Thursday, March 26, 2009

Keynes and the toxic asset valuation plan

I recently watched as Christina Romer, chairwoman of the White House Council of Economic Advisors, made the statement on CNN's State of the Union that the new plan to buy up toxic assets was an attempt to, “…help the taxpayer by using the expertise of the market by trying to set the price for these toxic assets…” In light of this idea and the resurgence in Keynesian economics, I found these passages from Keynes’ General Theory of Employment, Interest, and Money disturbingly relevant:

“It might have been supposed that competition between expert professionals, possessing judgment and knowledge beyond that of the average private investor, would correct the vagaries of the ignorant individual left to himself. It happens, however, that the energies and skill of the professional investor and speculator are mainly occupied otherwise. For most of these persons are, in fact, largely concerned, not with making superior long-term forecasts of the probably yield of an investment over its whole life, but with foreseeing changes in the conventional basis of valuation a short time ahead of the general public. They are concerned, not with what an investment is really worth to a man who buys it 'for keeps', but with what the market will value it at, under the influence of mass psychology, three months or a year hence…Professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem form the same point of view. It is not a case of choosing those which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth, and higher degrees.” (Ch.12, Long-Term Expectation)

In their attempt to address toxic assets through a market-based valuation, I hope the government heeded Keynes’ observations and the current plan takes steps to prevent the distended speculation described above.