Thought Auction Rate Security Problems Were Over? Not Yet.

A year after the collapse of the auction rate security market, investors are still stuck in an estimated $176 billion of the securities, despite regulators forcing banks to buy back up to $50 billion.

Bloomberg did an interesting article on this highlighting the continued plight of investors stuck in auction rate preferred investments.

"The market’s meltdown, the result of the seizure in credit markets, initially left investors with bonds they couldn’t sell, though the securities paid interest at rates as high as 20 percent. Now, rates on securities auctioned every seven days pay an average 1.36 percent, according to an index from the Securities Industry and Financial Markets Association, after central banks slashed borrowing costs.

Investors are stuck because interest on auction-rate securities is lower than what issuers would have to pay on new borrowings, giving them little incentive to refinance. "

What the article doesn't do is distinguish between directly purchased municipal auction rate securities and purchasing the bonds via an auction rate preferred fund. Investors who purchased individual auction rate securities from municipalities have mostly been able to get their money out due to the bond's reset provisions. It's the investors who put money into auction rate funds at companies like Pimco, Black Rock, etc. that are stuck. In general, the reset provisions on these accounts in the case of an auction failure pegs the rate at slightly above some benchmark, like the Fed Funds rate. Now, these auction rate securities are paying virtually nothing and the funds have no reason to redeem the money.

In the utlimate irony, the auction rate security provisions are forcing some companies like Pimco to delay paying dividends. Such action may eventually force companies to redeem some of the cash.