Many brokerage firms have put their customers in short-term investments known as auction-rate securities that promised to be a safe and liquid alternative to cash. However, that promise of liquidity dried up weeks ago and now investors are stuck with securities they can’t sell and some are even being marked down in value.
The good news in all of this is that the banks and mutual-fund companies are working on valuing auction-rate holdings and finding alternative debt to help investors solve the liquidity problem. The bad news is that it’s unclear how such securities should be marked down.
UBS and Goldman Sachs Group Inc. are the firms that have announced that, using internal price models, they will mark down the value of these securities on client statements. The firms have not disclosed an actual amount but markdowns should vary between 3% and 5%. Other banks, like Merrill Lynch, Citigroup and Morgan Stanley, aren't making that move yet but Merrill clients have been told that there is no market for their securities. Some brokerage firms, including UBS and Merrill, are offering clients loans backed by their holdings to meet immediate cash needs.
It is a challenge to value assets at a realistic price during this credit crunch especially since there is no secondary market in which to sell these securities. Many suffering investors are individual investors – the bread and butter of Wall Street firms – and a lot of them have already started filing class-action suits and arbitration claims against the brokerage firms.
Closed-end funds have a $65 billion share in his $330 billion market. When the market seized up, regulators and primary sellers of close-end funds like Eaton Vance Corp., BlackRock Inc., Legg Mason Inc. and Nuveen Investments began discussing ways to refinance these securities and get owners of the securities out at full value.
One solution is, for a fee, the banks could financially back these securities to make the investments more liquid and secure. But the problems are banks are reluctant to make these guarantees in this current market and tax implications with the IRS could ensue.
This week, Nuveen said it would refinance almost $715 million in auction-rate securities issued in relation to four taxable funds and hopes to complete refinancing of all taxable funds in four to six months. This move would repay some investors in those securities at full value. Eaton Vance also began $1.6 billion in redemptions this week, and hopes to deal with the remaining two-thirds of its outstanding auction-rate securities in the coming months.
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