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Troubling Research on Troubled Assets: Charles Zheng on the U.S. Toxic Asset Auction Plan

  • Linus Wilson
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    Charles Zheng (2009) purports to model the U.S. toxic asset auction plan. In the model, “moderately poor bidders outbid rich bidders in such auctions,” because poor bidders have less to lose by defaulting on taxpayer loans. Thus, says Zheng: “After defeating their rich rivals and acquiring the toxic assets, such bidders will default on government-provided loans whenever the toxic assets turn out to be unsalvageable.” The chief trouble with the paper is that the assumptions do not fit reality. In reality, the government-provided loans used to buy toxic assets are nonrecourse, allowing the borrower to walk away from the loan with no penalties besides ceding the asset that the loan purchased. Thus, there is nothing to make rich bidders less ready to win the auction. Zheng’s conclusions that less well endowed borrowers will win toxic asset auctions are erroneous. Further Zheng’s use of auctions to model these plans is largely inappropriate since only one of the three government toxic asset plans has government backed investors bid for the same toxic asset in an auction format.

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    Article provided by Econ Journal Watch in its journal Econ Journal Watch.

    Volume (Year): 8 (2011)
    Issue (Month): 1 (January)
    Pages: 33-38

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    Handle: RePEc:ejw:journl:v:8:y:2011:i:1:p:33-38
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    1. Zheng Charles Zhoucheng, 2009. "The Default-Prone U.S. Toxic Asset Auction Plan," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 9(1), pages 1-11, May.
    2. Che, Yeon-Koo & Gale, Ian, 1998. "Standard Auctions with Financially Constrained Bidders," Review of Economic Studies, Wiley Blackwell, vol. 65(1), pages 1-21, January.
    3. Zheng, Charles Z., 2001. "High Bids and Broke Winners," Journal of Economic Theory, Elsevier, vol. 100(1), pages 129-171, September.
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