Baseball Trading Economics 101
As we enter the off-season with few marquee free agents on the market, the talk around baseball will start to revolve around potential trades. Fans, sportswriters and even real life GM's will start thinking about what they would be willing to offer other teams to get them to part with their stars. As George Costanza once mused, "I think I got it. How 'bout this? How 'bout this? We trade Jim Leyritz and Bernie Williams, for Barry Bonds, huh? Whadda ya think? That way you have Griffey and Bonds, in the same outfield! Now you got a team!" Unfortunately, a significant number of fans, sportswriters (and even the occasional GM) don't understand the basic rules that govern (or at least, should govern) trade value in baseball. So before the Mets go trading Jose Reyes and Mike Pelfrey for Johan Santana and Jason Bartlett, it is time to learn about the concept of lease equity.
Lease equity is, in a word (OK two), the easiest way to understand the trade market and assure that your team isn't selling its future for a short-term rental (yes, I am thinking of you, Houston Astros, for trading Jason Hirsh, Taylor Buchholz and Willy Taveras for Jason Jennings). The concept is simple, every player under contract has a certain value, in dollars, which is a function of the length they are under control and the amount of money they are owed. To figure out lease equity, you simply determine the difference between the relevant term of a player's contract and what that player would receive (or you, as the GM, would be willing to pay the player) as a free agent on the open market. So, if a player has a two-year contract for $10 million, but would likely get a two year contract for $15 million, that player has a lease equity value of $5 million. Significantly, lease equity value need not be positive. An albatross of a contract has negative value and, accordingly is only moveable as part of a salary dump. Indeed, a star can have negative lease equity value, as evidenced by the unwillingness of any team to pick up Manny Ramirez's contract a couple of years ago when he was left on waivers.
Under this scenario, it is clear that the most valuable commodity is a young star player locked up for multiple years. Indeed, a superstar at $15 million can have the same lease equity value as a replacement player at league minimum. Which brings me to an important concept, lease equity is not the same as quality. Having a team with lots of valuable commodities doesn't mean you will have success. Just ask the Florida Marlins, who have some great inexpensive players and not much success to show for it. Conversely, a team full of pricey veterans, think the Yankees, can be a powerhouse without a lot of contributions from its players with the most lease equity. A market priced Bobby Abreu or A-Rod added more to the Yankees success than guys like Joba, Hughes, Cabrera or Cano. What having a player with a positive lease equity value does is twofold: a GM can use that "saved" money elsewhere to improve his team within his budget or, alternatively, he can trade that value for other players who may have more value (as a player) or are a better fit for his team.
There are some other concepts that need to be understood, before we start figuring out how lease equity affects trade scenarios. The first concept is that control (i.e., the lease) is the key to value. Even if an arbitration eligible player does not have a contract for the next year, as long as his estimated value is higher than his probable salary (likely based on the arbitration rules), that player has positive lease equity value. The trick, of course, is estimating his salary and his likely free agent value.
The second issue to note is that lease equity value is market based. Unless a free agent takes a home town discount (which is rare because when a player signs an early extension, he is not really providing a discount but trading upside for security, just ask Chris Carpenter and the Cardinals), a free agent's lease equity is zero at the time he is signed. If the market determines that Gary Matthews or Juan Pierre is worth $50 million for 5 years, that is the market for a mediocre center fielder, irrespective if it is a "good" deal. The market is "right," because it constrains what a GM can do with his money or the lease equity value of the players he controls, the two primary assets that a GM has in building a team. Other signings also provide a good jumping off point for determining the values of players who are years from the market, like a Grady Sizemore (worth a lot more annually than Pierre or Matthews) or Lastings Milledge (probably fairly comparable).
The third issue to consider affects the way that "likely salary" is estimated. At this point, it's not unreasonable to assume that, if he hits the market a year from now, Johan Santana will command a six year $150 million contract. But $25 million a year is not the right number to plug in to determine his value in a trade right now. Santana is under contract for one year now at $13.25 million. If he went on the market and sought only a one year contract, he may well receive $30 million or higher. The reason for this is simple. As a one-year bet, the team takes a much smaller risk in terms of injury and future performance than with a long-term contract. Thus, a team would pay more, per year, for a shorter contract. After that, the player is still presumably available at market rate and the team can evaluate its needs then. Also, draft pick compensation if he leaves is also of some value. In other words, for evaluating trades, the shorter the remaining contract, the higher the assumption that needs to be made with respect to the per year annual salary.
The fourth issue to keep in mind is that, for prospects and young players, it may be hard to make a good estimate of future performance and reasonable minds may, and usually will, differ. That is how some players become busts and some trades for prospects go down as the worst in history. But just because it's hard, it doesn't mean it's impossible. The ability to project prospects is a cottage industry these days. Additionally, prospects are almost never likely to have negative lease equity value because if they fail, they will never cost much, and the option value of them being major league contributors can be estimated. Recognizing diamonds in the rough (think Terry Ryan getting Francisco Liriano as a throw-in for Pierzynski), is thus incredibly valuable to a team.
The fifth issue to note is that lease equity value in a contract may differ from team to team. When a player signs a free agent contract, the team that has the most need and willingness to meet that price makes the payment, thus establishing the value at the top. Based on market conditions, competitiveness and other factors, lease equity value in a trade can differ from one team to the next. The Mets might pay $35 million for one year of Santana, the Dodgers $30 million and the Royals $15 million. Those numbers factor into any offer that is made. Because lease value is subjective, each GM can determine it for his team separately.
The sixth issue to keep in mind is that lease equity value is a blunt instrument. Because we never know what a player will get on the open market (think of the collective reaction to Gil Meche's contract), the best we can do is estimate within a couple of million dollars. This may sound real rough, but when you factor in real numbers, you can see that it does not prevent appropriate consideration of trades. Also, because it is an art more than a science, there is no need to discount back the dollars in a salary or for determining equity value.
So What Is Santana Worth
Now comes the fun part, let's talk trade and value.
If the Twins decide they can't re-sign Santana this Winter, he will probably be the best player traded this Winter. As noted, he is set to make $13.25 million, at which point he will be a free agent and then may be acquired for "only" money at the market rate. For argument's sake, I am willing to say that if Santana was looking for only a one-year deal this offseason, he may fetch over $30 million. So let's assign a lease equity value to him, optimistically, at $20 million. Now, here in New York, no doubt based on his subpar September there are already beat writers and some fans talking about including Jose Reyes in a trade for Santana. Reyes is signed, including options, for the next four years (including an $11 million option in 2011) for $29.5 million. If Reyes were to be a free agent, for the four years covering his age 25-28 years, I think he likely would get $19-20 million per year, if not more, leaving him a lease equity value at around $45-50 million, far more valuable than a single year of Santana. (Note that I assume fairly high values for young players. This is because, unlike most free agents, if they were to sign today, a GM would be able to buy the peak years, whereas for most free agents, they are already at or past their peak.) It is also hard to see how the Yankees could give up the likes of Phil Hughes and Joba Chamberlain, or the Dodgers to part with Kershaw, Billingsley and Loney for one year of Santana. Of course, trades are made in a market, and if the Dodgers are offering multiple players with high lease values like Kershaw, Billingsley and Loney, then the Yankees better offer a more valuable group if they expect to complete the trade.
But Santana is not the most valuable pitcher likely to be the subject of off-season rumors. Dan Haren is under control for the next three years (including options) for $16.25 million. Considering Barry Zito's contract, three years of Haren is probably a safe bet to cost $60 million. That $45 million or so in value is, at minimum, a sign to any thinking GM that, before pulling the trigger on the winning bid for the Santana sweepstakes, he should see if Billy Beane will take that package for Haren. The other A's pitchers likely to be the subject of rumor, Harden (under control for 2 years at $11.5 million) or Joe Blanton (three years of ML service, so three years of control subject to arbitration eligibility) will be much better deals for the budget-minded trader. Indeed, Harden, with his injury history, probably wouldn't get much more than two years at $15 million total (although he could outperform that significantly), indicating that he is not nearly as valuable to most teams. If Beane gets offered Milledge or Clayton Kershaw for him, he should probably jump at it.
Long gone are the days when, because of the reserve clause, a GM would make a trade based on the pure baseball talent of the players at issue. Today, dollars are the primary mover of trades, whether it is in a salary dump or a trade of a bargain player that will soon become unaffordable as a free agent. Whether consciously or unconsciously, lease equity value appears to inform the thoughts of most GMs making trades. Even rich teams, like the Mets and Yankees, have recently refrained from doing whatever possible to bring in top talent, instead recognizing that young, under-control players are the coin of the realm in today's baseball market. Remarkably, most journalists and fans don't think this way, as is clear when they talk about what it will take to get Santana. But GMs know they have budgets and that they can't just give away young cheap talent in exchange for market rate stars and expect to succeed in the long run. As long as a GM is mindful of the value he controls and the market for players, he will be able to get the most out of his resources. And, next time you hear that it the Twins are "demanding" Grady Sizemore for Santana, calmly know that Mark Shapiro and the Indians, if they have any sense, are not going to bite.
Doug Baumstein is a New York City lawyer and Mets fan.