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Fed Says LIBOR 'Understated,' Describes Wachovia Deposit Run at 2008 Meeting

NEW YORK (TheStreet) -- During their Sept. 29, 2008, emergency meeting, members of the Federal Open Market Committee sure had a lot on their plate, according to a transcript released Friday.

While much of the events discussed during the meeting are "history," there was a fateful comment related to the possible understatement of LIBOR in the midst of the crisis, which continues to be a major headache for the banking industry today.

Here's a quick rehash of events leading to that fateful day:

Fannie Mae (FNMA) and Freddie Mac (FMCC) -- which together continue to dominate the U.S. mortgage industry by purchasing most newly originated mortgage loans and are known as the government-sponsored enterprises, or GSEs -- were taken under government conservatorship on Sept 6, 2008, with the announcement made by former Federal Housing Finance Agency director James Lockhart and former Secretary of the Treasury Henry Paulson.

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Lehman Brothers filed for bankruptcy on Sept. 15.

Bank of America (BAC) on Sept. 15 announced an agreement to purchase Merrill Lynch -- the largest U.S. brokerage firm -- for $50 billion in stock. This turned out to be a much better deal for Bank of America than its purchase of Countrywide Financial, which was completed in July 2008 and led to years of very expensive litigation and putback settlements for BAC.

America International Group (AIG) facing a liquidity crisis on Sept. 16, as counterparties demanded delivery of massive amounts of collateral for credit default swap agreements, was the lucky recipient of an $85 billion revolving credit facility, provided by the Federal Reserve Bank of New York.

Washington Mutual Bank failed on Sept 25. This was the nation's largest bank failure ever, with $307 billion in assets and $188 billion in deposits. The Federal Deposit Insurance Corp. -- led at the time by Sheila Bair -- quickly sold the wreckage to JPMorgan Chase (JPM - Get Report) for $1.9 billion. That was a beautiful deal for the FDIC because JPMorgan took on all of Washington Mutual's deposits, eliminating any possibility of losses to depositors, at a time when the basic deposit insurance coverage was still $100,000.

On Sept. 29, Citigroup (C - Get Report) announced a deal to acquire the troubled Wachovia for the paltry sum of $2.16 billion in stock. That deal was personally brokered by Bair, but was eventually trumped by Wells Fargo (WFC) which more than doubled in size when it bought Wachovia for about $15 billion in stock on Dec. 31, 2008.

Also On Sept. 29, Congress struck down the bill introduced by the Treasury that eventually led to the $700 billion Troubled Assets Relief Program, or TARP. Stock investors showed their dismay, by sending the S&P 500 down 8.8% the same day. Congress quickly relented and passed the bill, with former President George. W. Bush signing the TARP legislation on Oct. 3, with the Dow Jones Industrial Average jumping 485 points and the S&P 500 recovering 5% that day.

But the FOMC didn't realize that the "Paulson financial rescue bill," as former Federal Reserve Chairman Ben Bernanke put it, was going to be rejected by Congress, or that the brutal market reaction to that rejection would lead to "good news" on Oct. 3, 2008.

Bernanke began the Sept. 29 meeting by discussing the increase of swap lines offered by the Fed's Foreign Currency Subcommittee to foreign central banks, the Wachovia situation, which required the invocation of "the systemic risk exception" to allow Citi to make its merger announcement, and the TARP bill.

William Dudley -- the former senior vice president of the Markets Group at the Federal Reserve Bank of New York, filling in for New York Fed President Tim Geithner, who was rather busy bailing out AIG -- said the large increase in swap lines offered to foreign central banks was in response to "dollar funding pressures in their home markets," and "should be considered as insurance in case market conditions continue to deteriorate and as reassurance to market participants that the world's major central banks are determined to respond in force to mitigate dollar funding pressures."

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