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Two economists we've been talking to took issue with Henry Paulson's announcement yesterday that he was giving up on Plan A, which was to buy up the mortgage backed securities that he once described as clogging up the financial system.

Larry Ausubel and Peter Cramton at the University of Maryland have a long history designing the kinds of auctions that might have been used to purchase them.

Cramton writes in an email that the auction would have been better than the current plan, which amounts to hand picking which banks live or die:

I view this as a bad outcome. Transparency is lost. Under the new plan, there is scope for a lot more discretion and favoritism. Further, the new plan does little to remove the toxic securities from the balance sheets of the banks. Nor does the new plan provide any price information to restore the secondary market for mortgage-related securities.

In contrast, the reverse auction approach, would use well-understood competition auctions to target the cash to where it is most needed, and at the same time reveal information to establish market prices. All this is done in a transparent competitive process, free of favoritism, thus restoring the secondary market for mortgage related securities.

The keys to success are transparency and competition. I see a lot more of both in the original reverse auction approach, than in the new plan.

Hear how a reverse auction would work.

categories: News

7:57 - November 13, 2008

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