How do you auction money?

Question

Like the Federal Reserve is doing. How does it work?

Answer 1

This is going to be a simplified explanation.  A true explanation would probably be much too long for Yahoo!Answers.  The auction feature is mainly a function of a central bank like the Federal Reserve.  It is just one of many methods of increasing the money supply.  

Banks may run short of cash because they have loaned out all of the amount they are allowed.  This causes a short-term credit crunch where businesses and people are not able to obtain the credit they need.  When this happens, interest rates rise and stifle growth.  In order to avoid credit crunch problems, the Federal Reserve offers short-term loans in the auction.  To do this, the Federal Reserve offers an amount of money at a certain interest rate.  Banks make counter offers and the Federal Reserve accepts the offers that meet its intended purpose.  The Federal Reserve increases the bank accounts of the banks that won at the auction.  Since these banks now have more cash, they can now make loans to businesses and people that need them.

Since the loans are short-term loans, once the banks get additional funds because of loans they made maturing or additional deposits, they pay back the Federal Reserve.

Answer 2

In response to the credit crisis, the Federal Reserve came up with a new vehicle called "Term Auction Facility".

In simplest terms, these are "$10M 30-day loans" which are put up for auction o despository institution (DI) . The bids are in the form of interest rate that the DI is willing to pay. So the DI with the highest bid interest rate wins.

So why was TAF created when banks could already borrow from the Fed using the Discount Window?

The Discount Window had a stigma. As the lender of "last resort", a bank going to the Fed for a loan was considered in trouble. So banks avoided using, even during these tough times.

So the Fed came up with TAF which made it more respectable to borrow from the Fed. Rather than banks coming up 'hat in hand' begging for loans, this is represented as a straight business deal.

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Results of the December 17th auction:

On December 17, 2007, the Federal Reserve conducted an auction of $20 billion in 28-day credit through its Term Auction Facility.  Following are the results of the auction:

Stop-out rate: 4.65 percent

        

Total propositions submitted: $61.553 billion

Total propositions accepted: $20.000 billion

Bid/cover ratio: 3.08

        

Number of bidders: 93

(Ref: http://www.federalreserve.gov/newsevents... )