Revealed: How deluded Bernanke thought economy could make 'soft landing' just months before the credit crunch

  • Housing market faced 'at worst an orderly decline', said Federal Reserve chairman in 2006
  • Timothy Geithner denied risk of 'collateral damage'
'Soft landing': Federal Reserve chairman Ben Bernanke saw little danger in the housing bubble

'Soft landing': Federal Reserve chairman Ben Bernanke saw little danger in the housing bubble

Ben Bernanke believed that the U.S. economy would have a 'soft landing' in the wake of falling house prices in 2006.

Instead, the next year saw the start of a credit crunch, which became a financial crisis, which became the Great Recession.

The extraordinary delusion of those who ran the world's biggest economy, from the chairman of the Federal Reserve downwards, has been laid bare by the release of transcripts of Fed meetings from the year before the crash.

Mr Bernanke predicted that the end of the housing bubble would be 'at worst an orderly decline', rather than the widespread disaster it became.

But his prediction that the bubble would pop gently was in fact one of the least wrong guesses about the future of the economy.

Treasury Secretary Timothy Geithner, then a Fed official, said there was little risk of 'collateral damage' from the housing market.

And Susan Bies, a Fed governor, even suggested that a fall in the housing market could benefit the rest of the economy.

The officials' optimism came despite glaring signs of the damage to the market, which were discussed in Fed meetings - for example, they mentioned that some builders were giving away cars to home-buyers, while others were disguising empty houses as occupied to encourage people to move to the area.

The transcripts released yesterday covered the eight meetings of the central bank's chief policy-making body, the Federal Open Market Committee, during 2006.

That included the last meeting of Federal Reserve chairman Alan Greenspan in January of that year and Bernanke's first meeting in March after he had succeeded Mr Greenspan as chairman.

'No collateral damage': Treasury Secretary Timothy Geithner was unconcerned

'No collateral damage': Treasury Secretary Timothy Geithner was unconcerned

At the time Mr Greenspan was seen off to rapturous applause for his perceived role in stabilising the economy, with Mr Geithner predicting that his reputation would rise even higher.

In fact, the former Fed chairman is now considered by many as one of the architects of the financial crisis due to his hands-off approach to bank regulation.

The transcripts show that at first Mr Bernanke did not express concern about the cooling of the housing market after a boom that had pushed sales and home prices to record levels.

Overrated? Alan Greenspan's genius is now less highly regarded than it was

Overrated? Alan Greenspan's genius is now less highly regarded than it was

'I agree with most of the commentary that the strong fundamentals support a relatively soft landing in housing,' he told his follow FOMC members at his first meeting as chairman in March.

He also said: 'I think we are unlikely to see growth being derailed by the housing market, but I do want us to be prepared for some quarter-to-quarter fluctuations,'

At his second meeting as chairman in May, Mr Bernanke still seemed fairly confident. 'So far we are seeing, at worst, an orderly decline in the housing market; but there is still, I think, a lot to be seen as to whether the housing market will decline slowly or more quickly.'

However, by the June meeting, he was expressing more caution saying that the slowdown in housing was 'an asset price correction' that needed to be watched carefully.

But at that meeting, Ms Bies argued that the deflation of the housing bubble could have a positive effect on the broader economy.

She said: '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.'

The fallout: Staff leave Lehman Brothers' New York headquarters after the bank's collapse in September 2008

The fallout: Staff leave Lehman Brothers' New York headquarters after the bank's collapse in September 2008

By the September meeting, Mr Bernanke sounded even more concerned about the impact on the broader economy from the slowdown in housing.

'I don't have quite as much confidence as some people around the table that there will be no spillover effect,' he said.

By contrast, Mr Geithner, who was then president of the Fed's New York regional bank, expressed more confidence that the economy could weather the troubles in housing, saying the issue would be the impact on consumer and business spending.

'We just don't see troubling signs yet of collateral damage and we are not expecting much,' Mr Geithner said at the September FOMC meeting.

The discussion by the members of the FOMC gave no indication that any of them foresaw the devastating impact that the collapse of the housing bubble would have. The country fell into a deep recession and severe financial crisis that led to the loss of more than 8million jobs.

Mr Bernanke and other Fed officials have admitted that they failed to see the severity of the shock waves from the housing bust. But the transcripts of their closed-door discussions in 2006 provide new details about how the central bank was responding to the unfolding crisis.

The transcripts of the final meeting of the year, in December, showed that Mr Bernanke was still expecting that the economy would experience a 'soft landing' in which growth would slow enough to cool inflation but not drop into a recession.'

Justin Wolfers, an economist at the University of Pennsylvania, told the New York Times that the transcripts were 'embarrassing for the Fed' - but he added that the crisis had pushed the whole discipline of economics into disrepute, as very few commentators predicted the coming storm.

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