NPLs: a lemon market?


The title of the article recalls and refers to an intervention made during the recent NPL Meeting held in Venice, which compared the NPL market with the economic theory of the lemon market.

This reference will be familiar to those who have studied these issues at the university: to help the other readers (including the author of this paper, who was curious about this quotation) understand, this theory can be attributed to George Akerlof and appeared for the first time in 1970 in one of his article. In short, it explains  how, in case of information asymmetry between the seller and the purchaser in a market, there are essentially two stages:

– in the first stage, the seller will offer products with a poor quality, taking advantage of the inadequate information provided to the customers;
– at the same time, the seller will be deferred from removing high quality lemons from the market, knowing that the market will not pay a premium price for the same reasons described in point 1;
– in the second step, the buyer realises that quality in that market is an uncertain data and high quality lemons do not remain on the market booth, therefore the buyer stops purchasing lemons, thus putting an end to this market.

Obviously, this theory is more complex and I have opted for a simplification. The author makes other examples (used cars, refined food) but does not mention the NPLs.

This comparison was undoubtedly smart and noteworthy; however, in our opinion, there are no grounds for this to happen in the NPL market, at least for three reasons:

1) The NPL market is currently characterised by an excess liquidity; some asset classes are growing into a bubble. Nowadays, buyers are too busy investing money to understand the intrinsic (asset quality) , this problem will be faced at a later time;

2) information asymmetry is basically due to the data bases originally kept by banks. The substantial difference over the lemon theory precisely lies in the fact that, considering the shortage or lack of data, NPL buyers offer prices below the average threshold to protect themselves. Generally, NPL buyers are as patient as the housewives at the market booths;

3) the market data quality is clearly improving thanks to a strong change of direction involving the banks, as well as to the work of the servicers engaged in the purchase and assessment processes.

In many cases, sellers and buyers are already able to distinguish between good and bad lemons; with reference to mortgage loans, the discussions have revolved exclusively around good lemons so far.

Emanuele Grassi

 

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