What is an Auction Rate Security?

Auction Rate Securities (ARS), also known as auction rate bonds or sale rate securities, is an underwriter issued by major Wall Street investment banks, US local governments, hospitals, student loan agencies, or closed-end funds. For long-term securities, the interest rate is set through the auction every month or even weekly. When the auction demand is insufficient, there will be oversold and the interest rate will be raised for re-auction.

Auction interest rate securities

This is a bond with a longer borrowing period, but it pays lower interest on short-term bonds. The interest is reset by holding auctions every 7 days, 28 days, or 35 days. Therefore, it is called the auction interest rate security. The minimum denomination for auction interest rate securities is $ 25,000, and most of the holders are institutional investors or individuals with certain financial resources.

In addition, the return on such investment products is higher than ordinary cash deposits. Since many investors are financial institutions, once this market is paralyzed, it will trigger a new wave of bank write-offs. Because the interest rate of ARS is regularly re-determined at auction, it is really a short-term investment. When the ARS market crisis emerges, more and more auctions are aborted, and gradually no one is interested, and investment banks will withdraw from this market, making the problem worse. .

The auction interest rate securities market has a history of 20 years, with a scale of US $ 330 billion and about 100,000 investors, which belongs to a small-scale market.

Auction interest rate

Since July 2008, the US federal government and several state governments have investigated and punished serious frauds and frauds during the auction and promotion of interest rate securities by many large Wall Street investment banks.

At present, the fines of several major investment banks in this incident, together with the asset deductions of approximately $ 4 billion faced by major banks after repurchasing auction-rate securities, will cause the total loss caused by this event to reach a new high. After the Internet bubble at the beginning of this century, New York State Attorney General Spitzer and the Securities and Exchange Commission (SEC) jointly imposed a $ 1.4 billion penalty on the lying of 10 research banks in their research reports and stock reviews. Several large mutual fund companies, such as Fidelity Investments, Franklin Resources and others, used fund assets in disguise to bribe brokerages in order to build momentum for themselves. They were punished by more than $ 5 billion.

Generally, securities dealers or underwriters that auction interest rate securities provide liquidity for the bonds. Therefore, this bond is considered to have excellent liquidity, which is equivalent to demand deposits. It is welcomed by many small investors. Wall Street investment banks and securities companies vow to guarantee the liquidity of securities and invest. People can exchange cash with brokers at any time. Many elderly people put their surviving funds on such bonds after retirement. In addition to being converted into cash at any time, the interest is also higher than demand deposits.

However, after February 2008, the situation of the US subprime mortgage crisis became more severe, and the securities dealers or underwriters fell into the quagmire of subprime mortgages. The liquidity of auction interest rate securities could not be taken into account, and the securities that investors requested to be exchanged were no longer purchased. Therefore, 3300 The billion-dollar auction interest rate securities market has little liquidity. Because securities are not liquid, investors cannot sell such assets, these bond assets cannot be valued, and the market value of such assets on the asset books of the majority of investors is written as zero. Accused.

Over the years, the largest underwriters in the auction interest rate securities market are UBS, Citibank, Merrill Lynch, Morgan Stanley, Goldman Sachs, JP Morgan Chase Bank, Lehman Brothers, and the Royal Bank of Canada, based in Toronto, Headquartered in Charlotte, North Carolina, the Bank of the Americas, the second largest commercial bank in the United States, and the fourth largest commercial bank, Wacovia Bank. Brokers can get 0.25% commission during the underwriting process.

New York's chief prosecutor Andrew Cuomo and prosecutors in Massachusetts, Texas, and Missouri have independently investigated complaints filed by investors and false underwriting by the underwriters in marketing such securities, and separately investigated The major banks filed a lawsuit. The lawsuit stated that after February 2008, these securities firms sold the bonds held by the Bank when the securities market was almost illiquid, while continuing to deceive retail investors to lie that the liquidity was still excellent. Persuade high.

Faced with prosecutions by various prosecutors, major investment banks have stated that they will actively cooperate with the investigation, fired securities brokers who made false promises, and stated that they will buy back the sold securities at the original price. The current settlement method is mainly for ordinary retail investors people.

On August 7, 2008, Citigroup agreed to repurchase US $ 7.3 billion of ARS bonds from retail investors at the original price, and received a fine of US $ 100 million. In addition, Citigroup will help 2600 institutional investors to sell US $ 12 billion of bonds If you ca nt sell it, you can repurchase the remaining bonds yourself; on the same day, Merrill Lynch agreed to repurchase US $ 10 billion of ARS bonds at the original face value from January 2009.

On August 8, the Swiss bank agreed to repurchase US $ 8.3 billion of ARS bonds at the original price, accept a fine of US $ 150 million, and also help institutional customers sell off US $ 10.3 billion worth of bonds. Similarly, if they cannot sell, they will buy back The remaining bonds.

On August 11, Morgan Stanley said it planned to repurchase approximately $ 4.5 billion of ARS bonds held by individuals, charities, and small and medium-sized enterprises at its original price, including a repurchase of 1.5 billion from two local governments in Massachusetts USD bonds and provide liquidity for institutional investors holding the securities.

Cuomo said on the 11th that Morgan Stanley's action was too late, and on the same day letters were sent to Morgan Stanley, JP Morgan Chase Bank and Wacovia Bank, urging the three banks to adopt the same solution.

On August 14, Morgan Stanley and JP Morgan Chase Bank announced a settlement agreement with state prosecutors, agreeing to pay a total of $ 60 million in fines and repurchase $ 7 billion in bonds.

Goldman Sachs, the fifth-largest underwriter in the ARS bond market, has so far held back on the measures it will take after the major banks promised to buy back about $ 40 billion in bonds, and still refuse to repurchase customers until August 14. Of bonds. In February 2008, Goldman Sachs withdrew from the securities market and no longer provided liquidity, which directly led to the collapse of the market. The SEC and state officials said Goldman Sachs will be called to the negotiating table in a few weeks. A spokesman for Goldman Sachs also said it was working with regulators on the matter.

On the morning of August 15, Cuomo held a press conference to announce that Wacovia Bank has reached an agreement with state prosecutors to repurchase US $ 8.5 billion of ARS bonds and pay a US $ 50 million fine. The lawsuit will be filed by New York State within a few days, and Merrill Lynch s initiative to buy back $ 10 billion last week was not enough to calm the matter.

As for Goldman Sachs' investment bank, Cuomo said harshly. "The bigger the bank and the more assets, the more we work hard. We have been investigating Goldman Sachs, and we are still negotiating while we are investigating."

Cuomo said that so far, letters have been sent to 25 financial institutions to investigate the ARS incident, including retail brokerages. "We started the investigation with the big bank, and then dealt with the small companies one by one."

As of August 15, five major banks have reached out-of-court settlements with state governments. If the $ 10 billion repurchase amount proposed by Merrill Lynch is included, a total of $ 51.9 billion in ARS bonds has been repurchased by six banks, including Merrill Lynch, with a fine of $ 360 million. It is worth mentioning that these settlements are only the settlement results of major banks and state governments. They do not involve the SEC. The SEC is currently conducting its own independent investigation. There will be another series of sanctions. It is believed that others have not been affected. A group of large penalties will propose a solution in the short term.

Unlike the crisis in the subprime mortgage market, the borrowers of auction interest rate securities have high credit and no default has occurred. The root cause of the problem is that the securities companies no longer guarantee such bonds, which causes the bonds to devalue after they are not liquid. Such bonds issued by local governments, hospitals, and higher education institutions have depreciated to 92% to 98% of their original face value; bonds issued by mutual funds have depreciated to 85% to 92%; bonds issued by student loan institutions have depreciated to 70% to 85% %.

To be sure, if the bonds remain on their books, the assets of the major banks will face a new round of deductions. The size of the deduction is currently estimated at US $ 4 billion, which is insignificant compared to the subtraction of subprime assets, but Against the background of the severe shortage of liquidity of major banks, the write-down of auction interest rate securities assets is tantamount to spreading a handful of salt on unhealed wounds.

Due to the credit crunch caused by the 2007 US subprime mortgage crisis, many investors once regarded it as a highly liquid short-term investment instrument and were auctioned by major financial institutions as "cash-like" auction interest rate securities. Now it has become an investor There is almost no liquid long-term assets in hand. Unlike subprime mortgage-backed securities (MBS) and guaranteed debt bonds (CDO) in the subprime crisis, auction rate securities are not the initiators of the subprime crisis but the crisis. The victim of the auction of interest rate securities was not the credit crisis caused by the default of the lender. The collapse of the ARS market was a liquidity crisis, and the source of this liquidity crisis was the subprime mortgage crisis. The flow experienced by the ARS market The sexual crisis has revealed the complexity of financial product innovation and deepened the links between financial sub-markets. Once a problem occurs in one market, it will immediately spread to the other market, resulting in a domino effect. It also reveals that market liquidity is not only related to The issue of currency stocks and flows is more about the confidence and willingness of market participants. Loss will affect the entire market, so the foundation for maintaining market stability lies in maintaining the confidence of market participants, and the fundamental way to maintain the confidence of market participants is to improve market transparency through institutional norms. Re-enacting the codex is a dead-end action. Improving market transparency to prevent financial market turbulence will be an eternal topic for financial regulators, and how financial institutions and investors can control liquidity risks in a rapidly changing financial market will also be an important and urgent issue.