Morning Must-Read: Joe Deaux: The Story of the Federal Reserve the Day After Lehman Brothers Collapsed

Joe Deaux: The Story of the Federal Reserve the Day After Lehman Brothers Collapsed: “Hours after Lehman Brothers tumbled into history as the largest bank failure in U.S. history, Federal Reserve Chairman Ben Bernanke’s concerns focused elsewhere.

Opening remarks on Sept. 16, 2008, according to transcripts released by the central bank on Friday, revealed that Bernanke and members of the Fed’s policy-making wing–the Federal Open Market Committee–were uncertain how the Lehman bankruptcy would affect the broader economic system…. The Fed… turned its attention to a discussion of whether to raise the federal funds rate, which on that day sat at 2%…. Lockhart predicted that the federal funds rate target would remain around the current 2% level for “several months” going into 2009, and he recommended that the Fed not change the rate at that meeting. Boston Fed President Eric Rosengren, whose comments pushed for the most accommodative monetary policy, offered a grim outlook…. “The failure of a major investment bank, the forced merger of another, the largest thrift and insurer teetering, and the failure of Freddie and Fannie are likely to have a significant impact the real economy…. Individuals and firms will become risk averse, with reluctance to consume or to invest” Rosengren said he supported a 25 basis-point cut to the Fed funds rate….

Kansas City Fed President Thomas Hoenig encouraged the committee to resist the impulse to easy monetary policy…. “We also have an inflation issue,” said Hoenig, who, like most of his colleagues, didn’t realize that the pullback in energy prices was part of an escalating trend that wouldn’t soon reverse. Repeatedly, FOMC members noted that inflation seemed to be dropping thanks to the fall in oil and gasoline prices, which added to their satisfaction of at least one worry they could drop. Still others feared that the committee couldnt rule out a spike in prices. Philadelphia Fed President Charles Plosser’s reasoning was that his concern stemmed from the fact that he didn’t see the downturn as entirely demand driven. Minneapolis Fed President Gary Stern said: “But I will agree that it is still an open issue.”…

Following Hoenig’s comments, San Francisco Fed President Janet Yellen — and current chairwoman of the Federal Reserve — chimed in with anecdotal examples of economic headwinds…. Yellen then said that the labor market was weakening, and that job cuts coupled with the housing and financial crisis “raises the potential for even worse news.” The then-Fed president agreed with the majority that, at least for that meeting, they should not raise rates….

Cleveland Fed President Sandra Pianalto said she had a “small preference” for an option that would raise the Federal funds rate by 25 basis points, but she also said she didn’t have a problem with leaving it unchanged. Richmond Fed President Jeffrey Lacker said he thought Lehman’s failure was a good thing, and that “it will enhance the credibility of any commitment that we make in the future to be willing to let an institution fail and to risk such disruption again.”…

It was Dallas Fed President Richard Fisher, though, who delivered one of the most bizarre updates to the committee on Sept. 16. Fisher, who often pushes for tight monetary policy, provided a politician-stump-speech-like comment, invoking Bob Dylan, that urged the FOMC to unanimously vote to keep the federal funds rate unchanged:

All of that reminds me — forgive me for quoting Bob Dylan — but money doesn’t talk; it swears. When you swear, you get emotional. If you blaspheme, you lose control. I think the main thing we must do in this policy decision today is not to lose control, to show a steady hand….

I would recommend, Mr. Chairman, that we embrace unanimously — and I think it’s important for us to be unanimous at this moment — alternative B. Thank you, Mr. Chairman.

Fisher said he believed there was mitigation of inflation, but still offered an unusual anecdotal example of price inflation at a Dallas bakery he’d been frequenting for 30 years, saying the establishment had just announced a price increase due to cost pressures….

Then it was time for Bernanke to step up. The head of central bank delivered a gloomy outlook, and he was the only FOMC member the day after Lehman Brothers collapsed to say that the economy was in a recession…. Ultimately, the FOMC agreed to leave interest rates unchanged, and they spent an extended amount of time determining the small changes in language to the statement…