The idea behind SecondMarket Inc.'s plan to revive trading of illiquid assets that have been weighing on bank balance sheets could be summed up with a Woody Allen line: Ninety percent of life is just showing up.
The New York company — which employs former Federal Deposit Insurance Corp. Chairman William Seidman as a senior adviser — plans to begin auctioning collateralized debt obligations and private-label mortgage-backed securities through its online market this quarter.
To entice prospective buyers, it will have the sellers offer to pay some of the proceeds from any sale to some or all of the losing bidders.
The idea is to create an "economic incentive" for buyers to spend time researching these particular assets at a time when the global market meltdown is creating competing bargains, said Barry Silbert, the privately held SecondMarket's chief executive. Even if some bidders participate primarily for the fee they would get for participating, they will help "establish a floor price" for the assets.
Policymakers once again are discussing government purchases of troubled assets. In a speech this month, Federal Reserve Board Chairman Ben Bernanke said troubled assets are a barrier to private investment in financial companies and may be inhibiting lending. He identified direct government purchases, asset guarantees, and the creation of a "bad bank" as possible solutions. FDIC Chairman Sheila Bair has expressed strong support for the idea of a bad bank.
Mr. Silbert said that if the government bought assets, either directly (as originally contemplated under the Troubled Asset Relief Program) or by creating a bad bank, his company could play a supporting role.
The government would likely demand limits on executive compensation or warrants in exchange for relieving bankers of their hard-to-value securities, he said. For companies that did not want to accept such onerous terms, SecondMarket could serve as "an alternative market to the government." In doing so, it would bring in private capital, so that the market is "not relying on the government to be the only buyer."
At the same time, he said, the auctions could "help serve as a price discovery tool for the government purchases."
Once the government has bought the assets, Mr. Silbert said, SecondMarket wants to be "the primary venue" for their disposition, since a market functions best with a network of buyers and sellers all in one place.
He acknowledged that the Resolution Trust Corp. (where Mr. Seidman also served as chairman) "used a lot of different agents and vendors to sell" the assets it picked up from failing thrifts. However, "in this age, through technology and through what we've built, there's no reason you'd need to have multiple different venues."
(An exception would be nonfinancial assets, such as real estate, which fall outside SecondMarket's purview, Mr. Silbert said.)
Founded four years ago, SecondMarket has brokered 2,000 transactions involving other types of illiquid assets, including corporate bankruptcy claims and restricted stock in public companies. It has sold assets with a face value of about $1 billion, though at their discounted prices the proceeds to sellers were in the range of $600 million to $750 million. The company's commission ranges from 2% to 5% and is typically split between the buyer and seller.
SecondMarket has a track record of facilitating sales of another kind of asset that has bedeviled bankers lately: auction-rate securities. Mr. Silbert said they accounted for about half of the transactions SecondMarket brokered last year.
Under settlements with regulators, financial companies like UBS AG and Citigroup Inc. agreed to repurchase tens of billions of dollars of auction-rate securities from investors who could not unload them when the market froze last year. In the third quarter, Citi recorded more than $600 million of market-related charges associated with the repurchases.
SecondMarket has applied for a patent on its idea for paying bidders simply to participate in auctions. To make sure that only serious, willing buyers participate, it will not allow losing bidders to collect participation fees they have earned until they purchase something else through SecondMarket.
"The fee stays with us until you've completed your first transaction," Mr. Silbert said.
In addition, a prevailing bidder who fails to complete a purchase can get kicked off the system — this has happened a few times since SecondMarket's inception.
Sellers will be able to set a minimum bid and a "reserve price" — a minimum acceptable bid whose amount is not known to the bidders. (They will know that such a price exists.)
Other companies are also trying to unclog the markets. Debt Exchange Inc. and First Financial Network Inc., for example, arrange the online sale of distressed loans for the FDIC.
Market observers said they had not heard of an auction structure like the one SecondMarket envisions.
"My first reaction was 'huh?'" said Lawrence J. White, the Arthur E. Imperatore Professor of Economics at New York University's Leonard N. Stern School of Business. He likened the fee for failed bidders to offering free coffee to people who show up for an auction — with the catch that they must eventually buy something not to have to pay for the coffee.
Upon further reflection, Prof. White said, "If these assets do come into an RTC-like organization, this may be one way of disposing of them. Any mechanism that can start a liquefying, price-discovery process sounds great."
SecondMarket plans to let providers of research and valuation services advertise their wares on its Web site for free. The company would get a commission for any sales these ads generate, but Mr. Silbert said the main purpose is to make analytical tools available for buyers to arrive at valuations.
Just as eBay Inc. spawned companies that sell boxes and bubble wrap, SecondMarket wants to create an "ecosystem" around its market, he said. "There are a lot of smart folks out there who have been laid off and are looking for something to do."
Over time, Mr. Silbert said, as the markets become more liquid, the fees paid for participating in the auctions could decline; the securities could later be sold through regular auctions, and eventually they would not need auctions at all. "Ultimately, we will see competitive bidding."
He said his company has yet to talk to any prospective sellers, though since it is free to put assets up for sale on its system — SecondMarket gets paid only if a sale is made — he expects strong interest, as sellers have nothing to lose should an auction fail.
He acknowledged that whether sellers will be willing to accept a fair market value is still "hard to estimate."
