The current financial crisis has resulted in trillions of dollars in mortgage-related assets with severely reduced value and little or no liquidity. Although actions such as the creation of the Troubled Asset Relief Program (TARP) in the U.S. have been successful in pulling the financial system back from the precipice, little has been done to address the removal of toxic mortgages from banks' balance sheets.

Some experts have suggested troubled asset auctions as a possible solution. The idea is that governments would purchase mortgage-related assets, thereby removing the "toxicity" from banks' balance sheet and allow the banking system to support new lending.

The 6th Forum on Competition and Regulation, held at IESE's Barcelona campus on June 17, focused on just this: using open, transparent auctions to buy these assets. The conference commenced with an introduction from Prof. Xavier Vives, Academic Director for the forum, who described the problem of troubled assets facing the financial sector in Spain.

Prof. Vives was followed by Prof. Lawrence Ausubel of the University of Maryland, an expert on the auction theory. Ausubel, who helped bring state-of-the-art auction designs to practice, including designing the virtual power plant auctions that are currently operated in Spain and France, described the idea behind purchasing mortgage-related assets from banks and how auctions could generate market prices for troubled assets.

Prof. Ausubel described several auction processes, including static, or sealed-bid auctions; dynamic auctions, where bidders bid aggressively and get informational feedback; and clock auctions, in which the auctioneer announces the price, waits for bidders to respond with quantities, then announces the next price until the market clears.

The advantages of the clock auction are that they are conducted in discrete rounds, prevent bidders from concealing their intentions by not allowing them to increase their quantities as the price progresses, and they maximize transparency, said Ausubel.

Data from economic experiments performed by the professor were also presented. These studies showed that, compared with sealed-bid auctions, bidders achieved significantly higher payoffs in clock auctions, without increasing cost to the government. Ausubel attributed these results to the fact that clock auctions allowed the bidders to better manage their liquidity needs. In addition, the data showed that the prices of troubled assets were not significantly different under the two auction formats, and there was significantly less variation in prices under the clock auctions.

Prof. Ausubel concluded his talk by stressing that a well-designed auction process can provide a quick and effective means to remove troubled assets from bank balance sheets, establish prices and provide transparency, all of which could play a role in reviving the financial sector from the damages caused by the financial crisis.