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Federal Reserve Shows that Foresight is Blind

They say that hindsight is 20/20. And foresight is not.

That reality was made all too apparent a couple of weeks ago when the Federal Reserve released the transcripts from its meetings in 2007, after the standard five-year delay. The transcripts give us a new view of what the Fed knew (and didn’t know) as the economy teetered on the verge of a recession.

At the beginning of 2007, the Fed was complacent about the risks to the housing market. Subprime lenders were going out of business. People were losing their homes. But the Fed didn’t connect the dots to the economy as a whole. At the Fed’s March meeting Chairman Bernanke said “the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained”. By August, the trouble was coming into focus. The day before the Fed meeting, American Home Mortgage, one of the largest subprime lenders, filed bankruptcy. Countrywide Financial was fishing for a lifeline. But the Fed still thought the economy could weather what was happening in the housing market…and didn’t even mention housing in its official August statement.

The use (and lack of use) of one word from the transcripts highlights the Fed’s decent from skepticism, to uncertainty, to fear. In January 2007, the word ‘recession’ was used 4 times. In June, it was used 3 times. In August, once. But in December…27 times.

It was in December 2007 that the recession began…and would last for 18 months. But even though the word recession was floated repeatedly at that meeting, the Fed still didn’t grasp the magnitude of what was happening. And at that December meeting, the head of the Fed’s research team still wasn’t forecasting a recession, even as one was already underway: “despite all the financial turmoil, the economy avoids recession”.

Again, hindsight is 20/20.

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