Cash=Auction Rate Securities ....Not Anymore.

Cash = Auction Rate Securities … not any more

There was a story in the paper today about a guy who sold his business and was sitting in about a billion dollars of “cash”, oops, I mean PARS. As he learned today, those two are not the same things, though for as long as anyone remembers they have been.

For a definition of what these securities are here is the wikipedia link
http://en.wikipedia.org/wiki/Auction_rate_security

I will say it again.. what is going on in the credit markets is completely off the charts wild.

Municipalities who have long relied on the short term markets to access capital at rates reflective of their underlying loan quality simply cannot rely on it anymore. Because investors were unwilling to buy their bonds, the auctions ‘failed’, which resulted in parties that wanted out, to be shut down. It is not really that bad, as in most cased the interest rate kicked up nicely, but if you needed that money for something, tough bananas.

As a holder of ARS you of course bought it because you thought is was a cash-like piece of paper with quick liquidity. What in fact you bought was a 30 year piece of paper. If it fails to clear the market it resets to the highest rate as outlined in the paperwork and whoever is holding the hot potato, stays holding it, until the next auction of until the issuer calls it.



Of note is that firms like Goldman Sachs, who issued the first tax exempt ARS in 1988, was unwilling to step in to take down the bonds. Not a good way to build client relationships either with the investor or the issuer. Of course they were not the only ones doing it, but still. It is clear that everyone is in the “protect your balance sheet mode”. Big Time.

Now for anyone reading who has a money market fund thinking “Oh My Gosh”, money market funds cannot buy these securities as they are effectively 30 year bonds. Money market funds have other troubles, but this is not directly one of them. Indirectly it is very disrupting, but this alone does not affect the funds liquidity.