*by* rootless2
*Sat Mar 28th, 2009 at 09:54:08 AM EST*

Krugman and Sachs make an expected value argument as if each asset was covered by a non-recourse loan. But the Geithner plan is based on pools. Let use Krugman's numbers of $100 face, $50 bad, $150 good with an even distribution. If you are able to assure 50/50 distribution, then $130 is investor break even since the investors 1/12 investment of about $10 makes $10 profit on the good assets and loses $10 on the bad ones. I'd say that nobody would be stupid enough to make investments on this type of basis, but reliance on Moody's AAA ratings convinces me otherwise. However the loans are not being sold individually, but in pools. If we minimally pool in sets of 4 then the investor only earns profit on sets with majority good loans and loses money on the even and majority bad loan sets. Binomial distribution then tells us that the break even bid is $105 (oops!)

Here is the calculation using Krugman's assumptions, but supposing that assets are pooled in groups of 4.
If we purchase at 105.6,
Each pool costs 4*105.6 = 422.4
the FDIC loan is 5/6*4*105.6 = 352
the investor puts in 1/12*105.6*4
and the Treasury matches
The first column has the purchase price
The second column has the number of good assets in
the pool the third is the net equity left over when the FDIC loan to the pool is repaid. The fourth is the investor return from the pool minus the original investment (the most the investor can lose is 4times the investor equity per asset). The fifth column is the frequency of pools with that number of good assets according to the binomial distribution. And the final is the investor result for pools of that type. So
with 16 pools, the investor must bid under 106 to expect to break even, granting Krugman's idea of an investor as someone using Moody's theory that previous performance **is** a guaranty of future results.

| |
4 | 248 | 88.8 | 1 | 88.8 |

3 | 148 | 38.8 | 4 | 155.2 |

2 | 48 | -11.2 | 6 | -67.2 |

1 | -52 | -35.2 | 4 | -140.8 |

0 | -152 | -35.2 | 1 | -35.2 |

| 46 | 0.8 |

Thanks to Migeru for posting the link to Krugman,

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