Failure in Auction Rate Security Market and What It Means

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The tremors of the housing market and credit credit crisis hit another type of investment this week, the auction rate security market. The Wall Street Journal and several other business magazines have reported auction rate security failures for both Georgetown University and Nevada Power. On the surface, a failure in the $300 billion auction market sounds like a big problem. Is it?

Accrued Interest states that:

"Well, it turns out to not be a very big deal. Issuers will wind up having to pay a fee to their investment banker to refinance the debt, but that's manageable. Some issuers may use this occasion to call their variable rate debt and sell fixed rate debt instead, given that interest rates are low. Assuming the debt is indeed refinanced, the ARS holders who are currently "stuck" will get taken out when the bonds are called."

The comment thread that follows the article is equally instructive and demonstrates the confusion that even experienced traders and investment advisors have with auction rate securities. It appears that:

  • Not all auction rate securities are backed by liquidity insurance. This means that you might be holding an auction rate security that you might not be able to sell. Some might have it and you'd have to check the specific of your auction rate security to know.
  • Most of the payments and principal are protected. Most auction rate securities are issues by municipalities, colleges, or other institutions with high credit ratings. The vast majority are also backed by insurance which protects the principal and interest.
  • If an auction fails, the rate on the ARS goes to the maximum, providing a nice return to holders. Some auction rates securities are resetting with yields as high as 12%.
  • The issuer of the auction rate security is ultimately on the line to pay the 12% and they will not be happy. Most have call-provisions and look for them to call the bond if the auction market continues to fail. Thus, if there are above market returns, they shouldn't last long.

Be sure to check with a qualified professional before making any decision regarding auction rate securities.

Please visit the Auction Rate Security section for more information.

 

 


Fed Rate Cut Hurts Savers

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The Fed today cut rates by .75% of 75 basis points in a bid to shore up the economy. No doubt, Bernanke is hoping the cut will drop rates on mortgages, eliminating some of the reset pain, as well as reinvigorate a dying consumer. The problem is, the rates cuts will put less money in the pockets of consumers.

The Fed today cut rates by .75% of 75 basis points in a bid to shore up the economy.  No doubt, Bernanke is hoping the cut will drop rates on mortgages, eliminating some of the reset pain, as well as reinvigorate a dying consumer.  The problem is, the rates cuts penalize those of us who have been responsible and who have assets in cash or cash equivalent securities.

As rates fall, the rates that banks pay out on savings, cds, and othe cash equivalent securities drops.  With the stock market faltering, cash equivalents appear to be the only safe place to stash your money.  Rates on these investments have been dropping since the first 50 basis point rate cut in September.  After a high of 6% on some savings accounts and short term CDs, you'll be lucky to get over 5% shortly. 

It's true that lower rates my help mortgage holders whose mortgages are about to reset.  Rates on the 10 year bond have fallen.  But once again, its responsible depositors who are subsidizing people who took out risky, and ill-considered mortgages. 

 


Are Financial Reporters Getting the Facts Correct?

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We all hope that the "respected" business news sources get information correct and write factually correct articles.  This does not seem to be the case with the recent money market problems. 

The Financial Times ran a story entitled: Ailing fund bailouts hit $3bn and repackaged the story in another article entitled: More money funds are bailed out.   The articles chronicle some of the problems normally safe money  market funds have run into because of the credit crisis.  But Crane Data, a money market and mutual fund information company had this to say about the reporting:

"Since the credit crisis began in August, we'​ve repeatedly seen incorrect reporting on money market mutual funds. But a new FT.com article takes the misinformation to a new level. In "Ailing fund bail-outs hit € 3 billion," reporter Deborah Brewster claims, "Two other fund managers have suspended redemptions at money market funds." Speaking on "breaking the buck", she says "Many money funds have done so recently". These statements are both false. Like CNBC and WSJ, FT confuses enhanced cash vehicles with money funds. The article also mistakes total amounts purchased from funds with actual losses or "bailouts", which are a mere fraction of the total securities purchased."

In a previous article I wrote (Are your money markets safe?), I did seem to find two money market funds, not enhanced money markets that were bailed out by  their parent bank so there is some stress in the money market world.  But there is also quite a bit of confusion and misinformation being reported.