Harry Newton's In Search of The Perfect Investment
Newton's In Search Of The Perfect Investment. Technology Investor.
8:30 AM EST Wednesday, February 27, 2008: Auction
Rate Preferred Auction Failures (Cont'd). I start with these words because
this column needs to appear on more search engines.
sum the story up: There are $60 billion of auction rate preferred securities
around. These securities were sold by brokers as cash or cash equivalents --
safe places to tuck your short-term money away for a week or a month. More importantly,
they were also sold by the issuers -- Nuveen, Eaton Vance, BlackRock, Pimco,
Gabelli, Van Kampen, etc. -- as cash or cash equivalents.
you needed your money, you simply put your securities up for auction and bingo
you received 100% of your money back. The only auction part of this system was
the interest rate you would receive for another 7 or 28 days. It varied, depending
on what short-term rates were doing at that time. The system worked because
a number of auction makers, like Citibank, Goldman, Morgans, Wachovia, Merrill
Lynch, Lehman Brothers, UBS Paine Webber and Bank of America, etc. always bought
the securities no one else wanted. They paid for them with their own money,
took them onto their balance sheet and tried to sell them at the following auction,
system worked fairly well for 20+years. But then two weeks ago, Citibank decided
it no longer wanted to buy the ARS paper that didn't sell. The reason? It probably
came to the conclusion that it simply didn't have enough capital -- what with
the mess that sub-prime and other dumb bad investments had done to its capital.
That caused everyone else say to themselves, "We are not legally obligated
to support this market. Let's pull out." Once the banks had pulled out,
the auctions started failing... and of course, at that point nobody wanted to
buy these securities since it was evident that they were unsellable. If you
bought them you were stuck with them.
that's where we stand today. Thousands of investors -- individuals and corporations
-- holding $60 billion of securities they can't sell. This is a massive disaster,
with huge legal implications. Fact is all these investors were sold these securities
as cash or cash equivalents by brokers, such as Deutsche Bank, Wachovia, Citibank
Smith Barney, Merill Lynch, UBS, and hundreds of small brokerage firms all over
the country. Fact is these investors were basically sold a dud investment. These
securities at present have no market, hence no value. For investors who have
their April 15 tax payments (or other upcoming payments, like a new house or
a new business) sitting in these things, this represents a huge financial disaster.
brokerage companies have, however, offered to loan these investors money against
these securities. I have been offered a loan against my securities. And the
rates I'm hearing on these loans are, in some cases, actually less than what
these securities are currently paying. My securities are now slightly over 4.2%
triple tax-free. The problem with this "deal" is that you never know
what rate your ARS will re-set to. It may be less than what you have to pay
your lender. And so far, I haven't seen the terms of these loans.
forward to last night. Nuveen, one of the largest issues of auction rate preferreds,
held a conference call "to discuss
topics related to Nuveen closed-end fund preferred shares."
You can listen to a replay. Call 1-888-266-2081 and enter conference access
code 1207768. The call replay will be available through March 4, 2008.
I believe this
was the first conference call devoted to auction rate preferreds. Over 2,000
people were on it -- the largest by far I've ever been on.
You won't learn
much from listening to the conference call. Nuveen management has no solution,
no timeframe and basically zero sympathy for the fools (me included) who bought
its auction rate preferred securities.
There are many
solutions to giving fools like me the ability to sell or redeem our shares.
The easiest is called de-leveraging It means selling bonds in the fund and buying
our securities back with the proceeds. Another way is to change the fund from
a closed-end fund to an open-ended fund -- like a mutual fund. This was allow
us to cash our securities in at the end of a day, as we do with mutual funds.
There are impediments
to this -- the major one being the greed and arrogance of Nuveen management.
Nuveen management gets paid a management fee on the total assets (i.e. all the
bonds) holds. If it sold some to pay you and me off, it would earn less money.
One caller actually asked if Nuveen management had considered foregoing management
fees until this disaster is resolved. And the answer was a resounding, "NO."
It was the only question that actually got a definitive answer. Everything else
was met by a resounding, "We understand your pain. We're working on a solution.
We have no idea what that solution might be -- if there ever is a solution.
And we don't know when that (undefined) solution might happen."
The call gave
arrogance a whole new meaning. My favorite part of it was the fact that Nuveen
scheduled only one hour for the call. They took a few questions from brokers
-- none from private investors (and none from me), said "thank you and
My money management
friends who are much smarter than I am, explained to me, "Harry, Nuveen
management has a major incentive to do absolutely nothing. They have your money.
It's cheap money. They have your cheap money forever. And they're going to keep
In the old days
when I ran a company and a customer complained, the first thing I would do would
be to solve the customer's problem. If it meant taking money out of my own pocket,
I'd do that. Customers are king. Customers are all I had. I wouldn't wait two
weeks. I wouldn't hold a conference call and say nothing. But Nuveen management
obviously doesn't feel that.
The only solution
to this is noise. We need to make lots of it. We need to bring major pressure
on the brokers who sold us this garbage and they, in turn, need to put pressure
on Nuveen management to solve this. I'm collecting names of owners of these
securities. Send me an email. We need to talk. This requires many brains. Send
me an email. I treat everything confidentially. Remember I have $4.5 million
of Nuveen securities. I have a major incentive to put pressure to solve this.
And Nuveen actually does have a major incentive to solve this -- if they don't,
nobody will ever deal with Nuveen ever again. But getting their management to
understand this seems a major task. As of last night's call, they still hadn't
Remember all my
articles about "Mattress Cash?" Please read this. It's from today's
Wall Street Journal, page D4.
a 'Safe' Investment Are Found Out the Hard Way
By JAMES B. STEWART
February 27, 2008; Page D4
They were sold
as a liquid, safe, slightly higher-yielding, tax-exempt alternative to money-market
funds. I should know, since I bought some. For several years I've been parking
a good part of my cash in auction-rate preferred shares.
These are typically
shares of a closed-end fund that used the proceeds to buy triple-A-rated securities.
(In my case, municipal bonds.) There was virtually no interest-rate risk since
the rate was set at frequent auctions of the shares. My shares were issued
by BlackRock, the asset-management firm almost half-owned by Merrill Lynch;
many other firms also sold the securities. When I needed cash, I simply redeemed
shares, as I did last month when I took advantage of the market downturn to
Last week, when
I read that some tax-exempt entities, even the Metropolitan Museum of Art,
were suddenly paying exorbitant rates because of "failed" auctions
for municipal bonds, I didn't suspect this would have any immediate impact
on me. I heard nothing from Merrill Lynch, which sold me the ARPS. My account
statement continues to show the shares at full face value.
I became more
concerned as news reports of failed auctions continued last week. Finally,
I called a broker to ask about the status of my ARPS. I learned that recent
auctions of these preferred shares have indeed failed, which means there were
no buyers at rates acceptable to the sellers. The market has virtually collapsed.
There is no guarantee the shares can be sold. Indeed, it's highly unlikely
they can be. What was a ready source of cash is now essentially frozen.
Last year, when
some money-market funds turned out to hold some mortgage-backed securities
and faced a liquidity crisis, their sponsors stepped in and redeemed the shares
at face value. This seemed the only decent course, not to mention a good investment
in customer loyalty.
But when I asked
a broker at Merrill Lynch if it would do the same for owners of these money-market
equivalents, the answer was "no" -- not after the multibillion-dollar
write-offs Merrill has taken on illiquid assets. Merrill Lynch and the other
big banks that sold these shares have stopped making a market in them, which
is a major reason the auctions have failed.
when asked for comment, told me: "We are offering our clients loans which
can give them liquidity." It wasn't yet clear whether these would be
interest-free loans, which they certainly should be, in my opinion.
on its Web site that "We do not see any issues with the financial health
or fundamentals of these funds as a result of the failed auctions." The
firm also said it "continues to closely monitor developments in the ARPS
The amount of
auction-rate preferred shares outstanding is massive -- an estimated $330
billion. Many firms besides Merrill Lynch sold the shares. Fortunately, I
have no immediate need for the cash. But given that these securities were
marketed as money-market alternatives, I'm sure that there are plenty of people
who do, and will be in for a rude shock when they try to redeem them.
I hope that
this will be a temporary paralysis and the market will come to its senses.
These securities still carry a triple-A rating. None of the underlying bonds
have defaulted. Interest is still being paid, at a slightly higher rate than
In my view,
any failure of the big banks to honor what is at least a moral commitment
to the people to whom they sold these shares is appalling. At least two states
are investigating, and I would expect them to be joined by the Securities
and Exchange Commission.
So is any fixed-income
security short of U.S. Treasurys and the biggest, most liquid money-market
funds safe at this point? I'd like to think so, but if you own any securities
that depend on investor confidence or raise any liquidity issues, be aware
of the risks.
As I've mentioned
before, creeping contagion in capital markets are seriously hurting the economy
(and in turn, I believe the stockmarket, whose prospects I continue to not like),
read this piece from Bloombergs:
'Brilliant' Fed Vision Evokes Investors' Frustration
By Craig Torres
Feb. 27 (Bloomberg)
-- In the second week of August, the short-term fixed-income sales team at
JPMorgan Securities Inc. sat stunned as the trillion-dollar market for asset-backed
commercial paper began to collapse.
In normal markets,
JPMorgan sells $25 billion of short-term IOUs for clients daily. "Within
the span of six or seven business days, every single investor stopped buying
asset-backed commercial paper tied to structured investment vehicles,'' said
John Kodweis, a managing director at the New York bank.
How the Federal
Reserve has responded to that credit debacle -- the worst since the savings
and loan crisis of the early 1990s -- defines Chairman Ben S. Bernanke's
reshaping of the world's most important central bank.
With its focus
on building consensus around long-term goals and attempts to separate liquidity
from broader monetary policy, Bernanke's approach evokes appreciation among
some economists. He's also caused frustration among traders trying to discern
walked into a job that I can best describe as trial by fire,'' said Allen
Sinai, president of New York- based Decision Economics Inc. Separating interest-rate
policy from liquidity tools was "absolutely brilliant,'' he said.
his failure to quickly recognize the economic impact of the market tumult
exacerbated the slowdown and meant that when the Fed began cutting rates,
reductions needed to be deeper and faster.
to be democratic in a crisis when leadership and image are so key,'' said
Karl Haeling, head of strategic debt distribution in New York at Landesbank
Baden-Wuerttemberg, Germany's fourth-largest bank. "The Fed seemed awfully
smug until August that this subprime issue was not a big issue. Then, they
had to come out with both barrels blasting.''
Fed chairman will give his semi-annual testimony to the House Financial Services
Committee today. His remarks will likely deal with risks to growth, while
underscoring that inflation remains a threat.
In August, Bernanke
defied traders' predictions of an immediate cut in the federal funds rate,
which affects borrowing costs for consumers and businesses. Instead, as credit
dried up, he responded with a $35 billion cash injection into banks Aug. 10.
Seven days later, he lowered the cost for banks to borrow directly from the
a month before lowering the federal funds rate. Even then, they said "inflation
risks remain,'' leading some on Wall Street to complain Bernanke was out of
on their message in the first five months,'' said Vincent Reinhart, former
director of the Fed's Division of Monetary Affairs. "They weren't willing
to emphasize why, or how they arrived at that inflation risk.''
economy continued to weaken.
delinquencies rose to a 20-year high in the third quarter, Fed officials cut
the federal funds rate just a quarter-point in October and said they thought
inflation risks "roughly balance'' risks to growth. Coming after a half-point
cut the previous month, the October action was seen by economists including
Stephen Stanley as a signal that policy makers thought they had eased credit
enough to sustain the economic expansion.
kind of scares me that the Fed had no idea things were going to get worse,''
said Stanley, chief economist at RBS Greenwich Capital Markets Inc., and a
former member of the Richmond Fed staff. "They were totally blindsided
by the deterioration in liquidity conditions after the October meeting.''
investors were expecting some promise of year-end liquidity following the
Federal Open Market Committee's meeting on Dec. 11. They didn't get one. Instead,
policy makers again cut the benchmark rate a quarter point and maintained
their view that "some inflation risks remain.''
their disappointment, driving the Dow Jones Industrial Average down 2.1 percent.
Markets were setting up for a panic.
The Fed again
surprised Wall Street the following morning, announcing that the central bank
would loan as much as $40 billion for 28 days through a facility that would
let banks borrow directly from the Fed.
The Fed also
arranged swap lines with the European Central Bank and the Swiss National
Bank, allowing them to channel dollars into their markets.
The Fed's response
to the credit squeeze "wasn't handled with the aplomb you would have
liked,'' said E. Craig Coats Jr., co-head of fixed income at Keefe Bruyette
& Woods Inc. in New York. Still, "it was actually pretty creative,
and I give them credit for trying.''
Only after Fed
officials saw the potential for higher unemployment and indicators such as
retail sales declining did they have confidence that inflation risks were
subsiding. They then cut the benchmark rate 1.25 percentage points in nine
days in January, the fastest reduction in two decades.
of keeping policy trained on a medium-term forecast while flooding the banking
system with short-term cash shows how the chairman has adopted some of the
discipline of inflation-targeting central banks in the United Kingdom and
banking is not a matter of magic touch,'' said Doug Elmendorf, a senior fellow
at the Brookings Institution in Washington, and a former Fed staff economist
under both Bernanke and former chairman Alan Greenspan. "It is a matter
of doing something systematically right.''
system also includes changes in governance and communication. Bernanke persuaded
fellow members of the Federal Open Market Committee to publish their projections
four times a year instead of two, and stretch out to a third year. The exercise
transformed the undefined preferences of Greenspan into numeric priorities
of an institution.
last in policy meetings, unlike Greenspan who argued his policy choice first.
Bernanke calls it "depersonalization.''"
It is commendable
that they are implementing these changes in the midst of the most challenging
environment for central banks in decades,'' said Angel Ubide, director of
global economics in Washington at Tudor Investment Corp., a hedge fund.
work on the Great Depression also came into play as he retooled the Fed's
function as lender of last resort to grapple with what NYU economist Nouriel
Roubini calls "the first crisis of financial globalization and securitization.''
Instead of bank
depositors fleeing banks, as in the Depression, it was commercial paper investors
who wanted safety. These investors were running from off-balance-sheet structured
investment vehicles, which have some features of banks with none of the backstops.
how the normal din of ringing phones fell quiet inside JPMorgan's mid-town
Manhattan trading room as credit markets dried up in early August. "It
was frightening at times,'' he said. "It took longer to sell commercial
paper, it was later in the day when we were done, and maturities were increasingly
The rush by
money market funds to securities not tied to mortgages or consumers created
new problems for the Fed.
On Aug. 20,
the three-month Treasury bill yield declined 0.66 percentage point in one
day to 3.09 percent, the biggest fall in two decades, in a stampede to safety.
On Aug. 21,
Bernanke, who had been holding twice-daily conference calls with the New York
Fed, reached for another tool. The New York bank halved the fee for dealers
borrowing securities from the central bank's portfolio.
Fed officials faced a new challenge. "Banks wouldn't lend to each other,''
said Haeling. "There was enough liquidity in the system. The trouble
was it wasn't getting to the right places.''
The price of
three-month interbank dollar loans in London rose to an average 60 basis points
over the federal funds rate in November, from 10 basis points in January to
the Fed had auctioned $130 billion in term reserves. The Libor to federal
funds rate spread fell back.
Now, Fed officials
have said they are considering making the facility permanent.
creative intelligent things about the banking problem. He recognized that
a central bank has two concerns -- the financial problem and the macroeconomic
problem,'' said Allan Meltzer, a Fed historian and Carnegie Mellon University
economist. "He acted appropriately.''
do I think this is funny?
Ralph returns from the doctor and tells his wife that the doctor
has told him he has only 24 hours to live.
Given this prognosis,
Ralph asks his wife for sex. Naturally, she agrees, and they make love.
About six hours
later, the husband goes to his wife and says, "Honey, you know I now have
only 18 hours to live. Could we please do it one more time?" Of course,
the wife agrees and they do it again.
Later, as the
man gets into bed, he looks at his watch and realizes he now has only 8 hours
left. He touches his wife's shoulder and asks, "Honey, please... just one
more time before I die ?" she says, "Of course, dear." And they
make love for the third time.
After this session,
the wife rolls over & falls asleep. Ralph, however, worried about his impending
death, tosses & turns until he's down to 4 more hours. He taps his wife,
who rouses. "Honey, I have only 4 more hours. Do you think we could...?"
At this point
the wife rolls over and says, "Listen Ralph, I have to get up in the morning...
This column is about my personal search for the perfect
investment. I don't give investment advice. For that you have to be registered
with regulatory authorities, which I am not. I am a reporter and an investor.
I make my daily column -- Monday through Friday -- freely available for three
reasons: Writing is good for sorting things out in my brain. Second, the column
is research for a book I'm writing called "In Search of the Perfect
Investment." Third, I encourage my readers to send me their ideas,
concerns and experiences. That way we can all learn together. My email address
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