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Auction-Rate Securities: The Big Chill Shows Signs Of Thawing

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Like our hangover lifting slowing after our third cup of coffee, it’s too early to say that the crisis in auction-rated securities has passed. But the situation is improving for these once liquid securities that investors discovered were not quite as liquid as they had thought when the investment banks stopped propping-up the auctions for them last week. About half the auctions at some investment banks are resetting now, according to people familiar with the matter.
This is good news for some investors who need liquidity. Unfortunately, not all investors will have access to their money. The auctions that are succeeding are those that have the highest reset rates when they fail and the strongest underlying credit. Investors holding paper with lower reset rates—rates tied to LIBOR often issued by closed end funds—will likely to continue to learn the harsh difference between “cash” and “cash equivalent.” The auctions for these securities continue to fail. As short term LIBOR rates and commercial paper rates have fallen, some investors have seen their rates decline to levels less than 4 times that of those with a fixed yield of 10% or more.
The reset rates, which not many in the market had given much thought to before the auctions began to fail, have turned out to be a crucial factor. These were rarely discussed, even by the brokers and money managers who sold these securities to clients, because the auctions so rarely failed. Hedge funds, foreign capital and banks this week have shown an increased appetite for the auction-rated securities, especially those that have now reset to pay high interest rates. One investment banker indicated that hedge fund interest is up nearly 1000% percent from where it was last week.
The ARS market does appear to be stabilizing, at least a bit, and some market watchers are hopeful this is the beginning of a broader thaw. Issuers of the auction-rated securities have indicated an interest in exercising their call rights to buy back the paper. But many of the issuers, particularly municipalities, are slow moving entities so it could take several weeks to restructure their financing. And with the municipal bond market still in flux due to concerns about the bond insurers, it could take even longer.
Now excuse us while we fetch yet another cup of coffee.