Seeker Blog

I’ve seen a lot of commentary to the effect that “reverse auctions are a horrible idea, untested and won’t work in the “Paulson plan”. If you are troubled, you should read the Oct 5th paper “A Troubled Asset Reverse Auction” by Lawrence M. Ausubel and Peter Cramton. Here are excerpts from the concluding paragraphs:

8 Feasibility

While the previous sections may have convinced the reader that an effective auction design is provided, it remains to overcome the hurdle of showing that it can be implemented in a short time. Thus, the purpose of this section is to demonstrate that implementing the auctions so as to begin in October 2008 is fully feasible, without sacrificing any of the essential features of the design.

<snip> following are real-world examples of how to operate the auctions correctly.

9 Conclusion

The US is embarking on the greatest public intervention into financial markets since the Great Depression. The ultimate success or failure of the intervention will depend, in part, on the fine details of the auction design.

The basic auction approach suggested here is neither new nor untested. It has been used successfully in many countries in recent years to auction tens of billions of dollars in electricity and natural gas contracts, as detailed in Section 8. Moreover, it is quite similar to the approach that has been used to auction more than $100 billion in mobile telephone spectrum worldwide. It is a dynamic version of the approach that financial markets use for share repurchases. If implemented correctly, each auction can be completed in less than one day. And the same software used for implementing electricity and gas auctions could be used to initiate these auctions in October.

Thus, the auction approach meets the three main requirements of the rescue plan: 1) provide a quick and effective means for the Treasury to purchase troubled assets and increase liquidity; 2) protect the taxpayer by yielding prices that are closely related to value; and 3) offer a transparent rules-based process that minimizes discretion and favoritism.

I’m convinced that the reverse auctions will perform as described. And I speculate that Paulson & Bernanke are clever enough to appreciate that no “silver bullet” can be expected to “fix the problem”, so they will be required to continue innovating additional “fixes”. Such as recapitalization by direct equity investment, such as interjecting the Fed in the interbank lending stream to restore trust. These men are basing their strategy on some excellent work by some of the best and brightest.

The TED Spread continues into scary, uncharted territory — demonstrating, I think, that the central challenge is psychology: the loss of trust. We don’t know what combination of public AND PRIVATE actions will trigger restoration of trust — we just have to keep hammering until we get results. We do know that more and more shrewd buyers like Warren Buffett will be spurred to action by the Fed/Treasury innovations.

And I wish the idiot press would stop yammering about the “$700 bn bailout”, and instead explain what the Paulson plan really is.