Transcripts show Fed wanted housing slowdown

The US Federal Reserve fretted about a slowdown in housing in 2006, but never considered the possibility that it could cause a financial crisis, according to complete transcripts of that year’s meetings.

Almost every Fed policymaker concluded that weaker housing would cause a slowdown in consumption and investment, but expected that to offset strength elsewhere in the economy, leading to continued growth overall.

“Housing is the crucial issue. To get a soft landing, we need some cooling in housing,” said Ben Bernanke, Fed chairman, in his summing up of the economic situation in March 2006. “I think we are unlikely to see growth being derailed by the housing market.”

The transcripts, released on Thursday, highlight the failure of the Fed – one matched by most other central banks, commentators and economists around the world – to spot dangers to the financial system from subprime mortgage lending. That complacency set the stage for the devastating crisis that began in the summer of 2007.

Throughout 2006, Fed officials were aware that a sharp slowdown in house building and sales was under way. “Even the Carolinas are starting to fold over, and the weakest area is California,” said Richard Fisher, Dallas Fed president, at the August meeting. “The big five builders and other homebuilders are reacting as you might expect. They are cutting staff.”

Indeed, a number of Fed officials saw the housing slowdown as welcome news that would help resolve a potential threat to the economy.

“As to housing, we are in fact, as all have noted, squeezing out of that sector the speculative excesses that developed with the low interest rates of recent years – and doing so is unavoidable if we want to correct the sector,” said Thomas Hoenig, then president of the Kansas City Fed, at the September 2006 meeting of the FOMC.

Fed officials made special efforts to talk to housebuilders, reflecting their fears about investment and consumption, but there is little evidence that they looked at where the credit to support the previous housing boom was coming from.

“Predatory lending is rearing its head at the lower end of the scale, and it’s something we have to continue to watch for. However, before I leave housing, let me just say that the bottom line is that overall mortgage credit quality is still very, very strong. We’re seeing predatory lending only in pockets of the market,” said Susan Bies, another governor, at the September meeting.

The transcript of the October 2006 meeting also describes Mr Bernanke’s first attempt to push the FOMC towards an explicit inflation objective, something that he has now returned to and which will be up for debate at the Fed’s next meeting in a couple of weeks.

The transcripts reveal widespread support for setting a clear inflation objective on the FOMC but most members, including Mr Bernanke, preferred to move gradually. Then, as now, the biggest concern was how putting a number on the Fed’s inflation goal would affect its other objective of maximum employment.

“I support the enunciation of a long-run numerical inflation objective,” said Janet Yellen, then president of the San Francisco Fed and now the vice-chair leading the Fed’s communications review, at the October 2006 meeting. “My main worry is the potential for de-emphasis on the other part of our mandate, namely maximum sustainable employment. Such a de-emphasis could occur in the minds of the public, and I could easily see how it could affect our own deliberations.”