Since the beginning of fiscal ‘08, auction-rate securities have been failing, leaving investors stuck with highly illiquid (bad) paper, sometimes with no maturity date and with unrealistic yields - given the illiquidity of the securities.
For those holding such paper, if the current situation persists , there is unfortunately only the option of setting ‘fair value’ for the securities, which requires marking them at a discount from par. This causes, in some cases, significant losses for the holder(s).
Many investors were told that ARS (auction-rate securities) were ‘equivalent to cash’ and would yield a bit higher than a money market account. However, they were severely demoralized after they were unable to access their money since the credit market collapse. (Some banks and investment houses once stuck with lots of bad paper dumped it on their unwitting customers - how’s that for a fair business practice?!!) Wall Street has sold over $300 billion of these securities to more than 100,000 individuals and other investors.
The full impact resulting from the loss of liquidity of the auction-rate securities market remains still unknown at this point, which is why regulators are taking action.
In letters send to Morgan Stanley (NYSE:MS), J.P. Morgan Chase & Co. (NYSE:JPM), and Wachovia Corp.(NASDAQ:WB), New York Attorney General Andrew Cuomo’s office - according to the WSJ - is demanding the banks to enter talks about resolving his investigation into Wall Street’s sales and marketing of auction rate securities.
“It would be unfair to consumers with accounts at other firms, as well as to the firms that settled, if our investigation were to slow down or stop,” the letters say.
Just last week, settlements were reached between Cuomo’s office that forced Swiss bank UBS (NYSE:UBS) to repurchase $20 billion in the securities. Merrill Lynch (MER) also will repurchase $10 billion while Citigroup (NYSE:C) agreed to buy back $7.3 billion of the securities.
Cuomo calls on Morgan Stanley, Wachovia and J.P. Morgan to “enter into immediate talks about resolving the investigation”. The three firms are considered to be the next biggest players in the market, after the three that already agreed to buy back securities.
J.P. Morgan Chase, Morgan Stanley and Wachovia said their firms are cooperating with regulators. It is yet unclear however, how much clients of combined banks hold in the securities.