Martin Wolf, Chief Economics Commentator for the Financial Times, posted an article back in August in which he examined the role of the Federal Reserve in saving both the economy and Wall Street. At that time Wolf described what he believed to be a market for lemons in the financial system that was being driven by “asymmetric information” mainly surrounding many of the structured products and associated derivative securities on the market. Buyers felt that sellers knew much more about the quality of the securities than the sellers did and the market then froze up.

 Wolf suggests that the solution with respect to Central Banks is merely “nothing”; Central Banks should stand by ready to provide liquidity and adjust interest rates but should not promote a market of lemons. In other words, Central Banks should avoid becoming a market maker of last resort at all costs. This would merely create a situation where Central Banks would be on the hook for securities they know nothing about – a clear violation of rational behavior. By refusing to act, sellers are then forced to turn their lemons into apples by being more transparent and reducing the asymmetric information in the marketplace. Put the onus on the marketplace to figure it out and let the Central Banks focus on preserving the health of the economy says Wolf.

 Nearly eight months have passed and while much has changed in the marketplace, there still exists a marketplace of lemons for many securities. Do to the complex nature of structured products and derivatives it is increasingly difficult for sellers to turn their lemons into apples.

 With respect to Wolf’s advice, the Federal Reserve has largely stuck to interest rate cuts as they try to restore confidence in the marketplace. However, on March 16 the Fed did exactly what Wolf warned not to do. In an effort to stop a market collapse, the Fed agreed to extend a line of credit in the amount of $30 billion to get the JP Morgan – Bear Stearns merger completed. However, the loan would be collateralized by $30 billion in these structured products in which the value of is still highly uncertain. While such emergency circumstances may have justified the extension of the loan, the damning precedent set by the Fed – that is, a market maker of last resort, is troublesome as it may serve to merely further postpone the inevitable “lemons-to-apples” transformation and extend the market for lemons in structured products.