Asset Sales and Financial Distress

5 July 2011 at 10:47 pm Peter G. Klein 5 comments

| Peter Klein |

“What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom,” Adam Smith famously observed. I noted in an earlier post on raising the debt ceiling that restructuring US government securities is hardly the “nuclear” option it’s portrayed in the pundit world; bankrupt firms, like bankrupt families and firms, restructure their debt obligations all the time. The notion of T-Bills as a sort of sacred relic, to be once and forever “risk-free,” seems more like religion than economics to me.

But, more important, there is another option for entities struggling to make their interest payments: asset sales. Just in the last couple days Bob Murphy, David Friedman, and Steve Horwitz have made this point. Public discussion on the US debt crisis assumes that the only options for meeting US debt obligations are increasing taxes, cutting spending, or both. But asset sales are another viable option. There’s a huge literature on this in corporate finance (e.g., Shleifer and Vishny, 1992; Brown, James, and Mooradian, 1994; John and Ofek, 1995), exploring the benefits and costs of asset sales as a source of liquidity for financially distressed firms. Of course, selling assets under dire circumstances, at fire-sale prices, is far from a first-best option but, as this literature points out, often better than bankruptcy or liquidation. (One of the best-known results, from John and Ofek, is that asset sales tend to increase firm value when they result in an increase in focus. Would it really be so bad if the US government sold off some foreign treasuries and currency, the strategic petroleum reserve, its vast holdings of commercial land, and other elements of a highly diversified, and unaccountably bloated, portfolio?)

Entry filed under: - Klein -, Financial Markets, Myths and Realities, Public Policy / Political Economy.

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5 Comments Add your own

1. Mathieu Bédard | 6 July 2011 at 7:21 am

Aren’t fire sales mostly due to adverse selection regarding the content and risk of the assets, and the fact that they’re likely taking place when potential buyers are also financially distressed or at least having severe problems? It seems to me like there isn’t much asymetry of information around the type of assets you mention and that the potential buyers are not especially threatened right now. I don’t see why a fire sale would take place.
2. Peter Klein | 6 July 2011 at 8:51 am

That’s one explanation for fire-sale prices, yes, but not the only one. In Shleifer and Vishny, it has to do with the industry-specific nature of the underlying shocks (meaning that potential buyers are also financially distressed). In any case, my point wasn’t about the asset prices, but just the fact that shedding assets is an obvious way for financially distressed entities to increase their liquidity, and that part of the story seems to apply pretty well to the USG!

I should add that there are obvious agency-theoretic and property rights reasons to limit the ability of government officials to sell assets, particularly in “normal” times. Bob Murphy’s piece linked above helpfully cites Mises’s discussion in Bureaucracy on this point. I also emphasize it in my 2010 EMR paper with Mahoney, McGahan, and Pitelis.
3. Alternative Debt Solutions: Intergovernmental Debt and Asset Sales | MyGovCost | 6 July 2011 at 8:51 am

[…] way to deal with the debt crisis is to cut spending, increase borrowing, or raise taxes. But as Peter Klein, David Friedman, Steve Horwitz, Bob Murphy, and several others are pointing out — the […]
4. Jim Chappelow | 7 July 2011 at 6:24 am

I made most of the same points last time I was on talk radio back in April. Here.

It’s also worth noting that the amount they’re spending on the “contingency operations” in Iraq and Afghanistan alone could just about fund the Treasury’s debt service needs, and it’s apparently well within the administration’s power repurpose these funds as we’ve seen with the Libya debacle.
5. Michael Marotta | 7 July 2011 at 7:22 am

This USGS link lets you see the federal lands.
http://www.nationalatlas.gov/mld/fedlanp.html
You can select an area and many other options. I zoned in on Michigan and included the Map Key to see the federal spaces here – Forest Service, Fish and Wildlife Service.