Within the past month, Merrill Lynch, Citigroup, and Wachovia (among other major Wall Street firms) have agreed to buy back auction-rate securities ("ARS") at face value as part of settlements with the SEC and state regulators. These investment banks, which underwrote the securities and built the house of cards, are largely to blame for February's ARS debacle.
This is obviously great news, not only for the banks' brokerage customers (who are stuck with illiquid securites worth less than face value) but also for the banks' registered representatives. Many of these representatives did not realize that they were selling snake oil and were facing angry customers and arbitration actions. I had expected the banks to hang their representatives out to dry in the arbitration proceedings.
On the other hand, it is bad news for the investment banks; they are now facing billions in ARS write-downs on top of billions in write-downs relating to other structured securities on their books. I imagine that their stock prices will continue to slide. (It is also bad news for the class-action plaintiffs' firms that are pursuing ARS cases against the investment banks -- they appear to have bet on the wrong horses.)
The settlements with the investment banks will solve only part of the problem: the buy-backs that will result from these settlements account for less than half the ARS market. It will be interesting to see what happens with respect to the brokerage firms that played no role in underwriting the securities or in running the auctions but that falsely marketed these securities to customers as money market equivalents. Unless they agree to buy back ARS from their customers, these firms will continue to face scrutiny from the SEC and state regulators. And brokerage customers will continue to file arbitration actions so long as their ARS remain illiquid.
Posted by Paul Malmfeldt on August 18, 2008.
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