Sense on Cents

I am long overdue to address the ongoing — as in 5+ years — nightmare that defines the world of auction-rate securities, aka Wall Street’s greatest scam.

“You mean this is still going on”  is a common refrain I have heard from a variety of media representatives, lawyers, investors, and even regulators.

Yes, indeed, the ARS nightmare continues with seemingly little evidence of meaningful support provided to those ARS investors still left standing in the cold wondering whatever happened to the concept of investor protection embedded in the securities reform legislation passed back in the 1930s.

We know that FINRA liquidated its own ARS holdings — all $650 million of them — back in 2007. If not for that fortuitous (??) stroke of luck (??), perhaps the regulator would also be waiting in line wondering if and when it might get its money back.

To check in on how the supposedly venerable firm of Goldman Sachs is partaking in the ongoing screwing of ARS clients, I thank a regular visitor to these parts who shared a commentary.

He penned this riveting piece of informative research recently at Seeking Alpha: 

One of the still unresolved casualties of the financial crisis was the breakdown in the market for municipal auction rate securities (“ARS”). Sold to many individual investors as a tax free money market alternative with a higher yield, this Wall Street “innovation” left both retail and institutional clients holding the bag when these auctions failed and the sponsoring investment banks failed to support the auctions that had once been very lucrative to their bottom lines. Investors, many of whom were assured that they’d always have access to their funds, were left holding the bag while many of the program dealers who underwrote these securities and ran the auctions were bailed out using taxpayer funds.

In the ensuing years since the financial crisis, attorneys general of many states have forced settlement agreements upon some of marketers of these toxic securities and many issues were restructured. However, there are still many hurting investors whose “money market” investment now has a maturity of 10 to 20 years with no way out. While this part of the story has been told many times, a less visible part of this story hasn’t received any press. It’s a tale reminiscent of the old adage, “tails I win heads you lose,” where program dealers and institutional issuers always win and the investor always loses.

In the face of a failed ARS auction, one of the most critical aspects of the issue is known as the maximum penalty rate. This is the rate the issuer is required to pay to the holder of the ARS in the event of a failed auction. Let’s say an investor did his due diligence and found a municipal ARS that paid 18% in the event of a failed auction. Hey, at that rate many investors would be happy to give up liquidity and hold the security to maturity. Unfortunately, it may not work that way.

Let’s examine two weekly reset, municipal ARS, both issued on behalf of companies that are now part of National Grid (NGG). Each has Goldman Sachs listed as either the sole program dealer or a co-program dealer responsible for managing the auction:

Each week, a new interest rate is determined through a dutch auctionwhere the lowest rate necessary to clear the buy orders, net of the sell and hold orders, determines the rate the issuer pays to bond holders for the upcoming week. Prior to the financial crisis, the detailed auction results were not disclosed to the investing public. However, with the typical rear view mirror mentality that U.S. regulators seem to operate under, this information is now available to the general public.

Digging through the auction data made available by the Municipal Securities Rules Making Board an interesting revelation comes into focus. It is often the program dealer that sets the maximum rate the issuer must pay, not an arm’s length auction process as one would expect when purchasing and holding this security. In the auction below for Issue A, a seller came in for $400,000 while there was only a single bid of $50,000. If Goldman Sachs didn’t step in and bid for the entire issue at .90%, National Grid would have been forced to pay the “maximum penalty rate,” a whopping interest rate 18% for the upcoming week:

In this case, Goldman Sachs is effectively capping the maximum rate with its bid for the entire issue $41,225,000 at .90% and protecting its institutional client, National Grid, at the expense of the holders of the issue.

Now let’s look at the auction results on the same day for Issue B. Many investors have been trying to get out of this supposed liquid investment since the onset of the financial crisis without success. In the auction below, there are sell orders totaling $5,375,000. Yet, with a floating penalty rate set at 250% of 30 day LIBOR, or 0.456%, Goldman Sachs has no reason to protect National Grid and it certainly has no interest in helping the stuck investors. As a result it makes no bid and sellers are stuck with no way out week after week after week as auctions continue to fail.

So what we have here is the typical story of the inequity of the financial crisis. A major U.S. Bank with a credit line to U.S. Taxpayer financing through the Fed window, a company that was bailed out by the U.S Government protects a foreign institution from a structure that could potentially cost it 18% on $41.125 million. Yet, in the case where investors could use some assistance from their flawed financial instrument, Goldman and National Grid are nowhere to be found.

Would it be too much to ask for Goldman Sachs and National Grid to get together, restructure and retire Issue B (it should be easy enough in this low interest rate environment) while at the same time helping holders of $55,000,000 in their illiquid “money market” investments?

What am I thinking? … forgive me for the thought. This is Wall Street, after all.

You want to do business with these folks? If these were sewing machines and not trade monitors being utilized by Goldman and their friendly regulators, it is more than likely the place would be shut down.

I commend the writer for shedding fabulous light on this ongoing dank ARS nightmare and bringing his work to my attention. I address this nightmare and the massive regulatory failure to properly protect ARS investors in my upcoming book.

Navigate accordingly.

Larry Doyle

Please pre-order a copy of my book, In Bed with Wall Street: The Conspiracy Crippling Our Global Economy, that will be published by Palgrave Macmillan on January 7, 2014.

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I have no 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.

This entry was posted on Wednesday, September 18th, 2013 at 7:59 AM and is filed under ARPS, ARS, Auction Rate Securities scandal, General. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.