a convincing degree of insurance against a more adverse outcome," he said.
However, many Fed board members, along with many other economists worldwide, continued to look optimistically on balance sheet rotten with what we soon knew to be mortgage assets toxic to the core.