Complicated Reverse Auction May Aid In Bailout
STEVE INSKEEP, host:
There's a big question hanging over the government's financial rescue plan. It's the same question that tripped up financial firms in the first place. The government wants to buy those toxic mortgage-backed securities and take them off everybody's hands, but it doesn't know how much to pay for them. If the government pays too much, those are your tax dollars being lost. If the government pays too little, it may not help the banks that it's trying to save. Federal Reserve Chairman Ben Bernanke has talked about using a kind of auction to find fair prices and we have more from NPR's David Kestenbaum.
DAVID KESTENBAUM: When Peter Cramton opened the newspaper a couple of weeks ago, he saw two words he was familiar with but you just never see in the newspaper, reverse auction.
Dr. PETER CRAMTON (Professor, Economics, University of Maryland): Yeah, my initial reaction was, how can that work? This seems strange.
KESTENBAUM: Cramton is one of the world's experts in designing complicated auctions. So is his colleague down the hall at the University of Maryland. They designed an auction the French use to buy something like 10 percent of their electricity, but that's small potatoes.
Dr. CRAMTON: This would be the largest auction ever that anybody has been involved in on the planet Earth.
KESTENBAUM: And they think they have come up with a plan that will work. On paper, it's about 21 pages long. So let's back up a bit. A reverse auction is like a normal auction, but as you might have guessed, it's sort of backward. It's perfect for the situation the government finds itself in, one buyer and a lot of people selling. Say a lot of people have bought a couch from IKEA that they want to sell. In a reverse auction, you don't bid on their couches, you say, hey, I want to buy a couch, then let them bid. I'll sell you mine for a hundred bucks, one guy says. Hey, I'll sell you mine for 90. If someone is really desperate and needs the cash, maybe someone offers to give you his couch for 30 bucks, so you, the buyer, get a good deal. Here, the government wants to buy not a couch but mortgage-backed securities and that makes things a lot more complicated. For starters, with the couch, you know about what a couch is worth. Not so with the mortgage backed securities.
Dr. LARRY AUSUBEL (Professor, Economics, University of Maryland): You're dealing with a basic situation of asymmetric information.
KESTENBAUM: This is Larry Ausubel, Cramton's collaborator down the hall.
Dr. AUSUBEL: What that means is that the people who own the mortgage backed securities know what they're really worth, or at least have a better idea of what they're worth than the government, which has very little idea at all.
KESTENBAUM: That's the inherent danger here, right?
Dr. AUSUBEL: Exactly.
KESTENBAUM: And another thing. Couches are pretty similar, but there are thousands of different kinds of mortgage backed securities and they're infinitely more complicated than couches. So getting all the details right, secret bids, open bids, how many auctions there will be, all these things are really, really important.
Dr. AUSUBEL: Whether you execute this program well or whether you execute this program badly could affect the number of zeros at the end of the taxpayer's loss.
KESTENBAUM: There's another challenge these guys are up against, and this is a big one. They don't actually want the auction to work too well. You don't want the lowest price for the couch. If the government pays what are called fire-sale prices for the mortgage-backed securities, Cramton says that's bad for the banks.
Dr. CRAMTON: If the price was too low then the banks would collapse and we would still have a mess.
KESTENBAUM: They've tried to set things up so the auction settles on a price that is sort of the consensus for what the mortgage-backed securities are worth. I spent over two hours with Cramton and Ausubel going over their plan and they explained at length why they believe the auction they've designed will minimize these problems. They've designed lots of these before, they say they've gone fine, and their mortgage plan has been getting a lot of attention.
Dr. CRAMTON: We've been talking to the government, yes.
KESTENBAUM: A lot?
Dr. CRAMTON: A fair amount in this last week.
KESTENBAUM: Do you think this is what they're going to use?
Dr. CRAMTON: I don't want to make any predictions today.
KESTENBAUM: Not everyone is convinced an auction will be so easy. Charles Calomiris, an economist at Columbia University, says when you start to think things through, it all gets very complicated.
Dr. CHARLES CALOMIRIS (Professor, Columbia Business School; Co-director, Financial Deregulation Project, American Enterprise Institute): It just strikes me that this is fraught with difficulties having to do with the thinness of these markets, the strategic elements in the bidding, and the fact that we don't even have a concept of what price it is we want to buy them out. We know we don't want to buy at fire sale. We want to buy at something above it. Well, how much above it?
KESTENBAUM: I reached Calomiris in Tanzania, where he's traveling. He had another phone call scheduled after mine. He said it happened to be to Larry Ausubel, the auction designer at the University of Maryland.
Dr. CALOMIRIS: Look, I mean, there's no ego involved in this at all. If Larry can convince me that he's got the right mechanism, that's great.
KESTENBAUM: Calomiris told me later they actually agree on a lot of things, but he wishes the government had taken a different approach, one that didn't get us into this whole mess of trying to figure out what these mortgage backed securities are worth. David Kestenbaum, NPR News.