Spero Consulting

Posts Tagged ‘illiquidity’

There are two related essays in the edi­to­r­ial sec­tion of today’s (March 30) edi­tion of The Wall Street Jour­nal regard­ing gov­ern­ment over­sight and reg­u­la­tion that are worth men­tion­ing: Wel­come, Busi­ness­men, to Gov­ern­ment Over­sight and Trans­parency Is More Pow­er­ful Than Reg­u­la­tion. We’ll men­tion the suf­fo­cat­ing nature of reg­u­la­tions and then dis­cuss the more inter­est­ing topic last, includ­ing our own work of using XML-​based sys­tems and tags for (inter­nal) man­age­ment infor­ma­tion sys­tems, which relates to the dis­cus­sion of XBRL sys­tems in the sec­ond column.

Suf­fo­cat­ing Reg­u­la­tions and Bureaucracy

Is there any other kind? Well, yes. As we see it, reg­u­la­tion is either suf­fo­cat­ing or inef­fec­tive, and the for­mer often has a crush­ing feel about it. Like mod­ern dig­i­tal tele­vi­sion sets, gov­ern­ment reg­u­la­tors seem to have no “fine-​tuning” dial; it’s gen­er­ally one extreme or the other: either there’s “NO EXCEPTIONS” or “it’s all good, do what you want.”

Vic­to­ria Toens­ing dis­cusses that over­bear­ing weight of the gov­ern­ment in Wel­come, Busi­ness­men, to Gov­ern­ment Over­sight in which she high­lights, among other indig­ni­ties, the silli­ness of gov­ern­ment offices unable to accept small gifts like cherry pies. Our guess is that she has spent most of her life in pub­lic ser­vice and doesn’t appre­ci­ate how sim­i­larly bureau­cratic large cor­po­ra­tions can be, but that’s besides the point because much – although not all – of that cor­po­rate bureau­cracy is induced by gov­ern­ment regulation.

We’ve dis­cussed both neg­a­tive aspects of reg­u­la­tion in numer­ous posts although we tend to high­light inef­fec­tive­ness because it has been very obvi­ous in the cur­rent finan­cial cri­sis and the mort­gage débâ­cle that pre­ceded (and which con­tin­ues to coin­cide with) it. For exam­ple, on Sat­ur­day we wrote The Cure is Worse than the Dis­ease, which crit­i­cizes Mr. Geithner’s pro­posed finan­cial sys­tem reg­u­la­tions.¹ We fear the suf­fo­ca­tion to come.

Gen­er­ally, we favor decen­tral­ized gov­ern­ment and much pre­fer decen­tral­ized work­ing envi­ron­ments, i.e, light reg­u­la­tion with the polic­ing authority’s option to crush, i.e., heav­ily penal­ize for indis­cre­tions. We take that from the Bible and the Para­ble of the Good (and Bad) Ser­vants, which cov­ers both moral haz­ard and igno­rance, and that’s why we’re strong pro­po­nents of nation­al­iz­ing the weak­est of the large banks. (Not because we think the gov­ern­ment will man­age them bet­ter but because we think share­hold­ers and cur­rent man­age­ments have for­saken the right to con­trol those assets.)

Suf­fo­cat­ing reg­u­la­tions and bureau­cracy usu­ally pro­vide no ben­e­fit to soci­ety and are inhu­mane and demean­ing. If “effec­tive,” they usu­ally end up killing the thing they are try­ing to pro­tect. (Nation­al­ized health-​care any­one?) In short, that’s why we’re against Mr. Geithner’s plan.

Trans­parency Anyone?

The other col­umn worth men­tion­ing is L. Gor­don Crovitz’s Trans­parency Is More Pow­er­ful Than Reg­u­la­tion in which he focuses his atten­tion on a sub­sti­tute for exten­sive reg­u­la­tory over­sight: more report­ing trans­parency. For sup­port of his posi­tion, he men­tions for­mer Supreme Court Jus­tice Louis Brandeis’s point that “sun­light is the best dis­in­fec­tant,” which we often cite, but is irrel­e­vant here.

While we tend to agree with many of his points, we think, that in the end, Mr. Crovitz draws the wrong con­clu­sions because (1) in gen­eral, in social set­tings more trans­parency isn’t nec­es­sar­ily bet­ter (doesn’t nec­es­sar­ily improve social wel­fare and can decrease it), and (2) in the spe­cial case of secu­ri­ti­za­tions of pooled assets, addi­tional trans­parency won’t solve the prob­lem of flawed pric­ing mod­els because the mod­els’ own­ers have lost con­fi­dence in them.

Is More Infor­ma­tion Always Better?

It depends. In sin­gle per­son games – i.e., nat­ural sci­ence exper­i­ments and games against nature, more infor­ma­tion is bet­ter. Roughly, that means it leads to higher expected sat­is­fac­tion for the par­tic­i­pant.² Clearly, record-​keeping is nec­es­sary for sev­eral rea­sons, but often those records don’t nec­es­sar­ily pro­vide mar­ginal ben­e­fit for decision-​makers in all deci­sions, i.e., the records might not iden­tify addi­tional rel­e­vant or dif­fer­en­tial costs or ben­e­fits among the pos­si­ble alter­na­tives for the deci­sion. Alter­na­tively, because they are not per­fectly ratio­nal, decision-​makers may not be able to cat­e­go­rize and syn­the­size or relate the new infor­ma­tion that is present, or they might mis­use it.

In a seem­ing con­tra­dic­tion to that view, last week, in Sep­a­rat­ing the Mort­gage Débâ­cle from the Liq­uid­ity Cri­sis, we agreed with Her­nando de Soto’s rec­om­men­da­tion that more details about con­tin­gent claims and secu­ri­ti­za­tion con­tracts should be made pub­lic, and Mr. Crovitz explains how this is tech­ni­cally fea­si­ble through the XBRL initiative.

As we see it, such details are infor­ma­tive about cer­tain aspects of the con­tracts, but not what Mr. Crovitz thinks. For exam­ple, it might help cred­i­tors bet­ter under­stand par­tic­u­larly low out­comes asso­ci­ated with cer­tain secu­ri­ties; so, we think that the details are worth report­ing, BUT the addi­tional details may not help with pric­ing claims on the pooled assets. Thus, we don’t see how trans­parency will induce liq­uid­ity. In fact, mar­kets often fail because there is “too much” trans­parency to sus­tain trans­ac­tions, i.e., no one wants the clearly-​identifiable crap – the lemons.

As we’ve writ­ten in the past, one of the prob­lems with these pric­ing mod­els for pooled assets is that their own­ers have lost con­fi­dence in them. They’ve lost con­fi­dence because they view the mod­els as no longer applic­a­ble, and they view them as no longer applic­a­ble because they have failed empirically.

They failed because they did not cap­ture the rela­tion­ships and inter-​relations among the assets, par­tic­u­larly among res­i­den­tial mort­gages. (In other words, the traders and ana­lysts vastly under-​estimated the joint depen­den­cies among cash flows and col­lat­eral val­ues, which those folks may express as hav­ing a poor esti­mate of the cor­re­la­tions, but which is likely more com­pli­cated and far less cal­cu­la­ble than that.) We’ve writ­ten about that on sev­eral occa­sions, includ­ing here: Trad­ing, Incen­tives, Orga­ni­za­tional Struc­ture and Risk Man­age­ment, where we explain it as a con­ta­gion. (We also dis­cuss it in Well, This Is a Fine Mess You’ve Got­ten Us into…. along with other still per­ti­nent issues.)

The prob­lem is that there are few math­e­mat­i­cally tractable ways to spec­ify how these assets are related; so, solv­able – but non­de­scrip­tive and mis­spec­i­fied – meth­ods were employed. In sta­ble times and with a bit of good luck, that mis­spec­i­fi­ca­tion didn’t seem to mat­ter. Unfor­tu­nately, luck changed, and did and it does now.

So, we don’t see how trans­parency will induce trad­ing, but that doesn’t mean that trad­ing can­not occur. (Mr. Crovitz has a good solu­tion, but to a dif­fer­ent prob­lem, i.e., Mr. de Soto’s problem.)

Our Solu­tion

Since Sep­tem­ber we’ve rec­om­mended changes in tax poli­cies – via mort­gage invest­ment tax cred­its or imme­di­ate write-​offs of pur­chase prices – as a way to induce trade and cre­ate liq­uid­ity in these secu­rity mar­kets. Pro­vid­ing a 30 – 40% cush­ion in the pur­chase price, will induce trad­ing even if buy­ers aren’t com­pletely con­fi­dent of their cal­cu­la­tions. Imag­ine if the same tax incen­tives were avail­able to new car buy­ers? (See “The Good Cop” sec­tion of Poor Mr. Gei­th­ner: No For­est, No Trees, Just Lost for a recent overview of our plan.)

What Does This Have to Do with MIS?

The same types of sys­tem that XBRL is based upon are avail­able very cheaply for inter­nal decision-​makers. We’re design­ing and imple­ment­ing sim­i­lar robust, tagged sys­tems for our clients. They are eas­ily search­able sys­tems – both infor­mally (ad hoc) and for­mally (rou­tine reports); they’re easy to update and edit; they’re secure; and they’re rel­a­tively inex­pen­sive. The ben­e­fits of tech­nol­ogy can now be real­ized by any size firm or orga­ni­za­tion. Con­tact us for more information.

As always, we might update this post after we re-​read it.

Copy­right © 2009 Spero Consulting.

Foot­notes:

Our site’s sta­tis­tics pro­gram keeps track of the search terms used to arrive at our hum­ble lit­tle venue, and this morn­ing we noticed a hit from the query, “How to trade CMBS?”

That, as they say, struck us kind of funny. 

We thought: given the ongo­ing and (we would guess) accel­er­at­ing prob­lems in com­mer­cial real-​estate such a ques­tion could come from either (1) some­one com­pletely unfa­mil­iar with Com­mer­cial Mortgage-​Backed Secu­ri­ties or (2) some­one com­pletely, deeply, and des­per­ately immersed in the indus­try. (As a last-​ditch effort for mar­ket­ing help.)

In that way, we’d imag­ine that on a daily basis any num­ber of commercial-​loan con­duit man­agers, bankers, struc­tur­ers, traders, and CMBS investors all pon­der the same question: how to trade CMBS? That, after all, is a defin­ing char­ac­ter­is­tic of an illiq­uid or frozen mar­ket. Ouch.

If you’re inter­ested in the nature of CMBS, the top post here is a good place to start.

We’ve dis­cussed Com­mer­cial Mortgage-​Backed Secu­ri­ties or CMBS in a num­ber of posts. So, it’s worth men­tion­ing that spreads on AAA CMBX (CDS) increased sub­stan­tially on Tues­day. At about 550 basis points, those spreads seem to be twice as high as the pre­vi­ous all-​time high, which was reached in the late win­ter of this year, and are seven or eight times higher than on Jan­u­ary 1.

It’s much harder to say where spreads on CMBS (bonds) are since they tend not to trade. His­tor­i­cally, they didn’t trade much, and now it is even less fre­quent. In fact, in June, we had a long post, On Nedges and Sledges and Paving the Road to Hell, on the dif­fi­cul­ties of using CMBX to hedge expo­sure to CMBS. As that post men­tioned, the now-​defunct Lehman Broth­ers was one of the firms hav­ing dif­fi­culty with things that were Some­what Like Hedges.

If the reader is unsure of the notion of CMBS, know that CMBS is very much like any other mortgage-​backed secu­rity, except: (1) the num­ber of loans in the col­lat­eral pool is smaller; (2) the dol­lar value per loan is sub­stan­tially greater (into the hun­dreds of mil­lions of dol­lar); (3) the bor­row­ers tend to be much more sophis­ti­cated and have bet­ter legal rep­re­sen­ta­tion; and (4) in our opin­ion, there is more sys­tem­atic risk, which mean less diver­si­fi­ca­tion and higher lev­els of default dur­ing eco­nomic downturns.

Like almost every­one else, we’re not sure how the loss given defaults would dif­fer res­i­den­tial mort­gages, but we doubt that it would be favor­able for com­mer­cial real estate. (By the way, read­ers look­ing for an illus­tra­tion of basic MBS should see the last part of Gos­samery Argu­ments for Trans­parency and Our Reply, in which we describe it in the sim­ple terms of a spreadsheet.)

We ask: what are the odds that the hous­ing mar­ket could crash in many parts of the coun­try, res­i­den­tial mort­gages defaults would rise, the econ­omy would seem­ingly slow down, unem­ploy­ment would increase, and the stock mar­ket would decrease sub­stan­tially AND com­mer­cial real estate would not suf­fer? Yeah, when stated pre­cisely, it seems like a silly ques­tion doesn’t it. 

So, with CMBS, we’d guess that the really bad times are just beginning.

In fact, we’d spec­u­late that pro­por­tion­ally – given the dif­fer­ent sizes of the mar­kets – the bad times may be sub­stan­tially worse for com­mer­cial mort­gages than for res­i­den­tial mortgages.

For exam­ple, in CMBS Mar­ket Begins to Show Fis­sures, two writ­ers for The Wall Street Jour­nal, describe two large –$209 mil­lion and $125 mil­lion – and recent (Decem­ber, 2007 and July, 2007, respec­tively) mort­gages that are close to default and men­tion that news was the impe­tus for spreads to increase on Tuesday.

Of course, we wouldn’t be a pedant if we didn’t men­tion that sev­eral of the fac­tors men­tioned above were start­ing to be present in July, 2007, and were cer­tainly evi­dent by Decem­ber, 2007, when those two loans were made.

In that respect, and given the ongo­ing col­lapse of the CMBS new issues mar­ket, we won­der how many other bad com­mer­cial real-​estate loans cur­rently sit in banks’ con­duits. As we under­stand it, the mar­ket for new issues has been dead for quite awhile; so, many pipelines likely con­tain similarly-​aged mort­gages (that never went into CMBS pools) and now sit in the nether world of loans avail­able for sale (although no one wants to buy them). (Kind of like pur­ga­tory, but with­out hope of heaven. In this case, inside the gates of hell.)

If J.P. Mor­gan, the orig­i­na­tor of those two loans, or other large play­ers made sim­i­lar loans in expec­ta­tion of con­tin­ued good times or a quick rebound, then one should expect larger loan-​loss reserves within the next six months or so.

In fact, (1) ithout prior large and pub­lic defaults and (2) given the mag­ni­tude of losses that many banks have incurred in their other port­fo­lios and (3) given the illiq­uid nature of the com­mer­cial mort­gage mar­ket that leads to a lack of “marks,” it seems highly unlikely that banks have already aggres­sively written-​down the value of their CMBS or their inven­tory of com­mer­cial mort­gage loans. 

In that case, one could infer that they – the banks (and their conduits) – were bet­ting that mar­kets would return to nor­mal. Unfor­tu­nately, if that was the bet, and if the above-​mentioned defaults are fol­lowed by oth­ers so spread lev­els stay high, then those banks will be forced to rec­og­nize addi­tional losses at the end the fourth quar­ter and into next year. 

We’d hate to be sit­ting on a large pile of recent, unse­cu­ri­tized, com­mer­cial mort­gages. It’s likely that they’re com­post­ing. While that might improve the prospect of growth in the future, it prob­a­bly stinks now.

Or – to seri­ously mix our metaphors – falling head-​over-​heels for the wolves’ claims that the “sky is falling.”

Our favorite line from the play and movie, A Man for All Sea­sons, is Saint Thomas More’s state­ment at his trial in which he gen­tly belit­tles one of his per­jur­ing accusers, Richie Rich:

“Why Richard, it prof­its a man noth­ing to give his soul for the whole world…Ahh, but for Wales?”

Mr. Rich received an appoint­ment from Henry VIII in Wales for his efforts.

After per­form­ing a short and cur­sory search of the web, we’re not sure – and it seems that no one else is, either – as to whether the mar­tyred Saint actu­ally made that statement, or whether it is an apoc­ryphally placed by the play­wright, Robert Bolt.

Nonethe­less, it so beau­ti­fully expresses the wry, amused, and con­sid­ered insight of a thought­ful, yet con­demned, man, who by quot­ing scrip­ture (Mark, 8:36), makes clears Rich’s Faus­t­ian bar­gain, and for what?

The Scared: We have been reminded of that 16^th cen­tury, court­room scene sev­eral times dur­ing the past sev­eral weeks, includ­ing today when we read Kim Strassel’s poorly-​reasoned, col­umn on in today’s WSJ, What Lead­er­ship Looks Like, and yes­ter­day, when we read The Wall Street Jour­nal’s edi­to­r­ial, enti­tled, “Free AIG.”

Yes­ter­day, the Journal’s the edi­to­r­ial staff seemed to regain – at least tem­porar­ily – their free-​market prin­ci­ples long enough to crit­i­cize the Fed­eral Reserve’s seizure of AIG in mid-​September. Unfor­tu­nately, the edi­tors have failed to take that same logic and apply it to the larger finan­cial cri­sis, as does Ms. Strassel and her subject, Congressman Paul Ryan.

Indeed, while claim­ing to be for “free mar­kets and free peo­ple,” they seemed awfully will­ing to for­sake it for a smidgen of a promise of secu­rity and stability.

Reg­u­lar read­ers know that we’re morally opposed to the plan for sev­eral rea­sons, includ­ing that trade-​off of free­dom for secu­rity and our doubts that it is nec­es­sary despite the many, many pleas of exi­gent cir­cum­stances, falling skies, and wolves.

Furthermore, as we have writ­ten exten­sively dur­ing the past two weeks, we believe that there are harm­ful imme­di­ate and long-​term impli­ca­tions of the bailout and that it will fail.

So, the promised secu­rity and sta­bil­ity will be illu­sory – a mirage, per­haps – as all such promises have been since at least the takeover of Bear Stearns in the early Spring. See any of these recent posts: The Finan­cial Bailout, Reverse Auc­tions and Mark­ing to “Mar­ket”; Moral Haz­ard and Another Prob­lem with Illiq­uid Assets; If ‘If’s and ‘But’s Were Candy and Nuts…(#2); Big­ger Is Not Nec­es­sar­ily Bet­ter; OMG! OMG! OMG! Largest US Bank Fail­ure Ever!; The Cri­sis and Free Mar­ket Crit­ics; The Uncer­tain Value of Mort­gage Secu­ri­ties; Sorry Mr. Bush, We Respect­fully Dis­agree; Could a “Bailout” Pro­long the Finan­cial Cri­sis?; Idio­syn­cratic and Con­cen­tra­tion Risk, Again.; and Pub­lic Bailout? Why Rush or Do It at All?. (Actu­ally most every­thing we’ve writ­ten dur­ing the past two weeks.)

In that regard, we have pro­posed our own privately-​oriented, market-​based plan, A Bet­ter Solu­tion (than a gov­ern­ment takeover), that requires only a few small changes in the tax laws to imple­ment. It is sim­i­lar to allow­ing accel­er­ated – well, imme­di­ate – depre­ci­a­tion of the cost or an invest­ment tax credit to the prospec­tive pur­chasers of cer­tain mort­gages and MBS and CDS issues. (Note: the cur­rent bill pro­vides invest­ment tax cred­its for risky R&D but not risky mort­gages. Does that make any sense?)

The Scary: in addi­tion, we ask the dear reader to con­sider this: if the cur­rent plan fails to alle­vi­ate the pan­ics, can he or she imag­ine how far the gov­ern­ment will fur­ther over­step its author­ity to solve what will then be a pro­longed cri­sis REQUIRING addi­tional gov­ern­men­tal inter­ven­tion, or have sup­port­ers not con­sid­ered that prospect?

The Sorry: the illu­sory nature of many such bar­gains and trade-​offs induced us won­der about the indi­vid­u­als – exec­u­tives, reg­u­la­tors, and employ­ees – who “cut cor­ners,” turned a “blind eye,” or just went along with some­thing in which they didn’t believe… in hopes of gain­ing the world or per­haps just a small bit, say, a lit­tle cor­ner of Wales or Long Island.

In the process, not only did they bear high per­sonal costs, but in many cases, the gains, e.g., the value of their stock grants or their new titles, turned out to be illu­sory. (Cromwell was guil­lotined a few years after More’s trial, too.)

We sym­pa­thize with them – not the amoral ones; they don’t care and would only mock our sym­pa­thy. No, we mean the folks with con­sciences, who knew right from wrong, but couldn’t resist and traded their decency (and in many cases their self-​worth) for the lure of a few dol­lars more or a lit­tle less aggra­va­tion. That near-​universal weak­ness is the rea­son that we and many oth­ers admire Sir Thomas, even if we can’t always emu­late him.

The Final Irony: All such sac­ri­fices (and gov­ern­ment direc­tives) are designed to lead one or one’s peo­ple to Utopia. By the way, who wrote that book?

in a Mark-​to-​Market Account­ing Régime.

Here’s a cou­ple of related issues that we can dis­cuss in the con­text of today’s The Wall Street Jour­nal arti­cle, Bailout Pro­posal Gets Hung Up Over Cen­tral Issue: Will It Work?

We’re deeply con­cerned about the moral haz­ard impli­ca­tions of any gov­ern­ment bailout, and we doubt that we are the only observer to har­bor such dark thoughts. How­ever, we also think that those impli­ca­tions could be real­ized imme­di­ately rather than, say, dur­ing the “next” down­turn in some far dis­tant time. Thus our pes­simism grows as does our annoy­ance with the fed­eral offi­cials who have pro­posed mas­sive snd expen­sive actions with­out suf­fi­cient lev­els of thought.

In that respect, can the reader say, “com­mer­cial real-​estate loans and CMBS?” And, does the reader know that illiq­uid CMBS – that’s redun­dant by the way-​is very dif­fi­cult to value, too? Not much dif­fer­ent than CDOs of MBS. We com­mented on some of those val­u­a­tion issues three months ago in this post: On Nedges and Sledges and Paving the Road to Hell.

We men­tion CMBS because we saw in the ref­er­enced arti­cle that many banks, not just the ail­ing ones, are try­ing to round-​up every­thing they don’t want, i.e., crappy loans and secu­ri­ties, to make it avail­able for sale to the government.

Can you, dear reader, blame the banks? We can’t. We’d cer­tainly like the feds to buy our Sub­ur­ban at its his­tor­i­cal cost, too. Mr. Paul­son are you listening? Can you help me, here?

As the arti­cle men­tions, it turns out that the banks would rather sell these items at their cur­rently marked val­ues than be forced to pos­si­bly devalue them at the end of the next report­ing period, which hap­pens to be next Tuesday.

It is prob­a­bly too late, so we doubt that it will hap­pen on Mon­day, but we could see a banker try­ing to con­vince a gov­ern­ment bureau­crat that the bank’s mark from June is still the best guess of where an item sells (if it were to sell to any­one in the mar­ket that doesn’t exist.)

We could also see the bankers’ expec­ta­tions of the sales (to the gov­ern­ment) to color their val­u­a­tions next week. As we wrote yes­ter­day in The Uncer­tain Value of Mort­gage Secu­ri­ties that expec­ta­tion will likely lead to greater adverse selec­tion prob­lems because of the pos­si­ble increase in the uncer­tainty regard­ing the value of each bank’s assets. In our view, this will exac­er­bate, not mit­i­gate, the cur­rent pan­icky behav­ior among banks as they deal with each other (until such exchanges with the gov­ern­ment actu­ally occur). How­ever, we could see it lead­ing to prob­lems after the bailout, too.

With that in mind, we ask the dear reader to guess the mul­ti­ple of $700 bil­lion that banks have iden­ti­fied as assets they’d like to sell? We’re guess­ing a mul­ti­ple of at least three – a few tril­lion dol­lars worth – with a sub­stan­tial amount of CMBS and inven­to­ried, pipelined, com­mer­cial mort­gages thrown into that mix. (Those are loans that con­duits made and planned to bun­dle into secu­ri­ties but are cur­rently stuck with because no one wants the CMBS that would be struc­tured from them.) Does the reader believe that only homes were over­built in for­mer boom towns?

So, for argument’s sake, and to be excru­ci­at­ingly pre­cise, let’s say that we are cor­rect that the bank’s col­lec­tively think that they’ll be able to sell $2.1 tril­lion worth of thin­gies to the gov­ern­ment at prices that the banks like. How will take affect next week’s third quar­ter val­u­a­tions, and what will hap­pen when they’re stuck with $1.4 tril­lion of stuff that they wish the gov­ern­ment had bought?

And that leads us to our sec­ond issue about the nature of dis­jointed and illiq­uid mar­kets and how a lit­tle infor­ma­tion can hurt a lot. You see, in social sit­u­a­tions, more infor­ma­tion is not nec­es­sar­ily better.

The fact that no one wants to buy the stuff doesn’t mean that there aren’t a lot of firms hold­ing sim­i­lar secu­ri­ties. So, let’s say that 20 firms are hold­ing a part of a par­tic­u­lar illiq­uid CDO issue or CMBS issue or what­ever it is that no one else wants.

If the thing is illiq­uid then – nowa­days – that means it’s not traded at all; so, there is no observ­able price; so, it is likely that the cur­rent marks vary across the 20 firms because they are all using slightly dif­fer­ent mod­els or all have slightly dif­fer­ent – albeit, likely inflated – expec­ta­tions of what a sale to the gov­ern­ment will bring.

All things equal, it would seem to us that the most des­per­ate firm would accept the low­est price offered by the Trea­sury. Again, all else equal, that’s usu­ally how its works; oth­er­wise, we have to add an adverse selec­tion argu­ment, too.

If that is true, then depend­ing upon how much of the issue the Trea­sury pur­chases, that low­est price is now an observ­able “mar­ket” price for the other 19 firms, and that’s not good with mark-​to-​market account­ing where a lit­tle bit of infor­ma­tion, based pos­si­bly upon one firm’s des­per­a­tion sale to the gov­ern­ment set the new (likely lower) mark for the other 19 firms. It might be infor­ma­tion and it might be the truth, but it cer­tainly wouldn’t help soci­ety. More infor­ma­tion isn’t always better.

That means addi­tional write-​downs may be forth­com­ing from, say, the other 19 firms. If that issue is part of our hypoth­e­sized $1.4 tril­lion above, then those write-​downs in the future after the gov­ern­ment pur­chase will be larger than they would have oth­er­wise been with­out the bailout. Of course, that’s based upon our argu­ment that the book val­ues of the issues would be higher than they oth­er­wise would have been (due to each bank’s antic­i­pa­tion of sell­ing to the gov­ern­ment at an inflated price). Such a sce­naroi would lengthen the dura­tion of the cri­sis and neg­a­tively influ­ence the behav­ior of the firms when they lend to each other in the near term. There will be more pan­ics that occur far­ther into the future.

Is this all idle spec­u­la­tion? Of course, we were a the­o­rist in col­lege. Are we wrong? It is quite pos­si­ble – the chair­man men­tions that it often hap­pens – but we doubt it in this case. Let us know what you think.