Records: Fed on edge during the 2008 crisis

Federal Reserve policymakers, in a tense meeting on one of the darkest days of the 2008 financial crisis, were worried that the failure of Lehman Bros. a day earlier would wreak havoc on a teetering financial system, but also feared that cutting already-low interest rates might prove an overreaction.

Transcripts of the U.S. central bank's meeting Sept. 16 that year, released Friday, showed then-Fed Chairman Ben Bernanke telling his colleagues he was philosophically torn about the collapse of the investment bank.

Citing the moral hazard of making such "ad-hoc" decisions over whether to help failing financial institutions, Bernanke weighed taking action "vs. the real possibility, in some cases, that you might have very severe consequences for the financial system and, therefore, for the economy of not taking action."

"Frankly," he said at the meeting, "I am decidedly confused and very muddled about this."

The central bank, which is still dealing with fallout from the crisis and the 2007-09 recession, released transcripts Friday of all 2008 meetings of the policy-setting Federal Open Market Committee, which typically waits five years before publishing full transcripts.

Looking back, the Fed was caught off guard by the severity of the crisis triggered by the subprime mortgage market. Starting in 2008, it quickly took a series of unprecedented steps to reinforce the crumbling financial system and to limit damage to the U.S. and world economies.

But Sept. 16, the day the Fed authorized a $85 billion loan to prevent the bankruptcy of insurer American International Group, policymakers were torn: Inflation was running high, but signs of economic weakness were everywhere.

People in the tony suburbs across the bay from San Francisco were even deferring cosmetic surgery, then San Francisco Fed chief Janet Yellen joked. A few weeks ago, she succeeded Bernanke at the Fed's helm.

Most of all, officials felt largely unable to gauge the effects of the crisis just one day after Lehman's bankruptcy, but Boston Fed president Eric Rosengren seemed certain of its impact.

"This is already a historic week, and the week has just begun," Rosengren said. He was the only policymaker at the table to call for a rate cut to offset the higher borrowing costs he anticipated many firms would face after the market turmoil.