Flying Blind: Inside the Federal Reserve's Damning 2006 Transcript

By Derek Thompson

What the Fed's remarkable pre-crash meeting -- and a similar transcript from the doomed Air France 447 flight -- teaches us about crisis and confidence

615 federal reserve.jpgReuters

There is something utterly engrossing about witnessing the spectacle of blithe ignorance in the face of impending doom.

So it is utterly engrossing, not to mention frightening, to read the January 2006 transcript of the Federal Reserve's eerily calm meeting at the dawn of the housing market's slow-motion meltdown. Consider some of the inauspicious details. Days after a sharp GDP decline, the Fed broadly considered the warning sign a statistical aberration. They characterized the housing crisis as a limited risk. Members praised Greenspan's tenure not only as unblemished, but also as a launching pad for years of steady growth. It's a grim scene, and it reminded me of another spookily casual transcript -- from the cockpit of doomed Air France flight 447.

***

On June 1, 2009, a plane carrying 228 people plunged into the Atlantic Ocean, in what became one of the greatest mysteries in modern aviation. How did a "technologically state-of-the art airliner" vanish into the water? As Popular Mechanics explained, it began with a storm and ended with simple human error.

Air France 447 had flown head first into a large system of thunderstorms. The captain left the cockpit to take a brief nap (he would return before the end), leaving the plane in the hands of thoroughly trained pilots. The time was 2:02 AM. Fifteen minutes later, everyone on board would be dead in the ocean.

Very soon, ice accumulation began to interfere with the speed sensors. An inauspicious aroma seeped into the cockpit. The pilots reacted with a bizarre combination of hasty actions and lazy thinking. When the plane had stalled, the pilots ignored the loud stall alarms. Their reaction -- to pull back on the stick -- was the exact opposite of what they were supposed to do in the situation. They assumed the plane's computer would prevent them from making a catastrophic mistake. But they failed to see that the computer had switched into an alternative mode that made it easier for them to stall the aircraft 30,000 feet above the ocean.

As the pilots pushed the plane's nose higher and higher in the sky, the plane did stall -- and fall. But none of pilots ever used the word "stall" in the transcript, including the captain, who returned in time to stop the crash, but failed. Nobody even diagnosed the problem until precisely 2:13 AM and 42 seconds in the black box log. It was too late. Forty-eight seconds later, AF447 and all 228 passengers hit the ocean.

And so, a highly advanced cockpit stocked with highly trained professions failed to avoid an utterly avoidable tragedy because of a mix of confusing conditions, overconfidence, and human error. I hope that, by laying out their circumstances so broadly, you'll understand where I see the parallels with the 2006 Fed meeting.

***

On January 31, 2006, a group of economic luminaries, including Alan Greenspan and Tim Geithner, gathered around a long ovular table in the offices of the Board of Governors of the Federal Reserve in Washington, D.C., to discuss the economy and send off Greenspan, the captain of the Fed.

At the time, warning signs abounded. The U.S. economy had already begun the epic free fall that would lead to recession in late 2007, cataclysm in late 2008, and 10% unemployment by 2010. The housing boom was mid-bust, with home ownership peaking at 69.2 percent in late 2004. (It has since fallen to below 60%, if you include delinquent mortgage borrowers.) Just days before the Fed meeting, the country had learned that GDP growth in the fourth quarter of 2005 had slowed to 1.1%, led by a nasty decline in consumer spending.

Still, practically all the participants said full-speed ahead. Even Janet Yellen, who did express some concerns about the housing market, told the departing Greenspan "that the situation you're handing off to your successor is a lot like a tennis racquet with a gigantic sweet spot." Eleven months later, after total national income had already begun shrinking, Tim Geithner, then president of the Federal Reserve Bank of New York, told his colleagues: "We think the fundamentals of the expansion going forward still look good."

Mistakes directly leading to the deaths of 200 passengers are a very different beast than mistaken economic forecasts, which (as part of a group of culprits including Wall Street greed, regulator incompetence, and home-buyers' ignorance) indirectly led to a great and devastating recession. But like the pilots, the Fed's failure was not a matter of education or training. These were among our greatest economic thinkers. Quite like the pilots, they trusted the mechanics of a complex system they did not fully understand, especially the connection between the housing and financial markets. Amazingly, in retrospect, they often emphasized inflation concerns over housing concerns and the health of Wall Street. ("Markets are now so much more developed and sophisticated that maybe it's different this time," Dino Kos told Greenspan.)

"The problem was not a lack of information," Binyamin Appelbaum writes in the New York Times. "It was a lack of comprehension, born in part of their deep confidence in economic forecasting models that turned out to be broken." It was total systemic failure, from 2006 into 2008, to diagnose a crisis and act to stop it, based partly on overconfidence that, in the economy, we had built an unstallable machine -- that the plane could, quite certainly, fly itself.

***

Air France 447 is deep in the ocean, and our economic malaise feels similarly unrecoverable. But there may be simple lessons to learn from these tragedies of expert overconfidence and strategic blindness.

"Today the Air France 447 transcripts yield information that may ensure that no airline pilot will ever again make the same mistakes," Jeff Wise writes at the conclusion of his story.

From now on, every airline pilot will no doubt think immediately of AF447 the instant a stall-warning alarm sounds at cruise altitude. Airlines around the world will change their training programs to enforce habits that might have saved the doomed airliner.

One hopes the lessons of 2006 will reverberate in the world economic community, as well. But you need only look at the debate over debt in the developed world to see that we have emerged from the Great Recession even more divided than we were going in. Across the Atlantic, the European economy is crashing. Its leaders are paralyzed by politics and uncertainty. The transcripts of the next crisis are being written as we speak.

This article available online at:

http://www.theatlantic.com/business/archive/2012/01/flying-blind-inside-the-federal-reserves-damning-2006-transcript/251361/