Abu Dhabi, UAEWednesday 22 January 2020

Can Yellen be the one to sort lemons from the cherries?

Janet Yellen would make a great Federal Reserve chief but the fact that we need her so badly and that markets so readily recognise this five years on from the collapse of Lehman is worrisome indeed.

Back in 2006, at the height of the US property boom, the street I lived on in Bedford-Stuyvesant, Brooklyn, seemed to magically transform into a luxury car dealer’s lot overnight.

One day it contained nothing but an Oldsmobile, a couple of Chrysler PT Cruisers and lots of Nissan and Toyota sedans. The Land Rover Discovery outside our smartly renovated brownstone was a personal point of pride and a sure sign that gentrification of our particular block was in full swing.

But then we were roundly trumped by a Mercedes coupé; not one but two Bentleys; multiple BMWs; a couple of Lincoln Navigators; and a bevy of lesser but equally smart SUVs.

Such an impressive display of automotive prowess might not be out of the ordinary on an Abu Dhabi street but in Brooklyn it either means all the drug dealers have relocated to the same block or everybody won the Powerball lottery.

It was neither.

What had instead happened was a mortgage broker had gone door-to-door selling refinance packages, equity lines of credit and other nefarious property-backed loans to those with a deed to a house and little else to their names.

It didn’t matter back then if you had no income to cover the monthly payments, or even the often-massive brokers’ fees.

The sales pitch – ludicrous though it was – foretold such enormous increases in house prices that the homeowner was assured he could meet the fees and repayments with the capital borrowed then refinance again or sell once the property value had increased by another couple of hundred thousand.

Of course, we know the result. Once everybody who was able had been sucked into this vortex of incredulity the global economy imploded.

In the microcosm of my street in Brooklyn, this seismic event played out at night. Every night, in fact, for about a month.

About six months after the cars all arrived we were woken – did I mention it was every night? – by the sound of car alarms going off, the rattle of chains, a grinding of gears, the beeping of a large vehicle moving in reverse and the Doppler of a departing truck.

This nocturnal symphony was the unmistakable soundtrack of the repo man, and he was pretty busy for much of the following two years, first with the cars and trucks, then with the houses. Then it was Lehman Brothers.

I was reminded of this most resonant of periods in economic history by a flurry of events that all occurred this week, starting on Sunday with the fifth anniversary of the Lehman bankruptcy, the largest in US history, now credited as the official start of the biggest global economic crisis ever known.

A day later and Larry Summers withdrew his hat from the ring of candidates to become the next chairman of the US Federal Reserve.

Almost at once bond yields on 10- year US Treasury notes plummeted, making borrowing cheaper all over the world. Stocks soared from Tokyo to Wall Street, risk was again back on the table in the global economy.

Mr Summers advocated a swift winding down of Fed support for the credit markets, which filled said markets with dread. The hope that inspired the rather unseemly rally that followed his demise hung on the likelihood that Janet Yellen, who favours a more lingering reduction in Fed support, will now get the nod.

Ms Yellen is the vice chair of the Fed and was a Fed governor under Alan Greenspan from 1994 to 1997. After that she was head of president Bill Clinton’s council of economic advisers for two years when she waded in to clean up the mess of the Asian financial crisis.

Her greatest achievement, though, was her co-authorship of The Market for Lemons, an economic paper published in 1970 that won her husband George Akerlof a Nobel Prize. The paper suggests that financial markets, like the used car market, are made up of lemons and cherries – the good and the bad.

When there are lots of lemons in the markets the cherries stay away and the market very quickly becomes bad, which is essentially what happened before the 2008 crash, when toxic mortgage- backed debt overwhelmed all other asset classes to dominate the investment landscape.

Ms Yellen was one of the small handful of economists to give warning on the housing market back then, and its creeping tendrils that were suffocating the life out of the global economy.

She would make a great Federal Reserve chief, but the fact that we need her so badly and that markets so readily recognise this five years on from the collapse of Lehman, and seven or eight years on from the top of the market largesse that briefly brought a few million dollars worth of cars to my Brooklyn block, is worrisome indeed.

It seems whoever becomes the next chairman of the Fed, there is still much to be done to assist the recovery of the global economy. And if that long sought-after goal is finally achieved, even more must be done to ensure we don’t get fooled again by the salesman hawking lemons door-to-door and keep our hands on the cherries.


Updated: September 18, 2013 04:00 AM