A Tale of Two Unknowns: The Fed's Second 2007 Emergency Meeting

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NEW YORK ( TheStreet) -- The Federal Reserve seriously was concerned it didn't have enough staffing to service the discount window in 2007.

Transcripts from the Federal Open Market Committee -- the Fed's policy-making wing -- from the early days of the financial crisis suggest that Fed members sometimes found themselves unfamiliar with the financial instruments that were beginning to cave and frightened by the prospects of encouraging more banks to approach its discount window to remain liquid.

During a second emergency meeting on Aug. 16, 2007, FOMC members debated the impending statement it would release the next day that said the central bank would reduce the primary credit rate -- one of three discount window programs it offers -- by 50 basis points to 5.75% in an effort to encourage banks to request loans from the regional Reserve banks.

Six days prior to this meeting, the FOMC had held its first emergency conference call of the approaching financial crisis to inform 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. Troubles with Washington Mutual and Countrywide (now part of Bank of America (BAC) ) had tormented markets and the commercial paper markets in Europe and the U.S. started to face pressures.

But banks rapidly became more illiquid than the Fed had anticipated in the first meeting, and members opposed a bailout option. Members avoided bailouts as an option because it wasn't clear in August 2007 just how unhealthy conditions would later become. General worry among Fed bankers, according to the transcript, was that illiquidity was spreading and banks were afraid to approach the discount window.

The discount window -- where banks go to ask the Reserve banks for loans -- carried a negative stigma.

"If somehow the stigma were reduced for coming to the window, they might be able to take advantage of that source of liquidity and act so that the help might relax some of the constraints in other markets," Timothy Geithner, then-president of the New York Fed and vice chairman of the FOMC, said in the emergency meeting.

The argument split into two directions: What if virtually none of the banks approach the discount window, despite a drop in the rate? Or, what if the "8,000 banks and many more depository institutions than that" all clamor at once to the window?

The latter situation raised some concern.

"Another issue of the narrower spread over the federal funds rate is that, as Brian Madigan pointed out, you probably increase the number of people, and so there are also some operational issues relating to the staff that the Federal Reserve Banks are managing," said New York Fed President William Dudley, who was then the manager of the System Open Market Account. " There is an issue in terms of the operational burden and our capacity to do that, given that this is basically very rarely used in the current environment."