The Federal Reserve yesterday released transcripts from 2006 (full official transcripts of Fed meetings are released five years after the meetings occur), which shed some light on how badly the Fed misinterpreted the housing bubble. “I really believe that the drop in housing is actually on net going to make liquidity available for other sectors rather than being a drain going forward, and that will also get the growth rate more positive,” said then Fed member Susan Bies. “Housing is a relatively small sector of the economy, and its decline should be self-correcting,” added Janet Yellen, now the Fed’s vice chairman.

Dallas Fed Chairman Richard Fisher said that, “as one CEO told me, the only subject that has been more analyzed than the housing situation is the birth of Brad Pitt’s baby.” Chairman Ben Bernanke, meanwhile, predicted “at worst, an orderly decline in the housing market,” while now Treasury Secretary Tim Geithner (then president of the New York Federal Reserve) said, “we think the fundamentals of the expansion going forward still look good.”

The Fed’s perspective is perhaps best summed up by Gary Stern, then president of the Minneapolis Federal Reserve, in a March 2006 meeting:

I thought I would comment a bit more on two issues in particular—one is housing—where I wonder if the significance of potential developments might not be being exaggerated a bit. I certainly agree that changes in housing prices, up or down, feed into household wealth and through that into consumer spending. I think that’s a perfectly acceptable story. So if housing prices go down or level off, they will have that effect on wealth and potentially on spending.

But there seems to be a view that, in some sense, an exogenous pronounced decline in housing prices is possible, maybe even likely, and that this could be more devastating for the economy. It’s not that I would quibble with that story, but I would wonder about its likelihood because it seems to me more likely that housing is the tail rather than the dog in this. That is, as long as employment continues to go up, incomes continue to go up, and mortgage rates remain relatively moderate, then I would expect that we would avoid severe difficulties in housing except for a few markets that are particularly inflated at this point.

From the transcripts, it becomes clear that Fed officials thought the economy supported the housing market. But it was actually the other way around: the housing sector was supporting the economy. Meanwhile, the nation’s biggest banks had entwined themselves (via the housing market, which they were helping prop up with predatory subprime loans) to such an extent that when housing finally declined, the whole system fell apart.

In the lead-up to the financial crisis that crippled the American economy and plunged the country into a recession, the Federal Reserve made trillions in undisclosed loans to struggling banks and financial institutions, according to official documents obtained by Bloomberg News. Banks then turned those loans into more than $13 billion in previously undisclosed profits.

The total commitment of the Fed loans amounted to $7.77 trillion, and unlike the funds made available by the Troubled Asset Relief Program (TARP), the loans came with virtually no strings attached for the banks:

The amount of money the central bank parceled out was surprising even to Gary H. Stern, president of the Federal Reserve Bank of Minneapolis from 1985 to 2009, who says he “wasn’t aware of the magnitude.” It dwarfed the Treasury Department’s better-known $700 billion Troubled Asset Relief Program, or TARP. Add up guarantees and lending limits, and the Fed had committed $7.77 trillion as of March 2009 to rescuing the financial system, more than half the value of everything produced in the U.S. that year.

“TARP at least had some strings attached,” says Brad Miller, a North Carolina Democrat on the House Financial Services Committee, referring to the program’s executive-pay ceiling. “With the Fed programs, there was nothing.”

In one month, Morgan Stanley — one of the most vulnerable financial companies at the time — took $107 billion in secret loans, enough to pay off a tenth of the nation’s delinquent mortgages. The loans, like those made to other institutions, were never reported to Morgan Stanley’s shareholders or the taxpayers who subsidized them.

Other banks drew similar loans without disclosing them. Bank of America, for instance, held $86 billion in public debt on the day then-CEO Ken Lewis declared his company “one of the strongest and most stable major banks in the world.” Bank of America’s Fed borrowing peaked at $91.4 billion in February 2009; at the same time, it benefited from $45 billion in TARP loans.

And even while members of Congress were working to overhaul the nation’s financial regulatory system, the banks and the Fed kept them in the dark about the loans. Rep. Barney Frank (D-MA), one of the architects of the Wall Street reform act that eventually became law, and former Sen. Judd Gregg (R-NH), the GOP’s lead negotiator on TARP, told Bloomberg they were unaware of the specifics of such loans.

Had Congress had such information, members of both parties would have changed their votes to favor Wall Street reform, Sen. Sherrod Brown (D-OH) said. Former Sen. Byron Dorgan (D-ND), meanwhile, said knowledge of the loans could have led to a push to reinstate the Glass-Steagall Act, which prohibited banks from owning investment companies and vice versa, thereby limiting their size and vulnerability to such crises.

The secret nature of the loans, however, instead helped Wall Street work to “preserve a broken status quo” that allowed its biggest banks to grow even larger than they were before the crisis. The nation’s largest banks have turned more in profit in the last 30 months than they did in nearly eight years preceding the crisis, all while spending millions to derail significant reform legislation. And since the Dodd-Frank Act became law, they have spent millions more to weaken its rules and prevent certain regulations from taking effect. Bank lobbying, in fact, is now on pace to reach a record high this year.

Chicago Federal Reserve President Charles Evans

The Federal Reserve today released its latest policy statement, announcing that it is taking no new moves to boost the economy’s sluggish growth. However, for the first time since 2007, one of the voting members of the central bank — Chicago Fed President Charles Evans — dissented from the Fed’s decision from the left:

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action was Charles L. Evans, who supported additional policy accommodation at this time.

Evans has been a consistent voice on the Fed for doing more to stimulate the economy. He laid out his reasoning in a speech last month:

With unemployment having lingered for so long at rates around 9 percent, it is perhaps natural that some would begin to think that nothing more can be done to improve upon this situation. However, I don’t agree…[T]hese are not ordinary times — we are in the aftermath of a financial crisis with massive output gaps, with stubborn debt overhangs and high degrees of household and business caution that are weighing on economic activity. As Ken Rogoff wrote in a recent piece in the Financial Times, “Any inflation above 2 percent may seem anathema to those who still remember the anti-inflation wars of the 1970s and 1980s, but a once-in-75-year crisis calls for outside-the-box measures.” The Fed has done a good deal of thinking out of the box over the past four years. I think it is time to do some more.

The last dissent from the left on the Fed was from Boston Fed President Eric Rosengren, who has also said that “if the economy gets weaker and the inflation rate gets lower, we should be thinking about alternative policies.”

As Matt Yglesias has written, “the Federal Reserve system has an obligation to not sit idly by and let the country endure years of mass unemployment.” However, several of the right-leaning members of the central bank have consistently said the Fed shouldn’t do more out of fears of sparking inflation.

But that bias on may be shifting. As the Wall Street Journal noted, “Vice Chairwoman Janet Yellen, New York Fed President William Dudley and Governor Daniel Tarullo all warned that the economy is at risk and that the Fed may need to purchase more securities-a step known to some as quantitative easing-to push down long-term rates.” Since congressional Republicans don’t seem inclined to let anything that might even moderately help the economy become law, hoping for the Fed’s doves to swing the central bank in their favor might be one of the few options left for boosting the economy.