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Going Once. Going Twice.

When Congress finally sorts out what the financial bailout looks like, the government will still have to deal with its Goldilocks problem. It has to make sure it doesn't pay too much or too little for Wall Street's bad loans.

Ideally, the Fed wants to buy assets cheaply enough to make sure taxpayers get a good deal and even make money when markets stabilize. But it has to pay a high enough price to avoid causing banks unneeded pain.

Peter Cramton, an economics professor at University of Maryland, says the best way to do that is to hold what's known as a "reverse auction."

Through the process, the government would announce a target for how much of a particular security it is seeking to buy in dollar terms, and an initial buying price.

Sellers would indicate how much they would sell at that initial price, and if there were too many sellers, the government would lower its price until the amount of securities that banks are willing to sell equals the government's target.

The goal is to to drive purchase prices downward rather than up.

"I believe an auction is necessary," he said. "Its important taxpayers only pay what these securities are worth."

Cramton, who has set up auctions for governments globally, says the process would work well for types of securities held by multiple banks, but not as well for securities that are owned by just one or two institutions because there wouldn't be enough competition to ensure a fair price.

"I don't think it would be a problem, but there's a lot of money at stake. It's best to be as careful as possible," he said.



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The suggestion sounds like the government should play "Market Maker" - or "make a market" in these frozen mortgage backed securities. Since they've taken over Fannie & Freedie, it would seem to be the next logical step. For better or worse, that's what we get for the government backing part of the GSE equation.

Sent by D Rotzler | 8:44 PM | 9-22-2008

The troubled institutions should issue bonds that the government would buy in return for the interest and principal payments. The interest rate would draw others to buy the bonds and infuse liquidity into the financial market. This would be a more direct way of getting liquidity rather than the Treasury's complex way of determining the true value of the toxic securities.

Sent by Howard Thompson | 2:30 PM | 9-24-2008