An Optimistic View on Auction Rate Securities

Keith knew he had invested in a liquid asset that was easily accessible if needed, but it was only upon hearing the news of the failure of the auction-rate securities market that he discovered what kind of investment he actually possessed.

"I had a sum of money that had matured from another investment, and it went into my broker's hands," says Keith. "He told me he had a short-term investment, a liquid asset that paid quite a good rate and would be a good place to put the money until we found a better investment. So he went ahead and invested my funds.

auction rate security losses

This took place in August 2007. As I'd been working with this same Bank of America broker for some time and he'd always done well for me, I had no reason to doubt. But I found out something was wrong in March or April when I received a letter from the Bank of America stating a problem with auction-rate securities (ARS). They disclosed that they had used a third party company to value the investment and at that time they weren't able to put a value to the investment because of the failed auction."

The news hardly troubled Keith since he was unaware he held auction-rate securities. To his knowledge, his investment was in the form of bonds from the Mississippi Higher Education Association, with no mention or explanation of ARS.

"When I received my individual portfolio statement the following month," says Keith, "it was short a substantial amount of money so I immediately called my broker for clarification and he explained that the failure in the ARS market directly concerned my investment so we discussed my best course of action. He also freely admitted the bank had sold the ARS as a completely liquid asset. That's how they were told to market them.

After asking myself what to do next, I decided to do some research to find out what the real situation was and what the market consensus was. I found that there were mixed feelings out there. Right now the market doesn't exist since it is linked to the credit issues and so forth.

Taking it up with my broker again, it was his contention that sometime in the not too distant future--it could be a year or two years--the market would return. The investment was still there; it still pays a default interest rate and I see interest paid on a monthly basis. Furthermore, my broker told me that if I needed some money in a hurry, they would offer me a loan at 0 percent, or whatever percentage would offset that default rate.

I don't need the money. This was basically and ultimately a long-term investment. That being the case, we decided to just watch the market and see what happens. It wasn't a huge amount invested--about $100,000, but it's enough. At this point, I'm not overly concerned. The reality is that I have an investment in the Mississippi Higher Education Association and it can still be sold in 2031 when it matures.

And the other thing is that if things get worse, there's always legal recourse against Bank of America. I know that I would be joining a long list of disgruntled investors. And I expect that at some point there will be some kind of collective action. It's a $330 billion market so obviously the money is there. It hasn't just disappeared. And I know that ultimately there has to be some kind of interaction from the government. A lot of investigating is going on now."

An Optimistic View on Auction Rate Securities

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