$330 Billion Market for Auction Rate Securities Frozen, Yet Brokers Still Get Paid: Regulators Investigate
The $330 billion auction-rate securities market is still frozen solid. Since February 13, hundreds of auction failures have occurred each day. The results can be devastating: The issuers are forced to pay high penalty interest rates. The investors are unable to extricate themselves from these investments, even though their brokers sold the securities as if they were as liquid as cash or cash equivalents. To add insult to injury, the brokerage firms continue to get paid by the issuers to hold the auctions that fail.
As many have recently – and painfully – learned, auction-rate securities are long-term bonds intended to behave like short-term debt. They have been sold by brokers as liquid investments and categorized as cash and cash equivalents. The rates are set through a bidding process managed by investment banks and are usually held every seven, 28 or 35 days.
In mid-February, the auction rate market collapsed as investors stopped buying these securities based on fears about the creditworthiness of the bond insurers who guaranteed the debt. At that time, the investment banks ceased stepping in and covering the shortfalls in demand by purchasing the auction rate securities for their own accounts.
Auction-rate bond failures rose to 71% this week as 2,023 out of 2,865 auctions failed. Leading borrowers such as the Dallas Ft. Worth Airport and Ascension Health in Missouri are refinancing their debt to avoid paying penalty interest rates. The Dallas Ft. Worth Airport converted $337 million of auction debt into fixed rate bonds paying as high as 6.25%. That rate is still lower than the penalty rates on some auction-rate securities after one bond insurer lost its investment grade credit rating.
Meanwhile, issuers continue to pay the investment banks continue for holding the auctions even when they fail. New York State alone has paid ten investment banks more than $600,000 since mid-February to handle bids of auction bonds even though the auctions failed and the state has paid higher penalty interest rates. These investment banks, including Citigroup and Goldman Sachs, receive $10 million each year to oversee the bidding auctions. They still get paid even though they have pulled the rug out from the auctions.
On Friday afternoon, Massachusetts Secretary of State William Galvin announced an investigation into the practices used to sell auction rate securities at UBS, Merrill Lynch and Bank of America. Galvin said that the probe was prompted by investor complaints that they could not sell these securities.
According to a statement by Galvin: “My office has received calls from people who thought they were investing in safe, liquid investments only to find out that they had, in fact, purchased auction-market securities that are now frozen and they cannot get their money out.”
Galvin’s statement then took aim at the investment firms: “The recent freezing of the auction markets coincided with the decision by a number of major brokers to stop supporting the auction market and appears to be yet another after-effect of the subprime lending excesses and the subprime market meltdown.”
Galvin’s investigation may mean that the “free lunch” the brokerage firms have enjoyed on the auction-rate market may soon be ended.
Page Perry, LLC is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 30 occasions. Page Perry’s attorneys are actively involved in counseling institutional and individual investors regarding their subprime investment problems and have brought claims for investors with losses relating to subprimes. For further information, please contact us.
