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Reverse auctions: a defense
The US is embarking on the greatest public intervention into financial markets since the Great Depression. The ultimate success or failure of the intervention will depend, in part, on the fine details of the auction design.
The basic auction approach suggested here is neither new nor untested. It has been used successfully in many countries in recent years to auction tens of billions of dollars in electricity and natural gas contracts, as detailed in Section 8. Moreover, it is quite similar to the approach that has been used to auction more than $100 billion in mobile telephone spectrum worldwide. It is a dynamic version of the approach that financial markets use for share repurchases. If implemented correctly, each auction can be completed in less than one day. And the same software used for implementing electricity and gas auctions could be used to initiate these auctions in October.
Here is the whole paper, thanks go to Samson in the comments section. So far this is the best paper I've seen on the topic. Tim Harford offers other useful links. Still, I am inclined to agree with Arnold Kling:
The theory that you can fix credit markets by "removing the clog" of mortgage securities is just that--a theory. My guess is that it will not work. I am sure that other things will have to be tried sooner or later--probably sooner. I hope the other moves work. I do not think it is at all realistic to rely on the Paulson plan.
Posted by Tyler Cowen on October 7, 2008 at 01:31 PM in Economics | Permalink
Comments
Tyler you might find it interesting to read Jason Busch's post on discussing reverse auctions with the Treasury Department last week. He also links to the the RFP they've released for custodial and auction services.
http://www.spendmatters.com/index.cfm/2008/10/6/Solving-the-Credit-Crisis-Treasurys-Fast-and-Subtle-Call-for-Sourcing-Providers
and the link for the RFP http://www.treas.gov/initiatives/eesa/docs/notice_custodian-services.pdf
Posted by: David Rotor at Oct 7, 2008 2:02:48 PM
I agree about Paulson Plan. The plan by a treasonous marxist has no chance of working in a capitalist society.
Posted by: A Stoner at Oct 7, 2008 2:17:06 PM
Doesn't another key point with an auction have to be that the opportunity is going away? Don't the banks have to feel that not all of the stuff will be bought so they really put some thought into their pricing? Have they shown they can put thought into pricing on any timeframe?
Does there come a point where 'we' say, each action didn't work, and at best they are inconsequential?
If so, how would we know when that point came?
We haven't had any banks go out of business in almost a week. Maybe Hank and Ben just need an 'atta boy and a breather.
Btw, from the great depression recapitulation department?
1924: Johnson-Reed Act passed, severely limiting immigration
http://news.yahoo.com/s/ap/20081007/ap_on_bi_ge/immigration_raid
Posted by: Andrew at Oct 7, 2008 2:23:15 PM
I can see two problems with the auction. One, it doesn't establish a rational market price, or two, it does.
Posted by: Andrew at Oct 7, 2008 3:02:56 PM
On a happier note, how did everyone celebrate the bailout?
I put another $1000 on my charge. After a wedding and other festivities, I'm going to have my house painted. All with consumer debt.
Posted by: aaron at Oct 7, 2008 3:21:46 PM
I think you're jumping to a conclusion about what's going to happen. Here's Bernanke today:
"It is unlikely that a single method will be used for acquiring assets; inevitably, some experimentation will be necessary to determine which approaches are most effective. Importantly, the legislation that created the TARP does provide sufficient flexibility to allow for different approaches to solving the problem--subject, of course, to the close oversight that will ensure that the program's funds are used in ways that are in the interest of taxpayers."
I know I'm reassured.
Posted by: Don the libertarian Democrat at Oct 7, 2008 4:30:27 PM
Has anyone ever studied the tendency of experts in a given field to exaggerate problems that pertain to their field?
I'm not saying that's necessarily happening here, although people have made similar arguments about climatological experts and global warming, and sometimes I just wonder.
Has the tendency ever been scientifically studied?
Posted by: mk at Oct 7, 2008 6:33:19 PM
Has anyone ever studied the tendency of experts in a given field to exaggerate problems that pertain to their field?
I'm not saying that's necessarily happening here, although people have made similar arguments about climatological experts and global warming, and sometimes I just wonder.
Has the tendency ever been scientifically studied?
Posted by: mk at Oct 7, 2008 6:34:54 PM
Doesn't a reverse auction require that all the participants have identical units for sale, so they are only competing on price?
Surely one bank's problem CDO is not identical to another's...
-dk
Posted by: Dick King at Oct 7, 2008 6:43:00 PM
I don't understand the logic of the Kling quote.
There are a lot of people claiming a lot of different things, but neither Kling nor anyone else I have read claims that the cause of the credit market anomalies we are seeing is anything other than uncertainty around counterparty exposure to toxic assets. Doesn't it follow that if one could wave a wand and transform all those toxic assets into solid, AAA, government-backed assets, that the credit market anomalies would go away?
One can certainly believe that we shouldn't wave such a wand, that the auctions that Paulson is planning on wielding as such a wand are impracticable, etc. But if Kling thinks the toxic securities aren't the problem, I'd be very interested to hear his radical, new theory of what is.
Posted by: David Wright at Oct 7, 2008 6:58:10 PM
I'm a complete novice here. And the fact that complete novices feel empowered to comment is probably a bad sign. Personally I feel like all of the experts have proven their incompetence and so why can't I have a turn?
Clearing out the toxic paper seems like an important step. But the fundamental issue keeping me out of the market (even more so than not having any real money to invest) is that the credit rating agencies have completely flushed their credibility. Who can I lend money to? How can I feel confident that it will be repaid?
The market is a confidence game, after all. Rating agencies seem to be the cornerstones of confidence. Nuke them from space (which is basically what they did by whoring themselves out like that) and what is left to base my confidence on?
Nothing.
Nothing at all.
That looks like round 2 of the bailout. A whole new credit rating system. How quickly can you whip that up for me, and make it believable?
Posted by: Randy at Oct 7, 2008 8:04:54 PM
mk: "Has anyone ever studied the tendency of experts in a given field to exaggerate problems that pertain to their field?"
suppose someone does study the tendency of experts in a given field to exaggerate the problems that pertain to their field so thoroughly that this person could be considered an expert in their field. then, how would you evaluate a conclusion that experts do in fact exaggerate problems?
Posted by: samson at Oct 7, 2008 11:26:23 PM
Another issue that has not been pointed is the role of the effective total amount of money destined to buy actives.
If the 700b equalled or exceeded the total of toxic actives then the banks would not have incentives to really compete in the auctions.
On the other hand, if that amount is effectively scarce, competition in the auctions is likely to reveal, apart from real value of toxic actives, relatively scarcity of liquidity, which will not be the same among all agents involved in the auctions. In this case, the plan will fail to reveal precisa information about the toxic actives, and what is needed to solve the confidence crisis is exactly that: information.
Posted by: Abel Fernandez at Oct 8, 2008 7:32:59 AM
