Monthly Archives: June 2008

The ripples from the subprime crisis have reached an unlikely and surprising sector, municipal bonds.  Defaults of subprime mortgages have started a sequence of problems in the credit markets over the past year eventually impacting the municipal bond market (munis).  

Last summer losses in the taxable bond sector and the debt tied to subprime mortgages led to serious write downs. During the last two weeks of February the bond market essentially crashed, resulting in the worst week in the municipal bond market in over a decade. Municipal yields went up about 50 basis points and municipal bond funds declined by anywhere from four to ten percent, which is unheard of over such a short period of time. The media offered little explanation, leaving many investors in the dark. 

In the past bond insurers were capitalized, and the major firms (including MBIA and FGIC) were rated AAA, the highest credit quality. The ratings of the firms are extended to the bonds under guarantee. This caused certain bonds to receive AAA ratings when they should have been investment grade or lower. The higher ratings made it possible for a variety of fiduciaries to own the bonds, and make interest costs lower.  

Potential losses are still unknown, and attempts to recapitalize in order to save their AAA rating are ongoing. But, the damage has been done and bond insurers are being downgraded. According to Bond Buyer, as of April 15, FGIC, once the firm with the strongest capital base, had been downgraded to barely investment grade or slightly below.  

The hesitancy of bond insurers’ ratings parallels the hesitancy of issuers’ underlying ratings. As a result, many bonds are lowering to the underlying ratings, and in some cases even lower.   

Since the downfall first started, there have been signs that the municipal bond market would have serious consequences if bond insurers downgrade, such as the values of munis dropping significantly. These downgrades also have harmful effects on banks’ balance sheets, because some of the corporate debt is owned by major money center banks.  

Munis are relatively new, and gained popularity because the bonds are exempt from federal taxes, as well as city and state taxes if living in the state it’s issued. They also have extremely low default rates and are dominated by the individual investors, who purchase about two-thirds of the bonds.

Many investors are feeling handcuffed to their auction-rate securities (ARS) as the struggle to get money back from the Wall Street banks continues. Bank of America, UBS AG and Wachovia Corp, (three of the firms that sold $330 billion worth of these securities) are now preventing efforts to create a second market. This market would provide investors access to their cash.

One investor, who has not had access to his invested money since February when the auction rate market began to freeze, is upset the bank is unwilling to release his bonds. Bank of America refuses to let him sell $100,000 of securities to Fieldstone Capital Group, claiming the deal is not in his interest. Brokers rejecting these transactions claim they are saving their customers from further unnecessary losses on the securities that they marked as cash-like instruments to begin with.

According to Vincent Dicarlo, formerly a lawyer at the SEC’s enforcement division, “if an investor finds a buyer, he should be able to move his securities to another dealer or take possession to complete the transaction.”

UBS has refused to find buyers for customer’s auction-rate securities because, in their opinion, the secondary market is “inefficient”. What could the secondary market be inefficient to if the primary market no longer exists?

“For someone needing their cash, the only choice is to go to the secondary market and sell them with a haircut,” said Steven Caruso, an attorney at Maddox Hargett & Caruso, who is representing investors in lawsuits against dealers.

According to Darrell Preston’s June 6, Boomberg.com article, since March at least 24 proposed class action suits have been filed over claims investors were told the securities were almost as liquid as cash. These investors have been caught for months with auction rate debt since the buyers that ran the bidding could no longer support the market due to losses linked to subprime mortgages. Before investors believed they could get their money back right away because dealers always bought the unsold securities.

Not only has Wall Street misrepresented these products to their customers, it appears some firms are now preventing these same customers from getting the relief and access to their money that many desperately need.

Bloomberg is reporting that Charles Schwab Corp., the largest U.S. online brokerage, may set aside $260 million to settle investors’ claims regarding losses from their Yield Plus mutual fund.  To date, eight different class actions have been filed against Charles Schwab relating to their Yield Plus fund.

There are a number of problems with this rumored settlement.  The first is that a Schwab spokesman has commented that it is “inappropriate and misguided” at this early stage to speculate regarding settlement.  Secondly, the Bloomberg report only addresses the class actions that have been filed.  A number of investors, seeking better outcomes, are choosing to participate in their own individual arbitrations. 

Charles Schwab is accused of misleading investors by marketing, offering and selling its Yield Plus fund as only “marginally” riskier than cash.  From July 1 through April 30, investors in this fund lost $1.3 billion.   

According to Bloomberg, securities class action settlements typically begin around 1% of investors’ losses.  The $260 million figure being reported represents 20 percent of losses.  Our firm believes that investors may stand a better chance of recieving a greater recovery of their losses through individual arbitration actions.

Investors of the Charles Schwab Yield Plus mutual fund are encouraged to contact an attorney to discuss their options.        

Morgan Keegan investors critically affected by the subprime mortgage crisis are taking a stand. Recent allegations claim the company inadequately managed funds and unjustly explained losses during the subprime market collapse. Many investors are also accusing Morgan Keegan of fraud because they presented these funds as “safe and stable investments.”

One investor seeking to recover damages filed an arbitration claim with FINRA against Morgan Keegan for $4 million last week.

The claim alleges misrepresentation and omission of information in its registration statements and prospectus releases with regard to the funds’ investments in collateralized debt obligations, resulting in exposure to the subprime mortgage market. Further damages came from false and misleading statements issued by Morgan Keegan with regard to the funds’ safety, and capacity to generate income.

The damages are in connection with the sale of unsuitable funds which include; the RMK High Income Fund (RMH), the RMK Multi-sector High Income Fund (RHY), the RMK Advantage Income Fund (RMA), the RMK Strategic Income Fund (RSF) and the Regions MK Select High Income fund (MKHIX).

There are many other investors in the same situation hoping to recover varying amounts in claims already filed against Morgan Keegan.

Charities and other smaller investors have also been affected by Morgan Keegan. Last October Maddox Hargett & Caruso represented an Indiana-based charity by filing a FINRA claim regarding a loss in a RMK fund totaling almost $50,000.

Investors, big or small, are choosing the arbitration process to recover their damages instead of waiting for a class action lawsuit that could take years to settle. We encourage all investors of Morgan Keegan funds to contact us.

Chief executive officer of Wachovia Corp., Kennedy Thompson, has stepped down (at the board’s request) after being blamed for losses costing the lender more than half of its market value this year. Thompson’s departure comes less than a month after his title was officially removed, making him the latest CEO to be ousted during the housing market chaos. Chairman Lanty Smith temporarily replaces him as CEO and Ben Jenkins is the interim chief operating officer.

Thompson’s title was removed after the annual meeting in April where shareholders, upset with the company’s first quarterly loss in seven years, requested his termination. Wachovia’s stock fell four percent and their shares dropped over 40 percent this year.

Even before his removal, Thompson’s standing with Wachovia was feeble. He recently admitted Wachovia’s $24 billion acquisition of Golden West Financial Corp. in 2006, in hopes to expand business during the housing boom, was “ill-timed”. The increased mortgage defaults and write downs due to subprime home loans caused the fallout.

Thompson slipped up again early this May. According to David Mildenberg and Hugh Son in their Bloomberg.com article Monday, the bank reported a first-quarter loss of $708 million, 80 percent more than Wachovia previously reported, due to the write-downs for bank-owned insurance policies. As a result, the bank had to cut its dividend by 41 percent and raised around $8 billion in new capital.

Wachovia formed a four-person search committee headed by Smith to find a permanent replacement for Thompson. Many wonder if his removal means more problems for Wachovia. The company has suffered a serious of setbacks, including their recent losses and investigations.

Washington Mutual Inc. seems to be on a similar path. They reported yesterday CEO Kerry Killinger was also stripped from his CEO title. The recent changes in many companies are occurring due to the credit losses from the current housing crisis and $386 billion in asset write downs.

Preferred holders are fed up with waiting for Pacific Investment Management Co. (Pimco) to figure out a course of action to help those suffering after the collapse of $330 billion auction-rate securities market.  

Pimco is struggling to find a comfortable medium between their preferred holders and investors in the funds’ common shares, which trade on exchanges like stocks. The two groups have competing interests, therefore, making it difficult for the fund managers to refinance ARS without hurting the common holders by increasing costs.  

Municipal-bond issuers control a majority auction-rate market, so when the companies insuring these bonds were threatened by reduced credit-ratings, the market failed. The crisis left investors alarmed and with $63.4 billion of illiquid preferred shares.  

One holder told Bloomberg.com he bought “several hundreds of thousands of dollars” in the auction- rate preferred shares issued by Pimco’s closed-end funds before the freeze in February. Shareholders similarly situated are disappointed in Pimco’s lack of communication and failure to develop a solution. They have a just reason to be frustrated.  Pimco is the only top five manager of publicly traded closed-end funds without a plan for their investors to cash out.  

According to a company spokesman in Christopher Condon’s May 30, 2008 article, Pimco is “devoting considerable time, energy and attention to finding an approach that, consistent with our fiduciary obligation, reconciles the competing considerations facing common and preferred shareholders.”  Only time will tell how Pimco ultimately decides to treat investors.