Investors and taxpayers are both hurting from the freeze in the $330 billion auction-rate securities market, now into its third month. Investors can't get their assets out and taxpayers are paying the price for municipalities that issued the auction-rate bonds and now are being asked to pay up to redeem and restructure the debt. As Gretchen Morgenson from the New York Times points out, Wall Street is the only winner coming out of all this while investors are crying for rescue.
Brokerage firms operated the auction-rate market on behalf of municipalities, nonprofits, and closed-end mutual funds and were paid 0.25 percent of the security’s total issue for each year of its life. However, with the frozen market, firms are still earning these service fees when 70 percent of the weekly securities auctions are failing.
Additionally, firms are earning banking fees when municipalities redeem the securities and they take in yet another round of revenue when they help issuers untangle from derivative contracts that are often intertwined with the securities. These derivatives were supposed to reduce costs for the issuers by hedging their interest rate risks. But with the continuing decline in interest rates, these derivatives can be expensive.So, what options are there for investors?
Investors get interest on their money but that interest is not nearly enough to compensate for being stuck in their holdings. $78 billion in auction-rate securities will be redeemed by issuers but almost three-fourths of that involves municipal notes, which has exorbitant penalty rates for failed auctions. Investors in the remaining securities are receiving no offers to redeem their securities. That's party due to low penalty rates on those securities so there is little incentive to redeem.
The Restricted Securities Trading Network, a secondary market, can be an option for desperate investors who are willing to sell their securities at a discounted rate ranging from 2 percent to as high as 25 percent. So far, the action in that market is limited but this trading is an opportunity for municipal issuers to buy back the securities at a savings while letting investors get some liquidity.
After the buyback, securities issuers might also be able to renegotiate contracts to eliminate payments for unsold securities and failed auctions. Then issuers could get additional savings by refinancing the rest of its securities at current market rates.
However, this is where a conflict of interest can arise between Wall Street firms and their issuer clients versus investor clients. If a brokerage firm is advising an auction-rate issuer to redeem securities at a discount, then the firm's investors who bought those securities would record a loss. Selling at a discounted price could also force the firm to mark down similar securities, also resulting in a loss for investors.
Wall Street cannot ignore this conflict and it should stop billing issuers for failed auctions and start encouraging issuers to redeem securities at fair market price. On the other hand, governments should not rely on Wall Street to have a conscience; it should be aggressive in representing its citizens to make sure Wall Street takes action. Issuers can also help pave the road to redemption by opening their auctions to more potential buyers by making the auction results transparent so bidders can see which auctions are safer.
2 comments:
As you know, banks have created a terrible problem for customers in putting them into Auction Rate Securities, representing them to be liquid and safe, and the customers are now trapped without liquidity. In many cases, the banks sold those customer the banks own securities that they were trying to unload as this market unraveled.
Many of the bank customers who can't get to their money are also borrowers from the bank. Although the loan documents most likely state that there is a waiver of any right of setoff or counterclaim, I question whether one could bring an action for an injunction against the bank from calling a default in a loan that the borrower is unable to pay due to a lack of liquidity created by the very same bank? Public policy against waiver of setoff where possible fiduciery duty exists? Some lender liability principal?
One of the challenges is that the customer agreements only provide for two forms of dispute resolution; class action, or arbitration. I wonder if one could use the filed class action and intervene with this motion. I assume it would not play out well in an industry arbitration.
Your thoughts?
blame it on the banks. look at freddy mac and fanny mae. They bought these loans from mortage brokers, packaged them and resold them to financial instutions while telling them that they are "virtually riskless because they have the backing of the federal govt". Now the financial instutions did try to sell them off just before the meltdown and they are to blame for that, but the origin of the problem is in the federal beauracts who think they know how to make loans and asses risk. I am mad at Barnie Frank. common where is the coverage on him as he condones the banks while getting his bonus.
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