Why did the market for auction-rate securities collapse so violently earlier this year? Shortly after the auctions seized up we published a “primer” on what had happened, explaining that changes in the way corporations account for the securities. With corporate demand gone, banks found themselves having to soak up more and more inventory. The capital commitment required to do this grew at the same time the banks faced challenges from other parts of the credit markets, and eventually the banks decided to let the auctions fail.
This view is echoed in a new article in Compliance Week, a weekly newsletter on corporate compliance and risk management. Most of the article is devoted to a discussion about how financial officers should value auction-rate securities. (Short answer: It’s complicated!) But there is also a good discussion why the auctions failed. And by “good” we mean: “totally agrees with us.”
Espen Robak, president of Pluris Valuation Advisers, says the jitters over credit markets aren’t entirely to blame for the ARS freeze. Guidance from the Securities and Exchange Commission and from Big 4 audit firms told investors they couldn’t view ARS as equivalent to cash, so they became less popular as a cash management vehicle for corporate treasuries, he says. That contributed to the sell-off and dwindling number of buyers.
Robak says companies went on a selling spree in the latter half of 2007, shedding some $70 billion in ARS: “That’s an awful lot of paper to change hands in such a short period of time.”
Cos. Face Auction Rate Insecurities [Compliance Week]