The Fed Really Couldn’t Comprehend Economics in 2006

By
Timothy Geithner.Photo: Evan Vucci

The problem with private conversations that later become public is that they're almost always humiliating, because the passage of time brings with it new information that often invalidates past opinions or illuminates old ignorance. For the Federal Reserve, whose 2006 meeting transcripts have been released after a standard five years, it's all that and more, considering the financial meltdown that followed their talks and the depth of their cluelessness. Despite some signs that the housing market was beginning to crumble, officials showed few signs of concern — actually, they worried that the economy was growing too fast.

The transcripts "clearly show some of the nation's pre-eminent economic minds did not fully understand the basic mechanics of the economy that they were charged with shepherding," the New York Times reports. "The problem was not a lack of information; it was a lack of comprehension, born in part of their deep confidence in economic forecasting models that turned out to be broken."

"We think the fundamentals of the expansion going forward still look good," said Timothy  Geithner, then president of the Federal Reserve Bank of New York, in December 2006, a few years before he became Treasury secretary. A few months earlier, of the housing market issues, he said, "We just don't see troubling signs yet of collateral damage, and we are not expecting much."

Others concurred, and thought maybe the housing slump would actually improve the economy. "I really believe that the drop in housing is actually on net going to make liquidity available for other sectors rather than being a drain going forward, and that will also get the growth rate more positive," said Fed governor Susan Bies. "Of course, housing is a relatively small sector of the economy, and its decline should be self-correcting," said another official.

"It's embarrassing for the Fed," said an economics professor of the transcripts. "You see an awareness that the housing market is starting to crumble, and you see a lack of awareness of the connection between the housing market and financial markets."

"It's also embarrassing for economics," he added. "My strong guess is that if we had a transcript of any other economist, there would be at least as much fodder."

Elsewhere in the talks, there's gossip, of course, but mostly kind words for Alan Greenspan, who had just ended his time as chairman."I'd like the record to show that I think you’re pretty terrific, too," Geithner said at Greenspan's final meeting. "And thinking in terms of probabilities, I think the risk that we decide in the future that you're even better than we think is higher than the alternative." As the Times notes gently, that opinion is "now held by a much smaller number of people." Call it another bad guess.

A different official had similar warm and fuzzy feelings: "It's fitting for Chairman Greenspan to leave office with the economy in such solid shape," she said. "The situation you're handing off to your successor is a lot like a tennis racquet with a gigantic sweet spot." But the ball in that volley, as it turns out, was something more like a grenade.