Inside the Fed's First Financial-Crisis Meeting; Cramer Was Right

NEW YORK ( TheStreet) -- We now know the Federal Reserve was terrified of the crisis brewing in 2007. Something was wrong, but no one knew what.

The central bank called together three emergency conference calls in 2007 as the housing and financial crisis was beginning to frighten investors. The Fed made publicly available on Friday the conversations of meetings from the Federal Open Market Committee (FOMC), the policy-making wing of the Fed.

The minutes of the meetings reveal that Fed policymakers referred to TheStreet founder Jim Cramer's famous televised rant about the crisis, which follows our summary of the Fed proceedings.

Aug. 10, 2007, 8:45 a.m.

Fed Chairman Ben Bernanke held an emergency meeting to inform FOMC members that the central bank would be issuing a statement later in the day to say that it would provide liquidity to maintain "orderly functioning" of the financial markets.

"As you know, financial markets have been fragile," Bernanke said. "They appeared to continue to be fragile overnight. There are difficulties with commercial paper funding and other short-term funding and a lot of concerns about counterparty risk."

Bernanke then turned to New York Fed President William Dudley, then the manager of the System Open Market Account, who revealed that two troubled companies were driving the market's uncertainty: Washington Mutual and Countrywide (now part of Bank of America ( BAC)). Also stoking fears was pressure on commercial paper markets in Europe and the U.S.

"Washington Mutual and Countrywide have both made statements in their 10-Q filings that unnerved the market a little, Washington Mutual saying that they're having some trouble in terms of liquidity and Countrywide saying that there are unprecedented disruptions in the credit market," Dudley said.

Worries about these two companies, according to the conversations, hadn't yet prompted concerns that other financial institutions were beginning to feel the pressure.

Treasury Secretary Timothy Geithner, then the vice chairman of the FOMC and New York Fed president, chimed in to reassure members that the "more diversified" institutions had reported no funding pressure and that money actually was flowing to them.

"That, of course, could change quickly," Geithner said. "But apart from those that are more narrowly in the mortgage market that can't basically sell any non-agency products, I don't think we're seeing any sense of funding pressure."

In retrospect, we know that the crisis eventually spread to virtually every major financial institution in the country. But that was August 2007 -- seven months before the Fed provided a $30 billion loan to JPMorgan ( JPM) for its purchase of the ailing Bear Stearns.

The FOMC continued to discuss the federal funds rate, when Dallas Fed President Richard Fisher and Geithner jumped into a minor scuffle.

Fisher questioned whether an official statement from the FOMC would be the best action to calm markets, and he asked what it would do to help them rein in "reckless and irresponsible" behavior by creditors.

Geithner said he felt a statement would be the most "powerful" action as he believed it didn't make sense to attempt to persuade banks to lend to unstable institutions.

Fisher relented, agreeing with Geithner that a statement was the "correct thing," but he added that he felt the Fed should receive something in return for providing liquidity.

"I don't agree with that. I don't think that's the way to think about it. This is a general signal that we're prepared to relax or to provide liquidity to help make sure markets come back in some more orderly functioning," Geithner said. "You can't condition that statement without undermining its basic power in some sense."

Fisher again caved and said he didn't want to amend the statement, just that he wanted his mindset to be known.

It was at this moment when Bernanke unloaded.

"My understanding of the market's problem is that price discovery has been inhibited by the illiquidity of the subprime-related assets that are not trading, and nobody knows what they're worth, and so there's a general freeze-up," Bernanke said. "The market is not operating in a normal way. The idea of providing liquidity is essentially to give the market some ability to do the appropriate repricing it needs to do and to begin to operate more normally. So it's a question of market functioning, not a question of bailing anybody out."

The conversation continued as Philadelphia Fed President Charles Plosser, a noted hawk on the FOMC, returned to the question of liquidity. Echoing a sentiment he continues to repeat to this day, Plosser asked in 2007 when it would end.

Dudley offered a simple response: when things settle down and liquidity in markets improves.

Note: The Fed's two current monetary easing programs include $40 billion a month in open-ended, mortgage-backed securities purchases and $45 billion a month in open-ended, longer-term Treasury bond purchases.

"I think there's a lot of suspicion, both in the markets and elsewhere, that the effects of all that easing policy is having kind of diminishing returns," Plosser said in an interview with TheStreet on Jan. 16, 2013. "The benefits, if you will, are not as strong as they were at the height of the crisis."

The meeting then turned to concerns about Europe and whether institutions in the eurozone would be at significant risk of liquidity problems.

Atlanta Fed President Dennis Lockhart asked if there were any "analogs" to Countrywide and Washington Mutual in Europe. The answer to Lockhart's question revealed how unaware Fed members were of the gaping problems that would eventually cripple the U.S. financial system.

"I think there is a general sense that a lot of this subprime stuff ended up, as it has in the past, in institutions in Europe," Geithner responded. "So I assume that we have the risk ... b ut, again, we have no indication from any of our counterparts yet that any major institutions face a significant funding or solvency issue."

Geithner's was the final point made by a member during the first emergency meeting held by the FOMC in regards to the financial crisis.

Plosser asked Bernanke to repeat the statement to the committee. He did so.

The Fed released this statement on Aug. 10, 2007. It was the first in a string of emergency monetary-policy releases that for the coming years would grip Americans, financial markets and the rest of the world.

A few days before the Fed's first emergency meeting, TheStreet's Jim Cramer unloaded on Fed officials in the following remarks:
"I have talked to the heads of almost every single one of these firms in the last 72 hours, and Ben Bernanke has no idea what it's like out there. None. And Former St. Louis Fed. President Bill Poole has no idea what it's like out there. My people have been in this game for 25 years and they're losing their jobs, and these firms are going to go out of business, and he's nuts! They're nuts! They know nothing!... This is a different kind of market, and the Fed is asleep."

Here's that video:

-- Written by Joe Deaux in New York.

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