Against Monopoly

defending the right to innovate

Monopoly corrupts. Absolute monopoly corrupts absolutely.

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Sandro Brusco on the Bailout

My friend and colleague Sandro Brusco posted the following on noiseFromAmerika.

I am reporting it here because, personally, I believe the repeated, desperate and everyday more damaging efforts by this administration, the previous, and the Federal Reserve to "save" the American banks in their current form and keep their executives and managers where they are, i.e. to preserve the status quo, is the worst case of monopolistic power being exercised on the American people in very many decades. We will pay this dearly, and for a long time, where "we", here, refers to the average guy consumer/taxpayer.

It is an insanely bad exercise in political monopoly power and economic monopoly power. Its aim is to keep a few thousands incompetent super-rich monopolists where they are, which where they should not be.


The new plan to rescue banks, as described by the New York Times, looks a lot like all the older plans. The basic idea seems to be always the same: overpay the toxic assets using taxpayers' money. I don't really have much to add to what Paul Krugman has already said on the subject in a couple of posts in his blog. The approach is, quite simply, nonsensical. The relevant quote from the NYT article is the following:

Risk-taking institutional investors, like hedge funds and private equity funds, have refused to pay more than about 30 cents on the dollar for many bundles of mortgages, even if most of the borrowers are still current. But banks holding those mortgages, not wanting to book huge losses on their holdings, have often refused to sell for less than 60 cents on the dollar.

The approach of this administration, and of the previous one as well, seems to be that the investors are unreasonably risk averse, or irrational, or whatever, and they should buy the toxic assets at a price closer to what the banks want. Otherwise, you see, the banks would have to ''book huge losses''. Why the market is not working is left unexplained. The solution is simply to fill the gap between the 30 and the 60 cents with a huge public subsidy.

We can only hope that this approach will fail, the same way that it failed when it was first proposed in the fall of 2008. Yes, of course, we do need some sort of intervention. The point has been made by many, and I find this exposition by fellow game theorist Sandeep Baliga very clear. But there are many different ways to intervene. In a previous post I have tried to explain how to set up a better mechanism for price discovery of the toxic assets. Other ideas have been floated. Bulow and Klemperer, for example, have suggested a clever variation on the good bank / bad bank approach. As a minimum, if the administration is really unwilling to consider new ideas (but why?), it should at least consider some variant of the Swedish approach: let the banks fail, take them over, recapitalize and then resell them.

The plan instead is to use public money to help the creditors (other than depositors, already covered by FDIC insurance) and the shareholders of the banks. No explanation is given of why private investors are so reluctant to buy the toxic assets. What if the investors are correct in their assessment and these assets are really worth no more than 30 cents on the dollar? Why should the taxpayers bear all the risk? And what if the money is not enough and we keep having zombie banks? The whole thing is almost too depressing to contemplate.


Having banks lend the money to purchase their own allegedly "underpriced" assets is an excellent idea. As Brusco says, banks won't price those assets as high if their own money is on the line. And if the government's payback is senior to theirs, they'll likely be even more realistic about the asking price.

Also, as Brusco points out, if the price paid for the assets is lower, more of them will be sold off for any given amount of money, which will resolve the problem sooner and with less risk to the taxpayer.

Why should the taxpayers bear all the risk? And what if the money is not enough and we keep having zombie banks? The whole thing is almost too depressing to contemplate. perfume animale

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