It took me longer than it should have done – and an informative conversation with a public-spirited economist – to reflect that Tim Geithner’s toxic asset purchase plan will not do anything to reveal realistic prices of toxic assets. Leave aside the possibility of collusion, or the certainty that banks will offload only the worst possible assets ig the auction rules allow it.
Rather, the basic objection is very simple. With the Treasury taking most of the downside risk, bidders have an incentive to overpay. After all, would you play roulette if I offered to make good 90 per cent of any losses? What would your poker strategy be if you kept half your winnings but I bankrolled most of any losses? There seems to be little point in this auction; if this is the best the Treasury can do to promote price discovery I think we need to consider entirely different approaches. It not that I’m complaining about the subsidy – although that is always galling – but that the subsidy comes in a form that undermines the whole point of the auction.
(Jeff Sachs covered some of this ground in an op-ed yesterday that did not appear in the UK print edition of the FT.)
Update: One would expect the banks selling toxic assets to receive most of the subsidy, although if the auction is not competitive, bidding institutions will also scoop some.