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Fed Committee Transcripts Suggest A Prescient KC President

Thomas Hoenig

(The Kansas City Star) – There’s news from the Federal Reserve.

No, not that the Fed’s monetary policy committee is meeting today and Wednesday to consider what to do about our current economic malaise.

The betting line is that the Fed will cut the key short-term interest rate another quarterpoint, to 2 percent. The Fed might then pause to see if a recent flurry of cuts from 5.25 percent will prove to be an elixir for an economy that probably has slipped into recession.

Rather, the news that caught my attention comes from recently released transcripts of the

2002 meetings of the Federal Open Market Committee . It makes monetary policy for the

United States. The transcripts, released after a five-year delay that reflects an irksome lack of transparency at the Fed, shed new light on its role in fueling a housing bubble that has since popped — putting us in our current economic predicament.

This limited space simply can’t capture the nuance contained in the transcripts of those

2002 Fed meetings, which run roughly 100 pages each. Folks who want to jump into the deep end of the information pool can go to federalreserve.gov/fomc/transcripts to read transcripts going all the way back to the Paul Volcker-led Fed of the late 1970s. (They’re fascinating, if you’re an econo-geek.)

But one theme in the newly released transcripts is how Tom Hoenig, president of the

Federal Reserve Bank of Kansas City , expressed concern as early as March 2002 about how incredibly low short-term interest rates — then 1.75 percent, and on the way to 1 percent — might be “setting up conditions that I think will give rise to future imbalances.”

In May, Hoenig again warned about “risks of … some financial excess.” In June, he called the low-interest-rate regime “extremely accommodative. And I think we need to take a longer-term view of this.”

The transcripts also reveal how captivated the then Fed chairman, Alan Greenspan, was with how the housing boom was leading the economy out of the 2001 recession.

“Despite the weakness in the economy, homebuilding has been remarkably well maintained,” Greenspan said in June. “We are getting fairly dramatic increases in a lot of areas in the market value of homes and hence in total housing equity, from which there has been a consistent degree of extractions” in the form of refinancings and home equity loans.

“Unless we get a significant decline in home prices, and that’s a very questionable prospect at this stage, it’s hard to imagine that there will not be very considerable ongoing support for consumption expenditures coming out of the housing equity markets,” Greenspan said.

In August, Greenspan acknowledged concerns about a “housing value bubble” but questioned “whether that’s a valid notion.”

There’s more — much more. But you get the picture. And now, with the benefit of hindsight, it has become apparent that Hoenig’s crystal ball on housing was clearer than Greenspan’s.

The seeds of a housing bubble had already found purchase in the fertile soil of incredibly low interest rates of 2002. Housing values raced ahead of the household income growth needed to support them over the long haul. Many homeowners tapped into inflated housing equity to fund their consumer whims. The subprime industry scribbled out mortgages for anyone who had a pulse and sold them in bundles to greater-yield-chasing fools on Wall Street.

And so here we are now.

The housing bubble has burst. Home values are reverting to the mean, as they must — more painfully in some markets than others. The subprime mortgage meltdown has caused a credit squeeze that has gripped broader financial markets. We’re probably in recession.

Greenspan has left the Fed, written a book and spends a fair amount of time defending his increasingly tarnished legacy.

Hoenig is still leading the Kansas City Fed and participates in Federal Open Market

Committee meetings, though he’s a nonvoting member at the moment.

And the current Fed chairman, Ben Bernanke, is struggling with the most difficult economic circumstances since the stagflation that vexed the Volcker-led Fed.

Admittedly, Fed transcripts aren’t the makings of an action movie script. So far as I can tell, no one yells. No one curses. No punches are thrown. It’s all very collegial, and once in a great while even humorous.

But the distinct viewpoints of Hoenig and Greenspan during 2002, and how Greenspan prevailed in forging an aggressive rate-cutting consensus, have a very real bearing on the pickle we’re now in.

My takeaway is this: Hoenig, a pretty low-key guy who toils in our midst here in Kansas

City, is a smart cookie. And even though he isn’t a voting member of the Fed committee that’s meeting this week, he’s still in the room sharing his opinion.

In recent months, Hoenig hasn’t been quite as enthusiastic about slashing interest rates as his colleagues — going so far as to break with the majority on one rate-cut vote late last year.

In recent speeches, Hoenig has been “cautiously optimistic” that the economy still can pull out of the slowdown without a recession. He also has fretted about whether overly aggressive rate cutting now might feed an inflationary spiral that could force the Fed to sharply reverse course on monetary policy.

Hoenig isn’t a broken watch — someone who is right just twice a day. He was right early and often in 2002. He just might be right again.

It’s worth listening to him.

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