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The Hidden Costs of The Auction Failures

Unless you are in private wealth management, the term “auction rate securities” might be new to you. But over in the private wealth group, they’ve been treating these things as if they were cash. Clients were funneled into the bonds and told they were the most liquid investment short of actual cash. But yesterday the bond auctions failed in a dramatic fashion, leaving many investors in illiquid positions.
All that you can read in the Wall Street Journal today. But what the Journal doesn’t explain is that this investor liquidity is already having repercussions in the broader marketplace, including the stock market. Many individual investors would use the proceeds from the auction of their bond holdings to purchase equities. Now that they are locked into the bonds, they are effectively frozen out of the stock market. Brokers have told DealBreaker that many clients simply will not be able to purchase stocks until the market for auction rate securities begins operating again, and they expect this lack of purchasers will have a depressive effect on stock prices.
The situation could deteriorate further. Investors who need liquidity might be forced to sell stock, or refrain from making major purchases—such as homes. So far most of the attention of market watchers has been focused on the direct effects of the auction failures. But if this doesn’t turn around soon, there could be major financial consequences.
Debt Crisis Hits a Dynasty [Wall Street Journal]