How the Fed Prepared to Buy Bank Stocks in 2007: Street Whispers

NEW YORK (TheStreet) -- As the U.S. subprime housing market went into meltdown in 2007 and brought Wall Street to its knees -- leading to trillions in bailout measures -- some officials in the Federal Reserve were ready to buy up bank stocks.

Little did they know by 2008 it would be all but impossible for the Fed not to hold them despite stated policies against equity ownership.

While transcripts of meetings from 2007 released on Friday provide a glimpse into the Fed's slow recognition of the cracks in megabanks that would imperil the global economy, poorly timed comments like one governor's hypothetical recommendation to buy bank shares near pre-crisis stock highs also foreshadow the extreme and still unknown steps that the central bankers took to rescue Wall Street when the crisis hit.

According to transcripts from a Sept. 18, 2007 meeting, then-Governor Frederic Mishkin recommended that the Fed consider buying bank stocks given the bright long-term prospects of the financial sector, particularly in originating home loans if lending standards improved.

"In particular, we've gone to an originate-to-distribute model, which Fed Governor Randall Kroszner mentioned, and we have found some serious flaws in it. The expectation is that we will have new models coming out. In fact, I think that this is actually going to be a long-run profit opportunity for the banks. So if we were allowed to buy bank stocks, I think it would be a good idea," says Mishkin.

"Laughter," is the reaction of Fed officials to Mishkin's idea, according to the Fed's transcript.

Mishkin's recommendation was used as a hypothetical to describe the health of the U.S. financial system when early signs of crisis emerged. Still, it raises key unanswered questions from the financial crisis and the Fed's unprecedented action.