The Market in Toxic Cars
Mark Thoma has an extremely useful post that helps elucidate the structure of different plans for dealing with “toxic assets” by way of a little analogy. Here’s the setup:
Imagine a car lot that has 100 cars on it. However, some of these cars have problems. Half of them will have engine troubles that total the cars – the engines blow up and the cars are then worthless – and this will happen just after purchase. The other half are perfectly fine. Unfortunately, there is no way to tell prior to purchase which type of car you will get no matter how hard you try. Thus, half of the assets on the car dealer’s “balance sheet” – the cars on its lot – are toxic, and lack of transparency makes it impossible to tell which ones are bad prior to purchase.
If all the cars were in perfect shape, they would sell for $20,000 each. Thus, there are (50)*($20,000) = $1,000,000 in assets on the books according to one way of doing the accounting, but that doesn’t necessarily represent the true value of the cars on the lot.
The town where this dealership is located relies upon this business for jobs, it is essential, but, unfortunately, business has fallen off to nothing. Nobody is willing to risk losing $20,000 by purchasing a car that might die just after purchase, so the price has fallen. The expected value of a car is $10,000, but it’s an all or nothing proposition, the car runs or it dies, and since people are risk averse nobody is wiling to pay the $10,000 expected value. In fact, the highest price they are willing to pay, $6,000, is lower than the minimum price the dealer is willing to accept.
Thoma outlines three different ways the government might try to intervene in the market and create a situation where at the end of the day the bad cars are on the crap heap, the good cars are in the hands of customers, and the car dealership has enough financing to get more inventory.
You really need to click over to read the full analysis, but the choice between the Geithner Plan and a nationalization plan winds up mostly hinging, in my view, on how you feel about the management of the car dealership. You might find the idea of a government-owned car dealership—even just temporarily owned—very troubling. The dealership would be managed according to political dictates and subject to the whim of the local legislators. This might wind up being a very poorly managed car dealership, indeed. And you could create a situation in which nobody wants to buy the dealership under the conditions the legislature is attaching, but nobody wants to compete with it either since the dealership can operate with government subsidies. Hence, you’ve got a situation where the town depends for employment on make-work jobs at an inefficiently-run state-owned car dealership.
Another view you might take is that there’s something badly wrong with the managers of the car dealership. Somehow they wound up with all these undetectable bum cars in their inventory, even though the presence of such a mass of bum cars wrecks their entire business, and even though they’re allegedly experts in assessing cars. If you rescue the dealership in a way that keeps existing management in place, it’s not clear where this leaves you going forward. What’s their business going to be? Will they start buying good cars and reselling them at a profit? But if that’s their business, then how come they weren’t doing that in the first place? Are they going to go back to buying bum cars and trying to pass them off as good ones? How long is that going to last? And what problem have we really solved?
There are risks either way. The Saab Story sounds better to me, but people who have a higher regard for private enterprise and its titans than I do will see it another way.
45 Responses to “The Market in Toxic Cars”
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March 23rd, 2009 at 8:46 am
Perhaps the best way to answer the question “nationalization vs. private management” is to ask, which strategy does the individual running the rescue plan feel most comfortable managing?
Because it’s very important that the plan not only be workable, but that also executed well.
March 23rd, 2009 at 8:58 am
Or you could say, if I do not trust private entities with Social Security because they’ll loot it, why in Koshchei’s name would any sane person trust those very same entities with something an order of magnitude more important.
March 23rd, 2009 at 9:01 am
The third option is to have no government plan. If the banks have done all the damage they can do, then leave them alone to find there own way out.
March 23rd, 2009 at 9:05 am
Or the government could simply do what I suggested six months ago: provide capital (loans) to a REPLACEMENT car dealership
with competent management and good prospects. Let that dealership buy the good cars from the old dealership — because mechanics can tell a lemon from a good car — and let the owners of the old dealership eat the losses for their irresponsibility.
I am repeatedly amazed at the dishonesty on American political discourse. If the Democrats were intent upon saving the economy, they would have used the $10 Trillion they pissed away on the bad bank to instead provide capital to real businesses that have real prospects and are real investments.
Instead, this deeply corrupt bailout of campaign donors with taxpayer dollars is STILL starving honest businesses of capital.
The Democrats are showing that they are just as crooked as the Republicans — albeit they do feel compelled to put out more deceitful propaganda re taking care of the “Peepul” — while fucking the People with a broken beer bottle.
March 23rd, 2009 at 9:08 am
Has anyone seen the Democrats INDICTING anyone for this massive disaster/Act of sabotage? Holding any politican RESPONSIBLE?
If the Democrats were really the Tribunes of the people, they would be holding the perps responsible. Instead, they’re in bed with them.
March 23rd, 2009 at 9:09 am
“the crap heap”
Is that another term for Atrios’ “Big Shitpile?”
March 23rd, 2009 at 9:09 am
You ended up with so many bad cars on the lot because for a time every car the managers of the lot bought they could sell for a profit. There were no bad cars. All cars were good, so good, that the people who bought them could turn around and sell them to someone else for a profit and that person could do the same, etc.
The people who run used car lots know used cars and how to sell them better then anybody else but they are also a greedy unscrupulous group and need to be watched and regulated closely. There are no other groups of people (miraculously free of greed and full of scruples) who can come in and do the job. They don’t exist.
March 23rd, 2009 at 9:13 am
A huge uproar over $180 Million in bonuses to AIG executives — while $10 Trillion is being shipped out the back door of the Treasury. Yet does a SINGLE FUCKING DEMOCRAT point this out?
That the bonus uproar is just a distraction to divert voters attention away from the REAL crime in progress — AIG counterparties like Goldman Sachs being made well with tax dollars.
The Democrats don’t OPPOSE Republicans — they COLLABORATE with them. In a perpetual game of Good Guy-Bad Guy with the common citizens.
March 23rd, 2009 at 9:14 am
Just as an aside on history of economics matters, Thoma’s “market for cars under imperfect information” set up for this is a nice twist on George Akerlof’s famous “Market for Lemons” work (which got him a Nobel — see http://nobelprize.org/nobel_prizes/economics/articles/akerlof/index.html )
Later on, Akerlof did the “looting of government support arrangements” research with Paul Romer, which looked at the S&L bailout
March 23rd, 2009 at 9:14 am
Except they’re both Bad Guys.
March 23rd, 2009 at 9:17 am
It’ time to look again at Krugman’s take on the Geithner plan:
FROM: http://krugman.blogs.nytimes.com/2009/03/21/despair-over-financial-policy/
Money quotes:
“…It’s exactly the plan that was widely analyzed — and found wanting — a couple of weeks ago. The zombie ideas have won…
For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose. So sure, these investors will be ready to pay high prices for toxic waste. After all, the stuff might be worth something; and if it isn’t, that’s someone else’s problem…. And I fear that when the plan fails, as it almost surely will, the administration will have shot its bolt…”
Time once again for “progressives” to download the latest version of the DNC’s BaseFucking(tm) software.
March 23rd, 2009 at 9:26 am
First, it’s not clear why the used-car analogy sheds light on the actual problem, which isn’t exactly mysterious, but let’s use it anyway. Is it really true that you can’t tell which cars are bad by looking under the hood? Mortgage-backed securities, after all, have an underlying pool of mortgages, which could be sampled and assessed. This assessment should provide some reasonable basis for eventual payout, without relying on the current market price of the MBS.
Right now, you have progressive economists divided on the plan–and their disagreement seems to rest on a faith-based opinion about the value-to-maturity of the “toxic” securities.
March 23rd, 2009 at 9:29 am
Could everyone please dial it down a notch? “Damn them all” freakouts aren’t going to influence any decision makers views, other than to make them see progressives as fringe crazies. Calm down & stop playing into the stereotype.
We’ll learn a lot in the next few weeks: will ‘private capital’ step up to participate in this thing & risk having the govt in their business? If not, they’ll have made the case that nationalization is the only viable option left.
March 23rd, 2009 at 9:30 am
While it is true that it was the Republicans who CAUSED this disaster, it is DEMOCRATIC Congresses who have been dumping the COSTS onto the common taxpayer. First under Bush, now under Obama. With NO justification whatsoever.
Whatever happened to the bearded progressive insurgent that used to run this blog, by the way? Did Jennifer have him whacked and she is now writing this blog under the old pen name?
Because, Normally, one has to read Robert Samuelson at the Washington Post to see the kinda of Apologias I been seeing here lately. Or watch an Inspector Clouseau movie.
March 23rd, 2009 at 9:32 am
I’m guessing the comment about “the Saab Story” at the end is in reference to Swedish style nationalization. Pun aside, if anyone else out there still has faith in the Saab brand, please go to rescue-saab.com.
March 23rd, 2009 at 9:36 am
Larry G -
I don’t think the difference of opinion is based on speculation about the true value of the toxic assets, but rather how you deal w/ the uncertainty about that. Some think that making a market for them is the best way to shed light on it, others that the only way to figure it out is to figure it out & therfore the govt should take over the banks to dig into the books and find out what the cash flows are going to be, odds of default, etc. The fundamental problem is that doing that is really time-intensive, data intensive, and ultimately pretty speculative at the end of the day, so you need to cotrol the assets to untangle it all.
March 23rd, 2009 at 9:38 am
Looks like the banksters have paid Obama to finish the job BushCo started with TARP. Remember all those times Matt just about spurted in his pants over how much money Obama was raising during the campaign? Well, now we get to pay it all back 1000 times over.
March 23rd, 2009 at 9:39 am
I thought the analogy was more like there are several of these car dealerships filled with some large percentage of lemon cars, and that they made financial investments and loans based on the argument that all of these cars would someday be worth two to ten times what they’re worth now.
And that the several dealerships along with the local government are absolutely opposed to any action such as inspections which might lead to either (a) a reasonable disclosure of information which reveals which dealerships have what amount of lemon vehicles, and (b) any actions whatsoever which cause the current dealerships’ owners, investors, and managers to lose any of their own money whatsoever.
March 23rd, 2009 at 9:40 am
Re TW’s comment ““Damn them all” freakouts aren’t going to influence any decision makers views, other than to make them see progressives as fringe crazies.”
—————-
Actually, the only way I know of to “influence any decision makers views” is to (a) write them $200,000 campaign donation checks or (b) turn some of them over to Dexter and let him extract their fucking eyeballs with a pocketknife as an example to the others.
Should we take a vote?
March 23rd, 2009 at 9:46 am
TW @ 14
Get with the program!
ObaMmmmMmmmGood is busy assuring the hedge fuckers that while it was important for the peeps to have their bitch fest in the House there will be no, none, zilch interference in their bidness operations.
Dat be rite chilluns, we gon gib dem hedge fukkers a trillions o de bucks to do wit lik dey want.
Mebe dis time dey put de lube on de broke beer bottle for dey dun fukk us.
March 23rd, 2009 at 9:47 am
For all my hatred of the wingnuts, I’ll give them this: whenever BushCo tried to fuck them over (think Harriet Myers, amnesty for illegals) they at least had the balls to stand up to him.
“Progressives” OTOH let themselves be rolled over and over again. Think Matt, Iraq, 2003.
March 23rd, 2009 at 9:52 am
“Or not. But as always, I really think Matt is just wrong that the primary issue here is management, as opposed to potential costs to the government.”
If cost to Uncle Sam is the issue then the public should be given cost estimates of both the Geithner plan and nationalization so as to allow a comparison. But of course that won’t happen. Guess why.
March 23rd, 2009 at 9:53 am
Anyone notice how Obama is crawdading away from his social justice promises made during the campaign? Because we don’t have money for them?
We have millions of kids out there growing up in shitty school systems who will are being condemned to lives of hopeless poverty — because their competitors in China and India are getting a leg up. Just look at the test scores.
But if you give $10 Trillion away to crooks, that’s the result.
We have millions of people who are dying before their time from lack of medical care — and that number will soar as retiring baby boomers lean on a Medicare system that is underfunded by $32 Trillion.
But it you give $10 Trillion away to crooks, that’s the result.
We have millions of people stuck in miserable prisons for much of their lives — an incarceration rate that is 4 times higher than China’s. Because we give million of our citizens no choice between starvation and crime — instead of giving them economic opportunities.
But if you give $10 Trillion away to crooks, that’s the result.
Anyone seeing a single Democratic politican expressing anger over these outcomes?
One of these days, the deep misery caused by their corruption is going to arrive on their own fucking doorsteps.
March 23rd, 2009 at 10:01 am
The whole thing is an utter abomination: putting the taxpayers into interest-bearing debt to buy out bad assets at face value, so the damned bankers will be able to resume loaning money again.
The money ought to be spent building a new financial system, with heavy input from Social Credit and greenback ideas. First of all, if we agree the money being spent isn’t inflationary because of the existing demand shortfall, why would it be inflationary in particular to simply print it into existence rather than borrow it at interest? Just deposit a trillion or two in specially created checking accounts for every citizen, in a new network of local economic reconstruction banks. Then authorize the banks to issue loans on a fractional reserve basis for local economic development (with emphasis on the Emilia-Romagna model of industrial production and household microenterprise). I think Kucinich proposed something like this.
March 23rd, 2009 at 10:06 am
Re DTM at 23: “In nationalization, the government assumes all the liabilities of the firm as well as the assets. And something Thoma doesn’t go into is that some of the liabilities can’t be given any sort of haircut (e.g., the insured depositors).”
————–
1) If government liabilities were a concern, then why did the government extend FDIC insurance from $100,000 to $250,000? Why did it extend that insurance to accounts that had not been covered in the past? Why did the Fed also extend $6 TRILLION in Guarantees? Why did the Fed give out $Trillions in loans secured by shit?
2) Roughly half of US Households get less than $50,000 a year in income. How many Americans does DTM think have more than $100,000 in their bank accounts? Does DTM think the government actions in (1) were for them?
March 23rd, 2009 at 10:16 am
Asia Times re how the Dollar is likely to lose a lot of value due to this bailout: http://www.atimes.com/atimes/China_Business/KC18Cb01.html
March 23rd, 2009 at 10:19 am
Don Williams is right. We are in this banking mess because we started insuring depositors more than they should be insured. Simply raise the FDIC fees to cover the new insurance, and banks that do not like the fees can become uninsured. Banks that cannot survive, like Citibank, can just wither away.
It seems to me we have a predictable outcome, a progressive Congress that grabbed a flawed theory to justify government intervention, but then that intervention turned into a swingle by the banks.
March 23rd, 2009 at 10:27 am
“Could everyone please dial it down a notch? “Damn them all” freakouts aren’t going to influence any decision makers views…”
Of course, neither will soft utterances of assent. But at least the freakouters don’t indulge in fantasies of influence, believing themselves under the gaze of onlooking “decision-makers”, and correcting themselves accordingly, like Christians mindful of the eye of God. Which is just to say, at least the Freaks aren’t ridiculous.
March 23rd, 2009 at 10:36 am
George Bush and Dick Cheney’s response to 9/11 was “Now’s our chance.” Invading Iraq had nothing to do with addressing the crisis that suddenly slapped them upside the head; they just took advantage of the situation to ram through an ideological project they’d long wanted to do anyway, and they exploited the public’s trust to do so.
Just about all of the criticisms I see on this thread amount to people complaining that Barack Obama isn’t doing the same thing. He isn’t taking advantage of the political situation to ram through somebody’s fantasy of “a whole new economic system” and “power to the people.”
Well…GOOD.
March 23rd, 2009 at 10:54 am
Re joe at 32: “Just about all of the criticisms I see on this thread amount to people complaining that Barack Obama isn’t doing the same thing. He isn’t taking advantage of the political situation to ram through somebody’s fantasy of “a whole new economic system” and “power to the people.””
—————-
Well, I’m complaining that he’s taking $10 Trillion from the common citizens and using it to pay the gambling debts of the Superrich –in exchange for about $700 million in campaign donations.
Although i suppose for Obama to NOT do that would –in Washington’s view — be “somebody’s fantasy of a whole new economic system”
March 23rd, 2009 at 10:58 am
The analogy would be complete if the dealer had assembled cars from parts bought at flea markets and chop shops without any inspection or quality control of any kind. Then, the dealer reassembled the cars, paid a mechanic to “inspect” them and fraudulently sold the cars as certified pre-owned.
The local economist, who mistakenly believes that his specialty exists in a vacuum devoid of politics, concludes that all the different plans are a wash. Each will probably save the town while costing a lot of tax money.
But you can’t save the town without considering the townspeople. If they haven’t been personally ripped off by this car dealer, they know someone who has. And they live with the after effects every day: the streets are lined with blown out cars, such that the towing company is the only business that’s still booming. The townspeople sure as hell don’t want to see the crook rewarded!
So the Saab story is the only viable alternative.
March 23rd, 2009 at 11:07 am
Thoma’s analogy is misleading. The problem with cars is that no one wants to keep 100 cars of which 50 blow up. Since each buyer wants just one car, each buyer faces huge risk. It’s worse if the dealer gets to pick the car you buy and knows which blow up.
In finance, there are a lot of CDOs. No one every counts them. People just talk about how many dollars are invested in some kind of CDO. The units exist, but barely matter.
For example when was the last time you saw an actual stock certificat, that is, a piece of paper which gives the bearer a right to a dividend and a vote (just in case the answer is “never. What’s a stock certificate”).
In the finance analogy, I could go to the dealer and buy 1% of each of the cars on the lot. This doesn’t work so well with cars (what do you do with 1% of a car whether or not the car blows up). It works fine with CDOs (put em in a spe and slice em).
March 23rd, 2009 at 11:09 am
Well, I’m complaining that he’s taking $10 Trillion from the common citizens and using it to pay the gambling debts of the Superrich –in exchange for about $700 million in campaign donations.
This would be a compelling argument, except that the alternative you want to see is for him to take $10 trillion or more from the common citizens and spend it on a nationalization plan.
There is zero zip nada no difference in the cost to “the common citizens,” except that your preferred alternative may turn out to be more expensive.
So no, Don, the cost to “the common citizens” is not what you are complaining about. Here, let me quote you a few times:
If the Democrats were intent upon saving the economy, they would have used the $10 Trillion they pissed away on the bad bank to instead provide capital to real businesses that have real prospects and are real investments.
Whatever happened to the bearded progressive insurgent that used to run this blog, by the way?
Actually, the only way I know of to “influence any decision makers views” is to (a) write them $200,000 campaign donation checks or (b) turn some of them over to Dexter and let him extract their fucking eyeballs with a pocketknife as an example to the others.
Anyone notice how Obama is crawdading away from his social justice promises made during the campaign? Because we don’t have money for them?
Your first comment demonstrates that your crocodile tears over the costs of a performance. The rest demonstrate that you just want to play the Progressive Insurgent.
March 23rd, 2009 at 11:26 am
Re Joe’s comment “This would be a compelling argument, except that the alternative you want to see is for him to take $10 trillion or more from the common citizens and spend it on a nationalization plan.
There is zero zip nada no difference in the cost to “the common citizens,” except that your preferred alternative may turn out to be more expensive.”
—————–
Oh bullshit. A) I’ve never argued in favor of nationalization in which the government would take on the liabilities of the banks –my whole argument has been against that. (b) What I have said it that the government should not be loaning to financial con artists but should instead support real businessman –that run the real economy that we all depend upon to live. Government money invested in real businesses is likely to be repaid with a profit — whereas the money going into the financial bailout is going where, exactly?
You can argue that the government is liable for deposits –but again, I argued that the government should not be issuing those guarantees to begin with. What insurance company gives unlimited coverage to a driver with a history of drunken car crashes –google “Long Term Capital Management”, Savings and Loan crisis of 1989,etc. I think Bernanke’s $6 Trillion in guarantees should be repudiated by Congress — and the FDIC’s new guarantees should also be repudiated.
March 23rd, 2009 at 11:33 am
OK – you don’t want to take $10 trillion from “the common citizen” for a nationalization scheme. You want to take it from them for a bank subsidy scheme, just like Geithner. You just think you’ve selected a better class of bankers to loan “the common citizen’s” money to. Maybe they are, maybe they aren’t, but for you to complain that Geithner is using taxpayer money to subsidize rich bankers, when your plan is to use taxpayer money to subsidize rich bankers, is…well…rich, and somewhat hypocritical to boot.
March 23rd, 2009 at 11:50 am
Can the proponents of nationalization explain how the process would work with ginormous financial services holding companies with hundreds subs, including many based in foreign nations, rather than commercial banks? And what happens to the bondholders? If there’s no negotiated agreement on a haircut, what happens when bondholders sue for default? I’m not opposed to nationalization in principle, but I’ve never seen anyone explain specifically how it can/would be done.
March 23rd, 2009 at 12:01 pm
Re joe from Lowell: “OK – you don’t want to take $10 trillion from “the common citizen” for a nationalization scheme. You want to take it from them for a bank subsidy scheme, just like Geithner. You just think you’ve selected a better class of bankers to loan “the common citizen’s” money to. Maybe they are, maybe they aren’t, but for you to complain that Geithner is using taxpayer money to subsidize rich bankers, when your plan is to use taxpayer money to subsidize rich bankers, is…well…rich, and somewhat hypocritical to boot.”
——————
Only a moron would make NO distinction between making a good investment in a viable business versus pouring money down a rathole.
Only a moron would make NO distinction between making a loan to businessmen who make the products that support our economy –and ultimately, our lives — versus pouring $Trillions into a fucking crooked dice game.
March 23rd, 2009 at 12:05 pm
PS Only a moron would make no distinction between bankrupt parasites demanding a bailout for their irresponsible behavior versus a solvent businessman making a request for a loan , who is prepared to submit a business plan and to accept the usual due diligence followed by successful creditors.
March 23rd, 2009 at 12:50 pm
Shorter Don Williams: you give me too much credit, joe. Even my banging on about upward redistribution is just a pose. My real argument has nothing to do with that at all.
March 23rd, 2009 at 1:56 pm
This reminds me of the prisoners dilemma. If we construct this convoluted set of circumstances that don’t actually exist we have this problem that requires government intervention to solve properly.
Fact is, we can tell which cars suck. We’ve been watching their performance for an ample amount of time and know exactly which ones are more distressed than the others. Far more than 50% of the cars are lemons, and any mildly intelligent person wouldn’t go anywhere near the lot.
A couple auto mechanics buy up the cars they think are worthwhile at a good price, fix them(restructure loans), and sell them back to the marketplace in a much more stable and useful condition.
Those holding the assets aren’t actually dealt some great injustice by being stuck with them. The used car salesman would be much more likely to sit on his thumbs if each an every car he had was returning 5% of it’s value every year. Helping him sell off the lemons before their returns blow will unfairly disadvantage someone at some point, and it is the nature of business and capitalism for those who make bad decisions to deal with them.
March 23rd, 2009 at 8:20 pm
All those banks Atrios mentions as “EATED” by the F.D.I.C. — once they are taken over (nationalized) is there any interference by the legislature?
March 27th, 2009 at 11:19 am
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