Friday, May 16, 2008

Auction Rate Securities Earn Wall Street Billions in Fees

Auction-rate securities, which increased to $330 billion over 24 years, are marked by a history of secrecy and dealer manipulation of borrowers and investors, according to U.S. Securities and Exchange Commission documents.

"Proponents of auction bonds downplayed the risks for issuers and buyers, first by not talking about earlier problems, and then managing auctions to keep rates at levels that pleased everybody, at least for a while,'' said Joseph Fichera, chief executive officer of New York-based Saber Partners, which advises governments in their negotiations with banks.

Billions in Fees

Rates on the bonds are determined by bidding typically every 7, 28 or 35 days. If buyers are scarce, the auction fails and some bondholders who wanted to sell are left holding the securities. The issuer gets stuck with a penalty rate.

For investment banks, the bonds generated more than $1 billion in fees at the initial sale. They also received annual payments for handling the auctions of a quarter percentage point, or about $825 million a year based on the $330 billion outstanding before the collapse.

Bankers earned additional, undisclosed profit from arranging swaps intended to convert the variable interest rate on an auction bond to a fixed one. Culinary Institute, for example, expected the combination of auction-rate bonds and swaps to result in fixed borrowing costs of 3.36 percent to 3.68 percent on its three sales, less than O'Mara says it would have paid for ordinary fixed-rate bonds.

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