Study Suggests Buying Toxic Assets Could Work Purchasing toxic assets from banks is still the fairest way to save the American economy, say two University of Maryland economics professors. To prove it, they had a group of graduate students take part in what's known as a reverse auction.
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Study Suggests Buying Toxic Assets Could Work

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Study Suggests Buying Toxic Assets Could Work

Study Suggests Buying Toxic Assets Could Work

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ROBERT SIEGEL, host:

Many economists say the Treasury was right to change course from buying up toxic mortgage-backed securities to investing directly in banks. But Paulson's original plan still has its staunch defenders, as NPR's David Kestenbaum reports.

DAVID KESTENBAUM: When Henry Paulson announced that original plan to buy up the toxic securities, two economists at the University of Maryland, Larry Ausubel and Peter Cramton, got very excited. They knew just how to do it. Something called a reverse auction. They'd run these auctions before on large scales, and they were working on a plan with the folks at the Treasury Department. Then the decision came to change course. Larry Ausubel was not happy.

Professor LARRY AUSUBEL (Economics, University of Maryland): Instead of conducting transparent auctions, the Treasury is going to instead distribute suitcases of cash.

KESTENBAUM: Ausubel and Cramton have not given up hope. There is, after all, a new administration coming in. Ausubel and Cramton still think plan A was the way to go, and last month they did a dry run of an auction. Instead of banks, they used graduate students. They sat in what looked like a boardroom, with a long table, forest-green leather chairs, wood paneling. Cramton went over the rules.

Professor PETER CRAMTON (Economics, University of Maryland): What we're going to do is go over the instructions, which I just emailed to you about an hour before you arrived, so you probably haven't...

KESTENBAUM: Each student would play the role of a bank that owned toxic mortgage-backed securities. Their goal would be to sell those toxic assets to the government and to get as much money for them as possible. The government hoped the auction would set a fair price, so taxpayers wouldn't get a raw deal. And I was surprised to learn there would be real money at stake, not $700 billion, but real money. Andy Stocking(ph), a student, told me if they played well, they could earn something like $800.

Oh, it's 800 for each?

Mr. ANDY STOCKING (Student, University of Maryland): It's 800 for each person.

KESTENBAUM: Oh, and there are how many participants?

Mr. STOCKING: Sixteen.

KESTENBAUM: Oh, do the math for me.

Mr. STOCKING: It's 16,000 - it's $14,000? Don't put that on the radio because...

(Soundbite of laughter)

Mr. STOCKING: All your people are going to respond, he's an idiot. Why is he running this auction?

KESTENBAUM: Our math was a bit off. It's about $13,000 total, $100 per student, per day, depending on how well they do. The students sat down at computers. Larry Ausubel explained that the software was the real deal. They'd used it in actual auctions.

Professor AUSUBEL: I think this year it has been used for approximately $5 billion worth of auctions - electricity, natural gas, and some rough diamonds.

KESTENBAUM: In this auction, the banks try to sell their toxic stuff to the government by bidding. They compete. One might offer to sell a mortgage-backed security for 60 cents. Another might say, wait, buy mine. I'll sell it to you for 55. It's a reverse auction because the bidding drives prices down. The students were given information about their bank's finances, and they talked about strategy. Pretty quickly, some of them were looking over at their neighbors' computer screens. Like this woman, Kahwa Douoguih.

Ms. KAHWA DOUOGUIH (Student, University of Maryland): We're actually talking about colluding right now. We're trying to, you know, base our strategy on that extra information.

KESTENBAUM: You're trying to cheat?

Ms. DOUOGUIH: Well, we're just seeing how easy, or not, it is.

KESTENBAUM: This was all part of the experiment. If the students could find a way to game the system, so would the banks in the real world. If the students found a hole, or if the auction didn't work as designed, this could turn out to be a very expensive experiment for the university. It might have to pay the students way more than that $13,000. I called Peter Cramton up to see how the experiment had gone.

Professor CRAMTON: I got it right here on my computer. We also had expenses for coffee and bagels, snacks, and other things like that. But the subject's expense alone was $12,855.03.

KESTENBAUM: Very close to the estimated $13,000. No one found a way to cheat, and the auction was a success. The banks that most needed to get rid of their mortgage-backed securities, so they could have cash on hand, did. And the taxpayers did not get ripped off. Cramton thinks the auction is the fairest way to distribute the bailout money. Under the current plan, the government is buying stocks in banks, but it's deciding which banks secretly.

Professor CRAMTON: And it really is moving down the path of crony capitalism, in my mind, where the government is picking winners and losers in a nontransparent way. And furthermore, the new plan does little to remove the toxic securities from the balance sheets of the bank, which is the basic problem.

KESTENBAUM: The Treasury Department's hope is that by shoring up the banks it won't matter that they're holding toxic securities on their books. Treasury Secretary Henry Paulson told NPR last week that buying up the securities would take too long and that he'd need more than the $700 billion to buy up enough of them. David Kestenbaum, NPR News.

SIEGEL: From reverse auctions to credit default swaps, you can find it all on our Planet Money page at npr.org/money.

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