What are auction rate securities? How did these securities cause billions in losses to investors and businesses?
Auction rate security, according to Wikipedia, "refers to a debt instrument (corporate or municipal bonds) with a long term maturity for which the interest rate is regularly reset at a dutch auction."
Throughout the 1990s and up to 2008, bank loans became more expensive. As a result, ARSs became increasingly attractive. They were lower in cost and flexible for variable rate debt. Auctions were typically held every 7, 28 or 35 days.
So what happened to cause such big losses?
When the meltdown of 2008 occurred, the auctions started to go badly. In late 2008, the auctions ceased altogether. That meant that holders of ARSs -- were touted by banks as safe and liquid -- had no place to sell them. The market froze and today is practically non existent.
With no place to sell their ARSs, investors and businesses were left with two choices: Either take the losses and write them down, or hold on for dear life until they matured (some of them maturing way out to 2047).
Meanwhile, losses mounted are are still mounting. Bristol-Myers Squibb Co. (NYSE: BMY), 3M Co. (NYSE: MMM), US Airways Group Inc. (NYSE: LCC), and Texas Instruments Inc. (NYSE: TXN) among others are estimated to have lost a whopping $4.8 billion in the second quarter.
These losses have prompted lawsuits against issuing firms such as Citigroup Inc. (NYSE: C) on the basis that they peddled these securities as safe and liquid. Some firms are settling these suits by buying back ARSs from those investors who have less than $10 million in holding.
This was but another hand grenade lobbed during our financial meltdown. How all of this is finally resolved is up in the air at the moment.
Should banks and other issuers of ARSs buy them back? If so, should they buy them back at face value or at a discounted price?
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Reader Comments (Page 1 of 1)
9-02-2009 @ 12:15PM
Kathy said...
The answer is a resounding yes.
State authorities have demonstrated that top management at least two investment banks were aggressively pushing these toxic investments out the door with deceptive marketing at the SAME TIME that they were ditching their own holdings. This is, and was found to be, fraud.
Mid-stream brokerages are not exempt. They sold junk. If they didn't know it was junk, as they claim, they failed in their responsibility to customers and should have their licenses withdrawn.
In fact, there has been discussion in some states about pulling the license to do business of firms that defrauded customers through ARS. Take note, Oppenheimer and Schwab.
9-02-2009 @ 2:32PM
Jerry said...
This is another poorly written, un-informed article about ARS. I'm not going to go into a long winded diatribe, but in a nutshell here's the deal: MOST brokerages have redeemed their clients for selling them these poison securities they touted as cash. Citi, Merrill, Morgan, Fidelity, TD Ameritrade, UBS, etc., etc.
BUT there are a few holdouts. The most notorious holdout is Oppenheimer % Co, which still owes its clients nearly $1 billion. A trial is scheduled in November in Boston. The MA Attorney Gen has proof that Oppenheimer execs sold off their personal holdings after learning the market was tanking, leaving their clients holding the bag. You'd think this would be a major story in the press. But it's not, probably because Oppenheimer buys ads on CNBC, the Wall St Journal, Money Mag. etc.
The few advocates of ARS holders have all fled. Jim Stewart at WSJ stopped writing about the issue after his brokerage paid him back.
This is a sealth scandal, and the silence of the media to cover this, is unforgivable.
9-02-2009 @ 3:06PM
mikaele said...
Everyone payed taxes on earned money and then were duped out of that money by firms that changed the amount a buy in was to get smaller investors in! Were already busted prior for misrepresenting and admitted no wrong doing! Payed fines. Told investors that it was a cash equivalent , not a perpetual investment with no maturity date. Comes with free SEC cover letter, "we don't know what to do!" Busy counting the fines they collect from banks and firms that neither admit nor deny wrong doing, so they can continue?
While most firms have been forced to redeem from the A.G's , I wonder why anyone would even pose the question
If they should be payed back!