When Janet Yellen became president of the Federal Reserve Bank of San Francisco in June 2004, a massive real estate bubble was building in the vast nine-state area that it oversees.
Her staff alerted her that banks were overinvesting in speculative commercial real estate at a time when housing prices in the region were ballooning. But as chief regulator in the Federal Reserve’s largest district, Yellen conveyed two starkly different messages.
In public remarks across the Western region’s nine states, she downplayed risks that were building in the financial sector, reporting positive economic signs even as warning signals began to emerge.
Behind the scenes at the Fed, she contends that she and her staff were "pleading with Washington" to issue supervisory guidance that would enable bank examiners to take a tougher line on risky real estate lending.
Yellen, who was nominated earlier in October to be the next chair of the U.S. central bank, played a little-examined role at the Fed in expressing unease about what she dubbed the "600-pound gorilla" – her reference at a Fed meeting in June 2007 to the real estate bubble and signs it could turn into a bust. When the bust came it led directly to the financial crisis.
The difference between her public remarks and internal Fed role could draw scrutiny when the Senate Banking Committee holds a hearing on her nomination in mid-November.
Yellen declined to comment for this article when contacted through the Fed.
She certainly had a front row seat on the real estate bubble. Yellen’s region included three of the four states hardest hit by foreclosures – Nevada, Arizona and California. The same states also led the nation in the percentage of consumer bankruptcies.
Eight banks supervised by her team failed, the second-highest number among the Fed’s 12 regional banks. A big culprit was unchecked investments in real estate, including speculative land development loans.
But Yellen confronted the limits of quietly leaning on Washington for corrective action. As she later told a panel probing the roots of the crisis, she felt one Fed action – an advisory opinion in 2007 that asked banks to control commercial real estate lending – was worthless. One could "rip it up and throw it in the garbage can," she said. "It wasn’t a tool that was of any use to us in controlling this risk."
Yellen, 67, has been credited with seeing signs of the crisis before many other Fed officials. When she landed the regional Fed job after teaching at the University of California, Berkeley, housing prices were climbing to alarming levels.
In Los Angeles and San Diego, home prices more than doubled between the beginning of 2000 and when Yellen took on the job in the summer of 2004, according to Standard & Poor’s/Case-Shiller index data. In Las Vegas, they jumped 50 percent in the previous year alone. And in San Francisco, prices had risen nearly 40 percent since the dot-com crash of 2000-2001.
The 54 banks under the San Francisco Fed’s supervision were leveraging too much of their capital in real estate, Yellen later observed.
The San Francisco Fed kept thick case files on the banks it supervised; she described reviewing a grocery cart full of records when she first came on the job. But regulatory policy was set by the central bank’s board in Washington, and the role of the regional Fed banks was to enforce it.
Yellen later told the financial crisis panel that in dealing with the Fed’s board, she privately urged clear guidance. "As worried as we were, we never simply went into banks and said, ‘We insist you’ve got to have a higher capital requirement.’ Did we have the power to do that? I think we felt we did not," she told the commission.
Stephen Hoffman, the officer in charge of bank supervision at the San Francisco Fed during Yellen’s tenure and now a managing director at consulting firm Promontory Financial Group, corroborated Yellen’s account.
"Was she going in and pounding on the table somewhere? No. But she was clearly making people aware that things were building and that there was a risk there, that if things went wrong there could have been significant challenges," he said.
The Fed did not issue an advisory to banks about commercial loans until January 2007 and it stopped short of a full-fledged order.
By then, recalled Bruce Norris, president of California real estate investment firm The Norris Group, some experts were questioning if regulators were asleep on the job. "Yellen had a lot of company," he told Reuters. "I just could never figure out why they weren’t more concerned until it was too late."
If a crisis was looming, Yellen gave little hint of it as she traveled around her district speaking to banking and business groups. She reassured audiences that there were nuanced but optimistic signs even as recession closed in.