- The borrowers really can't (or won't) pay them back
- There is not enough liquidity so the banks can't sell them
- There is a "lemon" discount based on asymmetric information
- Buyers or sellers of the assets are somehow irrational
Wednesday, 25 March 2009
I promised more on the lemons discussion but Sandro Brusco has gone into more depth in this posting than I could have done in the time I had available yesterday.
There's some way to go in analysing this, but Brusco has a couple of important points:
The first is that the problem will only be solved by revealing information. He suggests doing this by requiring managers to make a personal investment in the assets, so they have an incentive to get the valuation right. As an alternative, I would consider simply publishing the detail of the assets so that third parties can look at what they consist of and make their own determination of value. Depending on the level of detail, this may raise privacy concerns for the original mortgage borrowers, so it won't be possible to publish absolutely everything. But I'm sure a lot could be released.
The second is that the banking system can't function normally until this information is revealed, so it's critical to get it done soon. This is why the Geithner plan may be so powerful in the end - because it forces assets to be valued, probably quicker even than in a nationalisation scenario. Uncertainty is a big killer of economic activity - in an environment where credit and insurance is not fully available, it imposes a deadweight loss. In the current situation the loss is big.
I am still going to try and work out a mechanism for determining the different components of discount on the lemon assets: