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Archive for January, 2009


Auction Rate Securities Still Failing to provide Liquidity Solution for Large Investors

2008 marked many memorable controversies in the financial world. From Bernie Madoffs $50 billion ponzi scheme to the crash of the financial markets, and let’s not forget the collapse of the auction-rate securities (ARS) market. As a result, individual and institutional investors of ARS have now found themselves entangled in a financial nightmare.

For investors who’ve been stuck holding illiquid auction-rate securities since February 2008, the likelihood that regulators will find a solution to their dilemma anytime soon is remote. Even though some of Wall Street’s biggest firms have bought back more than $60 billion of their clients’ securities, another $135 billion of the bonds still remain frozen.

As reported Dec. 31, 2008 by the Boston.com, the illiquidity status of auction-rate securities is hitting small businesses especially hard. Vicor Corp., which makes power systems for electronics, is one of those businesses. The company invested nearly $40 million in auction-rate securities before the market’s collapse in February. At the time, the company’s management thought the bonds were safe and liquid investments. Now, the earliest that Vicor can expect to see some of its auction-rate money is 2010.

UBS is one of the firms that sold Vicor the auction bonds, and it has pledged to buy back about $18 million worth of the securities beginning in June 2010. However, Vicor also bought another $20 million of auction securities from Bank of America, which has yet to offer any kind of buy-back program to Vicor and other large institutional and corporate holders of auction-rate securities.

Suffering from the same terrible fate is another company named Tufts Health Plan, who lost a huge chunk of its money that was tied up in illiquid auction-rate securities The Massachusetts-based health care provider has nearly half of its total cash holdings – approximately $30 million – in auctionrate securities at Citigroup. So far, Citigroup hasn’t announced any plans to help Tufts get its money back.

Raymond James ARS Investors at a Total Loss?

Investors with Raymond James Financial, who thus far have only received a four-page letter dated January 2, 2009 from Thomas James, chairman and chief executive officer, in which he says the company cannot repurchase the securities it sold because it doesn’t have enough capital on hand, are still holding out for answers from the St. Petersburg-based financial services firm regarding their illiquid auction rate securities.

The message is of little comfort to clients of Raymond James Financial who currently own about $1 billion in outstanding auction-rate bonds and auction-rate preferred securities. It’s the same scenario they’ve faced since February 2008, when the $330 billion auction-rate securities market collapsed and left hundreds of thousands of investors unable to sell securities that had been touted as cash equivalents.

Facing pressure from state and federal regulators, a number of financial firms such as UBS, Wachovia, Merrill Lynch, Morgan Stanley and others announced plans to repurchase the illiquid securities from their clients. Many already have completed their buyback programs. Clients of Raymond James Financial, however, have been left in a holding pattern.

As it turns out, they may be in for a long wait. Any potential relief is likely tied to Raymond James Financial’s ability to secure a bank loan and buy back the securities after it becomes a bank-holding company. But that process will not be completed until next summer.

Meanwhile, Raymond James Financial remains under investigation by the Securities and Exchange Commission (SEC), the New York Attorney General and the Florida Office of Financial Regulation for its handling of auction-rate securities.

As of December 31, 2008, shares of Raymond James Financial had fallen more than 40% meaning the company’s stock has taken a beating from the firm’s inability to make good on its customers’ auction-rate securities.

$8.3 Billion Loss Likely to Spilt Citigroup

Double of what analysts had predicted, Citigroup posted a whopping $8.9 billion fourth-quarter loss. The New York-based bank has been forced to resort to the drastic measure of splitting into two separate entities: Citicorp and Citi Holdings, as a means to try and raise some capital.

Citicorp will focus on traditional banking, with Citi Holdings to include the bank’s asset management and consumer finance units, as well as some $300 billion of Citigroup’s most risky assets. Citi Holdings also will oversee Citigroup’s 49% stake in the recently announced venture with Morgan Stanley.

By splitting in two, CEO Vikram Pandit believes Citigroup will be able to free up its capital, while at the same time unload the more troubled assets that have continued to plague the bank for the past year.

Citigroup’s fourth-quarter loss also included $7.78 billion in write-downs on subprime mortgages, collateralized debt obligations and structured investment vehicles. In total, Citigroup’s losses have surpassed the $90 billion mark over the past 15 months.

During the Jan. 16 2009 conference call with analysts, Pandit also noted the likelihood of future layoffs. The bank, which already reduced its workforce by 52,000 in 2008, is expected to let go another 23,000 employees by the end of December 2009.

In addition Citigoup’s woes are reflected in their plummeting share prices, which plunged nearly 90% in 2008. In October of 2008, the bank was the recipient of $45 billion from the U.S. Treasury in an attempt by the government to conduct an emergency rescue of the bank. Meanwhile, news of Pandit’s restructuring plans did little to improve investor confidence. Citigroup stock has been trading at below $3.50 which is a sign of trouble ahead, especially when you compare their January 16, 2007 stock price which was trading at $54.39 some three years ago.

Morgan Stanley and Citigroup Plan to Merge Brokerage Departments

Still suffering in the aftermath of financial crisis, job lay-offs and a lack of investor confidence, mega bank Citigroup is reportedly gearing itself up to sell its Smith Barney brokerage unit to Morgan Stanley.

According to reports in the Wall Street Journal and the New York Times, the deal would be structured as a joint venture and entail payment from Morgan Stanley for an undisclosed sum that would give Morgan a larger stake in the transaction.

News of a potential deal appeared shortly after Citigroup announced that Robert Rubin, former U.S. Treasury secretary under Bill Clinton, had resigned from his post as senior adviser and director of the bank. Rubin’s resignation came after ongoing criticism for his role in encouraging the bank to increase its trading of high-risk mortgage-related securities – a move that many say led to Citigroup’s current financial troubles.

In the past six months, Citigroup has been rocked with staggering financial losses. Despite a second, $20 billion injection of capital from the government’s $700 billion bailout, along with federal guarantees to cover more than $300 billion of the bank’s exposure to toxic mortgage-backed securities, Citigroup continued to experience problems. With losses totaling more than $20 billion, its stock value responded by plunging nearly 80% in 2008.

Faced with eroding investor confidence and a stock price that continued to slide downward, CEO Vikram Pandit reportedly initiated private talks in November with his top executive team regarding the sale of all or parts of the financial services company.

The possibility of this merge would reunite Pandit with former employer Morgan Stanely. Pandit , who left Morgan Stanley in 2005 after being passed over for a promotion and providing them with 22 years of service went on to begin his own hedge fund firm, Old Lane. Old Lane was later sold for $800 million to Citigroup. Pandit had been on the job with Citigroup for only five months before taking the reins of the company as CEO. His predecessor had been Charles Prince, who resigned following shockingly large losses connected to investments in subprime mortgages.

Scandals and Setbacks: a Financial Summary of 2008

2008 will forever be the year that subprime mortgages and corporate scandals altered the face of Wall Street. With $800 billion in writedowns and losses the market found itself buried under the weight of the subprime crisis. Stock markets worldwide crashed by more than $30 trillion taking mega investment houses like Bear Stearns down with them. At the core of the problem were investments tied to faulty valuation models and high-risk mortgage-backed securities and their derivative spin-offs, collateralized debt obligations (CDOs), which all lead to State, municipal and corporate pension funds suffering huge losses.

Then there’s the near financial collapse of mortgage giants Fannie Mae and Freddie Mac and American Insurance Group (AIG), which required a financial intervention courtesy of the U.S. government. Lehman Brothers, the fourth largest investment bank in the United States, filed for bankruptcy protection in 2008. Washington Mutual and IndyMac, along with some 20 other banks were forced to close their doors. Government bailouts reached an astronomical $9 trillion. And as a final nod to 2008, investors lost some $50 billion in a Ponzi scheme orchestrated by the former Nasdaq chairman, Bernard (Bernie) Madoff.

For investors, 2008 is the year that went from bad to worse. It began with the collapse of the auction-rate securities market in February 2008 and continued with credit default swaps and structured investment products. For the first time since the 1930s, the Dow Jones Industrial Average experienced losses of more than 30%, closing the year at 8,776.39. By comparison, the Dow finished out 2007 at 13,264.82. Bank stocks in particular took a beating in 2008, with Bank of America and Citigroup losing nearly 70% of their value. As for shareholders, they saw about $7 trillion of their wealth wiped out.

In the world of ultra-short bond funds, 2008 provided the lesson that ultra short does not translate to “ultra safe.” A number of supposedly safe and conservative ultra-short funds got into trouble in 2008 by investing in risky mortgage-backed securities and collateralized mortgage obligations (CMOs). When losses in those toxic assets began to skyrocket, investors lined up to pull their money out in droves, sparking a wave of fund redemptions.

As a result, several fund managers were forced to liquidate their funds’ assets. State Street Global Advisors’ SSgA Yield Plus Fund began liquidating in May after the fund fell 19%. It turns out more than 50% of the fund’s assets were tied to mortgage-related securities funds. One month later, the Evergreen Ultra- Short Opportunities Fund liquidated, as well, when its assets plunged more than 20% in value.

Investors, meanwhile, are suing the funds, charging that they investments were represented as conservative “cash alternatives” and similar to money-market funds. Far from safe or conservative, the funds were heavily concentrated in risky mortgage and asset-backed securities

Capping out 2008, of course, is the Bernie Madoff scandal. The disgraced hedge fund manager was arrested December 11, 2008 by federal agents on charges of securities fraud for scamming $50 billion from investors. Meanwhile, the Securities and Exchange Commission (SEC), the supposed protector of investors and their investments, apparently turned a blind eye to Madoff’s subterfuge over the years by ignoring red flags that signaled problems with his funds and their “too-good-to-be-true” returns.

Confidence in Wall Street was ultimately lost, with the enormity of the Madoff scandal, and the failure of government officials to step in before it was too late. Subsequently, investors and Wall Street will forever be scarred from a year that was punctuated by the subprime crisis and corporate scandals – including the implosion of Bear Stearns, the collapse of the auction rate securities market, the bankruptcy of Lehman Brothers and inept accounting practices by Fannie Mae and Freddie Mac and other institutions.

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