The New York Times reports that a distressed securities investor, Arthur D. Lipson, has a plan to unfreeze the accounts of those people who were suckered into thinking that Auction Rate Securities (ARSs) were as good as cash. But ARSs, whose rates were supposed to reset every week at about 3%, are illiquid because accounting rule changes made them quite unpopular with corporate treasurers. The resulting failed auctions have frozen the accounts.
I posted on this $330 billion ARS market last week and have been stunned to learn about all the people who thought that significant portions of their life savings were safe, only to learn that the funds are frozen. For these people, it's as if they went to the bank to withdraw their deposits and now they can't get their money out. I don't know how these people can sleep at night. I'd have trouble coping.
But Lipson argues that the closed-end funds that hold these ARSs are trading at a discount and that these discounts present an opportunity for closed-end funds to do the right thing, for both common and preferred shareholders. Lipson suggests that these closed-end funds' managers should sell the underlying securities - utility stocks and shares of real estate investment trusts - and use the proceeds to buy back common shares.
What good is that? Lipson thinks it would shrink the size of the funds and allow them to redeem some of the preferred shares they issued to increase the fund's yield. Unfortunately, Lipson believes that managers won't implement his plan because doing so would severely reduce the management fees they receive, based on the assets in the funds.
So Lipson has launched proxy fights at three funds, seeking board representation to try to force them to follow his prescription. I am glad the New York Times is covering this story and believe it warrants some serious government intervention.
Unfortunately, with Washington trying to plug a host of other leaks in our economic dike, these frozen ARS accounts may not get the attention they deserve.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter
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Reader Comments (Page 1 of 1)
3-09-2008 @ 8:57AM
pat19b said...
Peter,
John Thain should be in focus as he's on both the board of Blackrock and the CEO of Merrill Lynch which owns 49 % of Blackrock. Wow what a conflict. He could get your plan moving. But who will he serve ? Blackrock or his wronged customers at Merrill.
3-09-2008 @ 9:35AM
Lee Epstein said...
While Mr. Cohan is correct about the angst brought on by being locked in an illiquid, he is incorrect about the cause of the problem. It is not that they, "... are illiquid because accounting rule changes made them quite unpopular with corporate treasurers." Most of the $200 billion locked in ARS belong to corporations that want out just as badly as individual investors. The problem is the result of the "auction agents," broker dealers that chose to cease supporting the Dutch auction mechanism with their capital, after doing so consistently for almost twenty years. Who was to know?
3-09-2008 @ 12:07PM
Michael Boustead said...
Really confused by the article on ARS. Ignoring the large majority of ARS from muni funds selling at a premium, why would one deleverage a closed end fund in order solve the ARS mess and then use the vast majority of the funds from the deleveraging to redeem common shareholders. In the current market environment it would seem to me that one would want to limit as far as possible the forced sale of assets. If deleveraging is correct, which it may well be, redeem the preferred dollar for dollar from the proceeds of the sales.