12 Oct 2008

Vernon Smith Calls Bailout Scheme "Ridiculous"

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Here at Free Advice, we have been rather skeptical of the Paulson Plan, to say the least. In addition to its naked theft of $700 billion (at least) from taxpayers, the plan makes no sense economically. I.e. we are paying hundreds of billions for the government to kick the economy while it’s down.

To add fuel to the fire, in a recent WSJ op ed Nobel laureate Vernon Smith explained that the Treasury’s plan to buy up “toxic” debt is silly. Smith is quite literally one of the top 5 world experts on auctions and public policy.

The Senate spelled it out more clearly: “troubled assets are not limited to mortgage related assets but could include auto loans, credit card debt, student loans or any other paper related to commercial loans.”

“Any other paper?” Heaven help us! …

Auction designers should immediately note that we are talking about a market with one buyer and many sellers of a hodge-podge of items. The mechanism that will be used is a “reverse auction” — with sellers competitively submitting asking prices to sell Treasury a heterogeneous mix of good, some sour, apples and oranges whose content is better known to sellers than the Treasury.

Treasury expertise is in auctioning Treasury securities of a given maturity to multiple competing buyers: say $10 billion worth of six-month bills, or two-year notes. In either case every bill (or note) is identical to every other one. The only uncertainty is the final clearing price and Treasury is assured that it will get the best price.

Treasury has no expertise in this ridiculous new venture.

I note with some irony that although Smith is nobody’s fool when it comes to auctions, apparently he’s not good at market timing. When googling to find the above article, I came across a WSJ piece from May 23, 2007 that began like this: Vernon Smith, a Nobel laureate economist, is so bullish on stocks that he’s put money in small drug companies — investments he “wouldn’t have touched in the late 1990s,” he says.

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