To address the turmoil in financial markets, Congress passed and the President signed the Emergency Economic Stabilization Act (EESA; H.R. 1424 , P.L. 110-343 ) on October 3, 2008. Well-designed auctions can help price such assets in an efficient manner. In mid-January 2009, Congress declined to block a Presidential request to release the second tranche of $350 billion in TARP funds. According to some experts, market pricing of such assets implies that reverse auctions would play an important role in the plan. In early February 2009, the chair of the EESA Congressional Oversight Board expressed concern that the Troubled Asset Relief Program (TARP) had overpaid for assets it had acquired. Dutch Auctions and Reverse Dutch Auctions

In early October 2008, the Bush Administration proposed using reverse auctions to purchase mortgage-related securities from financial institutions, which are similar to the multiple-unit Dutch auctions that the Treasury uses to sell government securities. While the Bush Administration focused on other strategies to address continuing financial turmoil, a "Financial Stability Plan" outlined by President Obama's Treasury Secretary, Timothy Geithner, may include reverse auctions as part of the proposed "Public-Private Investment Fund." In reverse multi-unit Dutch auctions, a buyer (e.g., the U.S. Treasury) buys a given number of units from private parties (e.g., financial institutions) at a price set by the last accepted bid. Auctions provide a means of selling objects whose value to potential owners is unknown to the seller. A large research literature in economic theory and experimental economics examines how different types of auctions work. Designing 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. Quality Differences of Troubled Assets Presents Challenges for Auctions

As noted above, federal stakeholders bear the costs of risks caused by uncertainty about the value of troubled assets and by the possibility of overpaying for assets. The diversity or heterogeneity of troubled assets may present challenges to the Treasury auction program. Similar problems may occur with reverse Dutch auctions used to buy troubled assets. The reverse Dutch auctions used by the Treasury would need to be adapted to buy highly diverse and relatively small-volume securities, whose characteristics may not be well understood by many buyers. Reverse Dutch auctions may therefore be vulnerable to adverse selection, meaning that the average credit quality of submitted assets of a given type may be systematically worse than the average credit quality of all assets of that type. Auction mechanisms, however, might be designed that could mitigate these adverse selection problems. The reverse auction program essentially swaps Treasury securities for troubled mortgage-backed securities. If the prices at which Treasury securities are exchanged for troubled assets are close to current market prices for those assets, then financial institutions may gain liquidity, but might not receive much additional capital. Some economists have argued that other means of injecting capital into the financial sector, such as purchases of preferred stock or capital injections balanced by equity warrants (i.e., options to claim an equity stake), might be a better strategy. Auctions may capture higher revenues for governments and can allocate scarce resources more efficiently than traditional methods. Different policy issues, however, may require different types of auctions to achieve reasonable results.
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. While the last Bush Administration Treasury Secretary, Henry Paulson, initially proposed using reverse Dutch auctions to purchase troubled assets—primarily mortgage-related securities from financial institutions—he soon chose to shelve the reverse auction program. A "Financial Stability Plan" outlined by his successor, Secretary Timothy Geithner, may include reverse auctions, according to some experts. Much of this plan would require Congressional authorization.
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. The price discovery properties of auctions could stimulate trading by reducing private traders' uncertainty about the value of troubled assets. The EESA Congressional Oversight Board expressed concern over asset pricing in the Troubled Asset Relief Program (TARP). Well-designed auctions can reduce the chances of overpaying for assets.
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.
A reverse auction program essentially swaps Treasury securities for troubled mortgage-backed securities. If Treasury securities are exchanged for troubled assets at prices close to those assets' current market prices, costs to the taxpayer would be minimized. Financial institutions, however, may gain some liquidity, but might not receive much additional capital. Some economists argued that other means of injecting capital into the financial sector, such as purchases of preferred stock or capital injections balanced by equity warrants (i.e., options to claim an equity stake), would be a better strategy. Since passage of EESA, the U.S. Treasury has been working to design methods to inject capital into firms and restore market liquidity. In mid-January 2009, Congress declined to block release of the second tranche of $350 billion in TARP funds.
The heterogeneity of troubled assets may present challenges to the Treasury auction program. The reverse Dutch auctions would need to be adapted to buy highly diverse and relatively small-volume securities, in a way that minimizes risks of trading manipulation. Reverse Dutch auctions may be vulnerable to adverse selection, meaning that the average credit quality of submitted assets of a given type may be systematically worse than the average credit quality of all assets of that type. Auction mechanisms might be designed that could mitigate these problems.
Recent academic research in auction theory and in experimental economics has examined how various types of auctions work. Auctions may capture higher revenues for governments and can often allocate scarce resources more efficiently than traditional methods of selling or purchasing. Different policy problems, however, call for different types of auctions. Government economists involved in designing reverse auctions to buy troubled assets have drawn upon academic research and internal Treasury research. This report will be updated as events warrant.