Proof Leaked: Bernanke Clueless About Housing Bubble in ’07

January 21st, 2013

Newly-released minutes from Federal Reserve meetings in 2007 show that the vast majority of Fed Governors had no idea that the housing bubble was about to burst. Even though many financial analysts warned a crash was looming, including then-Congressman Ron Paul and Austrian economist Peter Schiff, Fed officials downplayed the theory that housing defaults could affect the broader economy.

Six years later, US markets are still crawling at a snail’s pace. Will history remember the housing bubble as the primary event that started the second Great Depression? Will Ben Bernanke’s legacy be that of a failed Federal Reserve Chairman that turned a market correction into a decade of despair? Why were Federal Reserve officials clueless about the housing bubble when so many Austrian economists had been predicting it for years?

The Proof Is in the Minutes, Now Made Public

In January of 2007, Ben Bernanke said, “The housing market has looked a bit more solid, and the worst outcomes have been made less likely.” His view was that the fundamentals in housing were improving, thus reducing the risk of a crash. Current Treasury Secretary Tim Geithner was the head of the New York Fed at that time. His view was that the subprime mortgage mess represented too small a share of the market to affect the broader economy. Said Geithner, “Remind us what share of the total outstanding stock of mortgages consists of subprimes or what share of the housing stock do we think is financed at the subprime level? My recollection is that the share is still small even though it has been a large part of the recent flows.”

As the crisis began to unfold, Fed officials continued to argue that it wasn’t going to be that bad. Said Bernanke in August of ’07, “I think the odds are that the market will stabilize. Most credits are pretty strong except for parts of the mortgage market.” As trouble emerged with Bear Sterns, Tim Geithner continued to downplay the consequences, “Direct exposure of the counterparties to Bear Stearns is very, very small compared with other things.”

Dallas Fed Governor Dissents

To make matters worse, one Fed official did see trouble coming and made it clear at the meetings. His warnings were ignored. In a May meeting, Dallas Fed President Richard Fisher said, “On the housing front, I have been bearish—more bearish than anybody at this table…I am more concerned than I was before. We can go through the numbers, but I think it is best expressed by the CEO of one of the five big builders, who said that in March he was arguing internally with his board that the headlines were worse than reality and now reality is worse than the headlines.”

As problems emerged at Bear Stearns, Richard Fisher doubled down on his concerns, “I was once a hedge fund manager—I know all the tricks that are played there, including, by the way, the valuation of underlying securities—in a day when the business was less sophisticated than it is now. I don’t feel I understand this issue … I don’t think the issue is contained. I do think there is enormous risk.”

Inevitably, Fisher’s concerns were ignored, and Federal Reserve officials made monetary policy decisions based on the viewpoint that the broader economy could easily absorb any forthcoming housing defaults. That theory was proven terribly wrong as credit markets iced over and spread across the world economy. Since then, the Federal Reserve has attempted to “fix” the problem caused by Greenspan’s late ’90s rate decreases by pushing interest rates further below natural market values, likely just making things worse.

Will the Federal Reserve also fail to notice the upcoming commercial real estate, retail, and student loan crashes? Hopefully, the bank’s charter will be revoked before we get the chance to find out.

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About the Author: Barry Donegan

Barry Donegan is a singer for the experimental mathcore band Look What I Did, a writer, a self-described "veteran lifer in the counterculture", a political activist/consultant, and a believer in the non-aggression principle.