Think For Yourself

Part of my duties is to write an Internal Use Only market commentary. Today I decided to discuss the Auction Rate Secuirties debacle. Some were not thrilled with what I had to say.

Today I had the audacity to tell brokers that if they believed that perpetual securities which rely on successful auctions to provide liquidity were true money markets, they were mistaken. I had one broker tell me that the ARS department marketed ARS to brokers as money markets and they appear on clienst statements and firm planning software as money markets. As far as they and their clients were concerned, ARS were money markets. The fact that these instruments had no maturity, they had auctions. One only needed to liquidate at the auctions (frequency depends on the issue) and one received his or her cash. But, what would happen when auctions fail. As Bondguy 1824 mentioned in his blog, auctions have failed in the past (albeit not on such a large scale). Nothing is certain except a stated maturity date. This is where the problems lie.

Investors who hold ARS with failed auctions usually receive interest payments which are much higher than the advertised rate. In the case of ARS issued by the Port Authority of NY and NJ, the coupon jumped from 4.20% to 20%. Who wouldn't like that? Someone who needed to cash out.

Apparently brokers and clients all over Wall Street, instead of using ARS as money market alternatives (exchanging potentially less liquidity for enhanced yield), they used them as they woud use a CD or Treasury Bill.

Claims by brokers that ARSwere market as a riskless liquid way to enhance return rings hollow with me. If one is receiving higher return, one is probably incurring some kind of increases risk. There are no free lunches. I have no way of verifying how ARS was marketed to brokers and clients. I do not work in that capacity, but it appears to be the most recent case of the ignorant leading the ignorant leading the ignorant. Watch the lawsuits fly.


Let this be a lesson to all brokers, investment advisers etc. You (yes you) must know your clients and your products.