Auction Rate Securities: Still Frozen After All This Time

Posted by John Carney, Mar 25, 2008, 9:50am

More than a month after the trouble started, much of the auction rate securities market remains frozen, leaving hundreds of millions of investor dollars locked-up in illiquid securities. No-one has come forward with a solution, and there is little hope that the market will unfreeze anytime soon. Brokers have offered to loan money to clients with frozen money but this has provoked outrage from customers who are being asked to pay a premium by the same brokerages that led them to invest in the frozen securities in the first place. And most brokerages are refusing to do what many customers demand: buy-out the customer positions.

Joe Mysak at Bloomberg reports that the problem stretches much deeper into the investor world than many suspected.


I'm still getting e-mail on this situation. Closed-end- fund, preferred-share holders, at least the ones I've heard from, are livid at the fund companies and feel betrayed by their brokers. I find it very odd that the fund companies and the brokerage houses feel that they can alienate this crowd.

Who buys auction-rate securities? It's not just ``the rich.'' I've heard from self-employed people who thought it was a good, temporary place for their life savings, at least until they decided what else to invest in. I've heard from people who sold businesses and put the money there, and from people who inherited some money and did the same.

The amount of money ranges from $50,000 to several million dollars. In each case, the investors say they were advised by their brokers that their money was in a cash equivalent. The investors rarely looked at prospectuses.

He also notes that if the market for these securities ever does come back, we can expect a lot more regulation.


Auction-Market Investors Look to Regulator for Hope [Bloomberg]

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Posted in: Auction Failure, Auction Rate Securities

Comments

Posted by guest, Mar 25, 2008 10:17AM

I might be missing something here but aren't people who are 'locked into' these securities earning some outlandish interest rates on their investment? I can understand broker dealers having issues with having funds stuck in illiquid securities which need to be marked to market but why should it matter to individual investors (as long as they are reasonably assured that the funds WILL come back at some time)!

Posted by guest, Mar 25, 2008 10:19AM

a number of brokerage firms are offering loans against ARS not at a 'premium'. in fact most cases loans are being offered against this illiquid garbage at a low loan-to-value at a discounted interest rate that puts the clients cost to borrow much lower than the yield on the illiquid securitiy itself. While horrible and inconvenient to be stuck in an illiquid investment, at least the yield is still considerably higher than the loan interest to borrow against the investment. still making more money than you could be selling the ARS

Posted by guest, Mar 25, 2008 10:20AM

it is a big problem if a business put their entire cash management business in auction rate securities that they cannot sell, and therefore cannot meet those mundane details like contract payments, payrolls, and taxes. that is the big deal

Posted by guest, Mar 25, 2008 10:21AM

I don't think the issuers who are paying the painfully high penalty rates are particularly happy either.

Posted by guest, Mar 25, 2008 10:27AM

For some folks a big issue is that they need their "cash" to pay taxes. Now that they realize what was sold to them as cash isn't, they are pissed. That their broker is now magnanimously offering to loan them money doesn't really cut it. That the brokers aren't making people whole on this shows how strapped their firms are too.

Posted by guest, Mar 25, 2008 10:27AM

Damn. I wish they would let me into the ARS market. I would GLADLY park 100 grand with Porth Authority @ 15%.

Posted by lasherm9, Mar 25, 2008 10:33AM

The increase in penalty rate paid by the fund companies range, for most CE funds, range from 0.1%-0.5% higher than LIBOR. I wouldn't call this outlandish. Also, many investors were sold this POS as "cash equivalents" and required immediate access to their cash. Imagine going to your bank to liquidate your CD and they tell you that it has turned into a 50 year bond that that no one will buy.

Posted by golden girl, Mar 25, 2008 10:34AM

@10:17 - no. Some of the PARS had high fail rates (to the tune of 15%) but many had fail rates pegged to short term LIBOR or commercial paper (for example, 85% of the short term LIBOR, or CP + x basis points). As these rates have fallen, some investors actually found themselves getting lower coupons than they were getting when the auctions were resetting.

Furthermore, the high failure rate notes were mostly snapped up by institutional and foreign investors, leaving those who happened to hold these less attractive notes stuck in them. It basically split the market into two.

The other thing to keep in mind is that these failure rates were not components of the bond that were taken in mind during the cash management process - ie, people building PARS portfolios did not diversify across various failure rates so it was kind of "luck of the draw".

Posted by guest, Mar 25, 2008 10:34AM

You are welcome to it. Anyone can.

YES YOU CAN!

Posted by guest, Mar 25, 2008 10:38AM

what is also interesting is back before february all of the big investments houses were participating in these auctions to keep them going. When they stopped participating in these auctions how many of them do you think retained their positions in the arcs? Something tells me that their positions were eliminated or significantly reduced prior to their decision not participate in the auctions.

Posted by guest, Mar 25, 2008 10:42AM

@10:38 are we destined to relive the same comments that were posted back when this was news the first time around?

how is that interesting NOW? i know why it was interesting in february.

Posted by guest, Mar 25, 2008 10:51AM

what is also interesting is Bear Stearns had a couple of hedge funds that failed. something tells me it had to do with mortgages.

Posted by guest, Mar 25, 2008 11:01AM

auctions? someone call Sothebys.

Posted by guest, Mar 25, 2008 11:01AM

nothing works, and nothing will ever work again, because of THE SUBPRIMES

Posted by guest, Mar 25, 2008 11:01AM

nothing works, and nothing will ever work again, because of THE SUBPRIMES

Posted by guest, Mar 25, 2008 11:18AM

What your "guest" with the 10:17 AM posting is missing is that the people with investments in the closed end mutual fund portion of the ARPS are not getting any outlandish interest rates. The rates are as some of the later postings state, lower than when we were advised to buy these things as alternatives to cash or money market funds. In addition, no broker or fund manager has suggested that we can be reasonably assured that we will ever get our investment back or if we do that it will be at par.

Posted by Serge Birbrair, Mar 25, 2008 11:32AM

Some of those securities pay ZERO interest at the moment and they mature in...2045.
This is some "cash equivalent" investment, isn't it? Anybody wants some? Cheap?

Here is more information on the subject:
http://nothingcontroversial.com/UBS-ARC-FRAUD/ARS.html

Posted by golden girl, Mar 25, 2008 11:34AM

@10:42, thank god we have your enlightening commentary to supplement this old discussion.

Posted by guest, Mar 25, 2008 11:42AM

this thread is like taking a dick in the ear. you're not quite sure why it's there, but you know you wish it would stop.

Posted by Debter, Mar 25, 2008 11:44AM

Once again, most of you have no grasp of the difference b/w preferred's and plain ol' reg ARS. Preferred's are shares of a mutual fund invested in long muni bonds, not ARS, these SHARES reset weekly. Preferred's are the leverage the fund uses, while paying the lendor/ shareholder the variable/ auction rate and investing long for the common shareholder. ARS are issued by entities (not mutual funds) like the port authority or MTA, and are reset weekly, 28 days or 35 days, with a long(er) dated final maturities. ARS pay high penalty rates for the most part. Preferred's pay low penalty rates for the most part. Brokers did not make it clear what would happen in the even of a fails, but there it is, right there in paperwork. It's called the prospectus and it's VERY IMPORTANT. Fuck people, do some reading every now and then, it's your money.

Posted by Anonymous, Mar 25, 2008 12:15PM

11:42, I hope you are a chick.

Posted by Serge Birbrair, Mar 25, 2008 12:23PM

Guest :) I like your analogy!

Here is the new URL:
http://ARSclassAction.com/

Posted by guest, Mar 25, 2008 12:46PM

Why the hell isn't some smart hedge fund in there buying up all these illiquid, high-yielding ARS, and paying off the current holders with T-bills or cash?

Jeez.

Posted by Serge Birbrair, Mar 25, 2008 12:54PM

because they are not high-yielding,
which part of
"Most of them pay between ZERO and Libor + 1.25%" you do not understand?

If you wanna buy my "high yielding" ARC paying ZERO interest at the par, I'll give you 30 days net to pay and charge you only 5% interest if you are late.

Posted by guest, Mar 25, 2008 12:55PM

No, I am not a girl, but I'm damn sure if there was a dick in my ear those would be my sentiments.

Posted by guest, Mar 25, 2008 12:57PM

I have read through all of these comments and I want to set the record straight. The majority of the ARS securities that are illiquid are paying a relatively low interest rate. In some cases pretty darn close to LIBOR. The ones that were paying "outlandish" rates have already been redeemed.

So we have a product that has sold as a Cash Equivilant ... but really it was a loan to a fund with no maturity date.

No once cared becasue for 28 years the banks were propping up the market. Then they ran short on cash because of all the bad mortgages they wrote and sold their inventory and shut down the market.

Now you have paper that you can't sell. Could be a main street business that was parking cash for 6 months or a guy like me who had parked cash that was committed to another investment. Now my house is at risk. You get the picture.

Bottom line ... anyone holding ARS paper is getting and unfair deal.

Posted by guest, Mar 25, 2008 1:04PM

thanks for laying down the law @1257

Posted by guest, Mar 25, 2008 1:06PM

I'm sure you can sell it at some price, you just choose not to. If the loss is significant, wont you get the benefit on next years 1040?

Posted by Serge Birbrair, Mar 25, 2008 1:15PM

Next year 1040.....

OK, let me do the quick math:
1 mil in ARCs will result in the loss of 400,000 if one can find a buyer and at 3000 a year is good for 133 years worth of deductions.

Geeze, great plan, maybe UBS aquires me and use me against their profits!

No, wait a minute, they just wrote off 13 billions they lost in subprime mortgages
:(

naaahhh...I'll have to live another 133 years and take advantage of the great $3000 a year deduction!

Maybe Paris Hilton marries me and write me off?

Posted by diablo, Mar 25, 2008 1:19PM

@1:06 PM

Guest @12:57 has the story right.

As far as I know there's no secondary market for this junk.

Posted by Anal_yst, Mar 25, 2008 1:24PM

I wrote a little bit about this the other day, specifically regarding legal liability, checsky here
http://1-2knockout.typepad.com/12_knockout/2008/03/pointing-out-th.html

Posted by guest, Mar 25, 2008 1:29PM

when did you guys start a competing blog?

Posted by guest, Mar 25, 2008 1:30PM

using another site to promote your own is tacky, anal_yst.

Posted by Anal_yst, Mar 25, 2008 1:32PM

I've already had my own blog for about 2 years, I just seldom post anything...1-2Knockout is not a competing blog to DB by any stretch of the imagination. Not in this world or any other alternate reality in which you might be travelling.

Posted by Anal_yst, Mar 25, 2008 1:37PM

And @ 1:30 its not promoting, would you rather I copy and paste my whole 7-paragraph rant into a comment?

I didn't think so.

Posted by guest, Mar 25, 2008 1:43PM

12:57 is right, UBS and other investment banks marketed these securities as short term (still stated that way on my monthly statements). $86B of the $350B ARS market is backed by student loans (guaranteed 97% by the Department of Education)which were touted as the safest corner in the market. Unfortunately, the safest corner of the market is also the most illiquid because the reset rates can go as low as the T-bill rate (can you say less than 1-2% annually). It sucks and the banks created the market, sold it and for 25 years supported it, they need to step up to what they have done and make it right. Either create a secondary market because there is none at the moment or buy us out.

Posted by guest, Mar 25, 2008 2:05PM

Anal-yst, your site would merge well with LoS

With intermittent posting by the 6 of you, you'd have a competing DB-type blog worthy of consistent ad revenue

Posted by guest, Mar 25, 2008 2:51PM

Its now on my hourly scan list...

I had wondered what happened to some of my favorite posters here... and since DB does not allow the troops to take over the joint on weekends... I think this is a great solution.

~Stupid Equity Guy

Posted by golden girl, Mar 25, 2008 3:41PM

Stupid Equity Guy, that's what they made the Community tab for. Investor Cluzo posted something last Friday but I don't think people knew about it, could have been a good commenting area over the weekend like the BSC post was 2 weeks ago.

Posted by onetwo , Mar 25, 2008 3:48PM

@ Stupid Equity: What do you think is a great solution? Just curious.

@1:43 - While i agree that the current situation "sucks" (i am a former ubs client and employee with money that was tied up in the ARPs), I am not sure you have actually proposed any reasonable solutions--nor do i think there necessarily are any easy "outs".

You are right that this is an extremely old and traditionally stable market. Before this year there had never been a failed auction that I know of. The way ARPs are traded is via dutch auction. There have to be enough bidders to clear the periodic transactions at or below a reference interest rate (cap rate). When there are too few bidders the banks HAVE traditionally backstopped the securities. However, this means the bank now owns the securities on their balance sheet -- thus increasing there VaR et al. This the banks did this for about three months before they finally had to pull the plug, be it for cash or risk reasons. They simply can't help you any more. Hence the problem.

@Everyone:
The new 1-2knockout site is by no means a competitor to DB. Heck everyone who writes for it got their start by simply spewing garbage during down-time on these very boards. The site is much more commentary based--some insightful, some funny, some just simply terrible. It's is still in it's infancy though, and we are trying to figure a number of things out, so give it time. Hopefully, one day, we can reach the paramount of financial bloggery along with LorS, DB, Going Private, etc. I doubt it, but a guy can dream can't he?

That said, check it out, but I know I'll still be here reading DB every day.

Posted by Serge Birbrair, Mar 25, 2008 5:06PM

re: This the banks did this for about three months before they finally had to pull the plug, be it for cash or risk reasons. They simply can't help you any more.

yeah, having AAA rated securities on the books is RISKY, having mezzanine subprime mortgages leveraged 30:1 is NOT.

I love your logic. Thank you, Sir. May I have another?

Posted by worldmover102, Mar 26, 2008 8:24PM

A new class action has been filed against Morgan Stanley. The same law firm filed class action lawsuits against some of the other larger banks for misrepresentations in the sale of ARSs. The class action complaints are all available online at their website. www.zlk.com

Posted by guest, Mar 26, 2008 10:34PM

We all know this was an ongoing scam. Let's not play games.

Now, all we have to do is convince a few judges and jury's of that fact and the good old boys will have to go to the discount window one mo' time.

Posted by diablo, Mar 28, 2008 6:54PM

UBS is now going to mark down the price for illiquid ARS in their customers' accounts. This is sort of like adding insult to injury.

As other brokers will follow the UBS example, another escalation of lawsuits should be expected.

http://online.wsj.com/article/SB120672890827072299.html

Posted by guest, Mar 30, 2008 3:21PM

I have done some extensive research on the student loan ARPS, mostly the ones guaranteed fy the FFELP program. There is a secondary market out there and these are worth around 90 cents on the dollar. Their penalty rate is Libor + 1.5% mostly (the senior A tranches), and their collateral is in very good condition (especially if you own the 2001 through 2004 vintages). I manage a small fund and we are buyers of this paper. My suggestion if you own these student loan FFELP backed ARPS : HOLD IT. They are one of the safest decently yielding investment you will find. Soon enough this market will stabilize (maybe in 1-2 years?) and you will be happy you did. If you need money now, try borrowing against it. Most brokers should lend you at Libor + 0.5%, which should leave you with a 1% spread virtually risk free. I am curious to people's thoughts on this and , for those injured, would you sell your ARPS at 90 cents on the dollar? I am unsure of the true market value of them in today's environment because few people know that you can actually take a loss and liquidate them.

Posted by Serge Birbrair, Mar 31, 2008 6:00AM

There is a good chance the SEC Court rulings were broken by your broker/dealer:
http://arsclassaction.com/SEC.html
worth checking into.

Also, Bill Gross in his speech on March 31, 2003 made an interesting description and prophecy which came all true. We ARE the "plankton"

http://arsclassaction.com/billgross.html

Posted by guest, May 07, 2008 6:47PM

I have read all of these comments, arguments and defenses.

The only thing that is absolutely clear is that there is quite a bit of confusion, even amongst the relatively educated.

And it is a sad day in America when banks can walk away from their obligations while foreclosing on their customers. If individuals and businesses in this country can not trust banks, (supposedly under the watch of our government), how will this economy function?

It will not function.

Its time for serious investigation, and its time for some banking executives to not only step down, but to face charges.

The entire industry is absolutely a shame to our nation.

Let them prepare their arguments for their God.


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