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Your example brings to mind Mazda and the 4703 potential "lemons"...

http://online.wsj.com/article/SB120942873506551291.html

They came to the same conclusion as you did.

The problem with the government buying CDOs was that there was never a way to give a convincing argument that the government wouldn't end up losing a lot of money on the deal, when all was said and done. There was no stomach for telling taxpayers that they have to overpay for poor investments, bailing out buffoons.

The only way the purchasing of CDOs could work would be if you could guarantee that the government was getting a good deal by severely underpaying for these assets.

Now, you might well argue that TARP as it stands now is a bust, and could end up costing the taxpayers a lot of money. But the money to the banks was sold as a purchase of equity. That seems, on a first look, a better investment than CDOs.

The lemon car story is a myth.

"Therefore, owners of good cars will not place their cars on the used car market"

This is absurd. It fails to take into account the fact that economic value is individual and subjective. Prices are not measures of value, certainly not subjective use-value.

If you buy a new car, the value of your previous car, and your willingness to sell it, is primarily the result of the law of diminishing marginal utility. The new car now provides the services that previously were the responsibility the old car. As a result, the value to you of the old car is greatly diminished no matter how 'good' you may think it is. Your old car may well be very valuable to someone else who doesn't have any car at all, but the difference between the importance of the old car to him and to you means that, in the end, the potential buyer will start with a substantial consumer surplus which can help insure against the risk of problems that neither the buyer or the seller can accurately forecast.

Regards, Don

Driving cars over a cliff is way different from paying people to cut brake lines. If government subsidizes lemons people will produce more K-cars. This is literally what the big-3 execs want with their bailout request.
I think your advice is the same as are recommendations for accounting transparency with the added caveat that instead of decreeing new regulations, companies have the option of instead accepting a Crown buyout.
The entire investment industry is founded on secrecy. Employees make more money if losses are hidden, so expect these players to fight such regulations tooth and nail. An honest broker industry is 1/2 the size of an industry funded by commissions and options. I agree Nick, send them to Labor Ready. A bank is residential mortgages, business loans and financial services. The latter is poisoned in USA and small business loan rates are now unnecessarily high. A difficulty might be regulators might not be skilled enough to verify if "transparent" balance sheets are fudged by CFOs.

Phillip, I'm not sure how much of a subsidy it is: presumably the reverse auction would not yield prices significantly different than the actual perceived value of the asset on the part of the seller. Since these assets will sell for less than they cost to produce, I'm not sure it leads to production of poor assets--it might dull the vigilance in ensuring the quality of production (whether cars or financial instruments). It's not a money pump, so firms will still try to minimize the production of lemons, although minimize given that the penalty of producing lemons may not be as severe.

Chris S: I had forgotten all about that news story. It illustrates my model exactly (even down to the asset being cars!). Presumably Mazda decided that the total value of the cars would be higher if it destroyed the lemons.

Don the LD: sometimes things are bad for the taxpayers but good for the citizens. Actually, if that weren't true, taxes would (or ought to be) zero! But yes, politically it might be a hard sell.

Don Lloyd: I'm not following you. In my model, the values were use-values (the amount a rational person would be willing to pay for a car, given a 10% rate of subjective time preference, the $10 bus fare, plus my assumption that they are subjectively indifferent between riding the bus and driving a car). I am assuming that everyone has the same use-values (preferences). And I (implicitly) assumed the marginal utility of a second car is zero. Fully Austro-compatible, I think. I just didn't use the terminology.

Phillip and Andrew: I dunno. I ducked the whole moral hazard question. Still trying to get my head around liquidity.

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