Use caution with auction rate certificates
Kansas City Star
Be wary of brokers and bankers touting can’t-lose investments that turn out to be anything but.
That’s the hard lesson learned by thousands of consumers just now finding their savings are irretrievably stuck in something called auction rate certificates, or ARCs.
They were told the obscure investments were as safe and liquid as money markets, T-bills and CDs, but with bigger returns. Now they’re wondering if they’ll ever seen their money again.
We’re talking lots of money – $330 billion to be exact – much of it not even earning interest. This could be the next big shoe to drop on an already stumbling economy.
“It’s a huge problem,” said Philip M. Aidikoff, past president of the Public Investors Arbitration Bar Association, one of dozens of lawyers hearing from desperate consumers.
Missouri is one of nine states that are part of a regulatory task force now investigating whether consumers got duped.
Once again you can thank in part big Wall Street brokerage houses that helped turn the subprime mess into a national calamity by slicing up high-risk loans and selling them like securities.
Auction rate certificates are basically long-term bonds of 20 to 30 years. They’re issued by municipalities and institutions, including hospitals and state student loan agencies.
But they are sold as short-term investments at weekly or monthly “auctions,” where investors can sell certificates they own or buy more, depending on the prices set at the auctions.
Many consumers were sold ARCs through their local bank. Because of the frequent auctions, the banks touted ARCs as being safe and liquid. And customers could squeeze a little more out of their investment.
For instance, a money market might return 3.5 percent in interest, while an ARC might return 4 percent.
Couples used ARCs as a way to save up for taxes or to buy a house. Congregations relied on them to save contributions to remodel their churches. Small businesses invested their payrolls.
But the promise of liquidity proved fleeting – and illusory. In reality, the auctions were little more than some big Wall Street banks getting together and trading paper, officials say.
Sales “depended on a few banks trading these investments back and forth,” said Kansas City investment attorney Diane Nygaard. Without the banks propping them up, there could be no auctions.
So when Wall Street experienced its own liquidity problems in 2007, the big brokerage banks began pulling out of the auctions.
Some auctions failed last fall. But most failed in February, when consumers started receiving letters saying, in essence, oops, your money is no longer available to you – at least not for 20 to 30 years.
And by the way, your account is losing value and your interest has dropped, too.
Some lucky consumers were able to sell off their ARCs. But attorneys and experts estimate that, with the auctions now all but dead, 50 to 80 percent of consumers are stuck.
Some Kansas City customers have seen interest rates on their ARCs fall from 4.78 percent to a flat zero. As the accounts lose value, some banks are even assessing customers a custodial fee.
So, should brokers and bankers have known better? There’s evidence to think so.
Back in May 2006, the Securities and Exchange Commission alleged that 14 brokerage firms had added capital to hide risks that the auctions could freeze up. The firms paid $13 million in fines, without admitting wrongdoing. Indeed, even as the auctions began failing last year, banks sent promotional letters to customers touting ARCs as “ultra high quality investments” for “your liquid funds.”
A secondary market has started to develop to buy ARCs from consumers – but at 50 to 80 cents on the dollar.
Consumers also have the option of suing or seeking redress through arbitration proceedings, experts say. There are already a couple of class-action lawsuits brewing. Congress is sure to notice, too.
Rest assured there is more to this story.