Sense on Cents

Each and every time I read a review of the Auction Rate Preferred Securities market, I come away thinking it was one enormous Ponzi scheme. Let’s review the facts as reported from a just published Bloomberg story of a $4.7 BILLION Settlement by Citigroup and Wachovia with California Auction Rate Investors:

States, student-loan agencies and closed-end mutual funds were the primary issuers of the securities, long-term bonds with interest rates set at weekly or monthly auctions.

1. Issuers have long term projects funded by long term loans or preferred shares. Those loans or shares are the underlying collateral in an auction rate preferred transaction. While people investing in a pure Ponzi scheme believed they were investing in a legitimate money manager’s business, investors in ARPS believed they were investing in a money market fund. The key here is MISREPRESENTATION.

The debt, marketed by bankers as cash equivalents, offered investors yields of a quarter-percentage point or more above conventional money-market funds, indexes show.

2. In both a Ponzi scheme and ARPS, the allure of regular liquidity with solid returns draws new money into the game. With a Ponzi scheme, the returns are better than a benchmark index. With ARPS, the returns were better than other cash alternatives or money market funds.  (more…)