A proposed method for Treasury to buy toxic assets comes with caveats.

The Treasury needs to avoid overpaying, but if its auction mechanism ends up pricing securities too low, it may invite the disaster it seeks to avoid. If firms unload a bunch of securities at fire-sale prices, any firms that continue to carry similar assets will be forced to write down their values in accordance with the auction's outcome. This would erode an already fragile capital base in the financial industry, restricting the ability of financial institutions to borrow and lend.

The architects of the auction have to walk the fine line between fire-sale and taxpayer ripoff. This is an interesting problem for auction engineers, who are typically hired to tease out the most value from an auction. In a reverse auction, that means giving the sale to the seller with the lowest willingness to sell (or reservation price). Generally, open bidding offers the best way to achieve this outcome. Sellers see rival bids throughout the auction and can therefore lower their bids without fear of selling for way less than anyone else's reservation prices. The open process typically pushes seller bids closer to the lowest reservation price than alternative schemes.

In the Treasury's case, the lowest possible price is not necessarily a good thing, so auction engineers may look for ways to pad bids without encouraging excessively high prices. Some sort of sealed-bid reverse auction might achieve this goal.

In a sealed-bid reverse auction, the sellers would not see one another's bids. They will therefore fret over the prospect of the Winner's Curse: winning the auction only to find out that they're selling securities to the Treasury for way less than the next lowest bidder was willing to accept. The prospect of the Winner's Curse would keep financial institutions from offering their true reservation prices, potentially preventing a destabilizing fire-sale.

The particulars of the auction design are an important and open question. Let's hope the Treasury hires mathematicians and economists that are up to the task.

Explainer thanks Chris Makler for help with this article. For a fun read on auctions, and markets in general, check out the late John McMillan's Reinventing the Bazaar.