On Tuesday, 10 February 2009, Treasury Secretary Geithner proposed the aggregator bank (“public-private investment fund”) as a key instrument to resolve the financial crisis (www.financialstability.gov). The Treasury description leaves many issues unanswered. Here we explain how an aggregator bank might operate in practice. We fill in some of the major details so as to enhance the effectiveness of the aggregator bank. In particular, the approach emphasizes transparency and value to the taxpayer, minimizing the need for bank-by-bank negotiations and thereby minimizing the opportunities for the government to play favorites.Auctions, financial auctions, financial crisis

Lawrence M. Ausubel

Peter Cramton

English

Research Papers in Economics

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Economists’ Voice  www.bepress.com/ev  February, 2009 © The Berkeley Electronic Press
Making Sense of the Aggregator Bank
LAwrEncE M. AuSuBEL And PETEr crAMTon
O
n Tuesday, 10 February 2009, 
Treasury  Secretary  Geithner 
proposed the aggregator bank 
(“public-private  investment 
fund”) as a key instrument to 
resolve the financial crisis. The Treasury de-
scription leaves many issues unanswered. So 
how might an aggregator bank operate in prac-
tice? We fill in some of the major details so as 
to enhance the effectiveness of the aggregator 
bank. In particular, our approach emphasizes 
transparency and value to the taxpayer, mini-
mizing the need for bank-by-bank negotiations 
and thereby minimizing the opportunities for 
the government to play favorites, or to appear 
to play favorites.
For concreteness we use specific numbers 
for the various parameters in the plan. These 
are for illustration purposes only; the actual 
numbers would be set by the Treasury after 
careful analysis.
The aggregator bank is a vehicle to remove 
toxic securities from banks so that the banks’ 
remaining balance sheets have a readily-as-
sessable value, enabling investors and coun-
terparties to be confident that solvent banks 
are indeed solvent. To limit the size of the 
public investment and to avoid putting tril-
lions of dollars in mortgage securities directly 
in  government  hands,  the  aggregator  bank 
obtains private capital to supplement govern-
ment capital, and it operates under a blend of 
public and private control.
essential elements of the aggregator bank
B
ank qualification. Banks apply to participate 
in  the  program.  Participation  comes  with 
a number of obligations including a high level 
of disclosure. Banks that are in such bad shape 
that rescue is futile fail to qualify. These non-
qualifying banks are handled through the stan-
dard process for taking over insolvent banks.
Securities  to  be  purchased.  The  Treasury 
identifies the set of securities eligible for pur-
chase by the aggregator bank. These include 
primary  mortgage-related  assets,  but  do  not 
include  derivatives  of  these  securities,  such 
as credit default swaps. Whole mortgages on 
Lawrence  M.  Ausubel  and  Peter  Cramton  are  Professors 
of  Economics  at  the  University  of  Maryland.  Their 
auction  proposal  and  experiments  relating  to  troubled 
assets  have  received  the  attention  of  the  Treasury  and 
policy makers, and can be found at www.ausubel.com and 
www.cramton.umd.edu.--
Economists’ Voice  www.bepress.com/ev  February, 2009
bank balance sheets, not yet securitized, may 
be bundled into bank-specific securities, and 
may be included as well.
Security  pools.  The  securities  are  grouped 
into a number of pools. Each security in a pool 
has  similar  default  characteristics.  Securities 
within a particular pool are close substitutes. 
The use of pools of related securities enhances 
price transparency and limits adverse selection.
Reference  prices.  Each  security  is  given  a 
reference price. This is the government’s best 
estimate of the current value of the security as 
a percentage of the face value, that is, “cents-
on-the-dollar.” The reference prices are deter-
mined from all the observable characteristics of 
the security, state-of-the-art valuation models 
and, when available, recent comparable trans-
actions. Reference prices are used to adjust for 
the relative differences in quality of securities 
within a pool.
Floor (guarantee). Each pool of securities is 
assigned a guaranteed floor, which limits the 
loss of the aggregator bank on the pool of secu-
rities. For example, if a pool has been assigned a 
60% floor, this means that the aggregator bank 
has been granted a government guarantee that 
the value of the pool will not fall below 60% of 
its purchase price; that is, the total loss on the 
pool is limited to 40% of its purchase price.
Public capital. This is the maximum amount 
of the aggregator bank’s public capitalization, 
assumed to be $50 billion here, that is assigned 
to a given pool. For example, $10 billion of 
public capital may be assigned to each of five 
security pools.
Private capital. This is the amount of capi-
tal offered by private investors, such as institu-
tional investors, hedge funds and the general 
public, to assist in the purchase of a given pool 
at a given price. For example, private investors 
may offer $20 billion of capital if the securities 
are purchased at 100% of the reference price, 
and this amount may increase to $30 billion 
if the purchase price is 95% of the reference 
price. In economic terms, this is the private 
demand for the pool of securities.
Ownership. The public and private owner-
ship shares of a security pool are in the same 
proportions as the public and private capital. 
Thus, if $10 billion of public capital is allocated 
toward a given security pool and if the private 
sector offers $20 billion of private capital for 
this pool then the public ownership share will 
be one-third and the private ownership share 
will be two-thirds. If necessary, the government 
limits public capital to assure that the public 
share remains below 50%, to avoid holding a 
majority interest in the aggregator bank.
Leverage of aggregator bank. The aggregator 
bank will sell bonds to leverage its capital. The 
leverage of each pool is not allowed to exceed 
a specified multiple of its capital for the pool. 
The multiple may be higher for a safer security 
pool, and lower for a riskier security pool. For 
example, a low-risk pool may have a maximum 
leverage ratio of 8, whereas a high-risk pool 
may have a maximum leverage ratio of 4. The 
leveraged funds would come from bonds is-
sued for the purpose. To further attract private 
capital, the government may facilitate the sale 
of the bonds through a subsidy of some kind, 
such as favorable lending terms.
Demand. Take the previous example of $10 
billion of public capital and $20 billion of pri-
vate capital at 100% of the reference price, and 
assume a leverage ratio of four-to-one for the par-
ticular security pool. Then the aggregator bank’s 
demand for this pool is (10 + 20) x 4 = $120 bil-
lion. If private capital increases to $30 billion at 
a purchase price of 95% of the reference price, 
then  the  aggregator  bank’s  demand  increases --
Economists’ Voice  www.bepress.com/ev  February, 2009
to (10 + 30) x 4 = $160 billion. The demand 
curve for each pool, including both private and 
public demand, is announced before the start of 
the pricing process for the particular pool. This 
announcement of demand motivates sellers to 
participate to sell their toxic securities.
Supply. Qualifying banks offer securities for 
sale in a competitive process. For each pool of 
securities, each bank offers a share of its hold-
ings of the pool it desires to sell as a percent-
age  of  the  reference  price.  For  example,  the 
bank may offer its entire holdings of the pool 
for prices at or above 105% of the reference 
price, but only three-quarters of its portfolio 
at 100% of the reference price, and one-half 
of its portfolio at 95% of the reference price. 
For each pool, banks are constrained to offer 
a particular fraction of their entire holdings of 
the pool of securities. That is, the bank cannot 
“cherry pick” by offering a larger quantity of 
one security that the bank believes is especially 
over-priced by the model that determined ref-
erence prices. This structure limits the adverse 
selection  problem  that  the  aggregator  bank 
faces in purchasing assets from better informed 
banks—the  tendency  of  the  banks  to  more 
eagerly offer securities that are overpriced.
Reference-price  auction.  Prices  are  deter-
mined  in  a  transparent  and  competitive  re-
verse auction. You may have thought that the 
Treasury was no longer considering the use of 
auctions. However, Secretary Geithner stated, 
“Our objective is to use private capital and pri-
vate asset managers to help provide a market 
mechanism  for  valuing  these  assets.”  Market 
mechanism means “auction.” The banks com-
pete to sell their portfolios of troubled assets. 
Here is what we mean by a reverse auction. Re-
lated pools are auctioned at the same time in 
a simultaneous descending clock auction. For 
each pool, there is a “price clock,” indicating 
the tentative price of each pool, as a percentage 
of the reference price. Bidders (the banks) ex-
press the quantities they wish to supply at the 
current prices. The price is decremented for 
each pool of securities that has excess supply, 
and bidders again express the quantities they 
wish to supply at the new prices. This process 
repeats until supply is made equal to demand. 
The tentative prices and assignments then be-
come final. As an example, if a pool clears at 
95% of the reference price and the reference 
price for the particular security is 65 cents on 
the dollar, then each bank offering the security 
is paid 95% × $0.65 for every dollar of face-
value that is sold. Details of the design are pre-
sented in a working paper we wrote last fall 
that is available online.
advantages of the aggregator bank
T
he  aggregator  bank  as  presented  above 
has several important advantages relative 
to TARP.
• Focused participation on the supply side. Bank 
participation is limited to those banks who 
appear strong enough to save. The securi-
ties purchased are limited to primary assets 
and whole mortgages, and not derivatives.
• Broad participation on the demand side. De-
mand consists of both public and private 
capital. Moreover, the private capital is not 
restricted in any way. This maximizes the 
money available to purchase the troubled 
assets.  The  floor  on  losses  of  each  pool 
motivates private capital to participate. Fa-
vorable lending terms may also be used to 
leverage private capital.
• Avoids adverse selection. The approach mit-
igates adverse selection by using reference 
prices, based on state-of-the-art modeling, 
and limiting each bank’s supply offer to a --
Economists’ Voice  www.bepress.com/ev  February, 2009
share of the bank’s holdings for the partic-
ular pool of securities. Mitigating adverse 
selection—the problem of buying more of 
securities  that  are  overpriced—protects 
both the taxpayer and the private inves-
tors in the aggregator bank. Importantly, 
reference  prices  play  a  limited  role—to 
account  for  differences  among  securities 
within a pool. Absolute prices are deter-
mined in the auction.
• Transparent price determination. Securities are 
purchased in a transparent and competitive 
reverse auction. This protects both taxpayers 
and private investors. In addition, and per-
haps more importantly, the process jump-
starts  the  secondary  market  for  securities 
by determining and revealing true market 
prices for each security. This price determi-
nation will create immediate liquidity in the 
securities, and push auction prices up from 
fire-sale prices to market prices that better 
reflect the hold-to-maturity value of the se-
curities.  The  competitive,  rule-based  pro-
cess also avoids discretion, and the resulting 
lobbying, favoritism, and corruption.
• Private  management  of  purchased  assets. 
Since the government remains a minority 
shareholder, the aggregator bank will rely 
primarily  on  private-sector  management 
of the purchased assets with the oversight 
of  the  government,  as  a  major  minority 
shareholder.
• Readily implemented. All of the elements of 
the aggregator bank are standard and well-
understood. The reference price approach 
has already been studied by the Treasury, 
since the fall. Also the auction methodol-
ogy is commonly used in practice and was 
experimentally tested in the fall by us.
The aggregator bank must have an explicit 
charter that limits what it can do. It can buy 
assets as described in its charter. It can manage 
the purchased securities, determining what and 
when to sell. It cannot engage in other invest-
ments or take positions in derivative securities. 
These limitations protect private investors, and 
help assure that the aggregator bank achieves 
its mission at least cost to the taxpayer.
Letters commenting on this piece or others may 
be  submitted  at  http://www.bepress.com/cgi/
submit.cgi?context=ev.
references and further reading
Ausubel,  Lawrence  M.  and  Peter  Cramton 
(2009) “No Substitute for the ‘P’-Word in Finan-
cial Rescue,” The Economists’ Voice, 6(2): Art. 
2. Available at: http://www.bepress.com/ev/vol6/
iss2/art2.
Ausubel,  Lawrence  M.  and  Peter  Cramton 
(2008)  “A  Troubled  Asset  Reverse  Auction,” 
Working Paper, University of Maryland. October 
5.  Available  at:  http://www.cramton.umd.edu/
papers2005-2009/ausubel-cramton-troubled-
asset-reverse-auction.pdf.
Ausubel,  Lawrence  M.  and  Peter  Cramton 
(2008) “Auction Design Critical for Rescue Plan,” 
The Economists’ Voice, 5(5): Art. 5. Available at: 
http://www.bepress.com/ev/vol5/iss5/art5.
Ausubel,  Lawrence  M.,  Peter  Cramton,  Emel 
Filiz-Ozbay,  Nathaniel  Higgins,  Erkut  Ozbay, 
and Andrew Stocking (2008) “Common-Value 
Auctions with Liquidity Needs: An Experimen-
tal Test of a Troubled Assets Reverse Auction,” 
Working Paper, University of Maryland. Decem-
ber 14. Available at: http://www.cramton.umd.
edu/papers2005-2009/acfho-common-value-
auctions-with-liquidity-needs.pdf.

Making Sense of the Aggregator Bank

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