Auction-Rate Securities, RIP?

Do auction-rate securities have a future? I'm not sure myself, so I put a couple of questions to Floyd Newton, a partner in King & Spalding's finance practice. Floyd has a long history in the auction-rate market, and seems to know what he's talking about.

My first question was whether the new electronic trading platform being launched by Restricted Stock Partners is likely to help bring liquidity back to the market. Floyd says no:

I do not believe that this imitative will have any effect on the secondary market for auction-rate securities. These securities are readily available from the existing broker-dealers, and I am not aware of any reason why having an electronic trading platform from this company would have a positive impact on this market. The principal issues in this market are simply a lack of investor confidence in this market. When auctions begin to fail, for whatever reason, it creates a "panic," where investors rush to get out unless the broker-dealers act to stabilize the market, and at the present, they are not able to do this.

My second question was whether John Carney is right when he says that auction-rate securities never had much of a market to begin with, and were always supported by the broker-dealers. Floyd's unsure about that as well:

This is a more complicated question. First, I am not sure that I agree that the auction market "never had enough buyer demand" to support itself. I doubt that this market would have gotten to this size if there were not buyers out there demanding this product, at least until they became concerned about their liquidity. Stabilization is a different issue. There is nothing wrong with stabilization to protect the market and produce more uniform results. Where the buyers lose confidence in the market in a short time period and there is a "rush" to the door by the investors, it is not surprising that the broker-dealers are not willing to "stabilize" the market.
Going forward, I suspect that this market will not exist in its present form. Investors in this type of security are very concerned about their liquidity, and with the liquidity of these investments now in question, it is unlikely that they will return in volumes needed to support this market.

Overall, then, it seems that the market used to be healthy, once upon a time, but that it's now a thing of the past - and nothing, not even a swanky new electronic trading platform, is likely to save it.

Comments

[stockbroker...:]

Investors who were promised safety and liquidity will still suffer losses in the secondary markets, if ever established. Now firms are offering margin Reg T-4 lending on these instruments and have recently found religion in disclosing the risks associated with these securities, which they claim they were unaware at the time of recommendation. It is amazing how this problem has not be covered in the corporate media to any meaningful extent.

2008 Mar 05 08:41 AM

[BondGuy:]

Agree with stockbrokerfraud.com. This has been truly appalling behavior that does huge damage to investor confidence not only in these notes, not only in munis, but in all aspects of financial markets. It's obvious that retail investors assume the same decency in others that they have in their normal, everyday dealings with others. Now they have learned this is not reciprocated by the financial industry, which will damage confidence in the entire private investment system.

2008 Mar 05 09:39 AM

[Phil Trupp:]

As of this writing (12/08), details of the ARS fraud have been exposed. Most of the $330 billion in frozen assets have been returned to frantic investors--but at a great cost to the financial industry as a whole. The loss of trust by investors can not be overstated.

It should have been clear as far back as 2004 that banks and brokers who peddled these securities had no respect for securities laws or their clients. They shrugged off SEC's cease and desist orders, lied to investors, and had no intention of returning anyone's money. It took action by state attorney generals, threats of prison time and huge fines to thaw the money freeze Compounding the problem was Washington's indifferent role. SEC Commissioner Christopher Cox, who was certainly aware of the commissioner's cease and desist orders, did nothing to enforce them. He has since come under increasing criticism, not only for his role in the ARS scandal, but also for a deregulation stance which has helped to throw all financial markets into chaos. His refusal to reinstate the safety net provided 70 years ago during the Great Depression has led to a short selling frenzy which has resulted in trillions of dollars of lost wealth. Mr. Cox even ignored the infamous Bernard Madoff, whose phony hedge fund turned out to be a $50 billion Ponzi scheme. Between Wall Street and Washington, the "free market" seems to have become criminal subculture.

More immedately, I am engaged in writing a book about the ARS scandal and am seeking investor interviews. If anyone out there has a story to tell, I will consider it for use in the manuscript. You may reach me online at [e-mail]. You may use your name or a pseudonym, the name of financial organization you dealt with, and disclose the worth of your ARS holdings if you choose to do so. I will guarantee your confidentiality.

The ARS debacle is an epic tale of Wall Street white collar crime and greed, and it was the tip-off for the financial meltdown we now face. I hope my book will serve investors first and foremost.

Thank you,

Phil Trupp

2008 Dec 16 04:25 PM