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Calling All Auction-Rate Securities Holders: “A Break for 8 Banks” or Did the Fed Violate Your Property Rights?

Posted by Larry Doyle on April 14, 2011 5:48 PM |

New information would seem to implicate the Federal Reserve for violating the property rights of tens of thousands of investors holding auction-rate securities. Could this be true? Let’s navigate.

I have been writing about the nightmare known as auction-rate securities since mid-January 2009. I often pause to reflect on ARS holders whom I have ‘met’ here at Sense on Cents but whom I will never truly know. I think of how their lives have been forever changed and negatively impacted from having been entangled in this ARS web. The pain shared in so many stories is very real.

I have also often thought that somebody or some institution within our government sacrificed the welfare (cash, mental, physical, emotional) of so many tens of thousands of individual ARS holders in order to help our large financial institutions. I shared that opinion in the midst of an interview with PBS last week. (The PBS documentary addressing the ARS travesty should run this summer.)

Today we learn that the Federal Reserve intervened in the midst of an SEC investigation of the ARS scandal in mid-2008 and ‘slowed the horses.’

I thank the various readers who brought this story written by Gretchen Morgenson in today’s New York Times to my attention. Morgenson elevates her standing in the Sense on Cents Hall of Fame in writing, In Financial Crisis, No Prosecution of Top Figures.

In her commentary Morgenson highlights how the government in the personages of a number of individuals felt compelled to save the economy by saving the banks. If individual rights to property had to be trampled in the process, so be it.

Really? Is that how a nation of laws is supposed to work. Let’s navigate and ask some hard questions that demand answers.

Specifically in regard to the ARS debacle, Morgenson writes,

In July 2008, the staff of the S.E.C. received a phone call from Scott G. Alvarez, general counsel at the Federal Reserve in Washington.

The purpose: to discuss an S.E.C. investigation into improprieties by several of the nation’s largest brokerage firms. Their actions had hammered thousands of investors holding the short-term investments known as auction-rate securities.

These investments carry interest rates that reset regularly, usually weekly, in auctions overseen by the brokerage firms that sell them. They were popular among investors because the interest rates they received were slightly higher than what they could earn elsewhere.

For years, companies like UBS and Goldman Sachs operated auctions of these securities, promoting them as highly liquid investments. But by mid-February 2008, as the subprime mortgage crisis began to spread, investors holding hundreds of billions of dollars of these securities could no longer cash them in.

As the S.E.C. investigated these events, several of its officials argued that the banks should make all investors whole on the securities, according to three people with knowledge of the negotiations but who were not authorized to speak publicly, because banks had marketed them as safe investments.

What do we learn? Well, actually we knew most of what I will highlight here but Morgenson confirms:

1. The SEC was increasingly well aware of the widespread improprieties that various banks and brokers engaged in while marketing ARS.

2. The SEC knew it had a major problem and appreciated that ARS investors should be made whole. Remember, the money invested in ARS was investor money. ARS were sold as cash-equivalents.

3. The Wall Street banks and brokers misrepresented ARS as safe, cash-equivalent investments. In any court of law with a rational judge, an ARS case brought by a plaintiff should have been a slam-dunk.

Morgenson highlights that the Federal Reserve’s Scott Alvarez intervened with the SEC in July 2008. At that point the Fed obviously knew that the large Wall Street banks were in serious trouble and would need all the cash they could find to support their rapidly eroding capital base. Screw the ARS holders even if it was their cash.

Seemingly according to Alvarez and the Federal Reserve the banks needed the cash more than the individuals and institutions to whom it belonged.

Wait a second here? Did the Fed effectively abrogate the property rights of these ARS holders and further facilitate a fraud perpetrated by the Wall Street banks and brokers? Call me crazy but it is very obvious that is exactly what the Fed did. Under what statute is the Federal Reserve allowed to do that? Is there any doubt as to who calls the shots in this country?

Do you think when the banks saw the Fed step in like this in mid-2008 that the banks believed the Fed would ultimately bail them out? Lehman’s Dick Fuld certainly believed that and overplayed his hand prior to Lehman’s failure but Bank of America, Citigroup, Goldman and the other banks could likely sense their leverage over the Fed was increasing. Let’s navigate further as Morgenson writes,

But Mr. Alvarez suggested that the S.E.C. soften the proposed terms of the auction-rate settlements. His staff followed up with more calls to the S.E.C., cautioning that banks might run short on capital if they had to pay the many billions of dollars needed to make all auction-rate clients whole, the people briefed on the conversations said. The S.E.C. wound up requiring eight banks to pay back only individual investors. For institutional investors — like pension funds — that bought the securities, the S.E.C. told the banks to make only their “best efforts.”

This shift eased the pain significantly at some of the nation’s biggest banks. For Citigroup, the new terms meant it had to redeem $7 billion in the securities for individual investors — but it was off the hook for about $12 billion owned by institutions. These institutions have subsequently recouped some but not all of their investments. Mr. Alvarez declined to comment, through a spokeswoman.

An S.E.C. spokesman said: “The primary consideration was remedying the alleged wrongdoing and in fashioning that remedy, the emphasis was placed on retail investors because they were suffering the greatest hardship and had the fewest avenues for redress.”

Wow!! So the Fed and the SEC started picking the winners and losers in terms of who got repaid and who did not. Hold on a second. If that is the case, then why three years after the ARS market totally froze and with Wall Street having paid out multiple hundreds of billions in bonuses and compensation over the last few years are there still many thousands of ARS investors waiting to be repaid approximately $100 billion?

Have we further crossed the threshold from trying to save the banks and the economy while violating the rights of the ARS investors to now simply permitting the effective theft of ARS funds by the banks and the brokers?

Get Alvarez back in here and ask him that!! Answer that question!! Get Bernanke and Geithner too. Don’t forget Cuomo!! Answer the question, gentlemen!! Ask Mary Schapiro as well.

I will share that a very knowledgeable individual on this topic wrote to me today and said,

It really is a sensational story even beyond the ARS. I just hope people will take notice. It calls into serious question the ethics of DOJ, Geithner, Cuomo, and the “W” administration. As you know, I was told by a cabinet member that “W” knew of the ARS scandal but didn’t understand it or pursue the deal making.

Let me remind these officials of one simple thing. While you think you may be doing the right thing by our country and our economy, in regard to the ARS nightmare,


Thank you Ms. Morgenson for your superb work on this topic. Thank you also to PBS for the work they are doing on producing the documentary on the ARS debacle.

While this nightmare continues, let us NEVER forget that FINRA, Wall Street’s SRO charged with protecting investors liquidated its own ~$647 million ARS position from its own internal investment portfolio at some point in mid-2007. America still needs to learn the details of that liquidation.

You can not make this stuff up but the fight continues. On behalf of every ARS investor I will keep punchin’ for your benefit.

Questions and comments encouraged and appreciated.

Larry Doyle

Related Commentary
Sense on Cents/ARS
Sense on Cents/Wall Street-Washington Incest
Sense on Cents/Harry Markopolos: “Don’t Trust Your Government”

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

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