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Ideology Became the Fed's Biggest Foe During the 2008 Financial Crisis

Stocks in this article: JPM BAC

NEW YORK (TheStreet) -- The 2008 Federal Reserve transcripts that were released last Friday revealed that economic ideology hindered judgment by some members of the policy-making committee to foresee the impending financial collapse.

Central bankers who fought for tighter monetary policy during the year, like Kansas City Fed President Thomas Hoenig and Dallas Fed President Richard Fisher, repeatedly expressed their concern about rising inflation and that downside risks to the economy weren't as bad as other members argued.

"Some of them were mired in ideology," FAO Economics chief economist Robert Brusca said in a phone interview from New York. Brusca said the financial services sector was ripped apart in front of the so-called hawks' eyes and they failed to recognize it.

"It was just," Brusca paused, "wow."

Then-Chairman Ben Bernanke throughout 2008 had to consider the opinions of all his voting members so as to avoid making any of them feel alienated. Bernanke, who was far more negative than most of his colleagues about the state of the U.S. economy, knew that he had to build consensus in order to shift Fed policy toward looser monetary policy to offset the impending decline.

Hawkish members like Fisher, Hoenig or former St. Louis Fed President William Poole expressed their worry of lowering the federal funds rate at a time when they fundamentally believed inflation was rising too quickly. Poole complained in an emergency January meeting that the FOMC shouldn't raise rates in between scheduled meetings and that doing so would seem like the Fed reacting to a weakening stock market.

Bernanke, in the transcripts, believed that the economy was softening, which would merit the Fed lowering rates.

Sometimes it's important to remember that the Fed will lower rates about the same time the stock market sells off because both the market and the central bank foresee a fundamental problem to adjust for in the economy, Brusca said.

The biggest shock was the reaction to the Lehman Brothers bankruptcy, Moody's Capital Markets Research Group economist Ben Garber said in a phone interview from New York.

Garber said the transcripts showed that the Fed went into reactive mode following Lehman's collapse, which helped trigger the blowups in the financial services sector.

"Lehman was a very poor choice," Garber said about letting the investment bank fall into bankruptcy.

The inability of hawkish members to see the crumbling economy as they feared a sudden spike in inflation proved that sometimes ideology can be the central banking's biggest foe.

-- Written by Joe Deaux in New York.

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