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The Economists' Voice 2.0The Financial Crisis, Health Care Reform, and More$
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Joseph Stiglitz and Aaron Edlin

Print publication date: 2014

Print ISBN-13: 9780231160155

Published to Columbia Scholarship Online: November 2015

DOI: 10.7312/columbia/9780231160155.001.0001

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Auction Design Critical for Rescue Plan

Auction Design Critical for Rescue Plan

(p.154) Chapter 20 Auction Design Critical for Rescue Plan
The Economists' Voice 2.0

Lawrence M. Ausubel

Peter Cramton

Columbia University Press

This chapter assesses the Treasury’s proposal to invest $700 billion in mortgage-related securities to resolve the financial crisis, using market mechanisms such as reverse auctions to determine prices. While a well-designed auction process can indeed be an effective tool for acquiring distressed assets at minimum cost to the taxpayer, a simplistic process could lead to higher cost and fewer securities purchased. It is critical for the auction process to be designed carefully. The immediate crisis is one of illiquidity. Banks hold a variety of mortgage-backed securities, some almost worthless, while others retain considerable value. None can be sold, except at fire-sale prices. The Treasury proposes to restore liquidity by stepping in and purchasing these securities. But at what price? A better approach would be for the Treasury to conduct a separate auction for each security and limit itself to buying perhaps 50 percent of the aggregate face value. If the security clears at 30 cents on the dollar, this means that the holders value it at 30 cents on the dollar. The auction then works as intended. The price is reasonably close to value. The “winners” are the bidders who value the asset the least and value liquidity the most.

Keywords:   financial regulation, Treasury Department, mortgage-related securities, financial crisis, reverse auctions, liquidity

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