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.


  1. and what about the effect of RISK on price - if there is little or no risk then the price tends to be higher - so it was w/ securitized debts which had a mistaken perception of their risk (AAA indeed!) - which has since overcorrected to a ZZZ (for Zombie Market?) -- and now we have the gov't assuming most of the risk so that a higher price will likely be assigned to these WMDs - Weapons of Market destruction (at least higher than 'worthless' or 'who knows what')...was there ever really a 'perfect, ideal' market...let us list the many, many false assumptions...

  2. I couldn't agree more. Paul Krugman's blog has some great discussions of this very issue, yet I have still not heard of any response from Geithner, Summers or anyone for that matter.

  3. Yes, short term perspective is so misleading, and pressure to succeed in the short run is definitely behind many problems in our financial system. That was a great quote!

  4. new book out - Animal Spirits - by George A Akerlof & Robert J Shiller looks to address the falacies of 'rational market economics'. Keynes rises from the grave to chide us...can't wait to read it - that and The Bernie Madolf Story (or how regulation doesn't work if you don't do it)...maybe we will learn something......nah.