Corporate Governance

When Did the Auction Rate Securities Market REALLY Collapse?

By Jim Hodgson

The prevailing wisdom holds that the market for auction rate securities (essentially long-term bonds that carry an interest rate that is reset through periodic auctions) froze up last February. That is when the public auctions for these securities started to fail as those securities up for auction were left on the block unsold.  To this day, of course, the ARS market is all but dead.  But, the banks that sponsored these auctions would have the public believe that the $300 billion ARS market collapsed virtually overnight.  The reality may be far different, however.

A recent report by Business Week suggests that the investment banks that host these auctions ?may have known about problems with the securities months, and even years, before the market disintegrated.?  This is because the banks running the auctions habitually intervened in auctions to prop up the market for the ARSs they had originally sold.  In the case of UBS, for instance, the bank bought ARSs at almost 90% of the auctions it hosted in 2006 and 2007.

So, it looks like it was only when the public ARS market dried up completely that banks like UBS, Goldman Sachs, and Piper Jaffray simply had to stop buying:  their inventories were overflowing to the tune of billions of dollars worth of this illiquid paper.

Various investor lawsuits seek to hold these financial institutions accountable for ?continu[ing] to hype the investments as high quality? as inventory accumulated in the firms? accounts and brokers were instructed to dump the securities on unsuspecting customers.  In fact, New York Attorney General Andrew Cuomo seeks to have UBS buy back all $25 billion worth of ARSs sold to UBS customers.  It will take some time to gain a sense of where these lawsuits are headed; but, one thing?s for sure:  the investment houses that were marketing ARSs knew a lot more about the quality of what they were peddling a lot earlier than any of them let on.

Full post as published by PomTalk on July 31, 2008 (boomark / email).