Game Theory Exposes PPIP As Fraudulent

[girl gone mad]

Game Theory Exposes PPIP As Fraudulent
By James Keller
http://www.realclearmarkets.com/articles/2009/04/game_theory_exposes_ppip_as_fr.html">Real Clear Markets

Game theory tells us that a risk neutral gambler would pay $50 dollars for a coin flip that paid $0 for Heads and $100 for Tails. Game theorists would call $50 the value of the bet.

Suppose someone is willing to fund your gambling problem, and lend you $80 at zero interest. Better still, if you lose the bet you don’t have to pay him back. Under that scenario, the same gambler would pay $90 for the bet, giving him an even chance of winning or losing $10.

This is a microcosm of what the Public-Private Investment Program (PPIP) is intended to do: create an incentive for investors to pay $90 for a bet that is only worth $50. It is bad economics and bad public policy and it is probably fraudulent. Congress should act pre-emptively to halt Treasury Secretary Tim Geithner’s latest scheme.

In the gaming example above the lender has a bet where he gets $80 or zero with equal odds. The value of that bet is $40. Since he paid $80 for it, he has an expected loss of $40. The PPIP puts the taxpayer, via the Federal Deposit Insurance Corporation, in a similar position. The details are only slightly more complicated. A full analysis would include the diversity in the pools of loans, the interest rate charged by the lender, and the opportunity cost to the lender for a similarly risky bet.

We don’t have enough information from the FDIC about what it intends to charge for the 84% of the PPIP it is guaranteeing and we don’t know the exact mix of assets. But once these are revealed, the analysis becomes straightforward, and the expected loss to the FDIC can be estimated with a reasonable degree of certainty.

Why is this particularly interesting? Many commentators have pointed out the obvious: that the PPIP is another welfare program for the big banks, funded by the taxpayer.

It is interesting because the legislation governing the FDIC does not allow it to take expected losses above its capital base, and that capital base is now just $30 billion. Against a $500 billion PPIP, it only requires a 6% overpayment to wipe out the FDIC’s capital.

The New York Times’ Andrew Ross Sorkin pressed the FDIC’s Shelia Bair on this point and she apparently claimed that the accountants “signed off on no net losses.” But we are now in zero sum territory. There are only the assets, the banks, and the government. The windfall to the banks is offset by the expected loss to the government. Convincing one’s accountants that a transaction with a high expected loss has no expected loss is fraud.

http://www.realclearmarkets.com/articles/2009/04/game_theory_exposes_ppip_as_fr.html">More...

[ananda]

1. Game theory is so flawed...

It's based on numbers and mechanism..
and humans are neither numbers nor
machines.

[Democracyinkind]

2. It's illustrative in a very misleading way. It takes a philosopher to get its limits, I'm told.

Anyways I still wouldn't advise anyone to buy that shit.

[girl gone mad]

4. How is it misleading?

Enlighten us.

[Democracyinkind]

7. I didn't mean his post, I meant game theory applied to reality.

Didn't want to make the impression that I was blasting the OP. Are you reacting to a sensed snobbishness of my post? That wasn't my intention.

If you're simply interested in game theory and what I meant by that comment, mail me. I'll do my best :-)

[girl gone mad]

3. We're talking about money and how people will behave with money.

It's actually fairly straightforward.

But, if you feel this example, also cited by Nobel prize winning economists Paul Krugman and Joseph Stiglitz, is wrong, please explain why.

[yowzayowzayowza]

5. Not so fast. Social welfare is an important element in the ...

2007 Nobel Economics Prize for Mechanism Design theory. See also: http://www.guardian.co.uk/business/2007/oct/15/ukeconomy.economics2

That was thanks to an innovative procedure designed to squeeze potential buyers into making bids that reflected what they saw as the true worth of the licences, and prevented them colluding to pay lower prices.

[ixion]

8. actually, we're both... and all critical theories are 'flawed'

everything, including humans, can be reduced to numbers. And, while there are certainly differences between the quantum behaviors of our brains, we are, in essence, organic machines.

As for the flaws in Game Theory, you can point to flaws in ANY critical theory from Aristotelian logic to Deconstructionism.

All that aside, PPIP is a ripoff and a scam, and it takes no critical theory to prove that, just common sense.

[Hawkowl]

11. WRONG!! WRONG!!

This is THE model that Wall Street uses! This is the way to think that is beaten into all of them at the graduate school level. My graduate school courses for economics were 90% mathematics and probability. It is no different than modeling of casino gambling. Options/derivatives are highly "mechanical" and nothing but numbers representing not real assets but only probabilities of what an asset, or an option of an asset might do.

Probability is a very accurate model of human behavior. You may be used to it in another form: polling.

[Kevin Cloyd]

6. Gambling with O.P.M.

To take the gambling analogy a different direction, in a casino the games of chance are stacked in the house’s favor, black jack, roulette, slot machines all, over the long run, pay out less than they bring in. That’s why they use a six deck stack when dealing black jack, so really good black jack players who can count cards are rarely in positions where they have better odds than the house.

Here we have a case where the odds are stacked against the house, it’s like the black jack dealer had to deal his hole card face up and the players got their hole card face down.

For too long the Federal government has been spending O.P.M. OTHER PEOPLES MONEY.

[Joanne98]

9. The dreaded PPP.......

[leftofthedial]

10. Geithner is a crook.

He is trying to superglue the pieces of a burst balloon and fill it up with air before we all notice it is broken.

Meanwhile, his cronies get trillions of our dollars. This entire scheme does not create a single real American job.