The auction-rate market

A good overview on the failures is covered by the NY Times today.

The $330 billion auction-rate market is dominated by municipalities and other tax-exempt institutions like the Port Authority of New York and New Jersey, which had issued some auction securities and had its interest rate soar to 20 percent on Wednesday. Closed-end mutual funds, student loan companies and corporations also issue such securities....

The Port Authority rate was 4.3%, now it's 20%??? On $100 million, they are paying $389,000 a week instead of $83,600. The State of Wisconsin's rate on $950 million of their securities went from 5.2% to 10%. Remember how Bank of America juiced the credit card rates last week to offset their losses in mortgages? It's the same here, but done on a more "sophisticated" scale.

The S.E.C. investigation centered on how bidding was conducted for these securities. Critics complain that investment banks have the upper hand in bidding because they can bid after seeing what other investors have bid.

All you have to do is find out who bought the Port's paper!

The situation is an awkward one for investment banks and brokers that have had to tell clients that their cash is frozen until at least the next auction — if not longer. One affluent New Jersey family has sued Lehman Brothers for the declining value of its cash in auction-rate securities. Lehman has said it acted properly...

See my post: http://aaronandmoses.blogspot.com/2008/02/credit-crisis-intensifies.html

This year, Bristol-Myers Squibb, the drug maker, took a $275 million write-off on money it had invested in auction-rate securities that it was unable to sell because of failed auctions.

BMY had $811 million in auction rate securities (ARS) at year end 2007. The value was marked down to $419 million-that's a $392 million hit. After tax they wrote off $275 million. So BMY's experience was that these "cash equivalents" were worth only .50 cents on the dollar. (Obviously all of these auction rates are not like BMY's experience.) But the rates show the panic in this area of the market that is "misunderstood." Cash equivalent ="misunderstood?"

Only on Wall Street's can this be a definition of a cash equivalent, and only on Wall Street can a "cash equivalent" be "misunderstood!"

http://www.nytimes.com/2008/02/15/business/15place.html?ref=business