The auction-rate securities fiasco

Published on Online Journal, by Peter Morici, Feb 29, 2008.

I don’t know how Broadway sells tickets these days when folly is in so plain array on Wall Street. Auction-rate securities drama provides the latest tale of greed and betrayal.

Investors are stuck with big losses, because investment banks miscalculated their own risks and are putting it to their clients, again.

Municipalities and public agencies, like the New York Dormitory Authority, require long-term financing for big projects …

… Rather than taking possession of unsold securities, bankers told investors their liquid investments are temporarily frozen and will be paid the lower penalty rates issuers are bound to pay if the market doesn?t clear.

Now, many investment banks are pulling back or withdrawing from the market.


These actions essentially shift interest rate risk and big losses on the bonds from the investment banks back on to the private investors and corporations who trusted them. Meanwhile, public agencies are stuck with debt they can?t move and excessive borrowing costs.

The banks did not provide market-making and underwriting services for free. They were paid generous fees and engineers received bonuses in the millions. By presenting these securities to investors as liquid they were insuring investors against interest rate risk – at least investors thought they were.

Once again, investment banks have betrayed their clients by failing in their obligations and responsibilities. (full text).

(Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission).

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