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?

Continue reading Has Wall Street betrayed businesses with auction rate securities?

Has Wall Street betrayed businesses with auction rate securities? originally appeared on BloggingStocks on Tue, 01 Sep 2009 10:30:00 EST. Please see our terms for use of feeds.

Brokerage house Charles Schwab & Co. (NASDAQ: SCHW) is facing the wrath of New York Attorney General Andrew Cuomo. The state's top attorney sent a letter to Schwab last Friday, warning that he plans to sue the firm for civil fraud in relation to its marketing and sales of auction-rate securities (ARS). Cuomo added that he is open to a possible settlement, although Schwab must be willing to repurchase ARS from its investors who are still holding them.

In response, Schwab is defending itself. "The Attorney General's allegations are without merit," stated the brokerage firm. "They unfairly lay blame on our company for an illiquid market and improper behavior by the large Wall Street firms."

Continue reading Charles Schwab faces fraud suit from NY Attorney General Andrew Cuomo

Charles Schwab faces fraud suit from NY Attorney General Andrew Cuomo originally appeared on BloggingStocks on Mon, 20 Jul 2009 12:20:00 EST. Please see our terms for use of feeds.

It was a year ago today that I wrote my first post on Auction Rate Securities (ARS). That was when people who thought their money was in something safe, like a money market fund used to be, found out their funds were frozen. And 7,678 comments later, there are still people who have not gotten their money back. But it isn't for lack of trying -- they've contacted regulators, journalists, and Congress in their efforts. Some have succeeded and some have not.

The $330 billion ARS market was originally created for companies to park their short-term cash safely while financing various municipal projects. The rates on the ARS would reset in weekly or monthly auctions. But then a change in an accounting rule made it unattractive for companies to invest in ARS. So in order to keep the ARS market from collapsing, brokers started to support the auctions themselves and pushed hard to dump those ARS on their unsuspecting "wealth management" customers -- e.g., individual investors.

Continue reading Auction Rate Securities (ARS) anniversary: A year of pain and battles

Auction Rate Securities (ARS) anniversary: A year of pain and battles originally appeared on BloggingStocks on Fri, 27 Feb 2009 12:05:00 EST. Please see our terms for use of feeds.

Historians are likely to look back on this week as one of the most significant in American economic history. This was the week that the government let Lehman Brothers Holdings Inc. (NYSE: LEH) fail -- a record $639 billion bankruptcy, lent $85 billion to keep American International Group (NYSE: AIG) from collapsing, and pumped $300 billion into global financial markets to keep them from seizing up. But that turned out not to be enough to keep the markets afloat -- for that Hank Paulson needed the ultimate bailout.

While I don't remember much of the American History I studied in high school, one thing sticks with me today. It always seems that it takes a major crisis to get America to make big changes. It is never possible for leaders to foresee problems and take action to avert them before they turn catastrophic. The averting catastrophe approach always struck me as far smarter than the crisis approach. However, it seems that lawmakers need tangible evidence of prior bad outcomes to make the case that the status quo is deeply flawed and must change.

While he had already loosened up $800 billion in taxpayer money by Wednesday, Paulson needed an even scarier story to get Washington to agree to an additional $500 billion to create an agency to buy illiquid assets from financial institutions. What exactly did he tell Congress and the president to scare them into agreeing to this plan? AP suggests that he described evidence of the global financial market ceasing to function and painted a frightening picture of the economic and political chaos that would ensue if that functioning ceased for an extended period of time.

Continue reading How Paulson scared Washington into $500 billion bailout

How Paulson scared Washington into $500 billion bailout originally appeared on BloggingStocks on Sat, 20 Sep 2008 08:05:00 EST. Please see our terms for use of feeds.

The New York Times reports that two Credit Suisse brokers took Auction Rate Securities (ARS) fraud to a new level. They fabricated an ARS-issuing agency -- a made up student loan securitizer -- as they sold investors their most toxic Collateralized Debt Obligations (CDOs) backed by subprime mortgages and mobile home loans. Their deception is not new in concept -- evidence of ARS fraud has already emerged -- but the scope of the fraud is noteworthy.

Since I first began writing about the $330 billion ARS market -- long-term securities whose rates were reset in weekly auctions until they failed -- 6,162 comments have appeared from people trying to get their money back. And many of the issuers have announced settlements with authorities because investigators have found evidence that many of them were actively trying to dump the ARS from their own books into those of unsuspecting individual investors by telling them the ARS were safe and offered slightly higher-than-money-market yields.

But this Credit Suisse fraud reaches a different level. According to the Times, "Eric Butler, [who] sold customers some of the most toxic investments of the subprime age - [CDOs] - in what federal prosecutors characterize as a $1 billion bait-and-switch -- told those investors that they were getting "securities [that] were as safe as cash." The Times wrote that Butler "claimed, [that] the outfit that issued them, Glacier Education Loan, bought student loans guaranteed by the federal government. The problem: there is no such thing as Glacier Education Loan."

Continue reading Credit Suisse brokers take Auction Rate Securities fraud to new depths

Credit Suisse brokers take Auction Rate Securities fraud to new depths originally appeared on BloggingStocks on Thu, 04 Sep 2008 09:48:00 EST. Please see our terms for use of feeds.

It turns out that Charles Schwab (NASDAQ: SCHW) and TDAmeritrade (NASDAQ: AMTD) may have sold auction-rate securities by using misleading marketing about whether or not the instruments were "cash equivalents." According to The New York Times, the "point of sale" activity at the discount and retail brokerages is similar, they said, and some of the discount brokerage firms use financial advisers or may have improperly listed information on their websites.

Schwab argues that it was only an "agent" and did not slant the marketing of auction-rates one way or the other.

It is safe to predict that Andrew Cuomo, the New York State Attorney General, will get discount brokerage firms to buy the auction-rate paper back from their customers. Cuomo can probably find some marketing material where the nature of the securities was represented the wrong way.

But, Cuomo's actions have stepped over the line. In all probability, many discount brokerage customers bought the auction-rates on their PC without seeing any information about whether their liquidity could be undermined. Discount brokerage customer often do their own research.

Cuomo won't care. He won't try to find out which people got their auction-rates without being attracted to them by marketing. He will get the discount firms to buy all of the paper back. The companies do not want years of litigation.

Cuomo is running for governor, or perhaps the U.S. Senate. He does not have time to pause for such details.

Douglas A. McIntyre is an editor at 247wallst.com.

Discount brokers may be caught up in auction-rate scandal originally appeared on BloggingStocks on Sat, 16 Aug 2008 11:40:00 EST. Please see our terms for use of feeds.

Continue reading Closing Bell: Dow pops up, and the bulls are eating bear meat this weekend

Closing Bell: Dow pops up, and the bulls are eating bear meat this weekend originally appeared on BloggingStocks on Fri, 08 Aug 2008 16:58:00 EST. Please see our terms for use of feeds.

This week, state investigators from Massachusetts and New York revealed more pieces of the scam that was the $330 billion ARS market. Up until this week, it had been known that UBS AG (NYSE: UBS) had told its brokers to dump this toxic waste on its so-called private clients -- individual investors -- to keep UBS from needing to write it off from its own books.

But this week we learned that banks had been colluding for as long as two years to prop up the weekly auctions that were supposed to set the rates on these securities. It looked like there was good evidence that the banks were committing securities fraud when they sold ARS on the premise that they were cash-like and offered slightly higher yields than money market funds. Why the fraud? Because, their internal e-mails and behavior revealed that they were desperate to get rid of the toxic waste.

Moreover, those e-mails show that the banks' claim that the auctions suddenly failed in February 2008 is another fraud. As I posted, Merrill Lynch & Co. (NYSE: MER) e-mails reveal that the auctions started failing in January 2006. And it was public knowledge, according to Financial Week, that ARS auctions were failing last September -- 60 such auctions failed to the tune of $6 billion.

Continue reading Did banks collude to freeze the auction rate securities (ARS) market?

Did banks collude to freeze the auction rate securities (ARS) market? originally appeared on BloggingStocks on Sun, 03 Aug 2008 10:40:00 EST. Please see our terms for use of feeds.

BusinessWeek has provided investors a valuable public service by reading through rafts of e-mails subpoenaed by Massachusetts and New York in their suits against UBS AG (NYSE: UBS). Its analysis reveals that the collapse of the $330 billion Auction Rate Securities (ARS) market -- in which customers bought what they were told were cash-like investments with slightly higher yields that reset in weekly auctions -- did not collapse in the way that ARS peddlers claimed. And this difference between what BusinessWeek reveals and what ARS peddlers claim could put the peddlers in deep legal yogurt.

ARS peddlers claim the weekly auctions were going great until February 2008 when they suddenly failed. BusinessWeek found that ARS auctions began failing over two years earlier than the ARS peddlers claimed. Specifically, it found that "from January 2006 through February 2008, UBS bought securities at 88% of the 30,000 auctions it ran" because not enough buyers showed up at the auctions. And UBS and 15 other brokerages failed to disclose that they were propping up the auctions. As a result, in 2006, the SEC fined those brokerages $13 million -- including Citigroup (NYSE: C) and Merrill Lynch & Co. (NYSE: MER) -- for "failing to disclose that they sometimes supported the auctions."

Despite their efforts to support the auctions, ARS inventories accumulated on brokers' books. By August 2007, UBS's inventory had tripled to $3 billion, from $1 billion in March 2007. David Shulman, the UBS executive in charge, mobilized his 850 brokers to dump the ARSs from UBS' books to its private client accounts. But Shulman, who is on-leave from UBS, front-ran that trade. As BusinessWeek reported, "Only hours earlier, Shulman had moved to cut his personal exposure. E-mails show that UBS's compliance department cleared him to sell $475,000 worth of auction-rate securities from his own account."

Continue reading Evolution of the Auction Rate Securities scam

Evolution of the Auction Rate Securities scam originally appeared on BloggingStocks on Thu, 31 Jul 2008 12:19:00 EST. Please see our terms for use of feeds.

Imagine your broker parked your funds in an account that he said would be as safe as a money market fund but offer slightly higher yields. If you went for that line, you might now be among those who hold the $330 billion worth of Auction Rate Securities (ARS) whose weekly price-setting auctions stopped working in February. Now, Bloomberg News reports that those who are trying to get at their funds through arbitration will be lucky to receive 22 cents on the dollar.

I first began posting on the ARS market back in February. Since then 5,482 comments have appeared from people trying to unfreeze their funds from what their brokers told them were safe investments. Massachusetts and New York have sued one of the ARS hawkers -- UBS AG (NYSE: UBS) -- thanks to e-mails that indicated that when the ARS auctions failed, UBS decided to dump this toxic waste on individual investors rather than take the losses on its own books. New York's attorney general found that UBS executives sold $21 million worth of their ARS holdings before launching this campaign to dump them on the public.

Many are now trying to get their money back through a process called arbitration. If your claim is above $50,000 you will face a panel of three judges, two "public" and one of whom represents the ARS industry. Bloomberg reports that the process for choosing the panelists virtually assures that consumers will be judged by a representative of the industry that defrauded them. So it's no wonder that arbitration rulings have given investors enormous haircuts.

Continue reading Will Auction Rate Securities holders get 22 cents in arbitration?

Will Auction Rate Securities holders get 22 cents in arbitration? originally appeared on BloggingStocks on Wed, 30 Jul 2008 10:35:00 EST. Please see our terms for use of feeds.

I began following the Auction Rate Securities (ARS) market -- those bond-like securities whose rates used to reset in weekly auctions -- back in February when those auctions failed. Since then 5,341 comments have appeared from people whose hard-earned cash is frozen in what was marketed to them as safe, money-market-like securities with slightly higher yields.

I credit Cuomo with adding a useful detail to the brief against UBS. He points out that UBS senior executives were selling $21 million worth of ARSs as its brokers were desperately pushing the toxic waste onto their individual customers. This reminds me of the same kind of deception we saw during the dot-com era when an analyst, Henry Blodget, wrote bullish reports about companies that he trashed in e-mails to his colleagues.

Continue reading Cuomo sues UBS for Auction Rate Securities deception

Cuomo sues UBS for Auction Rate Securities deception originally appeared on BloggingStocks on Fri, 25 Jul 2008 08:55:00 EST. Please see our terms for use of feeds.

A number of corporations bought auction rate securities with their excess cash. They believed that since the instruments offered better yield than many market funds, they would be good for balance sheet management. They also thought that since auction-rate paper had been liquid and widely traded since 1985 that moving in and out of the market would be easy.

It was easy until it wasn't.

The investment banks and money center banks which made the market in these instruments pulled out at the beginning of the credit crisis. They did not want to keep risking their own capital to buy the paper and hold it to keep the market trading. Traditionally what was not bought at one auction was picked up by banks and held until the next round of trading. In essence, large financial firms kept the market trading by underwriting the system in exchange for large commissions.

Continue reading Auction rate securites: The suckers look for excuses

Auction rate securites: The suckers look for excuses originally appeared on BloggingStocks on Mon, 30 Jun 2008 10:58:00 EST. Please see our terms for use of feeds.

The New York Times reports that Massachusetts secretary William Galvin has subpoenaed some revealing e-mails from UBS AG (NYSE: UBS) that illustrate its decision to stick retail investors with its worthless ARS inventory.

I've been following the $330 billion ARS market since February when the weekly auction market for resetting their yields seized up. Since then 4,852 comments have been posted from individual investors whose money is frozen in ARS limbo.

The e-mails reveal that UBS's corporate customers did not want to buy the ARS on UBS's books. So UBS tried to unload the worthless securities onto its individual customers. Absent dumping the ARS, UBS would need to take the hit itself. Rather than do that, UBS decided to let those foolish enough to fall for the ARS sales pitch to take the losses. The Times illustrates this decision clearly in an e-mail from Joe Gallichio, a managing director in the municipal finance department at UBS, on February 21, after the ARS market had frozen.

Continue reading When it comes to auction rate securities, UBS stands for U've Been S@$#ed

When it comes to auction rate securities, UBS stands for U've Been S@$#ed originally appeared on BloggingStocks on Sat, 28 Jun 2008 20:17:00 EST. Please see our terms for use of feeds.

UBS helps Lakes Entertainment out of ARS mess -- sort of originally appeared on BloggingStocks on Thu, 17 Apr 2008 11:25:00 EST. Please see our terms for use of feeds.

Imagine you take your hard earned money and at the urging of your broker put it into an account that pays just a bit more than a typical money market fund. Your broker assures you that the account would offer a higher return and would offer liquidity at weekly auctions. Sounds good, no?

Now imagine that you wake up one morning and find that money frozen -- as in you thought you had easy access to your money and now you can't get a penny of it. As I posted last month, that's what happened to investors in Auction Rate Securities (ARS) -- a $330 billion market. Since that post, there have been 583 comments from people who have been affected by this mess.

One commenter, Dave Lehrian, needs to pay taxes on a business he sold. He moved the entire proceeds from selling his business from a bank account at Wells Fargo & Co. (NYSE: WFC) into an ARS. Now he still owes $350,000 in taxes on the sale but can't get his money out of the ARS account to pay them. I can only imagine the frustration he must feel. Here, in his own words, is his story:

Continue reading An Auction Rate Securities (ARS) David vs. Goliath story

An Auction Rate Securities (ARS) David vs. Goliath story originally appeared on BloggingStocks on Tue, 25 Mar 2008 13:35:00 EST. Please see our terms for use of feeds.

The Wall Street Journal [subscription required] reports that we need to learn about another acronym thanks to Wall Street's financial engineers whose fragile financial instruments keep blowing up. Today's explosion is in variable-rate demand notes (VRDN) -- which let issuers borrow for long periods -- but at short-term interest rates. Like auction-rate securities (ARSs), interest payments adjust on a weekly or even daily basis. The difference is that securities firms sell VRDNs at whatever interest rate meets the market's demand.

This is a huge market -- $500 billion, or 52% bigger than the $330 billion ARS market. I've been asked what I thought the next shoe to drop would be after the ARS blowup. And I'm happy to report that I said I had no idea. I had never heard of VRDNs before this morning. But the market for VRDNs is freezing up -- just like the ARS market.

Specifically, some VRDN auctions failed -- hitting some municipalities with sharply higher interest because dealers of the debt are having trouble selling it. Last week, rates on $300 million of California's variable-rate demand notes rose to 8.25% from 2% the previous week. As with the ARS market, this freeze up will lead to more unpleasant surprises for holders of VRDNs -- like the one I posted on yesterday in which a journalist who thought his ARS investment was as liquid as a money market fund discovered his funds were frozen.

The latest $500 billion explosion in Wall Street's bowl of alphabet soup originally appeared on BloggingStocks on Thu, 28 Feb 2008 11:17:00 EST. Please see our terms for use of feeds.

As I posted last week, Auction rate securities (ARSs) is a $330 billion market for long-term bonds that are supposed to pay lower rates because their interest rates are set through auctions. Municipalities who issued ARSs are suffering because 1,000 of these auctions failed and instead of paying 3% interest rates, they have to pay 20%. And if that wasn't bad enough, the investment banks that oversee these auctions are refusing to let investors withdraw their money.

DealBreaker explains that the demand for ARSs dried up sometime last year, and evaporated completely in 2008. This shift was driven by a March 2007 decision by the Financial Accounting Standards Board (FASB) that the heading "cash equivalents" should be eliminated from balance sheets and cash-flow statements. The FASB recommended that cash-flow statements should present only flow related to cash. Items currently classified as cash equivalents would be classified in the same way as other short-term investments.

Corporations responded to this by moving out of the ARSs so that their balance sheet cash positions would not be reduced as a result of the FASB decision. This meant that many corporations no longer wanted to buy ARSs. As corporate demand for ARSs vanished, banks had to keep more ARS inventory onto their own books. Since banks need to maintain a constant ratio of capital to assets, they needed to increase their capital commitment at the same time the banks faced challenges from other parts of the credit markets -- such as Collateralized Debt Obligations (CDOs). Last week they decided against committing additional capital to supporting the auction, and let them fail.

Continue reading Why the $330 billion auction-rate securities market failed

Why the $330 billion auction-rate securities market failed originally appeared on BloggingStocks on Thu, 21 Feb 2008 11:45:00 EST. Please see our terms for use of feeds.

It seems as though every week, the public is forced to learn another one of Wall Street's strange names for a surefire deal that couldn't miss. But the reason we're learning about those strange names is because -- contrary to promises -- the can't miss deals are shutting down -- taking Wall Street's credibility down along with them.

The latest of these is auction rate securities (ARSs) -- a $330 billion market for long-term bonds that are supposed to pay lower rates because their interest rates are set through auctions. The New York Times reports that municipalities who issued ARSs are suffering because 1,000 of these auctions failed and instead of paying 3% interest rates, they have to pay 20%. And if that wasn't bad enough, the investment banks that oversee these auctions are refusing to let investors withdraw their money.

Which investment banks are imposing this pain? Goldman Sachs Group (NYSE: GS), Merrill Lynch (NYSE: MER), and Lehman Brothers Holdings (NYSE: LEH) and the problem with ARSs is not limited to municipalities entities such as the Port Authority of New York and New Jersey. Closed-end mutual funds, student loan companies and corporations also issue them.

Continue reading Auction Rate Securities: The latest $330 billion catastrophe

Auction Rate Securities: The latest $330 billion catastrophe originally appeared on BloggingStocks on Fri, 15 Feb 2008 09:05:00 EST. Please see our terms for use of feeds.