How does a Reverse Auction Help Banks?

Banks are in desperate need of capital and the Paulson proposed bailout plan is looking like it will buy distressed assets using a reverse auction mechanism. Capital, if you’re unaware, is things like deposits, CDs, savings accounts, equity, and cash on hand. The amount of capital limits the amount you can lend. Giving banks more capital (by allowing them to sell distressed assets) will allow them to lend, easing the credit crunch.

So, How Does a Reverse Auction Work?

A purchaser organizes the auction, first by setting the time, place, and the type of good or service that will be purchased. Sellers arrive and bid downward during the auction the amount they’re willing to provide their good or service at. Once completed, the lowest price good or service is purchased. A similar mechanism is used for Bid & Proposal work for the government and contracting.

Banks don’t want to sell at these prices, will they participate?

Ultimately, we’re going to have to overpay for the first few auctions if we want to attract banks to the facility. After that, it will only matter if banks are willing to participate at the prices the facility grants and willing to go along with the terms imposed by the final version of the bailout bill. Now, if these auctions are combined with some form of equity infusion such as preferred stock sales, then we might see banks participate to get the equity and unload the mortgages. The combined cash and equity will give them more operating capital to work with at the expense of existing shareholders.

Ultimately we’re going to just have to wait and see if banks come to the facility to play ball or not as well as what terms ultimately get tacked on to the bill.