How Would a Reverse Auction of Impaired Debt Work?

As the ” Emergency Economic Stabilization Act” works its way through Congress, NERA Economic Consulting takes a look at how “reverse-auctions” of impaired financial instruments might work.

NERA notes that  such auctions would be vastly different from the standard auctions of a small number of types of government securities that the Treasury is used to running:

There are likely at least 100,000 individual mortgage-related securities, obligations, and other instruments outstanding, with many further divided into multiple rated tranches, and there are vastly more outstanding whole loans. Attempting to mirror the auction for US government securities by pricing such assets individually or very tightly specifying the assets to be priced as one would require an impractically large number of auctions.

NERA sees benefits holding auctions in multiple rounds, but recognizes that the urgency of the situation works against this.

The advantage of a multiple-round format is that it can aid in price discovery. Bidders can learn how much supply is offered at various prices and refine their valuations of the asset being auctioned. This benefit is especially relevant in the current context, where uncertainty over the value of the assets is at the heart of the crisis. However, multiple-round auctions require more time to set up and run, and measures to ensure that competition is sufficient to drive the price down from its initial level may be needed. In the context of financial markets where they are not used routinely, such auctions would require that bidders be trained. Time, which is also at the heart of the crisis, may well be in short supply.

The full paper Buying the Bad Stuff: Implementation Considerations for the Paulson Plan is available free of charge.

Comments

[kingaj12:]

I guess I have a fundamental question about this. How are the auction participants going to determine the value of the securities? How are they going to get any more visibility into these CDO's than the current owners?

2008 Sep 29 12:43 PM