A Freeze in Auction-Rate Securities Opens a Door for the Restricted Securities Trading Network
One of the casualties of the credit crisis has been the collapse of the auction-rate securities market, an obscure sector of the debt market that was used by municipalities, schools and closed-end mutual funds to raise money. With an estimated $330 billion in outstanding obligations, auction-rate securities (ARSs) essentially are long-term debt instruments that pay short-term rates and that were sold by Wall Street to corporations and wealthy individual investors.
"This was a product that was sold as a cash equivalent," says Barry Silbert, chief executive of New York-based Restricted Stock Partners (RSP), which operates the Restricted Securities Trading Network, an electronic marketplace built for trading illiquid securities. In the wake of failed auctions, the company recently developed a secondary market for ARSs that links investors who want to sell the instruments with hedge funds and institutions that are buying distressed securities.
Before the credit problems erupted, brokers and big banks conducted periodic auctions on a daily, weekly or monthly basis, at which point the interest rates for the ARSs were reset. "If you held these [auction-rate securities], you could decide to get in or out based on the interest rate it was paying," explains Silbert.
In mid-February, however, the auctions started to fail because there was not enough investor demand for the securities that were being sold. Previously, the auctions provided an ample market for investors to buy or sell the ARSs, and the banks would step in and support the auctions by buying whatever excess securities could not be sold. But, "Given the issues with the credit markets, the banks couldn't continue buying these securities and putting them on their balance sheets," relates Silbert.
A Lack of Support
During the week of Feb. 15, 2008, all of the big investment banks — including the likes of Goldman Sachs, Merrill Lynch and UBS — stopped supporting the auctions, according to Silbert. Anywhere between 60 percent and 80 percent of the auctions failed, he contends. As a result, issuers had to pay higher interest rates to compensate for the lack of liquidity, and investors became trapped — they could not sell their securities.
Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio
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