Reference no: EM13192652
When the U.S. Treasury developed its economic rescue plan in Fall 2008, an important part of this was its Troubled Asset Relief Plan (TARP). In its earliest drafts, the Treasury proposed to use a Dutch Auction to find buyers for "toxic" home mortgages that financial institutions owned. Financial institutions such as banks and savings and loans had foreclosed upon some of these mortgages and repossessed the home because some of their customers could not keep up with significant upward adjustments in their mortgage interest rates, or their customers had lost their jobs, etc. Others might default in the future because some of the financial institutions had unwisely granted too many "NINJA" mortgages (no income, no job, no assets).
As a result, financial institutions were sitting there with lots of partially paid for residential properties backed by mortgages, some of which were in default and some of which likely would go into default in the future. They wanted (many may still want) to get rid lots of these mortgages and sell them to the Treasury, or to risk-taking investors, thereby strengthening their balance sheets and freeing up money for other uses.
An immediate problem was that the Treasury didn't really know what most of these mortgages actually were worth (25 percent of their face value, 75 percent, or somewhere in between?), nor did it know the condition of all of these houses, some of which had been sitting vacant. The Treasury was not well-equipped to find out this information, either, since the troubled institutions were located all across the United States and Treasury personnel are limited.
(A) Why did the Treasury like the idea of a Dutch Auction? Explain its advantages (in principle) to the Treasury.
(B) Ultimately, the Treasury did not use the Dutch Auction approach because it concluded that several critical conditions that usually apply in well-run Dutch Auctions did not exist here. Think carefully about those conditions and explain why they wouldn't have been present in a Dutch Auction for toxic mortgages.