Auction Basics: Background for Assessing Proposed Treasury Purchases of MortgageBacked Securities

"To address the turmoil in financial markets, the Emergency Economic Stabilization Act (EESA; H.R. 1424, P.L. 110-343), enacted on October 3, 2008, authorizes purchases of "troubled assets." The act passed the Senate on October 1, 2008, passed the House on October 3, 2008, and was signed into law the same day. The Administration proposed using reverse Dutch auctions to purchase troubled assets -- primarily mortgage-related securities from financial institutions. In reverse Dutch auctions, a buyer purchases multiple objects from private parties at a price set by the last accepted bid. The government has used reverse auctions since the Revolutionary War. Designing efficient reverse Dutch auctions may present some tradeoffs between enhancing competition among bidders and overpaying for assets relative to their quality. Careful auction design, however, can help minimize these problems. Auctions are especially useful for selling assets whose value to potential owners is unknown to the seller. Reverse auctions are useful when a buyer does not know what value sellers place on assets. Auction results could clarify the market value of troubled assets." Source: Congressional Research Service

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