Saturday, September 27, 2008

Randomization Mitigates the Bail Out Lemons Problem

Rob Shimer raises a number of key points in his post . I have a dumb question. If Wall Street firms who want to participate in the bailout must submit all of their assets to sale to the Treasury (rather than the subset that they want to sell) would this solve the Lemons problem? So, my solution is to introduce a randomization device. Each asset would be assigned a unique ID and the Treasury would pre-commit to draw from a random number generator (like the Lotto). If Asset B owned by firm j's number is drawn then it is sold to the government. I will leave it to smarter guys to figure out what the price should be. I like this proposal by Lucian Bebchuk of Harvard to set up an internal Treasury competition among fund managers who have the right incentives to maximize returns.