Conflicts entangle Auction Rate Market

“Safe as cash,” proclaimed the brokers as they sold billions of auction rate securities to investors. Now the market is locked up. Both investors and issuers have taken a big hit.

Have the investment bankers felt any pain? No! In fact they still make out like bandits even as the market refuses to thaw. Any way you slice it, the end game in the auction rate market for Wall Street firms is “heads I win, tails you lose.”

The entire market is rife with conflicts of interest. First the investment bankers marketed the securities as safe as cash in their own internal auction market and refuse to step in to keep the market liquid as over 70% of the weekly auctions fail. The Wall Street firms are still paid for their “services”, even though no securities are sold. Furthermore the bankers make big money when issuers directly redeem the auction rate notes.

To pour more pain on the fire, the investment bankers for the most part refuse to allow the notes to trade on a secondary market and demand that the auction rate securities be marked to face value. The places issuers in a situation where they can not buy back their own securities at a discount, at a time no investors will purchase them for face value. Of course, a wholesale discounted market would force the Wall Street firms to mark down similar securities on their own books; leading to billions more in losses.

At some point, local and state governments are going to demand action to fix this situation, and refuse to be held hostage by the Wall Street firms. The first step is to demand a transparent auction market where these securities can be sold for a discount or premium from face value. This is the only way to unfreeze the auction rate market and restore investor confidence.