Originally, it was meant to smooth out short-term liquidity and financial needs via overnight & 30-60 terms, but there were situations where contracts could be 'open ended' eg 1-2 years. Where it's gone crazy (IMHO) is Congress added, during last fall's hysteria, a bunch of new ares like commercial paper, money market funds, etc that qualify under this program.
That, dear readers, is how the Fed magically increased reserves by a $1-2T in just the last few months. That is, a lender bank provides $10-50B or so of toxic mortgage backed securities that the Fed takes as collateral for a comparable fund infusion. Simple as that, no?
Well, if it's that simple, why bother with the $1T pork bill currently working its way through Congress? Because the bank doesn't spend the money directly - it's supposed to lend it. But because we are in a deflationary spiral, no one is borrowing/lending right now, so they're sitting on these reserves. ( Btw, this is called 'velocity'. If you are holding out in the expectation of getting a better deal as prices drop, or are waiting to enter into a loan to buy a house/car, start a business, etc, you are helping reduce velocity.)
But even the Fed has its limits, which is why Congress is entertaining the 'bad bank' concept. Instead of using interbank Fed processes, .gov will just go out and buy a couple $T or so of bad assets so that the banks are left with 'good assets' in which to restore solvency. An astute person at this point has probably identified the risk with these plans: it socializes the cost of holding these bad assets with the backing of the US gov't.
If you agree with Denninger that real estate needs to come back to 3-4x income in order to provide an sustainable market, then these asset values won't come back for a long, long time. In addition, if you agree with Mish that the consumer model is dead, then we're not going to see another credit expansion boom in which to also raise asset values.
IOW, we've bet the farm on two losing propositions in an effort to stop the debt-deflation cycle. That's why we're not seeing hyper-inflation - normally, what Bernanke is doing would fuel crazy price increases; instead, things are bumping along because whatever he is doing is being more than offset by the credit unwind.
So there you go. Also, one other thing: conspiracy guys think Bernanke & Co. are helping our their buddies by buying these assets to help them keep their jobs, get their bonuses, receive kick-backs, you name it.
Hyper-inflation is still on the horizon. Printing more bills for wealth that doesn't exist, and never existed in the first place, ensures this. Bank on it...