A number of corporations bought auction rate securities with their excess cash. They believed that since the instruments offered better yield than many market funds, they would be good for balance sheet management. They also thought that since auction-rate paper had been liquid and widely traded since 1985 that moving in and out of the market would be simple.
It was simple until it wasn’t.
The investment banks and money center banks which made the market in these instruments pulled out at the beginning of the credit crisis. They did not want to keep risking their own capital to buy the paper and hold it to keep the market trading. Traditionally what wasn’t bought at one auction was picked up by banks and held until the next round of trading. In essence, huge financial firms kept the market trading by underwriting the system in exchange for big commissions.
A new study shows that financial executives at companies which bought the securities would make sure they kept their value even if the market broke down. According to the FT, “More than 85 per cent of companies that invested in the collapsed market for auction-rate securities thought Wall Street banks would provide support during crises.” The results are from a survey by the Association for Financial Professionals.
What companies which bought into the market didn’t do was read the fine print in their sales agreements. The guarantees which they thought the banks provided simply weren’t there.
It is hard to believe that sophisticated CFOs and treasurers at big companies could be taken in. But as they say, a sucker and his money are soon parted.
Douglas A. McIntyre is an editor at 247wallst.com.
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