The day after the US decided not to bail out Lehman Brothers in September of 2008, Federal Reserve Board officials were huddling in Washington, DC, to decide what to do next, newly released transcripts of Fed minutes reveal.
Should they lower, raise or keep interest rates the same?
As soon as Lehman filed for bankruptcy protection on Sept. 15, markets began crashing around the world and insurer AIG teetered on insolvency and was bailed out, while US citizens were feverishly moving their money into FDIC-insured banks in amounts of under $100,000 to keep it safe.
Within days, it would become clear that the US — and the rest of the world — was on the verge of another Great Depression and letting Lehman fail had been the trigger.
Led by Chairman Ben Bernanke, himself a student of the Great Depression, the Fed in October would start cutting rates, ending the year at nearly zero.
But on Sept. 16, Fed officials were wringing their hands about the prospect of inflation — not deflation — as they gathered for their regular meeting.
The world had changed, but they couldn’t quite come to grips with it.
“An inflation problem is brewing … The financial crisis threatens to roll on for such a long time and to demand so much attention that the private sector may rationally conclude that we have lost all sight of our inflation objective,” bemoaned St. Louis Federal Reserve Bank President James Bullard.
His comments, among other revealing statements, appeared in transcripts of Federal Open Market Committee minutes — released Friday morning — during the eventful year of 2008.
Overall, the bankers seemed paralyzed and decided to keep rates steady that day.
“I would encourage the Committee to resist the impulse to ease policy in a sense of doing something,” said Kansas City Fed President Fred Hoenig. “We also have an inflation issue.”
There was even talk of raising rates by Philadelphia Fed President Charles Plosser. He finally argued that while it wasn’t the time to “shock markets by raising rates,” it would have to happen sooner than expected.
The lone dove was Boston Fed President Eric Rosengren, who wanted to lower rates — by 25 basis points. “This is already a historic week, and the week has just begun,” he said, pointing to the likelihood of a run on money-market funds.
Rosengren alone saw the future clearly. “Deleveraging is likely to occur with a vengeance as firms seek to survive this period of significant upheaval. Given that many borrowers will face higher interest rates as a result of financial problems, we can help offset this additional drag by reducing the federal funds rate,” he pleaded.
The bankers also pondered whether letting Lehman fail was the wrong move. “It’s too soon to know whether what we did with Lehman is right,” said Rosengren. “Given that the Treasury didn’t want to put money in, what happened was that we had no choice. But we took a calculated bet.”
As they grappled with the magnitude of that decision, they did recognize that many US financial institutions had become, as Hoenig put it in the meeting, too big to fail. He even suggested coming up with a plan to put banks in receivership in the future.