Bank customers with funds locked up in auction rate securities are discovering that even if they find willing buyers for their securities, they may not be able to sell them. Earlier this year, nearly all the auctions for the securities failed as banks pulled their support for the auction. Customers, many of whom believed the securities were safely liquid cash-equivalents, found themselves unable to access their funds. While some issuers who faced high penalty rates following auction failures have redeemed their ARS, hundreds of millions of dollars remains locked-up.
It is an ugly situation that has bank customers bringing lawsuits against their brokers and the issuers of the securities. And it just got worse. According to Bloomberg's Darrell Preston, Bank of America, UBS, Wachovia and at least four dozen other firms that sold ARS are blocking attempts to create a secondary market for the securities. They say they are preventing customers from selling at a discount and incurring needless losses.
Maybe the banks really do only have their customers' best interests in mind. But the move also serves the interests of the banks. For one thing, preventing customer losses also makes it harder to sue the banks for their role in the ARS market.
"By allowing customers to sell at a discount, the banks allow customers to establish damages,'' said Bryan Lantagne, the securities division director for Massachusetts Secretary of State William Galvin.
And the banks may have another reason to avoid allowing a secondary market. It's still unclear about how much ARS are held directly by the banks themselves but some reports suggest they may hold a great deal. Since few of these default, the banks can carry these on their balance sheets at par value or close to it. But if they start trading at a discount in the secondary market, the banks will have to mark these at market value, incurring another round of write-downs. In short, the banks have an interest in preventing the formation of a transparent market in auction rate securities.
Banks Say Auction-Rate Investors Can't Have Money [Bloomberg]