A blissful ignorance about oncoming financial catastrophe was not confined, in 2006, to members of the public who had never heard of Lehman Brothers. It extended all the way to the top of the Federal Reserve, the US central bank charged with steering the economy.
Minutes of its interest rate-setting meetings from that year, as US house prices began to crumble, show its top officials laughing about excesses in the housing market and what turned out to be signals of trouble in the economy of Iceland, whose subsequent collapse was a harbinger of the global credit crisis. The reputations of the economists who ran the Fed, in particular its previously feted chairman, Alan Greenspan, have long been tarnished by their failure to foresee the crisis, but the newly released minutes take their embarrassment to new levels. The transcripts also threaten to hamper the Fed's efforts to restore its legitimacy in the eyes of the American people at a time when it is under attack as never before.
The revelations are especially bad for the Treasury Secretary, Tim Geithner, who was previously president of the Fed's New York branch. At the first meeting of 2006, he added his voice to a chorus of praise for the retiring Mr Greenspan. "I'd like the record to show that I think you're pretty terrific too," Mr Geithner said. "And thinking in terms of probabilities, I think the risk that we decide in the future that you're even better than we think is higher than the alternative."
A committee member, Janet Yellen added: "The situation you're handing off to your successor is a lot like a tennis racquet with a gigantic sweet spot." Unfortunately, the economy was like a tennis racquet: it was full of holes.
Although the Fed team became increasingly aware of problems in the housing market, they laughed them off and consoled themselves with economic models suggesting any effects on the wider economy would be limited. Unbeknown to the Fed, dodgy mortgages based on inflated house prices had infected the entire financial system, yet one committee member was still describing the capital markets as "probably more profitable and more robust" than they had ever been – even at the year's end.
By summer 2007, the housing downturn was starting to take down hedge funds, and big banks started failing in 2008. In December 2007, the US economy went into what became known as the Great Recession.