Elizabeth Nowicki, a guest on CNBC this morning, was described as a "former SEC lawyer" and current member of a college law faculty.
If she epitomizes the way the SEC views financial markets, then we're in serious trouble.
While participating in a spirited debate with other guests and on-air staff, including a former federal prosecutor, Nowicki displayed a shocking lack of understanding of the current Goldman/ACA/Paulson affair.
Specifically, Nowicki declared that Goldman's behavior in this matter is identical to that of Wall Street analysts, such as Mary Meeker and Henry Blodgett, during the dot com bubble of the late 1990s. Nowicki contended that, just like those analysts, giving public opinions directly to retail investors which may have belied their private views, Goldman similarly duped public retail investors.
That's not even remotely close to what happened. Even if you believe Goldman behaved unethically, it was, at no time, trying to influence retail investors to buy securities which it had underwritten after ACA constructed the securities.
If Nowicki can't distinguish between retail brokerage analysts speaking out of both sides of their mouths, one being to retail investors, and the process of underwriting of complex securities for sale to sophisticated, institutional investors, then it's a good thing she's no longer on the SEC staff.
Question is, are there more like Nowicki, similarly unaware of these differences, still on that staff? And perhaps involved in bringing the Goldman suit?
A suit, by the way, which we've now learned was cleared for prosecution by the narrowest of margins, 3-2. Probably along political party lines.
Nowicki's views tend to reinforce my belief that it's rare to find A-team players among government agencies.
Showing posts with label Auction Rate Securities. Show all posts
Showing posts with label Auction Rate Securities. Show all posts
Tuesday, April 20, 2010
Wednesday, September 10, 2008
On Auction Rate Securities & Brokerages
I have written five pieces on the subject of auction rate securities, the latest one found here, less than a month ago. In it, I related the humorous and shocking revelation by James Stewart, a financial advice columnist for the Wall Street Journal, that he, too, was a victim of these instruments. In my post, I wrote,
"Which brings me to a hilarious companion piece in the same WSJ edition.
It seems that James B. Stewart, a regular investment columnist who writes "Common Sense," lost his. He spent yesterday's column bitching about his lack of satisfaction as a 'victim' of the ARS mess.
Stewart alleges,
"It's not like we were clamoring to buy these securities. Like other victims I've heard from, I got a call urging me to take advantage of an offer that was being extended to valuable clients."
For more on this, see my prior, linked post, for my story of the early days of CMOs and their buyers.
But, back to Mr. Stewart. For someone so lofty as to write a column in the WSJ on investing, wouldn't you think he would know better than to offer an excuse like the above for purchasing ARS notes? Really- something for nothing, James?
Free extra returns, just for 'valuable clients?'
I have to laugh, because I've never bought any structured finance instrument in my life. The market-making assurances on these instruments are simply not to be believed.
Anyone with any experience in securities markets would know this."
Now, in an article from the weekend edition of the WSJ, we learn just how misguided and gullible Stewart really was for believing the 'valued customer' hokum.
Here are some of the choicer passages from the Journal's recent piece,
"For years, financial advisers promoted auction-rate securities to clients, friends and even family. Now, in the latest twist of the roiled credit markets, some brokers are siding with customers who allege that the securities weren't as billed. They were widely pitched as higher-yielding alternatives to easily bought-and-sold, super-safe money-market mutual funds -- but investors like Mr. Pellizzetti have been trapped in them since February, unable to cash out at full value after the market for auction-rate securities collapsed.
The auction-market crisis appears to be slowly working itself out. In recent weeks, most of Wall Street's biggest brokerage firms, including UBS, have agreed to buy back more than $40 billion of auction-rate securities from their clients, including individuals, charities and small businesses. Some have reached pacts with state and federal authorities to resolve probes into their sales, while other investigations continue. The pacts may help investors like Mr. Pellizzetti get their money back.
In the wake of all this, a behind-the-scenes debate is unfolding about the role played by brokers. Even as the auction market burgeoned to $330 billion in recent years, many brokers knew little about its inner workings, according to regulatory documents, lawsuits and interviews with brokers and their clients. Does that make financial advisers victims, too, if they reasonably relied on their firms' descriptions of the products, however thin they were? Or are securities brokers obligated to learn as much as they can about any investment they pitch, ensuring they themselves fully understand what they are selling?
Tamar Frankel, a professor at Boston University School of Law, says brokers' legal liability is a bit of a gray area, but her opinion is that a broker is obligated to learn about what he sells. "If he sells poison, he's got to know."
In interviews conducted by Massachusetts regulators and included in the state's complaint against UBS, a UBS financial adviser, Leonard Burd, acknowledged receiving no training on the securities other than marketing materials posted on UBS's intranet, and said he didn't read those materials or know of any risks before UBS pulled out of the market in February.
"All I knew" was that the auctions "worked in my career for 10 years seamlessly, and I had no understanding as to the backdrops of it at all," said Mr. Burd in the interview. Reached by phone, he said attorneys didn't want him to speak to the media.
"According to Mr. Pellizzetti's son, internal UBS sales meetings described any chance of auction failure as 'remote & temporary' explaining that at worst any illiquidity would be resolved" in the very next auction for that security, the claim alleges. After his son left UBS, Mr. Pellizzetti continued to purchase the securities through another UBS broker, the claim says.
One factor in financial advisers' willingness to promote the securities may have been the richer commissions they brought. At UBS, for instance, financial advisers received a portion of the 0.25% reward received by their firms for managing the securities, while no commission was available for putting the same investors in UBS's standard money-market fund, according to the Massachusetts complaint.
UBS denies that its advisers had an incentive to put clients into auction-rate securities.
Some brokers apparently did dig deeply enough to figure out that the securities were problematic. The Massachusetts complaint against UBS cites Jan. 10 emails from Sarah M. Sullivan, a financial adviser in Boston, to a senior manager explaining her reluctance to pitch the securities to clients who wanted alternatives to low-yielding money-market funds.
She had just listened to a conference call by UBS auction-market specialists aimed at boosting sales of the securities, according to the complaint. "We continue to be frustrated by the lack of information that they are providing to us," she wrote. She said she would be particularly concerned about putting any client into the securities just ahead of the April 15 tax-filing deadline. "If there is a failed auction, the client may not be able to access the funds. The bottom line is that rather than moving more cash into [the securities] we will probably be liquidating them for many clients."
She concluded: "Given the strange and difficult environment, it is imperative that we are fully aware of the risk we are taking. We do not want to imperil any relationships over something as 'simple' as their cash investments."
A follow-up email from the senior manager instructed a colleague to "get one of your people on the phone with Sarah ASAP so we can provide the appropriate color." The complaint doesn't detail Ms. Sullivan's subsequent actions. A spokesman for Mr. Galvin, the Massachusetts' regulator, said the state wouldn't comment beyond what is in the filings. UBS declined to elaborate or make Ms. Sullivan available for an interview."
My reason for presenting these extended passages is to refute some truths implied by the WSJ's financial columnist, James B. Stewart.
To wit, I contend that, in reality, you should believe that your broker is NOT:
a) well-informed and educated about what s/he is peddling to you.
b) truly interested in your economic welfare first, before their own.
c) unmotivated by commissions on what they sell you.
When you hear the phrase 'valued client' from a broker, run, do not walk, the other way. Hang up the phone, close and delete the email.
From the Journal's extensive article on the UBS case involving auction rate securities, we see that many brokers simply have no idea of the nature and behavior of many financial instruments which they sell to clients, once those instruments go beyond basic equities, debt and simple money market accounts.
Investor beware.
"Which brings me to a hilarious companion piece in the same WSJ edition.
It seems that James B. Stewart, a regular investment columnist who writes "Common Sense," lost his. He spent yesterday's column bitching about his lack of satisfaction as a 'victim' of the ARS mess.
Stewart alleges,
"It's not like we were clamoring to buy these securities. Like other victims I've heard from, I got a call urging me to take advantage of an offer that was being extended to valuable clients."
For more on this, see my prior, linked post, for my story of the early days of CMOs and their buyers.
But, back to Mr. Stewart. For someone so lofty as to write a column in the WSJ on investing, wouldn't you think he would know better than to offer an excuse like the above for purchasing ARS notes? Really- something for nothing, James?
Free extra returns, just for 'valuable clients?'
I have to laugh, because I've never bought any structured finance instrument in my life. The market-making assurances on these instruments are simply not to be believed.
Anyone with any experience in securities markets would know this."
Now, in an article from the weekend edition of the WSJ, we learn just how misguided and gullible Stewart really was for believing the 'valued customer' hokum.
Here are some of the choicer passages from the Journal's recent piece,
"For years, financial advisers promoted auction-rate securities to clients, friends and even family. Now, in the latest twist of the roiled credit markets, some brokers are siding with customers who allege that the securities weren't as billed. They were widely pitched as higher-yielding alternatives to easily bought-and-sold, super-safe money-market mutual funds -- but investors like Mr. Pellizzetti have been trapped in them since February, unable to cash out at full value after the market for auction-rate securities collapsed.
The auction-market crisis appears to be slowly working itself out. In recent weeks, most of Wall Street's biggest brokerage firms, including UBS, have agreed to buy back more than $40 billion of auction-rate securities from their clients, including individuals, charities and small businesses. Some have reached pacts with state and federal authorities to resolve probes into their sales, while other investigations continue. The pacts may help investors like Mr. Pellizzetti get their money back.
In the wake of all this, a behind-the-scenes debate is unfolding about the role played by brokers. Even as the auction market burgeoned to $330 billion in recent years, many brokers knew little about its inner workings, according to regulatory documents, lawsuits and interviews with brokers and their clients. Does that make financial advisers victims, too, if they reasonably relied on their firms' descriptions of the products, however thin they were? Or are securities brokers obligated to learn as much as they can about any investment they pitch, ensuring they themselves fully understand what they are selling?
Tamar Frankel, a professor at Boston University School of Law, says brokers' legal liability is a bit of a gray area, but her opinion is that a broker is obligated to learn about what he sells. "If he sells poison, he's got to know."
In interviews conducted by Massachusetts regulators and included in the state's complaint against UBS, a UBS financial adviser, Leonard Burd, acknowledged receiving no training on the securities other than marketing materials posted on UBS's intranet, and said he didn't read those materials or know of any risks before UBS pulled out of the market in February.
"All I knew" was that the auctions "worked in my career for 10 years seamlessly, and I had no understanding as to the backdrops of it at all," said Mr. Burd in the interview. Reached by phone, he said attorneys didn't want him to speak to the media.
"According to Mr. Pellizzetti's son, internal UBS sales meetings described any chance of auction failure as 'remote & temporary' explaining that at worst any illiquidity would be resolved" in the very next auction for that security, the claim alleges. After his son left UBS, Mr. Pellizzetti continued to purchase the securities through another UBS broker, the claim says.
One factor in financial advisers' willingness to promote the securities may have been the richer commissions they brought. At UBS, for instance, financial advisers received a portion of the 0.25% reward received by their firms for managing the securities, while no commission was available for putting the same investors in UBS's standard money-market fund, according to the Massachusetts complaint.
UBS denies that its advisers had an incentive to put clients into auction-rate securities.
Some brokers apparently did dig deeply enough to figure out that the securities were problematic. The Massachusetts complaint against UBS cites Jan. 10 emails from Sarah M. Sullivan, a financial adviser in Boston, to a senior manager explaining her reluctance to pitch the securities to clients who wanted alternatives to low-yielding money-market funds.
She had just listened to a conference call by UBS auction-market specialists aimed at boosting sales of the securities, according to the complaint. "We continue to be frustrated by the lack of information that they are providing to us," she wrote. She said she would be particularly concerned about putting any client into the securities just ahead of the April 15 tax-filing deadline. "If there is a failed auction, the client may not be able to access the funds. The bottom line is that rather than moving more cash into [the securities] we will probably be liquidating them for many clients."
She concluded: "Given the strange and difficult environment, it is imperative that we are fully aware of the risk we are taking. We do not want to imperil any relationships over something as 'simple' as their cash investments."
A follow-up email from the senior manager instructed a colleague to "get one of your people on the phone with Sarah ASAP so we can provide the appropriate color." The complaint doesn't detail Ms. Sullivan's subsequent actions. A spokesman for Mr. Galvin, the Massachusetts' regulator, said the state wouldn't comment beyond what is in the filings. UBS declined to elaborate or make Ms. Sullivan available for an interview."
My reason for presenting these extended passages is to refute some truths implied by the WSJ's financial columnist, James B. Stewart.
To wit, I contend that, in reality, you should believe that your broker is NOT:
a) well-informed and educated about what s/he is peddling to you.
b) truly interested in your economic welfare first, before their own.
c) unmotivated by commissions on what they sell you.
When you hear the phrase 'valued client' from a broker, run, do not walk, the other way. Hang up the phone, close and delete the email.
From the Journal's extensive article on the UBS case involving auction rate securities, we see that many brokers simply have no idea of the nature and behavior of many financial instruments which they sell to clients, once those instruments go beyond basic equities, debt and simple money market accounts.
Investor beware.
Friday, August 15, 2008
Auction Rate Securities, Goldman Sachs & "Sophisticated" Investors
Last week, I wrote this post about the ARS settlement reached by Merrill Lynch, Citigroup and UBS.
In that piece, I wrote,
"Buyers of financial service products, especially 'structured' products, should know the intrinsic value and risks of such products on their own. They should not simply trust an institutional salesperson to tell the the truth- the whole truth.
Buyers of ARSs were defrauded- this is clear. They were lied to regarding how liquid the instruments would be, and that the added yield over money market instruments was somehow riskless.
But, really, in the end, should they not have known enough to ask questions? Like,
"But, how can they have a higher yield with no added risk? Surely, there must be something about them that is riskier? What is it?"
When you read about retail customers losing millions of dollars in these ARS investments, don't you wonder how they could be sufficiently intelligent to amass that much money, only to be so easily hoodwinked by some financial schlockmeister spinning tales to separate them from their hard-earned money?"
Thus, yesterday's Wall Street Journal article concerning Goldman Sachs' refusal to repurchase ARS securities sold to their clients is an exception to the recent trend among banks which sold this toxic dreck.
According to the Journal article,
"Wealthy clients, institutions and corporations have been largely left out of those pacts."
And, knowing Goldman's clientele to be much more high-end than the other banks, I can understand their reticence to reimburse sophisticated investors- especially institutional ones.
The Journal article exemplifies a former INtel and Dell senior executive, one Carl Everett, as having become disillusioned with Goldman's failure to rescue his position in ARSs. The piece doesn't mention his net worth, nor the face value of his ARSs. One somehow suspects that they would qualify Mr. Everett as a 'sophisticated' investor.
Which brings me to a hilarious companion piece in the same WSJ edition.
It seems that James B. Stewart, a regular investment columnist who writes "Common Sense," lost his. He spent yesterday's column bitching about his lack of satisfaction as a 'victim' of the ARS mess.
Stewart alleges,
"It's not like we were clamoring to buy these securities. Like other victims I've heard from, I got a call urging me to take advantage of an offer that was being extended to valuable clients."
For more on this, see my prior, linked post, for my story of the early days of CMOs and their buyers.
But, back to Mr. Stewart. For someone so lofty as to write a column in the WSJ on investing, wouldn't you think he would know better than to offer an excuse like the above for purchasing ARS notes? Really- something for nothing, James?
Free extra returns, just for 'valuable clients?'
I have to laugh, because I've never bought any structured finance instrument in my life. The market-making assurances on these instruments are simply not to be believed.
Anyone with any experience in securities markets would know this.
Should James B. Stewart even be writing a weekly investing column for the WSJ, if he was taken in by such a simple ruse as the ARS game, and went for the old 'something for nothing' con?
Monday, August 11, 2008
Update on UBS's ARS Settlement
I wrote in error last week, in this post, that,
"Breaking stories this afternoon on the internet have UBS agreeing to repurchase some $8.3B of the ARS instruments they bamboozled their clients into stuffing into their portfolios."
In fact, according to this weekend's Wall Street Journal headline, UBS agreed to pay $19 billion to clean up its share of the ARS mess.
Thus, Merrill, Citigroup and UBS have agreed to make good on a total face value of $36B, not just $25B, in fraudulently-marketed, misrepresented ARS notes.
This makes UBS the 'winner' in this sad story, outstripping even securities giant Merrill Lynch in its ability to churn out and place these toxic investment securities to its customers. In fact, UBS accounts for just over half of the total.
Who's going to subscribe to a new equity issue of the Swiss bank now, in order to help plug this latest gaping hole in its balance sheet?
"Breaking stories this afternoon on the internet have UBS agreeing to repurchase some $8.3B of the ARS instruments they bamboozled their clients into stuffing into their portfolios."
In fact, according to this weekend's Wall Street Journal headline, UBS agreed to pay $19 billion to clean up its share of the ARS mess.
Thus, Merrill, Citigroup and UBS have agreed to make good on a total face value of $36B, not just $25B, in fraudulently-marketed, misrepresented ARS notes.
This makes UBS the 'winner' in this sad story, outstripping even securities giant Merrill Lynch in its ability to churn out and place these toxic investment securities to its customers. In fact, UBS accounts for just over half of the total.
Who's going to subscribe to a new equity issue of the Swiss bank now, in order to help plug this latest gaping hole in its balance sheet?
Friday, April 04, 2008
Congress Determines There Were No Buyers of Toxic Structured Finance Instruments- Only Sellers!
This week's appearance by Bernanke in front of a joint Congressional committee provided another pathetic example of Ted Kennedy's failing grasp of reality. To be fair, not only Teddy, but many of his Democratic and Republican fellow Senators and Representatives, too.
Brow beating the Fed Chairman, Ted repeatedly asked Bernanke why the Fed didn't 'remove harmful financial products' from the 'shelves' of America's banks, just like the Congress forced toy retailers to clear their shelves of lead-contaminated painted toys. Judging from Kennedy's assault on Bernanke, it is clear that Ted thinks there were no buyers of structured finance instruments, only sellers.
Here's a little piece of information you evidently missed, Ted.
Wall Street's investment banks, and commercial banks, too, wouldn't have securitized toxic loans if there weren't informed, willing adult institutional buyers.
That's right. Nobody actually put a gun to anybody's head to make them buy CDOs or auction-rate securities.
As I wrote in this post last year, every institutional investor who bought CDOs, shares of an SIV, or other structured finance instruments surely believed they were receiving excess returns for no commensurate additional risk.
Without willing buyers, none of the risky, opaque structured instruments now so roundly criticized and reviled by regulators and Congressional pooh bahs would have ever been created and sold.
Further, very few retail investors seem to have bought CDOs. Those were mostly institutional investors including your typical local county or state pension or sinking funds. Those people are paid to make informed investment decisions. They can't blame the rating agencies or their investment bank advisers for decisions for which they are handsomely paid.
These investment professionals, the ones who willingly bought CDOs, SIV shares, and similar structured finance instruments, are, it seems to me, the real source of the financial market excesses. These people, whoever and wherever they are to be found, failed to exercise due diligence in understanding what they were buying on behalf of their investing organizations.
How does Senator Kennedy propose to stop this consensual buying behavior?
Maybe we should be realistic and stop denying the obvious. We have financial market turmoil because a lot of institutional investors failed to do their jobs, became greedy, and believed excess returns could be had for no added risk.
It turns out that they were, as usual in every financial cycle, wrong on all counts.
Don't blame the sellers of these instruments. Or at least, not them alone.
Blame the buyers who provided the market demand for the toxic financial paper that lies at the root of the credit market mess.
Brow beating the Fed Chairman, Ted repeatedly asked Bernanke why the Fed didn't 'remove harmful financial products' from the 'shelves' of America's banks, just like the Congress forced toy retailers to clear their shelves of lead-contaminated painted toys. Judging from Kennedy's assault on Bernanke, it is clear that Ted thinks there were no buyers of structured finance instruments, only sellers.
Here's a little piece of information you evidently missed, Ted.
Wall Street's investment banks, and commercial banks, too, wouldn't have securitized toxic loans if there weren't informed, willing adult institutional buyers.
That's right. Nobody actually put a gun to anybody's head to make them buy CDOs or auction-rate securities.
As I wrote in this post last year, every institutional investor who bought CDOs, shares of an SIV, or other structured finance instruments surely believed they were receiving excess returns for no commensurate additional risk.
Without willing buyers, none of the risky, opaque structured instruments now so roundly criticized and reviled by regulators and Congressional pooh bahs would have ever been created and sold.
Further, very few retail investors seem to have bought CDOs. Those were mostly institutional investors including your typical local county or state pension or sinking funds. Those people are paid to make informed investment decisions. They can't blame the rating agencies or their investment bank advisers for decisions for which they are handsomely paid.
These investment professionals, the ones who willingly bought CDOs, SIV shares, and similar structured finance instruments, are, it seems to me, the real source of the financial market excesses. These people, whoever and wherever they are to be found, failed to exercise due diligence in understanding what they were buying on behalf of their investing organizations.
How does Senator Kennedy propose to stop this consensual buying behavior?
Maybe we should be realistic and stop denying the obvious. We have financial market turmoil because a lot of institutional investors failed to do their jobs, became greedy, and believed excess returns could be had for no added risk.
It turns out that they were, as usual in every financial cycle, wrong on all counts.
Don't blame the sellers of these instruments. Or at least, not them alone.
Blame the buyers who provided the market demand for the toxic financial paper that lies at the root of the credit market mess.
Thursday, April 03, 2008
More on Auction Rate Securities
The Wall Street Journal published an article this past Tuesday on auction-rate securities, with another one this morning. Recently, I've been getting a large number of readers coming to my blog for this post from mid-February.
Probably the best that can be said is that nothing has improved about this situation.
In Tuesday's article, the Journal reported that UBS has begun writedowns of retail account holders' auction-rate assets. Today's article noted that, by contrast, Merrill Lynch is still recording them at a higher value to its retail customers, although they note that the firm itself has reduced the values at which it carries comparable auction-rate securities.
Like a hot-house flower, it seems that auction-rate securities could only exist and thrive in a rather narrowly-defined financial market condition. A condition of fairly easy and low-risk credit which has now vanished from current credit markets.
At this point, it is probably fair to say that the word 'fix' doesn't really apply to the auction-rate securities dilemma. A word like 'end' or 'terminate' seems more applicable. In time, one suspects that these securities will simply disappear as they are replaced by less-volatile, truly more cash-equivalent securities.
Hopefully, both issuers and buyers will now be more sanguine and suspect when Wall Street securities salespeople insist that some abstruse, complex instrument is 'as safe and liquid' as cash.
Probably the best that can be said is that nothing has improved about this situation.
In Tuesday's article, the Journal reported that UBS has begun writedowns of retail account holders' auction-rate assets. Today's article noted that, by contrast, Merrill Lynch is still recording them at a higher value to its retail customers, although they note that the firm itself has reduced the values at which it carries comparable auction-rate securities.
To attempt to end the mess involving these notes, some issuers either calling their own notes or simply refunding with conventional long term debt.
But it's noteworthy that nearly two months after the Journal's first mention of this market failure, the only 'solutions' in sight are the same as those originally mentioned- lending to customers on the collateral of a reduced value of the auction-rate securities, and calling/reissuance of the auction-rate securities as conventional longer term securities.
Is this not essentially indicative of an instrument which has no further use in current markets?
Like a hot-house flower, it seems that auction-rate securities could only exist and thrive in a rather narrowly-defined financial market condition. A condition of fairly easy and low-risk credit which has now vanished from current credit markets.
At this point, it is probably fair to say that the word 'fix' doesn't really apply to the auction-rate securities dilemma. A word like 'end' or 'terminate' seems more applicable. In time, one suspects that these securities will simply disappear as they are replaced by less-volatile, truly more cash-equivalent securities.
Hopefully, both issuers and buyers will now be more sanguine and suspect when Wall Street securities salespeople insist that some abstruse, complex instrument is 'as safe and liquid' as cash.
Friday, February 15, 2008
Auction-Rate Securities Troubles
Yesterday's article in the Wall Street Journal regarding the Maher family, Lehman Brothers, and auction-rate securities sheds new light on yet another corner of the troubled fixed-income markets.
The most interesting portions of the article, to me, were the relatively new information about this type of securities, and Lehman's suspect actions in putting a client in them.
According to the Journal article,
"The Mahers rank among the earliest victims of "auction rate" securities, a once-obscure type of bond now sending shock waves through broad swaths of the U.S. economy. Auction-rate securities -- an unusual type of long-term bond that behaves like a short-term bond -- have become a keystone of modern finance. They are routinely used to fund everything from college student-loan programs to municipal road-and-bridge projects.
These bonds became popular with investors looking for cashlike investments, because they offered better returns than traditional money-market investments but were just as easy to buy and sell.
Recently, however, that advantage has disappeared. The market for auction-rate securities has dried up amid fears about fallout from the subprime-mortgage crisis. This week, New York's Port Authority saw the interest rate on some of its debt jump to 20% from 4.2% amid disruptions in this market."
From what I can deduce from this, auction-rate securities have their interest rates reset by market-auctions, rather than, like a long-term bond, simply carry a fixed or variable, according to some index like LIBOR, rate.
Thus, the price of the securities which, of course, varies inversely with the yield, can plunge if, for some reason, the auction reset results in a very high interest rate being paid to new buyers of the debt. This is evidently what happened to the Maher's Lehman-based holdings.
The Journal article goes on to report,
"The brothers have filed a claim against Lehman, saying it mismanaged their money. The complaint, filed last month with the Financial Industry Regulatory Authority, which resolves disputes between investors and brokers, says Lehman ignored the Mahers' request to put the money in short-term, low-risk investments such as Treasurys and municipal bonds."
According to the Mahers, they didn't realize that Lehman was putting their money into these potentially volatile securities. As the fixed-income markets became increasingly unstable late last year, these securities fell victim to demand simply evaporating, necessitating very high rates of interest to result from the auctions. The Mahers had informal asset management advice from a banker, Mr. Liu, at the firm that sold their business, Greenhill & Co. So abstruse were the instruments that even Mr. Liu didn't fully understand them.
The article continues,
"Baffled by the codes, Mr. Liu says he phoned Lehman and learned that many were corporate auction-rate securities. Mr. Liu, who had only a vague understanding of the securities, asked Lehman for details.
Auction-rate securities usually are long-term bonds with interest rates that are reset periodically (usually once a month) at an auction. Because the auctions happen so often, the bonds traditionally were much easier to buy and sell than other forms of long-term debt. Auction-rate securities worked well for over 20 years and were regarded by Wall Street as cashlike investments, since they were highly liquid and highly rated.
But if buyers stop showing up for auctions, they become tough to sell, or even to value."
Lehman had put the Mahers into most of their auction-rate securities a few weeks earlier, in July. It reinvested about $100 million of the Mahers' money in auction-rate securities in mid-August, the Mahers say."
So Lehman, according to the Maher's and their informal advisor, Mr. Liu, failed to invest the Maher's money as directed. Apparently, the Maher's aren't the only investors displeased with Lehman's conduct involving auction-rate securities. The Journal article concludes with the passage,
"Many companies, including 3M and US Airways, are already writing down the value of their auction-rate securities. Bristol-Myers Squibb in January took an impairment charge of $275 million because of auction-rate securities it held.
Merrill Lynch & Co. recently bought back $13.9 million in debt securities that it sold to the city of Springfield, Mass. The Massachusetts secretary of state has since filed a civil lawsuit against Merrill charging the firm with fraud and misrepresentation.
In their claim, the Mahers are demanding their $286 million back from Lehman, along with interest, and are seeking punitive damages of up to an additional $857 million."
Just when you thought you had understood some of the more exotic credit market instruments, this story appears. It turns out that the Port Authority of New York and New Jersey saw its interest rate on auction-rate securities it issued jump to 20% this week, amidst weak investor demand for the notes.
How is it that with so many educated, intelligent investment bankers working in fixed-income departments throughout the industry, instruments such as CDOs and auction-rate debt fail to observe that there are times when demand for such exotic securities evaporates? And current 'values' cannot be easily determined?
If well-compensated, experienced sellers and investors continue to trade these instruments, without realizing all of the risks, can any regulator or government really have an impact on this business?
Or do investors and issuers simply need to experience the pain of loss with these securities, in order to learn not to participate in those markets anymore?
The most interesting portions of the article, to me, were the relatively new information about this type of securities, and Lehman's suspect actions in putting a client in them.
According to the Journal article,
"The Mahers rank among the earliest victims of "auction rate" securities, a once-obscure type of bond now sending shock waves through broad swaths of the U.S. economy. Auction-rate securities -- an unusual type of long-term bond that behaves like a short-term bond -- have become a keystone of modern finance. They are routinely used to fund everything from college student-loan programs to municipal road-and-bridge projects.
These bonds became popular with investors looking for cashlike investments, because they offered better returns than traditional money-market investments but were just as easy to buy and sell.
Recently, however, that advantage has disappeared. The market for auction-rate securities has dried up amid fears about fallout from the subprime-mortgage crisis. This week, New York's Port Authority saw the interest rate on some of its debt jump to 20% from 4.2% amid disruptions in this market."
From what I can deduce from this, auction-rate securities have their interest rates reset by market-auctions, rather than, like a long-term bond, simply carry a fixed or variable, according to some index like LIBOR, rate.
Thus, the price of the securities which, of course, varies inversely with the yield, can plunge if, for some reason, the auction reset results in a very high interest rate being paid to new buyers of the debt. This is evidently what happened to the Maher's Lehman-based holdings.
The Journal article goes on to report,
"The brothers have filed a claim against Lehman, saying it mismanaged their money. The complaint, filed last month with the Financial Industry Regulatory Authority, which resolves disputes between investors and brokers, says Lehman ignored the Mahers' request to put the money in short-term, low-risk investments such as Treasurys and municipal bonds."
According to the Mahers, they didn't realize that Lehman was putting their money into these potentially volatile securities. As the fixed-income markets became increasingly unstable late last year, these securities fell victim to demand simply evaporating, necessitating very high rates of interest to result from the auctions. The Mahers had informal asset management advice from a banker, Mr. Liu, at the firm that sold their business, Greenhill & Co. So abstruse were the instruments that even Mr. Liu didn't fully understand them.
The article continues,
"Baffled by the codes, Mr. Liu says he phoned Lehman and learned that many were corporate auction-rate securities. Mr. Liu, who had only a vague understanding of the securities, asked Lehman for details.
Auction-rate securities usually are long-term bonds with interest rates that are reset periodically (usually once a month) at an auction. Because the auctions happen so often, the bonds traditionally were much easier to buy and sell than other forms of long-term debt. Auction-rate securities worked well for over 20 years and were regarded by Wall Street as cashlike investments, since they were highly liquid and highly rated.
But if buyers stop showing up for auctions, they become tough to sell, or even to value."
So we see yet another instance in which investors failed to completely understand that, for some instruments, there is no way a market can be guaranteed to exist continuously. In this case, rather than frequent auctions keeping yields competitive, but leaving the securities reasonably valuable, the lack of risk appetite by buyers has caused rates to skyrocket, correspondingly sending the bond values plummeting.
And, in a page right out of the CDO story, sometimes the bonds can't be valued at all, because the auctions draw no bidders.
Oops!
Regarding Lehman, the article continues,
"Mr. Liu says he came away from his conversation with Lehman unsure of the quality of the bonds' underlying assets. He consulted with the Mahers, and they agreed the bonds should be sold as soon as possible. Mr. Liu told Lehman to "unwind the positions and give the Mahers their money back."
Lehman, however, had trouble selling. In early August, the market for auction-rate securities grew skittish as one auction for lower-grade securities failed.Lehman had put the Mahers into most of their auction-rate securities a few weeks earlier, in July. It reinvested about $100 million of the Mahers' money in auction-rate securities in mid-August, the Mahers say."
So Lehman, according to the Maher's and their informal advisor, Mr. Liu, failed to invest the Maher's money as directed. Apparently, the Maher's aren't the only investors displeased with Lehman's conduct involving auction-rate securities. The Journal article concludes with the passage,
"Many companies, including 3M and US Airways, are already writing down the value of their auction-rate securities. Bristol-Myers Squibb in January took an impairment charge of $275 million because of auction-rate securities it held.
Merrill Lynch & Co. recently bought back $13.9 million in debt securities that it sold to the city of Springfield, Mass. The Massachusetts secretary of state has since filed a civil lawsuit against Merrill charging the firm with fraud and misrepresentation.
In their claim, the Mahers are demanding their $286 million back from Lehman, along with interest, and are seeking punitive damages of up to an additional $857 million."
Just when you thought you had understood some of the more exotic credit market instruments, this story appears. It turns out that the Port Authority of New York and New Jersey saw its interest rate on auction-rate securities it issued jump to 20% this week, amidst weak investor demand for the notes.
How is it that with so many educated, intelligent investment bankers working in fixed-income departments throughout the industry, instruments such as CDOs and auction-rate debt fail to observe that there are times when demand for such exotic securities evaporates? And current 'values' cannot be easily determined?
If well-compensated, experienced sellers and investors continue to trade these instruments, without realizing all of the risks, can any regulator or government really have an impact on this business?
Or do investors and issuers simply need to experience the pain of loss with these securities, in order to learn not to participate in those markets anymore?
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