Huge Wall St settlement for Auction Rate Securities "Victims" Friday, August 08, 2008
Image via WikipediaAccounting to the FT,
Citigroup is to buy $7.5bn worth of ARS from retail investors in the next three months while Merrill Lynch announced that it would buy back ARS it sold to investors starting next year. There are currently $12bn of such holdings but Merrill said it expected there would be $10bn by the time it begins its buy-back. Meanwhile, UBS was on Thursday night close to finalising the details of its own deal with regulators.
Apparently Citi also has to pay a $100m fine to settle claims from regulators that it had misrepresented ARS as liquid, cash-like securities.
I previously wrote about the ARS market here.
These are staggering deals, imposed by the regulator to "protect" Main Street from being financially injured.
Prior to markets seizing up, ARS markets were indeed very liquid and paid higher returns to investors than bank deposits, with rates set through an auction clearing process. To my knowledge, relatively few investors suffered any capital losses since the lenders remained solvent. What disappeared was the liquidity that enabled people to release cash by selling their holdings i.e. buyers simply disappeared regardless of rates on offer. Lenders, as a consequence of being unable to refinance elsewhere, were also unable to buy back the securities despite the punitive rates many of them were obliged to pay under the terms of the securities.
The penalities / settlement redresses two issues
1) Wall Street brokers failed to alert people to the fact that the markets were becoming increasingly illiquid i.e. negligent in their duty to clients. Obviously had they done so, that would have simply accelerated the collapse in such markets.
2) The banks themselves took advantage of clients by offloading increasingly illiquid stock onto them, prompted by internal risk concerns, whilst maintaining their stance that there were no problems.
What is most disturbing about this episode is that an efficient cash market and the related instrument has been irreputably harmed to the detriment of future borrowers and lenders alike.