Gretchen Morgenson penned an insightful piece in the March 9, 2008 Sunday Business section of the New York Times. Ms. Morgenson likened auction-rate securities to the Hotel California, where investors have checked-in, but they can never leave.
Auction-rate securities are debt instruments whose interest rates reset at regular intervals, often weekly, and usually have long maturities. The auctions for these notes are overseen by the very Wall Street firms that originally sold them.
Historically these notes freely traded at the auctions. As a result, Wall Street sold these products to investors as an alternative to cash. However, when the $330 billion market for these products halted in February 2008, investors were left holding these notes with no market available. This freeze has left investors with no immediate way to liquidate their positions.
To date, the auction-rate securities have not defaulted. Investors are receiving a fixed interest rate as detailed in the note’s offering documents. But clearly the failing auctions are creating concerns among investors as to when, if ever, they can access their money. Many feel that it is only a matter of time before we see the first defaults.
What is clear at this time is that these products were misrepresented by Wall Street. They were sold as cash alternatives. Considering investors are not free to liquidate at their pleasure, these investments are not cash alternatives. As Ms. Morgenson suggests in her article, investors are in for a shock when they see their month-end statements reflecting major declines in the value of their auction-rate securities.