Auction Rate Preferred : The Bail Out

by | Aug 9, 2008 | Asset Management

In one of my most recent posts I discussed the “ready to explode” product issued by brokerage firms called “auction rate preferred securities.”

Well, that didn’t take long.

In this past week UBS (the parent company of PaineWebber), announced they are spending $19 billion (yes, billion with a B) to buy back auction rate preferred securities their brokers had sold to their clients. Citigroup (which owns Smith Barney), announced they are doing the same — for $7.5 billion. Merrill Lynch announced that they will buy back $10 billion of these securities sold by their brokers over the next few months.

That is $36 billion these brokerage firms have whipped out their checkbooks for… and we haven’t even heard from Wachovia or Morgan Stanley yet!

Understand that the auction rate preferred market is a $300 billion market. It’s a lot bigger than people realize. And it’s been around longer than most people know. I went on sales calls in the 1980s and marketed these investments as alternatives to commercial paper to universities and small publicly traded corporations.

So everyone is feeling the heat from these brokers walking away from this market… individuals can’t get out of these investments, which were sold to them as money market alternatives. Some publicly traded corporations have had to show losses on their books along with anyone else who listened to their broker and used these products as an alternative to short-term investments like treasury bills and commercial paper.

One of the best questions you can ask whenever considering an investment you are unfamiliar with, is this: “OK, sounds good. Now how do we get out of these things?”

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