The citric fruit is cropping up in the oddest of places — specifically, in relation to Tim Geithner’s PPIP plan.
For instance, it’s in economist Willem Buiter’s Maverecon blog.
Banks with toxic assets on their balance sheet can choose to keep them there rather than participate in the Legacy Loans or Legacy Securities Programs. Citigroups and Bank of America already have government insurance/guarantees for hundreds of billions worth of toxic and bad assets. They are not going to be in a hurry to clear their balance sheets. By making participation voluntary the Treasury has created an adverse selection machine. Only those whose toxic or bad assets are priced higher than the reservation value of the banks who hold them will offer them for sale. Surely, the designers of the scheme must have read George Akerlof’s famous ‘lemons’ paper?
It’s also in a Los Angeles Times Op-Ed penned by The Baseline Scenario‘s Simon Johnson and James Kwak.
… there is a “lemons” problem, also known as adverse selection. Even with a reasonable degree of disclosure, the selling banks will still know more about their assets than the buyers. The banks will be trying to dump their most toxic assets (their lemons); the buyers, fearing exactly this behavior, will reduce all their bids accordingly. This will make it harder for buyers and sellers to meet.
The basic premise of Akerlof’s ‘lemons problem’, first set forth in his 1970 Nobel prize-winning paper, is that markets tend to break down when there’s asymmetric information between buyer and seller. Think of it as the economic version of that Groucho Marx quote: “I don’t want to belong to any club that will accept me as a member”. You wouldn’t want to buy an asset anyone is willing to sell to you. You’re naturally suspicious of the asset — a salient point in these times of toxicity.
Of course, the Geithner plan is aimed at overcoming the lemon problem by providing enough of an upside incentive — and limited downside — to encourage boldness in buyers. Buiter, Johnson and Kwak seem to think the Treasury hasn’t done enough in that respect, buyers won’t be emboldened. They will still be wary of the lemons.
If you want to read more, here’s the first page of Akerlof’s lemons paper (A JSTOR subscription is required for the rest).
Alternatively, you can read Akerlof’s personal reflections on writing the paper here.
Related links:
Lemon socialism – Wikipedia
Geithner, the early maths – FT Alphaville