Friday, September 26, 2008

Game Theory

The Financial Ninja strikes again with an absolutely great post regarding Game Theory and the Bailout. (The quote seen below comes from Econompic Data but the insight about it comes from the Ninja.)
“Lets assume for the time being that there are only two banks; Bank A and Bank B.

The media / political pundits would have you believe the likely outcome of the bailout is the top-left box in which both Bank A and B sell risk assets to the Treasury. In this case, the result is a more regulated banking industry, with imposed limits to salary, but importantly markets clear.

HOWEVER, it is in BOTH banks interest to deviate from that.

Why? Simple. If Bank A (or B) believe the other is selling their risk assets to the Treasury; they will each be better off holding on to theirs.

Why? If the other bank sells and they hold, markets will still clear (in theory) and the bank that holds onto their risk assets can sell at the new market prices. This results in increased market share as they:

*Can pay more for talent
*Are less regulated
*Don’t have the stigma of selling to the Treasury (think of what selling portrays to the market)

This is even worse in the “real world” as all banks have the incentive to wait for other banks to sell risk assets to the Treasury to clear markets.

The likely result? The bottom right box in which no bank sells voluntarily and markets remain frozen. While there were many problems with the initial plan, at least there was a 100% incentive to sell the assets.”

The Ninja's also right about Econompic Data, an eye candy blog with brains behind the imagery.

Last but not least, a few other qualified folks have doubts too.

World Fact Book: Rank Order - Current account balance (2007) (of nations)

Game Theory - "Game theory attempts to mathematically capture behavior in strategic situations, in which an individual's success in making choices depends on the choices of others."

Bud Fox: Why do you need to wreck this company?
Gordon Gecco:
Because it's wreckable, all right?
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